SATCON TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS

	January 1, 2005			September 30, 2004
	(Unaudited)			(Audited)
ASSETS
Current assets:
Cash and cash equivalents	$	7,067,496		$	1,171,152
Restricted cash and cash equivalents	1,011,900			1,011,900
Accounts receivable, net of allowance of $821,744 and $848,565 at January 1, 2005 and September 30, 2004, respectively	5,033,309			6,274,178
Unbilled contract costs and fees	486,469			447,405
Funded research and development expenses in excess of billings	399,575			292,111
Inventory	6,393,376			6,184,672
Prepaid expenses and other current assets	1,049,108			687,083

Total current assets	21,441,233			16,068,501
Warrants to purchase common stock	28,975			7,036
Property and equipment, net	5,687,826			5,913,211
Goodwill, net	704,362			704,362

Intangibles, net	2,260,028			2,391,193
Other long-term assets	536,704			501,634

Total assets	$	30,659,128		$	25,585,937

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	154,936		$	184,177
Accounts payable	3,980,652			3,823,249
Accrued payroll and payroll related expenses	1,509,717			1,449,349
Other accrued expenses	2,478,445			2,412,409
Accrued contract losses	247,444			514,489
Deferred revenue	1,027,400			2,048,442
Accrued restructuring costs	240,000			495,612

Total current liabilities	9,638,594			10,927,727
Redeemable convertible Series B preferred stock (425 shares issued and outstanding; face value: $5,000 per share; liquidation preference: 100%)	2,125,000			2,125,000
Long-term debt, net of current portion	294,342			311,178
Other long-term liabilities	516,070			563,372
Commitments and contingencies
Stockholders’ equity:
Common stock; $0.01 par value, 50,000,000 shares authorized; 33,182,694 and 28,226,010 shares issued and outstanding at January 1, 2005 and September 30, 2004, respectively	331,828			282,261
Additional paid-in capital	146,972,424			139,208,000
Accumulated deficit	(129,092,433		)	(127,659,993		)
Accumulated other comprehensive loss	(126,697		)	(171,608		)

Total stockholders’ equity	18,085,122			11,658,660
Total liabilities and stockholders’ equity	$	30,659,128		$	25,585,937

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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended
	January 1, 2005			December 27, 2003
Revenue:
Product revenue	$	8,270,224		$	6,208,546
Funded research and development and other revenue	912,865			1,978,602

Total revenue	9,183,089			8,187,148

Operating costs and expenses:
Cost of product revenue	7,221,362			5,198,152

Research and development and other revenue expenses:
Funded research and development and other revenue expenses	747,400			1,378,782
Unfunded research and development expenses	42,653			985

Total research and development and other revenue expenses	790,053			1,379,767
Selling, general and administrative expenses	2,522,080			2,241,483

Amortization of intangibles	111,671			111,672

Restructuring costs	(255,612		)	—

Total operating costs and expenses	10,389,554			8,931,074

Operating loss	(1,206,465		)	(743,926		)
Net unrealized gain on warrants to purchase common stock	21,939			42,782
Net gain on Series B warrants	—			35,442
Other expense	(18,056		)	—

Interest income	1,818			2,410
Interest expense	(231,676		)	(258,367		)

Net loss	$	(1,432,440	)	$	(921,659	)
Net loss per weighted average share, basic and diluted	$	(0.05	)	$	(0.04	)

Weighted average number of common shares, basic and diluted	29,114,757			24,274,611

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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended December 27, 2003
(Unaudited)

	Common Shares	Common Stock		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income (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	—	—		—			(921,659		)	—			(921,659		)	$	(921,659	)
Issuance of common stock to 401(k) Plan	48,804	488		138,115			—			—			138,603			—
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	1,826,176	18,262		1,527,350			—			—			1,545,612			—
Issuance of common stock in connection with cashless exercise of warrants to purchase common stock	76,520	765		(765		)	—			—			—			—
Issuance of common stock in connection with the exercise of stock options to purchase common stock	17,000	170		10,540			—			—			10,710			—
Issuance of common stock in connection with the conversion of 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 subordinated debentures	666,000	6,660		825,840			—			—			832,500			—
Issuance of common stock in lieu of first year interest on subordinated debentures	8,298	83		23,981			—			—			24,064			—
Issuance of common stock in lieu of first six - months dividend on Series B convertible preferred stock	76,054	761		229,454			—			—			230,215			—
Issuance of common stock to Auerelius Consulting Group	45,000	450		101,700			—			—			102,150			—
Issuance of warrants to purchase common stock	—	—		32,087			—			—			32,087			—
Mark-to-market Series B warrants	—	—		(35,442		)	—			—			(35,442		)	—
Foreign currency translation adjustment	—	—		—			—			(20,151		)	(20,151		)	(20,151		)

