UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended December 31, 2004

[  ] Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from _____ to _____

 Commission File Number 1-10869

                   UQM TECHNOLOGIES, INC.               

(Exact name of registrant as specified in its charter)

        7501 Miller Drive, Frederick, Colorado 80530       

(Address of principal executive offices) (Zip code),

                              (303) 278-2002                                

(Registrant’s telephone number, including area code)

 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X   No       

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)

Yes        No   X  

The number of shares outstanding (including shares held by affiliates) of the registrant’s common stock, par value $0.01 per share at January 24, 2005 was 23,175,829.

TABLE OF CONTENTS

ITEM 1: FINANCIAL STATEMENTS

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets, Continued

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations (unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (unaudited)

Non-Cash Investing and Financing Transactions:

During the nine months ended December 31, 2004, we retired property and equipment with an original cost of $88,870 and accumulated depreciation of $88,538.

See accompanying notes to consolidated financial statements.

 

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

Our raw material inventory is subject to obsolescence and potential impairment due to bulk purchases in excess of customers’ requirements. We periodically assess our inventory for recovery of its carrying value based on available information, expectations and estimates and adjust inventory-carrying values to the lower of cost or market for estimated declines in the realizable value of our inventories.

 

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

In January 2004, we announced our intention to exit our contract electronics manufacturing business whose operations were reported as the electronic products segment. For all periods presented, we have reclassified operating results of the electronic products segment to loss from operations of discontinued electronic products segment. All segment assets were reclassified to the balance sheet caption "assets of discontinued operations", all segment liabilities other than long-term estimated future lease obligation were reclassified under the caption "liabilities and commitments of discontinued operations" and long-term estimated future lease obligations were reclassified under the caption "long-term portion of accrued lease obligations. During the fiscal first quarter we completed the divestiture of the assets of this business for $895,000, net of legal expenses, in cash and a 15 percent ownership interest in the purchaser. In our judgment there is doubt regarding our ability in the future to sell or otherwise liquidate the common stock of the purchasing entity, and accordingly, we recorded the stock at no value as

 

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

At December 31, 2004, we have two reportable segments: technology and mechanical products. The technology segment encompasses our technology-based operations including core research to advance our technology, application and production engineering and product development and job shop production of prototype components. The mechanical products segment encompasses the manufacture and sale of permanent magnet motors and electronic controllers. Salaries of the executive officers and corporate general and administrative expense are allocated to our segments annually based on a variety of factors. The percentage allocated to the technology segment and mechanical products segment were 93 percent and 7 percent for the quarter and nine months ended December 31, 2004, and were 67 percent and 33 percent for the quarter and nine months ended December 31, 2003, respectively.

Intersegment sales or transfers, which were eliminated upon consolidation, were nil and $28,917 for the quarters ended December 31, 2004 and 2003, respectively, and $152,250 and $78,541 for the nine months ended December 31, 2004 and 2003, respectively.

The technology segment leases office, production and laboratory space in a building owned by the mechanical products segment, based on a negotiated rate for the square footage occupied. Intercompany lease payments, were $44,085 and $43,105 for the quarters ended December 31, 2004 and 2003, respectively, and $132,255 and $125,397 for the nine months ended December 31, 2004 and 2003, respectively, and were eliminated upon consolidation.

Our reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different business strategies.

 

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

Rent expense, net of sublease payments, under these leases was $3,941 and $68,459 for the quarters ended December 31, 2004 and 2003, respectively, and $23,625 and $206,910 for the nine months ended December 31, 2004 and 2003, respectively.

Litigation

We have previously reported a claim against us by Hussmann Corporation filed in the Circuit Court of St. Charles County, Missouri. On December 17, 2004, the Court in this action dismissed with prejudice all of the plaintiff’s claims against us. On January 19, 2005, Hussmann filed a notice of appeal seeking review of the dismissal with the Missouri Court of Appeals. We intend to file an answer to the appeal and believe that Hussmann’s claims are without merit and we intend to contest them vigorously. Nevertheless, we cannot assure you that the Hussmann action will not be reinstated in the event the Hussmann appeal is successful.

In addition, we are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, and based on current available information, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial position, results of operations or cash flow, although there can be no assurance that adverse developments in these matters could not have a material impact on a future reporting period.

