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AMERICAN SUPERCONDUCTOR CORP /DE/ - 10-K - MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Executive Overview American Superconductor Corporation was founded on April 9, 1987. We are a leading provider of megawatt-scale solutions that lower the cost of wind power and enhance the performance of the power grid. In the wind power market, we enable manufacturers to field highly competitive wind turbines through our advanced power electronics products, engineering, and support services. In the power grid market, we enable electric utilities and renewable energy project developers to connect, transmit and distribute power through our transmission planning services and power electronics and superconductor-based products. Our wind and power grid products and services provide exceptional reliability, security, efficiency and affordability to our customers. Our wind and power grid solutions help to improve energy efficiency, alleviate power grid capacity constraints and increase the adoption of renewable energy generation. Demand for our solutions is driven by the growing needs for renewable sources of electricity, such as wind and solar energy, and for modernized smart grids that improve power reliability and quality. Concerns about these factors have led to increased spending by corporations as well as supportive government regulations and initiatives on local, state, national and global levels, including renewable portfolio standards, tax incentives and international treaties. We manufacture products using two proprietary core technologies: PowerModule™ programmable power electronic converters and our Amperium® HTS (High Temperature Superconductor) wires. These technologies and our system-level solutions are protected by a broad and deep intellectual property portfolio consisting of hundreds of patents and licenses worldwide. We operate our business under two market-facing business units: Wind and Grid. We believe this market-centric structure enables us to more effectively anticipate and meet the needs of wind turbine manufacturers, power generation project developers and electric utilities. • Wind. Through our Windtec Solutions, our Wind business segment enables manufacturers to field wind turbines with exceptional power output, reliability and affordability. We supply advanced power electronics and control systems, license our highly engineered wind turbine designs, and provide extensive customer support services to wind turbine manufacturers. Our design portfolio includes a broad range of drive trains and power ratings up to 10 megawatts ("MW"). We provide a broad range of power electronics and software-based control systems that are highly integrated and redesigned for optimized performance, efficiency, and grid compatibility. • Grid. Through our Gridtec Solutions, our Grid business segment enables electric utilities and renewable energy project developers to connect, transmit and distribute power with exceptional efficiency, reliability and affordability. We provide transmission planning services that allow us to identify power grid congestion, poor power quality and other risks, which help us determine how our solutions can improve network performance. These services often lead to sales of grid interconnection solutions for wind farms and solar power plants, power quality systems and transmission and distribution cable systems. Our fiscal year begins on April 1 and ends on March 31. When we refer to a particular fiscal year, we are referring to the fiscal year beginning on April 1 of that same year. For example, fiscal 2012 refers to the fiscal year beginning on April 1, 2012. Other fiscal years follow similarly. On April 4, 2012, we completed a private placement of a $25.0 million of senior convertible note (the "Initial Note") with Capital Ventures International ("CVI"), an affiliate of Heights Capital Management. On December 20, 2012, we entered into an Amendment and Exchange Agreement (the "Amendment") with CVI, pursuant to which we exchanged the Initial Note for a new unsecured, senior convertible note (the "Exchanged Note"), which had the same principal amount and accrued interest as the Initial Note at the time of the exchange. On June 5, 2012, we entered into a $10.0 million Loan and Security Agreement ("Term Loan") with Hercules Technology Growth Capital, Inc. See Liquidity and Capital Resources below for further discussion of these debt arrangements. We have experienced recurring operating losses and as of March 31, 2013, had an accumulated deficit of $800.1 million. In addition, we have experienced recurring negative operating cash flows, which has resulted in a 32-------------------------------------------------------------------------------- Table of Contents reduction of our cash balance. These factors raise substantial doubt regarding our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. At March 31, 2013 we had cash and cash equivalents of $39.2 million, which compares to cash used in operations of $45.3 million and $141.0 million for the years ended March 31, 2013 and 2012, respectively. Cash used in operations for the year ended March 31, 2013 included approximately $14.3 million in payments to settle adverse purchase commitments, which are not expected to recur. We obtained financing totaling approximately $35.0 million during the quarter ended June 30, 2012. No additional financing has been obtained since then. In order for us to continue operations beyond the next twelve months and be able to discharge our liabilities and commitments in the normal course of business, we need to significantly increase sales through executing our strategy to broaden our customer base, enter new markets, and commercialize our superconductor product line. In addition, we must potentially reduce operating expenses in line with business conditions in order to decrease the amount of cash used in operations and continue to work with the holder of our convertible note in order to maintain the ability to make monthly amortization payments on the convertible note in shares of common stock. In addition, we are actively seeking to sell our minority investments in Tres Amigas and Blade Dynamics and have recently engaged a financial advisor to assist with that effort. There can be no assurance that we will be able to sell one or both of these investments on commercially reasonable terms or at all. In response to the Sinovel situation discussed below and challenging market conditions, particularly in the wind power market, from April 1, 2011 through the date of this filing, the Company has reduced its global workforce by approximately 57%. In addition, we plan to consolidate certain of our office locations. These workforce reductions and planned office consolidations are expected to lower operating costs and enhance liquidity. Our cash requirements depend on numerous factors, including the ability to pay the principal and interest on the Exchanged Note in stock, successful completion of our product development activities, ability to commercialize our product prototypes, rate of customer and market adoption of our products, collecting receivables according to established terms, and the continued availability of U.S. government funding during the product development phase in our Superconductors business. Significant deviations to our business plan with regard to these factors, which are important drivers to our business, could have a material adverse effect on our operating performance, financial condition, and future business prospects. We expect to pursue the expansion of our operations through internal growth, diversification of our customer base, and potential strategic alliances. See below for a discussion of liquidity and capital resources. In fiscal year 2012, two customers, Inox Wind Limited ("Inox") and Beijing JINGCHENG New Energy ("JCNE"), accounted for approximately 19% and 13%, respectively, of our total revenues. In fiscal year 2011, two customers, Inox and Doosan Heavy Industries, accounted for approximately 18% and 11%, respectively, of our total revenues. Sinovel had been our largest customer, accounting for 68% of our total revenue for fiscal 2010. We did not have any revenues from Sinovel in fiscal 2012 or 2011. Sinovel was the only customer accounting for more than 10% of our total revenue for fiscal 2010. We derived our revenues from Sinovel through sales of core electrical components as well as development contracts for the design of wind turbines. On March 31, 2011, Sinovel refused to accept contracted scheduled shipments with a revenue value of approximately $65.2 million. In addition, we had approximately $62.0 million (excluding value-added tax) owed to us for prior shipments from Sinovel as of March 31, 2011, for which we neither recorded as revenue nor as a receivable. The last payment received from Sinovel was in early March 2011. During March 2011, we engaged in discussions with Sinovel regarding the acceptance of its scheduled shipments, outstanding receivables, and the delivery of a custom solution desired by Sinovel for low voltage ride through ("LVRT") that required a modification to our existing LVRT design. The custom design required modified software and additional hardware. Toward the end of March, Sinovel requested that we provide them with the additional hardware without additional cost. On March 31, 2011, we proposed to Sinovel that we would provide the additional hardware without additional cost if Sinovel would accept the scheduled shipments. Sinovel rejected this proposal due to what we were told was excess inventory of our components. Since Sinovel did not 33-------------------------------------------------------------------------------- Table of Contents give us the requisite notice under our contracts that they intended to delay deliveries, we believe that these actions constitute material breaches of our contracts. As of the date of this filing, we have not received payment from Sinovel for any outstanding receivables nor have we been notified as to when, if ever, Sinovel will accept contracted