SATCON TECHNOLOGY CORP - 10-Q Quarterly Report - 03/27/2004

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended March 27, 2004

Commission File Number 1-11512

SATCON TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		04-2857552 (IRS Employer Identification No.)
161 First Street Cambridge, Massachusetts (Address of principal executive offices)		02142-1221 (Zip Code)

(617) 661-0540
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common Stock, $0.01 Par Value,
28,090,736 shares outstanding as of April 30, 2004.

TABLE OF CONTENTS

			Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Financial Statements of SatCon Technology Corporation
	Consolidated Balance Sheets as of March 27, 2004 (Unaudited) and September 30, 2003 (Audited)		2
	Consolidated Statements of Operations (Unaudited)		3
	Consolidated Statements of Changes in Stockholders' Equity (Unaudited)		4
	Consolidated Statements of Cash Flows (Unaudited)		6
	Notes to Interim Consolidated Financial Statements (Unaudited)		7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			41
Item 4. Controls and Procedures			42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			43
Item 2. Changes in Securities and Use of Proceeds			43
Item 3. Defaults Upon Senior Securities			43
Item 4. Submission of Matters to a Vote of Security Holders			44
Item 5. Other Information			44
Item 6. Exhibits and Reports on Form 8-K			44
Signature			45
Exhibit Index			46

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED BALANCE SHEETS

				March 27, 2004			September 30, 2003
				(Unaudited)			(Audited)
ASSETS
Current assets:
	Cash and cash equivalents			$	3,324,579		$	728,415
	Restricted cash and cash equivalents				165,384			506,776
	Accounts receivable, net of allowance of $935,576 and $937,030 at March 27, 2004 and September 30, 2003, respectively				4,507,658			5,498,998
	Unbilled contract costs and fees, net of allowance of $200,000 and $0 at March 27, 2004 and September 30, 2003, respectively				927,109			802,804
	Funded research and development expenses in excess of billings				102,705			150,411
	Inventory				4,858,084			5,802,120
	Prepaid expenses and other current assets				1,000,768			726,357

		Total current assets			14,886,287			14,215,881
Warrants to purchase common stock					93,924			97,490
Property and equipment, net					6,243,559			6,927,411
Goodwill, net					704,362			704,362
Intangibles, net					2,654,387			2,918,188
Other long-term assets					100,034			118,610

		Total assets		$	24,682,553		$	24,981,942

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Bank line of credit			$	—		$	1,801,869
	Current portion of long-term debt				222,337			271,090
	Accounts payable				3,405,270			5,967,651
	Accrued payroll and payroll related expenses				1,223,085			1,340,244
	Other accrued expenses				2,036,314			2,917,176
	Accrued contract losses				208,750			387,778
	Deferred revenue				673,045			2,447,054
	Accrued restructuring costs				495,612			495,612

		Total current liabilities			8,264,413			15,628,474
Redeemable convertible Series A preferred stock (132.7 shares issued and outstanding; face value: $12,500 per share; liquidation preference: 150%)					—			1,658,750
Redeemable convertible Series B preferred stock (495 shares issued and outstanding; face value: $5,000 per share; liquidation preference: 100%)					2,475,000			—
Convertible subordinated debentures (Face value: $762,500; liquidation preference: 150%)					—			762,500
Long-term debt, net of current portion					409,005			501,590
Other long-term liabilities					148,540			268,482
Commitments and contingencies
Stockholders' equity:
	Common stock; $0.01 par value, 50,000,000 shares authorized; 27,883,970 and 21,023,200 shares issued and outstanding at March 27, 2004 and September 30, 2003, respectively				278,840			210,232
	Additional paid-in capital				138,552,541			122,792,791
	Accumulated deficit				(125,265,636	)		(116,701,523	)
	Accumulated other comprehensive loss				(180,150	)		(139,354	)

		Total stockholders' equity			13,385,595			6,162,146

		Total liabilities and stockholders' equity		$	24,682,553		$	24,981,942

The accompanying notes are an integral part of these consolidated financial statements.

2

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

				Three Months Ended						Six Months Ended
				March 27, 2004			March 29, 2003			March 27, 2004			March 29, 2003
Revenue:
Product revenue				$	6,205,099		$	4,250,142		$	12,413,645		$	9,580,805
Funded research and development and other revenue					1,953,968			1,126,065			3,932,570			2,475,812

		Total revenue			8,159,067			5,376,207			16,346,215			12,056,617

Operating costs and expenses:
Cost of product revenue					5,164,265			5,577,724			10,362,417			11,678,316
Research and development and other revenue expenses:
	Funded research and development and other revenue expenses				1,416,360			939,764			2,795,142			2,176,500
	Unfunded research and development expenses				316			532,875			1,301			1,113,710

		Total research and development and other revenue expenses			1,416,676			1,472,639			2,796,443			3,290,210
Selling, general and administrative expenses					2,565,195			3,913,950			4,806,678			7,693,675
Amortization of intangibles					111,671			147,328			223,343			294,061
Write-off of impaired goodwill and intangible assets					—			5,751,082			—			5,751,082

		Total operating costs and expenses			9,257,807			16,862,723			18,188,881			28,707,344

Operating loss					(1,098,740	)		(11,486,516	)		(1,842,666	)		(16,650,727	)
Net unrealized loss on warrants to purchase common stock					(46,348	)		(9,246	)		(3,566	)		(3,409	)
Net unrealized gain on Series B warrants					—			—			35,442			—
Write-down of investment in Beacon Power Corporation					—			(541,885	)		—			(541,885	)
Other income					—			55,700			—			55,700
Interest income					4,114			841			6,524			2,541
Interest expense					(6,501,480	)		(169,940	)		(6,759,847	)		(367,928	)

Net loss				$	(7,642,454	)	$	(12,151,046	)	$	(8,564,113	)	$	(17,505,708	)

Net loss per weighted average share, basic and diluted				$	(0.29	)	$	(0.68	)	$	(0.34	)	$	(1.01	)

Weighted average number of common shares, basic and diluted					26,783,766			17,831,359			25,529,189			17,354,495

The accompanying notes are an integral part of these consolidated financial statements.

3

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

For the six months ended March 29, 2003

(Unaudited)

													Accumulated Other Comprehensive Loss
		Common Shares		Common Stock			Additional Paid-in Capital			Accumulated Deficit			Unrealized Loss on Beacon Power Corporation			Foreign Currency Translation Adjustment			Total Accumulated Other Comprehensive Loss			Total Stockholders' Equity			Comprehensive Loss
Balance, September 30, 2002 (Audited)		16,741,646		$	167,416		$	115,800,692		$	(85,220,361	)	$	(588,944	)	$	(233,193	)	$	(822,137	)	$	29,925,610
Net loss		—			—			—			(17,505,708	)		—			—			—			(17,505,708	)	$	(17,505,708	)
Change in unrealized gain (loss) on Beacon Power Corporation common stock		—			—			—			—			47,059			—			47,059			47,059			47,059
Other than temporary write-down of investment in Beacon Power Corporation		—			—			—			—			541,885			—			541,885			541,885			541,885
Issuance of common stock to 401(k) Plan		302,589			3,026			410,342			—			—			—			—			413,368			—
Issuance of warrants to purchase common stock		—			—			20,100			—			—			—			—			20,100			—
Issuance of common stock in connection with Series A warrant exercise		1,258,549			—			—			—			—			—			—			—			—
Issuance of common stock in lieu of first year dividend on Series A Preferred Stock		362,168			—			—			—			—			—			—			—			—
Foreign currency translation adjustment		—			—			—			—			—			93,347			93,347			93,347			93,347

Comprehensive loss																									$	(16,823,417	)

Balance, March 29, 2003 (Unaudited)		18,664,952		$	170,442		$	116,231,134		$	(102,726,069	)		—		$	(139,846	)	$	(139,846	)	$	13,535,661

The accompanying notes are an integral part of these consolidated financial statements.

4

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

For the six months ended March 27, 2004

(Unaudited)

		Common Shares		Common Stock			Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total Stockholders' Equity			Comprehensive Loss
Balance, September 30, 2003 (Audited)		21,023,200		$	210,232		$	122,792,791		$	(116,701,523	)	$	(139,354	)	$	6,162,146
Net loss		—			—			—			(8,564,113	)		—			(8,564,113	)	$	(8,564,113	)
Issuance of common stock to 401(k) Plan		107,070			1,071			256,976			—			—			258,047			—
Issuance of common stock in connection with exercise of Series A warrant to purchase common stock		28,000			280			—			—			—			280			—
Issuance of common stock in connection with exercise of warrants to purchase common stock		2,201,176			22,012			1,834,850			—			—			1,856,862			—
Issuance of common stock in connection with cashless exercise of warrants to purchase common stock		209,422			2,094			(2,094	)		—			—			—			—
Issuance of common stock in connection with the exercise of stock options to purchase common stock		67,750			677			42,153			—			—			42,830			—
Issuance of common stock in connection with the conversion of redeemable convertible Series A preferred stock		1,327,000			13,270			1,645,480			—			—			1,658,750			—
Issuance of common stock in connection with the conversion of convertible subordinated debentures		666,000			6,660			825,840			—			—			832,500			—
Issuance of common stock in lieu of first year interest on convertible subordinated debentures		8,298			83			23,981			—			—			24,064			—
Issuance of common stock in lieu of first six -months dividend on redeemable convertible Series B preferred stock		76,054			761			229,454			—			—			230,215			—
Issuance of common stock to Auerelius Consulting Group		90,000			900			193,950			—			—			194,850			—
Issuance of options and warrants to purchase common stock to non-employees		—			—			46,634			—			—			46,634			—
Issuance of warrants to convertible subordinated debentures holders		—			—			46,577			—			—			46,577			—
To record beneficial conversion feature of convertible subordinated debentures		—			—			138,977			—			—			138,977			—
Issuance of warrants to Series B preferred stockholders		—			—			1,242,441			—			—			1,242,441			—
To record beneficial conversion feature of the Series B preferred stock		—			—			3,655,607			—			—			3,655,607			—
Issuance of warrants to BHP in connection with the issuance of the Series B preferred stock		—			—			435,166			—			—			435,166			—
Issuance of common stock in connection with the conversion of redeemable convertible Series B preferred stock		2,080,000			20,800			5,179,200			—			—			5,200,000			—
Mark-to-market Series B warrants		—			—			(35,442	)		—			—			(35,442	)		—
Foreign currency translation adjustment		—			—			—			—			(40,796	)		(40,796	)		(40,796	)

Comprehensive loss																			$	(8,604,909	)

Balance, March 27, 2004 (Unaudited)		27,883,970		$	278,840		$	138,552,541		$	(125,265,636	)	$	(180,150	)	$	13,385,595

The accompanying notes are an integral part of these consolidated financial statements.

5

SATCON TECHNOLOGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

					Six Months Ended
					March 27, 2004			March 29, 2003
Cash flows from operating activities:
	Net loss				$	(8,564,113	)	$	(17,505,708	)
		Adjustments to reconcile net loss to net cash used in operating activities:
			Depreciation and amortization			991,881			1,246,082
			Provision for uncollectible accounts			216,249			157,462
			Provision for excess and obsolete inventory			140,785			645,112
			Net unrealized loss on warrants to purchase common stock			3,566			3,409
			Net unrealized gain on Series B warrants			(35,442	)		—
			Write-down of impaired goodwill and intangible assets			—			5,751,082
			Write-down of investment in Beacon Power Corporation			—			541,885
			Non-cash compensation and consulting expense			467,444			413,368
			Non-cash interest expense			6,676,368			68,350
			Gain on sale of equipment			—			(55,700	)
		Changes in operating assets and liabilities:
			Accounts receivable			975,091			2,755,093
			Unbilled contract costs and fees			(324,305	)		713,310
			Prepaid expenses and other current assets			(450,616	)		(336,444	)
			Inventory			803,251			(1,504,488	)
			Other long-term assets			18,576			10,986
			Accounts payable			(2,562,381	)		632,214
			Accrued payroll and payroll related expenses, other expenses, accrued contract losses and restructuring costs			(1,058,938	)		1,299
			Deferred revenue			(1,774,009	)		1,756,987
			Other liabilities			(135,376	)		(187,372	)

		Total adjustments				3,952,144			12,612,635

	Net cash used in operating activities					(4,611,969	)		(4,893,073	)

	Cash flows from investing activities:
		Purchases of property and equipment				(44,228	)		(240,685	)
		Proceeds from sale of equipment				—			68,450

	Net cash used in investing activities					(44,228	)		(172,235	)

	Cash flows from financing activities:
		Net (repayments) borrowings under bank line of credit				(1,801,869	)		107,767
		Repayment of long-term debt				(141,338	)		(129,902	)
		Proceeds from issuance of convertible subordinated debentures				70,000			—
		Net proceeds from issuance of convertible preferred stock				6,925,000			3,176,000
		Net proceeds from exercise of warrants and options to purchase common stock				1,899,972			—

	Net cash provided by financing activities					6,951,765			3,153,865

	Effect of foreign currency exchange rates on cash and cash equivalents					(40,796	)		93,347

	Net increase (decrease) in cash and cash equivalents					2,254,772			(1,818,096	)
	Cash and cash equivalents at beginning of period, including restricted cash and cash equivalents					1,235,191			2,120,306

	Cash and cash equivalents at end of period, including restricted cash and cash equivalents				$	3,489,963		$	302,210

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Non-Cash Investing and Financing Activities:
Valuation adjustment for warrants to purchase common stock					$	(3,566	)	$	(3,409	)
Valuation adjustment for Series B warrants					$	35,422		$	—
Change in unrealized loss on Beacon Power Corporation common stock					$	—		$	47,059
Interest and Income Taxes Paid:
Interest					$	83,446		$	295,943
Income Taxes					$	—		$	—

The accompanying notes are an integral part of these consolidated financial statements.