 

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements, Continued

(unaudited)

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" ("SFAS 151"), which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. SFAS 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We are evaluating the impact of this standard on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary Assets-an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions ("SFAS 153"), which replaces the exception permitting non-monetary exchanges of similar productive assets from measurement based on the fair value of the assets exchanged with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS 153 shall be effective for non-monetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. We are evaluating the impact of this statement on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based Payment" ("SFAS 123R"). SFAS 123R addresses all forms of share-based payment ("SBP") awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123R will require us to expense SBP awards as compensation cost based on the fair value of the SBP on the date of issuance. SFAS 123R requires us to adopt the new accounting provisions beginning in the second quarter of fiscal year 2006. We are evaluating the impact of this standard on our consolidated financial statements.

This Report contains statements that constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. These statements appear in a number of places in this Report and include statements regarding our plans, beliefs or current expectations, including those plans, beliefs and expectations of our officers and directors with respect to, among other things the development of markets for our products; the adequacy of our cash balances and liquidity to meet future operating needs, and our ability to issue equity or debt securities; and the effect of legal actions and claims that we are involved in. Important Risk Factors that could cause actual results to differ from those contained in the forward-looking statements are listed below in Part II, Item 5 Other Information.

Financial Condition

Cash and cash equivalents at December 31, 2004 were $7,530,856 and working capital (the excess of current assets over current liabilities) was $9,191,599 compared with $2,958,590 and $3,972,559, respectively, at March 31, 2004. The increase in cash and cash equivalents and working capital is primarily attributable to the proceeds from the Company’s follow-on offering of common stock completed in November 2004, which resulted in cash proceeds, net of the offering costs, of $6,767,596.

Short-term investments increased to $1,024,669 at December 31, 2004 from $47,119 at March 31, 2004 reflecting purchases of investment securities with original maturity dates greater than three months.

Accounts receivable increased $276,935 to $789,930 at December 31, 2004 from $512,995 at March 31, 2004. The increase is primarily attributable to higher product sales revenue levels and slower collections during the quarter ended December 31, 2004.

Costs and estimated earnings on uncompleted contracts increased $153,736 to $399,720 at December 31, 2004 versus $245,984 at March 31, 2004. The increase is due to less favorable billing terms on contracts in process at December 31, 2004. Estimated earnings on contracts in process declined to $224,560 or 7.3 percent of contracts in process of $3,071,404 at December 31, 2004 compared to estimated earnings on contracts in process of $305,943 or 12.2 percent of contracts in process of $2,500,059 at March 31, 2004. The decrease in estimated margins on contracts in process is attributable to anticipated cost overruns on certain engineering projects.

Inventories increased $313,536 to $741,974 principally due to higher levels of raw material, work-in process and finished goods inventories which increased $301,746, $5,422 and $6,368, respectively. The increase in raw materials inventories is attributable to higher stocking levels of certain products under bulk purchase commitments. The increases in work-in-process and finished goods inventories are attributable to higher production levels for low volume motors and controllers that will be shipped in future periods.

Prepaid expenses increased to $145,825 at December 31, 2004 from $72,649 at March 31, 2004 primarily reflecting the prepayment of insurance premium costs on our commercial insurance coverages.

Assets of discontinued operations was nil at December 31, 2004 compared to $1,226,943 at March 31, 2004 due to the completion of the divestiture of the equipment and inventory of our electronic products segment and the subsequent cessation of operations during the first fiscal quarter. See also note 8 to the consolidated financial statements above.

We invested $82,614 for the acquisition of property and equipment during the first nine months of the fiscal year compared to $107,204 for the comparable nine months last year. The decrease in capital expenditures is primarily due to lower capital spending by the technology segment.

Accounts payable increased to $721,506 at December 31, 2004 from $392,474 at March 31, 2004, primarily due to increased purchases of raw material inventory.

Other current liabilities increased $17,359 to $275,617 at December 31, 2004 from $258,258 at March 31, 2004. The increase is primarily attributable to higher levels of accrued personal property and real estate taxes, and customer deposits.

