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BALQON CORP. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our financial statements and the related notes to financial statements included elsewhere in this report. This report and our financial statements and notes to financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing our business strategies. Our actual results could differ materially from those expressed in these forward-looking statements as a result of any number of factors, including those set forth under the "Risk Factors" section and elsewhere in this report. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation: · the projected growth or contraction in the industries within which we operate; · our business strategy for expanding, maintaining or contracting our presence in these markets; · anticipated trends in our financial condition and results of operations; and · our ability to distinguish ourselves from our current and future competitors. We do not undertake to update, revise or correct any forward-looking statements. Any of the factors described above or elsewhere in this report, including in the "Risk Factors" section of this report, or referenced from time to time in our filings with the Securities Exchange Commission, or SEC, could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. Business Overview We are a developer and manufacturer of electric drive systems and battery systems for trucks, tractors, buses, industrial equipment and renewable energy storage devices. We also design and assemble electric powered yard tractors, short haul drayage tractors and inner city trucks utilizing our proprietary drive system technologies. Each of our electric drive systems is comprised of an electric motor, transmission, our proprietary flux vector motor controller (which controls the speed of an electric motor by varying the input frequency and voltage from a vehicle's batteries), power electronic components and proprietary software configured to specific application needs. Our lithium battery modules feature our proprietary battery management system, or BMS, an electronic device mounted on each lithium battery cell to monitor and balance the state of charge of the battery, including its temperature, voltage and current during charge and discharge cycles. Our proprietary software allows our BMS to be used on any battery cell chemistry. A key element of our strategy is to integrate our proprietary technologies such as our flux vector motor controllers and BMSs into diversified vehicle platforms to address a growing global demand for commercial electric vehicles. We are also engaged in the research and development of battery and power management systems for use in the renewable energy storage industries, such as the wind, solar and geothermal industries. 20-------------------------------------------------------------------------------- We sell our electric drive systems and lithium battery modules to global original equipment manufacturers, or OEMs, of trucks, buses and industrial equipment that are engaged in the development of electric or hybrid vehicle platforms to address local market needs. Our sales strategy is to partner with OEMs to develop product solutions for specific market needs utilizing our complete propulsion and energy systems. We believe that this strategy will result in a reduction of the costs associated with product development and integration and will also reduce time to market cycles for our OEM partners' new product platforms. We also develop, design, assemble, market and sell zero-emissions heavy-duty electric yard tractors, heavy-duty short haul drayage tractors, heavy-duty inner city Class 7 and Class 8 delivery trucks and medium-duty electric trucks that feature our proprietary electric drive systems and lithium battery modules. Our heavy-duty electric vehicles are suitable for use in the transportation of containers and heavy loads in on-highway and off-highway applications at facilities such as marine terminals, rail yards, industrial warehouses, intermodal facilities (facilities where freight is transferred from one mode of transportation to another without actual handling of the freight itself when changing modes), military bases and industrial plants. Our medium-duty electric trucks are designed for inner city applications. As of the date of this report, our electric vehicle product portfolio features three products in our Nautilus product line, the Nautilus XE20, a heavy-duty electric yard tractor, the Nautilus XE30, a heavy-duty electric short-haul tractor, and the Nautilus XRE20, a longer-range version of the Nautilus XE20. We also offer a heavy-duty Class 7 and Class 8 electric truck, the Mule M150, and a medium-duty electric truck, the Mule M100, that features our proprietary electric drive systems and lithium battery modules. The Mule M150 is designed as a zero emissions solution to transport loads of up to 7 tons in short-haul on-highway applications while the Mule M100 is an on-road electric truck designed for use in inner city applications and is designed to transport loads of up to four tons with a range of between 96 and 150 miles under loaded conditions. Recent Developments During the first six months of 2011 and through July 25, 2011, a significant portion of our production efforts have been focused on designing an electric drive system configuration that can be integrated into 14 to 30 passenger mini-buses in connection with an order from Winston Global Energy, or WGE, and an agreement with Ashok Leyland Ltd., integrating the electric drive systems we developed in connection with the WGE order and our agreement with Ashok Leyland into the mini-bus chassis specified by each of them, developing a medium-duty on-road electric truck, our Mule M100, and producing Nautilus XRE20s in connection with an agreement with T&K Logistics, Inc. and an agreement with the City of Los Angeles. During