shipments that were scheduled for delivery after March 31, 2011. Additionally, based, in part, upon evidence obtained through an internal investigation and a criminal investigation conducted by Austrian authorities regarding the actions of a former employee of our Austrian subsidiary, we believe that Sinovel illegally obtained and used our intellectual property in violation of civil and criminal intellectual property laws. In July 2011, a former employee of our Austrian subsidiary was arrested in Austria on charges of economic espionage and fraudulent manipulation of data. In September 2011, the former employee pled guilty to the charges, and was imprisoned. The evidence presented during the court hearing showed that this former employee was contracted by Sinovel through an intermediary while employed by us and improperly obtained and transferred to Sinovel portions of our wind turbine control software source code developed for Sinovel's 1.5MW wind turbines. Except for portions of this 1.5MW wind turbine software, we do not believe that the source code for any other turbines, such as the 3MW, 5MW and 6MW wind turbines that were designed by and co-developed with us have been transferred to Sinovel. Moreover, we believe the evidence shows this former employee illegally used source code to develop, for Sinovel, a software modification to circumvent the encryption and remove technical protection measures on the PM3000 power converters in 1.5MW wind turbines in the field. We believe that only the binary code, or upper layer, of the PM3000 software developed to circumvent the encryption and remove technical protection measures was transferred to Sinovel. We do not believe that any PM3000 source code was transferred to Sinovel. These actions potentially enable Sinovel to deploy, independent of us, wind turbine control software, including a low voltage ride through solution, on all of its 1.5MW wind turbines in the field. In addition, by having the wind turbine control source code, Sinovel could potentially modify the source code to allow the use of core electrical components, including power converters, from other manufacturers. On September 13, 2011, we commenced a series of legal actions in China against Sinovel. We filed a claim for arbitration in Beijing, China to compel Sinovel to pay us for past product shipments and to accept all contracted but not yet delivered core electrical components and spare parts under all existing contracts with us. The arbitration claim was filed with the Beijing Arbitration Commission in accordance with the terms of our supply contracts with Sinovel. We also filed civil and criminal complaints against Sinovel. We cannot provide any assurance as to the outcome of these legal actions. We are now operating our business under the assumption that Sinovel will not be a customer. For more information about these legal proceedings, see Part I, Item 3, "Legal Proceedings." Results of Operations Fiscal Years Ended March 31, 2013 and March 31, 2012 Revenues Total revenues increased by 14% to $87.4 million in fiscal 2012 from $76.5 million in fiscal 2011. Our revenues are summarized as follows (in thousands): Fiscal Years Ended March 31, 2013 2012 Revenues: Wind $ 44,231 $ 44,642 Grid 43,188 31,901 Total $ 87,419 $ 76,543 Revenues in our Wind business unit consist of revenues from wind turbine electrical systems and core components, wind turbine license and development contracts, service contracts and consulting arrangements. Our Wind business unit accounted for 51% of total revenues in fiscal year 2012 and 58% in fiscal year 2011. 34 -------------------------------------------------------------------------------- Table of Contents Revenues in the Wind business unit decreased 1% to $44.2 million in fiscal 2012 from $44.6 million in fiscal 2011. The decrease in Wind business unit revenues was driven primarily by lower revenues from certain customers in Korea and China partially offset by higher revenues from Inox and JCNE. Revenues in our Grid business unit consist of revenues from D-VAR®, D-VAR® RT, SVC and PowerModuleTM product sales, contract revenues, HTS wire sales, revenues under government-sponsored electric utility projects, and other prototype development contracts. We also engineer, install and commission our products on a turnkey-basis for some customers. The Grid business unit accounted for 49% of total revenues in fiscal year 2012 and 42% in fiscal year 2011. Grid revenue increased 35% to $43.2 million in fiscal 2012 from $31.9 million in fiscal 2011. The increase in revenues was primarily due to higher D-VAR system revenues in the United Kingdom and Australia. Revenues from significant Grid government-funded contract revenues are summarized as follows (in thousands): Revenue Earned for Revenue Earned the Year Expected Total through Ended March 31, Project Name Contract Value March 31, 2013 2013 2012 HYDRA $ 29,043 $ 14,519 $ 2,361 $ 1,606 LIPA I and II 40,141 40,141 163 1,577 DOE-FCL 7,898 7,536 287 696 Total $ 77,082 $ 62,196 $ 2,811 $ 3,879 These significant projects represented 7% and 12% of our Grid business unit's revenue for fiscal 2012 and 2011, respectively. Project HYDRA is a project with Consolidated Edison, Inc. which is being partially funded by the Department of Homeland Security ("DHS"). DHS is expected to invest up to a total of $29.0 million in the development of a new HTS power grid technology called FaultBlocker™ cable systems. FaultBlockerTM cable systems are designed to utilize customized Amperium™ HTS wires, and ancillary controls to deliver more power through the grid while also being able to suppress power surges that can disrupt service. On January 7, 2013, DHS committed an additional $1.6 million in funding on Project HYDRA. Of the total $29.0 million in funding expected from DHS, it has committed funding of $20.5 million to us as of March 31, 2013. Consolidated Edison and Southwire Company are our subcontractors on this project. LIPA II is a project to install an HTS power cable using our Amperium™ wire for the Long Island Power Authority. This contract was completed during fiscal 2012. DOE-FCL is a project to develop and demonstrate a transmission voltage SuperLimiter fault current limiter ("FCL"). The contract is near completion and we do not anticipate fully reaching the expected total contract value. Cost of Revenues and Gross Margin Cost of revenues decreased by 13% to $71.9 million in fiscal 2012, compared to $82.9 million in fiscal 2011. Gross margin increased to 17.7% in fiscal 2012 from (8.3)% in fiscal 2011. The increase in gross margin in fiscal 2012 was driven primarily by recoveries of adverse purchase commitments and the realization of benefits from cost reduction activities undertaken in fiscal 2011 and fiscal 2012. 35 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Research and development A portion of our R&D expenditures related to externally funded development contracts has been classified as cost of revenues (rather than as R&D expenses). Additionally, a portion of R&D expenses was offset by cost-sharing funding. Our R&D expenditures are summarized as follows (in thousands): Fiscal Years Ended March 31, 2013 2012 R&D expenses per consolidated statements of operations $ 15,325 $ 27,271 R&D expenditures reclassified as cost of revenues 13,226 12,002 R&D expenditures offset by cost-sharing funding 194 164 Aggregated R&D expenses $ 28,745 $ 39,437 R&D expenses (exclusive of amounts classified as cost of revenues and amounts offset by cost-sharing funding) decreased by 44% to $15.3 million, or 18% of revenue, for fiscal 2012 from $27.3 million, or 36% of revenue, for fiscal 2011. The decrease in R&D expenses was primarily due to decreased headcount and related labor spending as a result of restructuring activities undertaken in fiscal 2011 and fiscal 2012. The increase in R&D expenditures reclassified to cost of revenue was primarily driven by an additional funded project development in Austria for a large-scale wind turbine and increased engineering effort to lower the cost of our electrical control systems product. Aggregated R&D expenses, which include amounts classified as cost of revenues and amounts offset by cost-sharing funding, decreased 27% to $28.7 million, or 33% of revenue, for fiscal 2012, compared to $39.4 million, or 52% of revenue, for fiscal 2011. The decrease in fiscal 2012 was driven primarily by the net impact of the factors described above. We present aggregated R&D, which is a measure (a "non-GAAP measure") not calculated in accordance with generally accepted accounting principles in the United States of America ("GAAP"), because we believe it provides useful information on our aggregate R&D spending and because R&D expenses as reported on the consolidated statements of operations have been, and may in the future be, subject to significant fluctuations solely as a result of changes in the level of externally-funded contract development work, resulting in significant changes in the amount of the cost recorded as costs of revenues rather than as R&D expenses, as discussed above. Selling, general, and administrative SG&A expenses decreased by 31% to $49.7 million, or 57% of revenue, in fiscal 2012 from $72.1 million, or 94% of revenue, in fiscal 2011. Fiscal 2012 SG&A expenses included approximately $0.7 million in legal expenses related to the issue with Sinovel and $1.8 million for a contingent liability to settle the class action shareholder lawsuit. Fiscal 2011 SG&A expenses included approximately $5.8 million in legal expenses related to the issue with Sinovel, a $4.9 million expense of patent costs as a result of changing our accounting policy for legal costs to defend and maintain our patents and $2.1 million in severance costs for our former Chief Executive Officer. The decrease in SG&A expenses was primarily related to the aforementioned items in fiscal 2011 as well as realization of benefits from cost reduction activities undertaken in fiscal 2011 and fiscal 2012. Amortization of acquisition related intangibles We recorded $0.3 million in fiscal 2012 and $1.0 million in fiscal 2011 