Liabilities and commitments of discontinued operations was $148,744 at December 31, 2004 compared to $554,564 at March 31, 2004. The decrease was due to the completion of the divestiture of the equipment and inventory of our electronic products segment and the subsequent cessation of operations during the first fiscal quarter. The balance represents accrued legal fees associated with the Hussmann litigation, see also note 11 to the consolidated financial statements above, and the current portion of the accrued lease obligations reflecting the estimated obligation for future lease payments on subleased facilities of our discontinued electronic products segment. We completed a sublease with the purchaser of the assets of this discontinued segment for the remaining term of our lease. However, we are the primary obligor on the lease and due to doubt regarding the sublessee’s financial capability to meet its obligation under the sublease, we have recorded the foregoing accrued lease obligation which is our estimate of the amount which will not be recoverable under the sublease agreement. See also note 8 to the consolidated financial statements above.

Billings in excess of costs and estimated earnings on uncompleted contracts decreased $28,063 to $161,189 at December 31, 2004 from $189,252 at March 31, 2004 reflecting reduced levels of billings on engineering contracts at a rate faster than the performance of the associated work during the first nine months of the fiscal year versus the same period last year.

Long-term debt, less current portion decreased $101,991 to $844,432 at December 31, 2004 from $946,423 at March 31, 2004 reflecting principal repayments on the mortgage debt for our Frederick, Colorado facility.

Long-term accrued lease obligation was $70,745 at December 31, 2004 compared to $192,118 at March 31, 2004, reflecting the estimated obligation for future lease payments on subleased facilities of our discontinued electronic products segment. See also note 8 to the consolidated financial statements above.

Common stock and additional paid-in capital increased to $231,748 and $64,762,728, respectively, at December 31, 2004 compared to $195,726 and $58,025,631 at March 31, 2004. The increases were primarily attributable to completion of a follow-on offering of 3,600,000 shares of common stock to investors in North America and Europe. Net cash proceeds to the Company from the offering were $6,767,596.

Results of Continuing Operations

Continuing operations for the quarter ended December 31, 2004 resulted in a loss of $367,172 or $0.02 per common share on total revenue of $1,307,583 compared to a loss from continuing operations of $260,552 or $0.02 per common share on total revenue of $1,187,181 for the comparable quarter last year. Operations for the third quarter resulted in a net loss of $392,980 or $0.02 per common share versus a net loss of $1,511,768 or $0.08 per common share for the third quarter last year.

Revenue from contract services declined $271,887 or 31.2 percent to $598,323 for the third quarter of fiscal 2005 compared to $870,210 for the comparable quarter last year. The decrease is primarily attributable to lower staff utilization on revenue generating programs due to cost overruns on certain engineering projects which negatively impacted revenue recognition during the quarter.

Product sales revenue for the quarter more than doubled to $709,260 compared to $316,971 for the comparable quarter last year. Mechanical products segment product sales revenue increased $288,729 or 132.3 percent to $507,031 compared to $218,302 for the comparable quarter last year due to increased shipments of wheelchair propulsion motors. Technology segment product sales revenue increased $103,560 to $202,229 for the quarter ended December 31, 2004 compared to $98,669 for the comparable period last year due to increased shipments of propulsion systems for hybrid electric bus programs.

Gross profit margins for the third quarter decreased to 8.7 percent compared to 22.0 percent for the comparable quarter last year. Gross profit margins on contract services decreased to a negative 2.4 percent for the third quarter compared to 25.8 percent margin for the comparable quarter last year. The decrease in contract services margins for the quarter is attributable to decreased overhead absorption and cost overruns on certain engineering contracts. Gross profit margin on product sales during the third quarter increased to 18.0 percent compared to 11.6 percent for the comparable quarter last year. The increase in margins on product sales resulted from increased overhead absorption associated with higher production levels in both the technology segment and the mechanical products segment.

Research and development expenditures were $42,875 for the quarter ended December 31, 2004 compared to $97,892 for the comparable quarter last year. The decrease was primarily due to completion of an internally funded development of a new microprocessor platform for our power electronic controls in a prior period.

Production engineering costs were $93,479 for the quarter ended December 31, 2004 versus zero for the comparable quarter last year. The increase is attributable to the Company’s strategy to increase its manufacturing capability and infrastructure, and consists primarily of salary and overhead costs for newly hired manufacturing management and staff personnel.

General and administrative expense for the quarter ended December 31, 2004 decreased to $357,062 from $410,815 for the comparable quarter last year. The decrease in general and administrative expenses is attributable to lower insurance premium costs, bid and proposal costs and exhibition costs in the current quarter versus the comparable prior year quarter.

