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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 October 31, 2010,

or

 

¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission File No. 0-49629

 

 

Quantum Fuel Systems Technologies Worldwide, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		33-0933072
(State of Incorporation)		(IRS Employer I.D. No.)

17872 Cartwright Road, Irvine, CA 92614

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (949) 399-4500

 

 

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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to rule 405 of the Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Number of shares outstanding of each of the issuer’s classes of common stock, as of December 3, 2010:

186,960,246 shares of Common Stock, $.001 par value per share, and 999,969 shares of Series B Common Stock, $.001 par value per share.

 

 

 

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INDEX

QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

 

Part I. Financial Information			1
Item 1. Financial Statements:			1
Condensed consolidated balance sheets – April 30, 2010 and October 31, 2010 (unaudited)			1
Condensed consolidated statements of operations (unaudited) – Three and six months ended October  31, 2009 and 2010			2
Condensed consolidated statements of cash flows (unaudited) – Three and six months ended October  31, 2009 and 2010			3
Notes to condensed consolidated financial statements (unaudited) – October 31, 2010			4
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
Item 3. Quantitative and Qualitative Disclosures About Market Risk			49
Item 4. Controls and Procedures			49
Part II. Other Information			50
Item 1A. Risk Factors			50
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			53
Item 4. Submission of Matters to a Vote of Security Holders			53
Item 5. Other Information			53
Item 6. Exhibits			53
Signatures			54

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PART I—FINANCIAL INFORMATION

 

Item 1.

Financial Statements.

QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		April 30, 2010				October 31, 2010
						(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	4,026,882			$	3,672,835
Accounts receivable, net			2,833,137				3,577,277
Inventories, net			1,766,420				1,464,032
Deferred debt issuance costs, net			—				1,114,864
Prepaids and other current assets			927,920				1,493,325
Total current assets			9,554,359				11,322,333
Property and equipment, net			8,096,787				8,944,630
Investment in and advances to affiliates			6,971,944				7,163,247
Asset held for sale			2,089,947				2,061,150
Intangible asset, net			8,575,518				8,245,922
Goodwill			32,858,914				32,883,956
Prepayments to affiliate			3,971,600				4,185,500
Deposits and other assets			899,058				783,751
Total assets		$	73,018,127			$	75,590,489
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable		$	4,167,199			$	3,002,212
Accrued payroll obligations			1,353,709				1,333,012
Deferred revenue			200,562				772,422
Accrued warranties			89,754				100,820
Derivative instruments			12,547,000				8,306,000
Other accrued liabilities			1,853,468				2,502,849
Current portion of long-term debt			519,243				19,058,220
Total current liabilities			20,730,935				35,075,535
Long-term debt, net of current portion			21,133,928				6,873,908
Deferred income taxes			481,330				508,783
Derivative instruments			6,669,000				3,428,000
Commitments and contingencies
Equity:
Stockholders’ equity:
Preferred stock, $.001 par value; 20,000,000 shares authorized; none issued and outstanding at April 30, 2010 and October 31, 2010			—				—
Series B common stock, $.001 par value; 2,000,000 shares authorized; 999,969 issued and outstanding at April 30, 2010 and October 31, 2010			1,000				1,000
Common stock, $.001 par value; 398,000,000 shares authorized; 169,155,324 issued and outstanding at April 30, 2010 and 186,960,246 issued and outstanding at October 31, 2010			169,155				186,960
Additional paid-in-capital			395,709,444				404,252,871
Accumulated deficit			(372,016,566	)			(375,085,973	)
Accumulated other comprehensive loss			(755,791	)			(533,945	)
Total stockholders’ equity			23,107,242				28,820,913
Noncontrolling interests			895,692				883,350
Total equity			24,002,934				29,704,263
Total liabilities and equity		$	73,018,127			$	75,590,489

See accompanying notes.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Revenue:
Net product sales		$	424,766			$	835,004			$	612,157			$	1,479,074
Contract revenue			2,230,414				3,050,178				5,136,729				5,966,039
Total revenue			2,655,180				3,885,182				5,748,886				7,445,113
Costs and expenses:
Cost of product sales			594,933				878,440				861,543				1,437,640
Research and development			3,508,755				4,282,216				7,304,212				8,119,307
Selling, general and administrative			3,176,472				3,582,829				6,759,098				7,371,812
Total costs and expenses			7,280,160				8,743,485				14,924,853				16,928,759
Operating loss			(4,624,980	)			(4,858,303	)			(9,175,967	)			(9,483,646	)
Interest expense, net			(762,782	)			(732,458	)			(1,453,216	)			(1,191,598	)
Fair value adjustments of derivative instruments			(34,870,000	)			4,070,000				(34,832,000	)			7,482,000
Loss on modification of debt and derivative instruments			(2,570,000	)			—				(9,539,000	)			—
Loss on settlement of debt and derivative instruments, net			(207,152	)			—				(401,371	)			—
Equity in earnings of affiliates, net			379,000				74,720				487,000				145,955
Other income (expense), net			(15,981	)			17,212				(20,466	)			17,212
Loss from operations before income tax expense			(42,671,895	)			(1,428,829	)			(54,935,020	)			(3,030,077	)
Income tax expense			(1,000	)			(25,963	)			(2,041	)			(39,330	)
Net loss attributable to stockholders		$	(42,672,895	)		$	(1,454,792	)		$	(54,937,061	)		$	(3,069,407	)
Per share data - basic and diluted:
Net loss attributable to stockholders		$	(0.35	)		$	(0.01	)		$	(0.48	)		$	(0.02	)
Number of shares used in per share calculation - basic and diluted			121,890,999				187,799,269				113,326,834				184,082,954

See accompanying notes.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Six Months Ended October 31,
		2009				2010
Cash flows from operating activities:
Net loss		$	(54,937,061	)		$	(3,069,407	)
Adjustments to reconcile net loss from operations to cash used in operating activities:
Depreciation on property and equipment and amortization of intangibles			644,283				877,989
Share-based compensation charges			513,014				569,539
Fair value adjustments of derivative instruments			34,832,000				(7,482,000	)
Loss on modification of debt and derivative instruments			9,539,000				—
Loss on settlement of debt and derivative instruments			401,371				—
Provision for inventory obsolesence			229,486				127,852
Other non-cash items			(21,386	)			179,505
Changes in operating assets and liabilities:
Accounts receivable			(1,761,163	)			(749,106	)
Inventories			648,384				174,536
Other assets			(220,859	)			(591,648	)
Accounts payable			217,737				(364,878	)
Deferred revenue and other accrued liabilities			680,296				1,721,712
Net cash used in operating activities			(9,234,898	)			(8,605,906	)
Cash flows from investing activities:
Additions to property and equipment			(359,023	)			(1,512,798	)
Deposit received on asset held for sale			—				245,850
Payments to non-controlling interests			—				(105,364	)
Investment in and advances to affiliates			(165,000	)			—
Net cash used in investing activities			(524,023	)			(1,372,312	)
Cash flows from financing activities:
Borrowings on term notes, net of issuance costs			3,000,000				3,380,225
Borrowings on capital leases and other financing			—				304,710
Payments on capital leases and other financing			(22,583	)			(266,587	)
Proceeds from issuance of common stock, net of transaction fees			9,339,798				6,221,344
Proceeds from issuance of warrants classified as derivative instruments			1,395,000				—
Proceeds from exercise of warrants and options			4,000				—
Net cash provided by financing activities			13,716,215				9,639,692
Net effect of exchange rate changes on cash			—				(15,521	)
Net increase (decrease) in cash and cash equivalents			3,957,294				(354,047	)
Cash and cash equivalents at beginning of period			2,621,215				4,026,882
Cash and cash equivalents at end of period		$	6,578,509			$	3,672,835

See accompanying notes.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

October 31, 2010

1) Background and Basis of Presentation

Background

Quantum Fuel Systems Technologies Worldwide, Inc. and Subsidiaries (collectively referred to as “Quantum,” “we,” “our” or “us”) is a fully integrated alternative energy company and a leader in the development and production of advanced clean propulsion systems and renewable energy generation systems and services.

We believe that we are uniquely positioned to integrate advanced fuel system, electric drive, software control strategies and battery control system technologies for alternative fuel vehicles, in particular, plug-in hybrid, electric and hydrogen hybrid vehicles based on our years of experience in vehicle-level design, vehicle electronics, control strategies and system integration. We are also an independent power producer and developer of renewable energy projects and provider of related services.

We provide powertrain engineering, system integration, manufacturing and assembly of packaged fuel systems and battery control systems for vehicles and other applications including fuel cells, hybrids, plug-in electric hybrid, alternative fuels, and hydrogen refueling. We also design, engineer and manufacture hybrid and fuel cell vehicles.

Our portfolio of technologies include electronic controls, hybrid electric drive and control systems, hydrogen storage and metering systems, advanced lithium-ion battery control systems, and other alternative fuel technologies that enable fuel efficient, low emission hybrid, plug-in hybrid electric, fuel cell and other alternative fuel vehicles.

We were incorporated in the state of Delaware in October 2000 as Quantum Fuel Systems Technologies Worldwide, Inc., a wholly-owned subsidiary of IMPCO Technologies, Inc (IMPCO). We spun off from IMPCO and became a separate company on July 23, 2002.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with United States (US) generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Quantum Fuel Systems Technologies Worldwide, Inc., our wholly owned subsidiary, Schneider Power, Inc (SPI), and our majority-owned subsidiary, Quantum Solar Energy, Inc. (Quantum Solar).

The condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from uncertainty related to our ability to continue as a going concern.

On April 16, 2010, we completed the acquisition of SPI, an alternative energy company with a portfolio of clean electricity generation development projects and land positions in prospective wind and solar power areas in North America and the Caribbean.

On August 27, 2008, start-up activities were initiated in Quantum Solar to develop a solar panel distribution and manufacturing operation in Irvine, California. We currently own 85.0% of Quantum Solar and the remaining 15.0% is owned by the majority shareholder of our affiliate, asola Advanced and Automotive Solar Systems GmbH (Asola).

We also hold ownership interests in certain unconsolidated active businesses that are accounted for either under the equity or cost methods of accounting. These interests include: (i) on September 3, 2009, we acquired an ownership interest in Shigan Quantum Technologies PVT LTD (Shigan Quantum), a start-up manufacturer of fuel injectors based in New Delhi, India, (ii) on October 6, 2009, we acquired an ownership interest in Power Control and Design, Inc. (PCD), a power control electronics software developer based in Newbury Park, California, (iii) on January 4, 2008, we acquired an ownership interest in Asola, a solar module manufacturer located in Erfurt, Germany, and (iv) on August 7, 2007, we co-founded Fisker Automotive, Inc. (Fisker Automotive) with Fisker Coachbuild, LLC, which was formed for the purpose of producing premium plug-in hybrid automobiles. Our equity ownership was approximately 1% at October 31, 2010 and we currently account for our investment in Fisker Automotive under the cost method of accounting. See Note 5 for further discussion of these businesses.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

We also had an ownership interest in Advanced Lithium Power, Inc. (ALP) that we obtained on March 3, 2006. ALP ceased operations in June 2010 upon the appointment of a receiver. Our remaining investment in ALP was fully written off as of April 30, 2010.

These condensed consolidated financial statements are unaudited and have been prepared in accordance with the instructions of Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. These adjustments consist of normal and recurring accruals, as well as non-recurring charges.

All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to fiscal year 2010 amounts to conform to the fiscal year 2011 presentation.

In preparing the consolidated financial statements, we have evaluated subsequent events. Subsequent events are events that occur after the balance sheet date but before the consolidated financial statements are issued or are available to be issued.

Capital Resources

From our inception through October 31, 2010, we have funded our operations and strategic investments primarily with proceeds from public and private offerings of our common stock and borrowings with financial institutions and our current senior lender. Capital transactions completed during fiscal 2011 and capital commitments available to us are as follows:

 

•

On October 13, 2010 and October 19, 2010, we raised cumulative gross proceeds of $4.0 million in a private placement transaction in exchange for issuing senior subordinated bridge notes payable and warrants to certain accredited investors (see Note 7). The net amount received by us from the transactions, after deducting placement agent fees and transaction expenses, was $3.4 million.

 

•

On various dates from April 30, 2010 through July 26, 2010 we raised cumulative gross proceeds of $10.9 million in connection with a private placement offering from the sale of 19.7 million shares of our common stock at a price of $0.55 per share (see Note 10). The investors and placement agent also received warrants in connection with the transactions. The net amount received by us from the transactions, after deducting placement agent fees and offering expenses, was $9.3 million (of which $6.2 million was received in the first quarter of fiscal 2011).

 

•

On May 30, 2008, we initially secured a $10.0 million unconditional commitment (Lender Commitment) from an affiliate of our senior lender that allows us to draw on the commitment at our option and also allows the senior lender to fund the commitment at the senior lender’s option under certain defined structures. The option for either party under the Lender Commitment, as last modified on November 24, 2009, expires on March 31, 2011. To date, neither we nor the senior lender have exercised the option under the Lender Commitment. We are contractually limited to drawing down a maximum of $2.5 million in any 30 day period; therefore, we must provide notice to the senior lender beginning on or before December 20, 2010 in order to have full access to the commitment prior to the expiration date.

Liquidity

Our historical operating results, capital resources and financial position in combination with current projections and estimates were considered in management’s plan and intentions to fund our operations over a reasonable period of time which we define as the twelve month period ending as of October 31, 2011. For purposes of liquidity disclosures, we assess the likelihood that we have sufficient available working capital and other principal sources of liquidity to fund our operating activities and obligations as they become due and the likelihood that we will be able to maintain compliance with the required provisions contained within our debt instruments over the twelve month period.

Our principal sources of liquidity at October 31, 2010 amounted to $13.7 million, consisting of $3.7 million of cash and cash equivalents and $10.0 million under the Lender Commitment that is available to be drawn upon through March 31, 2011. We have historically incurred operating losses and negative cash flows from operating activities. Specifically, we have used $14.7 million and $8.6 million in cash for operating activities during the twelve-month period of fiscal 2010 and the first six months of fiscal 2011, respectively.

As discussed further in Note 7, we have $25.9 million of outstanding debt obligations as of October 31, 2010. The total cash that could be required to service these debt instruments over the next twelve months is $20.5 million, including $4.2 million related to the Bridge Notes that are scheduled to mature on December 31, 2010 and $15.7 million related to a term note and three convertible notes held by our senior lender that are scheduled to mature on July 31, 2011.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

As of the date of this report, we do not have sufficient cash on hand to pay the $4.2 million due under the Bridge Notes when they mature on December 31, 2010. Our ability to draw upon the $10.0 million Lender Commitment is contractually limited to $2.5 million during any 30 day period so prior to the maturity date of the Bridge Notes we cannot draw an amount sufficient to satisfy the amount due. In order to avoid being in default of the Bridge Notes, we will need to raise additional capital prior to December 31, 2010 sufficient to satisfy our obligations under the Bridge Notes or seek an extension of the maturity date. A default in payment of the Bridge Notes will constitute a default under all of our senior indebtedness and our senior lender will have the right to declare the full amount of the senior indebtedness immediately due and payable. Accordingly, a default in the Bridge Notes could have a material adverse affect on our business and our ability to continue as a going concern.

Based on our current projections and estimates, we expect that we will continue to incur operating losses and negative cash flows for the foreseeable future. Therefore, in order to pay our senior indebtedness when it matures on July 31, 2011 and to cover our working capital requirements, we will also need to raise approximately $20 million of additional capital in public and/or private offerings of equity or debt securities. If we are unsuccessful in raising sufficient capital to pay the senior indebtedness, then we will need to either refinance our senior indebtedness or seek an extension of the maturity dates. Given our historical operating results and the difficult credit markets that currently exist, we do not expect that we will be able refinance our senior indebtedness with a traditional commercial loan. Rather, we will need to seek an alternative loan arrangement such as a convertible debenture or other equity linked debt security.

Although we will try to negotiate an extension of the applicable maturity dates with the lenders and we have successfully extended the scheduled maturity dates on the debt obligations with our senior lender in the past on several occasions, we cannot provide any assurances that we will be able to further modify the current arrangements with our senior lender nor modify the current arrangement on the Bridge Notes. We are also currently evaluating our options for raising additional capital in order to maintain sufficient liquidity to meet our obligations as they become due. The actual amount of capital that we will need to raise is highly dependent upon the levels of debt conversions by our convertible note lenders and our ability to further extend the scheduled maturity dates of our obligations with our lenders.

Although we expect to use a significant amount of cash in our operations over the next year for our operating activities and debt service, our current operating plan anticipates increased revenues and improved profit margins for the twelve month period, primarily associated with the first half of fiscal 2012, which we expect will reduce the levels of cash required for our operating activities as compared to historical levels of use.

In addition to our need to raise sufficient capital to cover our existing operations and debt service obligations through October 31, 2011, we will also need to raise additional capital in order to complete the proposed Asola LOI transaction, complete the build out of our Spring Bay Wind Farm and other planned wind development projects, complete the planned Quantum Solar manufacturing operation in Irvine, California, and to further develop the next generation of our Q-Drive hybrid electric propulsion system. We do not plan to move forward with the proposed Asola LOI transaction, the build out of the Spring Bay Wind Farm project or the Quantum Solar manufacturing operation until we raise a level of additional capital to be able to fund one or more of these projects and maintain sufficient levels of working capital for our overall business.

Although we anticipate that we will be able to raise sufficient additional capital through public or private offerings of equity or debt securities and/or through federal and state governmental grants or loans to: (i) provide sufficient liquidity for our working capital needs, including the debt service requirements discussed above, (ii) complete the Spring Bay Wind Farm, (iii) complete the Quantum Solar manufacturing operation, and (iv) provide capital for other initiatives over the coming months, we cannot provide any assurances that we will be able to secure additional funding on terms acceptable to us, if at all. In addition, we will need to increase revenues and improve profit margins for our business to be sustainable over the long term. An inability by us to modify our scheduled debt service obligations, achieve our current operating plan or raise sufficient capital to cover any shortfall would have a material adverse affect on our ability to meet our obligations as they become due and to continue as a going concern without actions outside the ordinary course of business, which could include curtailing operations.

Use of Estimates in the Preparation of Consolidated Financial Statements

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates include assessing our levels of liquidity needs through October 31, 2011, collectability of accounts receivable, estimates of contract costs and percentage of completion, the use and recoverability of inventory, the carrying

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

amounts and fair value of long-lived assets and goodwill, including estimates of future cash flows and market valuations associated with asset impairment evaluations, the fair value of derivatives associated with debt instruments and warrants, the realization of deferred taxes, useful lives for depreciation/ amortization periods of assets and provisions for warranty claims, among others. The markets for our products are characterized by competition, technological development and new product introduction, all of which could impact the future realizability of our assets. Actual results could differ materially from those estimates.

Revenue Recognition

We generally manufacture products based on specific orders from customers. Revenue is recognized when the earnings process is complete and collectibility is reasonably assured, which for product sales is generally upon shipment. We include the costs of shipping and handling, when incurred, in cost of goods sold.

Contract revenue for customer funded research and development is principally recognized by the percentage of completion method. Generally, we estimate percentage complete by determining cost incurred to date as a percentage of total estimated cost at completion. For certain other contracts, percentage complete is determined by measuring progress towards contract deliverables if it is determined that this methodology more closely tracks the realization of the earnings process. For contracts measured under the estimated cost approach, we believe we can generally make dependable estimates of the revenue and costs applicable to various stages of a contract. Recognized revenue and profit are subject to revisions as the contract progresses to completion. Our estimates of contract costs are based on expectations of engineering development time and materials and other support costs. These estimates can change based on unforeseen technology and integration issues, but known risk factors and contract challenges are generally allowed for in the initial scope and cost estimate of the program. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known.