in amortization expense related to our core technology and know-how, and trade names and trademark intangible assets. The lower amortization in fiscal 2012 was driven by certain intangibles becoming fully amortized and impaired in fiscal 2011. Write-off of advance payment In October 2011, we terminated our previously planned acquisition of The Switch due to adverse market conditions for a financing required to fund the acquisition. As a result, The Switch retained a $20.6 million 36-------------------------------------------------------------------------------- Table of Contents advance payment as a break-up fee, and we recorded a write-off of the advance payment during the year ended March 31, 2012. Restructuring and impairments As part of our effort to re-size the business and reduce costs, we recorded restructuring and impairment charges of $7.9 million in fiscal 2012, compared to $9.2 million in fiscal 2011. For fiscal 2012, these amounts consist primarily of a long-lived asset impairment charge of $5.0 million, employee severance and benefit costs of $2.5 million and facility exit costs of $0.4 million. For fiscal 2011, these amounts primarily consisted of employee severance and benefit costs of $5.3 million, impairment charges of $1.7 million on long-lived assets for which there was no remaining future economic benefit as of March 31, 2012 and facility exit costs of $2.2 million related to the remaining lease commitments and certain asset impairments on the leased space in our Klagenfurt and Middleton locations. Operating loss Our operating loss is summarized as follows (in thousands): Fiscal Years Ended March 31, 2013 2012 Operating loss: Wind $ (16,098 ) $ (62,217 ) Grid (23,815 ) (29,645 ) Unallocated corporate expenses (17,828 ) (44,577 ) Total $ (57,741 ) $ (136,439 ) Wind generated an operating loss of $16.1 million in fiscal 2012 compared to an operating loss of $62.2 million in fiscal 2011. The decrease in operating loss for fiscal 2012 was primarily attributable to the cost reduction efforts described above, as well as a decrease in Sinovel litigation expenses and executive severance costs incurred in fiscal 2011. Grid operating loss decreased to $23.8 million in fiscal 2012 from $29.6 million in fiscal 2011. The decrease in operating loss for fiscal 2012 is primarily attributed to the cost reduction efforts described above, and higher revenues. Unallocated corporate expenses in fiscal 2012 included restructuring and impairment charges of $7.9 million, $8.1 million in stock-based compensation expense and a loss contingency of $1.8 million related to the class action shareholder lawsuit. Unallocated corporate expenses in fiscal 2011 included the write-off of the advanced payment to The Switch of $20.6 million, restructuring and impairment charges of $9.2 million, and expense of patent costs of $4.9 million related to changing our accounting policy for legal costs to defend and maintain our patents, as well as $9.9 million in stock-based compensation expense. Change in fair value of derivatives and warrants The change in fair value of derivatives and warrants resulted in a $7.6 million gain in fiscal 2012, and was driven by mark-to-market adjustments on these liabilities created through the debt arrangements entered into during fiscal 2012. The mark-to-market gain was driven primarily by our lower stock price during fiscal 2012, which is a key valuation variable. Interest (expense) income, net Interest expense, net was $14.9 million in fiscal 2012 compared to interest income, net of $0.2 million for fiscal 2011. The increase in interest expense, net was driven by debt arrangements entered into during fiscal 2012. 37-------------------------------------------------------------------------------- Table of Contents Other (expense) income, net Other expense, net was $1.3 million in fiscal 2012, compared to other income, net of $0.7 million in fiscal 2011. The increase in other expense, net was due primarily to lower foreign exchange gains in fiscal 2012, compared to fiscal 2011. The primary components of other income (expense), net in fiscal 2012 include net foreign currency translation gains of $0.5 million, offset by aggregate losses on minority investments in Blade Dynamics and Tres Amigas of $2.2 million. Income Taxes We recorded an income tax benefit of $0.3 million in fiscal 2012, compared to income tax expense of $1.4 million in fiscal 2011. The decrease in income tax expense was driven primarily by a refund of Chinese income taxes of $0.9 million in fiscal 2012 and $0.8 million reduction of foreign income taxes in Austria. Certain asset write-offs in our foreign jurisdictions are considered permanent differences and are not tax deductible. Other asset write-offs, such as inventory and prepaid value-added taxes in China in fiscal 2010, are not currently deductible and result in deferred tax assets. Due to uncertainty around the realization of these deferred tax assets, they have been fully reserved as of fiscal years ended March 31, 2012 and March 31, 2013. Please refer to the "Risk Factors" section in Part I, Item 1A, for a discussion of certain factors that may affect our future results of operations and financial condition. Fiscal Years Ended March 31, 2012 and March 31, 2011 Revenues Total revenues decreased by 73% to $76.5 million in fiscal 2011 from $286.6 million for fiscal 2010. Our revenues are summarized as follows (in thousands): Fiscal Years Ended March 31, 2012 2011 Revenues: Wind $ 44,642 $ 231,761 Grid 31,901 54,842 Total $ 76,543 $ 286,603 Our Wind business unit accounted for 58% of total revenues for fiscal year 2011 and 81% for fiscal year 2010. Revenues in the Wind business unit decreased 81% to $44.6 million in fiscal 2011 from $231.8 million in fiscal 2010. The decrease in Wind business unit revenues was driven primarily by the situation with Sinovel. Revenues from Sinovel were $194.8 million in fiscal 2010. Based on the average Euro and Renminbi exchange rates in fiscal 2011, revenues denominated in these foreign currencies translated into U.S. dollars were $0.6 million higher compared to the translation of these revenues using the average exchange rates of these currencies for fiscal 2010. The Grid business unit accounted for 42% and 19% of revenues for fiscal 2011 and 2010, respectively. Grid revenue decreased 42% to $31.9 million in fiscal 2011 from $54.8 million in fiscal 2010. The decrease in 38-------------------------------------------------------------------------------- Table of Contents revenues was primarily due to a significant D-VAR® project in Australia that was completed in fiscal year 2010. Revenues from significant Grid government-funded contract revenues are summarized as follows (in thousands): Revenue Earned for Revenue Earned the Year Ended Expected Total through March 31, Project Name Contract Value March 31, 2012 2012 2011 HYDRA $ 29,043 $ 12,158 $ 1,606 $ 979 LIPA I and II 40,141 39,978 1,577 4,050 DOE-FCL 7,898 7,249 696 2,147 NAVSEA Motor Study 6,511 6,492 - 280 Total $ 83,593 $ 65,877 $ 3,879 $ 7,456 These significant projects represented 12% and 14% of our Grid business unit's revenue for fiscal 2011 and 2010, respectively. Of the total $29.0 million in funding expected from DHS, it had committed funding of $15.6 million to us as of March 31, 2012. Cost of Revenues and Gross Margin Cost of revenues decreased by 73% to $82.9 million for fiscal 2011, compared to $308.2 million for fiscal 2010. Gross margin decreased to (8.3)% in fiscal 2011 from (7.5)% in fiscal 2010. Cost of revenues in fiscal 2010 was negatively impacted by $102.7 million in non-recurring charges relating to the write-off of inventory and the recording of a liability for adverse purchase commitments in connection with the situation with Sinovel. The decrease in gross margin in fiscal 2011 was driven primarily by the lost gross margin on sales to Sinovel, which did not occur in fiscal 2011, partially offset by the negative impact of the write-offs described above on gross margin in fiscal 2010, as well as $1.3 million in adverse purchase commitment recoveries in fiscal 2011. Based on the average Euro and Renminbi exchange rates in fiscal 2011, costs of revenues denominated in these foreign currencies translated into U.S. dollars were $1.0 million higher compared to the translation of these cost of revenues using the average exchange rates of these currencies for fiscal 2010. Operating Expenses Research and development Our R&D expenditures are summarized as follows (in thousands): Fiscal Years Ended March 31, 2012 2011 R&D expenses per consolidated statements of operations $ 27,271 $ 32,517 R&D expenditures reclassified as cost of revenues 12,002 18,012 R&D expenditures offset by cost-sharing funding 164 440 Aggregated R&D expenses $ 39,437 $ 50,969 R&D expenses (exclusive of amounts classified as cost of revenues and amounts offset by cost-sharing funding) decreased by 16% to $27.3 million, or 36% of revenue, for fiscal 2011 from $32.5 million, or 11% of revenue, for fiscal 2010. The decrease in R&D expenses was primarily due to decreased headcount and related labor spending as a result of restructuring activities undertaken in fiscal 2011. The decrease in R&D expenditures reclassified to cost of revenue was primarily driven by lower development project related revenue. Aggregated R&D expenses, which include amounts classified as cost of revenues and amounts offset by cost-sharing funding, decreased 23% to $39.4 million, or 52% of revenue, for fiscal 2011, compared to $51.0 million, or 18% of revenue, for fiscal 2010. The increase in fiscal 2011 was driven primarily by the net impact of the factors described above. 