Interest income increased to $30,947 for the third quarter compared to $7,886 for the prior year third quarter. The increase is attributable to higher levels of invested cash and higher yields on invested cash balances during the quarter versus the comparable quarter last year.

Interest expense decreased by $3,164 to $18,151 for the quarter ended December 31, 2004 versus $21,315 for the comparable quarter last year. The decrease is attributable to lower average mortgage borrowings outstanding throughout the current fiscal quarter versus the comparable quarter last year.

Continuing operations for the nine months ended December 31, 2004, resulted in a loss of $1,443,354 or $0.07 per common share on total revenue of $3,226,056 compared to a loss from continuing operations of $902,774 or $0.05 per common share on total revenue of $4,276,100 for the comparable period last year. Operations for the nine months ended December 31, 2004 resulted in a net loss of $1,488,134 or $0.07 per common share versus a net loss of $2,904,075 or $0.15 per common share for the same period last year.

Revenue from contract services declined $603,892 or 27.3 percent to $1,605,622 for the nine months ended December 31, 2004 compared to $2,209,514 for the comparable period last year. The decrease is primarily attributable to lower staff utilization on revenue generating programs due to cost overruns on certain engineering projects which negatively impacted revenue recognition during the first nine months of the year.

Product sales revenue for the first nine months declined 21.6 percent to $1,620,434 compared to $2,066,586 for the comparable period last year. Mechanical products segment product sales revenue for the nine months period decreased $432,952 or 27.6 percent to $1,134,567 compared to $1,567,519 for the comparable period last year due to decreased shipments of wheelchair propulsion motors. Technology segment product sales revenue decreased $13,200 to $485,867 for the nine months ended December 31, 2004 compared to $499,067 for the comparable period last year due to lower levels of product sales due to the transfer of certain production products to our mechanical products segment.

Gross profit margins for the first nine months decreased to 2.6 percent compared to 19.9 percent for the comparable period last year. Gross profit margins on contract services decreased to a negative 10.6 percent for the nine months ended December 31, 2004 compared to 23.7 percent margin for the comparable period last year. The decrease in contract services margins for the current fiscal period is attributable to estimated cost overruns on certain engineering contracts. Gross profit margin on product sales during the first nine months decreased to 15.7 percent compared to 15.8 percent for the comparable period last year. The decrease in margins on product sales resulted from decreased overhead absorption associated with lower production levels for wheelchair motors.

Research and development expenditures were $138,550 for the nine months ended December 31, 2004 compared to $394,405 for the comparable period last year. The decrease was primarily due to the completion of an internally funded development of a new microprocessor platform for our power electronic controls that was active during the nine months of the comparable prior year period.

Production engineering costs were $93,479 for the nine months ended December 31, 2004 versus zero for the comparable period last year. The increase is attributable to the Company’s strategy to increase its manufacturing capability and infrastructure, and consists primarily of salary and overhead costs for newly hired manufacturing management and staff personnel.

General and administrative expense for the nine months ended December 31, 2004 decreased to $1,295,053 from $1,313,242 for the same period last year. The decrease in general and administrative expenses is primarily attributable to lower insurance premium costs in the first nine months of the year versus the comparable prior year period.

Interest income increased to $47,736 for the nine months ended December 31, 2004 compared to $18,956 for the comparable period last year. The increase is attributable to higher levels of invested cash and higher yields on invested cash balances during the nine-month period versus the comparable period last year.

Interest expense decreased by $8,788 to $57,128 for the nine months ended December 31, 2004 versus $65,916 for the comparable period last year. The decrease is attributable to lower average mortgage borrowings outstanding throughout the current fiscal period versus the comparable period last year.

Results of Discontinued Operations

In January 2004, we announced our intention to exit our contract electronics manufacturing business whose operations were reported as the electronic products segment. For all periods presented, we have reclassified operating results of the electronic products segment to loss from operations of discontinued electronic products segment. All segment assets were reclassified to the balance sheet caption "assets of discontinued operations", all segment liabilities other than long-term estimated future lease obligation were reclassified under the caption "liabilities and commitments of discontinued operations" and long-term estimated future lease obligations were reclassified under the caption "long-term portion of accrued lease obligations. During the fiscal first quarter we completed the divestiture of the assets of this business for $895,000, net of legal expenses, in cash and a 15 percent ownership interest in the purchaser. In our judgment there is doubt regarding our ability in the future to sell or otherwise liquidate the common stock of the purchasing entity, and accordingly, we recorded the stock at no value as a result of this uncertainty. In the event we are able to realize value from the sale or liquidation of this asset at a future date, we would at that time record a gain equal to the amount of the value received.