the second quarter of 2011, our research and development efforts also included work on the development of new products to address the on-road markets in the United States and increasing the range of our yard tractors. In November 2010, T&K Logistics, the provider of logistics services to Ford Motor Company and the manager of on-site transportation of trailers and containers at Ford Motor Company's assembly plant in Wayne, Michigan, agreed to lease 10 of our Nautilus yard tractors for use at the assembly plant for a period of 36 months. During the first six months of 2011, we have shipped five of our Nautilus XRE20s to T&K Logistics and intend to deliver the remaining five units by October 31, 2011. The five Nautilus XRE20s we shipped featured battery modules with double the battery energy and, therefore, double the range of our Nautilus XE20s. As of July 25, 2011, the five Nautilus XRE20s we shipped are awaiting the installation of charging systems. We expect the vehicles to be installed with charging systems and become fully operational in August 2011 and expect to begin generating lease revenues associated with this leasing arrangement during the latter part of the third quarter of 2011. 21 -------------------------------------------------------------------------------- In December 2010, we entered into a three year distribution agreement, or Distribution Agreement, with Seven One Limited, or SOL, under which we were appointed as the exclusive authorized distributor in the United States for the promotion, marketing and sale of lithium iron phosphate batteries and high voltage charging systems manufactured by Seven One Battery Company. At June 30, 2011, 3,361 batteries are held on consignment with a value of $2,487,700. For the six months ending June 30, 2011, 203 batteries were sold for $113,680. In January 2011, we entered into an agreement with WGE, an affiliate of our Chairman of the Board headquartered in Shenzhen China, under which WGE agreed to purchase 300 of our electric drive systems at an aggregate purchase price of approximately $15.9 million. The electric drive systems are to be integrated into 14 to 30 passenger mini-buses and must be delivered by no later than July 25, 2012. During the second quarter of 2011, we spent significant efforts towards developing a medium-duty electric drive system that would seamlessly integrate into a 14 passenger mini-bus chassis specified by WGE. As of July 25, 2011, we have delivered one electric drive system under the WGE purchase order and are working with WGE to ensure that it can be integrated into the mini-bus chassis specified by WGE. We expect to begin testing the 14 passenger mini-bus that incorporates our medium-duty electric drive system during the third quarter of 2011 and expect to begin generating revenues under the WGE purchase order during the latter part of the third quarter of 2011 and into the fourth quarter of 2011. Under an agreement with the City of Los Angeles, or City of Los Angeles Agreement, we agreed to sell 20 Nautilus E20 heavy-duty electric yard tractors (the predecessor to our Nautilus XE20) and five Nautilus E30 short-haul tractors (the predecessor to our Nautilus XE30) to the City of Los Angeles for use at the Port of Los Angeles. As of July 25, 2011, we have delivered 14 Nautilus E20s (including four Nautilus XE20s two of which have been retrofitted with extended range lithium batteries and are referred to as our Nautilus XRE20s) and one Nautilus XE30, to the Port of Los Angeles under the terms of the City of Los Angeles Agreement. Initial use of the electric vehicles at the Port of Los Angeles evidenced that the vehicles had a range of between five and six hours. Upon the request of the City of Los Angeles to increase the range of the vehicles to meet two shift operations, we retrofitted two of the vehicles we had delivered under the City of Los Angeles Agreement with extended range lithium battery systems, hydraulic systems and software thereby extending the range of the resultant vehicle, the Nautilus XRE20. The two Nautilus XRE20s have evidenced a range of over 16 hours of operation during preliminary testing. As of July 25, 2011, the two Nautilus XRE20s continue to undergo further tests under various load conditions to determine whether the vehicles can operate for two shift operations on a single charge. During the year ended December 31, 2010, we delivered electric drive systems and lithium battery modules to Ashok Leyland, a large manufacturer of trucks and buses based in India, to be installed into intercity hybrid buses to be used for demonstration purposes. The intercity hybrid buses incorporating our electric drive systems and lithium battery modules underwent field tests for eight months. As a result of the successful demonstration and testing of these intercity hybrid buses, in April 2011, we entered into a Joint Development Agreement with Ashok Leyland under which we will work with Ashok Leyland to jointly develop and test six electric vehicles (comprised of buses and trucks) using Ashok Leyland's glider chassis and our electric drive systems and lithium battery modules. As of July 25, 2011, we have delivered two electric drive systems to Ashok Leyland for integration into prototype inner city buses. Subject to the six prototypes meeting established performance and cost targets and/or Ashok Leyland obtaining firm requirements from its customers, Ashok Leyland has agreed to purchase a minimum of 14 drive systems from us for sale to its customers. During the second quarter of 2011, we completed the development of our medium-duty electric truck, the Mule M100, and delivered one Mule M100 that incorporates our proprietary drive system to a customer in the United States. The Mule M100 is designed to transport loads of up to four tons with a range of between 96 and 150 miles under loaded conditions and targets inner city delivery applications for customers in North America. 