In certain circumstances, customers pay one price for multiple products and services. For arrangements with multiple deliverables, revenue is recognized upon the delivery of the separate units. Consideration from multiple element arrangements is allocated among the separate elements based on their relative fair values.

Effective with our acquisition of SPI on April 16, 2010, our product revenues now include energy generation sales associated with a wind farm which are recognized at the time of generation and delivery to the purchasing utility provider as metered at the point of interconnection with the transmission system. The rate paid by the purchasing utility provider is established in the Power Purchase Agreement (PPA) executed between us and the utility provider.

Recent Accounting Pronouncements Adopted

Effective May 1, 2010, we adopted new guidance under Accounting Standards Codification (ASC) No. 810-10-05, “Consolidations-Variable Interest Entities.” ASC 810-10-05 changes the approach to determining the primary beneficiary of a variable interest entity (VIE) and requires companies to more frequently assess whether they must consolidate VIEs. The adoption of this guidance did not have a material impact on our financial position or results of operations.

Recent Accounting Pronouncements Issued

In September 2009, the Financial Accounting Standards Board (FASB) reached a consensus on Accounting Standards Update (ASU) No. 2009-13, “Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements.” ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: i) vendor specific objective evidence (VSOE) or ii) third-party evidence (TPE), before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. Early adoption is permitted. This new update is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Based on the current nature of our operations, we do not expect that the adoption of this requirement on May 1, 2011 will have a material impact on our consolidated financial statements.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

2) Acquisition of Schneider Power, Inc.

On April 16, 2010 we completed our acquisition of Toronto, Ontario, Canada-based Schneider Power, Inc. (SPI) under the terms of a definitive Arrangement Agreement executed on November 24, 2009 (the “Arrangement Agreement”) pursuant to which we acquired all of the outstanding shares of SPI in a stock-for-stock exchange. Effective upon the closing of the Arrangement Agreement, we now operate SPI as a wholly-owned subsidiary. SPI is a renewable energy company that develops and constructs electricity generation facilities. SPI also owns and operates a wind farm in Ontario, Canada and has a significant portfolio of renewable wind and solar energy projects in North America and the Caribbean in various stages of development. We report the operations of SPI in the Renewable Energy business segment (see Note 11).

In connection with the closing of the Arrangement Agreement, we issued a total of 16.8 million shares of our common stock to SPI shareholders (representing 0.236 of a Quantum common share for each SPI common share outstanding), which included 0.2 million of shares issued to holders of SPI in-the-money compensatory stock options at the time of closing. All outstanding SPI stock options and SPI warrants were cancelled effective upon the closing of the transaction. We provided the former SPI warrant holders with Quantum replacement warrants that allowed these warrant holders to purchase up to 2.1 million shares of our common stock at exercise prices ranging from $0.48 to $2.41 per share. On August 21, 2010, 1.5 million of the replacement warrants expired. The remaining replacement warrants have an exercise price of $0.88 per share and expire on May 13, 2011. The closing of the Arrangement Agreement was accounted for as an acquisition of SPI by Quantum.

Consideration and Measurement of Goodwill

The total fair value of the consideration provided by us on the closing date was $11.9 million and there is no further contingent consideration of other adjustments contemplated per the terms of the definitive business combination agreement.

We have preliminarily identified $9.4 million of tangible and intangible assets at fair value as of the date of the closing, which was net of the fair value of liabilities assumed and non-controlling interests. As a result, we have preliminarily ascribed $2.5 million of the consideration related to the transaction as goodwill in the Renewable Energy business segment representing the expected synergies and other intangible value that the SPI acquisition brought to our overall alternative energy business strategy (see Notes 6 and 11). Because the transaction was completed near the end of our fiscal 2010 period, we have not yet finalized the fair values of the assets acquired and liabilities assumed in connection with the acquisition, including the finalization of deferred tax assets and liabilities associated with the new subsidiary. During the six months ended October 31, 2010, we revised our estimate of the fair value of certain liabilities assumed which resulted in an increase to goodwill of $0.1 million. We expect to complete our analysis during the remainder of fiscal 2011.

 

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The preliminary fair value of the net assets acquired on April 16, 2010, including changes in estimates made during the six months ended October 31, 2010, is as follows:

 

Components of Consideration:
Quantum common shares issued and exchanged for SPI common shares		$	11,620,031
Quantum common shares issued to former SPI option holders			147,689
Quantum warrants issued to former SPI warrant holders			169,000
Total consideration		$	11,936,720
Fair Value of Business Acquired:
Tangible assets acquired at fair value:
Cash and cash equivalents		$	596,053
Accounts receivable			45,373
Prepaids and other current assets			608,060
Deposits and other assets			684,882
Property and equipment			1,912,829
Asset held for sale			2,095,057
Total tangible assets acquired			5,942,254
Intangible assets acquired at fair value:
Renewable energy project assets			8,613,000
Goodwill ascribed to transaction			2,524,818
Total assets acquired			17,080,072
Liabilities assumed at fair value:
Accounts payable			(1,273,568	)
Accrued payroll obligations			(198,252	)
Loan payable to Quantum			(624,510	)
Other accrued liabilities			(357,529	)
Long-term debt			(1,311,064	)
Deferred income taxes			(480,548	)
Total liabilities assumed			(4,245,471	)
Non-controlling interests in SPI at fair value			(897,881	)
Total liabilities assumed and non-controlling interests			(5,143,352	)
Net assets acquired		$	11,936,720

 

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Pro Forma Data

The operating results of SPI have been included in our consolidated financial statements from the date of the acquisition. The pro forma financial data set forth below gives effect to our acquisition of SPI as if the acquisition had been completed on May 1, 2009. The pro forma financial data includes adjustments to reflect an increase in operating expenses associated with intangible asset amortization (resulting from the identification of renewable energy project intangible assets in connection with the acquisition that were not previously recorded) and an increase in the number of shares used in per share calculation as a result of shares issued in connection with the transaction. The pro forma financial data excludes those adjustments made to the book value of SPI’s tangible assets acquired and liabilities assumed based on their estimated fair value at the date of acquisition.

 

		Three months ended October 31, 2009								Six months ended October 31, 2009
		As Reported				Pro Forma (unaudited)				As Reported				Pro Forma (unaudited)
Net revenue		$	2,655,180			$	3,851,019			$	5,748,886			$	7,030,655
Operating loss		$	(4,624,980	)		$	(4,553,672	)		$	(9,175,967	)		$	(9,546,624	)
Net loss applicable to common stock		$	(42,672,895	)		$	(42,590,564	)		$	(54,937,061	)		$	(55,314,870	)
Net loss per share - basic and diluted		$	(0.35	)		$	(0.31	)		$	(0.48	)		$	(0.43	)
Number of shares - basic and diluted			121,890,999				138,702,028				113,326,834				130,137,863

The pro forma financial information is for informational purposes only and is not indicative of what the actual consolidated results of operations might have been had the transaction occurred on May 1, 2009.

Investment in Grand Valley

Included in the SPI assets acquired is $2.1 million (as of April 16, 2010) related to a renewable energy project asset that we have classified as held for sale. This asset represents the fair value of SPI’s investment in a wind farm project that is under development and that we refer to as the Grand Valley Wind Farm. We have recorded the asset at its fair value, less estimated cost to sell. As of the closing date of the Arrangement Agreement, management of SPI had committed to a plan to sell the asset and the asset was available for immediate sale in its present condition subject only to terms that are usual and customary for this type of sale. Actions to locate a buyer have been initiated and the sale of the asset is considered probable within the next year.

SPI executed a non-binding letter of intent dated June 30, 2010 (the “Grand Valley LOI”) with a non-affiliated third party for the proposed sale of the Grand Valley Wind Farm asset. The terms of the Grand Valley LOI, as amended on December 1, 2010, call for the buyer to make good faith deposits to SPI at dates based on the buyer’s ability to achieve certain milestones with a proposed closing date on or before January 31, 2011. SPI expects to receive Canadian Dollar (CAD) 2.1 million in total sales proceeds upon completion of the sale. In July 2011, we collected an initial deposit in the amount of CAD 250,000 toward the completion of the sale.

 

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3) Accounts Receivable

Accounts receivable consist of the following:

 

		April 30, 2010				October 31, 2010
Customer accounts billed		$	1,189,097			$	2,549,806
Customer accounts unbilled			1,716,149				1,124,152
Allowance for doubtful accounts			(72,109	)			(96,681	)
Accounts receivable, net		$	2,833,137			$	3,577,277

We assess the collectibility of receivables associated with our customers on an ongoing basis.

4) Inventories

Inventories consist of the following:

 

		April 30, 2010				October 31, 2010
Materials and parts		$	3,670,420			$	3,566,653
Work-in-process			72,757				4,029
Finished goods			904,494				907,711
			4,647,671				4,478,393
Less: provision for obsolescence			(2,881,251	)			(3,014,361	)
Inventories, net		$	1,766,420			$	1,464,032

5) Strategic Investments

Investment in Fisker Automotive

On August 7, 2007, we and Fisker Coachbuild, LLC, launched a new venture, Fisker Automotive, Inc. (Fisker Automotive), to produce premium plug-in hybrid automobiles. We initially owned 62.0% of Fisker Automotive; however, Fisker Automotive has since raised a level of capital that has resulted in the dilution of our direct ownership interest to approximately 1% at October 31, 2010.

Fisker Automotive’s first scheduled production vehicle, the Fisker Karma, a four door hybrid-electric premium sports sedan that incorporates our plug-in hybrid electric vehicle architecture known as Q-Drive, is expected to have initial deliveries beginning in the spring of 2011.

On April 29, 2010, we executed a long-term production supply agreement with Fisker Automotive which, as later amended on November 8, 2010, sets forth the definitive terms pursuant to which we are the exclusive supplier of certain key sub-systems and control systems included in the Q-Drive powertrain system for the Fisker Karma production vehicle and we will also receive a royalty for each Fisker Karma vehicle sold that incorporates our Q-Drive technology (the “Fisker Production Agreement”). The Fisker Production Agreement covers the program life of the vehicle platform and outlines minimum volumes of 45,000 vehicles over this period.

We accounted for our investment in Fisker Automotive under the equity method of accounting from the date of our initial ownership interest through the first quarter of fiscal 2011. During the second quarter of fiscal 2011, we changed the method of accounting to the cost method as a result of changes in the composition of the Fisker Automotive board of directors and the dilution of our equity interest since the initial formation of the venture such that we no longer are considered to have significant influence over Fisker Automotive; however, under both of these methodologies, our investment in Fisker Automotive has been carried at zero for all periods presented.

 

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We are currently providing engineering services to Fisker Automotive, including system validation, certification and other pre-production development activities, under the third phase of the development of the Fisker Karma vehicle platform in addition to supplying certain prototype component parts for pre-production Fisker Karma vehicles.

We have received $22.5 million in cash from Fisker Automotive and have recognized $23.1 million in cumulative revenue through October 31, 2010 of which $1.8 million and $2.9 million was recognized during the three and six month periods ended October 31, 2010.

Investment in Affiliates

We account for our active affiliates, Asola, PCD, and Shigan Quantum under the equity method of accounting. The components of investment in and advances to affiliates is as follows:

 

		April 30, 2010				October 31, 2010
Quantum Affiliates:
Asola		$	6,806,944			$	7,024,292
PCD			165,000				134,837
Shigan-Quantum			—				4,118
Investment in and advances to affiliates		$	6,971,944			$	7,163,247

Asola

On January 4, 2008, we acquired a 24.9% ownership interest in asola Advanced and Automotive Solar Systems GmbH (Asola), a solar module manufacturer located in Erfurt, Germany. In exchange for the ownership interest, we provided the following consideration (i) 0.3 million euro (US$0.4 million), (ii) commitment to contribute an additional 1.2 million euro to provide for capital equipment for the planned expansion of Asola’s annual manufacturing capacity to approximately 40 to 45 megawatts (MW), (iii) commitment to provide a guaranty to Asola’s bank of 1.0 million euro related to an anticipated expansion of Asola’s bank financing arrangement, and (iv) commitment to transfer 15.0% ownership interest in our solar venture in the United States, if and when such venture was established. We also have an option to increase our ownership interest in Asola by an additional 7.8% in exchange for 0.1 million euro. We account for our equity interest in Asola under the equity method of accounting.

Over the past year we have engaged in discussions with Asola’s majority share holder, ConSolTec GmbH (ConSolTec), to outline terms that could result in us acquiring a controlling equity interest in Asola. On August 24, 2010, we executed a non-binding Letter Of Intent with ConSolTec (Asola LOI), which sets forth terms related to a proposed transaction pursuant to which we and Consoltec would establish a newly formed holding company, with us as the controlling equity holder, to create a solar panel manufacturing, distribution and sales entity to service global markets. The assets of the new entity would include Asola and Quantum Solar as wholly-owned subsidiaries. Under the proposed terms of the Asola LOI, the transaction is contingent upon several conditions including our ability to raise a certain level of capital in order to provide compensation to ConSolTec and to provide sufficient equity capital to the new entity to enable the entity’s expansion into additional global markets. The Asola LOI contemplates a transaction completion date of December 31, 2010; however, we do not believe we will complete the transaction by that date and will seek an extension.

Prior to the execution of the Asola LOI, we provided Asola and ConSolTec with written notice on December 28, 2009, that we were exercising our right to increase our ownership interest in Asola to 32.66% in exchange for payment of 0.1 million euro. The transaction to increase our ownership interest by 7.76% has not yet been completed and we have reserved our right to withdraw the exercise pending the outcome of the Asola LOI and our evaluation of the impact that the exercise may have on certain material contracts to which Asola is a party.

The conversion rate of one Euro Dollar (euro) to one US Dollar was 1.32 to 1.0 as of April 30, 2010 and 1.40 to 1.0 as of October 31, 2010. We account for our equity interest in Asola under the equity method of accounting. Although Asola is a variable interest entity, we are not considered the primary beneficiary.

On May 8, 2008, we paid 1.2 million euro (US$1.9 million) to Asola to satisfy the commitment to provide funds for capital equipment noted in (ii) above. In August 2008, we satisfied the commitment noted in (iv) above by transferring 15.0% ownership in Quantum Solar to Asola’s majority shareholder, ConSolTec GmbH (ConSolTec).

 

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Our equity in earnings of Asola was US$0.1 million and US$0.2 million for the three and six month periods ended October 31, 2010. Our equity in earnings takes into consideration the differences between German GAAP and US GAAP. Such differences are adjusted for in calculating our equity in earnings under US GAAP.

Asola has a certain long-term solar cell supply agreement dated November 1, 2007 (Supply Agreement) with one of its suppliers of solar cells for Asola’s solar module manufacturing operations. We have a related unconditional commitment under a November 2007 agreement with Asola to purchase one-half of the solar cells and to provide our share of prepayments totaling 4.5 million euro to Asola in connection the Supply Agreement. As of October 31, 2010, we had provided Asola with 3.0 million euro for our share of prepayments under the Supply Agreement. The remaining 1.5 million euro was due on September 1, 2009 but, as discussed in more detail below, the Supply Agreement is currently in dispute. We have not purchased any solar cells under our agreement with Asola and we are still obligated to provide an additional 1.5 million euros to Asola to satisfy our share of the September 1, 2009 prepayment required under the Supply Agreement. Asola has not initiated or threatened to take any action against us in connection with our obligations under our agreement with Asola.

Beginning in calendar 2009, the worldwide supply of solar cells increased and suppliers in the industry lowered prices for both the immediate delivery of solar cells and for longer term solar cell purchase arrangements. As a result of these price declines, the spot rates of solar cells for immediate delivery are significantly below the purchase prices for calendar 2009 and 2010 that are specified under the Supply Agreement. The Supply Agreement includes a “loyalty clause” that states that if a provision of the Supply Agreement proves to be unreasonable for one of the parties to the agreement, then any such circumstance will be taken account of in a fair and reasonable way. Pursuant to the Supply Agreement, Asola was required to take delivery of solar cells with a combined power of 4.0 million watts in calendar 2009 and 10.0 million watts in calendar 2010. Asola has not taken delivery of these cells and has claimed that the “loyalty clause” requires that the supplier amend the prices specified under the Supply Agreement in a reasonable manner. The matter reached an impasse with the supplier and is currently working its way through the German legal system. In August 2010, a settlement and oral hearing was held which did not change our view that we do not have a loss contract that requires a charge to be recognized.

If Asola is unable to successfully modify its remaining commitments under the Supply Agreement we may have to record a charge in the future equal to the sum of our prepayments made to date, plus the remaining unconditional commitments, less the estimated net realizable value of the solar cells to be acquired under our agreement with Asola. This amount cannot be reasonably estimated at this time based on the uncertainty with forecasting future market prices over the remaining period of the Supply Agreement. However, we currently believe that the range of a potential charge that we could be required to recognize would be limited to $11.2 million, which amount represents the total of all solar cell prepayments and other advances made by us to Asola, plus our net investment in Asola at October 31, 2010. If we complete the transaction as contemplated under the Asola LOI, the amount of potential loss that we could be exposed to under the Supply Agreement would increase as a result of us acquiring an anticipated controlling equity ownership in Asola.

Although we do not intend to purchase cells from Asola or make the scheduled prepayment that was due to Asola in September 2009 in connection with the Supply Agreement until the contractual matter discussed above is resolved, our unconditional remaining obligations, prior to any modifications discussed above, to purchase solar cells from Asola and provide our share of prepayments to Asola over the next five years (in euros and in US dollars based on the currency exchange rate as of October 31, 2010) is as follows:

 

		Euros:				US Dollars:
Two months ended December 2010		€	13,875,000			$	19,358,000
Twelve months ended December 2011			15,720,000				21,933,000
Twelve months ended December 2012			15,220,000				21,235,000
Twelve months ended December 2013			14,620,000				20,398,000
Twelve months ended December 2014			13,920,000				19,421,000
Thereafter			39,955,000				55,745,000
Total		€	113,310,000			$	158,090,000

We provided Asola with a loan in the amount of US$2.2 million on September 26, 2008 for the purpose of assisting Asola in meeting its September 2008 prepayment obligation under the Supply Agreement. The loan is evidenced by a promissory note and is guaranteed by ConSolTec, which guaranty is secured by ConSolTec’s pledge of all of its ownership interest in Quantum Solar. Per the stated terms of the note, the loan accrues interest at a 6.0% annualized rate and was set to mature upon the earlier of Asola’s completion of a capital raise of at least 20.0 million euro or March 31, 2010. Although Asola has not repaid the loan in accordance with the stated terms and we do not expect repayment during our fiscal 2011, we still consider the outstanding balance to be fully collectible. As a result, we classify the loan in noncurrent assets as part of the investment in and advances to affiliate on the accompanying condensed consolidated balance sheets at April 30, 2010 and October 31, 2010.