In addition, the purchaser executed a sublease on our St. Charles, Missouri manufacturing facility for the remaining term of our lease. However, we are the primary obligor on the lease and due to doubt regarding the sublessee’s financial capability to meet its obligation under the sublease, accordingly, we have recorded a liability of $201,690 at December 31, 2004 which is our estimate of the amount which may not be recoverable under the sublease agreement. This estimate could be revised either up or down depending on future events, and any such changes could result in a material impact on our financial condition, results of operations and liquidity.

Loss from discontinued operations for the quarter and nine months ended December 31, 2004 was $25,808 or nil per common share and $44,780 or nil per common share, respectively, compared to a loss from discontinued operations of $1,251,216 or $0.06 per common share and $2,001,301 or $0.10 per common share for the prior year quarter and nine-month period.

Liquidity and Capital Resources

Our cash balances and liquidity throughout the first nine months of the fiscal year were adequate to meet operating needs. At December 31, 2004, we had working capital (the excess of current assets over current liabilities) of $9,191,599 compared to $3,972,559 at March 31, 2004. The increase of $5,219,040 in working capital is primarily attributable to cash proceeds, net of offering costs, of $6,767,596 received from a follow-on offering of common stock completed in November 2004.

Net cash used in operating activities of continuing operations was $1,683,267 for the nine months ended December 31, 2004 versus net cash used of $891,417 for the comparable period last year. The increased cash usage is primarily attributable to higher levels of operating losses, accounts receivable and inventories.

Net cash used in investing activities of continuing operations for the first nine months of fiscal year 2005 was $190,586 compared to cash used in investing activities of $157,776 for the comparable period last year. The increase is primarily due to the purchase of short-term investment securities of $977,550, offset by cash proceeds of $895,000, net of selling expenses, from the divestiture of the assets of our contract electronics manufacturing business.

Net cash provided by financing activities of continuing operations was $6,686,149 for the nine months ended December 31, 2004 compared to cash provided by financing activities of $2,061,257 for the comparable period last year. The increase is attributable to cash proceeds from the our follow-on offering of common stock completed in November 2004, which resulted in cash proceeds, net of the offering costs, of $6,767,596.

Our debt facilities require compliance with certain financial covenants in order for the financing to continue to be available on a long-term basis. At December 31, 2004, we were in compliance with all financial covenants. In the event our operating results are not sufficient to maintain compliance with these covenants, we could experience a material adverse change in liquidity.

We expect to manage our operations and working capital requirements to minimize the future level of operating losses and working capital usage consistent with execution of our business plan; however, we cannot provide assurance that we will be successful in achieving these objectives. We believe our available cash resources are sufficient to fund our expected level of operations for the next several years. During fiscal 2004, the emerging market for hybrid electric automobiles began to expand at an unexpected rate due to the market success of the Toyota Prius hybrid electric passenger car and the Honda Insight and Civic hybrid electric passenger cars. As a result, several automakers have announced planned introductions of similar vehicles and others are expected to follow as the market acceptance of these vehicles continues to grow. As a result of this industry trend, we currently expect expanded demand for our proprietary propulsion systems, which are suited for a wide range of hybrid electric vehicle platforms. In order to capitalize on this anticipated expansion in demand, we have begun to make substantial investments from the proceeds of our recently completed follow-on offering of common stock in human resources and we expect to make additional investments in human resources, manufacturing facilities and equipment, production and application engineering, among other things, in future periods from our available cash balances. We expect to fund our operations over at least the next several years from existing cash balances and from available bank financing, if any. We can, however, not provide any assurance that our existing financial resources will be sufficient to execute our business plan. If our existing financial resources are not sufficient to execute our business plan, we may issue equity or debt securities in the future. In the event financing or equity capital to fund future growth is not available on terms acceptable to the Company, we will modify our strategy to align our operations with then available financial resources.