Comprehensive loss																$	(941,810	)

Balance, December 27, 2003	25,142,052	$	251,421	$	127,291,131		$	(117,623,182	)	$	(159,505	)	$	9,759,865

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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended January 1, 2005
(Unaudited)

	Common Shares	Common Stock		Additional Paid-in Capital		Accumulated Deficit			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity			Comprehensive Loss

Balance, September 30, 2004 (Audited)	28,226,010	$	282,261	$	139,208,000	$	(127,659,993	)	$	(171,608	)	$	11,658,660

Net loss						$	(1,432,440	)	—			$	(1,432,440	)	$	(1,432,440	)

Issuance of common stock to 401(k) Plan	78,700	787		147,955		—			—			148,742			—
Issuance of common stock in connection with the exercise of stock options to purchase common stock	4,000	40		2,480		—			—			2,520			—
Issuance of common stock in lieu of six -months dividend on redeemable convertible Series B preferred stock	25,500	255		63,495		—			—			63,750			—

Issuance of warrants to Common stockholders, related to December Financing Transaction	—	—		1,602,954		—			—			1,602,954			—

Issuance of common stock in connection with the December Financing Transaction	4,848,484	48,485		5,778,561		—			—			5,827,046			—

Adjustment to conversion price related to re-pricing of Convertible Series B Preferred Stock	—	—		126,059		—			—			126,059			—

Adjustment in conversion price of Series B Warrants	—	—		42,920		—			—			42,920			—

Foreign currency translation adjustment	—	—		—		—			44,911			44,911			44,911

Comprehensive loss	—	—		—		—			—			—			$	(1,387,529	)

Balance, January 1, 2005	33,182,694	$	331,828	$	146,972,424	$	(129,092,433	)	$	(126,697	)	$	18,085,122

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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended
	January 1, 2005			December 27, 2003

Cash flows from operating activities:
Net loss	$	(1,432,440	)	$	(921,659	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	482,166			512,908
Provision for uncollectible accounts	20,889			16,299
Net unrealized gain on warrants to purchase common stock	(21,939		)	(42,782		)
Net unrealized loss on Series B warrants	—			(35,442		)
Non-cash compensation expense	148,742			240,753
Non-cash interest expense	182,865			186,502
Changes in operating assets and liabilities:
Accounts receivable	1,219,980			173,680
Unbilled contract costs and fees	(39,064		)	(139,347		)
Prepaid expenses and other current assets	(469,489		)	(182,007		)
Inventory	(208,704		)	1,595,262
Other long-term assets	(35,070		)	—
Accounts payable	157,403			(1,322,454		)
Accrued payroll and payroll related expenses, other expenses, accrued contract losses and restructuring costs	(343,128		)	52,479
Deferred revenue	(1,021,042		)	(1,276,322		)
Other liabilities	(50,563		)	(1,405,244		)

Total adjustments	23,046			(1,625,715		)

Net cash used in operating activities	(1,409,394		)	(2,547,374		)

Cash flows from investing activities:
Purchases of property and equipment	(125,616		)	(24,310		)

Net cash used in investing activities	(125,616		)	(24,310		)

Cash flows from financing activities:
Net repayments under bank line of credit	—			(1,801,869		)
Repayment of long-term debt	(46,077		)	(69,735		)
Net Proceeds from issuance of Common Stock and Warrants	7,430,000			—
Proceeds from issuance of convertible subordinated debentures	—			70,000
Net proceeds from issuance of convertible preferred stock	—			6,974,855
Net proceeds from exercise of warrants and options to purchase common stock	2,520			1,556,602

Net cash provided by financing activities	7,386,443			6,729,853

Effect of foreign currency exchange rates on cash and cash equivalents	44,911			(20,151		)