 

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We recorded our initial investment in Asola at cost and adjust the carrying amount of the investment to recognize advances we provide to Asola, the impacts of foreign currency translation and our share of the earnings or losses of Asola after the date of acquiring the ownership interest. The activity and carrying balances for the six month period ending October 31, 2010 is as follows:

 

		U.S. Dollars:
Investment In and Advances to Asola:
Balance at April 30, 2010		$	6,806,944
Foreign currency translation			144,516
Equity in earnings for the six months ended October 31, 2010			172,000
Net settlement of accrued interest on note receivable			(99,168	)
Balance at October 31, 2010		$	7,024,292

Power Control and Design

On October 6, 2009, we acquired a 22% interest in Power Control and Design, Inc. (PCD) in exchange for a cash payment of $165,000. PCD designs and develops control software for use in motor control, solar-to-grid, wind-turbine, electric vehicle charges and power conversion products and applications for infrastructure, automotive, aerospace and industrial markets. Our net equity in losses associated with PCD has been nominal to date and our investment balance at October 31, 2010 was $0.1 million.

Shigan Quantum

On September 3, 2009, we acquired a 25% interest in Shigan Quantum Technologies PVT LTD (Shigan Quantum), a start-up company organized under India’s Corporate Act, in exchange for transferring certain of our intellectual property to the new entity. Shigan Quantum intends to manufacture and sell gaseous fuel injectors using our technologies and variants thereof. We have not contributed any assets with a historical cost basis to the affiliate and have no obligation to fund deficit balances. The net operating activities of this affiliate have been insignificant to date and our investment balance at October 31, 2010 is nominal.

6) Goodwill, Intangibles and Other Long-lived Assets

Goodwill

The balance of goodwill by reportable segment at April 30, 2010 and October 31, 2010 is as follows:

 

		Fuel Systems Segment				Renewable Energy  Segment				Totals
Balance at April 30, 2010		$	30,400,000			$	2,458,914			$	32,858,914
Increase in estimated liabilities acquired in connection with acquisition			—				59,893				59,893
Currency translation			—				(34,851	)			(34,851	)
Balance at October 31, 2010		$	30,400,000			$	2,483,956			$	32,883,956

Intangibles

We amortize specifically identified intangible assets using the straight-line method over the estimated useful lives of the assets. In connection with the acquisition of SPI, we identified $8.6 million of project assets associated with SPI’s renewable energy portfolio that we have classified as an intangible asset of the Renewable Energy reporting segment. The intangible asset is being amortized over its estimated useful life of 20 years.

 

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Property and equipment

Changes in property and equipment for the six months ended October 31, 2010 are as follows:

 

		Balance at April 30, 2010				Additions				Transfers				Depreciation				Disposals/ Foreign Currency/ Other				Balance at October 31, 2010
Property and equipment in service, net		$	4,995,131			$	—			$	908,436			$	(671,978	)		$	(22,607	)		$	5,208,982
Construction in progress:
Wind farm development (see Note 11)			131,149				1,398,772				—				—				29,630				1,559,551
Solar module manufacturing line (see Note 11)			2,095,016				—				—				—				—				2,095,016
Leasehold improvements / plant equipment			875,491				—				(875,491	)			—				—				—
Other			—				114,026				(32,945	)			—				—				81,081
Total construction in progress			3,101,656				1,512,798				(908,436	)			—				29,630				3,735,648
Total property and equipment, net		$	8,096,787			$	1,512,798			$	—			$	(671,978	)		$	7,023			$	8,944,630

Impairment of Long-lived Assets

We believe that no event or circumstance exists that would indicate a potential impairment of the carrying values of goodwill, the intangible asset, or any other significant long-lived asset as of October 31, 2010.

 

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7) Debt Obligations

Our current and long-term debt consists of the following:

 

		April 30, 2010				October 31, 2010
Obligations to Senior Lender:
Convertible Note I: $4,588,924 principal, $173,499 accrued interest and $263,608 of unamortized premium in April 2010; $4,850,618 principal, $171,765 accrued interest and $119,661 of unamortized premium in October 2010		$	5,026,031			$	5,142,044
Convertible Note II: $4,248,595 principal, $160,632 accrued interest and $244,057 of unamortized premium in April 2010; $4,490,882 principal, $159,026 accrued interest and $110,786 of unamortized premium in October 2010			4,653,284				4,760,694
Convertible Note III: $1,919,818 principal, $72,585 accrued interest and $110,282 of unamortized premium in April 2010; $2,029,300 of principal, $71,859 of accrued interest and $50,060 of unamortized premium in October 2010			2,102,685				2,151,219
Term Note B			5,558,684				5,558,684
Consent Fee Term Note: $3,000,000 principal, less discount of $132,000 in April 2010; $3,000,000 principal in October 2010			2,868,000				3,000,000
Obligations to Other Creditors:
Investor Bridge Term Loans: $4,045,000 principal and $189,358 of unamortized discount in October 2010			—				3,855,642
Bank Term Loan			1,302,312				1,252,411
Other obligations			142,175				211,434
Long-term debt, current and non-current			21,653,171				25,932,128
Less current maturities for scheduled cash payments and net amortization of premiums & discount			(519,243	)			(19,058,220	)
Long-term debt, non-current		$	21,133,928			$	6,873,908

Convertible Notes

We have three outstanding convertible promissory notes each originally issued on August 3, 2009, which we refer to as Convertible Note I, Convertible Note II, and Convertible Note III (collectively, the “Convertible Notes”). Each of the Convertible Notes has identical contractual terms for the remainder of the arrangements.

The significant contractual terms of the amended Convertible Notes as of April 30, 2010 were as follows: (i) annual fixed interest rates of 11.5% through August 31, 2010 (consisting of required minimum payments-in-kind (PIK) of 5.0% and cash or PIK options of 6.5%), declining to 9.5% thereafter as a result of scheduled decreases in the required minimum PIK from 5.0 % to 3.0%, (ii) scheduled semi-annual interest payment dates on January 1 and July 1 of each year until maturity and the principal under the notes cannot be prepaid in part or whole by us without consent of our senior lender, (iii) scheduled maturity dates of March 31, 2011, (iv) senior lender had the right to extend the scheduled maturity dates to August 31, 2013, subject to proper notice by March 15, 2011, and (v) outstanding principal under the Convertible Notes convertible into shares of our common stock at a fixed conversion price of $0.71 per share at any time until maturity at the option of the senior lender.

Since the date that the Convertible Notes were modified on April 30, 2010, we have classified the value, if any, of the embedded conversion features of the notes as equity.

On July 1, 2010, we elected to add the entire amount of accrued interest to principal under the Convertible Notes that was payable on the scheduled semi-annual interest payment date in accordance with the PIK provisions contained within the notes.

On July 8, 2010, the Convertible Notes and the Consent Fee Term Note (discussed below) were amended in exchange for a debt modification fee payable to the senior lender. We satisfied the debt modification fee with the issuance of 1.7 million shares of our common stock to the senior lender that had a fair value of $0.9 million on the modification date and

 

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recorded the fair value of the fee as a deferred asset. The Convertible Notes were revised to amend the stated maturity dates from March 31, 2011 to July 31, 2011. As a result of these modifications, we no longer have any contractual requirement to remit cash to service any potential principal reductions on the Convertible Notes until at least July 31, 2011.

We determined that the amendments to the Convertible Notes on July 8, 2010 were not substantial and did not represent an implied exchange of debt instruments. However, we reduced the balances of the unamortized debt premiums under the Convertible Notes as of July 8, 2010 by approximately $0.1 million, which equaled the immediate increase in fair value of the embedded conversion features under the Convertible Notes as a result of the modifications. The net balances of the debt premiums and the fair value of the debt modification fee are being amortized through July 31, 2011, which represents the amended scheduled maturity dates.

Term Note B

At April 30, 2010 and October 31, 2010, the significant contractual terms of Term Note B that was initially issued on January 16, 2008 were as follows: (i) fixed interest rate of 6.5% payable monthly in arrears, (ii) scheduled maturity date of January 16, 2015, (iii) the note has no scheduled principal amortization payments before maturity; however, our senior lender with proper notice has the option to demand all or part of the principal amount due under the note at any time, (iv) the note can be repaid in cash or restricted shares at our option, subject to certain conditions, including that our share price must be at least $0.50 for five consecutive business days prior to the payment date; however, this specific condition is only applicable for principal demands made by the senior lender after January 16, 2012, (v) we have the right to make prepayments under the note beginning on January 16, 2012 (the “First Call Date”); however, our option to make prepayments in shares is limited to $2.0 million in any ten business day period after the First Call Date, and (vi) when demand for payment or a prepayment is made, the principal amount due under Term Note B is subject to upward adjustment based upon the volume weighted average price (VWAP) for our common stock for the five business days immediately prior to the repayment date (the “VWAP Price”). When demand for payment is made by the senior lender or called by us, the actual amount required to be paid in satisfaction of the amount so demanded or called is equal to the greater of (A) 1.0 and (B) 1.5 multiplied by the lesser of (x) the VWAP for our common stock for the five business days immediately prior to the repayment date and (y) $3.50.

We refer to the required formula discussed above as the Term Note B principal multiplier feature. If we elect to pay in stock, then the number of shares to be issued is equal to the actual amount required to be paid (determined in accordance with the above formula) divided by the VWAP Price. Based on the foregoing formula, the principal multiplier only increases the amount payable above the face value of the note (i.e. has “intrinsic value”) when our VWAP Price is above $0.66 per share.

As of October 31, 2010, the minimum amount of principal that is payable through the maturity date under the principal multiplier feature is $5.6 million and the maximum amount of principal that is payable under the principal multiplier feature is $29.2 million (assuming that the VWAP Price is at or above $3.50). The principal multiplier feature under the note did not have any intrinsic value as of this date.

Term Note B has characteristics of and acts consistent with the types of debt securities generally considered to be convertible debt instruments primarily as a result of the embedded principal multiplier feature which provides the senior lender with potential additional value for their investment in connection with increases in our share price in a manner consistent with conversion features under typical convertible note instruments. Further, the share settlement provisions and below market interest rate structure of Term Note B is consistent with convertible debt instruments. As such, we consider the note to be a convertible debt instrument in applying applicable accounting guidance. Since the date that the note was last modified on April 30, 2010, we have classified the value, if any, of the embedded principal multiplier feature as equity.

Consent Fee Term Note

The terms of our credit facilities with our senior lender required that we obtain the consent of our senior lender prior to entering into the Arrangement Agreement with SPI (see Note 2). On November 24, 2009, we and our senior lender executed a consent fee arrangement under which the senior lender agreed to give its consent to the proposed business combination. The consent fee was $3.0 million unless the business combination agreement was terminated in which case the consent fee would have automatically been reduced to $1.5 million. The consent fee was paid by delivery of a promissory term note (the “Consent Fee Term Note”) on November 24, 2009.

At April 30, 2010 the significant contractual terms of the Consent Fee Term Note were as follows: (i) note accrues interest at 0.0% per annum for the first full year and at 6.0% thereafter, (ii) scheduled maturity date of January 16, 2015, (iii) the note has no scheduled principal amortization payments before maturity; however, our senior lender with proper notice had the option to demand all or part of the principal amount due under the note beginning after July 1, 2010 if the VWAP for our common stock for the five business days preceding the date that a demand is made would have been above $0.50 at the time of the demand, otherwise, the senior lender could not make demand until March 31, 2011, (iv) the note can

 

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be repaid in cash or restricted shares at our option, subject to certain conditions, including that our share price must be at least $0.50 for five consecutive business days prior to the payment date; however, this specific condition is only applicable for principal demands made by the senior lender after March 31, 2011, (v) we have the right to make prepayments under the note beginning after January 16, 2012, and (vi) when demand for payment or a prepayment is made, the principal amount due under the Consent Fee Term Note is subject to upward adjustment based upon the VWAP for our common stock for the five business days immediately prior to the repayment date. When demand for payment is made by the senior lender or called by us, the actual amount required to be paid in satisfaction of the amount so demanded or called is equal to the greater of (a) the amount so demanded or called and (b) that amount determined by multiplying the principal amount so demanded or called by 0.8, with that product then multiplied by the lesser of (x) the VWAP Price and (y) $2.50.

We refer to the required formula discussed above as the Consent Fee Term Note principal multiplier feature. If we elect to pay in stock, then the number of shares to be issued is equal to the actual amount required to be paid (determined in accordance with the above formula) divided by the VWAP Price. Based on the foregoing formula, the principal multiplier only increases the amount payable above the face value of the note (i.e. has “intrinsic value”) when our VWAP Price is above $1.25 per share.

Similar to Term Note B, the Consent Fee Term Note is also considered to be a convertible debt instrument in applying applicable accounting guidance. Since the date that the acquisition of SPI was completed on April 16, 2010, which resolved a contingency in the contractual terms of the original note, we classify the value, if any, of the embedded principal multiplier feature as equity.

A debt discount, initially recognized at $0.5 million upon the issuance of the note in November 2009, was fully amortized through July 1, 2010 which was the first possible date that the senior lender could demand repayment of the note under the original terms of the note.

On July 8, 2010, the earliest date specified in the original Consent Fee Term Note that the senior lender could make a demand if our VWAP Price was below $0.50 was amended from March 31, 2011 to July 31, 2011. As a result of this modification, we have no contractual requirement to remit cash to service any potential principal reductions on the note until at least July 31, 2011. We determined that there was no change in the fair value of the embedded principal multiplier as a result of the debt modification and determined that the amendment to the Consent Fee Term Note was not substantial and did not represent an implied exchange of debt instruments.

As of October 31, 2010, the minimum amount of principal that is payable through the maturity date under the principal multiplier feature is $3.0 million and the maximum amount of principal that is payable under the principal multiplier feature is $6.0 million (assuming that the VWAP Price is at or above $2.50). The principal multiplier feature under the note did not have any intrinsic value as of this date.

Investor Bridge Term Loans

On October 13, 2010 and October 19, 2010, we received total cumulative gross proceeds of $4.0 million in connection with the closing of a private placement transaction with certain accredited investors in exchange for issuing senior subordinated bridge notes payable (collectively, the “Bridge Notes”) and warrants to the investors. The significant terms of the Bridge Notes on the origination dates were as follows: (i) scheduled maturity dates of December 31, 2010, (ii) interest at 15.0% per annum, payable in cash upon maturity, (iii) principal payable in cash and cannot be prepaid, (iv) no conversion rights by note holders, and (v) notes are subordinate to outstanding obligations under debt instruments held by our senior lender.

We incurred direct issuance costs of $0.7 million in connection with the private placement transaction of which we allocated $0.6 million to the Bridge Notes which is being amortized to interest expense over the life of the notes with the remaining $0.1 million allocated to the related warrants (see Note 10). In addition, we recorded a debt discount on the origination date of the Bridge Notes equal to the fair value of the warrants issued with the Bridge Notes of $0.2 million that is being amortized over the life of the notes.

Bank Term Loan

In connection with our acquisition of SPI on April 16, 2010, we assumed a bank term loan that had an original principal amount of Canadian Dollar (CAD) 1.5 million upon its inception on April 3, 2007. The note accrues interest at a fixed rate of 7.0%; requires fixed payments of CAD 13,482 per month in cash through March 10, 2012, with the remaining principal amount of CAD 1.2 million due in cash on the maturity date of April 3, 2012. The loan is secured by power generation machinery and equipment and other assets of SPI’s Providence Bay Wind Farm project. The conversion rate of one CAD to one US Dollar was 0.98 to 1.0 as of October 31, 2010.

 

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Lender Commitment

On May 30, 2008, we secured the $10.0 million Lender Commitment from an affiliate of our senior lender that allows us to draw on the commitment at our option and also allows the senior lender to fund the commitment at the senior lender’s option under certain defined structures.

The option for either party under the Lender Commitment, as last modified on November 24, 2009, expires on March 31, 2011. To date, neither party has exercised its option. The terms of the amended Lender Commitment are as follows: (a) should we choose to draw on the commitment, the senior lender has the right to make the investment as either: (i) a two year secured convertible note, the conversion price fixed at $0.71 per share, with the coupon on the note equal to 18.0% that can be added to the principal at our option under a PIK provision or (ii) a senior secured straight note that redeems in cash at 130% of face value after one year; (b) we may only exercise up to $2.5 million in any 30 day period and we are required to provide the senior lender with a five day notice period of our intent to draw on the commitment; (c) in exchange for extending the commitment, the senior lender has the “put” option to make a $10.0 million investment that will be structured as a non-interest bearing convertible note priced at 100.0% of par and redeemable at 120.0% of par two years after the funding date and the note under this structure would convert into our common stock at a fixed conversion price of $0.71 per share.

Since we are limited to drawing down a maximum of $2.5 million in any 30 day period, we must provide notice to the senior lender beginning on or before December 20, 2010 in order to have full access to the commitment prior to the March 31, 2011 expiration date.

The written put option, which allows the senior lender to make a $10.0 million cash payment to us in exchange for a debt instrument in the form of a convertible note, is considered to be a derivative instrument. Accordingly, the fair value of the instrument is recognized as a non-current derivative liability and marked to market each period (see Note 8).

Collateral and Covenants

Our obligations under the debt instruments with our senior lender and senior subordinated debt holders are secured by substantially all our assets. In addition, our obligations under the Bank Term Loan assumed on April 16, 2010 are secured by the assets of SPI. We were in compliance with existing covenants and other requirements of the debt instruments with our senior lender, senior subordinated debt holders and our bank lender as of October 31, 2010.

Debt Maturities

The table below shows scheduled maturities of our long-term debt for each of the next five year periods ending October 31. Although the senior lender has the option to extend the scheduled maturity dates on the amended Convertible Notes, for purposes of this disclosure, we have used the scheduled maturity dates of October 31, 2011 for these three notes:

 

		Scheduled Payments				Net Amortization of Premiums & Discount				Total Maturities of Long-Term Debt
October 31:
2011		$	18,967,071			$	91,149			$	19,058,220
2012			6,784,813				—				6,784,813
2013			47,245				—				47,245
2014			39,338				—				39,338
2015			2,512				—				2,512
Thereafter			—				—				—
		$	25,840,979			$	91,149			$	25,932,128

 

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8) Derivative Instruments and Fair Value Measurements

We measure our financial assets and liabilities in accordance with Fair Value Measurements and Disclosures under GAAP, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. GAAP describes three different valuation techniques to be used in determining fair value for financial assets and liabilities: the market, income or cost approaches. The three valuation techniques are consistent with generally accepted valuation methodologies. The hierarchy which prioritizes the inputs used to measure fair value from market based assumptions to entity specific assumptions are as follows:

Level 1: Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation.

We measure financial instruments that we consider to be derivatives at fair value on a recurring basis, which at April 30, 2010 and October 31, 2010 consisted of the Lender Commitment (see Note 7) and certain warrant contracts (see Note 10).

Our derivative instruments are measured on their respective origination dates, at the end of each reporting period and at other points in time when necessary, such as modifications, using Level 3 inputs. We do not report any financial assets or liabilities that we measure using Level 1 or Level 2 inputs and there were no transfers in or out of Level 3 for the first six months of fiscal 2011.