6

SATCON TECHNOLOGY CORPORATION

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

MARCH 27, 2004 AND MARCH 29, 2003

(Unaudited)

Note A. Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of SatCon Technology Corporation and its wholly-owned subsidiaries (collectively, the "Company") as of March 27, 2004 and have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All intercompany accounts and transactions have been eliminated. These unaudited consolidated financial statements, which, in the opinion of management, reflect all adjustments (including normal recurring adjustments) necessary for a fair presentation, should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended September 30, 2003. Operating results for the three and six months ended March 27, 2004 are not necessarily indicative of the results that may be expected for any future interim period or for the entire fiscal year.

Note B. Realization of Assets and Liquidity

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years. In addition, the Company has used, rather than provided, cash in its operations.

The Company has incurred significant costs to develop its technologies and products. These costs have exceeded total revenue. As a result, the Company has incurred losses in each of the past five years. As of March 27, 2004, it had an accumulated deficit of $125,265,636. During the six months ended March 27, 2004, the Company incurred a loss from operations of $1,842,666. In addition, the Company's business plan envisions a significant increase in revenue and reductions in the cost structure in the last half of fiscal year 2004 compared with the same period in fiscal year 2003. If, however, the Company is unable to realize its plan, it may not be in compliance with loan covenants which may cause a default, as defined, and may need to raise additional funds by selling stock, restructuring its borrowings, selling assets, or taking other actions to conserve its cash position. In addition, the Company's stock is listed on the Nasdaq National Market which requires it to comply with Nasdaq's Maketplace Rules. These rules require that the Company maintain a market value of $50 million or have total assets of $50 million and $50 million of total revenue and that the stock price stays above $1.00, among others. The Company's market value on April 30, 2004 was approximately $75 million. However, if the Company fails to maintain compliance with these rules and the Company' Common Stock is delisted from the Nasdaq National Market, there could be greater difficulty in obtaining financing.

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying unaudited consolidated balance sheet is dependent upon the continued operations of the Company. The unaudited consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded

7

asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

In October 2003, all of the holders of warrants issued in connection with the February 2003 financing transaction, exercised their warrants to purchase 1,574,000 shares of the Company's Common Stock. These warrants had an initial exercise price of $1.50 but based on the Company not meeting certain financial parameters in its fiscal fourth quarter, the exercise price would have been adjusted to $1.00 upon the filing of the Company's Form 10-K for the fiscal year ended September 30, 2003. The Company offered these warrant holders an opportunity to exercise these warrants at $1.00 per share in October 2003, in exchange for the holders to waive their right to any penalties because the registration statement underlying the securities issued in the February 2003 financing transaction had not been declared effective by the United States Securities and Exchange Commission prior to June 19, 2003. The effect of the repricing did not have a material effect on the results of operations or financial condition of the Company during the six months ended March 27, 2004 as substantially all of the effects of the repricing had been recorded as of September 30, 2003.

In October 2003, the holders of the redeemable convertible Series A Preferred Stock converted 132.7 shares into 1,327,000 shares of the Company's Common Stock. As a result of this conversion, the Company recorded the remaining unamortized balance of the prepaid first year dividends, or $67,976, in October 2003.

In October 2003, the holders of the convertible subordinated debentures converted $762,500 into 610,000 shares of the Company's Common Stock. As a result of this conversion, the Company recorded the remaining unamortized balance of the prepaid first year interest, or $81,155, in October 2003. Also in October 2003, an additional investment of $70,000 was made by issuing $70,000 of convertible subordinated debentures. The Company also issued 8,298 shares of Common Stock as payment of the first year interest, valued based on the average of the closing bid and ask price of the Common Stock on the Nasdaq National Market for the five trading days preceding February 18, 2003. These secured convertible subordinated debentures were subsequently converted at a conversion price per share of $1.25 into 56,000 shares of Common Stock. As a result of this conversion, the Company recorded all of the interest on these debentures in October 2003. In connection with this transaction, the Company issued warrants to purchase up to 28,000 shares of Common Stock. Warrants which were exercised at a price of $1.00 per share, and warrants to purchase up to 28,000 shares of Common Stock which were exercisable for one business day after the date of their issuance and had an exercise price of $0.01 per share. The note purchase agreement required the registration statement underlying the common stock being declared effective by the United States Securities and Exchange Commission (the "SEC"). Failure to satisfy this contingency may have resulted in a portion or all of the proceeds being returned to the investors. The Company filed the required registration statement with the SEC on December 23, 2003 and it was declared effective on December 31, 2003. After the resolution of this item outside the Company's control, the Company accounted for the transaction in accordance with Emerging Issues Task Force ("EITF") No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments ("EITF 00-27"), allocating the proceeds received net of transaction costs based on the relative fair

8

value of the subordinated convertible debentures and the warrants issued to the investor, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities as follows:

Security		Face Value			Fair Value			Allocation of Proceeds, Net of Transaction Costs			Beneficial Conversion Feature			Discount
Subordinated convertible debentures		$	70,000		$	70,000		$	23,423		$	138,977		$	185,554
Warrants			—		$	139,196		$	46,577			—			—

The Company recognized the discount as interest expense through the earliest date of conversion and accordingly, the Company recorded $185,554 of additional interest expense during the three months ended March 27, 2004.

On October 31, 2003, the Company completed a $7.7 million equity transaction involving the issuance of 1,535 shares of its Series B Convertible Preferred Stock, $0.01 par value per share (the "Series B Preferred Stock"), and warrants to purchase up to 1,228,000 shares of the Company's Common Stock, to accredited investors (the "October 2003 Financing Transaction").

In connection with the October 2003 Financing Transaction, the Company issued shares of Series B Preferred Stock for $5,000 per share. The Series B Preferred Stock is convertible into a number of shares of Common Stock equal to $5,000 divided by the conversion price of the Series B Preferred Stock, which is $2.50. The total number of shares of Common Stock issuable upon conversion of the shares of Series B Preferred Stock issued and sold was 3,070,000. As of March 27, 2004, 1,040 shares of the Series B Preferred Stock had been converted into 2,080,000 shares of Common Stock. As of March 27, 2004, the liquidation preference of the remaining 495 shares of Series B Preferred Stock was $2,475,000, and these were convertible into 990,000 shares of Common Stock. The Series B Preferred Stock accrues dividends of 6% per annum, increasing to 8% per annum on October 1, 2005. The dividend for the first six months was paid at closing by issuing 76,054 shares of Common Stock, valued based on the average of the closing bid and ask price of the Common Stock on the Nasdaq National Market for the five trading days preceding October 31, 2003. All further dividends will be paid on a semi-annual basis. Except in certain limited circumstances, the Company may opt to pay these dividends in cash or in shares of Common Stock.

As part of the October 2003 Financing Transaction, the Company also issued warrants to purchase up to 1,228,000 shares of its Common Stock. These warrants are exercisable for a five-year term and have an initial exercise price of $3.32 per share, which represents 110% of the average closing price of the Common Stock for the five trading days preceding October 31, 2003. These warrants are immediately exercisable and expire on October 31, 2008. The Company has valued these warrants at $2,935,558, using the Black-Scholes option-pricing model.

Burnham Hill Partners, LLC, a division of Pali Capital, Inc. ("BHP"), served as placement agent for the transaction. As part of its commission, BHP received a cash placement fee equal to 7% of the gross proceeds received by the Company in connection with the financing. Based on the amount of the financing, this cash placement fee was approximately $540,000 (including reimbursement of out-of-pocket expenses), which was paid from gross proceeds received by the Company. BHP will also

9

receive a cash placement fee of 4% of the aggregate consideration received by the Company in connection with the cash exercise of warrants issued to the investors in the financing, as well as certain warrants issued in the Company's previous financing (which were exercised prior to October 31, 2003). In addition, BHP, or its assigns, received warrants, with an exercise price of $0.01 per share, to purchase an aggregate of 150,430 shares of Common Stock. These warrants are immediately exercisable and expire five years after date of issuance. The Company has valued these warrants at $435,166, using the Black-Scholes option-pricing model and has treated this as a transaction cost.

The stock purchase agreement required the registration statement underlying the common stock being declared effective by the SEC. Failure to satisfy this contingency may have resulted in a portion or all of the proceeds being returned to the investors. The Company filed the required registration statement with the SEC on December 23, 2003 and it was declared effective on December 31, 2003. However, because the Company failed to initially file this registration statement with the SEC on or before December 15, 2003, it was potentially required to pay liquidated damages to each of the investors in the private offering of 3% of the investor's investment in cash for the first month of delay and 1.5% of the investor's investment for each additional month of delay in cash or shares of the Company's common stock, at its option. As of March 27, 2004, the Company had accrued $61,400 for these potential penalties which is included in selling, general and administrative expenses for the six months ending March 27, 2004. After the resolution of this item outside the Company's control, the Company accounted for the transaction in accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, allocating the proceeds received net of transaction costs based on the relative fair value of the redeemable convertible Series B Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities as follows:

Security		Face Value			Fair Value			Allocation of Proceeds, Net of Transaction Costs			Beneficial Conversion Feature			Discount
Redeemable convertible Series B preferred stock		$	7,675,000		$	12,398,195		$	5,247,393		$	3,655,607		$	6,083,214
Warrants			—		$	2,935,558		$	1,242,441			—			—

The Company recognized the discount as interest expense through the earliest date of conversion and accordingly, the Company recorded $6,083,214 of additional interest expense during the three months ended March 27, 2004.

As of March 27, 2004, 1,040 shares of the Series B Preferred Stock had been converted into 2,080,000 shares of Common Stock. As a result of the conversions, the Company recorded the unamortized balance of the prepaid first six-months dividend on the converted securities, or $83,248, during the six months ended March 27, 2004.

In November 2003, the Company repaid all outstanding amounts under the line of credit (the "Loan") with Silicon Valley Bank (the "Bank") and the Bank released $375,000 of the $506,776 cash previously restricted. In addition, on December 12, 2003, the Company amended its agreement with the Bank. Under the amended agreement, the Bank will provide the Company with a line of credit of up to

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$6,250,000 (the "Amended Loan"). The Amended Loan is secured by most of the assets of the Company and advances under the Amended Loan are limited to 80% of eligible accounts receivables, which would permit borrowings up to $5,000,000. Interest on outstanding borrowings accrues at a rate equal to the Bank's prime rate of interest plus 1.5% per annum. In addition, the Company will pay to the Bank a collateral handling fee of 2.4% per annum of the average daily outstanding balance. The interest rate could increase to the Bank's prime rate plus 3.0% per annum and the collateral handling fee increases to 3.0% per annum if the Company fails to meet certain financial ratios. In addition, the Company has agreed to the following fees: (i) a $23,250 non-refundable facility fee upon the execution of the agreement; (ii) an unused line fee in an amount equal to 0.50% per annum on the difference between $5 million and the average daily principal balance of the loans outstanding during the month; and (iii) an early termination fee of $25,000 if the Company terminates the agreement before June 12, 2004. The Amended Loan contains certain financial covenants relating to net tangible worth, as defined, which the Company must satisfy in order to continue borrowing from the Bank. The Amended Loan matures on December 9, 2004. In connection with the Amended Loan, the Company issued to the Bank a warrant to purchase up to 16,164 shares of its common stock, at an exercise price of $2.32 per share. This warrant is immediately exercisable and expires on December 11, 2010. The Company has valued this warrant at $32,087, using the Black-Scholes option-pricing model and is and has treated this as a deferred financing cost and is amortizing this value on a straight line basis through December 9, 2004.

In January 2004, JP Turner & Company exercised a warrant to purchase 125,000 shares of common stock for $1.05 per share. In February 2004, Fuel Cell Energy Inc. exercised a warrant to purchase 250,000 shares of common stock for $0.72 per share.

The Company believes that the combination of existing cash on hand as of March 27, 2004, together with the ability to borrow under the Amended Loan will be sufficient to fund its operations through September 30, 2004. This belief is also based on the results achieved during the first half of fiscal 2004 and current backlog.