Net increase in cash and cash equivalents	5,896,344			4,138,018
Cash and cash equivalents at beginning of period, including restricted cash and cash equivalents	2,183,052			1,235,191

Cash and cash equivalents at end of period, including restricted cash and cash equivalents	$	8,079,396		$	5,373,209

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Non-Cash Investing and Financing Activities:
Valuation adjustment for warrants to purchase common stock	$	—		$	42,782
Valuation adjustment for Series B preferred stock and warrants	$	168,979		$	35,422
Common stock issued in lieu of dividend on redeemable convertible Series B Preferred Stock	$	63,750		$	254,279
Common stock issued related to 401(K) contributions	$	148,742		$	138,603
Interest and Income Taxes Paid:
Interest	$	28,811		$	71,865
Income Taxes	$	—		$	—

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

SATCON TECHNOLOGY CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 1, 2005 AND DECEMBER 27, 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 January 1, 2005 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 inter-company 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, 2004. Operating results for the three months ended January 1, 2005 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 ten years. As of January 1, 2005, it had an accumulated deficit of $129,092,433 since inception. During the three months ended January 1, 2005, the Company incurred a loss from operations of $1,206,465 and used cash in operations of $1,409,394. The Company’s restricted cash balances at January 1, 2005 and September 30, 2004 were $1,011,900.

In addition, the Company envisions successfully completing its fixed-price contract with the EDO Corporation. Initially this contract was for $1.1 million which during 2004 was increased to $1.5 million. Through January 1, 2005, the Company has incurred approximately $2.7 million of costs and has projected a total cost of approximately $3.0 million before satisfying the requirements of this contract. As of January 1, 2005 the total $3.0 million has been fully accrued and reflected in the Company’s results of operations for the period ended January 1, 2005. Due to the technical challenges associated with this contract it is possible that the Company will overrun its latest forecast before successfully completing the contract as it has done in the past (the Company accrued $0.6 million in contract losses associated with this contract in fiscal year 2003 and had incurred an additional $0.9 million in fiscal 2004 related to the EDO contract.). If, however, the Company is unable to complete this contract as envisioned it may continue to incur losses putting a strain on cash flow and exposing the Company to potential contractual remedies, as defined. If this were to occur it could result in non-compliance with the New Loan covenants, as defined, and the Company may be forced to raise additional funds by selling stock or taking other actions to conserve its cash position.

In view of the matters described in the preceding paragraphs, 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 asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

On December 22, 2004, the Company completed an equity transaction for $7.4 million (net of transaction costs) involving the issuance of 4,848,484 shares of Common Stock and warrants to purchase up to 2,181,181 shares of Common Stock, to several unrelated institutional investors (the “December 2004 Financing Transaction”). The warrants are

exercisable for a five-year term and have an exercise price of $2.00 per share. The Company valued these warrants at $1,602,954, using the Black-Scholes option pricing model, with the following assumptions: an expected life of five years, expected volatility of 73.4%, no dividends, and risk-free interest rate of 4%.

As a result of the December 2004 Financing Transaction, in accordance with the anti-dilution provisions of the Company’s Series B Convertible Preferred Stock, the Company was required to adjust the conversion price of the remaining 425 shares of Series B Preferred Stock outstanding at that time. These shares of Series B Preferred Stock have a liquidation preference of $5,000 per share and 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, as a result of the December 2004 Financing Transaction, has been adjusted from $2.50 per share to $2.36 per share. At January 1, 2005, 425 shares of the Series B Preferred Stock remained un-converted into shares of Common Stock. As of January 1, 2005, the liquidation preference of the remaining 425 shares of Series B Preferred Stock was $2,125,000, and these are convertible into 900,424 shares of Common Stock. The Series B Preferred Stock accrues dividends of 6% per annum, increasing to 8% per annum on October 1, 2005.

In addition, in accordance with the anti-dilution provisions of the warrants issued in connection with the sale of the Series B Preferred Stock (the “Series B Warrants”), the Company was also required to adjust the exercise price of the Series B Warrants. The Series B Warrants are exercisable for up to 1,228,000 shares of Common Stock, are exercisable for a five-year term and had an initial exercise price of $3.32 per share. As a result of the December 2004 Financing Transaction, the exercise price on these warrants was adjusted to $3.06 per share. The Company re-valued these warrants using the Black-Scholes option pricing model, with the following assumptions: an expected life of four years, expected volatility of 73.4%, no dividends, and risk-free interest rate of 4%, resulting in an additional adjustment of $42,920, which was recorded as interest expense for the period ended January 1, 2005.