22-------------------------------------------------------------------------------- During the second quarter of 2011, we delivered one complete electric drive system for integration in to a heavy-duty tractor to Mol Industries, an OEM located in Europe. We anticipate that Mol Industries will complete the heavy-duty tractor during the third quarter of 2011 and commence demonstrations at ports, warehouses and industrial plants across Europe during the fourth quarter of 2011. We anticipate that the heavy-duty tractor will comply with all European standards and will meet all required CE requirements. We expect that the anticipated demonstrations of the Mol Industries tractor featuring our electric drive system will result in additional orders for our electric drive systems from OEMs in Europe. During the second quarter of 2011, we also received orders for an aggregate of 32 flux vector motor controllers from customers engaged in manufacturing monorail systems, electric buses and industrial equipment for use in military applications. Critical Accounting Policies Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our financial statements: Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Material estimates relate to the recognition of contract revenues and estimated costs to complete contracts in process, and recoverability of reported amounts of long-lived assets. Actual results may differ from those estimates. Revenues Sales of Production Units and Parts. We recognize revenue from the sale of completed production units and parts when there is persuasive evidence that an arrangement exists, delivery of the product has occurred and title has passed, the selling price is both fixed and determinable, and collectability is reasonably assured, all of which generally occurs upon shipment of our product or delivery of the product to the destination specified by the customer. We determine whether delivery has occurred based on when title transfers and the risks and rewards of ownership have transferred to the buyer, which usually occurs when we place the products with the buyer's carrier. We regularly review our customers' financial positions to ensure that collectability is reasonably assured. Except for warranties, we have no post-sales obligations. 23 -------------------------------------------------------------------------------- Contract Revenue and Cost Recognition on Prototype Vehicles. In accounting for contracts, we recognize revenues using the percentage-of-completion method of accounting by relating contract costs incurred to date to the total estimated costs at completion. This method is used because management considers costs to be the best available measure of progress on its contracts. Contract losses are provided for in their entirety in the period that they become known, without regard to the percentage-of-completion. We also recognize as revenues costs associated with claims and unapproved change orders to the extent it is probable that such claims and change orders will result in additional contract revenue, and the amount of such additional revenue can be reliably estimated. Contract costs include all direct material and labor costs. The liability "Billings in excess of costs and estimated earnings on uncompleted contracts" represents billings in excess of revenues earned. Stock-Based Compensation We periodically issue stock instruments, including shares of our common stock, stock options, and warrants to purchase shares of our common stock to employees and non-employees in non-capital raising transactions for services and for financing costs. We account for stock option awards issued and vesting to employees in accordance with authorization guidance of the Financial Accounting Standards Board, or FASB, where the value of stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Options to purchase shares of our common stock vest and expire according to the terms established at the grant date. We account for stock options and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance of the FASB whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached, or (b) at the date at which the necessary performance to earn the equity instruments is complete. We estimate the fair value of stock options and warrants using the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of options that have no vesting restrictions and are fully transferable. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock and the expected life of stock options. Projected data related to the expected volatility of stock options is based on the average volatility of the trading prices of comparable companies and the expected life of stock options is based upon the average term and vesting schedules of the options. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of our employee stock options. We estimate the fair value of shares of common stock issued for services based on the closing price of our common stock on the date shares are granted. Derivative Financial Instruments We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, we use the Monte Carlo simulation model to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date. 24--------------------------------------------------------------------------------Impairment of Long-Lived Assets The FASB, has established guidelines regarding when impairment losses on long-lived assets, which include property and equipment, should be recognized and how impairment losses should be measured. Guidance of the FASB also provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. We periodically review, at least annually, such assets for possible impairment and expected losses. If any losses are determined to exist they are recorded in the period when such impairment is determined. Based upon management's assessment, there were no indicators of impairment of our long lived assets at June 30, 2011 or December 31, 2010. Financial