The following table presents information about our contractual obligations and commitments as of December 31, 2004:

*Excludes sublease payments

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in United States requires management to make judgements, assumptions and estimates that effect the dollar values reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to, allowance for doubtful accounts receivables, asset recovery and realization for discontinued operations, costs to complete contracts and the recoverability of inventories. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgements, assumptions and estimates used in preparation of the Consolidated Financial Statements.

Our trade accounts receivable is subject to credit risks associated with the financial condition of our customers and their liquidity. We evaluate all customers periodically to assess their financial condition and liquidity and set appropriate credit limits based on this analysis. As a result, the collectibility of accounts receivable may change due to changing general economic conditions and factors associated with each customers’ particular business. It is reasonably possible, that future events or changes in circumstances could cause the realizable value of our trade accounts receivable to decline materially, resulting in material losses.

Asset Recovery and Realization – Discontinued Operations

On May 18, 2004, we completed the sale of the assets of our electronic products segment. Part of the consideration received from this divestiture was common stock of the purchasing entity, a privately held corporation. In our judgement there is doubt regarding our ability in the future to sell or otherwise liquidate the common stock of the purchasing entity, and accordingly, we recorded the stock at no value as a result of this uncertainty. In the event we are able to realize value from the sale or liquidation of this asset at a future date, we would, at that time, record a gain equal to the amount of the value received. In addition, the purchaser completed a sublease agreement with us whereby it assumed the remaining lease obligation under our master lease. Similarly, in our judgement there is doubt regarding the purchaser’s financial capability to meets its obligations under the sublease agreement. Accordingly, we have recorded a liability of $201,690 at December 31, 2004 which represents the amount we estimate may not be recoverable under the sublease agreement. This estimate could be revised either up or down depending on future events, and any such changes could result in a material impact on our financial condition, results of operations and liquidity.

We maintain raw material inventories of electronic components, motor parts and other materials to meet our expected manufacturing needs for proprietary products. Some of these components may become obsolete or otherwise impaired due to bulk purchases in excess of customer requirements. Accordingly, we periodically assess our raw material inventory for potential impairment of value based on then available information, expectations and estimates and establish impairment reserves for estimated declines in the realizable value of our inventories. The actual realizable value of our inventories may differ materially from these estimates based on future occurrences and any resulting change in our estimates. It is reasonably possible, that future events or changes in circumstances could cause the realizable value of our inventories to decline materially, resulting in material impairment losses.

Percentage of Completion Revenue Recognition on Long-term Contracts: Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts

We recognize revenue on the development projects funded by our customers using the percentage-of-completion method. Under this method, contract services revenue is based on the percentage that costs incurred to date bear to management’s best estimate of the total costs to be incurred to complete the project. Many of these contracts involve the application of our technology to customers’ products and other applications with demanding specifications. Management’s best estimates have sometimes been adversely impacted by unexpected technical challenges requiring additional analysis and redesign, failure of electronic components to operate in accordance with manufacturers’ published performance specifications, unexpected prototype failures requiring the purchase of additional parts and a variety of other factors that may cause unforeseen delays and additional costs. In the event that total costs are estimated to exceed the contract value, the costs expected to be incurred in excess of the contract value are accrued at that date. It is reasonably possible that total costs to be incurred on any of the projects in process at December 31, 2004 could be materially different from management’s estimates, and any modification of management’s estimate of total project costs to be incurred could result in material changes in the profitability of affected projects or result in material losses on any affected projects.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4" ("SFAS 151"), which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. SFAS 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We are evaluating the impact of this standard on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153, "Exchanges of Non-monetary Assets-an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions ("SFAS 153"), which replaces the exception permitting non-monetary exchanges of similar productive assets from measurement based on the fair value of the assets exchanged with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS 153 shall be effective for non-monetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. We are evaluating the impact of this statement on our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004) "Share-Based Payment" ("SFAS 123R"). SFAS 123R addresses all forms of share-based payment ("SBP") awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123R will require us to expense SBP awards as compensation cost based on the fair value of the SBP on the date of issuance. SFAS 123R requires us to adopt the new accounting provisions beginning in the second quarter of fiscal year 2006. We are evaluating the impact of this standard on our consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange and interest rates. We do not use financial instruments to any degree to manage these risks and do not hold or issue financial instruments for trading purposes. All of our product sales, and related receivables are payable in U.S. dollars. We are subject to interest rate risk on our debt obligations. One of our long-term debt obligations has a variable rate of interest indexed to the prime rate. The interest rate on these instruments approximates current market rates as of December 31, 2004. A one-percent change in the prime interest rate would increase or decrease interest expense by $1,589 on an annual basis based on outstanding borrowings at December 31, 2004 on debt with adjustable interest rate provisions.