As a result of the December 2004 Financing Transaction the Company recorded the following non-cash charges as interest expense in its Statement of Operations for the Period ended January 1, 2005:

Security	Conversion/Exercise Price		Adjusted Conversion/Exercise Price		Interest Expense
Redeemable convertible Series B Preferred Stock	$	2.50	$	2.36	$	126,059
Warrants to purchase Common Stock	$	3.32	$	3.06	$	42,920
Total					168,979

Burnham Hill Partners, LLC, a division of Pali Capital, Inc. (“BHP”), acted as the Company’s financial advisor in connection with the December 2004 Financing Transaction. The Company agreed to pay BHP a fee equal to 6% of the gross proceeds received by the Company in connection with the financing. Based on the amount of the financing, this fee was approximately $480,000, which was paid from gross proceeds received by the Company.

On December 12, 2003, the Company amended its agreement with Silicon Valley Bank (the “Bank”). Under the amended agreement, the Bank agreed to provide the Company with a line of credit of up to $6,250,000 (the “Amended Loan”). The Amended Loan was to mature 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 was immediately exercisable and expires on December 11, 2010. The Company had valued this warrant at $32,087, using the Black-Scholes option-pricing model and has treated this as a deferred financing cost and has amortized this value on a straight line basis through December 9, 2004. On December 3, 2004 the maturity of the Amended Loan was extended through December 31, 2004, and on December 21, 2004, the maturity of the Amended Loan was again extended to March 1, 2005. On December 23, 2004, using the proceeds from the December 2004 Financing Transaction, the Company paid off all amounts outstanding on the Amended Loan. As of January 1, 2005, there were no amounts outstanding on the Amended Loan.

Effective January 31, 2005, the Company entered into a new loan agreement with the Bank (the “New Loan”), which replaced the Amended Loan. Under the terms of the New Loan, the Bank will provide the Company with a credit line of up to $7.0 million. The New Loan is secured by most of the assets of the Company and advances under the New Loan are limited to 80% of eligible receivables and up to $1.0 million based on the levels of eligible inventory. Interest

on outstanding borrowings accrues at the Bank’s prime rate of interest plus 2% per annum. In addition, the Company will pay to the Bank a collateral handling fee of $1,000 per month and has agreed to the following additional fees: (i) $25,000 commitment fee; (ii) an unused line fee in the amount of 0.5% per annum; and (iii) an early termination fee of 0.5% of the total credit line if the Company terminates the New Loan within the first six months. The New Loan contains certain financial covenants relating to tangible net worth, as defined, which the Company must satisfy in order to continue to borrow from the Bank. The New Loan will expire on January 30, 2006.

The Company anticipates that its current cash, after the December 2004 Financing Transaction, together with the ability to borrow under the New Loan will be sufficient to fund its operations at least through September 30, 2005. This assumes the Company achieve its business plan and complete the above described EDO Contract with out significant further losses or other remedies. Further, this assumes that the Company will be able to remain in compliance with all New Loan covenants. If, however, the Company is unable to realize its operating plan and is unable to remain in compliance with an New Loan agreement with the Bank, the Company may be forced to raise additional funds by selling stock or taking other actions to conserve its cash position.

Note C. Significant Accounting Policies and Basis of Presentation

Basis of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

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. When appropriate the Company provides for a warranty reserve at the time the product revenue is recognized.

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 January 1, 2005 and September 30, 2004, the Company has accrued $247,440 and $514,489, respectively, for anticipated contract losses on commercial contracts.

Cost of product revenue includes materials, 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.

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.

Cash and Cash Equivalents

Cash and cash equivalents include demand deposits, overnight repurchase agreements with the Bank and highly liquid investments with maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates market value. At January 1, 2005 and September 30, 2004, the Company has restricted cash of $1,011,990. These amounts represent collateral for outstanding line of credit, letters of credit, performance on a contract with an international customer and credit card purchases. In addition, at January 1, 2005 and September 30, 2004, the Company had overnight repurchase agreements with the Bank of $7,406,540 and $880,895, respectively.