Condition and Results of Operations Our total revenues increased by $73,188, or 13.5%, to $615,606 for the first six months of 2011 as compared to $542,418 for the first six months of 2010. We reported a net loss of $3,672,112 for the first six months of 2011 as compared to a net loss of $1,790,371 for the first six months of 2010. Our total revenues decreased by $4,531, or 0.9%, to $499,820 for the second quarter of 2011 as compared to $504,351 for second quarter of 2010. We reported a net loss of $1,138,588 for the second quarter of 2011 as compared to a net loss of $789,025 for the second quarter of 2010. The decline in our financial performance during 2011 is a result of increased operating, marketing and interest expenses, offset by the change in fair value of our derivative instruments, without a commensurate increase in revenues. In December 2010, we raised $5,000,000 in connection with a private placement of common stock and warrants. Using the capital we raised in December 2010, we ramped up our production processes during the first six months of 2011. Our lack of significant revenues during the first six months of 2011 is a direct result of the length and complexity of our product development process. Typically, we experience a significant time lag between receiving an order for our electric drive systems and recognizing revenue in connection with the order due to the development time required to integrate our technologies into new vehicle platforms specified by our customers. For example, while our electric drive systems and battery modules can be integrated into a multitude of product platforms, often times a substantial amount of time is needed to make design modifications to our product to ensure its integration into each new vehicle platform. In most cases new designs require sourcing of raw materials contributing further to the already lengthy production time. In the case of a new customer or a new product platform, it is customary in our business to complete and deliver a single unit prior to producing the entire order. Once the initial product is delivered, installed and accepted by our customer, we begin production on the remaining order based on production delivery dates agreed upon with our customer. While most of our production efforts during the first six months of 2011 were focused on the WGE purchase order and the T&K Logistics leasing arrangement, 75% of our revenues were derived from the delivery of drive systems to our OEM customers in the United States, Asia and Europe. These drive systems were customized for vehicle configurations to be used in both on-road and off-road applications. We anticipate that the delivery of these drive systems will result in additional orders from our OEM partners in the future. During the first six months of 2011, approximately 8% of our revenues were derived from engineering services provided to, Alliant Techsystems, Inc., in connection with a joint development project to determine the feasibility of the use of hydrogen fuel cells in our Nautilus XE20 yard tractors. During the first phase of the project, we provided design concepts to Alliant Techsystems to demonstrate the feasibility of utilizing hydrogen fuel cells in a plug-in hybrid Nautilus XE20 as an on-board charger for lithium batteries. As of July 25, 2011, our design proposal has been accepted by Alliant Techsytems and we are awaiting approval of the second phase of the project during which, if approved, we will provide a completed prototype vehicle Nautilus XE20 that features an integrated hydrogen fuel cell charging system designed by a third party. We do not anticipate that a significant portion of our future revenues will be derived from engineering services, but rather will be derived from the sale of our products as we begin to generate revenues as a result of the ramp up in our production efforts and continue to focus on obtaining new orders for our products. 25-------------------------------------------------------------------------------- As of June 30, 2011, we had a working capital deficiency of $1,394,428, an accumulated deficit of $19,011,005 and reported a net loss for the first six months of 2011 of $3,672,112. Our plans for correcting these deficiencies include the future sales of our products and technologies and the raising of capital, which we expect will help provide us with the liquidity necessary to meet operating expenses. Over the longer-term, we plan to achieve profitability through the sale of our drive systems, electric vehicles and other products. Although approximately $16 million of our current backlog of approximately $19 million is attributable to our outstanding purchase order for 300 of our electric drive systems from WGE, we believe that our customer base will expand during the remainder of 2011. In 2011, we expect our sales to grow in emerging markets such as India and China. We are optimistic that the demonstration of electric buses utilizing our technologies for Ashok Leyland in Asia during 2010 will result in additional sales in the region. In addition, we believe that the integration of our drive systems into medium-duty on-road commercial vehicles will result in increased sales in the United States in 2011. Further, we are optimistic that the demonstration of our extended range Nautilus CRE20 to existing and potential customers will result in additional sales of our electric vehicles. Our OEM partners in domestic and international markets have experienced increased sales activity for their products, which we expect will result in increased sales for our electric drive systems and battery systems. We anticipate that a majority of future sales of our electric vehicles will be made directly to domestic and international OEMs. In 2010, we demonstrated the performance of our Nautilus XE20 to a large automotive company, a marine terminal and several warehouses and we are optimistic that these