Note C. Significant Accounting Policies

Revenue Recognition

The Company recognizes revenue from product sales in accordance with Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and the Company has determined that collection of the fee is probable. Title to the product passes upon shipment of the product, as the products are typically shipped FOB shipping point, except for certain foreign shipments. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. The Company provides for a warranty reserve at the time the product revenue is recognized.

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The Company performs funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts. Product development revenue is included in product revenue. Cost reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts may contain incentive clauses providing for increases or decreases in the fees depending on how costs compare with a budget. On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as the services are performed. In each type of contract, the Company receives periodic progress payments or payments upon reaching interim milestones. All payments to the Company for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. When the current estimates of total contract revenue for commercial product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as research and development expense as incurred. As of March 27, 2004 and September 30, 2003, the Company has accrued $208,750 and $387,778, respectively, for anticipated contract losses on commercial contracts.

Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in research and development and other revenue expenses.

Deferred revenue consists of payments received from customers in advance of services performed, product shipped or installation completed.

Long-Lived Assets

Effective October 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. This statement affects the Company's treatment of goodwill and other intangible assets. The statement requires that goodwill existing at the date of adoption be reviewed for possible impairment and that impairment tests be periodically performed, with impaired assets written down to fair value. Additionally, existing goodwill and intangible assets must be assessed and classified within the statement's criteria. Intangible assets with finite useful lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indeterminable lives will cease.

The Company performs a goodwill impairment test on an annual basis, as of the beginning of its fiscal fourth quarter, and on an interim basis, if certain conditions exist, as required by SFAS No. 142 on an annual basis. The Company determines the fair value of each of the reporting units based on a discounted cash flow income approach.

Stock-Based Compensation

SFAS No. 123, Accounting for Stock-Based Compensation, requires the measurement of the fair value of stock options or warrants granted to employees to be included in the statement of operations

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or, alternatively, disclosed in the notes to consolidated financial statements. The Company accounts for stock-based compensation of employees under the intrinsic value method of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and has elected the disclosure-only alternative under SFAS No. 123. The Company records the fair value as determined using the Black-Scholes option-pricing model of stock options and warrants granted to non-employees in exchange for services in accordance with EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and is amortized ratably over the period the service is performed in the consolidated statement of operations.

Had compensation cost for the Company's stock-based compensation been determined based on fair value at the grant dates as calculated in accordance with SFAS No. 123, the Company's net loss and loss per share for the three and six months ended March 27, 2004 and March 29, 2003 would have been increased to the pro forma amounts indicated below:

		Three Months Ended												Six Months Ended
		March 27, 2004						March 29, 2003						March 27, 2004						March 29, 2003
		Net Loss			Loss per Share			Net Loss			Loss per Share			Net Loss			Loss per Share			Net Loss			Loss per Share
As Reported		$	(7,642,454	)	$	(0.29	)	$	(12,151,046	)	$	(0.68	)	$	(8,564,113	)	$	(0.34	)	$	(17,505,708	)	$	(1.01	)
Stock based employee compensation expense			(749,433	)		(0.03	)		(1,043,562	)		(0.06	)		(1,551,691	)		(0.06	)		(2,137,467	)		(0.12	)

Pro Forma		$	(8,391,887	)	$	(0.31	)	$	(13,194,608	)	$	(0.74	)	$	(10,115,804	)	$	(0.40	)	$	(19,643,175	)	$	(1.13	)

The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. SFAS No. 123 does not apply to awards prior to 1996 and additional awards in future years are anticipated.

The fair value of each stock option is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions: an expected life of seven years, expected volatility ranging from 117.5% to 120.0%, no dividends, and risk-free interest rate of 4.00% for the six months ended March 27, 2004 and an expected life of seven years, expected volatility ranging from 93.8% to 98.8%, no dividends, and risk-free interest rate of 4.00% for the six months ended March 29, 2003.

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, Accounting for Stock Based Compensation—Transition and Disclosure, an amendment to FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Finally, SFAS No. 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial reporting. For entities

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that voluntarily change to the fair value based method of accounting for stock-based employee compensation, the transition provisions are effective for fiscal years ending after December 15, 2002. For all other companies, the disclosure provisions and the amendment to APB No. 28 are effective for interim periods beginning after December 15, 2002. The Company adopted the disclosure provisions of SFAS No. 148 and did not have a material effect on its financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, to provide clarification on the meaning of an underlying, the characteristics of a derivative that contains financing components and the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. SFAS No. 149 will be applied prospectively and is effective for contracts entered into or modified after June 30, 2003. This statement is applicable to existing contracts and new contracts entered into after June 30, 2003 if those contracts relate to forward purchases or sales of when-issued securities or other securities that do not yet exist. The adoption of SFAS No. 149 did not have a material effect on the Company's results of operations or financial condition.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of the interim period of adoption. The adoption of SFAS No. 150 did not have a material effect on the Company's results of operations or financial condition.

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Note D. Loss per Share

The following is the reconciliation of the numerators and denominators of the basic and diluted per share computations of net loss:

		Three Months Ended						Six Months Ended
		March 27, 2004			March 29, 2003			March 27, 2004			March 29, 2003
Net loss		$	(7,642,454	)	$	(12,151,046	)	$	(8,564,113	)	$	(17,505,708	)

Basic and diluted:
Common shares outstanding, beginning of period			25,142,052			16,904,827			21,023,200			16,741,646
Weighted average common shares issued during the period			1,641,714			926,532			4,505,989			612,849

Weighted average shares outstanding—basic and diluted			26,783,766			17,831,359			25,529,189			17,354,495

Net loss per weighted average share—basic and diluted		$	(0.29	)	$	(0.68	)	$	(0.34	)	$	(1.01	)

As of March 27, 2004 and March 29, 2003, 4,726,453 and 5,687,563 shares of common stock issuable upon the exercise of options and warrants, respectively, were excluded from the diluted weighted average common shares outstanding as their effect would be antidilutive. In addition, as of March 27, 2004 and March 29, 2003, 990,000 and 2,538,000 shares of common stock issuable upon the conversion of the redeemable convertible preferred stock, respectively, were excluded from the diluted weighted average common shares outstanding as their effect would be antidilutive.

On April 19, 2004, the Company completed the first phase of its stock option exchange offer. A total of 781,158 options with an average exercise price of approximately $12.30 were tendered by employees and directors and then cancelled by the Company in exchange for the future issuance of options. New options will be issued in the final phase of the exchange offer on or after October 20, 2004 at the then current market price to employees and directors who are employed by the Company or serve as directors of the Company from the acceptance date through the date that the new options are granted. As of April 30, 2004, the Company is obligated to issue 697,108 options associated with the exchange, subject to certain conditions. Executive officers of the Company elected not to participate in the program.

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Note E. Inventory

Inventory consists of the following:

		March 27, 2004			September 30, 2003
Raw material		$	987,932		$	1,316,910
Work-in-process			3,404,730			2,488,556
Finished goods			465,422			1,996,654

		$	4,858,084		$	5,802,120

Note F. Segment Disclosures

The Company's organizational structure is based on strategic business units that perform services and offer various products to the principal markets in which the Company's products are sold. These business units equate to three reportable segments: Applied Technology, Power Systems and Electronics.

SatCon Applied Technology, Inc. performs research and development services in collaboration with third parties. SatCon Power Systems, Inc. specializes in the engineering and manufacturing of power systems. SatCon Electronics, Inc. designs and manufactures electronic products. The Company's principal operations and markets are located in the United States.

The accounting policies of each of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on revenue and profit and loss from operations, including amortization of intangibles. Common costs not directly attributable to a particular segment are included in the Applied Technology segment. These costs include corporate costs such as executive officer compensation, facility costs, legal, audit and tax and other professional fees and totaled $629,230, $1,222,127, $1,329,280 and $2,466,836 for the three and six months ended March 27, 2004 and March 29, 2003, respectively.

The following is a summary of the Company's operations by operating segment:

			Three Months Ended						Six Months Ended
			March 27, 2004			March 29, 2003			March 27, 2004			March 29, 2003
Applied Technology:
	Funded research and development and other revenue		$	1,953,968		$	1,126,065		$	3,932,570		$	2,475,812

	Loss from operations, including amortization of intangibles of $80,421 and $88,884 for the three months ended March 27, 2004 and March 29, 2003, respectively, and $160,843 and $177,768 and for the six months ended March 27, 2004 and March 29, 2003, respectively		$	(706,110	)	$	(1,824,989	)	$	(1,314,861	)	$	(3,450,717	)

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Power Systems:
	Product revenue		$	3,981,089		$	2,246,224		$	8,149,058		$	5,354,446

	Loss from operations, including amortization of intangibles of $0 and $27,194 for the three months ended March 27, 2004 and March 29, 2003, respectively, $0 and $53,793 for the six months ended March 27, 2004 and March 29, 2003, respectively, and write-off of impaired assets of $5,751,082 for the three and six months ended March 29, 2003		$	(321,699	)	$	(9,350,338	)	$	(363,572	)	$	(12,442,601	)

Electronics:
	Product revenue		$	2,224,010		$	2,003,918		$	4,264,587		$	4,226,359

	Loss from operations, including amortization of intangibles of $31,250 for the three months ended March 27, 2004 and March 29, 2003 and $62,500 for the six months ended March 27, 2004 and March 29, 2003		$	(70,931	)	$	(311,189	)	$	(164,233	)	$	(757,409	)

Consolidated:
	Product revenue		$	6,205,099		$	4,250,142		$	12,413,645		$	9,580,805
	Funded research and development and other revenue			1,953,968			1,126,065			3,932,570			2,475,812

	Total revenue		$	8,159,067		$	5,376,207		$	16,346,215		$	12,056,617

	Operating loss		$	(1,098,740	)	$	(11,486,516	)	$	(1,842,666	)	$	(16,650,727	)
	Net unrealized loss on warrants to purchase common stock			(46,348	)		(9,246	)		(3,566	)		(3,409	)
	Net unrealized gain on Series B warrants			—			—			35,442			—
	Write-down of investment in Beacon Power Corporation			—			(541,885	)		—			(541,885	)
	Other income			—			55,700			—			55,700
	Interest income			4,114			841			6,524			2,541
	Interest expense			(6,501,480	)		(169,940	)		(6,759,847	)		(367,928	)

	Net loss		$	(7,642,454	)	$	(12,151,046	)	$	(8,564,113	)	$	(17,505,708	)

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Common assets not directly attributable to a particular segment are included in the Applied Technology segment. These assets include cash and cash equivalents, prepaid and other corporate assets and amounted to $4,438,805 and $1,578,302 at March 29, 2004 and September 30, 2003, respectively. The following is a summary of the Company's assets by operating segment:

			March 27, 2004			September 30, 2003
Applied Technology:
	Segment assets		$	9,190,874		$	6,977,993
Power Systems:
	Segment assets			9,021,952			11,189,338
Electronics:
	Segment assets			6,375,803			6,717,121

Consolidated:
	Segment assets			24,588,629			24,884,452
	Warrants to purchase common stock			93,924			97,490

Total assets			$	24,682,553		$	24,981,942

The Company operates and markets its services and products on a worldwide basis with its principal markets as follows:

			Three Months Ended						Six Months Ended
			March 27, 2004			March 29, 2003			March 27, 2004			March 29, 2003
Revenue by geographic region based on location of customer:
	United States		$	7,428,840		$	4,622,526		$	14,051,747		$	10,237,337
	Rest of world			730,227			753,681			2,294,468			1,819,280

	Total revenue		$	8,159,067		$	5,376,207		$	16,346,215		$	12,056,617

			March 27, 2004			September 30, 2003
Long-lived assets (including goodwill and intangible assets) by geographic region based on location of operations:
	United States		$	9,709,449		$	10,656,469
	Rest of world			86,817			109,592

	Total long-lived assets (including goodwill and intangible assets)		$	9,796,266		$	10,766,061

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Note G. Legal Matters

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

In July 2003, Donald R. Gililland, Sharon Gililland, Vernon Dunham and Jean Dunham, owners of the real property commonly known as 4890 E. La Palma Avenue, Anaheim, CA 92870 (collectively the "Owners") which facility formerly housed the Company's Ling Electronics division, filed a complaint against the Company for breach of lease with the Orange County Superior Court. The complaint alleges, among other things, failure of the Company to maintain/repair premises. The Owners allege that the cost of correction and repair of the various breaches by the Company of its obligations under the Lease will exceed the sum of $400,000. The Company does not believe that this complaint has substantial merit and intends to vigorously defend against it.