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

Inventory is stated at the lower of cost or market and costs are determined based on the first-in, first-out method of accounting and include material, labor and manufacturing overhead costs.

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the asset’s estimated useful life. The estimated useful lives of property and equipment are as follows:

		Estimated Lives
Machinery and equipment		3-10 years
Furniture and fixtures		7-10 years
Computer software		3 years
Leasehold improvements		Lesser of the remaining life of the lease or the useful life of the improvement

When assets are retired or otherwise disposed of, the cost and related depreciation and amortization are eliminated from the accounts and any resulting gain or loss is reflected in other income (loss).

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 publicly available information 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.

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 repeated, 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 as of the beginning of its fiscal fourth quarter, 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.

Foreign Currency Translation

The functional currency of the Company’s foreign subsidiary is the local currency. Assets and liabilities of foreign subsidiaries are translated at the rates in effect at the balance sheet date, while stockholders’ equity (deficit) is translated at historical rates. Statements of operations and cash flow amounts are translated at the average rate for the period. Translation adjustments are included as a component of accumulated other comprehensive loss. Foreign currency gains and losses arising from transactions are reflected in the loss from operations and were not significant during the three months ended January 1, 2005 or for the fiscal year ended September 30, 2004.

Use of Estimates

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period reported. Management believes the most significant estimates include the net realizable value of accounts receivable and inventory, the recoverability of long lived assets and intangible assets, the accrued contract losses on fixed price contracts, the recoverability of deferred tax assets and the fair value of equity and financial instruments. Actual results could differ from these estimates.

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 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 Emerging Issues Task Force (“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.

No stock based employee compensation costs are included in the determination of net loss for all periods presented.

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 months ended January 1, 2005 and December 27, 2003 would have been increased to the pro forma amounts indicated below:

	Three Months Ended
	January 1, 2005						December 27, 2003
	Net Loss			Loss per Common Share, Basic and Diluted			Net Loss			Loss per Common Share, Basic and Diluted
As Reported	$	(1,432,440	)	$	(0.05	)	$	(921,659	)	$	(0.04	)
Stock based employee compensation expense	(168,276		)	(0.01		)	(802,258		)	(0.03		)

Pro Forma	$	(1,600,716	)	$	(0.06	)	$	(1,723,917	)	$	(0.07	)

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 72.3% to 80.4%, no dividends, and risk-free interest rate of 4.0% for the three months ended January 1, 2005, and an expected life of seven years, expected volatility ranging from 117.5% to 119.3%, no dividends, and risk-free interest rate of 4.00% for the three months ended December 27, 2003.

Net Loss per Basic and Diluted Common Share

The Company reports net loss per basic and diluted common share in accordance with SFAS No. 128, Earnings Per Share, which establishes standards for computing and presenting earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.

Concentration of Credit Risk

Financial instruments that subject the Company to concentrations of credit risk principally consist of cash equivalents, trade accounts receivable and unbilled contract costs.

The Company’s trade accounts receivable and unbilled contract costs and fees are primarily from sales to U.S. government agencies and commercial customers. The Company does not require collateral and has not historically experienced significant credit losses related to receivables or unbilled contract costs and fees from individual customers or groups of customers in any particular industry or geographic area.

The Company deposits its cash and invests in short-term investments primarily through a national commercial bank.

Recent Accounting Pronouncements

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

In December 2004, the FASB issued SFAS No. 123 (Revised 2004) “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R addresses all forms of share-based payment (“SBP”) awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS No. 123R will require the Company to expense SBP awards with compensation cost for SBP transactions measured at fair value. The FASB originally stated a preference for a lattice model because it believed that a lattice model more fully captures the unique characteristics of employee stock options in the estimate of fair value, as compared to the Black-Scholes model which the Company currently uses for its footnote disclosure. The FASB decided to remove its explicit preference for a lattice model and not require a single valuation methodology. SFAS No. 123R requires the Company to adopt the new accounting provisions beginning in its fourth quarter of 2005. The Company has not yet determined the impact of applying the various provisions of SFAS No. 123R.