demonstrations will result in an increase in our domestic sales. The tables presented below, which compare our results of operations from one period to another, present the results for each period, the change in those results from one period to another in both dollars and percentage change, and the results for each period as a percentage of net revenues. The columns present the following: · The first two data columns in each table show the absolute results for each period presented. · The columns entitled "Dollar Variance" and "Percentage Variance" shows the change in results, both in dollars and percentages. These two columns show favorable changes as a positive and unfavorable changes as negative. For example, when our net revenues increase from one period to the next, that change is shown as a positive number in both columns. Conversely, when expenses increase from one period to the next, that change is shown as a negative in both columns. · The last two columns in each table show the results for each period as a percentage of net revenues. 26--------------------------------------------------------------------------------Second Quarter of 2011 Compared to the Second Quarter of 2010 Results as a Percentage of Net Revenues for the Three Months Ended Dollar Percentage Three Months Ended June 30, Variance Variance June 30, 2011 2010 Favorable Favorable (Unaudited) (Unaudited) (Unfavorable) (Unfavorable) 2011 2010 Net revenues $ 499,820 $ 504,351 $ (4,531 ) (0.9)% 100% 100% Cost of revenues 360,067 459,010 98,943 21.6% 72% 91% Gross profit 139,753 45,341 (94,412 ) (208.2)% 28% 9% General and administrative expenses 1,057,877 419,588 (638,290 ) (152.1)% 212% 83% Research and development 143,613 58,575 (85,038 ) (145.2)% 29% 12% Depreciation and amortization 147,776 41,896 (105,880 ) (252.7)% 30% 8% Loss on change in derivative liability (464,847 ) - 464,847 100.0% 93% - Interest expense 393,921 314,307 (79,614 ) (24.9)% 79% 63% Net loss $ (1,138,588 ) $ (789,025 ) $ 348,563 (44.1)% (228)% (157)% Net Revenues. The slight decline in our revenues during the second quarter of 2011 is largely due to a change in the mix of products and services sold during that quarter as compared to the second quarter of 2010. During the second quarter of 2011, 77% of our revenues were generated from the shipment of drive systems for integration into medium sized buses and a heavy-duty tractor. During the second quarter of 2010, sales were comprised of one electric vehicle and related battery charging equipment. Additionally, during the second quarter of 2010, revenues of $34,874 were realized from a lithium-battery grant from the City of Los Angeles. Comparable grant revenues were not realized during the second quarter of 2011. Based on our current backlog and capital resources, we expect that our revenues will increase significantly over the second half of 2011. Additionally, we expect that in 2011 we will derive more revenues from the sale of drive systems than from the sale of our electric vehicles and batteries. We expect that sales of our drive systems will represent approximately 75% of net revenues during 2011. Gross Profit. During the second quarter of 2011, we generated a gross profit, as a percentage of net revenues, of 28% as compared to 9% for the second quarter of 2010. This increase in gross profit margin is attributable to higher margins on the sales of drive systems and battery systems and chargers as compared to lower profit margins from the sales of an electric vehicle and battery charger, coupled with no profit margin on from the $34,874 of net revenues derived from progress work on the lithium-ion grant contract during the second quarter of 2010. Based on current cost data for the products in our backlog that we anticipate will be shipping during the remainder of 2011, we anticipate that our gross profit margin will be approximately 18% of net revenues for 2011. General and Administrative Expenses. The significant increase in general and administrative expenses is comprised largely of an increase in unapplied overhead of $181,766, an increase in marketing expenses of $48,970, an increase in legal, consulting and professional fees of $321,043, and a net increase of $86,511 of other general and administrative expenses. While our general and administrative expenses are expected to increase over the near term, these expenses as a percentage of net revenues are expected to decrease as we increase our net revenues. We expect that over the near term, our general and administrative expenses will increase as a result of expenses related to increased management personnel, additional administrative and sales personnel, and additional employees associated with the anticipated ramp up in our business and sales. 27-------------------------------------------------------------------------------- Research and Development Expenses. The increase in research and development expenses is comprised of a $22,323 increase in supplies and $62,715 increase in salaries and wages from new personnel employed in the research and development group. We expect our research and development expenses to remain high during the remainder of the year as we develop new drive systems for our OEM partners worldwide. Depreciation and Amortization. The increase in depreciation and amortization expenses is due largely to a $116,948 of amortization expense related to the battery distribution agreement with SOL for the second quarter of 2011, which expense was not incurred during the second quarter of 2010. We expect depreciation and amortization expenses to continue at comparable levels over the next few quarters until the Distribution Agreement has been fully amortized in December 2013. Change in Fair Value of Derivative Liability. At June 30, 2011, the fair value of our derivatives increased to $1,054,232. This amount was determined by management with the use of an independent valuation specialist using