The derivatives and their respective fair values measured using Level 3 inputs as of April 30, 2010 and October 31, 2010 are as follows:

 

		April 30, 2010				October 31, 2010
Derivative instruments classified as current liabilities:
Warrant contracts issued in October 2006		$	4,160,000			$	3,559,000
Warrant contracts issued in June 2007			4,100,000				1,937,000
Warrant contracts issued in August 2008			4,287,000				2,810,000
			12,547,000				8,306,000
Derivative instruments classified as non-current liabilities:
Written Put Option under $10.0 million Lender Commitment			5,518,000				2,844,000
Warrant contracts issued in August & September 2009			1,151,000				584,000
			6,669,000				3,428,000
Total balance of derivative instruments		$	19,216,000			$	11,734,000

We determined the fair values of the derivative instrument liabilities associated with the written put option contained within the Lender Commitment and certain warrant contracts primarily based on option-pricing mathematical models generally referred to as “Black-Scholes” and “Monte Carlo” option-pricing models. These models determine the value of the derivative instruments based on complex mathematical formulas that assume that returns on our underlying stock are normally-distributed and that risk-free interest rates and stock volatilities will remain constant over the term of the contract. We used the Black-Scholes model to calculate the value of the June 2007 Warrants, the August 2009 Warrants and the September 2009 Warrants. For the written put option contained within the Lender Commitment and the derivative warrant contracts that incorporate more complex terms, including exercise price reset provisions (the October 2006 Warrants and the August 2008 Warrants), we utilize the Monte Carlo model which is similar to the Black-Scholes model; however, the Monte Carlo model simulates several thousand possible (but random) price paths for the underlying value of the derivative instruments. These random price paths are then averaged to determine the value of the derivative instruments as of the reporting period date.

 

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The following table summarizes the changes in the fair value during the three and six months ended October 31, 2010 for the derivative instrument liabilities using Level 3 inputs:

 

		Written Put Option				Warrants				Total
Balance at April 30, 2010		$	5,518,000			$	13,698,000			$	19,216,000
Fair value adjustments recognized in earnings			(1,082,000	)			(2,330,000	)			(3,412,000	)
Balance at July 31, 2010		$	4,436,000			$	11,368,000			$	15,804,000
Fair value adjustments recognized in earnings			(1,592,000	)			(2,478,000	)			(4,070,000	)
Balance at October 31, 2010		$	2,844,000			$	8,890,000			$	11,734,000

The fair value of derivative instrument liabilities measured with Level 3 inputs are revalued quarterly. The assumptions used in the calculations under our binomial and/or option pricing models as of April 30, 2010 and October 31, 2010 were as follows:

 

		Written Put Option				October ‘06 Warrants				June ‘07 Warrants				August ‘08 Warrants				Aug/Sept ‘09 Warrants
April 30, 2010:
Annual volatility (1)			89.3	%			79.7	%			77.4	%			72.8	%			77.4%-94.5	%
Risk-free rate			1.5	%			2.0	%			2.4	%			2.4	%			1.2%-2.0	%
Discount rate for cash payments			14.3	%			N/A				N/A				N/A				N/A
Dividend rate			0.0	%			0.0	%			0.0	%			0.0	%			0.0	%
Closing price of Quantum stock		$	0.70			$	0.70			$	0.70			$	0.70			$	0.70
Conversion / exercise price		$	0.71			$	0.55			$	2.09			$	3.13			$	0.85
October 31, 2010:
Annual volatility (1)			93.2	%			86.0	%			80.7	%			76.8	%			82.5%-90.2	%
Risk-free rate			0.4	%			0.5	%			0.8	%			1.2	%			0.3%-0.8	%
Discount rate for cash payments			15.7	%			N/A				N/A				N/A				N/A
Dividend rate			0.0	%			0.0	%			0.0	%			0.0	%			0.0	%
Closing price of Quantum stock		$	0.46			$	0.46			$	0.46			$	0.46			$	0.46
Conversion / exercise price		$	0.71			$	0.53			$	2.09			$	2.88			$	0.85

 

(1)	Annual volatility is based on the historical average of our identified peer group for a period consistent with the remaining term of the contract.

Fair Value Option

We have adopted ASC Topic No. 825 “Financial Instruments” (ASC 825), which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. We did not elect to adopt the fair value option for any of our financial assets or liabilities that were not already measured on a recurring basis. Based on certain qualifying events, we may elect to adopt the fair value option in the future for certain financial assets and liabilities.

We apply fair value techniques on a non-recurring basis associated with valuing potential impairment losses related to goodwill and other long-lived assets (see Note 6).

 

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9) Warranties

We offer a warranty for all of our alternative fuel products. The specific terms and conditions of those warranties vary depending on the platform and model year. Warranty is provided for under terms similar to those offered by the original equipment manufacturer (OEM) to its customers. We estimate the costs that may be incurred under our warranty provisions and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and cost per claim.

We generally disclaim all warranties on our prototype hydrogen fuel storage systems. At our discretion or under certain programs, we may provide for the replacement cost or perform additional tests of prototype component parts subsequent to product delivery. We include an estimate of these types of arrangements as part of our warranty liability. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.

Changes in our product warranty liability for the six months ended October 31, 2010 are as follows:

 

Balance at April 30, 2010		$	89,754
Warranties issued during the period			30,275
Adjustments to pre-existing warranties			1,042
Settlements made during the period (1)			(20,251	)
Balance at October 31, 2010		$	100,820

 

(1)	Consists of material and labor costs incurred to repair or replace products under warranty contracts.

10) Stockholders’ Equity

Stock Incentive Plan

We have one stock option plan, the 2002 Stock Incentive Plan (the “Plan”), which provides that options to purchase shares of our common stock and awards of restricted stock may be granted to directors, employees, associates and consultants. Options expire ten years after the date of grant or 30 days after termination of employment and generally vest ratably at the rate of 25% on each of the first four anniversaries of the grant date. New shares are issued to satisfy stock option exercises under the Plan. Options awarded are granted with an exercise price equal to the market price of our stock at the date of grant. Restricted stock generally cliff vests on the third anniversary of the grant date.

Share-Based Compensation

We have included the following amounts for share-based compensation cost in the accompanying condensed consolidated statements of operations:

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Cost of product sales		$	4,556			$	8,632			$	9,780			$	13,059
Research and development			49,698				40,557				69,636				66,808
Selling, general and administrative			157,585				302,737				433,598				489,672
Total share-based compensation		$	211,839			$	351,926			$	513,014			$	569,539

 

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Below is a summary of the options activity under the Plan for the six months ended October 31, 2010:

 

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Life (In Years)				Aggregate Intrinsic  Value
Options outstanding at April 30, 2010			4,260,453			$	1.08
Granted			4,040,000			$	0.59
Exercised			—			$	—
Forfeited			(103,500	)		$	0.63
Expired			(8,195	)		$	4.84
Options outstanding at October 31, 2010			8,188,758			$	0.84
Vested and expected to vest at October 31, 2010			7,571,503			$	0.86				7.3			$	—
Options exercisable at October 31, 2010			3,261,735			$	1.14				4.7			$	—

On May 1, 2010, an additional 5.1 million shares of common stock became available for future grant under the Plan pursuant to an “evergreen” provision contained in the Plan. At October 31, 2010, there were 6.3 million shares of common stock available for grant under the Plan.

The fair value of options granted was estimated using the following weighted-average assumptions:

 

		Three Months  Ended October 31,								Six Months Ended October  31,
		2009				2010				2009				2010
Dividend yield			n/a				0.0	%			n/a				0.0	%
Expected life - years			n/a				6.2				n/a				6.2
Risk-free interest rate			n/a				2.0	%			n/a				2.0	%
Expected volatility of common stock			n/a				89.4	%			n/a				89.4	%

A summary of the grant date fair value and intrinsic value information is as follows:

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Weighted average grant date fair value per share			None granted			$	0.44				None granted			$	0.44
Intrinsic value of options exercised		$	2,250				No activity			$	2,250				No activity
Total fair value of options vested during the period		$	60,146			$	324,291			$	119,797			$	393,119

Warrants

In connection with a $12.5 million private placement offering completed on June 29, 2006, investors received warrants to purchase 0.9 million shares of our common stock at an exercise price of $3.94 per share to the investors (the “June 2006 Warrants”). The warrants can be exercised at any time and expire in June 2011.

In connection with a $10.0 million private placement offering completed on October 27, 2006, investors received warrants to purchase 2.1 million shares of our common stock at an initial exercise price of $2.36 per share (the “October 2006 Warrants”). The warrants can be exercised at any time and expire in April 2014.

In connection with a $18.75 million private placement offering that was completed on June 22, 2007, investors received warrants to purchase 15.0 million shares of our common stock at $2.09 per share, which included 2.5 million shares provided to the October 2006 investors in exchange for those investors waiving certain rights obtained in the October 2006 private placement (the “June 2007 Warrants”). The warrants can be exercised anytime and expire in December 2014.

 

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In connection with a $19.1 million registered direct offering completed on August 25, 2008, the investor received warrants to purchase 13.5 million shares of our common stock at an initial exercise price of $4.00 per share (the “August 2008 Warrants”). The warrants can be exercised at any time and expire in August 2015.

In connection with a $12.3 million private placement offering completed in two rounds that closed on August 3, 2009 (the “August 2009 Warrants”) and September 4, 2009 (the “September 2009 Warrants”), investors received warrants to purchase 2.0 million shares of our common stock at an exercise price of $0.85 per share to the investors. The warrants became exercisable beginning in February 2010, of which 0.6 million relate to the August 2009 Warrants and expire in August 2014 and 1.4 million relate to the September 2009 Warrants and expire in September 2014. In connection with the transaction, the placement agent also received 1.0 million in warrants to purchase shares of our common stock at an exercise price of $0.85 per share that became exercisable beginning in March 2010, of which 0.7 million expire in September 2012 and 0.3 million expire in September 2014.

On April 16, 2010, in connection with the acquisition of SPI, we provided the former SPI warrant holders with Quantum replacement warrants that allowed these former SPI warrant holders to purchase up to 2.1 million shares of our common stock at exercise prices ranging from $0.48 to $2.41 per share (the “April 2010 Replacement Warrants”). On August 21, 2010, 1.5 million of the replacement warrants expired. The remaining replacement warrants have an exercise price of $0.88 per share and expire on May 13, 2011. The fair value of the replacement warrants on the closing date was included as part of the consideration paid in connection with the acquisition (see Note 2).

In connection with a $10.9 million private placement offering completed on various dates from April 2010 through July 2010 (the “Spring 2010 Warrants”), investors received warrants to purchase 3.9 million shares of our common stock at an exercise price of $0.91 per share to the investors. The warrants became exercisable beginning in October 2010. In connection with the transaction, the placement agent also received 2.4 million in warrants to purchase shares of our common stock at an exercise price of $0.91 per share that became exercisable beginning in October 2010. The warrants expire five years from the date they were issued (April 2015 thru July 2015). The net amount received by us from the transactions, after deducting placement agent fees and offering expenses, was approximately $9.3 million (of which $6.2 million was received in the first quarter of fiscal 2011).

On October 13, 2010 and October 19, 2010, in connection with the issuance of the Bridge Notes, investors received warrants to purchase 0.7 million shares of our common stock at an exercise price of $0.67 per share (the “October 2010 Warrants”). The warrants expire five years from the date they were issued. We recorded a debt discount on the origination date of the Bridge Notes equal to the fair value of the October 2010 Warrants of $0.2 million that is being amortized over the life of the notes (see Note 7).

We evaluate the warrants provided in connection with each of our private placement or public offerings and we have concluded that liability classification is appropriate for warrants issued in October 2006, June 2007, August 2008, August 2009 and September 2009. We have further concluded that equity classification is appropriate for the warrants that we refer to as the June 2006 Warrants, the Spring 2010 Warrants and the October 2010 Warrants due to the fact that these warrants are required to be physically settled in shares of our common stock and there are no provisions that could require net-cash settlement. The proceeds from the transactions in June 2006, in the spring of 2010 and in October 2010 that gave rise to these warrants have been allocated to the stock or debt and the warrants based on their relative fair values. We aggregate the values allocated between the stock and warrants for financial reporting purposes as both types of instruments issued in June 2006 and in the spring of 2010 have been classified as permanent equity. The classification as equity for the June 2006 Warrants, the Spring 2010 Warrants and the October 2010 warrants could change as a result of either future modifications to the existing terms of settlement or the issuance of new financial instruments by us that could be converted into an increased or unlimited number of shares. If a change in classification of these warrants is required in the future, the warrants would be treated as derivatives, brought onto the balance sheet at their fair value, and marked to market each period, with the changes in fair values being recognized in the respective period’s statement of operations.

The October 2006 Warrants, the June 2007 Warrants and the August 2008 Warrants contain contractual provisions that could potentially require us to net-cash settle the value of the remaining outstanding warrants in the event of a change in control or other fundamental change in Quantum in the future. Since the contractual provisions that could require us to net-cash settle the warrants are not within our control, equity classification is precluded. As such, we consider these warrants to be derivative instruments that are classified as current liabilities, recorded at fair value and marked to market each period, with the changes in fair values being recognized in the respective period’s statement of operations.

Further, the August 2009 Warrants and the September 2009 Warrants contain cashless warrant exercise provisions whereby the settlement calculation may incorporate the book value per share of common stock if there is not a public market for the common stock. Under GAAP, if an instrument’s settlement calculation incorporates variables other than those used to determine the fair value of a fixed-for-fixed forward or option on equity shares, the instrument would not be considered

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

indexed to the entity’s own stock and therefore would not be precluded from derivative instrument consideration. As such, we consider these warrants to be derivatives that are classified as non-current liabilities, recorded at fair value and marked to market each period, with the changes in fair values being recognized in the respective period’s statement of operations.

The fair values of the derivative liabilities associated with warrant contracts as of April 30, 2010 and October 31, 2010, and a summary of the changes in the fair values of those derivative instruments during the six months ended October 31, 2010 are disclosed in Note 8.

The October 2006 Warrants and the August 2008 Warrants also contain contractual provisions which, subject to certain exceptions, reset the initial exercise price of such warrants if at any time while such warrants are outstanding, we sell or issue shares of our common stock or rights, warrants, options or other securities or debt convertible, exercisable or exchangeable for shares of our common stock at a price below $2.36 for the October 2006 Warrants or $4.00 for the August 2008 Warrants, provided that the exercise price for the August 2008 Warrants cannot be reset below $1.93. Since the initial issuance of these warrants, we have completed certain subsequent capital transactions that have contractually reset the exercise price of the October 2006 Warrants and August 2008 Warrants to $0.53 and $2.88 as of October 31, 2010, respectively. As a result of exercise price resets to date and in the event of further price resets to the October 2006 Warrants and/or the August 2008 Warrants, the number of shares of our common stock that is subject to such warrants contractually increases so that the aggregate purchase price payable applicable to the exercise of the warrants after the reset of the exercise price is the same as the aggregate purchase price payable immediately prior to the reset. As a result of the exercise price resets, the number of shares subject to the October 2006 Warrants increased to 7.4 million as of October 31, 2010 and the number of shares subject to the August 2008 Warrants increased to 18.7 million as of October 31, 2010. Any resets to the exercise price of the October 2006 Warrants and/or August 2008 Warrants in the future will have an additional dilutive effect on our existing shareholders.

Warrant activity and warrants outstanding for the six month period ending October 31, 2010, reportable in the equivalent number of shares of our common stock that can be purchased upon exercise of the warrants, is as follows:

 

		Total Warrants
Warrants outstanding at April 30, 2010			46,666,435
Issued - original number			5,791,097
Issued - additional number			1,723,805
Expired			(1,466,440	)
Warrants outstanding at October 31, 2010			52,714,897

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

Shares Available

The number of undesignated shares available as of October 31, 2010, is as follows:

 

						Common Stock				Series B Common Stock				Preferred Stock
Shares authorized							398,000,000				2,000,000				20,000,000
Less shares issued and outstanding at October 31, 2010							(186,960,246	)			(999,969	)			—
Less shares designated for issuance under:
Stock options							(8,188,758	)			—				—
Warrants							(52,714,897	)			—				—
Conversion of principal under convertible notes			(1	)			(16,582,325	)			—				—
Lender Commitment			(2	)			(14,084,507	)			—				—
Total shares designated for future issuance							(91,570,487	)			—				—
Undesignated shares available							119,469,267				1,000,031				20,000,000
Other instruments in which share settlement is at Company option:
Principal repayment in shares under Term Note B			(3	)			11,117,368				—				—
Principal repayment in shares under Consent Fee Term Note			(3	)			6,000,000				—				—

 

(1)	Represents number of shares upon conversion of $11.8 million of principal and interest outstanding under three convertible notes at a fixed conversion price of $0.71 per share.

(2)	Represents the maximum possible shares issuable under the $10 million Lender Commitment if it becomes outstanding and is structured as a convertible note at a fixed conversion price of $0.71 per share.

(3)	Repayment of principal in shares is at our option, subject to certain conditions, including that our share price must be at least $0.50 for five consecutive business days prior to the payment date; represents the number of shares necessary for repayment of our term debt assuming $0.50 per share.

Stockholders’ Equity Roll-forward

The following table provides a condensed roll-forward of stockholders’ equity for the six months ended October 31, 2010:

 

		Common Stock Shares				Total  Equity (Deficit)
Balance at April 30, 2010			169,155,324			$	24,002,934
Share-based compensation on stock option and restricted stock awards			1,888,596				569,539
Issuance of common stock to investors			13,147,236				6,221,344
Issuance of common stock in connection with debt modification			1,660,000				878,140
Issuance of common stock in exchange for legal and consulting services			1,109,090				600,000
Issuance of warrants in connection with debt issuance, net of fees							200,207
Foreign currency translation			—				221,846
Change in non-controlling interests							(12,340	)
Debt premium reduction associated with debt modification							92,000
Net loss			—				(3,069,407	)
Balance at October 31, 2010			186,960,246			$	29,704,263

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

Comprehensive Income or Loss

The following table sets forth the reconciliation of net loss to comprehensive loss:

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Comprehensive loss, net of tax:
Net loss, as reported		$	(42,672,895	)		$	(1,454,792	)		$	(54,937,061	)		$	(3,069,407	)
Currency translation adjustments			288,456				593,003				644,060				221,846
Comprehensive loss, net of tax:		$	(42,384,439	)		$	(861,789	)		$	(54,293,001	)		$	(2,847,561	)

11) Business Segment and Geographic Information

Business Segments

We classify our business operations into three reporting segments: Electric Drive & Fuel Systems, Renewable Energy (beginning April 16, 2010 with the acquisition of SPI) and Corporate.

The chief operating decision maker allocates resources and tracks performance by the reporting segments. We evaluate performance based on profit or loss from operations before interest and income taxes.

Electric Drive & Fuel Systems Segment

Our Electric Drive & Fuel Systems segment supplies advanced propulsion and fuel systems for alternative fuel vehicles to OEM customers for use by consumers and for commercial and government fleets. We also provide our propulsion systems and hydrogen storage products for hybrid and fuel cell applications to major OEMs and certain governmental agencies through funded research and development contracts and on a prototype and production intent basis. This segment’s business operations primarily consist of design, integration and supply of electric drive and control system technologies and manufacture and supply of packaged fuel systems for use in hybrid, plug-in electric hybrid, hydrogen, fuel cell, and other alternative fuel vehicles.

Our Electric Drive & Fuel Systems segment generates product revenues through the sale of hydrogen fuel storage, fuel delivery, and electronic control systems to OEMs, the installation of our systems into OEM vehicles, and the sale of transportable hydrogen refueling stations. Product revenues are also generated through the sale of compressed natural gas (CNG), propane (LPG), and hydrogen fuel storage, fuel delivery, and electronic control systems for internal combustion engine applications.

Our Electric Drive & Fuel Systems segment also generates contract revenue by providing engineering design and support to OEMs so that our advanced propulsion systems integrate and operate with the OEM’s hybrid or fuel cell applications. Contract revenue is also generated from customers in the aerospace industry, military and other governmental entities and agencies, and other strategic alliance partners.

Renewable Energy Segment

Our Renewable Energy segment consists solely of the business operations of SPI. SPI, headquartered in Toronto, Ontario, Canada, is an independent power producer, developer of renewable energy projects and provider of related development services. SPI is a licensed electricity generator and wholesaler.