39-------------------------------------------------------------------------------- Table of Contents Selling, general, and administrative SG&A expenses decreased by less than 1% to $72.1 million, or 94% of revenue, in fiscal 2011 from $72.4 million, or 25% of revenue, in fiscal 2010. Fiscal 2011 SG&A expenses included approximately $5.8 million in legal expenses related to the issue with Sinovel, a $4.9 million expense of patent costs as a result of changing our accounting policy for legal costs to defend and maintain our patents and $2.1 million in severance costs for our former Chief Executive Officer. Fiscal 2010 SG&A expenses included $5.9 million in charges for the write-off of prepaid value-added taxes associated with the Sinovel matter. The decrease in SG&A expenses was primarily related to our headcount reductions in fiscal 2011, partially offset by effect of the charges described above. Amortization of acquisition related intangibles We recorded $1.0 million in fiscal 2011 and $1.5 million in fiscal 2010 in amortization related to our contractual relationships/backlog, customer relationships, core technology and know-how, trade names and trademark intangible assets. The lower amortization in fiscal 2011 was primarily driven by the write-off of certain intangible assets in fiscal 2010. Write-off of advance payment In October 2011, we terminated our previously planned acquisition of The Switch due to adverse market conditions for a financing required to fund the acquisition. As a result, The Switch retained a $20.6 million advance payment as a break-up fee, and we recorded a write-off of the advance payment during the year ended March 31, 2012. Restructuring and impairments During fiscal 2011, we undertook a systematic restructuring of our operations as a result of the material changes in our business resulting from the situation with Sinovel, which was approved by the Board of Directors. These actions resulted in the reduction of approximately 50% of our headcount and are expected to generate approximately $50 million in annual savings. We recorded restructuring and impairment charges of $9.2 million for the year ended March 31, 2012. These charges primarily consisted of employee severance and benefit costs related to the restructuring plan of $5.3 million, impairment charges of $1.7 million on long-lived assets for which there is no remaining future economic benefit as of March 31, 2012 and facility exit costs of $2.2 million related to the remaining lease commitments and certain asset impairments on the leased space in our Klagenfurt and Middleton locations Operating loss Our operating loss is summarized as follows (in thousands): Fiscal Years Ended March 31, 2012 2011 Operating loss: Wind $ (62,217 ) $ (100,546 ) Grid (29,645 ) (63,855 ) Unallocated corporate expenses (44,577 ) (13,582 ) Total $ (136,439 ) $ (177,983 ) Wind generated an operating loss of $62.2 million in fiscal 2011 compared to an operating loss of $100.5 million in fiscal 2010. The decrease in operating loss for fiscal 2011 was primarily attributable to cost reduction efforts as well as charges described above in fiscal 2010 related to the situation with Sinovel that did not recur in fiscal 2011. 40-------------------------------------------------------------------------------- Table of Contents Grid operating loss decreased to $29.6 million in fiscal 2011 from $63.9 million in fiscal 2010. The decrease in operating loss for fiscal 2011 is primarily attributed to the cost reduction efforts described above, partially offset by lower Grid revenues. Unallocated corporate expenses in fiscal 2011 included the write-off of the advance payment to The Switch of $20.6 million, restructuring and impairment charges of $9.2 million, and expense of patent costs of $4.9 million related to changing our accounting policy for legal costs to defend and maintain our patents. Unallocated corporate expenses also included $9.9 million in stock-based compensation expense for fiscal 2011 compared to $13.4 million in stock-based compensation expense for fiscal 2010. Interest income, net Interest income, net was $0.2 million and $0.8 million for fiscal 2011 and 2010, respectively. The decrease in interest income, net was driven by lower cash balances. Other income (expense), net Other income (expense), net was $0.7 million in fiscal 2011, compared to $6.8 million in fiscal 2010. The decrease in other income (expense), net was due primarily to lower foreign exchange and hedging gains in fiscal 2011, compared to fiscal 2010. The primary components of other income (expense), net include net foreign currency translation gain of $3.1 million partially offset by aggregate losses on minority investments in Blade Dynamics and Tres Amigas of $2.4 million for fiscal 2011. Income Taxes We recorded income tax expense of $1.4 million during fiscal 2011, compared to $16.0 million during fiscal 2010. The decrease in income tax expense was driven by lower income in foreign jurisdictions. Certain asset write-offs in our foreign jurisdictions are considered permanent differences and are not tax deductible. Other asset write-offs, such as inventory and prepaid value-added taxes in China in fiscal 2010, are not currently deductible and result in deferred tax assets. Due to uncertainty around the realizability of these deferred tax assets, they have been fully reserved as of fiscal years ended March 31, 2011 and March 31, 2012. Non-GAAP Measures Generally, a non-GAAP financial measure is a numerical measure of a company's performance, financial position or cash flow that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures included in this Form 10-K, however, should be considered in addition to, and not as a substitute for, or superior to, the comparable measure prepared in accordance with GAAP. We define non-GAAP net loss as net loss before adverse purchase commitment (recoveries) losses, net, stock-based compensation, amortization of acquisition-related intangibles, restructuring and impairment charges, changes in fair value of derivatives and warrants, non-cash interest expense, and the other non-cash or unusual items indicated in the table below. We believe non-GAAP net loss assists management and investors in comparing our performance across reporting periods on a consistent basis by excluding these non-cash or non-recurring charges that we do not believe are indicative of our core operating performance. We also regard non-GAAP net loss as a useful measure of operating performance which more closely aligns net loss with cash used in/provided by continuing operations. In addition, we use non-GAAP net loss as a factor in evaluating management's performance when determining incentive compensation and to evaluate the effectiveness of our 41-------------------------------------------------------------------------------- Table of Contents business strategies. A reconciliation of non-GAAP to GAAP net loss is set forth in the table below (in thousands, except per share data): Year Ended March 31, 2013 2012 2011 Net loss $ (66,131 ) $ (136,827 ) $ (186,284 ) Goodwill impairment - - 48,959 Provision for excess and obsolete inventory - - 63,882 Adverse purchase commitment (recoveries) losses, net (7,768 ) (1,299 ) 38,763 Write-off of prepaid value added taxes - - 5,905 Stock-based compensation 8,138 9,864 13,412 Amortization of acquisition-related intangibles 324 972 1,549 Restructuring and impairment charges 7,922 9,188 996 Executive severance - 2,066 - Sinovel litigation 691 5,846 - Contingency for shareholder lawsuit 1,800 - - Consumption of zero cost-basis inventory (2,111 ) (794 ) - Patent costs - 4,917 - Change in fair value of derivatives and warrants (7,556 ) - - Write-off of advance payment 20,551 - Non-cash interest expense 12,426 - - Non-GAAP net loss $ (52,265 ) $ (85,516 ) $ (12,818 ) Non-GAAP loss per share $ (0.98 ) $ (1.68 ) $ (0.27 ) Weighted average shares outstanding 53,070 50,842 47,103 We generated non-GAAP net loss of ($52.3) million, or ($0.98) per share, for fiscal 2012, compared to ($85.5) million, or ($1.68) per share, for fiscal 2011 and a non-GAAP net loss of ($12.8) million, or ($0.27) per share, for fiscal 2010. The decrease in non-GAAP net (loss) in fiscal 2012 over 2011 was primarily related to increased revenues and the benefits from cost reductions realized in fiscal 2012. The increase in non-GAAP net (loss) in fiscal 2011 over 2010 was primarily related to lower revenues and the effect of the large write-offs in fiscal 2010 related to the Sinovel matter, including goodwill and long-lived asset impairments, provisions for excess and obsolete inventory, adverse purchase commitments and write-off of prepaid value-added taxes, which totaled $158.5 million in the aggregate. Liquidity and Capital Resources At March 31, 2013, we had cash, cash equivalents, marketable securities and restricted cash of $50.2 million, compared to $66.2 million at March 31, 2012, a decrease of $16.0 million. Our cash, cash equivalents, marketable securities and restricted cash are summarized as follows (in thousands): March 31, 2013 2012 Cash and cash equivalents $ 39,243 $ 46,279 Marketable securities - 5,304 Restricted cash 10,956 14,626 Total cash, cash equivalents, marketable securities and restricted cash $ 50,199 $ 66,209 As of March 31, 2013, we had approximately $14.6 million of cash, cash equivalents, and restricted cash in foreign bank accounts. 