a Monte Carlo simulation model. The difference between the fair value of the derivatives at June 30, 2011 and December 31, 2010 of $98,258 was recognized as change in the fair value of derivatives on our financial statements during the period ended June 30, 2011. The financial instruments that resulted in the derivative liability were not in place during the second quarter of 2010. Interest Expense. The increase in interest expense is attributable to interest and the amortization of the related beneficial conversion feature on the additional $536,500 of convertible notes payable that were issued between June 30, 2010 and June 30, 2011. Six Months Ended June 30, 2011 Compared to the Six Months Ended June 30, 2010 Results as a Percentage of Net Revenues for the Six Months Ended Dollar Percentage Six Months Ended June 30, Variance Variance June 30, 2011 2010 Favorable Favorable (Unaudited) (Unaudited) (Unfavorable) (Unfavorable) 2011 2010 Net revenues $ 615,606 $ 542,418 $ 73,188 13.5% 100% 100% Cost of revenues 408,940 496,602 87,662 (17.7)% 66% 92% Gross profit 206,666 45,816 (160,850 ) (351.1)% 34% 8% General and administrative expenses 2,176,445 1,164,967 (1,011,478 ) (86.8)% 354% 215% Research and development 293,724 124,118 (169,606 ) (136.6)% 48% 23% Depreciation and amortization 314,044 75,035 (239,009 ) (318.5)% 51% 14% Loss on change in derivative liability 98,258 - (98,258 ) 100.0% 16% - Interest expense 996,307 472,067 (524,240 ) 111.1% 162% 87% Net loss $ (3,672,112 ) $ (1,790,371 ) $ (1,881,741 ) (105.1)% (597)% (330)% Net Revenues. The improvement in our financial performance during the first six months of 2011 as compared to the same period in 2010 is largely due a change in the mix of products and services sold during each of the periods. During the first six months of 2011, approximately 75% of our revenues were generated from the sale of drive systems while approximately 63% of our revenues generated during the first six months of 2010 were from the sale of two electric vehicles and related battery charging equipment. During the first six months of 2011, we also generated $48,450 in revenues from engineering services provided as compared to $34,874 in contract revenues related to the lithium-ion grant from the City of Los Angeles earned during the first quarter of 2010. The net increase of $13,576 in services revenues accounts for the additional increase in revenues during the first quarter of 2011 as compared to the first quarter of 2010. 28-------------------------------------------------------------------------------- Gross Profit. During the six months of 2011 our gross profit margin was attributable to higher margins on the sales of drive systems and batteries. Additionally, during the first six months of 2011 we recorded revenues from engineering services that were rendered at a minimal direct cost. The gross margin of 8% during the first six months of 2010 was attributable to lower profit margins from the sales of two electric vehicles and related battery charging equipment, coupled with no profit margin on the $34,874 of contract revenues generated during the first six months of 2010. General and Administrative Expenses. The increase in general and administrative expenses is comprised largely of an increase in unapplied overhead of $377,025, an increase in marketing expenses of $271,740, an increase in legal, consulting and professional fees of $249,546, and a net increase of $113,167 of other general and administrative expenses. Research and Development Expenses. The increase in research and development expenses is comprised of a $22,323 increase in supplies and a $147,283 increase in salaries and wages related to personnel employed to further our research and development efforts. Depreciation and Amortization. The increase in depreciation and amortization expenses is due largely to a $253,387 of amortization expense related to the battery distribution agreement with SOL for the first six months of 2011, which expense was not incurred during the first six months of 2010. Change in Fair Value of Derivative Liability. At June 30, 2011, the fair value of our derivatives increased to $1,054,232. This amount was determined by management with the use of an independent valuation specialist using a Monte Carlo simulation model. The difference between the fair value of the derivatives at June 30, 2011 and December 31, 2010 of $98,258 was recognized as change in the fair value of derivatives on our financial statements during the period ended June 30, 2011. The financial instruments that resulted in the derivative liability were not in place during the first six months of 2010. Interest Expense. The increase in interest expense is attributable to interest and the amortization of the related beneficial conversion feature on the additional $536,500 of convertible notes payable that were issued between June 30, 2010 and June 30, 2011. Liquidity and Capital Resources During the first six months of 2011, we funded our operations from cash provided from operations, the issuance of common stock in connection with the exercise of outstanding warrants and the remaining proceeds from the issuance and sale of our secured and unsecured debt and equity securities during 2010. As of June 30, 2011, we had a working capital deficiency of $1,394,428 as compared to working capital of $1,955,146 at December 31, 2010. At June 30, 2011 and December 31, 2010 we had an accumulated deficit of $19,011,005 and $15,338,893, respectively, and cash and cash equivalents of $353,076 and $4,407,273, respectively. The significant decrease in our cash position is a result of an increase in inventories associated with the shipment of five Nautilus XRE20s to T&K Logistics. Once battery units are installed we plan to sell our vehicles to a leasing company thereby reducing inventories. Our available capital resources at June 30, 2011 consisted primarily of approximately $353,076 