SPI owns and operates a 1.6 megawatt wind farm in Ontario, Canada and generates revenue from the sale of energy under the terms of Power Purchase Agreements (PPAs) with Bullfrog Power, Inc.

In addition to energy sales on our existing wind farm and future wind and solar energy farms that we are currently developing, we anticipate generating revenues and cash flows through the sale of ownership interests in our renewable energy projects and through development and construction services for renewable energy projects owned by third parties.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

SPI is currently in the advanced stages of developing the Spring Bay Wind Farm located in Ontario, Canada. During the first six months of fiscal 2011, $1.3 million of costs associated with the Spring Bay Wind Farm were incurred and recorded as construction in progress (see Note 6). The build out of the project will require approximately $15 million of project capital to be raised in the coming months in order for us to bring the project online as scheduled in April 2011. We currently have a conditional commitment from a lender to provide for debt financing of the project.

Corporate Segment

The Corporate segment consists of general and administrative expenses incurred at the corporate level that are not directly attributable to the Electric Drive & Fuel Systems or Renewable Energy reporting segments. Corporate expenses consist primarily of personnel costs, share-based compensation costs and related general and administrative costs for executive, finance, legal, human resources, investor relations and the board of directors.

All activities of Quantum Solar, which is still in the preliminary phase of its anticipated solar module manufacturing operation are included in our Corporate segment and to date principally consist of partial payments on long lead assembly equipment under construction for solar module production capability (see Note 6). Once Quantum Solar commences its manufacturing operations, we anticipate that we will report these activities under a new business segment separate from the Electric Drive & Fuel Systems, Renewable Energy and Corporate reporting segments.

Geographic Information

Our long-lived assets as of April 30, 2010 and October 31, 2010 are primarily based within facilities in Irvine and Lake Forest, California and on our wind farm located in Ontario, Canada. We also own land in Nova Scotia, Canada that we are developing as a renewable energy project. Our affiliate, Asola, is based in Erfurt, Germany.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

Financial Information by Business Segment

Selected financial information by business segment for continuing operations follows (in thousands):

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Total Revenue
Electric Drive & Fuel Systems		$	2,655			$	3,729			$	5,749			$	7,044
Renewable Energy			—				156				—				401
Corporate			—				—				—				—
Total		$	2,655			$	3,885			$	5,749			$	7,445
Operating Loss
Electric Drive & Fuel Systems		$	(2,776	)		$	(2,228	)		$	(4,748	)		$	(4,150	)
Renewable Energy			—				(422	)			—				(778	)
Corporate			(1,849	)			(2,208	)			(4,428	)			(4,556	)
Total		$	(4,625	)		$	(4,858	)		$	(9,176	)		$	(9,484	)
Product Gross Profit (Loss)
Electric Drive & Fuel Systems:
Net product sales		$	425			$	768			$	612			$	1,350
Cost of product sales			(595	)			(864	)			(861	)			(1,363	)
Gross profit (loss)		$	(170	)		$	(96	)		$	(249	)		$	(13	)
Renewable Energy:
Net product sales		$	—			$	67			$	—			$	129
Cost of product sales			—				(14	)			—				(75	)
Gross profit (loss)		$	—			$	53			$	—			$	54
Capital Expenditures
Electric Drive & Fuel Systems		$	171			$	59			$	359			$	115
Renewable Energy			—				70				—				1,398
Corporate			—				—				—				—
Total		$	171			$	129			$	359			$	1,513
Depreciation
Electric Drive & Fuel Systems		$	279			$	303			$	623			$	584
Renewable Energy			—				41				—				71
Corporate			10				8				21				17
Total		$	289			$	352			$	644			$	672
Amortization of Intangibles
Renewable Energy		$	—			$	102			$	—			$	206

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

Identifiable assets by reporting segment is as follows (in thousands):

 

		April 30, 2010				October 31, 2010
Identifiable Assets
Electric Drive & Fuel Systems		$	38,777			$	40,597
Renewable Energy - asset held for sale			2,090				2,061
Renewable Energy - all other assets			14,718				15,096
Corporate			17,433				17,836
		$	73,018			$	75,590

Research and development is expensed as incurred and is related to the operations of the Electric Drive & Fuel Systems and Renewable Energy business segments for each of the periods presented. Research and development expense includes both customer-funded research and development and internally-sponsored research and development. Customer-funded research and development consists primarily of expenses associated with contract revenue. These expenses include applications development costs in our Electric Drive & Fuel Systems business segment that are funded under customer contracts.

12) Earnings (Loss) Per Share

We compute net income (loss) per share by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares outstanding during the period. We consider common equivalent shares from the exercise of stock options, warrants and convertible debt payable in the instance where the shares are dilutive to our net income. The effects of stock options, warrants and convertible debt were anti-dilutive for all periods presented.

The following table sets forth the computation of basic and diluted loss per share:

 

		Three Months  Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Numerator for basic and diluted loss per share data - attributable to common stockholders:
Net loss		$	(42,672,895	)		$	(1,454,792	)		$	(54,937,061	)		$	(3,069,407	)
Denominator for basic and diluted loss per share data - weighted-average shares			121,890,999				187,799,269				113,326,834				184,082,954
Basic and diluted loss per share:
Net loss attributable to stockholders		$	(0.35	)		$	(0.01	)		$	(0.48	)		$	(0.02	)

For the three month and six month periods ending October 31, 2010, shares of common stock potentially issuable upon the exercise of options, warrants and convertible notes, in addition to shares potentially issuable in satisfaction of term note obligations, were excluded in the computation of diluted per share data, as the effects would be anti-dilutive.

 

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QUANTUM FUEL SYSTEMS TECHNOLOGIES WORLDWIDE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

October 31, 2010

 

The following table sets forth the amount of shares excluded, in thousands, from the computation of diluted earnings per share, as to do so would have been anti-dilutive:

 

		Six Months Ended October 31,
		2009				2010
Stock options			4,294				8,189
Warrants			41,936				52,715
Convertible notes			21,539				16,582
Term notes			16,592				17,117
Lender commitment			14,084				14,085
			98,445				108,688

13) Income Taxes

For our US-based businesses, we have a net deferred tax asset position primarily consisting of net operating loss carry forwards that are available to offset future taxable income. In accordance with GAAP, we have established a valuation allowance for our net deferred tax asset since it is unlikely that the asset will be fully realized based on our lack of earnings history and current evidence.

Our wholly-owned subsidiary, SPI, based in Canada, has certain deferred tax liabilities which cannot be offset by net operating loss carry forwards from the US businesses and represents the balance of the net deferred tax liability reported as of October 31, 2010 on the accompanying condensed consolidated balance sheet. Included in the net deferred tax liability is a deferred amount consisting of the tax effected difference between the book value and tax basis of the Grand Valley Wind Farm asset (see Note 2).

14) Commitments and Contingencies

We and our affiliates are subject to various legal proceedings and claims which arise out of the normal course of our business. Management and our legal counsel periodically review the probable outcome of pending proceedings and the costs reasonably expected to be incurred. We accrue for these costs when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In the opinion of management, any ultimate cost to us in excess of amounts accrued will not materially affect our consolidated financial position, results of operations or cash flows.

 

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ITEM 2.

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

Forward-Looking Statements

All statements included in this Quarterly Report on Form 10-Q and any documents incorporated herein by reference, other than statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. Examples of forward-looking statements include, but are not limited to, statements regarding our expectation that we will be able to raise a sufficient level of debt or equity capital to repay our debt obligations and fund our operations, our belief that our current operating plan will allow us to achieve profitability, our expectations of future revenue, expenses, gross margin and operating profit (loss), the level of growth in the hybrid, plug-in hybrid and fuel cell and alternative fuel industries, when our Q-Drive powertrain architecture and other products and technologies will be commercialized, our plans to develop new lower cost technologies, when Fisker Automotive will go to production, the number of vehicles that Fisker Automotive expects to sell, our belief that we will be a supplier to Fisker Automotive on a long-term basis, our expectation of liquidity requirements to fund our operations and debt through October 31, 2011, our intentions to commission a solar manufacturing facility in southern California, our expectation that the US, state and local governments will continue to support the advancement of alternative fuel technologies through loans, grants and tax credits, our belief that we have a competitive advantage over our competitors, our intentions to support the growth of our subsidiary, Schneider Power, Inc., and our German affiliate, Asola, our intentions to establish joint development programs and strategic alliances with leaders in the alternative energy industry, our relationship with General Motors and the impact such relationship will have on our ability to develop our products, the impact that new accounting pronouncements will have on our financial statements, and the effect that an adverse result in Asola’s dispute with its solar cell supplier could have on our financial statements.

Forward-looking statements generally can generally be identified by words such as “may,” “could,” “will,” “should,” “assume,” “expect,” “anticipate,” “plan,” “intend,” “believe,” “predict,” “estimate,” “forecast,” “outlook,” “potential,” or “continue,” or the negative of these terms, and other comparable terminology. Although we believe the expectations and intentions reflected in our forward-looking statements are reasonable, we cannot assure you that these expectations and intentions will prove to be correct. Various risks and other factors, including those identified in this Quarterly Report under Part II, Item 1A “Risk Factors” and those included in our other public filings that are incorporated herein by reference, could cause actual results, and actual events that occur, to differ materially from those contemplated by the forward looking statements.

Many of the risk factors are beyond our ability to control or predict. You should not unduly rely on any of our forward-looking statements. These statements are made only as of this Quarterly Report. Except as required by law, we are not obligated to publicly release any revisions to these forward-looking statements to reflect future events or developments. All subsequent written and oral forward-looking statements attributable to us and persons acting on our behalf are qualified in their entirety by the cautionary statements contained in this section and elsewhere in this Quarterly Report.

Company Overview

Unless the context otherwise requires, “we,” “our,” “us,” “Quantum” and similar expressions refers to Quantum Fuel Systems Technologies Worldwide, Inc. and Subsidiaries. We are a United States (US) public company listed on NASDAQ with our corporate offices located in Irvine, California.

We are a fully integrated alternative energy company—a leader in the development and production of advanced clean propulsion systems, and renewable energy generation systems and services. We believe that we are uniquely positioned to integrate advanced fuel system, electric drive, software control strategies and propulsion control system technologies for alternative fuel vehicles, in particular, plug-in electric hybrid, electric and hydrogen hybrid vehicles based on our years of experience in vehicle-level design, vehicle electronics, system control strategies and system integration.

Our Electric Drive & Fuel Systems business segment provides powertrain engineering, system integration, manufacturing and assembly of packaged fuel systems and propulsion control systems for vehicles and other applications including fuel cells, hybrids, plug-in electric hybrid, alternative fuels, and hydrogen refueling stations and systems. We also design, engineer and manufacture hybrid and fuel cell vehicles. Our customer base includes automotive Original Equipment Manufacturers (OEMs), military and governmental agencies, aerospace, and other strategic alliance partners.

Our portfolio of technologies and products include hybrid electric and plug-in hybrid electric powertrain systems, advanced battery control systems, electronic vehicle control systems and software, fuel storage and fuel delivery products and control systems for use in hybrid, electric, fuel cell, and other alternative fuel vehicles. We also design and manufacture computerized controls, regulators and automatic shut-off equipment, lightweight, high-pressure hydrogen and natural gas storage tanks using advanced composite technology and hydrogen refueling systems.

 

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With our recent acquisition of Schneider Power, Inc. (SPI) completed on April 16, 2010, our business now includes the Renewable Energy business segment, which consists of the development, construction and operation of wind and solar electricity generation facilities. SPI also owns and operates a wind farm in Ontario, Canada and has a significant portfolio of renewable wind and solar energy projects in North America and the Caribbean in various stages of development.

Business Strategy

Our mission is the creation of new technologies and product lines that help combat climate change and foster the responsible use of natural resources by positioning ourselves as a tier-one automotive supplier of world-class green vehicle technology, building renewable energy electricity generation facilities to replace dirty power producers, enable green technology integration and weight reduction in the aerospace sector and provide superior performing green technology products that provide a strategic advantage to our armed forces and US space programs.

Our strategy for achieving these objectives includes the following:

 

•

Commercialize our proprietary Q-Drive™ hybrid vehicle propulsion system and sub-systems.

 

•

Increase our participation in the hybrid and plug-in hybrid OEM vehicle markets by advancing and introducing new lower-cost technology and securing customer funding.

 

•

Design, integrate and assemble packaged fuel systems and re-fueling units for hydrogen and fuel cell vehicles, alternative fuel and other emerging applications.

 

•

Expand our renewable energy development and production platform, which includes the development of renewable energy electricity generation facilities and expansion plans for the production of solar panel manufacturing.

 

•

Focus research and development on hybrid and hydrogen fuel system technologies and securing outside funding to support these programs.

 

•

Leverage our battery and hydrogen storage systems into broader energy storage applications.

Financial Operations Overview

In managing our business, our management uses several financial and non-financial factors to analyze our performance. Financial factors include forecast to actual comparisons, analysis of revenue and cost trends, project costs and analysis, backlog of customer programs, and changes in levels of working capital. Non-financial factors include assessing the extent to which current programs are progressing in terms of timing and deliverables and the success to which our systems are interfacing with our customers’ vehicle applications. We also assess the degree to which we secure additional programs or new programs from our current or new OEM customers and the level of government funding we receive for propulsion systems and storage solutions. We also evaluate the number of units shipped as part of current and new programs and evaluate the operations of our affiliates.

Non-financial factors for the Renewable Energy business segment include wind study results, land ownership agreements, interconnections to the grid, program awards and power purchase agreements and other project metrics framing the underlying economics of a renewable energy farm.

We expense all research and development when incurred. Research and development expense includes both customer-funded research and development and company-sponsored research and development. Customer-funded research and development consists primarily of expenses associated with contract revenue. These expenses include application development costs we funded under customer contracts. We will continue to require significant research and development expenditures over the next several years in order to commercialize our products for hybrid, hydrogen fuel cell and alternative fuel applications.

We classify our business operations into three reporting segments: Electric Drive & Fuel Systems (formerly referred to as the Fuel Systems Segment), Renewable Energy (beginning April 16, 2010) and Corporate.

The chief operating decision maker allocates resources and tracks performance by the reporting segments. We evaluate performance based on profit or loss from operations before interest and income taxes.

Electric Drive & Fuel Systems Segment

Our Electric Drive & Fuel Systems segment supplies advanced propulsion and fuel systems for alternative fuel vehicles to OEM customers for use by consumers and for commercial and government fleets. Since 1997, we have sold approximately 20,000 fuel systems for alternative fuel vehicles. We also provide our propulsion systems and hydrogen storage products for hybrid and fuel cell applications to major OEMs and certain governmental agencies through funded research and

 

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development contracts and on a prototype and production intent basis. This segment’s business operations primarily consist of design, integration and supply of electric drive and control system technologies and manufacture and supply of packaged fuel systems for use in hybrid, plug-in electric hybrid, hydrogen, fuel cell, and other alternative fuel vehicles.

Our Electric Drive & Fuel Systems segment generates product revenues through the sale of hydrogen fuel storage, fuel delivery, and electronic control systems to OEMs, the installation of our systems into OEM vehicles, and the sale of transportable hydrogen refueling stations. Product revenues are also generated through the sale of compressed natural gas (CNG), propane (LPG), and hydrogen fuel storage, fuel delivery, and electronic control systems for internal combustion engine applications.

Our Electric Drive & Fuel Systems segment also generates contract revenue by providing engineering design and support to OEMs, primarily Fisker Automotive and General Motors, so that our advanced propulsion systems integrate and operate with the OEM’s hybrid or fuel cell applications. Contract revenue is also generated from customers in the aerospace industry, military and other governmental entities and agencies, and other strategic alliance partners.

On July 8, 2010, we announced that we had received an initial purchase order from Fisker Automotive, Inc. (Fisker Automotive) for supplying components of our hybrid powertrain system we refer to as Q-Drive for the Fisker Karma production program under the terms of our supply agreement with Fisker Automotive (the “ Fisker Supply Agreement”). Under the purchase order, we began shipping Q-Drive components to Fisker Automotive in July 2010 that will be incorporated in the Fisker Karma’s development fleet in support of Fisker Automotive’s efforts to initiate volume production of the Karma in February 2011.

On July 19, 2010, we announced that we had received a contract from Fisker Automotive for engineering and implementing production tooling for the Fisker Karma solar photovoltaic roof module under which our Electric Drive & Fuel Systems segment and our affiliate Asola will design and procure production tooling to enable production of solar roof modules beginning in early calendar 2011.

On October 6, 2010, the California Energy Commission (CEC) announced that we had been approved by the CEC’s board of directors for a $1.4 million grant under the CEC’s Alternative and Renewable Fuel and Vehicle Technology Program. The finalization of the grant award is pending approval of final documentation by the CEC. Upon completion of the expected award arrangement, the Electric Drive & Fuel Systems segment will use the proceeds to assist in the development of certain components for our next generation of the Q-Drive powertrain system.

On November 9, 2010 we announced that the specific components of our hybrid powertrain system to be supplied to Fisker Automotive by us under the Fisker Supply Agreement had been amended. Under the terms of the amended supply agreement, we will be the exclusive supplier to Fisker Automotive of the following components and subsystems included within our Q-Drive powertrain system that will be used in Fisker Automotive's Karma vehicle: (i) the hybrid controller and hybrid control software, (ii) the on-board charger, (iii) the DC-DC converter, and (iv) the solar roof. The purchase price for these components and subsystems on a per vehicle basis (which includes a service fee, license and royalty fee) starts at approximately $4,100 for the first 6,500 vehicles and gradually decreases based on volume to approximately $3,200 dollars once 30,000 units are ordered and stays at that price for volumes in excess of 30,000 units. The aggregate value of outstanding purchase orders related to the Fisker Karma program, as amended, approximated $24.4 million as of that date.

Renewable Energy

Our Renewable Energy segment consists solely of the business operations of SPI. SPI, headquartered in Toronto, Ontario, Canada, is an independent power producer, developer of renewable energy projects and provider of related development services and is a licensed electricity generator and wholesaler. Our development of renewable energy projects involves several sequential stages of completion and advancement before a project becomes operational. We conduct feasibility studies to obtain sufficient data to validate the wind and/or solar energy capacity from a prospective project. We must negotiate with local landowners to obtain easements to allow for the development of an energy farm on their properties. Applications are submitted to local utility providers to obtain approvals for grid interconnections, and environmental assessments and feasibility studies must be completed and submitted to Federal, Provincial and Municipal governments to obtain permits for construction and commissioning. Finally, we secure Power Purchase Agreements (“PPAs”) with a utility provider or power broker as a project approaches the construction and operational stage.

Wind and solar energy project returns depend mainly on the following factors: energy prices, transmission costs, wind and solar resources, wind turbine and solar module costs, construction costs, financing cost and availability of government incentives. In applying our strategy, we take into account the combination of all of these factors and focus on margins, return on invested capital and value creation as opposed solely to project size. Most of our projects offer attractive returns because of favorable wind and solar resources and higher energy prices. Additionally, in many cases, smaller, more profitable projects can create as much absolute value as do larger, lower-returning projects. We assess the profitability of each project by evaluating its net present value.