On or about January 23, 2004, SatCon Power Systems Canada Ltd. (SatCon Canada), a wholly-owned subsidiary of SatCon Technology Corporation, received a communication from Maltmans, a Canadian insurance adjuster for Falconbridge Dominicana, C.Por.A. (Falcondo), providing notice of a claim against SatCon Canada for costs and damages resulting from a fire at Falcondo's facility in the Dominican Republic. SatCon Canada is a subcontractor on an installation at Falcondo's facility in the Dominican Republic. Similar demands were sent by Maltmans to other contractors and suppliers of the project. Maltmans claims that preliminary estimates of losses are in excess of $10 million. Maltmans provided no basis for the estimated loss or any substantiation of the purported claim against SatCon Canada. SatCon Technology Corporation does not believe that there is any causal relationship between the products and services SatCon Canada provided at the facility and the fire that occurred. SatCon Technology Corporation has provided notice to its insurance company and is coordinating the gathering of information regarding the fire with the general contractor and its insurance representatives. The Company does not believe that this matter will materially adversely affect its results of operations or financial condition or net cash flows.

The Company is not aware of any other current or pending litigation to which the Company is or may be a party that the Company believes could materially adversely affect its results of operations or financial condition or net cash flows.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains or incorporates forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Act of 1934. You can identify these forward-looking statements by our use of the words "believes," "anticipates," "plans," "expects," "may," "will," "intends," "estimates," and similar expressions, whether in the negative or in the affirmative. Although we believe that these forward-looking statements reasonably reflect our plans, intentions and expectations, our actual results could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements below under the heading "Factors Affecting Future Results" that we believe could cause our actual results to differ materially from the forward-looking statements that we make. We do not intend to update information contained in any forward-looking statements we make.

Recent Developments

On October 31, 2003, we completed a $7.7 million financing transaction involving the issuance of 1,535 shares of our Series B Convertible Preferred Stock, and warrants to purchase up to 1,228,000 shares of our common stock, from 25 accredited investors.

In connection with the financing, we issued shares of Series B Preferred Stock for $5,000 per share. The Series B Preferred Stock is convertible into a number of shares of common stock equal to $5,000 divided by the conversion price of the Series B Preferred Stock, which is $2.50. The total number of shares of common stock issuable upon conversion of the shares of Series B Preferred Stock issued and sold is 3,070,000. As of March 27, 2004, 1,040 shares of the Series B Preferred Stock had been converted into 2,080,000 shares of Common Stock. The Series B Preferred Stock accrues dividends of 6% per annum, increasing to 8% per annum on October 1, 2005. The dividend for the first six months was paid at closing by issuing 76,054 shares of common stock, valued based on the average of the closing bid and ask price of the common stock on the Nasdaq National Market for the five trading days preceding October 31, 2003. All further dividends will be paid on a semi-annual basis. Except in certain limited circumstances, we may opt to pay these dividends in cash or in shares of common stock.

As part of the financing, we also issued warrants to purchase up to 1,228,000 shares of common stock. These warrants have an initial exercise price of $3.32 per share, which represents 110% of the average closing price of our common stock for the five trading days prior to October 31, 2003. These warrants are immediately exercisable and expire on October 31, 2008.

In November 2003, with the proceeds from this financing transaction, we paid off the outstanding balance under our line of credit with Silicon Valley Bank (the "Bank") of $1.8 million and the Bank released $0.4 million of the $0.5 million of cash previously restricted. In addition, on December 12, 2003, we amended our agreement with the Bank. Under the amended agreement, the Bank will provide us with a line of credit of up to approximately $6.3 million (the "Amended Loan"). The Amended Loan is secured by most of the assets of the Company and advances under the Amended Loan are limited to 80% of eligible accounts receivables, which will permit borrowings up to $5.0 million.

Overview

SatCon designs, develops and manufactures high-efficiency high power electronics and a variety of standard and custom high-performance machines for specific applications. SatCon's power control products convert, store and manage electricity for businesses and consumers, the U.S Government and military that require high-quality, uninterruptible power. SatCon is utilizing its engineering and manufacturing expertise to develop products that it believes will be integral components of distributed power generation and power quality systems. SatCon's specialty motors are typically designed and

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manufactured for unique customer requirements such as high power-to-size requirements or high efficiency.

SatCon has expanded its business and capabilities through the following acquisitions:

•: K&D MagMotor Corp.—a manufacturer of custom electric motors, acquired in January 1997.
•: Film Microelectronics, Inc.—a manufacturer of hybrid microelectronics, acquired in April 1997.
•: Inductive Components, Inc.—a value-added supplier of customized electric motors, acquired in January 1999.
•: Lighthouse Software, Inc.—a supplier of control software for machine tools, acquired in January 1999.
•: HyComp, Inc.—a manufacturer of electronic multi-chip modules, acquired in April 1999.
•: Ling Electronics, Inc.—a manufacturer of test equipment, power converters, amplifiers and converters, acquired in October 1999.
•: Inverpower Controls Ltd.—a manufacturer of power electronics modules and advanced high-speed digital controls, acquired in July 2001.

In addition, in November 1999, the Company acquired intellectual property, tooling and other assets from Northrop Grumman Corporation enabling the Company to manufacture and sell electric drive trains and in September 2002, we acquired certain intellectual property, equipment and other assets from Sipex Corporation to expand our high-reliability data conversion product line.

Critical Accounting Policies and Significant Judgments and Estimates

Our discussion and analysis of our financial condition and results of our operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenue and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, receivable reserves, inventory reserves, investment in Beacon Power Corporation, goodwill and intangible assets and income taxes. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The significant accounting policies that management believes are most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition

We recognize revenue from product sales in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and we have determined that collection of the fee is probable. Title to the product passes upon shipment of the product, as the products are typically shipped FOB shipping point, except for certain foreign shipments. If the product requires installation to be performed by us, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions

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lapse, unless we can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. We provide for a warranty reserve at the time the product revenue is recognized.

We perform funded research and development and product development for commercial companies and government agencies under both cost reimbursement and fixed-price contracts. Cost reimbursement contracts provide for the reimbursement of allowable costs and, in some situations, the payment of a fee. These contracts may contain incentive clauses providing for increases or decreases in the fee depending on how costs compare with a budget. On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as services are performed. In each type of contract, we receive periodic progress payments or payment upon reaching interim milestones and retain the rights to the intellectual property developed in government contracts. All payments to us for work performed on contracts with agencies of the U.S. government are subject to audit and adjustment by the Defense Contract Audit Agency. Adjustments are recognized in the period made. The Defense Contract Audit Agency has agreed-upon the final indirect cost rates for the fiscal year ended September 30, 2001. When the current estimates of total contract revenue and contract costs for product development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as funded research and development expenses as incurred. As of March 27, 2004 and September 30, 2003, we have accrued approximately $0.2 million and $0.4 million, respectively, for anticipated contract losses.

Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development and other revenue arrangements are included in funded research and development and other revenue expenses.

Deferred revenue consists of payments received from customers in advance of services performed, product shipped or installation completed.

Unbilled contract costs and fees represent revenue recognized in excess of amounts billed due to contractual provisions or deferred costs that have not yet been recognized as revenue or billed to the customer.

Accounts Receivable

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on a specific analysis of accounts in the receivable portfolio and historical write-off experience. While management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.

Inventory

We value our inventory at the lower of actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We periodically review inventory quantities on hand and record a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, as well as based on historical usage. Due to the custom and specific nature of certain of our products, demand and usage for products and materials can fluctuate significantly. A significant decrease in demand for our products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product

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demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.

At the end of June 2003, we were actively engaged in selling our Shaker product line, and we were pursuing a strategy that we hoped would lead to a strategic alliance with a larger company for the development and exploitation of the advantages embodied in our Uninterruptible Power Supply ("UPS") system. During the process of considering various options, we concluded that both our Shaker and UPS system inventories were overvalued based upon the June 2003 plans. We analyzed the situation and recorded in increase to our valuation reserve. This reserve was based on our assessment of the situation as of that time. Events in the future could be materially different than expected. Late in calendar year 2003, we decided to retain our Shaker product line, due in part to a significant improvement in our liquidity situation. In the first quarter of our fiscal year 2004, no shaker units were sold and our gross inventory for our Shaker product line inventory was $2.1 million and our valuation reserve against that inventory was $2.0 million, or 95%. During our second quarter of fiscal 2004, we were successful in resuming sales levels of our Shaker product line comparable to levels that existed prior to June 2003. As a result, we have used inventory that we had previously written-down below cost. During the second quarter of fiscal 2004, we sold inventory that originally had a cost of $0.1 million. Although it is unclear how much of the remaining inventory we will sell and during which periods it will occur, as we sell this inventory our cost of product revenue will be lower than normal as this inventory has been written-down below cost. As a result, to the extent this inventory is sold in the future, our margins will be favorably impacted compared with results that would otherwise be achieved.

Goodwill and Intangible Assets

Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market value of the assets purchased and liabilities assumed. We have accounted for our acquisitions using the purchase method of accounting. Values were assigned to goodwill and intangible assets based on third-party independent valuations, as well as management's forecasts and projections that include assumptions related to future revenue and cash flows generated from the acquired assets.

Effective October 1, 2001, we adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. This statement affects our treatment of goodwill and other intangible assets. The statement requires impairment tests be periodically repeated and on an interim basis, if certain conditions exist, with impaired assets written down to fair value. Additionally, existing goodwill and intangible assets must be assessed and classified within the statement's criteria. Intangible assets with finite useful lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indeterminable lives ceased.

We determine the fair value of each of the reporting units based on a discounted cash flow income approach. The income approach indicates the fair value of a business enterprise based on the discounted value of the cash flows that the business can be expected to generate in the future. This analysis is largely based upon projections prepared by us and data from sources of information publicly available at the time of preparation. These projections are based on management's best estimate of future results. In making these projections, we consider the markets we are addressing, the competitive environment and our advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as expected, and those differences may be material. In addition, we perform a macro assessment of the overall likelihood that we would achieve the projected cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.

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Long-Lived Assets

As of October 1, 2002, we adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The statement requires that long-lived assets be reviewed for possible impairment, if certain conditions exist, with impaired assets written down to fair value.

We determine the fair value of certain of the long-lived assets based on a discounted cash flow income approach. The income approach indicates the fair value of a long-lived assets based on the discounted value of the cash flows that the long-lived asset can be expected to generate in the future over the life of the long-lived asset. This analysis is based upon projections prepared by us. These projections represent management's best estimate of future results. In making these projections, we consider the markets we are addressing, the competitive environment and our advantages. There will usually be differences between estimated and actual results as events and circumstances frequently do not occur as expected, and those differences may be material. In addition, we perform a macro assessment of the overall likelihood that we would achieve the projected cash flows and performed sensitivity analysis using historical data as the basis for projected cash flows.

Income Taxes

The preparation of our consolidated financial statements requires us to estimate our income taxes in each of the jurisdictions in which we operate, including those outside the United States, which may be subject to certain risks that ordinarily would not be expected in the United States. The income tax accounting process involves estimating our actual current exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. We have recorded a full valuation allowance against our deferred tax assets of $41.9 million as of March 27, 2004, due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to adjust our valuation allowance which could materially impact our financial position and results of operations.

Results of Operations

Three Months Ended March 27, 2004 Compared to Three Months Ended March 29, 2003

Product Revenue. Product revenue increased by $2.0 million, or 46%, from $4.3 million in fiscal year 2003 to $6.2 million in fiscal year 2004. The increase in product revenue was comprised of over $1.7 million from our Power Systems division and $0.2 million from our Electronics division. The increase of $1.7 million in revenue from Power Systems was largely due to increased sales in our Power Conversion products, and to a lesser degree, increased sales in our Magnetics and Test and Measurement products.

Funded research and development and other revenue. Funded research and development and other revenue increased by $0.8 million, or 74%, from $1.1 million in fiscal year 2003 to $2.0 million in fiscal year 2004. This increase was primarily attributable to an increase in revenue of $0.6 million from a

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classified program where the end customer is the U.S. Navy, $0.2 million from a photovoltaics contract and $0.2 million from a contract with General Atomics to deliver power converter and control assemblies for the RV Triton, a British research vessel. These increases were offset in part by a $0.2 million reduction in revenue from the wind down of a contract with General Atomics to develop integrated power systems for the future U.S. Navy's "all-electric" ship.

Cost of product revenue. Cost of product revenue decreased by $0.4 million, or 7%, from $5.6 million in fiscal year 2003 to $5.2 million in fiscal year 2004 despite the increase in product revenue of $2.0 million. The decrease was primarily attributable to a reduction in our manufacturing cost structure, offset in part by an increase in material costs due to higher sales volume. In addition, we sold certain materials which had been substantially written down and reflected at reduced cost. This improved gross margin by $0.1 million during fiscal year 2004. Gross margin improved from -31% to 17% as a result of this reduction in manufacturing overhead and, to a lesser degree, higher sales volume.

Funded research and development and other revenue expenses. Funded research and development and other revenue expenses increased by $0.5 million, or 51%, from $0.9 million in fiscal year 2003 to $1.4 million in fiscal year 2004. The gross margin on funded research and other revenue improved from 17% in fiscal year 2003 to 28% in fiscal year 2004. This improvement is reflective of an increase in revenue and improved efficiency.