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
	January 1, 2005			December 27, 2003
Net loss	$	(1,432,440	)	$	(921,659	)

Basic and diluted:
Common shares outstanding, beginning of period	28,226,010			21,023,200
Weighted average common shares issued during the period	888,747			3,251,411

Weighted average shares outstanding—basic and diluted	29,114,757			24,274,611

Net loss per weighted average share, basic and diluted	$	(0.05	)	$	(0.04	)

As of January 1, 2005 and December 27, 2003, 5,809,508 and 5,491,605 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 January 1, 2005 and December 27, 2003, 900,424, as adjusted and 3,070,000 shares of common stock issuable upon the conversion of the redeemable convertible Series B Preferred Stock, respectively, were excluded from the diluted weighted average common shares outstanding as their effect would be antidilutive.

Note E. Inventory

Inventory at the end of each period were as follows:

	January 1, 2005		September 30, 2004
Raw material	$	1,696,925	$	1,369,096
Work-in-process	4,097,329		4,373,925
Finished goods	599,122		441,651

	$	6,393,376	$	6,184,672

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, $294,518, net of $255,612 in adjustments related to the 2002 accrued restructuring charge, and $592,897 for the three months ended January 1, 2005 and December 27, 2003, respectively.

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

	Three Months Ended
	January 1, 2005			December 27, 2003
Applied Technology:
Funded research and development and other revenue	$	912,865		$	1,978,602

Loss from operations, including amortization of intangibles of $80,421 and $80,422 for the three months ended January 1, 2005 and December 27, 2003, respectively	$	(767,919	)	$	(608,751	)

Power Systems:
Product revenue	$	6,030,580		$	4,167,969

Loss from operations for the three months ended January 1, 2005 and December 27, 2003, respectively	$	(296,048	)	$	(41,873	)

Electronics:
Product revenue	$	2,239,644		$	2,040,577

Loss from operations, including amortization of intangibles of $31,250 for the three months ended January 1, 2005 and December 27, 2003, respectively	$	(142,498	)	$	(93,302	)

Consolidated:
Product revenue	$	8,270,224		$	6,208,546
Funded research and development and other revenue	$	912,865		1,978,602

Total revenue	$	9,183,089		$	8,187,148

Operating loss	$	(1,206,465	)	$	(743,926	)
Net unrealized gain/(loss) on warrants to purchase common stock	21,939			42,782
Net unrealized gain on Series B warrants	—			35,442
Other income	(18,056		)	—
Interest income	1,818			2,410
Interest expense	(231,676		)	(258,367		)

Net loss	$	(1,432,440	)	$	(921,659	)

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 $8,931,676 and $2,924,667 at January 1, 2005 and September 30, 2004, respectively. The following is a summary of the Company’s assets by operating segment:

	January 1, 2005		September 30, 2004
Applied Technology:
Segment assets	$	13,340,288	$	7,477,961
Power Systems:
Segment assets	11,015,682		11,284,272
Electronics:
Segment assets	6,274,183		6,816,668
Consolidated:
Segment assets	30,630,153		$	25,578,901
Warrants to purchase common stock	28,975		7,036

Total assets	$	30,659,128	$	25,585,937

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

	Three Months Ended
	January 1, 2005		December 27, 2003
Revenue by geographic region based on location of customer:
United States	$	7,058,049	$	6,622,908
Rest of world	2,125,040		1,564,240

Total revenue	$	9,183,089	$	8,187,148

	January 1,		September 30,
	2005		2004
Long-lived assets (including goodwill and intangible assets) by geographic region based on location of operations:
United States	$	8,588,802	$	8,941,166
Rest of world	63,414		67,600

Total long-lived assets (including goodwill and intangible assets)	$	8,652,216	$	9,008,766

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”), filed a complaint with the Orange County Superior Court against the Company and co-defendant, Mechanical Technologies, Inc. (“MTI”) for breach of lease relating to the former headquarters of Ling Electronics in Anaheim, CA. The Company acquired Ling Electronics from MTI in 1999. The complaint alleged, among other things, failure of the Company and MTI to maintain/repair premises. The Owners alleged that the cost of correction and repair of the various breaches by the Company of its obligations under the Lease would exceed the sum of $400,000. On January 27, 2005, the Company reached agreement to settle this outstanding claim. The claim was settled for $240,000 and released the Company from any future obligations. The settlement amount is within the accrual established by the Company for this matter. (See Note I. Restructuring costs)

In October 2003, the Company was served with a Complaint by a former employee seeking, among other claims, severance and bonus compensation. In July of 2004, the employee filed an amended complaint in which two additional former employees joined the action seeking similar damages. The plaintiffs are seeking damages under multiple theories and claims in excess of $750,000.The Company has denied the allegations contained in the complaint and believes the claims are entirely without merit. It has and will continue to defend vigorously against the action.