 

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An energy project may be financed with all equity or a combination of equity and debt. Due to SPI’s limited cash availability and the high cost of development and construction of a project, SPI has historically entered into strategic relationships to provide for project financing. SPI will evaluate its project portfolio and assess sale, joint venture or own-account alternatives on a project-by-project basis once certain milestones are achieved. If SPI decides to enter into strategic relationships to provide for project equity and/or debt financing on certain of its projects, we anticipate that a typical strategic relationship would be structured in one of two ways, (i) SPI would transfer a majority interest to a strategic partner for a development fee while retaining a minority carried interest in the project; or alternatively (ii) SPI would transfer a partial interest to a strategic partner for a development fee while retaining a pro rata interest in the project. We would anticipate that SPI and the strategic partner would also enter into a development agreement pursuant to which SPI would provide development services for the project in addition to receiving a development fee.

In addition to energy sales on our existing wind electricity generation facility and future wind and solar energy facilities that we are currently developing, we anticipate generating revenues and cash flows through the sale of ownership interests in our renewable energy projects and through development and construction services for renewable energy projects owned by third parties. Prior to our acquisition, SPI entered into an arrangement to sell their interest in a 22 MW wind farm that was in an early development phase. SPI expects to receive Canadian Dollar (CAD) 2.1 million in sales proceeds upon completion of the sale. During the first half of fiscal 2011, we collected an initial deposit in the amount of CAD 250,000 toward the completion of the sale and expect to receive the remaining amount in the second half of fiscal 2011 upon final closing.

SPI owns and operates a 1.6 megawatt wind farm in Ontario, Canada and generates revenue from the sale of energy under the terms of Power Purchase Agreements (PPAs) with Bullfrog Power, Inc.

SPI is currently in the advanced stages of developing the Spring Bay Wind Farm located in Ontario, Canada. The build out of the project will require approximately $15 million of project capital to be raised in the coming months in order for us to bring the project online as scheduled in April 2011. We currently have a conditional commitment from a lender to provide for debt financing of the project (see Liquidity and Off Balance Sheet Disclosures).

SPI was recently awarded a PPA by the Ontario Power Authority, under its feed-in-tariff program, for an additional 10 MW development project in Ontario Canada that, subject to our ability to raise additional working capital, we plan to develop in calendar 2011.

Corporate Segment

The Corporate segment consists of general and administrative expenses incurred at the corporate level that are not directly attributable to the Electric Drive & Fuel Systems or Renewable Energy reporting segments. Corporate expenses consist primarily of personnel costs, share-based compensation costs and related general and administrative costs for executive, finance, legal, human resources, investor relations and our board of directors.

On August 27, 2008, start-up activities were initiated in Quantum Solar Energy, Inc. (Quantum Solar) based in Irvine, California and formed for the purpose of producing and distributing mono and poly-crystalline silicon solar modules with an initial capacity of 45 MW. We currently own 85.0% of Quantum Solar and the remaining 15.0% is owned by ConSolTec GmbH, the majority shareholder of Asola. All activities of the consolidated subsidiary are included in our Corporate segment and to date principally consist of partial payments on long lead assembly equipment under construction for solar module production capability. Once Quantum Solar commences its manufacturing operations, we anticipate that we will report these activities under a new business segment separate from the Electric Drive & Fuel Systems, Renewable Energy and Corporate reporting segments.

On September 15, 2010, the CEC announced that we had been approved by the CEC’s board of directors for a $4.4 million low interest loan under the CEC’s Clean Energy Business Financing Program. The finalization of the loan arrangement is pending approval of final documentation by the CEC. Upon completion of the expected loan arrangement, draw downs under the loan will be subject to certain conditions, namely, the investment by us of specified matching funds for the project. Any proceeds received under the loan arrangement will be utilized to assist in the purchase of manufacturing equipment for the start up of Quantum Solar’s module manufacturing operation (see Liquidity and Off Balance Sheet Disclosures).

 

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Strategic Investments

In addition to our Electric Drive & Fuel Systems and Renewable Energy businesses, we have acquired or obtained ownership interests in certain strategic businesses that are not included in our current reporting segments. Except as noted, our ownership in the entities discussed below does not rise to the level of a controlling interest but we are considered to be able to exert significant influence over their respective operations and accordingly, we account for our equity interests in these businesses under the equity method of accounting. Our respective share of the results of their operations is discussed in Non-Reporting Segment Results under Results of Operations.

Fisker Automotive

On August 7, 2007, we co-founded Fisker Automotive, a joint venture with Fisker Coachbuild, LLC, which was formed for the purpose of producing premium plug-in hybrid automobiles. Fisker Automotive is developing its first production-intent vehicle, the Fisker Karma, a 4-door luxury sports sedan PHEV that incorporates our Q-Drive system. We owned 6.2 million shares of Fisker Automotive’s common stock on October 31, 2010, which represented approximately 1% of the issued and outstanding shares of Fisker Automotive’s capital stock. During the second quarter of fiscal 2011, we changed the method of accounting for our investment in Fisker Automotive from the equity method to the cost method as a result of changes in the composition of the Fisker Automotive board of directors and the dilution of our equity interest since the initial formation of the venture such that we no longer are considered to have significant influence over Fisker Automotive; however, under both of these methodologies, our investment in Fisker Automotive has been carried at zero for all periods presented.

Asola

On January 4, 2008, we acquired a 24.9% ownership interest in Asola, a solar module manufacturer located in Erfurt, Germany. Asola has been developing and manufacturing high-efficiency photovoltaic modules for a number of innovative applications, including automotive, residential, and commercial applications for over 20 years. Asola developed the solar roof panel that is incorporated into the Fisker Karma PHEV. Asola’s current facility has an annual manufacturing capacity to produce 45 MW of solar panels.

Over the past year we have engaged in discussions with Asola’s majority share holder, ConSolTec GmbH (ConSolTec), to outline terms that could result in us acquiring a controlling equity interest in Asola. On August 24, 2010, we executed a non-binding Letter of Intent with ConSolTec (the “Asola LOI”), which sets forth terms related to a proposed transaction pursuant to which we and ConSolTec would establish a newly formed holding company, with us as the controlling equity holder, to create a solar panel manufacturing, distribution and sales entity to service global markets. The assets of the new entity would include Asola and Quantum Solar as wholly-owned subsidiaries. Under the proposed terms of the Asola LOI, the transaction is contingent upon several conditions including our ability to raise a certain level of capital in order to provide compensation to ConSolTec and to provide sufficient equity capital to the new entity to enable the entity’s expansion into additional global markets. The Asola LOI contemplates a transaction completion date of December 31, 2010; however, we do not believe we will complete the transaction by that date and will seek an extension (see Liquidity).

Prior to the execution of the Asola LOI, we provided Asola and ConSolTec with written notice on December 28, 2009, that we were exercising our right to increase our ownership interest in Asola to 32.66% in exchange for payment of 0.1 million euro. The transaction to increase our ownership interest by 7.76% has not yet been completed and we have reserved our right to withdraw the exercise pending the outcome of the Asola LOI and our evaluation of the impact that the exercise may have on certain material contracts to which Asola is a party.

Power Control and Design

On October 6, 2009, we acquired a 22% interest in Power Control and Design, Inc. (PCD). PCD designs and develops control software for use in motor control, solar-to-grid, wind-turbine, electric vehicle charges and power conversion products and applications for infrastructure, automotive, aerospace and industrial markets.

Shigan Quantum

On September 3, 2009, we acquired at 25% interest in Shigan Quantum Technologies PVT LTD (Shigan Quantum), a start-up company organized under India’s Corporate Act. Shigan Quantum intends to manufacture and sell gaseous fuel injectors using our technologies and variants thereof.

Advanced Lithium Power, Inc.

On March 24, 2006, we obtained a 35.5% ownership interest in Advanced Lithium Power Inc. (ALP), located in Vancouver, British Columbia. ALP was formed for the purpose of developing state-of-the-art lithium ion battery and battery

 

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management control systems that control state-of-charge and provide for thermal management. Our direct ownership interest in ALP as of April 30, 2010 was approximately 13%. In June 2010, certain secured creditors of ALP had a receiver appointed pursuant to the terms of a General Security Agreement between ALP and such secured creditors and as a result, ALP ceased operations.

 

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Results of Operations

Three and Six Months Ended October 31, 2009 and 2010

Total revenues and operating loss for our business segments and gross profit (loss) on our product sales for the three and six months ended October 31, 2009 and 2010 were as follows (in thousands):

 

		Three Months Ended October 31,								Six Months Ended October 31,
		2009				2010				2009				2010
Total Revenue
Electric Drive & Fuel Systems		$	2,655			$	3,729			$	5,749			$	7,044
Renewable Energy			—				156				—				401
Corporate			—				—				—				—
Total		$	2,655			$	3,885			$	5,749			$	7,445
Operating Loss
Electric Drive & Fuel Systems		$	(2,776	)		$	(2,228	)		$	(4,748	)		$	(4,150	)
Renewable Energy			—				(422	)			—				(778	)
Corporate			(1,849	)			(2,208	)			(4,428	)			(4,556	)
Total		$	(4,625	)		$	(4,858	)		$	(9,176	)		$	(9,484	)
Product Gross Profit (Loss)
Electric Drive & Fuel Systems:
Net product sales		$	425			$	768			$	612			$	1,350
Cost of product sales			(595	)			(864	)			(861	)			(1,363	)
Gross profit (loss)		$	(170	)		$	(96	)		$	(249	)		$	(13	)
Renewable Energy:
Net product sales		$	—			$	67			$	—			$	129
Cost of product sales			—				(14	)			—				(75	)
Gross profit (loss)		$	—			$	53			$	—			$	54

Electric Drive & Fuel Systems Segment

Product revenue for the Electric Drive & Fuel Systems segment increased $0.3 million, or 75% from $0.4 million in the second quarter of fiscal 2010 to $0.7 million in the second quarter of fiscal 2011, and increased $0.8 million, or 133%, from $0.6 million in the first six months of fiscal 2010 to $1.4 million in the first six months of fiscal 2011 due in part to the initial product shipments to Fisker Automotive related to our Q-Drive hybrid drive systems and increased shipments of high pressure fuel storage tanks for CNG applications. We expect product revenue to increase significantly in the latter part of fiscal 2011 as a result of anticipated sales to Fisker Automotive associated with the planned launch of the Fisker Karma in February 2011.

Contract revenue for the Electric Drive & Fuel Systems segment increased $0.8 million, or 36%, from $2.2 million in the second quarter of fiscal 2010 to $3.0 million in the second quarter of fiscal 2011, and increased $0.6 million, or 12%, from $5.1 million in the first six months of fiscal 2010 to $5.7 million in the first six months of fiscal 2011. Contract revenue is derived primarily from system development and application engineering of our products under funded Fisker Automotive contracts, OEM contracts, aerospace programs, and other funded contract work with the United States (US) military and other government agencies. Fisker Automotive represented $1.0 million and $1.6 million of contract revenue earned during the second quarters of fiscal 2010 and 2011, respectively.

For fiscal 2011 and for the foreseeable future, we anticipate that Fisker Automotive will represent a significant portion of our overall Electric Drive & Fuel Systems segment revenues as we continue to ship components and provide development services for the Fisker Karma series of vehicles.

Cost of product sales for the Electric Drive & Fuel Systems segment increased $0.3 million, or 50%, from $0.6 million in the second quarter of fiscal 2010 to $0.9 million in second quarter of fiscal 2011, and increased $0.5 million, or 56%, from $0.9 million in the first six months of fiscal 2010 to $1.4 million in first six months of fiscal 2011, primarily as a result of increased product revenues.

 

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Gross profits on product sales for the Electric Drive & Fuel Systems segment improved $0.1 million from a negative $0.2 million in the second quarter of fiscal 2010 to a negative $0.1 million in the second quarter of fiscal 2011. Gross profits on product sales for the first half of fiscal 2011 improved $0.3 million from a negative $0.3 million in the first six months of fiscal 2010 to $0.0 million in the first six months of fiscal 2011. The improved gross margins are primarily due to higher revenues realized in the first six months of fiscal 2011 that absorbed a fixed level of manufacturing overhead costs. We expect to realize improvement in our gross margins for the remainder of fiscal 2011 as we anticipate increased shipments of components to Fisker Automotive related to our Q-Drive hybrid drive system.

Research and development expense associated with development contracts increased $0.6 million, or 32%, from $1.9 million in the second quarter of fiscal 2010 to $2.5 million in the second quarter of fiscal 2011, and increased $0.4 million, or 9%, from $4.3 million in the first six months of fiscal 2010 to $4.7 million in the first six months of fiscal 2011, which was mainly due to higher development program revenues in the current period as compared to the same period in the prior year.

Internally funded research and development expense for the Electric Drive & Fuel Systems segment decreased $0.1 million, or 6%, from $1.6 million in the second quarter of fiscal 2010 to $1.5 million in the second quarter of fiscal 2011, and remained the same at $3.0 million for the first six months of both fiscal 2010 and fiscal 2011. Our internally funded research effort includes hybrid control strategies and proprietary software designed to precisely control hybrid propulsion and vehicle performance and hydrogen storage, injection and regulation programs.

Selling, general and administrative expenses for the Electric Drive & Fuel Systems segment decreased $0.2 million, from $1.3 million in the second quarter of fiscal 2010 to $1.1 million in the second quarter of fiscal 2011, and decreased $0.1 million, from $2.3 million in the first six months of fiscal 2010 to $2.2 million in the first six months of fiscal 2011.

Operating loss for the Electric Drive & Fuel Systems segment improved $0.6 million, from a loss of $2.8 million in the second quarter of fiscal 2010 to a loss of $2.2 million in the second quarter of fiscal 2011, and improved $0.6 million, from a loss of $4.8 million in the first six months of fiscal 2010 to a loss of $4.2 million in the first six months of fiscal 2011, mainly as a result of higher revenues generated.

Renewable Energy Segment

Our results of operations include the activities of our wholly owned subsidiary, SPI, for the period of time subsequent to our acquisition of SPI on April 16, 2010. SPI recognized $0.1 million and $0.1 million of revenue from energy sales related to its Providence Bay Wind Farm that is reported as part of net product revenues, $0.1 million and $0.3 million of revenue from construction management contract services and $0.6 million and $1.3 million of operating expenses during the second quarter and first six months of fiscal 2011, respectively. Included in operating costs for the six month period were $0.2 million representing amortization of the intangible asset associated with the renewable energy project portfolio identified in connection with the acquisition of SPI.

If we are successful in raising project capital over the coming months to support SPI’s planned completion of its Spring Bay Wind Farm and the continued development of its other renewable energy projects, we anticipate that revenues and operating costs of SPI would significantly increase over the next twelve months compared to the levels realized in the first half of fiscal 2011 and that SPI’s operating performance would improve.

Corporate Segment

Corporate expenses increased $0.4 million in the second quarter of fiscal 2011 from $1.8 million in fiscal 2010 to $2.2 million in fiscal 2011, and increased $0.1 million in the first six months of fiscal 2011 from $4.4 million in fiscal 2010 to $4.5 million in fiscal 2011 due in part to increased levels of legal activities and share-based compensation costs. Corporate expenses reported for this segment reflect the general and administrative expenses that indirectly support our ongoing Electric Drive & Fuel Systems, our Renewable Energy segment and any future operating segments. Corporate expenses consist primarily of personnel costs, share-based compensation costs and related general and administrative costs for executive, finance, legal, human resources, investor relations and our board of directors. Corporate expenses as a percentage of total consolidated revenues decreased to 61% for the first six months of fiscal 2011 as compared to 77% in the first six months of fiscal 2010, primarily due to higher revenues realized in fiscal 2011. We expect the amount of corporate expenses as a percentage of total consolidated revenues for the remainder of fiscal 2011 to continue to be lower than the levels incurred in the same periods of fiscal 2010 as we anticipate that our consolidated revenues for the remainder of fiscal 2011will be higher than the comparable previous year periods.

 

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Non-Reporting Segment Results

Interest Expense. Interest expense, net of interest income, amounted to $0.7 million in the second quarter of fiscal 2011 as compared to $0.8 million recognized in the second quarter of fiscal 2010 and $1.2 million in the first six months of fiscal 2011 as compared to $1.5 million recognized in the first six months of fiscal 2010. Interest expense primarily relates to debt instruments payable to our senior lender. The decline in expense during fiscal 2011 is primarily related to lower average levels of outstanding debt. We expect interest expense to increase in the second half of fiscal 2011 as a result of additional borrowings secured in October 2010 and potential new borrowings under the proposed solar manufacturing equipment loan.

Fair Value Adjustments of Derivative Instruments. Derivative instruments at April 30, 2010 and October 31, 2010 consist of the written put option under the $10.0 million Lender Commitment and warrant contracts referred to in our financial statements as the October 2006 Warrants, the June 2007 Warrants, the August 2008 Warrants, the August 2009 Warrants and the September 2009 Warrants. Fair value adjustments of derivative instruments, which represent non-cash unrealized gains or losses, amounted to a gain of $4.1 million and $7.5 million in the second quarter and first six months of fiscal 2011, respectively, compared to a loss of $34.9 million and $34.8 million in the second quarter and first six months of fiscal 2010, respectively. The share price of our common stock represents the primary underlying variable that impacts the value of the derivative instruments. Additional factors that impact the value of the derivative instruments include the volatility of our stock price, our credit rating, and discount rates. The unrealized gain recognized in fiscal 2011 was primarily attributable to the decrease in our share price over the course of the first six months of fiscal 2011 ($0.70 at April 30, 2010 and $0.46 at October 31, 2010) that materially decreased the fair value of the derivative instrument liabilities year over year. Conversely, our share price increased during the first six months of fiscal 2010 ($0.72 at April 30, 2009 and $1.19 at October 31, 2009) that materially increased the fair value of the derivative instruments during the prior year period. Due to the volatile nature of our share price, we expect that we will continue to recognize gains or losses on our derivative instruments each period and that the amount of such gains or losses could be material.

Loss on Modification of Debt and Derivative Instruments. During the first six months of our prior fiscal year, we recognized $9.5 million in losses associated with contractual modifications of our debt and derivative instruments issued to our senior lender. On July 10, 2009, the conversion features embedded within an existing and two new convertible note instruments issued on this date increased in fair value by $7.0 million as a result of certain modifications that included setting the fixed conversion price on the debt to $0.71 per share and pushing out the stated maturity dates on the outstanding balances. The embedded conversion features under these instruments were accounted for as derivatives effective at the time of their issuance until the notes were later modified on April 30, 2010 at which time the embedded conversion features no longer met the definition of derivative instruments. In addition, on August 3, 2009 we modified the $10.0 million lender commitment by fixing the conversion price under the convertible note structure available to the lender under its written put option that previously had been a price that would equal the market price on the date of the potential put. This modification to set a fixed conversion price prior to the exercise of the lender’s put option resulted in an immediate charge of $2.6 million in the second quarter of fiscal 2010. In the first six months of fiscal 2011, no modifications were entered into with respect to instruments accounted for as derivatives.

Loss on Settlement of Debt and Derivative Instruments. During the first six months of the prior fiscal year 2010, we repaid $7.3 million of term debt principal in shares of our common stock which had a fair value of $7.7 million on the settlement dates. The difference between the fair values of the shares issued and the reduction of the principal during the first six months of fiscal 2010 was recognized as a loss on settlement of debt of $0.4 million. There were no settlements associated with debt or derivative instruments that gave rise to a gain or loss in the first six months of fiscal 2011.