Quarterly Controls Evaluation and Related CEO and CFO Certifications.

We conducted an evaluation of the effectiveness of the design and operation of our "disclosure controls and procedures" (Disclosure Controls) as of the end of the period covered by this Quarterly Report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO).

Attached as exhibits to this Quarterly Report are certifications of the CEO and the CFO, which are required in accordance with Rule 13(a)-15(e) of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Definition of Disclosure Controls

Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. To the extent that components of our internal control over financial reporting are included within our Disclosure Controls, they are included in the scope of our quarterly controls evaluation.

Limitations on the Effectiveness of Controls

Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls also can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Scope of the Controls Evaluation

The evaluation of our Disclosure Controls included a review of the controls’ objectives and design, our implementation of the controls and the effect of the controls on the information generated for use in this Quarterly Report. In the course of the controls evaluation, we sought to identify data errors, controls problems or acts of fraud and confirm that appropriate corrective action, including process improvements, were being undertaken. This type of evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning controls effectiveness can be reported in our Quarterly Reports on Form 10-Q and to supplement our disclosures made in our Annual Report on Form 10-K. The overall goals of these various evaluation activities are to monitor our Disclosure Controls, and to modify them as necessary.

Among other matters, we also considered whether our evaluation identified any "significant deficiencies" or "material weaknesses" in our internal control over financial reporting, and whether we have identified any acts of fraud involving personnel with a significant role in our internal control over financial reporting. This information was important both for the controls evaluation generally, and because Item 5 in the certifications of the CEO and CFO require that the CEO and CFO disclose that information to our Board’s Audit Committee and to our independent auditors. In professional auditing literature, "significant deficiencies" are referred to as "reportable conditions," which are deficiencies in the design or operation of controls that could adversely affect our ability to record, process, summarize and report financial data in the financial statements. Auditing literature defines "material weakness" as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and the risk that such misstatements would not be detected within a timely period by employees in the normal course of performing their assigned functions.

Conclusions

Based upon the controls evaluation, our CEO and CFO have concluded that, subject to the limitations noted above, as of the end of the period covered by this Quarterly Report, our Disclosure Controls were effective to provide reasonable assurance that material information relating to the Company and its consolidated subsidiaries is made known to management, including the CEO and CFO.

PART II-OTHER INFORMATION

Litigation

We have previously reported a claim against us by Hussmann Corporation filed in the Circuit Court of St. Charles County, Missouri. On December 17, 2004, the Court in this action dismissed with prejudice all of the plaintiff’s claims against us. On January 19, 2005, Hussmann filed a notice of appeal seeking review of the dismissal, with the Missouri Court of Appeals. We intend to file an answer to the appeal and believe that Hussmann’s claims are without merit and we intend to contest them vigorously. Nevertheless, we cannot assure you that the Hussmann action will not be reinstated in the event the Hussmann appeal is successful.

In addition, we are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, and based on current available information, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial position, results of operations or cash flow, although there can be no assurance that adverse developments in these matters could not have a material impact on a future reporting period.

The following factors, other information in this document and the information incorporated by reference should be carefully considered before investing in our securities.

We have incurred significant losses and may continue to do so.

We have incurred significant losses. For the quarters and nine months ended December 31, 2004 and 2003 our net loss was $392,980 and $1,511,768, and $1,488,134 and $2,904,075, respectively. For the fiscal years ended March 31, 2004, 2003 and 2002 our net loss was $4,786,953, $3,598,650 and $8,592,655, respectively.

Our accumulated deficit at December 31, 2004 was $53,631,115 and our accumulated deficit at March 31, 2004 and 2003 was $52,142,981 and $47,356,028, respectively.

In the future we plan to make additional investments in product development and commercialization, which is likely to cause us to remain unprofitable.

Our operating losses and working capital requirements could consume our current cash balances.