in cash and cash equivalents. We expect that our future available capital resources will consist primarily of cash on hand, cash generated from our business, if any, and future debt and/or equity financings, if any. 29-------------------------------------------------------------------------------- Cash used in operating activities for the first six months of 2011 was $4,156,454 as compared to $1,574,756 of cash used in operating activities for first six months of 2010. During the first six months of 2011, cash used in operating activities included a net loss of $3,672,112, depreciation and amortization of $314,044, amortization of note discount of $822,739, an increase in the fair value of derivative liabilities of $98,258, and net cash used by operating assets and liabilities of $1,719,382. Material changes in asset and liabilities at June 30, 2011 as compared to December 31, 2010 that affected these results include: · an increase in accounts receivable of $499,048; · an increase in inventory of $862,398; · an increase in prepaid expenses of $327,099; and · a decrease in accounts payable of $30,838. Cash used in investing activities totaled $30,409 for the first six months of 2011 as compared to $6,436 of cash used in investing activities for the first six months of 2010. Cash provided by financing activities totaled $132,666 for the first six months of 2011 as compared to $1,532,425 for the first six months of 2010. Between February 2010 and April 2010, we raised an aggregate of $1,500,000 through the issuance of convertible notes to 11 accredited investors. The convertible notes are convertible into an aggregate of 1,999,993 shares of our common stock. In connection with this offering, we also issued three-year warrants to purchase an aggregate of 1,999,993 shares of common stock at an exercise price of $0.50 per share. Between July 2010 and December 2010, we raised an aggregate of $850,000 through the issuance of senior secured convertible debentures to 26 accredited investors. The senior secured convertible debentures are secured by a security interest in all of our personal property (subject to customary exceptions) and were initially convertible into shares of our common stock at an initial conversion price of $0.75 per share (subject to adjustment). In connection with this offering, we also issued five-year warrants to purchase an aggregate of 850,000 shares of our common stock at an initial exercise price of $0.75 per share (subject to adjustment). Under the adjustment provisions of the senior secured convertible debentures and warrants, the conversion price of the senior secured convertible debentures and the exercise price of the warrants were reduced to $0.64 in connection with a private placement of our common stock and warrants in December 2010. The terms of the senior secured convertible debentures include a restriction on our ability to pay dividends on our common stock. In December 2010, we raised $5,000,000 through the issuance of 7,812,500 shares of our common stock and a five-year warrant to purchase up to 7,812,500 shares of our common stock at an exercise price of $0.64 per share. During the first six months of 2011, we raised $132,666 in connection with the issuance of 258,332 shares of our common stock upon the exercise of warrants. We are obligated under registration rights agreements related to the above described private placements to file a registration statement with the SEC registering for resale shares of common stock and certain shares of common stock underlying the convertible notes and warrants issued in certain of the private placement transactions consummated between March 2009 and December 2010. Effective February 18, 2009, we entered into a Business Financing Agreement with Bridge Bank, National Association, or Bridge Bank Agreement. The Bridge Bank Agreement, as amended to date, provides us with an accounts receivable based credit facility in the aggregate amount of up to $2,000,000. 30 -------------------------------------------------------------------------------- The credit facility is formula-based and generally provides that the outstanding borrowings under the credit facility may not exceed an aggregate of 80% of eligible accounts receivable. We must immediately pay any advance made under the credit facility within 90 days of the earlier of (i) the invoice date of the receivable that substantiated the advance and (ii) the date on which the advance was made. Interest on the credit facility is payable monthly. As of June 30, 2011, there were no outstanding borrowings under the credit facility, eligible accounts receivable was $500,954 and availability under the credit facility was $400,763. The interest rate is variable and is adjusted monthly based on the per annum prime rate as published by Bridge Bank plus two percentage points, subject to a minimum rate of 6.0% per annum. In the event of a default and continuation of a default, Bridge Bank may accelerate the payment of the principal balance requiring us to pay the entire indebtedness outstanding on that date. Upon the occurrence and during the continuation of an event of default, the interest rate applicable to the outstanding balance borrowed under the credit facility will be increased by five percentage points above the per annum interest rate that would otherwise be applicable. The credit facility is secured by a continuing first priority security interest in all of our personal property (subject to customary exceptions). The credit facility may be terminated at any time by either party. Our plan of operations for the next 12 months includes (i) completing and delivering the remaining 10 heavy-duty electric vehicles under the City of Los Angeles Agreement, together with associated equipment including batteries and chargers, (ii) completing and delivering a substantial portion of the 300 electric drive systems ordered by WGE, (iii) completing and