Equity in Earnings of Affiliates. During the second quarter and first six months of fiscal year 2011, we recognized income of $0.07 million and $0.15 million representing the net equity in earnings of our affiliates that we account for under the equity method of accounting. The activity in fiscal 2011 is primarily associated with the operating results of Asola but also includes the nominal operating results of Shigan Quantum and PCD. In the prior fiscal year, we recognized $0.4 million and $0.5 million in the three and six months ended October 31, 2009, respectively, representing our equity share in earnings of Asola. Our ownership in Fisker Automotive was also accounted for under the equity method from inception of the business through August 2010; however, we did not recognize any share of losses realized by Fisker Automotive through August 2010 as our net investment balance in the business at all times had been zero and we had no obligation to fund deficit balances of the business. Effective as of September 2010, we now account for our ownership share in Fisker Automotive under the cost method.

Income Taxes. Our income tax expense is minor for all periods presented primarily as a result of our lack of earnings history. As a result of our historical losses, we have generated significant net operating losses that we can carry forward to offset taxable earnings that we generate in the future. We expect that income taxes will continue to be nominal for the remainder of fiscal 2011.

 

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Liquidity and Capital Resources

Cash Flow Activities

Net cash used in operating activities during the first six months of fiscal 2011 was $8.6 million as compared to $9.2 million used during the first six months of fiscal 2010. The cumulative impact of net changes in operating assets and liabilities during the first six months of fiscal 2011 was negligible on an overall basis. The level of cash used in the second quarter of fiscal 2011 of $2.6 million was less than the $6.0 million of cash used in the first quarter of fiscal 2011. We anticipate that the level of cash required for operations during our second half of fiscal 2011 will be less than the amount used in the first half and that our cash requirements for operations over the course of the entire fiscal 2011 will approximate the level of cash used during fiscal 2010.

Net cash used in investing activities during the first six months of fiscal 2011 was $1.4 million as compared to net cash used of $0.5 million during the first six months of fiscal 2010. Net cash used for investing activities in fiscal 2011 is primarily associated with activities to construct our Spring Bay Wind Farm that is scheduled to be operational in April 2011. The amount of cash required to complete the build out of the Spring Bay Wind Farm along with the development of other alternative energy projects in our portfolio is significant. If we are successful in raising sufficient capital to fund these active projects, our cash used for investing activities for the remainder of fiscal 2011 will be at levels significantly higher than the levels reported in fiscal 2010.

During the first six months of fiscal 2011, we also received $0.2 million related to a deposit on a non-binding arrangement dated June 30, 2010, for the proposed sale of the Grand Valley Wind Farm asset that we classify as an asset held for sale. The receipt of the deposit is included in other accrued liabilities on the condensed consolidated balance sheet at October 31, 2010 and reported as a cash flow from investing activities. The arrangement, as amended on December 1, 2010, outlines additional deposits of $1.8 million to be received by January 31, 2011 if the proposed sale of the asset is completed.

Net cash provided by financing activities during the first six months of fiscal 2011 was $9.6 million as compared to $13.7 million during the first six months of fiscal 2010. Cash provided during the first six months of fiscal 2011 consisted principally of net proceeds of $6.2 million from a private placement transaction partially completed in April 2010 and finalized during the first quarter of fiscal 2011 and net proceeds of $3.4 million from a private placement transaction completed in October 2010.

Capital Resources

From our inception through October 31, 2010, we have funded our operations and strategic investments primarily with proceeds from public and private offerings of our common stock and borrowings with financial institutions and our current senior lender. Capital transactions completed during fiscal 2011 and capital commitments available to us are as follows:

 

•

On October 13, 2010 and October 19, 2010, we raised cumulative gross proceeds of $4.0 million in a private placement transaction in exchange for issuing senior subordinated bridge notes and warrants to certain accredited investors. The net amount received by us from the transactions, after deducting placement agent fees and transaction expenses, was $3.4 million.

 

•

On various dates from April 30, 2010 through July 26, 2010 we raised cumulative gross proceeds of $10.9 million in connection with a private placement offering from the sale of 19.7 million shares of our common stock at a price of $0.55 per share. The investors and placement agent also received warrants in connection with the transactions. The net amount received by us from the transactions, after deducting placement agent fees and offering expenses, was $9.3 million (of which $6.2 million was received in the first quarter of fiscal 2011).

 

•

On May 30, 2008, we initially secured a $10.0 million unconditional commitment (Lender Commitment) from an affiliate of our senior lender that allows us to draw on the commitment at our option and also allows the senior lender to fund the commitment at the senior lender’s option under certain defined structures. The option for either party under the Lender Commitment, as last modified on November 24, 2009, expires on March 31, 2011. To date, neither we nor the senior lender have exercised the option under the Lender Commitment. We are contractually limited to drawing down a maximum of $2.5 million in any 30 day period; therefore, we must provide notice to the senior lender beginning on or before December 20, 2010 in order to have full access to the commitment prior to the expiration date.

 

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Liquidity

Our historical operating results, capital resources and financial position in combination with current projections and estimates were considered in management’s plan and intentions to fund our operations over a reasonable period of time which we define as the twelve month period ending as of October 31, 2011. For purposes of liquidity disclosures, we assess the likelihood that we have sufficient available working capital and other principal sources of liquidity to fund our operating activities and obligations as they become due and the likelihood that we will be able to maintain compliance with the required provisions contained within our debt instruments over the twelve month period.

Our principal sources of liquidity at October 31, 2010 amounted to $13.7 million, consisting of $3.7 million of cash and cash equivalents and $10.0 million under the Lender Commitment that is available to be drawn upon through March 31, 2011. We have historically incurred operating losses and negative cash flows from operating activities. Specifically, we have used $14.7 million and $8.6 million in cash for operating activities during the twelve-month period of fiscal 2010 and the first six months of fiscal 2011, respectively.

As discussed further in Note 7 to the condensed consolidated financial statements, we have $25.9 million of outstanding debt obligations as of October 31, 2010. The total cash that could be required to service these debt instruments over the next twelve months is $20.5 million, including $4.2 million related to the Bridge Notes that are scheduled to mature on December 31, 2010 and $15.7 million related to a term note and three convertible notes held by our senior lender that are scheduled to mature on July 31, 2011.

As of the date of this report, we do not have sufficient cash on hand to pay the $4.2 million due under the Bridge Notes when they mature on December 31, 2010. Our ability to draw upon the $10.0 million Lender Commitment is contractually limited to $2.5 million during any 30 day period so prior to the maturity date of the Bridge Notes we cannot draw an amount sufficient to satisfy the amount due. In order to avoid being in default of the Bridge Notes, we will need to raise additional capital prior to December 31, 2010 sufficient to satisfy our obligations under the Bridge Notes or seek an extension of the maturity date. A default in payment of the Bridge Notes will constitute a default under all of our senior indebtedness and our senior lender will have the right to declare the full amount of the senior indebtedness immediately due and payable. Accordingly, a default in the Bridge Notes could have a material adverse affect on our business and our ability to continue as a going concern.

Based on our current projections and estimates, we expect that we will continue to incur operating losses and negative cash flows for the foreseeable future. Therefore, in order to pay our senior indebtedness when it matures on July 31, 2011 and to cover our working capital requirements, we will also need to raise approximately $20 million of additional capital in public and/or private offerings of equity or debt securities. If we are unsuccessful in raising sufficient capital to pay the senior indebtedness, then we will need to either refinance our senior indebtedness or seek an extension of the maturity dates. Given our historical operating results and the difficult credit markets that currently exist, we do not expect that we will be able refinance our senior indebtedness with a traditional commercial loan. Rather, we will need to seek an alternative loan arrangement such as a convertible debenture or other equity linked debt security.

Although we will try to negotiate an extension of the applicable maturity dates with the lenders and we have successfully extended the scheduled maturity dates on the debt obligations with our senior lender in the past on several occasions, we cannot provide any assurances that we will be able to further modify the current arrangements with our senior lender nor modify the current arrangement on the Bridge Notes. We are also currently evaluating our options for raising additional capital in order to maintain sufficient liquidity to meet our obligations as they become due. The actual amount of capital that we will need to raise is highly dependent upon the levels of debt conversions by our convertible note lenders and our ability to further extend the scheduled maturity dates of our obligations with our lenders.

Although we expect to use a significant amount of cash in our operations over the next year for our operating activities and debt service, our current operating plan anticipates increased revenues and improved profit margins for the twelve month period, primarily associated with the first half of fiscal 2012, which we expect will reduce the levels of cash required for our operating activities as compared to historical levels of use.

In addition to our need to raise sufficient capital to cover our existing operations and debt service obligations through October 31, 2011, we will also need to raise additional capital in order to complete the proposed Asola LOI transaction, complete the build out of our Spring Bay Wind Farm and other planned wind development projects, complete the planned Quantum Solar manufacturing operation in Irvine, California, and to further develop the next generation of our Q-Drive hybrid electric propulsion system. We do not plan to move forward with the proposed Asola LOI transaction, the build out of the Spring Bay Wind Farm project or the Quantum Solar manufacturing operation until we raise a level of additional capital to be able to fund one or more of these projects and maintain sufficient levels of working capital for our overall business.

 

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Although we anticipate that we will be able to raise sufficient additional capital through public or private offerings of equity or debt securities and/or through federal and state governmental grants or loans to: (i) provide sufficient liquidity for our working capital needs, including the debt service requirements discussed above, (ii) complete the Spring Bay Wind Farm , (iii) complete the Quantum Solar manufacturing operation, and (iv) provide capital for other initiatives over the coming months, we cannot provide any assurances that we will be able to secure additional funding on terms acceptable to us, if at all. In addition, we will need to increase revenues and improve profit margins for our business to be sustainable over the long term. An inability by us to modify our scheduled debt service obligations, achieve our current operating plan or raise sufficient capital to cover any shortfall would have a material adverse affect on our ability to meet our obligations as they become due and to continue as a going concern without actions outside the ordinary course of business, which could include curtailing operations.

The accompanying condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from uncertainty related to our ability to continue as a going concern.

 

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Quantitative and Qualitative Disclosures About Market Risk

As of October 31, 2010, we are exposed to market risk from changes in our common stock pursuant to the terms of our derivative instrument liabilities associated with our Lender Commitment (as further described in Note 7 of the condensed consolidated financial statements) and warrants issued in October 2006, June 2007, August 2008, August 2009 and September 2009 (as further described in Note 10 of the condensed consolidated financial statements). The share price of our common stock represents the “underlying” variable that primarily gives rise to the value of our derivative instruments. In accordance with US GAAP, the derivative instrument liabilities are recorded at fair value and marked to market each period. Changes in fair value of the derivatives each period resulting from a movement in the share price of our common stock or the passage of time are recognized as fair value adjustments of derivative instruments on our consolidated statements of operations as other income or expense. The change in fair values of our derivatives can have a material impact on our earnings or loss each period. For example, if our share price immediately increased 10% above the closing price of $0.46 per share on October 31, 2010, the fair value of our derivative instruments would increase and a charge in the amount of $1.3 million related to the increase in fair value of the derivatives would be recognized as follows:

 

Derivative Financial Instrument:		Fair Value Reported  at October 31, 2010				Effect of 10% Pro  forma Share Price Increase				Pro forma Fair  Value
Written Put Option under $10.0 million Lender Commitment		$	2,844,000			$	408,000			$	3,252,000
Warrant contracts issued in October 2006			3,559,000				22,000				3,581,000
Warrant contracts issued in June 2007			1,937,000				330,000				2,267,000
Warrant contracts issued in August 2008			2,810,000				412,000				3,222,000
Warrant contracts issued in Aug/Sept 2009			584,000				91,000				675,000
		$	11,734,000			$	1,263,000			$	12,997,000

We are also exposed to risk from fluctuating currency exchange rates, primarily the US Dollar against the Euro Dollar and against the Canadian Dollar. Specifically, we are at risk that a future decline in the US Dollar against the euro will increase the amount that we will have to pay to satisfy requirements of our long-term supply agreement with Asola and other obligations that we enter into with European-based suppliers. On October 31, 2010, one euro was equal to 1.40 US Dollars. We have a remaining commitment to purchase solar cells with a cumulative power of 77.5 MW and make prepayments through December 31, 2017 at a fixed price of 113.3 million euro, or US$158.1 million, based on the currency exchange rate at October 31, 2010; a 10% decline in the US Dollar against the euro could require us to pay an additional US$15.8 million over the course of the remaining agreement. We face transactional currency exposures that arise when our foreign subsidiaries and affiliates enter into transactions denominated in currencies other than their own local currency. We also face currency exposure that arises from translating the results of our Canadian and German operations to the US Dollar.

We are not exposed to market risk from changes in interest rates due to the fixed nature of interest rates associated with our debt instruments.

To date, we have not used any derivative financial instruments for the purpose of reducing our exposure to adverse fluctuations in interest rates but we have entered into currency exchange arrangements for the purpose of reducing our exposure to adverse changes in currency exchange rates. As of October 31, 2010, we had no outstanding contractual commitments to purchase foreign currency. Net foreign currency transaction gains or losses were not significant during the first six months of fiscal 2011.

Off Balance Sheet Disclosures

Construction in Progress

Our wholly-owned subsidiary SPI is currently in the advanced stages of developing the Spring Bay Wind Farm located in Ontario, Canada. As of October 31, 2010, costs of $1.3 million related to the development of the project have been classified as construction in progress. The build out of the project will require approximately $15 million in additional costs to complete and the wind farm is scheduled to be online in April 2011 if sufficient capital is raised to complete the project over the coming months. In addition, we intend to establish a solar photovoltaic module manufacturing operation in Irvine, California during the fourth quarter of fiscal 2011 if we can obtain sufficient financing. As of October 31, 2010, this operation has used approximately $2 million to initiate construction of manufacturing equipment and may require approximately $10 million in additional capital for manufacturing equipment expenditures, facility improvements, and other costs to become operational.

 

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We do not plan to move forward with the build out of the Spring Bay Wind Farm project or the solar module manufacturing operation until we raise a level of additional capital to be able to fund one or both of these projects and maintain sufficient levels of working capital for our overall business (see Liquidity).

Asola Solar Cell Supply Agreement and Guarantee

Our affiliate, Asola, has a certain long-term solar cell supply agreement dated November 1, 2007 (Supply Agreement) with one of its suppliers of solar cells for Asola’s solar module manufacturing operations. We have a related unconditional commitment under a November 2007 agreement with Asola to purchase one-half of the solar cells and to provide our share of prepayments totaling 4.5 million euro to Asola in connection the Supply Agreement. As of October 31, 2010, we had provided Asola with 3.0 million euro for our share of prepayments under the Supply Agreement. The remaining 1.5 million euro was due on September 1, 2009 but, as discussed in more detail below, the Supply Agreement is currently in dispute. We have not purchased any solar cells under our agreement with Asola and we are still obligated to provide an additional 1.5 million Euro to Asola to satisfy our share of the September 1, 2009 prepayment required under the Supply Agreement. Asola has not initiated or threatened to take any action against us in connection with our obligations under our agreement with Asola.

Beginning in calendar 2009, the worldwide supply of solar cells increased and suppliers in the industry lowered prices for both the immediate delivery of solar cells and for longer term solar cell purchase arrangements. As a result of these price declines, the spot rates of solar cells for immediate delivery are significantly below the purchase prices for calendar 2009 and 2010 that are specified under the Supply Agreement. The Supply Agreement includes a “loyalty clause” that states that if a provision of the Supply Agreement proves to be unreasonable for one of the parties to the agreement, then any such circumstance will be taken account of in a fair and reasonable way. Pursuant to the Supply Agreement, Asola was required to take delivery of solar cells with a combined power of 4.0 million watts in calendar 2009 and 10.0 million watts in calendar 2010. Asola has not taken delivery of these cells and has claimed that the “loyalty clause” requires that the supplier amend the prices specified under the Supply Agreement in a reasonable manner. The matter reached an impasse with the supplier and is currently working its way through the German legal system. In August 2010, a settlement and oral hearing was held which did not change our view that we do not have a loss contract that requires a charge to be recognized.

If Asola is unable to successfully modify its remaining commitments under the Supply Agreement, we may have to record a charge in the future equal to the sum of our prepayments made to date, plus the remaining unconditional commitments, less the estimated net realizable value of the solar cells to be acquired under our agreement with Asola. This amount cannot be reasonably estimated at this time based on the uncertainty with forecasting future market prices over the remaining period of the Supply Agreement. However, we currently believe that the range of a potential charge that we could be required to recognize would be limited to $11.2 million, which amount represents the total of all solar cell prepayments and other advances made by us to Asola, plus our net investment in Asola at October 31, 2010. If we complete the transaction as contemplated under the Asola LOI, the amount of potential loss that we could be exposed to under the Supply Agreement would increase as a result of us acquiring an anticipated controlling equity ownership in Asola.

We also have an unconditional commitment to guaranty up to 1.0 million euro of Asola’s bank debt.

Warrants with Exercise Price Resets

We issued warrants to investors in October 2006 and in August 2008 that contain contractual provisions which, subject to certain exceptions, reset the exercise price of such warrants if at any time while such warrants are outstanding, we sell or issues shares of our common stock or rights, warrants, options or other securities or debt convertible, exercisable or exchangeable for shares of our common stock at a price below $2.36 for the October 2006 Warrants or $4.00 for the August 2008 Warrants, provided that the exercise price for the August 2008 Warrants cannot be reset below $1.93. Since the initial issuance of these warrants, we have completed capital raising transactions that resulted in the reset of the exercise price of the October 2006 Warrants and August 2008 Warrants to $0.53 and $2.88 as of October 31, 2010, respectively.

The October 2006 Warrants and August 2008 Warrants also contain a provision that increases the number of shares of common stock subject to such warrants if and when the exercise price is reset so that the aggregate purchase price payable applicable to the exercise of the warrants after the reset of the exercise price is the same as the aggregate purchase price payable immediately prior to the reset. As a result of the exercise price resets, the number of shares subject to the October 2006 Warrants and August 2008 Warrants increased to 7.4 million and 18.7 million, respectively, as of October 31, 2010. Any resets to the exercise price of the October 2006 Warrants and/or August 2008 Warrants in the future will have an additional dilutive effect on our existing shareholders.

 

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We evaluate the warrants provided in connection with each of our private placement or public offerings in accordance with applicable accounting guidance and we have concluded that liability classification is appropriate for warrants issued in October 2006, June 2007, August 2008, August 2009 and September 2009. We have further concluded that equity classification is appropriate for the warrants that we issued in June 2006, warrants issued in connection with the private placement that covered the period from April 30, 2010 through July 26, 2010 (the “Spring 2010 Warrants”) and the October 2010 Warrants due to the fact that these warrants are required to be physically settled in shares of our common stock and there are no provisions that could require net-cash settlement.

The proceeds from the transactions in June 2006 and in the spring of 2010 that gave rise to certain warrants have been allocated to the stock and the warrants based on their relative fair values. However, we aggregate the values for financial reporting purposes as both types of instruments issued in June 2006 and in the spring of 2010 have been classified as permanent equity. The proceeds from the bridge note transactions in October 2010 that gave rise to certain warrants have been allocated to the debt and the warrants based on their relative fair values.

The classification as equity for the June 2006 Warrants, the Spring 2010 Warrants and the October 2010 Warrants could change as a result of either future modifications to the existing terms of settlement or the issuance of new financial instruments by us that could be converted into an increased or unlimited number of shares. If a change in classification of these warrants is required in the future, the warrants would be treated as derivatives, brought onto the balance sheet at their fair value, and marked to market each period, with the changes in fair values being recognized in the respective period’s statement of operations.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with US generally accepted accounting principles (US GAAP) and are included elsewhere in this report. We believe that the application of certain critical accounting policies, which are important to our financial position and results of operations, require significant judgments and estimates on the part of management. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management considers an accounting estimate to be critical if:

 

•

it requires assumptions to be made that were uncertain at the time the estimate was made; and

 

•

changes in the estimate or different estimates that could have been selected could have a material impact on our results of operations or financial condition.