Our net loss for the nine months ended December 31, 2004 was $1,488,134 versus a net loss for the comparable period last year of $2,904,075. At December 31, 2004, our cash balances were $7,530,856. For our most recently completed fiscal year ended March 31, 2004 we had a net loss of $4,786,953 which includes the impairment of the carrying value of our discontinued electronic products segment and other estimated losses from the discontinuance of this business totaling $3,364,638. If our losses continue they could consume some or all of our cash balances. Management expects to make additional investments in human resources, manufacturing facilities and equipment, production and application engineering, among other things, in order to effectively compete in the emerging market for hybrid electric vehicles, which we expect will expand our operating losses and require us to secure additional funding beyond our existing cash resources. We cannot assure you, however, that funding will be available on terms acceptable to us, if at all.

Our government contracts can be cancelled with little or no notice and could restrict our ability to commercialize our technology.

Some of our technology has been developed under government funding by United States government agencies. In some cases, government agencies in the United States can require us to obtain or produce components for our systems from sources located in the United States rather than foreign countries. Our contracts with government agencies are also subject to the risk of termination at the convenience of the contracting agency and in some cases grant "march-in" rights to the government. March-in rights are the right of the United States government or the applicable government agency, under limited circumstances, to exercise a non-exclusive, royalty-free, irrevocable worldwide license to any technology developed under contracts funded by the government to facilitate commercialization of technology developed with government funding. March-in rights can be exercised if we fail to commercialize the developed technology. The implementation of restrictions on our sourcing of components or the exercise of march-in rights by the government or an agency of the government could restrict our ability to commercialize our technology.

We face intense competition in our motor development and may be unable to compete successfully.

In developing electric motors for use in vehicles and other applications, we face competition from very large domestic and international companies, including the world’s largest automobile manufacturers. These companies have far greater resources to apply to research and development efforts than we have, and they may independently develop motors that are technologically more advanced than ours. These competitors also have much greater experience in and resources for marketing their products.

If we fail to develop and achieve market acceptance for our products, our business may not grow.

We believe our proprietary systems are suited for a wide range of hybrid electric vehicle platforms. We currently expect to make substantial investments in human resources, manufacturing facilities and equipment, production and application engineering, among other things, to capitalize on the anticipated expansion in demand for products related to this market area. However, our experience in this market area is limited. Our sales in this area will depend in part on the market acceptance of and demand for our proprietary propulsion systems and future products. We cannot be certain that we will be able to introduce or market our products, develop other new products or product enhancements in a timely or cost-effective manner or that our products will receive market acceptance.

If we are unable to protect our patents and other proprietary technology, we will be unable to prevent third parties from using our technology, which would impair our competitiveness and ability to commercialize our products. In addition, the cost of enforcing our proprietary rights may be expensive and result in increased losses.

Our ability to compete effectively against other companies in our industry will depend, in part, on our ability to protect our proprietary technology. 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. We have historically pursued patent protection in a limited number of foreign countries where we believe significant markets for our products exist or where potentially significant competitors have operations. It is possible that a substantial market could develop in a country where we have not received patent protection and under such circumstances our proprietary products would not be afforded legal protection in these markets. Further, our competitors may independently develop or patent technologies that are substantially equivalent or superior to ours. We cannot assure that additional patents will be issued to us or, if they are issued, as to the scope of their protection. 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, it would divert funds and resources which otherwise could be used in our operations and we cannot assure that we would be successful in enforcing our intellectual property rights. In addition, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country where we may operate or sell our products in the future. If third parties assert technology infringement claims against us, the defense of the claims could involve significant legal costs and require our management to divert time and attention 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 results of operations may suffer either from reductions in revenues through our inability to serve customers or from increases in costs to license third-party technologies.

Use of our motors in vehicles could subject us to product liability claims, and product liability insurance claims could cause an increase in our insurance rates or could exceed our insurance limits, which could impair our financial condition, results of operations and liquidity.

Because some of our motors are designed to be used in vehicles, and because vehicle accidents can cause injury to persons and property, we are subject to a risk of claims for product liability. We carry product liability insurance of $1 million covering all of our products. If we were to experience a large insured loss, it might exceed our coverage limits, or our insurance carriers could decline to further cover us or raise our insurance rates to unacceptable levels, any of which could impair our financial position and results of operations.