Unfunded research and development expenses. We did not expend funds on unfunded research and development in fiscal year 2004 compared with $0.5 million spent in fiscal year 2003. The primary reason for this reduction in unfunded research and development expenses was primarily due to the completion of the UPS development activity, as that has been completed, and to a lesser degree the elimination of the radio frequency research effort in our Electronics division.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased by $1.3 million, or 34%, from $3.9 million in fiscal year 2003 to $2.6 million in fiscal year 2004. The decrease was primarily the result of a reduction in the selling and administrative cost structure in our Power Systems division and, to a lesser extent, lower spending in central corporate costs due to general streamlining of outside services and internal staffing. These decreases were offset, in part, by a $0.2 million increase to allowance for uncollectible accounts in fiscal year 2004.

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

Write-off of impaired assets. During the three months ended March 29, 2003, we experienced a significant adverse change in the business climate, in particular, significant reductions in revenues and cash flows. This coupled with our liquidity issues at the time, required us to consider selling assets unrelated to our engineering and manufacturing expertise in electromechanical systems. The assets and businesses we considered selling included our Ling test and measurement vibration system business, our patented smart predictive line control technology utilized by the electric arc steel manufacturing industry and patents acquired from Northrop Grumman related to hybrid electric vehicles. Based on these conditions, we performed an impairment test on an interim basis. We determined the fair value of each of the reporting units based on a discounted cash flow income approach. This analysis was largely based upon historical data. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Applied Technology and Electronics reporting units exceeded their carrying amounts and, therefore, no goodwill impairment existed as of March 29, 2003. As a result, the second step of the goodwill impairment test was not required to be completed. We continue to perform a goodwill impairment test for these reporting units on an annual basis and on an interim basis, if certain conditions exist. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Power Systems reporting unit does not exceed its carrying amount. The fair value was determined to approximate the fair value of the net tangible

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assets. The second step of the impairment test required us to write off the unamortized balance of the goodwill and intangible assets of the Power Systems reporting unit as of March 29, 2003 of $5.8 million.

Net unrealized gain/(loss) on warrants to purchase common stock. There was no significant net unrealized gain on warrants to purchase common stock in fiscal year 2004 and 2003. We account for our warrants to purchase Mechanical Technology Incorporated's common stock and to purchase Beacon Power Corporation's common stock in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, we have recorded these warrants at their fair value at March 27, 2004. Our warrants to purchase Mechanical Technology Incorporated's common stock expired unexercised on October 21, 2003 and January 31, 2004 and we no longer account for these warrants in accordance with SFAS No. 133.

Write-down of investment in Beacon Power Corporation. We accounted for our investment in Beacon Power using the fair value method as set forth in SFAS No. 115, Accounting for Certain Debt and Equity Securities. As of March 29, 2003, the quoted fair market value of Beacon Power's common stock held by us was $0.18 per share, or $0.8 million. Our cost basis in our investment in Beacon Power's common stock was approximately $0.30 per share, or $1.4 million, resulting in an unrealized loss of $0.5 million as of March 29, 2003. As of March 29, 2003, we believed the difference in the current fair market value and the cost basis of our investment represented an other than temporary decline based upon our ability and intent to hold the stock for a long enough period of time for it to recover. We recorded a charge of $0.5 million in the statement of operations to realize this loss. After the write-down, the new cost basis of the Beacon Power stock held by us was $0.18 per share. During 2003, we sold all of our shares of Beacon Power Corporation common stock

Interest expense. Interest expense was $6.5 million for fiscal year 2004 compared with $0.2 million for fiscal year 2003, an increase of $6.3 million. Interest expense for fiscal year 2004 was virtually all comprised of non-cash items including $6.1 million amortization of discount on the convertible redeemable Series B preferred stock, $0.2 million amortization of the discount on the subordinated convertible debentures, $0.1 million associated with the line of credit with Silicon Valley Bank and $0.1 million associated with the Series B preferred stock. Interest expense for fiscal year 2003 includes the amortization of the fair value, as determined using the Black-Scholes option pricing model, of the warrants we issued in connection with our existing line of credit of $0.1 million and $0.1 million of costs associated with the forbearance agreement entered into on December 19, 2002.

Six Months Ended March 27, 2004 Compared to Six Months Ended March 29, 2003

Product Revenue. Product revenue increased by $2.8 million, or 30%, from $9.6 million in fiscal year 2003 to $12.4 million in fiscal year 2004. The increase in revenue came primarily from our Power Systems division and was due to the sale of 2 UPS systems, compared to none in fiscal year 2003, as well as an increase in sales across all product lines.

Funded research and development and other revenue. Funded research and development and other revenue increased by $1.5 million, or 59%, from $2.5 million in fiscal year 2003 to $3.9 million in fiscal year 2004. This increase was primarily attributable to an increase in revenue of $1.2 million from a classified program where the end customer is the U.S. Navy, $0.3 million from a photovoltaics contract and $0.8 million from a contract with General Atomics to deliver power converter and control assemblies for the RV Triton, a British research vessel. These increases were offset in part by a $0.6 million reduction in revenue from the wind down of a contract with General Atomics to develop integrated power systems for the future U.S. Navy's "all-electric" ship.

Cost of product revenue. Cost of product revenue decreased by $1.3 million, or 11%, from $11.7 million in fiscal year 2003 to $10.4 million in fiscal year 2004 despite the increase in product revenue of $2.8 million. The decrease was primarily attributable to a reduction in our manufacturing

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cost structure, offset in part by an increase in material costs due to higher sales volume. In addition, we sold certain materials which had been substantially written down and reflected at reduced cost. This improved gross margin by $0.1 million during fiscal year 2004. Gross margin improved from -22% to 17% as a result of this reduction in manufacturing overhead and, to a lesser degree, higher sales volume.

Funded research and development and other revenue expenses. Funded research and development and other revenue expenses increased by $0.6 million, or 28%, from $2.2 million in fiscal year 2003 to $2.8 million in fiscal year 2004. The gross margin on funded research and other revenue improved from 12% in fiscal year 2003 to 29% in fiscal year 2004. This improvement is reflective of an increase in revenue and improved efficiency.

Unfunded research and development expenses. We did not expend funds on unfunded research and development in fiscal year 2004 compared with $1.1 million in fiscal year 2003. The primary reason for this reduction in unfunded research and development expenses was primarily due to the completion of the UPS development activity, as that has been completed, and to a lesser degree the elimination of the radio frequency research effort in our Electronics division.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased by $2.9 million, or 38%, from $7.7 million in fiscal year 2003 to $4.8 million in fiscal year 2004. Over half of this decrease was due to a shrinking of the selling and administrative cost structure in our Power Systems division. To a lesser extent, this reduction was a result of lower spending in our corporate costs due to a general streamlining of outside services and internal staffing. These decreases were offset, in part, by a $0.2 million increase to allowance for uncollectible accounts in fiscal year 2004.

Amortization of intangibles. Amortization of intangibles decreased by $0.1 million, or 24%, from $0.3 million in fiscal year 2003 to $0.2 million in fiscal year 2004. The decrease was the result of the write-off of the Power System's intangible assets that occurred in March 2003, which, accordingly, we are no longer amortizing.

Write-off of impaired assets. During the three months ended March 29, 2003, we experienced a significant adverse change in the business climate, in particular, significant reductions in revenues and cash flows. This coupled with our liquidity issues at the time, required us to consider selling assets unrelated to our engineering and manufacturing expertise in electromechanical systems. The assets and businesses we considered selling included our Ling test and measurement vibration system business, our patented smart predictive line control technology utilized by the electric arc steel manufacturing industry and patents acquired from Northrop Grumman related to hybrid electric vehicles. Based on these conditions, we performed an impairment test on an interim basis. We determined the fair value of each of the reporting units based on a discounted cash flow income approach. This analysis was largely based upon historical data. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Applied Technology and Electronics reporting units exceeded their carrying amounts and, therefore, no goodwill impairment existed as of March 29, 2003. As a result, the second step of the goodwill impairment test was not required to be completed. We continue to perform a goodwill impairment test for these reporting units on an annual basis and on an interim basis, if certain conditions exist. Based on the results of the first step of the goodwill impairment test, we determined that the fair value of the Power Systems reporting unit does not exceed its carrying amount. The fair value was determined to approximate the fair value of the net tangible assets. The second step of the impairment test required us to write off the unamortized balance of the goodwill and intangible assets of the Power Systems reporting unit as of March 29, 2003 of $5.8 million.

Net unrealized gain/(loss) on warrants to purchase common stock. There was no significant net unrealized gain on warrants to purchase common stock in fiscal year 2004 and 2003. We account for

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our warrants to purchase Mechanical Technology Incorporated's common stock and to purchase Beacon Power Corporation's common stock in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and, therefore, we have recorded these warrants at their fair value at March 27, 2004. Our warrants to purchase Mechanical Technology Incorporated's common stock expired unexercised on October 21, 2003 and January 31, 2004 and we no longer account for these warrants in accordance with SFAS No. 133.

Write-down of investment in Beacon Power Corporation. We accounted for our investment in Beacon Power using the fair value method as set forth in SFAS No. 115, Accounting for Certain Debt and Equity Securities. As of March 29, 2003, the quoted fair market value of Beacon Power's common stock held by us was $0.18 per share, or $0.8 million. Our cost basis in our investment in Beacon Power's common stock was approximately $0.30 per share, or $1.4 million, resulting in an unrealized loss of $0.5 million as of March 29, 2003. As of March 29, 2003, we believed the difference in the current fair market value and the cost basis of our investment represented an other than temporary decline based upon our ability and intent to hold the stock for a long enough period of time for it to recover. We recorded a charge of $0.5 million in the statement of operations to realize this loss. After the write-down, the new cost basis of the Beacon Power stock held by us was $0.18 per share. During 2003, we sold all of our shares of Beacon Power Corporation common stock.

Interest expense. Interest expense was $6.8 million for fiscal year 2004 compared with $0.4 million for fiscal year 2003, an increase of $6.4 million. Interest expense for fiscal year 2004 was virtually all comprised of non-cash items including $6.1 million amortization of discount on the convertible redeemable Series B preferred stock, $0.2 million amortization of the discount on the subordinated convertible debentures, $0.2 million associated with the redeemable convertible Series A preferred stock and subordinated debentures, $0.2 million associated with the line of credit with Silicon Valley Bank and $0.1 million associated with the Series B preferred stock, offset by a benefit from the negotiated reduction in fees associated with the February 2003 transaction. Interest expense for fiscal year 2003 includes the amortization of the fair value, as determined using the Black-Scholes option pricing model, of the warrants we issued in connection with our existing line of credit of $0.1 million and $0.1 million of costs associated with the forbearance agreement entered into on December 19, 2002.

Liquidity and Capital Resources

As of March 27, 2004, we had $3.5 million of cash, of which $0.2 million was restricted. At this time no funds had been drawn against our $6.3 million line of credit with Silicon Valley Bank. The maximum amount we can borrow under this agreement is $5.0 million based upon 80% of eligible receivables. As of March 27, 2004, approximately $2.8 million could have been borrowed. Our trade payables, at March 27, 2004, totaled $2.3 million, of which $0.8 million were for invoices over 60 days old. In addition, we had $1.1 million of accrued accounts payable at March 27, 2004 for goods and services received but not yet invoiced.

In October 2003, warrants to purchase 1.6 million shares of our Common Stock were exercised for net proceeds of $1.5 million, we sold an additional $0.1 million of convertible subordinated debentures and we sold shares of Series B preferred stock for proceeds of approximately $6.9 million, net of placement agent's fees and other issuance costs.

In November 2003, with the proceeds from these financing transactions, we paid off the outstanding balance under the line of credit of $1.8 million and the Bank released $0.4 million of the $0.5 million of cash previously restricted. In addition, on December 12, 2003, we amended our agreement with the Bank. Under the amended agreement, the Bank will provide us with a line of credit of up to approximately $6.3 million (the "Amended Loan"). The Amended Loan is secured by most of the assets of the Company and advances under the Amended Loan are limited to 80% of eligible

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accounts receivables, which will permit borrowings up to $5.0 million. Interest on outstanding borrowings accrues at a rate equal to the Bank's prime rate of interest plus 1.5% per annum. In addition, we will pay to the Bank a collateral handling fee of 2.4% per annum of the average daily outstanding balance. The interest rate increases to the Bank's prime rate plus 3.0% per annum and the collateral handling fee increases to 3.0% per annum if we fail to meet certain financial ratios. We have also agreed to the following fees: (i) a $23,250 non-refundable facility fee upon the execution of the agreement; (ii) an unused line fee in an amount equal to 0.50% per annum on the difference between $5 million and the average daily principal balance of the loans outstanding during the month; and (iii) an early termination fee of $25,000 if we terminate the agreement before June 12, 2004. The Amended Loan contains certain financial covenants relating to tangible net worth, as defined, which we must satisfy in order to continue borrowing from the Bank. The Amended Loan matures on December 9, 2004.