42-------------------------------------------------------------------------------- Table of Contents The decrease in total cash and cash equivalents, marketable securities and restricted cash was due primarily to cash used in operations, partially offset by the proceeds from our financings in fiscal 2012. See further discussions below. For fiscal 2012, net cash used in operating activities was $45.3 million, compared to $141.0 million in fiscal 2011. The decrease was primarily driven by lower cash used for working capital and the favorable effects of higher revenues and the benefits from cost reduction activities. We plan to closely monitor our expenses and, if required, expect to further reduce operating costs and capital spending to enhance liquidity. For fiscal 2012, net cash provided by investing activities was $7.4 million, compared to $63.3 million in fiscal 2011. The decrease in cash provided by investing activities was driven primarily by a decrease in proceeds from the maturity of marketable securities of $104.8 million, and a decrease in capital expenditures of $9.5 million, partially offset by a $20.6 million advance payment to The Switch in fiscal 2011, which was subsequently written off, and a decrease in the change in restricted cash of $12.8 million. For fiscal 2012, cash provided by financing activities was $31.2 million, compared to $0.1 million in fiscal 2011. The increase in cash provided by financing activities is primarily due to the net proceeds from the issuance of debt, net of expenses, of $32.9 million in fiscal 2012. At March 31, 2013 and 2012, we had $6.1 million and $12.1 million, respectively, of restricted cash included in current assets, and $4.8 million and $2.5 million of restricted cash included in long-term assets as of March 31, 2013 and 2012, respectively. These amounts included in restricted cash primarily represent deposits to secure letters of credit for various supply contracts. These deposits are held in interest bearing accounts. We have experienced recurring operating losses and as of March 31, 2013, had an accumulated deficit of $800.1 million. In addition, we have experienced recurring negative operating cash flows, which has resulted in a decrease in our cash balance. These factors raise substantial doubt regarding our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from this outcome of this uncertainty. At March 31, 2013 we had cash and cash equivalents of $39.2 million, which compares to cash used in operations of $45.3 million and $141.0 million for the years ended March 31, 2013 and 2012, respectively. Cash used in operations for the year ended March 31, 2013 included approximately $14.3 million in payments to settle adverse purchase commitments which are not expected to recur. We obtained financing totaling approximately $35.0 million during the quarter ended June 30, 2012. No additional financing has been obtained since then. In order for us to continue operations beyond the next twelve months and be able to discharge our liabilities and commitments in the normal course of business, we need to significantly increase sales through executing our strategy to broaden our customer base, enter new markets, and commercialize our superconductor product line. In addition, we must potentially reduce operating expenses in line with business conditions in order to decrease the amount of cash used in operations and continue to work with the holder of our convertible note in order to maintain the ability to make monthly amortization payments on the convertible note in shares of common stock. In addition, we are actively seeking to sell our minority investments in Tres Amigas and Blade Dynamics and have recently engaged a financial advisor to assist with that effort. There can be no assurance that we will be able to sell one or both of these investments on commercially reasonable terms or at all. On May 16, 2012, we entered into an agreement with one of our suppliers to settle certain of our adverse purchase commitments. The agreement was amended on November 6, 2012 (as amended, the "Settlement Agreement"). In conjunction with the Settlement Agreement, we agreed to pay the supplier approximately €2.2 million (the "Settlement Amount"). Under the Settlement Agreement, we had the option, at our sole discretion, to pay the settlement amount in cash, shares of our common stock, or a combination of cash and common stock. Accordingly, during the three months ended December 31, 2012, we issued 765,301 shares of our common stock to the supplier and filed a registration statement on Form S-3 to register the supplier's resale of such shares of common stock under the terms of the Settlement Agreement. If the net proceeds from the supplier's resale of the shares of common stock during a specified period plus any other cash payments made by us subsequent to the date of the Settlement Agreement were less than the Settlement Amount, we agreed to make 43-------------------------------------------------------------------------------- Table of Contents an additional payment equal to the shortfall in cash to the supplier no later than December 31, 2012. As of December 31, 2012, we paid $0.8 million as a result of such a shortfall. On April 4, 2012, we entered into a Securities Purchase Agreement with Capital Ventures International ("CVI"), an affiliate of Heights Capital Management (the "Purchase Agreement") and completed a private placement of a $25.0 million 7% senior convertible note (the "Initial Note"). After fees and expenses, the net proceeds were $23.2 million. The Initial Note had an initial conversion price of $4.85 per share, representing a premium of approximately 20% over our closing price on April 3, 2012. The Initial Note was payable in monthly installments beginning four months from issuance and ending on October 4, 2014. Monthly payments were payable in cash or shares of our common stock at our option, subject to certain trading volume, stock price and other conditions. CVI could also elect to defer receipt of monthly installment payments at its option. Any deferred installment payments would continue to accrue interest. We registered 10,262,311 shares of our common stock which may be used as payment for principal and interest in lieu of cash for resale under the Securities Act as required under a Registration Rights Agreement with CVI. On December 20, 2012, we entered into an Amendment and Exchange Agreement, (the "Amendment") with CVI, which amended the Purchase Agreement. Pursuant to the Amendment, the Company and CVI exchanged the Initial Note for a new unsecured, senior convertible note, (the "Exchanged Note"). At the time of the exchange, the Exchanged Note had the same principal amount and accrued interest as the Initial Note. The Exchanged Note is convertible into our common stock and has the same scheduled monthly installment payments as the Initial Note. The Exchanged Note provides us with additional flexibility to make monthly installment payments in shares of our common stock. We retain the ability to repay the Exchanged Note in cash. Specifically, the amendments to the Exchanged Note: • Allow us to convert, subject to the satisfaction of certain conditions set forth in the Exchanged Note, (a) at least $2.5 million of the approximately $5.3 million installment amount payable with respect to the January 2013 installment date (including approximately $4.2 million of deferred installment amounts from the period September 4, 2012 to December 3, 2012) into shares of the Company's common stock (on December 21, 2012 we converted $3.8 million in deferred installment amount principal and interest and issued 1,715,443 shares of common stock), and (b) the balance of the January 2013 installment amount in equal amounts on each of the February and March 2013 installment dates; • Reduce the price failure equity condition with respect to a particular date of determination from $2.50 to $1.00; • Reduce the aggregate daily dollar trading volume equity condition required for at least 25 of the 30 consecutive trading days immediately preceding a date of determination from $1,500,000 to $850,000 per trading day. In addition, if the aggregate daily dollar trading volume is between $50,000 and $850,000, the Company may still convert into common stock a portion of an installment amount payable with respect to an installment date equal to the quotient of (x) the aggregate daily dollar trading volume, divided by (y) $850,000; • Increase CVI's beneficial ownership limitation under the Exchanged Note from 4.99% to 9.99%; and • Reduce the conversion price, from $4.85 per share our common stock to $3.19 per share of our common stock, subject to certain price-based and other anti-dilution adjustments. On June 5, 2012, we entered into a Term Loan with Hercules Technology Growth Capital, Inc., under which we borrowed $10.0 million. After the closing fees and expenses, the net proceeds were $9.7 million. The Term Loan bears an interest rate equal to 11% plus the percentage, if any, in which the prime rate as reported by The Wall Street Journal exceeds 3.75%. We made interest only payments from July 1, 2012 through October 31, 2012, after which we began paying the Term Loan in equal monthly installments ending on December 1, 2014. The Term Loan is secured by substantially all of our existing and future assets, including a mortgage on real property owned by our wholly owned subsidiary, ASC Devens LLC, and located at 64 Jackson Road, Devens, Massachusetts. The Term Loan contains certain covenants that restrict our ability to, among other things, incur or assume certain debt, merge or consolidate, materially change the nature of our business, make certain investments, acquire or dispose of certain assets, make guaranties or grant liens on its assets, make certain loans, 44-------------------------------------------------------------------------------- Table of Contents advances or investments, declare dividends or make distributions or enter into transactions with affiliates. In addition, the Term Loan contains a covenant which requires us to maintain a minimum unrestricted cash balance in the United States of at least $10.0 million at the inception of the Term Loan, which will decrease starting November 1, 2012 and monthly thereafter by the amount of principal paid. The events of default under the Term Loan include, but are not limited to, failure to pay amounts due, breaches of covenants, bankruptcy events, cross defaults under other material indebtedness and the occurrence of a material adverse effect and/or change in control. In the case of a continuing event of default, the lender may, among other remedies, declare due all unpaid principal amounts outstanding and any accrued but unpaid interest and foreclose on all collateral granted to the lender as security under the Term Loan. The going concern opinion represents a violation of a covenant under the Term Loan. On June 11, 2013, the lender of our Term Loan provided a one-time limited waiver (the "Waiver") of the covenant that required us to deliver unqualified audited financial statements for the fiscal year ended March 31, 2013 as a result of the explanatory paragraph in the opinion of our independent auditors regarding there being a substantial doubt about