delivering the remaining five Nautilus XRE20 yard tractors to T&K Logistics for use at Ford Motor Company's assembly plant in Wayne, Michigan, (iv) working in conjunction with our OEM partners to develop medium-duty and light-duty commercial vehicles and (v) obtaining additional orders for our products. In addition, during 2011, we expect to incur approximately $400,000 in research and development expenses. We believe that we presently have sufficient plant and production equipment to meet our current operational plan and we do not intend to dispose of any plant and equipment. We presently have 31 employees and expect to hire additional personnel to meet production demands of increased product sales. Our present staff is sufficient to meet our current operational plan and we expect to hire additional personnel as we ramp up our production efforts during the remainder of 2011. Although we expect that the anticipated gross margin from the completion and delivery of these products will provide us with additional liquidity and capital resources, we believe that we will need additional liquidity and capital resources through debt and/or equity financing to complete all of our existing and anticipated future product backlog. As discussed in this report and in notes to our financial statements included in this report, we have suffered recurring losses from operations and at June 30, 2010, we had an accumulated deficit of $19,011,005 and a working capital deficiency of $1,394,428. 31 -------------------------------------------------------------------------------- We have been, and currently are, working toward identifying and obtaining new sources of financing. No assurances can be given that we will be successful in obtaining additional financing in the future. Any future financing that we may obtain may cause significant dilution to existing stockholders. Any debt financing or other financing of securities senior to common stock that we are able to obtain will likely include financial and other covenants that will restrict our flexibility. At a minimum, we expect these covenants to include restrictions on our ability to pay dividends on our common stock. Any failure to comply with these covenants would have a material adverse effect on our business, prospects, financial condition, results of operations and cash flows. In addition, our senior secured convertible debentures issued between July and December 2010 contain covenants that include restrictions on our ability to pay dividends on our common stock. If adequate funds are not available, we may be required to delay, scale back or eliminate portions of our operations and product and service development efforts or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain of our technologies or potential products or other assets. Accordingly, the inability to obtain such financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also adversely affect our ability to fund our continued operations and our product and service development efforts. Backlog As of July 25, 2011, we had a backlog of $19,365,548. The amount of backlog orders represents revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress. Our backlog consists primarily of a $15.9 million order from WGE, an affiliate of our Chairman of the Board, for 300 electric drive systems. Our backlog also includes our agreement to deliver six additional Nautilus XRE20 electric yard tractors and four additional Nautilus XE30 electric short haul tractors (and associated equipment) under our outstanding purchase order from the City of Los Angeles and our agreement to deliver five Nautilus XRE20 electric yard tractors for use at Ford Motor Company's assembly plant under our leasing arrangement with T&K Logistics. Our backlog also includes an order for an aggregate of 32 flux vector motor controllers from customers engaged in manufacturing monorail systems, electric buses and industrial equipment for use in military applications and our agreement to deliver four additional electric drive systems to Ashok Leyland. We believe that the majority of our current backlog will be shipped within the next 12 months. However, there can be no assurance that we will be successful in fulfilling such orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog. Effects of Inflation The impact of inflation and changing prices has not been significant on the financial condition or results of operations of our company. Impacts of New Accounting Pronouncements In May 2011, the FASB issued Accounting Standards Update, or ASU, No. 2011-4, which amends the Fair Value Measurements Topic of the Accounting Standards Codification to help achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. ASU No. 2011-4 does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting. The ASU is effective for interim and annual periods beginning after December 15, 2011. We will adopt the ASU as required. The ASU will affect our fair value disclosures, but will not affect our results of operations, financial condition or liquidity. In June 2011, the FASB issued ASU No. 2011-5, which amends the Comprehensive Income Topic of the ASU. The ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity, and instead requires consecutive presentation of the statement of net income and other comprehensive income either in a continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-5 is effective for interim and annual periods beginning after December 15, 2011. We will adopt the ASU as required. The ASU will have no affect on our results of operations, financial condition or liquidity. 32-------------------------------------------------------------------------------- We do not believe that the adoption of the above recent pronouncements will have a material effect on our results of operations, financial position or cash flow. Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on our present or future financial statements. |