We anticipate that our cash, together with the availability under the Amended Loan will be sufficient to fund our operations at least through September 30, 2004. This belief is also based on the results achieved during the first half of fiscal 2004 and the current backlog.

If additional funds are raised in the future through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and our stockholders may experience additional dilution. The terms of additional funding may also limit our operating and financial flexibility. There can be no assurance that additional financing of any kind will be available to us on terms acceptable to us, or at all. Failure to obtain future funding when needed or on acceptable terms would materially, adversely affect our results of operations.

Our financial statements for our fiscal year ended September 30, 2003, which are included in our Annual Report on Form 10-K, contain an audit report from Grant Thornton LLP. The audit report contains a going concern qualification, which raises substantial doubt with respect to our ability to continue as a going concern. However, our business plan, which envisions a significant improvement in results from the recent past, contemplates sufficient liquidity to fund operations at least through September 30, 2004. The receipt of a going concern qualification may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations.

We have incurred significant costs to develop our technologies and products. These costs have exceeded total revenue. As a result, we have incurred losses in each of the past five years. Since inception, we have financed our operations and met our capital expenditure requirements primarily through the sale of private equity securities, public security offerings, borrowings on our line of credit and capital equipment leases.

As of March 27, 2004, our cash and cash equivalents were $3.5 million, including restricted cash and cash equivalents of $0.2 million, an increase of $2.3 million from September 30, 2003. Cash used in operating activities for the six months ended March 27, 2004 was $4.6 million as compared to $4.9 million for six months ended March 29, 2003. Cash used in operating activities during the six months ended March 27, 2004 was primarily attributable to the net loss, net of unrealized gain on warrants to purchase common stock, offset by non-cash items such as depreciation and amortization, increases in allowances for uncollectible accounts and excess and obsolete inventory, non-cash compensation and consulting expense, non-cash interest expense and decreases in working capital. In particular, we reduced our trade payables for invoices over 60 days old from $3.5 million as of September 30, 2003 to $0.8 million as of March 27, 2004.

Cash used by investing activities during the six months ended March 27, 2004 was $0.0 million as compared to $0.2 million for the six months ended March 29, 2003.

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Cash provided by financing activities for the six months ended March 27, 2004 was $7.0 million as compared to $3.2 million for the six months ended March 29, 2003. Net cash provided by financing activities during the six months ended March 27, 2004 includes $7.0 million of proceeds from the sale of the redeemable convertible Series B Preferred Stock and the convertible subordinated debentures, $1.9 million of proceeds from the exercise of warrants to purchase common stock, offset in part by a reduction of $1.8 million in bank borrowings and $0.1 million repayment of long-term debt.

We lease equipment and office space under non-cancelable capital and operating leases. Future minimum rental payments, as of March 27, 2004, under the capital and operating leases with non-cancelable terms are as follows:

Fiscal Years ended September 30,		Capital Leases			Operating Leases
2004		$	161,325		$	443,688
2005			236,456			501,108
2006			316,762			262,367
2007			—			264,000
2008			—			291,500
Thereafter			—			612,500

Total		$	714,543		$	2,375,163

Factors Affecting Future Results

Our future results remain difficult to predict and may be affected by a number of factors which could cause actual results to differ materially from forward-looking statements contained in this Quarterly Report on Form 10-Q and presented elsewhere by management from time to time. These factors include business conditions within the distributed power, power quality, aerospace, transportation, industrial, utility, telecommunications, silicon wafer manufacturing, factory automation, aircraft and automotive industries and the world economies as a whole, and competitive pressures that may impact research and development spending. Our revenue growth is dependent, in part, on technology developments and contract research and development for both the government and commercial sectors and no assurance can be given that these investments will continue or that we will be able to obtain such funds. In addition, our growth opportunities are dependent on the introduction of new products that must penetrate distributed power, power quality, aerospace, transportation, industrial, utility, telecommunications, silicon wafer manufacturing, factory automation, aircraft and automotive markets. No assurance can be given that new products can be developed, or if developed, will be successful; that competitors will not force prices to an unacceptably low level or take market share from us; or that we can achieve or maintain profits in these or any new markets. Because of these and other factors, including, without limitation, the factors set forth below, past financial performance should not be considered an indicator of future performance. Investors should not use historical trends to anticipate future results and should be aware that the market price of our common stock experiences significant volatility.

We have a history of operating losses, may not be able to achieve profitability and may require additional capital in order to sustain our businesses. For each of the past eight fiscal years, we have experienced losses from operating our businesses.

As of March 27, 2004, we had an accumulated deficit of approximately $125.3 million. During the six months ended March 27, 2004, we had a loss from operations of approximately $1.8 million. If we are unable to operate on a cash flow breakeven basis during 2004, we may need to raise additional capital in order to sustain our operations. There can be no assurance that we will be able to achieve such results or to raise such funds if they are required.

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

Our financial statements for our fiscal year ended September 30, 2003, which are included in our Annual Report on Form 10-K, contain an audit report from Grant Thornton LLP. The audit report contains a going concern qualification, which raises substantial doubt with respect to our ability to continue as a going concern. The receipt of a going concern qualification may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations.

We could issue additional common stock, which might dilute the book value of our common stock.

We have authorized 50,000,000 shares of our common stock, of which 28,090,736 shares were issued and outstanding as of April 30, 2004. Our board of directors has the authority, without action or vote of our stockholders in most cases, to issue all or a part of any authorized but unissued shares. Such stock issuances may be made at a price that reflects a discount from the then-current trading price of our common stock. In addition, in order to raise capital that we may need at today's stock prices, we will need to issue securities that are convertible into or exercisable for a significant amount of our common stock. These issuances would dilute your percentage ownership interest, which will have the effect of reducing your influence on matters on which our stockholders vote, and might dilute the book value of our common stock. You may incur additional dilution of net tangible book value if holders of stock options, whether currently outstanding or subsequently granted, exercise their options or if warrant holders exercise their warrants to purchase shares of our common stock.

The sale or issuance of a large number of shares of our common stock could depress our stock price.

As of April 30, 2004, we have reserved 3,893,745 shares of common stock for issuance upon exercise of stock options and warrants, 2,057,680 shares for future issuances under our stock plans and 334,070 shares for future issuances as matching contributions under our 401(k) plan. As of April 30, 2004, holders of warrants and options to purchase an aggregate of 3,515,245 shares of our common stock may exercise those securities and transfer the underlying common stock at any time subject, in some cases, to Rule 144. As of April 30, 2004, we have also reserved 2,125,000 shares of common stock for issuance upon conversion of the outstanding redeemable convertible Series B preferred stock, which can be converted at any time.

Financial investors may have interests different than you or SatCon, and may be able to impact corporate actions requiring stockholder approval because they own a significant amount of our common stock.

We have recently completed two significant financing transactions. In February 2003, we raised approximately $4,000,000 through the issuance of securities that were convertible into or exercisable for up to 50% or more of the number of shares of our common stock outstanding at that time. In October 2003, we raised an additional $7,675,000 through the issuance of 1,535 shares of our Series B Convertible Preferred Stock and warrants to purchase up to 1,228,000 shares of our common stock from 25 accredited investors. Prior to the October 2003 transaction, all of the convertible securities issued in connection with the February 2003 transaction were exercised or converted and as a result of the exercise and conversion of these securities we raised approximately $1.5 million.

In future financings, we may also issue securities that are convertible into or exercisable for a significant number of shares of our outstanding common stock. Financial investors such as those who participated in our 2003 financings may have short-term financial interests different from SatCon's long-term goals and the long-term goals of our management and other stockholders. In addition, based

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on their significant ownership of our outstanding common stock, financial investors may be able to impact corporate actions requiring stockholder approval.

We have not consistently complied with Nasdaq's Marketplace rules for continued listing, which exposes us to the risk of delisting from the Nasdaq National Market.

Our stock is listed on the Nasdaq National Market, which affords us an opportunity for relatively broad exposure to a wide spectrum of prospective investors. As a requirement of continued inclusion in the Nasdaq National Market, SatCon must comply with Nasdaq's Marketplace Rules, which require that we maintain a market value of $50 million or have total assets of $50 million and $50 million of total revenue and that our stock price stays above $1.00, among others. On August 14, 2003, SatCon received notice from Nasdaq that it was not in compliance with Marketplace Rules. Subsequently, SatCon was advised that it had achieved compliance, and as of April 30, 2004, SatCon is in compliance with the Nasdaq National Market Marketplace Rules for Continued Inclusion. However, if we fail to maintain compliance with these rules and our common stock is delisted from the Nasdaq National Market, there could be a number of negative implications, including reduced liquidity in our common stock as a result of the loss of market efficiencies associated with the Nasdaq National Market, the loss of federal preemption of state securities laws, the potential loss of confidence by suppliers, customers and employees, as well as the loss of analyst coverage and institutional investor interest, fewer business development opportunities and greater difficulty in obtaining financing.

We expect to generate a significant portion of our future revenues from sales of our power control products and cannot assure market acceptance or commercial viability of our power control products.

We intend to continue to expand development of our power control products. We cannot assure you that potential customers will select SatCon's products to incorporate into their systems or that our customers' products will realize market acceptance, that they will meet the technical demands of their end users or that they will offer cost-effective advantages over existing products. Our marketing efforts to date involve development contracts with several customers, identification of specific market segments for power and energy management systems and the continuation of marketing efforts of recently acquired businesses. We cannot know if our commercial marketing efforts will be successful in the future. Furthermore, we cannot assure you that our products, in their current form, will be suitable for specific commercial applications or that further design modifications, beyond anticipated changes to accommodate different markets, will not be necessary. Additionally, we may not be able to develop competitive products, our products may not receive market acceptance, and we may not be able to profitably compete in this market even if market acceptance is achieved. If our products do not gain market acceptance or commercial viability, we will not achieve our anticipated levels of profitability and growth.

If we are unable to maintain our technological expertise in design and manufacturing processes, we will not be able to successfully compete.

We believe that our future success will depend upon our ability to develop and provide products that meet the changing needs of our customers. This requires that we successfully anticipate and respond to technological changes in design and manufacturing processes in a cost-effective and timely manner. As a result, we continually evaluate the advantages and feasibility of new product design and manufacturing processes. We cannot, however, assure you that our process development efforts will be successful. The introduction of new products embodying new technologies and the emergence of shifting customer demands or changing industry standards could render our existing products obsolete and unmarketable which would have a significant impact on our ability to generate revenue. Our future success will depend upon our ability to continue to develop and introduce a variety of new products and product enhancements to address the increasingly sophisticated needs of our customers. This will

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require us to continue to make substantial product development investments. We may experience delays in releasing new products and product enhancements in the future. Material delays in introducing new products or product enhancements may cause customers to forego purchases of our products and purchase those of our competitors.

We are heavily dependent on contracts with the U.S. government and its agencies or from subcontracts with the U.S. government's prime contractors for revenue to develop our products, and the loss of one or more of our government contracts could preclude us from achieving our anticipated levels of growth and revenues.

Our ability to develop and market our products is heavily dependent upon maintaining our U.S. government contract revenue and research grants. Most of our U.S. government contracts are funded incrementally on a year-to-year basis. Approximately 50% of our revenue during fiscal year 2003 was derived from government contracts and subcontracts with the U.S. government's prime contractors. Any change in our relationship with the U.S. government or its agencies whether as a result of market, economic, or competitive pressures, including any decision by the U.S. government to alter its commitment to our research and development efforts, could harm our business and financial condition by depriving us of the resources necessary to develop our products. In addition there can be no assurance that once a government contract is completed that it will lead to follow-on contracts for additional research and development, prototype build and test, or production. Furthermore, contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause. There can be no assurance that our U.S. government contracts will not be terminated or suspended in the future, or that contract suspensions or terminations will not result in unreimbursable expenses or charges or other adverse effects on us.

The accuracy and appropriateness of our direct and indirect costs and expenses under our contracts with the U.S. government are subject to extensive regulation and audit by the Defense Contract Audit Agency or by other appropriate agencies of the U.S. government. These agencies have the right to challenge our cost estimates or allocations with respect to any such contract. Additionally, substantial portions of the payments to us under U.S. government contracts are provisional payments that are subject to potential adjustment upon audit by such agencies. Adjustments that result from inquiries or audits of our contracts could have a material adverse impact on our financial condition or results of operations.

Since our inception, we have not experienced any material adjustments as a result of any inquiries or audits, but there can be no assurance that our contracts will not be subject to material adjustments in the future.

In the event that any of our government contracts are terminated for cause, it could significantly affect our ability to obtain future government contracts, which could seriously harm our ability to develop our technologies and products.

A significant portion of our revenue is derived from contracts with the U.S. government and its agencies or from subcontracts with the U.S. government's prime contractors, and a slowdown in government spending may adversely affect our ability to obtain anticipated revenues.

Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies or the imposition of budgetary constraints could significantly impair our ability to achieve this level of revenue going forward. Any reductions or slowdowns in government spending could also severely inhibit our ability to successfully complete the development and commercialization of our products. Changes in funding levels could cause the government to cancel existing contracts or eliminate follow-on phases in the future.

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The U.S. government has certain rights relating to our intellectual property.

Certain patents we hold are the result of retaining ownership of inventions made under U.S. government-funded research and development programs. With respect to any invention made with government assistance, the government has a nonexclusive, nontransferable, irrevocable, paid-up license to use the technology or have the technology employed for or on behalf of the U.S. government throughout the world. Under certain conditions, the U.S. government also has "march-in rights." These rights enable the U.S. government to require us to grant a nonexclusive, partially exclusive, or exclusive license in any field of use to responsible applicants, upon terms that are reasonable under the circumstances. If we refuse, the government can grant the license itself, provided that it determines that such action is necessary because we have not achieved practical application of the invention, or to alleviate health or safety needs, or to meet requirements for public use specified by federal regulations, or because products using such inventions are not being produced substantially in the United States. The exercise of these rights by the government could create potential competitors for us if we later determine to further develop the technologies and utilize the inventions in which the government has exercised these rights.

Our business could be adversely affected if we are unable to protect our patents and proprietary technology.

As of April 30, 2004, we held 72 U.S. patents and had 3 patent applications pending with the U.S. Patent and Trademark Office. We have also obtained corresponding patents in the rest of North America, Europe, and Asia for many of these patents. The expiration date of our patents range from 2009 to 2021, with the majority expiring after 2015. As a qualifying small business from our inception to date, we have retained commercial ownership rights to proprietary technology developed under various U.S. government contracts and grants.

Our patent and trade secret rights are of significant importance to us and to our future prospects. Our ability to compete effectively against other companies in our industry will depend, in part, on our ability to protect our proprietary technology and systems designs relating to our products. Although we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be successful in doing so. Further, our competitors may independently develop or patent technologies that are substantially equivalent or superior to ours. No assurance can be given as to the issuance of additional patents or, if so issued, as to their scope. Patents granted may not provide meaningful protection from competitors. Even if a competitor's products were to infringe patents owned by us, it would be costly for us to pursue our rights in an enforcement action and there can be no assurance that we would be successful in enforcing our intellectual property rights. Because we intend to enforce our patents, trademarks and copyrights and protect our trade secrets, we may be involved from time to time in litigation to determine the enforceability, scope and validity of these rights. This litigation could result in substantial costs to us and divert resources from operational goals. In addition, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country where we operate or sell our products.

We may not be able to maintain confidentiality of our proprietary knowledge.

In addition to our patent rights, we also rely on treatment of our technology as trade secrets and upon confidentiality agreements, which all of our employees are required to sign, assigning to us all patent rights and technical or other information developed by the employees during their employment with us. We also rely, in part, on contractual provisions to protect our trade secrets and proprietary knowledge. Our employees have also agreed not to disclose any trade secrets or confidential information without our prior written consent. These agreements may be breached, and we may not have adequate remedies for any breach. Our trade secrets may also be known without breach of these agreements or may be independently developed by competitors. Our inability to maintain the

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proprietary nature of our technology and information could harm our business, results of operations and financial condition by adversely affecting our ability to compete in our markets.

Others may assert that our technology infringes their intellectual property rights.

We believe that we do not infringe the proprietary rights of others and, to date, no third parties have asserted an infringement claim against us, but we may be subject to infringement claims in the future. The defense of any claims of infringement made against us by third parties could involve significant legal costs and require our management to divert time from our business operations. If we are unsuccessful in defending any claims of infringement, we may be forced to obtain licenses or to pay royalties to continue to use our technology. We may not be able to obtain any necessary licenses on commercially reasonable terms or at all. If we fail to obtain necessary licenses or other rights, or if these licenses are costly, our operating results may suffer either from reductions in revenues through our inability to serve customers or from increases in costs to license third-party technologies.

Loss of any of our key personnel, and particularly our Chief Executive Officer, could hurt our business because of their experience, contacts and technological expertise.

The loss of the services of one or more of our key employees or an inability to attract, train and retain qualified and skilled employees, specifically engineering and sales personnel, could result in the loss of customers or otherwise inhibit our ability to operate and grow our business successfully. In addition, our ability to successfully integrate acquired facilities or businesses depends, in part, on our ability to retain and motivate key management and employees hired by us in connection with these acquisitions. We have been particularly dependent upon the services of David B. Eisenhaure, our president, chief executive officer, chairman of the board and founder, as a result of his business and academic relationships, understanding of government contracts and technical expertise. The loss of Mr. Eisenhaure's services could have a material adverse effect on our business.

We expect significant competition for our products and services.

In the past, we faced limited competition in providing research services, prototype development and custom and limited quantity manufacturing. We expect competition to intensify greatly as commercial applications increase for our products under development. Many of our competitors and potential competitors are well established and have substantially greater financial, research and development, technical, manufacturing and marketing resources than we do. Some of our competitors and potential competitors are much larger than we are. If these larger competitors decide to focus on the development of distributed power and power quality products, they have the manufacturing, marketing and sales capabilities to complete research, development and commercialization of these products more quickly and effectively than we can. There can also be no assurance that current and future competitors will not develop new or enhanced technologies perceived to be superior to those sold or developed by us. There can be no assurance that we will be successful in this competitive environment.

Price increases of materials or components used by us could adversely affect the volume of our sales.

We use materials and components obtained from third-party suppliers to manufacture many of our products. If prices of materials and components that we use were to increase, we may not be able to afford them or to pass these costs on to our customers. Since some of our vendors are single sourced, our ability to consider lower priced options are limited in the short run. In addition, if we were required to raise the price of our products as a result of increases in the price of materials or components that we use, demand for our products may decrease which would reduce our sales.

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We are dependent on third-party suppliers for the supply of key components for our products.

We use third-party suppliers for components in many of our systems. From time to time, shipments can be delayed because of industry-wide or other shortages of necessary materials and components from third-party suppliers. A supplier's failure to supply components in a timely manner, or to supply components that meet our quality, quantity or cost requirements, or our inability to obtain substitute sources of these components on a timely basis or on terms acceptable to us, could impair our ability to manufacture our products. If alternative sources are identified, we may not be able to successfully integrate those components into our system without incurring additional cost and risk. In addition, to the extent the processes that our suppliers use to manufacture components are proprietary, we may be unable to obtain comparable components from alternative suppliers.

Long-term contracts are not typical in our business, and reductions, cancellations or delays in customer orders would adversely affect our operating results.

Other than certain contracts in our Applied Technology Division, we typically do not obtain long-term purchase orders or commitments from our customers. Instead, we work closely with our customers to develop accurate non-binding forecasts of the future volume and timing of orders to effectively allocate and manage our resources. Customers may cancel their orders, change production quantities from forecasted volumes or delay production for a number of reasons beyond our control. Significant or numerous cancellations, reductions or delays in orders by our customers would reduce or delay our net sales.

If we experience a period of significant growth or expansion, it could place a substantial strain on our resources.

If we are successful in obtaining rapid market penetration of our power control products, we may be required to deliver large volumes of technically complex products or components to our customers on a timely basis at reasonable costs to us. We have limited experience in ramping up our manufacturing capabilities to meet large-scale production requirements and delivering large volumes of our power control products. If we were to commit to deliver large volumes of our power control products, we cannot assure you that our efforts will be successful, that we will be able to satisfy large-scale commercial production on a timely and cost-effective basis or that such growth will not strain our operational and technical resources.

Our business could be subject to product liability claims.

Our business exposes us to potential product liability claims, which are inherent in the manufacturing, marketing and sale of our products, and we may face substantial liability for damages resulting from the faulty design or manufacture of products or improper use of products by end users. We currently maintain a low level of product liability insurance, and there can be no assurance that this insurance will provide sufficient coverage in the event of a claim. Also, we cannot predict whether we will be able to maintain such coverage on acceptable terms, if at all, or that a product liability claim would not harm our business or financial condition. In addition, negative publicity in connection with the faulty design or manufacture of our products would adversely affect our ability to market and sell our products.

We are subject to a variety of environmental laws that expose us to potential financial liability.

Our operations are regulated under a number of federal, state and foreign environmental and safety laws and regulations that govern, among other things, the discharge or release of hazardous materials into the air and water as well as the handling, storage and disposal of these materials. These laws and regulations include the Clean Air Act, the Clean Water Act, the Resource, Conservation and

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Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as well as analogous state and foreign laws. Because we use hazardous materials in our manufacturing processes, we are required to comply with these environmental laws. In addition, because we generate hazardous wastes, we, along with any other person who arranges for the disposal of our wastes, may be subject to potential financial exposure for costs associated with an investigation and any remediation of sites at which we have arranged for the disposal of hazardous wastes if those sites become contaminated and even if we fully comply with applicable environmental laws. In the event of a violation of environmental laws, we could be held jointly and severably liable for damages and for the costs of remedial actions. Environmental laws could also become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with any violation, although, to-date, we have not been cited for any improper discharge or release of hazardous materials.

Businesses and consumers might not adopt alternative distributed power solutions as a means for obtaining their electricity and power needs.

On-site distributed power generation solutions, such as fuel cell, photovoltaic and wind turbine systems, which utilize our products, provide an alternative means for obtaining electricity and are relatively new methods of obtaining electricity and other forms of power that businesses may not adopt at levels sufficient to grow this part of our business. Traditional electricity distribution is based on the regulated industry model whereby businesses and consumers obtain their electricity from a government regulated utility. For alternative methods of distributed power to succeed, businesses and consumers must adopt new purchasing practices and must be willing to rely less upon traditional means of purchasing electricity. We cannot assure you that businesses and consumers will choose to utilize this on-site distributed power market at levels sufficient to sustain our business. The development of a mass market for our products may be impacted by many factors which are out of our control, including:

•: market acceptance of fuel cell, photovoltaic and wind turbine systems that incorporate our products;
•: the cost competitiveness of these systems that incorporate our products;
•: regulatory requirements; and
•: the emergence of newer, more competitive technologies and products.

If a mass market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we will have incurred to develop these products.

The distributed power generation industry may become subject to future government regulation, which may impact our ability to market our products.

We do not believe that our products will be subject to existing federal and state regulations governing traditional electric utilities and other regulated entities. We do believe that our products will be subject to oversight and regulation at the federal, state or local level in accordance with state and local ordinances relating to building codes, safety, pipeline connections and related matters. This regulation may depend, in part, upon whether an on-site distributed power system is placed outside or inside a home. At this time, we do not know which jurisdictions, if any, will impose regulations upon our products. We also do not know the extent to which any existing or new regulations may impact our ability to sell and service our products. Once our customers' products reach the commercialization stage and they begin distributing systems to their target markets, federal, state or local government entities may seek to impose additional regulations. Any new government regulation of our products, whether at the federal, state or local level, including any regulations relating to installation and servicing of our products, may increase our costs and the price of our products and may have a negative impact on our revenue and profitability. Our quarterly operating results are subject to fluctuations, and if we fail to

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meet the expectations of securities analysts or investors, our share price may decrease significantly. Our annual and quarterly results may vary significantly depending on various factors, many of which are beyond our control.

Because our operating expenses are based on anticipated revenue levels, our sales cycle for development work is relatively long and a high percentage of our expenses are fixed for the short term, a small variation in the timing of recognition of revenue can cause significant variations in operating results from quarter to quarter. If our earnings do not meet the expectations of securities analysts or investors, the price of our stock could decline.

Existing stockholders can exert considerable control over us.

As of April 30, 2004, our executive officers and directors, and their affiliates, beneficially owned approximately 3,948,804 of our outstanding shares of common stock, representing approximately 13.6% of our outstanding common stock, a majority of which was beneficially owned by Mr. Eisenhaure, our president, chief executive officer, chairman of the board and founder. Specifically, as of such date, Mr. Eisenhaure beneficially owned 3,134,262 shares of our common stock, representing 11.0% of our outstanding common stock. If all of these stockholders were to vote together as a group, they would have the ability to exert significant influence over our board of directors and its policies. As a practical matter, Mr. Eisenhaure has significant influence over the election of our directors and determining the outcome of corporate actions requiring stockholder approval, including votes concerning director elections, bylaw amendments and possible mergers, corporate control contests and other significant corporate transactions, irrespective of how some of our other stockholders may vote. Accordingly, such concentration of ownership may have the effect of delaying, deterring or preventing a change in control, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could have an adverse effect on the market price of our common stock.

Provisions in our charter documents and Delaware law may delay, deter or prevent the acquisition of SatCon, which could decrease the value of your shares.

Some provisions of our certificate of incorporation and bylaws may delay, deter or prevent a change in control of SatCon or a change in our management that you as a stockholder may consider favorable. These provisions include:

•: authorizing the issuance of "blank check" preferred stock that could be issued by our board of directors to increase the number of outstanding shares and deter a takeover attempt;
•: a classified board of directors with staggered, three-year terms, which may lengthen the time required to gain control of our board of directors;
•: prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; and
•: limitations on who may call special meetings of stockholders.