our ability to continue as a going concern (the "Going Concern Opinion"). Because the Waiver was entered into prior to the issuance of the Going Concern Opinion, the Going Concern Opinion did not result in an event of default under our Term Loan agreement. If we fail to stay in compliance with our covenants or experience some other event of default, we may be forced to repay the outstanding principal of one or both of our debt obligations. In the case of the Exchanged Note, such an event of default would also include the requirement to pay a penalty as defined in the agreement. Should this occur, our liquidity would be adversely affected. If we successfully execute on our plans discussed above, then we believe that our available cash will be sufficient to fund our operations, capital expenditures and scheduled cash payments under our debt obligations for the next twelve months. Our ability to pay required monthly installment payments under the Exchanged Note in equity instead of cash is based on certain stock price and trading volume conditions that are outside of our control. If one or both of these equity conditions are not met (absent a waiver from the lender), we may be required to make required monthly installment payments in cash. As of the date of this Form 10-K, we have only made payments to the lender in shares of common stock and as a result the principal balance has been reduced by $9.6 million through March 31, 2013. If we fail one or both of the equity conditions, we can still make required payments in stock if the lender agrees to waive our compliance with the relevant equity conditions, which it has done in the past. There is no assurance that the lender will provide any waivers in the future. Our liquidity is highly dependent on our ability to profitably grow revenues through both the acquisition of new customers and growth from our existing customers, manage our operating expenses, maintain compliance with the covenants and restrictions on our debt obligations (or obtain waivers from our lenders in the event of non-compliance), and raise additional capital, as required. Potential sources of additional capital include sales of our minority investments in Tres Amigas and Blade Dynamics and obtaining additional financing (with the consent of our lenders, if required). There can be no assurance that sources of additional liquidity will be available on commercially acceptable terms or at all. Legal Proceedings We are involved in legal and administrative proceedings and claims of various types. See Part I, Item 3, "Legal Proceedings," for additional information. We record a liability in our consolidated financial statements for these matters when a loss is known or considered probable and the amount can be reasonably estimated. We review these estimates each accounting period as additional information is known and adjust the loss provision when appropriate. If a matter is both probable to result in liability and the amounts of loss can be reasonably estimated, we estimate and disclose the possible loss or range of loss. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in its consolidated financial statements. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, as defined under SEC rules, such as relationships with unconsolidated entities or financial partnerships, which are often referred to as structured finance or special 45-------------------------------------------------------------------------------- Table of Contents purpose entities, established for the purpose of facilitating transactions that are not required to be reflected on our balance sheet except as discussed below. We occasionally enter into construction contracts that include a performance bond. As these contracts progress, we continually assess the probability of a payout from the performance bond. Should we determine that such a payout is probable, we would record a liability. In addition, the Company has various contractual arrangements in which minimum quantities of goods or services have been committed to be purchased on an annual basis. Contractual Obligations Contractual obligations represent future cash commitments and liabilities under agreements with third parties. Operating leases include minimum payments under leases for our facilities and certain equipment; see Item 2, "Properties," for more information. Purchase commitments represent enforceable and legally binding agreements with suppliers to purchase goods or services. As of March 31, 2013, we are committed to make the following payments under contractual obligations (in thousands): Payments Due by Period Less than More than Total 1 Year 1-3 Years 3-5 Years 5 Years Non-cancellable purchase commitments $ 18,287 $ 17,245 $ 865 $ 177 $ - Convertible note 15,379 8,898 6,481 Senior Term Loan 8,077 4,615 3,462 Operating leases (rent) 3,990 1,719 1,796 475 - Operating leases (other) 175 75 54 46 - Total contractual obligations $ 45,908 $ 32,552 $ 12,658 $ 698 $ - We are able under certain conditions to repay the Convertible Note in shares of our common stock. See discussion above under "Liquidity and Capital Resources". Recent Accounting Pronouncements In January 2013, the FASB issued Accounting Standards Update No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (ASU 2013-01). The main objective in developing this update is to address implementation issues about the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The update requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. ASU 2013-01 is effective for our first quarter of fiscal 2014. We are currently evaluating the impact of adopting ASU 2013-01, but currently do not believe there will be a significant impact on our consolidated results of operations, financial condition, or cash flows. In February 2013, the FASB issued Accounting Standards Update No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). The amendments of this ASU require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income ("AOCI") by component. In addition, an entity is required to present, either on the face of the statement where net income (loss) is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 is effective for fiscal years and interim periods beginning after December 15, 2012. We early adopted ASU 2013-02 and it did not have a material impact on our consolidated results of operations, financial condition, or cash flows. 46-------------------------------------------------------------------------------- Table of Contents In March 2013, the FASB issued Accounting Standards Update No. 2013-05, Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (ASU 2013-05). The objective of the amendments in this update is to resolve the diversity in practice about whether Subtopic 810-10, Consolidation - Overall, or Subtopic 830-30, Foreign Currency Matters - Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity. In addition, the amendments in this update resolve the diversity in practice for the treatment of business combinations achieved in involving a foreign entity. ASU 2013-05 is effective for fiscal years and interim periods beginning after December 15, 2013. We are currently evaluating the impact of adopting ASU 2013-05, but currently do not believe there will be a significant impact on our consolidated results of operations, financial condition, or cash flows. We do not believe that other recently issued accounting pronouncements will have a material impact on our financial statements. Critical Accounting Policies and Estimates The preparation of consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and 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 under different assumptions or conditions. Our accounting policies that involve the most significant judgments and estimates are as follows: • Revenue recognition; • Accounts receivable; • Inventory; • Valuation of long-lived assets; • Income taxes; • Stock-based compensation; • Contingencies; • Product warranty; • Debt; and • Fair value of financial instruments Revenue recognition We recognize revenue for product sales upon customer acceptance, which can occur at the time of delivery, installation, or post-installation, where applicable, provided persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined during the arrangement that collectability is not reasonably assured, revenue is recognized on a cash basis of accounting. Certain of our contracts involve retention amounts which are contingent upon meeting certain performance requirements through the expiration of the contract warranty periods. For contractual arrangements that involve retention, we recognize revenue for these amounts upon the expiration of the warranty period, meeting the performance requirements and when collection of the fee is reasonably assured. 