Our management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our board of directors, and the audit committee has reviewed the disclosure presented below relating to them. We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

•

We generally manufacture products based on specific orders from customers. Revenue is recognized on product sales upon shipment or when the earnings process is complete and collectibility is reasonably assured. We include the costs of shipping and handling, when incurred, in cost of goods sold. We generally recognize revenue and profit as work progresses on long-term, fixed price contracts for product application development using the percentage-of-completion method. Generally, we estimate percentage complete by determining cost incurred to date as a percentage of total estimated cost at completion. For certain other contracts, percentage complete is determined by measuring progress towards contract deliverables if it is determined that this methodology more closely tracks the realization of the earnings process. For contracts measured under the estimated cost approach, we believe we can generally make dependable estimates of the revenue and costs applicable to various stages of a contract. Recognized revenue and profit are subject to revisions as the contract progresses to completion. Our estimates of contract costs are based on expectations of engineering development time and materials and other support costs. These estimates can change based on unforeseen technology and integration issues, but known risk factors and contract challenges are generally allowed for in the initial scope and cost estimate of the program. Our historical final contract costs have usually approximated the initial estimates and any unforeseen changes in the estimates have not normally resulted in a material impact to financial results. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known. For energy sales, we recognize revenues based on the terms of a power purchase agreement which outlines long-term pricing and escalation for the power produced by the renewable energy farm.

 

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•

We conduct a major portion of our business with a limited number of customers. For fiscal 2011 and for the foreseeable future, Fisker Automotive has represented and is expected to continue to represent, a significant portion of our revenues and accounts receivables. Credit is extended based upon an evaluation of each customer’s financial condition, with terms consistent with those present throughout the industry. Typically, we do not require collateral from customers. We have recorded an allowance for uncollectible accounts receivable based on past experience and certain circumstances surrounding the composition of total accounts receivable. To the extent we increase this allowance, we must include an expense in the statement of operations. If commercial conditions differ from management’s estimates, an additional write-off may be required.

 

•

We provide for the estimated cost of product warranties at the time revenue is recognized based on past experience and expectations of future costs to be incurred. Our Electric Drive & Fuel Systems segment provides product warranties in certain circumstances depending on the platform and model year. For prototype components and systems that are not production intent, warranties are generally not provided. While we engage in product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required.

 

•

We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. As part of our estimate, we rely upon future planned design configurations and projected alternative usage of certain components estimated by our engineering teams. We also consider estimated demand for service and warranty parts based on historical information. If actual usage rates or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

 

•

We account for our ownership interests in Asola, PCD and Shigan Quantum under the equity method of accounting in accordance with Accounting Standards Codification (ASC) Topic No. 323 “Investments—Equity Method and Joint Ventures” (ASC 323) as a result of our ability to exercise significant influence over the operating and financial policies of these affiliates. Under ASC 323, investments of this nature are recorded at original cost and adjusted periodically to recognize our proportionate share of the entity’s net income or losses after the date of investment. When net losses from an investment accounted for under the equity method exceed its carrying amount, the investment balance is reduced to zero and additional losses are not recorded. We resume accounting for the investment under the equity method when the entity subsequently reports net income and our share of that net income exceeds the share of net losses not recognized during the period the equity method was suspended. We account for our ownership interest in Fisker Automotive under the cost method of accounting in accordance with ASC Topic No. 325-20 “Cost Method Investments” (ASC 325-20). Under ASC 325-20, investments of this nature are initially recorded at cost. Income is recorded for dividends received that are distributed from net accumulated earnings of the investee subsequent to the date of investment. Dividends received in excess of earnings subsequent to the date of investment are considered a return of investment and are recorded as reductions in the cost of the investment. Investments are written down only when there is clear evidence that a decline in value that is other than temporary has occurred. Our foreign based affiliates have functional currencies other than the US Dollar. As such, translation adjustments may result from the process of translating our affiliates’ financial statements from their functional currency to US Dollars, which we account for in accordance with ASC Topic No. 830 “Foreign Currency Matters.”

 

•

We periodically evaluate our long-lived assets for impairment, particularly intangible assets and goodwill relating to acquisitions. Goodwill is not amortized, but is evaluated periodically for any impairment in the carrying value. We review our long-lived assets, which include property and equipment, construction in process, intangible assets and goodwill, for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors we consider important which could trigger an impairment review include, but are not limited to, the following: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of our use of the acquired assets or the strategy for our overall business; significant negative industry or economic trends; and a significant decline in our stock price for a sustained period. Goodwill and long-lived asset impairment assessments are generally determined based on fair value techniques, including determining the estimated future discounted and undiscounted cash flows over the remaining useful life of the asset. Those models require estimates of future revenue, profits, capital expenditures and working capital for each reporting unit. We estimate these amounts by evaluating historical trends, the current state of the automotive industry and the economy, current budgets, and operating plans. Discounted cash flows are calculated using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Determining the fair value of reporting units and goodwill includes significant judgment by management and different judgments could yield different results. Any resulting impairment loss could have a material impact on our financial condition and results of operations.

 

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•

We account for provisions contained within certain of our warrant contracts and the written put option contained within the Lender Commitment as derivative instrument liabilities in accordance with ASC Topic No. 815 “Derivatives and Hedging” (ASC 815). The share price of our common stock represents the underlying variable that gives rise to the value of the derivative instruments. Additional factors include the volatility of our stock price, our credit rating, discount rates, and stated interest rates. In accordance with ASC 815, the derivative instrument liabilities are recorded at fair value and marked to market each period. Changes in fair value of the derivatives each period resulting from a movement in the share price of our common stock or the passage of time are recognized as fair value adjustments of derivative instruments on our consolidated statements of operations as other income or expense. The fair value adjustments can have a material impact on our financial condition and results of operations.

 

•

We evaluate whether modifications to and restructuring of existing debt instruments result in substantial changes as defined by ASC Topic No. 470, “Debt” (ASC 470). Significant management judgment is required and we use the assistance of independent valuation consultants to estimate the fair value of the original and amended debt instruments as part of our evaluation. Different judgments could yield different results. If we determine that a substantial change has occurred with respect to the modifications, we treat the transaction as an extinguishment of the original debt and recognize a gain or loss on the debt retirement. If we determine that our senior lender has for economic or legal reasons related to our financial condition, granted us a concession that our senior lender would not otherwise consider, we treat the modifications as a troubled debt restructuring and analyze whether a gain should be recorded in connection with the concession.

 

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We account for stock compensation expense under ASC Topic No. 718 “Compensation—Stock Compensation” (ASC 718). ASC 718 requires all share-based payments, including grants of stock options and restricted stock, to be recognized in our financial statements based on their respective grant date fair values. Under this standard, the fair value of each employee stock option is estimated on the date of grant using an option-pricing model that meets certain requirements. We currently use the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. The Black-Scholes model meets the requirements of ASC 718 but the fair values generated by the model may not be indicative of the actual fair values of our share-based awards as it does not consider certain factors important to share-based awards, such as continued employment, periodic vesting requirements and limited transferability. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility and estimated life of our stock options at grant date based on historical data trended into the future. The risk-free interest rate assumption is the Constant Maturity Treasury rate on government securities with a remaining term equal to the expected term of the option. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock is based on the fair market value of our common stock on the date of grant. Share-based compensation expense recognized in our financial statements is based on awards that are ultimately expected to vest. The amount of share-based compensation expense is reduced for estimated forfeitures based on historical experience. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We evaluate the assumptions used to value stock-based awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. To the extent that we grant additional equity securities to employees or we assume unvested securities in connection with any acquisitions, our share-based compensation expense will be increased by the additional unearned compensation resulting from those additional grants or acquisitions.

 

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•

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves the estimation of our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. Included in this assessment is the determination of the net operating loss carry-forward that has resulted from our cumulative net operating loss. These temporary differences result in an overall net deferred tax asset or liability position. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent that we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or change this allowance in a period, we generally include an expense or benefit within the tax provision in the consolidated statement of operations. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our deferred tax assets. We have recorded a valuation allowance on our deferred tax assets due to uncertainties related to our ability to fully utilize these assets, primarily consisting of net operating losses and credits that may be carried forward before they expire, and that are subject to certain limitations. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust the recorded valuation allowance, which could materially impact our financial position and results of operations.

New Accounting Pronouncements

See Note 1 to the Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements adopted and issued.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Information required by Item 305 of Regulation S-K relating to quantitative and qualitative disclosures about market risks appear under the heading “Quantitative and Qualitative Disclosures About Market Risk” in Item 2 hereof, and is incorporated herein by this reference.

 

Item 4.

Controls and Procedures.

(a) Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in this report.

(b) Design of Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States.

Our internal control over financial reporting includes policies and procedures that:

 

•

Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of our assets;

 

•

Provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with US generally accepted accounting principles;

 

•

Provide reasonable assurances that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

•

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

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(c) Changes in Internal Control Over Financial Reporting

Except as noted below, there have been no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

On April 16, 2010, we completed our acquisition of SPI. During the second quarter of fiscal 2011, we continued to evaluate and integrate SPI’s operations, policies and processes into our overall system of internal control over financial reporting. We anticipate completing the integration of SPI by April 30, 2011.

PART II—OTHER INFORMATION

 

Item 1A.

Risk Factors.

Below is a summary of the risk factors we specifically identified in our fiscal year 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission on July 13, 2010, all of which are incorporated herein by reference. For a complete description of such risk factors, please refer to the 2010 Annual Report.

Risks Related to Liquidity and Capital Resources:

 

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We have a history of operating losses and negative cash flow and we anticipate that we will need to raise additional funds to finance operations.

 

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We will need to raise additional funds to take advantage of strategic business opportunities, to complete product and application development, to fund our wind and solar initiatives, future operating activities and contractual commitments, and/or pay off or refinance debt.

 

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We have three convertible notes outstanding with an aggregate principal and accrued interest balance of $11.2 million at April 30, 2010 and which mature on July 31, 2011 and which we may be unable to repay at maturity.

 

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Our shareholders are subject to significant dilution upon the occurrence of certain events.

 

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We are not in compliance with Nasdaq’s minimum bid requirement.

 

•

We may not be able to maintain compliance with NASDAQ’s continued listing requirements.

 

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The market price and trading volume of our common stock may be volatile.

 

•

We may not be able to obtain waivers of potential defaults in the future from our senior lender if we do not meet future requirements associated with our amended credit facility and convertible promissory note.

 

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We have a commitment to provide a guaranty to an affiliate’s credit facility that could be called upon if the affiliate defaults on the credit facility in the future.

 

•

The change in value of our derivative liabilities could have a material effect on our financial results.

Other Risks Related to our Business:

 

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Fisker Automotive represents a substantial portion of our existing and anticipated future revenues and these future revenues will depend on Fisker Automotive’s success.

 

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Fisker Automotive’s success and, in turn, our success and ability to reach profitability, is highly dependent on Fisker Automotive’s ability to access the full amount of a $528 million Department of Energy loan.

 

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SPI will need substantial additional capital in order to fund its renewable energy projects.

 

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SPI’s success is highly dependent on its ability to obtain permits, approvals, authorization, power purchase agreements and retain its land rights.

 

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Development and construction of wind and solar energy projects is subject to a number of risks and uncertainties.

 

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The Credit Agreement with our senior lender contains certain negative covenants that could restrict our ability to implement our business plan.

 

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Fluctuations in the Euro Dollar could have a material effect on SPI’s business and operations.

 

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Our fuel cell vehicle development and production revenue depends on our relationship with General Motors and General Motors’ viability and commitment to the commercialization of fuel cell vehicles.

 

•

We have commitments under a corporate alliance agreement with General Motors that require us to spend up to $4 million annually for research and development projects directed by General Motors.

 

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•

We depend on third-party suppliers for the supply of materials and components for our products.

 

•

Our business depends on the growth of hybrid electric, hydrogen, and alternative fuel based vehicles and the renewable energy industry.

 

•

Our ability to design and manufacture powertrain and fuel systems for hybrid, hydrogen and fuel cell applications that can be integrated into new vehicle platforms will be critical to our business and our ability to successfully complete existing development programs.

 

•

Decrease in demand or price for solar cells could have an adverse effect on our financial statements.

 

•

Past acquisitions and any future acquisitions, equity investments, joint ventures, strategic alliances or other similar transactions may not be successful.

 

•

Failure to secure financing for Quantum Solar could adversely affect our operating results.

 

•

A mass market for plug-in electric hybrid and hydrogen products and systems may never develop or may take longer to develop than anticipated.

 

•

Evolving customer design requirements, product specifications and testing procedures could cause order delays or cancellations.

 

•

The terms and enforceability of many of our strategic partner relationships are uncertain.

 

•

We currently face and will continue to face significant competition.

 

•

We depend on our intellectual property, and our failure to protect that intellectual property could adversely affect our future growth and success.

 

•

Our failure to obtain or maintain the right to use certain intellectual property may negatively affect our business.

 

•

We have limited experience manufacturing hybrid propulsion and fuel systems for fuel cell applications on a commercial basis.

 

•

We may not meet our product development and commercialization milestones.

 

•

Our business could suffer if we fail to attract and maintain key personnel.

 

•

We may be subject to warranty claims, and our provision for warranty costs may not be sufficient.

 

•

Our business may be subject to product liability claims or product recalls, which could be expensive and could result in a diversion of management’s attention.

 

•

Our insurance may not be sufficient.

 

•

Our business may become subject to future product certification regulations, which may impair our ability to market our products.

 

•

Failure to comply with applicable environmental and other laws and regulations could adversely affect our business and harm our results of operations.

 

•

New technologies could render our existing products obsolete.

 

•

Changes in environmental policies could hurt the market for our products and our renewable energy projects.

 

•

The development of uniform codes and standards for hydrogen fuel cell vehicles and related hydrogen refueling infrastructure may not develop in a timely fashion.

 

•

The recently completed restatement of our historical financial statements has already consumed, and may continue to consume, a significant amount of our resources and may have a material adverse effect on our business and stock price.

 

•

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.

 

•

Provisions of Delaware law and of our Certificate of Incorporation and Bylaws may make a takeover or change in control more difficult.

Material Changes to Risk Factors in Fiscal 2011:

Other than as discussed below, there have been no material changes to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended April 30, 2010, all of which are incorporated herein by reference.

 

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We have debt obligations scheduled to mature on December 31, 2010 and July 31, 2011 which we may be unable to repay at maturity.

We have certain term notes that are scheduled to mature on December 31, 2010 that require a contractual cash payment of $4.2 million to satisfy the aggregate principal and accrued interest upon maturity and we have three convertible notes and a certain term note that are scheduled to mature on July 31, 2011 that may require a contractual cash payment of up to $15.7 million to satisfy the aggregate principal and accrued interest upon maturity. We do not currently have sufficient available funds to repay these debt obligations. In addition, we must provide notice to our senior lender beginning on or before December 20, 2010 of our intent to start drawing down on the $10.0 million Lender Commitment which is limited to a maximum of $2.5 million in any 30 day period in order for us to have the ability to draw down the full commitment prior to the expiration of the commitment on March 31, 2011. If we are unable to raise the funds to repay the notes at maturity or we are unable to extend the maturity dates or otherwise refinance the obligations, we will be in default and the holder of the notes will have rights senior to those of our common stockholders. A default in payment of the Bridge Notes will also constitute a default under all of our senior indebtedness and our senior lender will have the right to declare the full amount of the senior indebtedness immediately due and payable. Accordingly, a default in the Bridge Notes could have a material adverse affect on our business and our ability to continue as a going concern.

We are not in compliance with Nasdaq’s minimum bid requirement.

On September 2, 2010, we received a staff determination letter from The Nasdaq Stock Market (Nasdaq) stating that we had not regained compliance with the $1.00 minimum closing bid price requirement for continued listing on The Nasdaq Global Market under Nasdaq Listing Rule 5450(a)(1) (the “Minimum Bid Price Rule”). On October 27, 2010, the Nasdaq Listing Qualifications Panel (the “Panel”) granted our request for an extension of time, as permitted under Nasdaq’s Listing Rules, to regain compliance with Minimum Bid Price Rule. In accordance with the Panel’s decision, we must evidence a closing bid of at least $1.00 for a minimum of ten consecutive days on or before March 1, 2011.

On October 11, 2010, our shareholders approved a proposal to give our board of directors the discretion to implement a 1-for-20 reverse stock split. We believe that a timely implementation of the reverse stock split, if necessary, will result in us regaining compliance with the Minimum Bid Price Rule, thus, allowing us to maintain the listing of our common stock on the Nasdaq Global Market.

The potential delisting of our common stock from trading on Nasdaq could have a material adverse effect on the market for, and liquidity and price of, our common stock and impair our ability to raise capital. Delisting from Nasdaq could also have other negative results, including, without limitation, the potential loss of confidence by customers and employees, the loss of institutional investor interest and fewer business development opportunities. If our common stock is delisted from trading on Nasdaq and if our common stock is not eligible for quotation on another market or exchange, trading of our common stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of or obtain accurate quotations for the price of our common stock, and there may also be a reduction in our coverage by security analysts and the news media, which may cause the price of our common stock to decline further.

Our ability to raise sufficient capital to meet our obligations may be impaired by our financial position and the existing credit markets.

Our history of operating losses and cash uses, our projections of the level of cash that will be required for our operations to reach profitability, the terms of the private placement transactions that we have entered into over the recent past to provide for our historical liquidity requirements, and the restricted availability of credit for emerging industries, may impair our ability to raise capital on terms that we consider reasonable and at the levels that we will require over the coming months. Our inability to raise sufficient capital as needed over the foreseeable future would have a material adverse effect on our ability to continue as a going concern.

 

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Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

 

Item 4.

Submission of Matters to a Vote of Security Holders

Not applicable.

 

Item 5.

Other Information

Not Applicable.

 

Item 6.

Exhibits.

The Exhibits included as part of this report are listed in the attached Exhibit Index, which is incorporated herein by this reference.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: December 10, 2010

 

 

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EXHIBIT INDEX

Form 10-Q For Period Ended October 31, 2010.

 

3 (i)		Amended and Restated Certificate of Incorporation, dated March 3, 2005, as amended.
10.1		Form of Note and Warrant Purchase Agreement between the Registrant and certain accredited investors in connection with a private placement transaction that closed in two tranches on October 13, 2010 and October 19, 2010. (Incorporated herein by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on October 19, 2010).
10.2		Form of Note issued by the Registrant to certain accredited investors in connection with a private placement transaction that closed in two tranches on October 13, 2010 and October 19, 2010. (Incorporated herein by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K filed with the Commission on October 19, 2010).
10.3		Form of Warrant issued by the Registrant to certain accredited investors in connection with a private placement transaction that closed in two tranches on October 13, 2010 and October 19, 2010. (Incorporated herein by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K filed with the Commission on October 19, 2010).
31.1		Certification of the Chief Executive Officer of the Company pursuant to Exchange Act Rule 13a-14(a).
31.2		Certification of the Chief Financial Officer of the Company pursuant to Exchange Act Rule 13a-14(a).
32.1		Certification of the Chief Executive Officer of the Company furnished pursuant to Exchange Act Rule 13a-14(b) and U.S.C. 1350.
32.2		Certification of the Chief Financial Officer of the Company furnished pursuant to Exchange Act Rule 13a-14(b) and U.S.C. 1350.

 

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