In addition, Section 203 of the Delaware General Corporation Law and provisions in some of our stock incentive plans may delay, deter or prevent a change in control of SatCon. Those provisions serve to limit the circumstances in which a premium may be paid for our common stock in proposed transactions, or where a proxy contest for control of our board may be initiated. If a change of control or change in management is delayed, deterred or prevented, the market price of our common stock could suffer.

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We are subject to stringent export laws and risks inherent in international operations.

We market and sell our products and services both inside and outside the United States. We are currently selling our products and services throughout North America and in certain countries in South America, Asia, Canada and Europe. Certain of our products are subject to the International Traffic in Arms Regulations (ITAR) 22 U.S.C 2778, which restricts the export of information and material that may be used for military or intelligence applications by a foreign person. Additionally, certain products of ours are subject to export regulations administered by the Department of Commerce, Bureau of Industry Security, which require that we obtain an export license before we can export products or technology. Failure to comply with these laws could result in sanctions by the government, including substantial monetary penalties, denial of export privileges and debarment from government contracts.

Revenue from sales to our international customers for our fiscal years ended September 30, 2003 and 2002 were $3.3 million and $7.2 million, respectively. Our success depends, in part, on our ability to expand our market for our products and services to foreign customers and our ability to manufacture products that meet foreign regulatory and commercial requirements. We have limited experience developing and manufacturing our products to comply with the commercial and legal requirements of international markets. We face numerous challenges in penetrating international markets, including unforeseen changes in regulatory requirements, export restrictions, fluctuations in currency exchange rates, longer accounts receivable cycles, difficulties in managing international operations, and the challenges of complying with a wide variety of foreign laws.

You are unlikely to be able to exercise effective remedies against Arthur Andersen LLP, our former independent public accountants.

Although we have dismissed Arthur Andersen LLP as our independent public accountants and have engaged Grant Thornton LLP, our financial statements for the fiscal year ended September 30, 2001 were audited by Arthur Andersen. On March 14, 2002, Arthur Andersen was indicted on federal obstruction of justice charges arising from the government's investigation of Enron Corporation. On June 15, 2002, a jury in Houston, Texas found Arthur Andersen guilty of these federal obstruction of justice charges. In light of the jury verdict and the underlying events, Arthur Andersen subsequently substantially discontinued operations and dismissed essentially its entire workforce. You are therefore unlikely to be able to exercise effective remedies or collect judgments against Arthur Andersen. In addition, Arthur Andersen has not consented to the inclusion of its report in this prospectus, and the requirement to file its consent has been dispensed with in reliance on Rule 437a promulgated under the Securities Act of 1933. Because Arthur Andersen has not consented to the inclusion of its report in this prospectus, you will not be able to recover against Arthur Andersen under Section 11 of the Securities Act for any untrue statement of a material fact contained in the financial statements audited by Arthur Andersen or any omissions to state a material fact required to be stated in those financial statements.

We are exposed to credit risks with respect to some of our customers.

To the extent our customers do not advance us sufficient funds to finance our expenses during the execution phase of our contracts, we are exposed to the risk that they will be unable to accept delivery or that they will be unable to make payment at the time of delivery. Occasionally, we accept the risk of dealing with thinly financed entities. We attempt to mitigate this risk by seeking to negotiate more timely progress payments and utilizing other risk management procedures.

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Our agreement with Silicon Valley Bank subjects us to various restrictions, which may limit our ability to pursue business opportunities.

Our accounts receivable financing agreement subjects us to various restrictions on our ability to engage in certain activities without the prior written consent of the bank, including, among other things, our ability to:

•: dispose of or encumber assets, other than in the ordinary course of business;
•: incur additional indebtedness;
•: merge or consolidate with other entities, or acquire other businesses; and
•: make investments.

These restrictions may also limit our ability to pursue business opportunities or strategies that we would otherwise consider to be in our best interests.

Our agreement with Silicon Valley Bank contains certain covenants that we may fail to satisfy which, if not satisfied, could result in the acceleration of the amounts due under such agreement and the limitation of our ability to borrow additional funds in the future.

As of April 30, 2004, we had no borrowings under our financing agreement with Silicon Valley Bank. This agreement subjects us to various financial and other covenants with which we must comply on an ongoing or periodic basis. The financial covenant requires us to maintain a minimum level of tangible net worth, as defined, which varies from month to month. If we violate this or any other covenant, there may be a material adverse effect on us. Most notably, our outstanding debt under this agreement could become immediately due and payable, the bank could proceed against any collateral securing such indebtedness and our ability to borrow additional funds in the future may be limited.

The holders of our Series B Preferred Stock are entitled to receive liquidation payments in preference to the holders of our common stock.

As of April 30, 2004, 425 shares of our Series B Preferred Stock were outstanding. Pursuant to the terms of the certificate of designation creating the Series B Preferred Stock, upon a liquidation of our company, the holders of shares of the Series B Preferred Stock are entitled to receive a liquidation payment prior to the payment of any amount with respect to the shares of our common stock. The amount of this preferential liquidation payment is $5,000 per share of Series B Preferred Stock, plus the amount of any accrued but unpaid dividends on those shares. Dividends accrue on the shares of Series B Preferred Stock at a rate of 6% per annum increasing to a rate of 8% per annum on October 1, 2005.

We have granted to certain investors rights of first refusal and exchange rights which would be triggered upon future financings.

In connection with our October 2003 financing, we granted rights of first refusal and exchange rights which would generally be triggered upon future financings we may seek to consummate. The right of first refusal allows investors to purchase future securities issued by us for a period of time following the initial closing of their financing. The exchange rights allow the investors to exchange any securities held by them into future securities that we may issue at the liquidation preference of the exchanged security. Each of these factors may adversely affect our ability to raise additional funds from third parties on terms acceptable to us, or at all.

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Effects of Inflation

We believe that inflation and changing prices over the past three years have not had a significant impact on our net revenue or on our income from continuing operations.

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, Accounting for Stock Based Compensation—Transition and Disclosure, an amendment to FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Finally, SFAS No. 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial reporting. For entities that voluntarily change to the fair value based method of accounting for stock-based employee compensation, the transition provisions are effective for fiscal years ending after December 15, 2002. For all other companies, the disclosure provisions and the amendment to APB No. 28 are effective for interim periods beginning after December 15, 2002. We adopted the disclosure provisions of SFAS No. 148 and it did not have a material effect on our financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, to provide clarification on the meaning of an underlying, the characteristics of a derivative that contains financing components and the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. SFAS No. 149 will be applied prospectively and is effective for contracts entered into or modified after June 30, 2003. This statement is applicable to existing contracts and new contracts entered into after June 30, 2003 if those contracts relate to forward purchases or sales of when-issued securities or other securities that do not yet exist. The adoption of SFAS No. 149 did not have a material effect on our results of operations or financial condition.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the SFAS No. 150 and still existing at the beginning of the interim period of adoption. The adoption of SFAS No. 150 did not have a material effect on our results of operations or financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion about our market risks disclosures involves forward-looking statements. Actual results could differ materially from those discussed in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

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Interest Rate Risk

We are exposed to market risk from changes in interest rates primarily through our financing activities. Interest on outstanding balances on the Amended Loan accrues at a rate equal to the Bank's prime rate of interest plus 1.5% per annum. The interest rate increases to the Bank's prime rate plus 3.0% per annum if we fail to meet certain financial ratios. Our ability to carry out our business plan or our ability to finance future working capital requirements may be impacted if the cost of carrying debt fluctuates to the point where it becomes a burden on our resources.

Foreign Currency Risk

Nearly all of our sales outside the United States are priced in US dollars. If the US Dollar strengthens versus local currencies, it may result in our products becoming more expensive in foreign markets. In addition, approximately 15-20% of our costs are incurred in foreign currencies, especially the Canadian dollar. If the US Dollar weakens versus these local currencies, it may result in an increase in our cost structure.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of March 27, 2004, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

(b) Changes in Internal Control Over Financial Reporting.

There was no change in our internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings:

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

In July 2003, Donald R. Gililland, Sharon Gililland, Vernon Dunham and Jean Dunham, owners of the real property commonly known as 4890 E. La Palma Avenue, Anaheim, CA 92870 (collectively the "Owners"), filed a complaint against the Company for breach of lease with the Orange County Superior Court. The complaint alleges, among other things, failure of the Company to maintain/repair premises. The Owners allege that the cost of correction and repair of the various breaches by the Company of its obligations under the Lease will exceed the sum of $400,000. We do not believe that this complaint has substantial merit and intend to vigorously defend against it.

On or about January 23, 2004, we received a communication from Maltmans, a Canadian insurance adjuster for Falconbridge Dominicana, C.Por.A. (Falcondo), providing notice of a claim against us for costs and damages resulting from a fire at Falcondo's facility in the Dominican Republic. We are a subcontractor on an installation at Falcondo's facility in the Dominican Republic. Similar demands were sent by Maltmans to other contractors and suppliers of the project. Maltmans claims that preliminary estimates of losses are in excess of $10 million. Maltmans provided no basis for the estimated loss or any substantiation of the purported claim against us. We do not believe that there is any causal relationship between the products and services we provided at the facility and the fire that occurred. We have provided notice to our insurance company and are coordinating the gathering of information regarding the fire with the general contractor and our insurance representatives. We do not believe that this matter will materially adversely affect our results of operations or financial condition or net cash flows.

We are not aware of any other current or pending litigation to which we are or may be a party that we believe could materially adversely affect our results of operations or financial condition or net cash flows.

Item 2. Changes in Securities and Use of Proceeds:

On December 30, 2003, we issued to Aurelius Consulting Group, Inc. ("Aurelius), pursuant to a marketing agreement, 45,000 shares of our Common Stock as part of the compensation for the services to be provided by Aurelius under the agreement. This Common Stock was issued in reliance upon the exemptions from registration under Section 4(2) of the Securities Act of 1933 or Regulation D promulgated thereunder, relative to sales by an issuer not involving any public offering.

During the second quarter of fiscal year 2004, we issued 2,080,000 shares of our Common Stock upon conversion of our Series B Preferred Stock. These shares were issued pursuant to an exemption afforded by Section 3(a)(9) of the Securities Act of 1933.

During the second quarter of fiscal year 2004, we issued 507,902 shares of our Common Stock upon exercise of warrants. Shares were purchased at exercise prices ranging from $0.72 to $1.75 per share. The weighted average exercise price for the shares issued under these warrants was $0.68 per share. These shares were issued in reliance upon the exemptions from registration under Section 4(2) of the Securities Act of 1933 or Regulation D promulgated thereunder, relative to sales by an issuer not involving any public offering.

Item 3. Defaults Upon Senior Securities:

Not applicable.

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Item 4. Submission of Matters to a Vote of Security Holders:

PROPOSAL				FOR		AGAINST/ WITHHELD		ABSTAIN
(1)		To elect the following Class I Directors:
		David B. Eisenhaure		23,291,757		151,498		—
		Alan P. Goldberg		23,290,882		152,373		—
		James L. Kirtley, Jr.		23,291,791		151,464		—
The other directors of the Company, whose terms of office as directors continued after the Annual Meeting, are Marshall J. Armstrong, Michael C. Turmelle, Anthony J. Villiotti and Gerald L. Wilson.
(2)		To ratify the selection of Grant Thornton LLP as independent auditors for the fiscal year ending September 30, 2004		23,200,254		148,456		94,545

Item 5. Other Information:

Not applicable.

Item 6. Exhibits and Reports on Form 8-K:

(a): Exhibits

The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Quarterly Report on Form 10-Q.

(b): Reports on Form 8-K

On December 30, 2003, we furnished a Current Report on Form 8-K, dated December 23, 2003, to report under Item 12 that we issued a press release announcing our financial results for our fourth quarter and fiscal year ended September 30, 2003.

On December 31, 2003, we furnished a Current Report on Form 8-K, dated December 30, 2003, to report under Item 12 that we issued a press release announcing, among other things, $2.2 million in new contracts and improved first quarter 2004 cash usage.

On February 13, 2004, we furnished a Current Report on Form 8-K, dated February 10, 2004, to report under Item 12 that we issued a press release announcing our financial results for our first quarter ended December 27, 2003.

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SIGNATURE

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

		SATCON TECHNOLOGY CORPORATION
Date: May 11, 2004		By:		/s/ RALPH M. NORWOOD Ralph M. Norwood Vice President and Chief Financial Officer

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EXHIBIT INDEX

Exhibit Number		Exhibit
31.1		Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SATCON TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS
SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY For the six months ended March 29, 2003 (Unaudited)
SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY For the six months ended March 27, 2004 (Unaudited)
SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
SATCON TECHNOLOGY CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS MARCH 27, 2004 AND MARCH 29, 2003 (Unaudited)

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits and Reports on Form 8-K

SIGNATURE
EXHIBIT INDEX