47-------------------------------------------------------------------------------- Table of Contents During fiscal 2010, we determined that a cash basis of accounting was appropriate for certain of our customers in China, except Sinovel, after June 30, 2010 and for Sinovel, after September 30, 2010. Under this method of accounting, cash is applied first against accounts receivable balances, then costs of shipments (inventory and value-added taxes) before recognizing any gross margin. No shipments were made to these customers in the fiscal year ended March 31, 2013. Payments of $3.4 million were received from these customers during the fiscal year ended March 31, 2013, for past shipments and recorded as revenue. We had previously recognized revenues for those customers based on the receipt of shipments but prior to its receipt of payment for such shipments. For certain arrangements, such as prototype development contracts and certain product sales, we record revenues using the percentage-of-completion method, measured by the relationship of costs incurred to total estimated contract costs. Percentage-of-completion revenue recognition accounting is predominantly used on certain turnkey power systems installations for electric utilities and long-term prototype development contracts with the U.S. government. We follow this method since reasonably dependable estimates of the revenues and costs applicable to various stages of a contract can be made. However, the ability to reliably estimate total costs at completion is challenging, especially on long-term prototype development contracts, and could result in future changes in contract estimates. For contracts where reasonably dependable estimates of the revenues and costs cannot be made, we follow the completed-contract method. For sales that involve the delivery of multiple elements, we allocate revenue to each undelivered element based on the element's fair value as determined by vendor-specific objective evidence ("VSOE"), which is the price charged when that element is sold separately, or third-party evidence ("TPE"). When VSOE and TPE are unavailable, fair value is based on our best estimate of selling price. When our estimates are used to determine fair value, management makes its estimates using reasonable and objective evidence to determine the price utilizing a cost plus reasonable margin consistent with how we have set our pricing historically for similar products and services. We review VSOE and TPE at least annually. If we conclude we are unable to establish fair values for one or more undelivered elements within a multiple-element arrangement using VSOE then we use TPE or our best estimate of the selling price for that unit of accounting, being the price at which the vendor would transact if the unit of accounting were sold by the vendor regularly on a standalone basis. We occasionally enter into construction contracts that include a performance bond or similar security. As these contracts progress, we continually assess the probability of a payout from these securities. Should we determine that such a payout is likely, we would record a liability and reduce revenue to the extent a liability is recorded. We enter into certain arrangements to license our technologies and to provide training services. We have determined that the license has no standalone value to the customer and is not separable from the training. Accordingly, we account for these arrangements as a single unit of accounting, and recognize revenue over the period of our performance and milestones that have been achieved. Costs for these arrangements are expensed as incurred. We have elected to record taxes collected from customers on a net basis and do not include tax amounts in revenue or costs of revenue. Customer deposits received in advance of revenue recognition are recorded as deferred revenue until customer acceptance is received. Deferred revenue also represents the amount billed to and/or collected from commercial and government customers on contracts which permit billings to occur in advance of contract performance/revenue recognition. Accounts Receivable Accounts receivable consist of amounts owed by commercial companies and government agencies. Accounts receivable are stated net of allowances for doubtful accounts. Our accounts receivable relate principally to a limited number of customers. As of March 31, 2013, three customers, Inox, CG Power Solutions UK Ltd., and HHI, accounted for approximately 41%, 17% and 11%, respectively, of our total receivable balance. As of March 31, 2012, three customers, Inox, Karara Mining Ltd, and EPC Service Company, accounted for 48-------------------------------------------------------------------------------- Table of Contents approximately 24%, 14%, and 11%, respectively, of our total receivable balance. Changes in the financial condition or operations of our customers may result in delayed payments or non-payments which would adversely impact our cash flows from operating activities and/or our results of operations. As such we may require collateral, advanced payment or other security based upon the customer history and/or creditworthiness. In determining the allowance for doubtful accounts, we evaluate the collectability of accounts receivable based primarily on the probability of recoverability based on historical collection and write-off experience, the age of past due receivables, specific customer circumstances, and current economic trends. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances may be required. Failure to accurately estimate the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on our business, financial condition, results of operations, and cash flows. Inventory Inventories include material, direct labor and related manufacturing overhead, and are stated at the lower of cost or market determined on a first-in, first-out basis. We record inventory when we take delivery and title to the product. Program costs may be deferred and recorded as inventory on contracts on which costs are incurred in excess of approved contractual amounts and/or funding, if future recovery of the costs is deemed probable. At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence. Inventories that management considers excess or obsolete are reserved. Management considers forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining excess and obsolescence and net realizable value adjustments. Once inventory is written down and a new cost basis is established, it is not written back up if demand increases. We recorded inventory reserves of $2.2 million during fiscal 2012 and $4.4 million during fiscal 2011, respectively, based on evaluating our ending inventories for excess quantities and obsolescence. We recorded an inventory reserve of approximately $63.9 million during fiscal 2010 based on our evaluation of forecasted demand in relation to the inventory on hand and market conditions surrounding our products as a result of the assumption that Sinovel and certain other customers in China would fail to meet their contractual obligations and demand that was previously forecasted would fail to materialize. If, in any period, we are able to sell inventories that were not valued or that had been reserved in a previous period, related revenues would be recorded without any offsetting charge to cost of revenues, resulting in a net benefit to its gross margin in that period. In fiscal 2012 and 2011, $2.1 million and $0.8 million, respectively, were recognized as a net benefit to gross margin for inventory previously reserved in fiscal year 2010. Valuation of long-lived assets We periodically evaluate our long-lived assets, consisting principally of fixed and amortizable intangible assets for potential impairment. In accordance with the applicable accounting guidance for the treatment of long-lived assets, we review the carrying value of our long-lived assets or asset group that is held and used, including intangible assets subject to amortization, for impairment whenever events and circumstances indicate that the carrying value of the assets may not be recoverable. Under the held and used approach, the asset or asset group to be tested for impairment should represent the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. The determination of our asset groups involves a significant amount of judgment, assumptions, and estimates. We have three asset groups under our two segments, PSNA, Windtec and Superconductor based on the fact that the individual subsidiary companies that support each reporting unit are dependent on one another such that the lowest level of largely independent cash flows is the reporting unit level. We evaluate our long-lived assets whenever events or circumstances suggest that the carrying amount of an asset or group of assets may not be recoverable from the estimated undiscounted future cash flows. 49 -------------------------------------------------------------------------------- Table of Contents Our judgments regarding the existence of impairment indicators are based on market and operational performance. Indicators of potential impairment include: • a significant change in the manner in which an asset is used; • a significant decrease in the market value of an asset; • identification of other impaired assets within a reporting unit; • a significant adverse change in its business or the industry in which it is sold; • a current period operating cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the asset; and • significant advances in our technologies that require changes in our manufacturing process. In fiscal 2012 and 2011, in response to challenging market conditions we completed certain restructuring activities, approved by the Board of Directors, in order to reduce costs and align our strategic priorities. Since the restructuring action impacted all of our operations, we concluded that there were indicators of potential impairment of our long-lived assets in both fiscal years and we therefore conducted an assessment of the recoverability of these assets by comparing the carrying value of the assets to the pre-tax undiscounted cash flows estimated to be generated by those assets over their remaining book useful lives. Based on the calculation performed by management, the sum of the undiscounted cash flows forecasted to be generated by certain assets were less than the carrying value of those assets. Therefore, there was an indication that certain of our assets were impaired and, as a result, we performed additional analysis. An evaluation of the level of impairment was made by comparing the implied fair value of those definite long-lived tangible and intangible assets of its reporting units against their carrying values. Additionally, the same assessment was conducted as of March 31, 2013 as a result of factors which raise substantial doubt, in the opinion of our auditors, about our ability to continue as a going concern. The fair values of the impacted property and equipment were based on what we could reasonably expect to sell each asset from the perspective of a market participant. The determination of the fair value of its property and equipment includes estimates and judgments regarding the marketability and ultimate sales price of individual assets. We utilized market data and approximations from comparable analyses to arrive at the estimated fair values of the impacted property and equipment. The fair values of amortization intangible assets related to completed technology and trade names were determined using primarily the relief-from-royalty method over the estimated economic lives of those assets from the perspective of a market participant. During fiscal 2012, we determined that certain of our Corporate assets and Grid segment property, plant and equipment were impaired as their carrying values exceeded their fair values. We determined the long-lived assets of our Wind segment were not impaired. Accordingly, for the year ended March 31, 2013 we recorded an impairment charge on certain of our Corporate assets and for the years ended March 31, 2013 and March 31, 2012 we recorded impairment charges on certain of our Grid segment property, plant and equipment. For the years ended March 31, 2013 and 2012, these charges totaled $5.0 million and $1.7 million, respectively. Income taxes Our provision for income taxes is composed of a current and a deferred portion. The current income tax provision is calculated as the estimated taxes payable or refundable on tax returns for the current year. The deferred income tax provision is calculated for the estimated future tax effects attributable to temporary differences and carryforwards using expected tax rates in effect in the years during which the differences are expected to reverse. We regularly assess our ability to realize our deferred tax assets. Assessments of the realization of deferred tax assets require that management consider all available evidence, both positive and negative, and make significant judgments about many factors, including the amount and likelihood of future taxable income. Based on all the available evidence, we have recorded valuation allowances to reduce our deferred tax assets to the amount that is more likely than not to be realizable due to the taxable losses that have been incurred since our inception and uncertainty around our future profitability. 50-------------------------------------------------------------------------------- Table of Contents Accounting for income taxes requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any changes in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision. We include interest and penalties related to gross unrecognized tax benefits within the provision for income taxes. (See Note 11, "Income Taxes," of our consolidated financial statements for further information regarding our income tax assumptions and expenses.) We evaluate our permanent reinvestment assertions with respect to foreign earnings at each reporting period. We have not recorded a deferred tax asset for the temporary difference associated with the excess of the tax basis over the book basis in our Austrian and Chinese subsidiaries as the future tax benefit is not expected to reverse in the foreseeable future. We have recorded a deferred tax liability as of March 31, 2013 for the undistributed earnings of our remaining foreign subsidiaries for which we can no longer assert are permanently reinvested. The total amount of undistributed earnings available to be repatriated at March 31, 2013 was $1.5 million resulting in the recording of a $0.5 million net deferred federal and state income tax liability. (See Note 11, "Income Taxes," of our consolidated financial statements for the results of this assessment.) Stock-based compensation We measure compensation cost arising from the grant of share-based payments to employees at fair value and recognize such cost over the period during which the employee is required to provide service in exchange for the award, usually the vesting period. Total stock-based compensation expense recognized during the fiscal years ended March 31, 2013, 2012, and 2011 was $8.1 million, $9.9 million, and $13.4 million, respectively. For awards with service conditions only, we recognize compensation cost on a straight-line basis over the requisite service/vesting period. For awards with performance conditions, accruals of compensation cost are made based on the probable outcome of the performance conditions. The cumulative effect of changes in the probability outcomes are recorded in the period in which the changes occur. Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. Management determined that expected volatility rates should be estimated based on historical and implied volatilities of our common stock. The expected term represents the average time that the options that vest are expected to be outstanding based on the vesting provisions and our historical exercise, cancellation and expiration patterns. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if circumstances change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate an expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. (See Note 12, "Stockholders' Equity," of our consolidated financial statements for further information regarding our stock-based compensation assumptions and expenses.) Contingencies From time to time, we are involved in legal and administrative proceedings and claims of various types. We record a liability in our consolidated financial statements for these matters when a loss is known or considered probable and the amount can be reasonably estimated. We review these estimates each accounting period as additional information is known and adjust the loss provision when appropriate. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in our consolidated financial statements. If, with respect to a matter, it is not both probable to result in liability and the amount of loss cannot be reasonably 51-------------------------------------------------------------------------------- Table of Contents estimated, an estimate of possible loss or range of loss shall be disclosed unless such an estimate cannot be made. We do not recognize gain contingencies until they are realized. Legal costs incurred in connection with loss contingencies are expensed as incurred. During the fiscal year ended March 31, 2013, we recorded a loss contingency of $1.8 million. (See Note 13, "Commitments and Contingencies", of our consolidated financial statements for further information). Product Warranty Warranty obligations are incurred in connection with the sale of our products. We generally provide a one to three year warranty on our products, commencing upon installation. The costs incurred to provide for these warranty obligations are estimated and recorded as an accrued liability at the time of sale. Future warranty costs are estimated based on historical performance rates and related costs to repair given products. The accounting estimate related to product warranty involves judgment in determining future estimated warranty costs. Should actual performance rates or repair costs differ from estimates, revision to the estimated warranty liability would be required. Debt For debt arrangements, we consider any embedded equity-linked components and account for the fair value of any embedded warrants and derivatives. We elect not to use the fair value option for recording debt arrangements and elect to record the debt at the stated value of the loan agreement on the date of issuance. Any other elements present are reviewed to determine if they are embedded derivatives requiring bifurcation and requiring valuation under the fair value option. Derivatives and warrants, which meet the condition to satisfy an obligation by issuing a variable number of equity shares, are recorded at fair value. The carrying value assigned to the host instrument will be the difference between the previous carrying value of the host instrument and the fair value of the warrants and derivatives. There is no immediate gain/loss from the initial recognition and measurement if the embedded derivative is accounted for separately from its host contract. There is an offsetting debt discount or premium as a result of the fair value assigned to the warrants and derivatives, as well as any debt issuance costs, which is amortized under the effective interest method over the term of the loan. Each reporting period, fair value is assessed for the warrants and derivatives with the change in value being recorded as other income/loss. (See Note 9, "Debt," and Note 10, "Warrants and Derivative Liabilities," of our consolidated financial statements for a full discussion regarding the activity and financial impact for our debt, warrants and derivative liabilities.) Fair Value of Financial Instruments Our financial instruments consist principally of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, derivatives, warrants, convertible note and a term loan. The estimated fair values have been determined through information obtained from market sources and management estimates. The carrying amounts of these instruments approximate fair value as of March 31, 2013. We have identified all of the derivatives associated with the Exchanged Note which include holder change of control redemption rights, issuer optional redemption rights, sale redemption rights and a feature to covert the Exchanged Note into equity at the holder's option. The derivative liability is subject to revaluation at each balance sheet date, and any change in fair value will be recorded as a change in fair value in other income (expense) until the earlier of their exercise or expiration of the derivatives associated with the Exchanged Note. We rely on assumptions in a lattice model to determine the fair value of the derivative liability. We have appropriately valued the derivative liability within Level 3 of the valuation hierarchy. Warrants were issued in conjunction with the Exchanged Note and Term Loan. These warrants are subject to revaluation at each balance sheet date, and any change in fair value will be recorded as a change in fair value in other income (expense) until the earlier of the warrants' exercise or expiration. We rely on assumptions used in a lattice model to determine the fair value of the warrants. We have appropriately valued the warrants within Level 3 of the valuation hierarchy. 52-------------------------------------------------------------------------------- Table of Contents |