On or about August 31, 2004, the Company was informed that Bristol Investment Group, Inc. had filed a Demand for Arbitration with the American Arbitration Association claiming that it was owed money and warrants under a September 2002 agreement whereby Bristol was to have arranged for a private placement financing transaction. The total amount at issue is approximately $240,000. The Company believes the demand is without merit and has counterclaimed against Bristol seeking repayment of monies already paid and unspecified damages for Bristol’s breach of the agreement. The Company does not believe that the matter will materially adversely affect the Company’s results of operations or financial condition.

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

Note H. Commitments and Contingencies

Letters of Credit

The Company utilizes a standby letter of credit to satisfy a security deposit requirement. This letter of credit is irrevocable and expires on July 15, 2005. In addition, the Company utilizes standby letters of credit to satisfy warranty commitments. These letters of credit are irrevocable and expire on February 15, 2005 and June 25, 2005. Outstanding standby letters of credit as of January 1, 2005 and September 30, 2004 were $961,900. The Company is required to pledge cash as collateral on these outstanding letters of credit. As of January 1, 2005 and September 30, 2004, the cash pledged as collateral for these letters of credit was $961,900, and is included in restricted cash and cash equivalents on the balance sheet.

Purchase Commitments:

In the ordinary course of business the Company enters into agreements with vendors for the purchase of goods and services through the issuance of purchase orders. In general the majority of these purchases do not represent commitments of the Company until the goods or services are received. In the third quarter of fiscal 2003 the Company provided for approximately $900,000 related to outstanding purchase commitments that were related to its Shaker and UPS product lines. At January 1, 2005 and September 30, 2004 the balance outstanding on these purchase commitments was $390,330. These amounts are included in other accrued expenses in the Company’s consolidated balance sheet.

Employment Agreements:

The Company has employment agreements with certain employees that provide severance payments and accelerated vesting of options upon termination of employment under certain circumstances or a change of control, as defined. As of January 1, 2005, the Company’s potential obligation to these employees was approximately $614,000. Subsequent to the end of the first fiscal quarter the Company severed the employment of an employee that had an employment agreement that provided for severance. The Company will record a charge of approximately $100,000 related to this severance agreement in its results of operations for the second fiscal quarter ended April 2, 2005.

Contract Losses:

In late fiscal 2002, the Company entered into a fixed price contract with EDO Corporation (“EDO”) for the design and development of a power converter for a new mine sweeping system for the U.S. Navy. The fixed price contract, which initially totaled $1.1 million, involved milestones and progress payments and called for the delivery of four prototype power units. These new power units require substantial engineering to meet the space, thermal and performance requirements of the customer. At the end of fiscal 2003 the Company forecasted that the project would be completed during fiscal 2004 and the Company accrued $0.7 million for the then anticipated cost overrun to be incurred for the project. Subsequently the Company was successful in negotiating with the customer to increase the contract value by $0.4 million to a total of $1.5 million which was not recorded at that time due to technological uncertainties that existed at that time.

In the third and fourth quarters of fiscal 2004 and through the first quarter of fiscal 2005, the Company encountered unanticipated problems related to performance requirements. At the end of the third quarter the Company had completed the technical design and was working on integration and testing. Currently, the Company estimates that it will incur costs of approximately $3.0 million to complete the project. Accordingly, the Company had recorded an additional charge in the third and fourth fiscal quarters of 2004 totaling $0.8 million. During the first quarter of fiscal 2005 there were no changes to the Company’s estimate and no additional charges were recorded related to these contracts.

Although the Company believes that it will complete this contract to the satisfaction of the customer, it is possible that the Company will not be successful. If this were to occur, the customer would have remedies, as defined in the contract, and the Company may be liable for those costs. The Company considers this unlikely and is unable to estimate any possible cost exposure at this time.

Note I. RESTRUCTURING COSTS

As of September 30, 2004, the Company had $495,612 accrued related to a restructuring cost, which was established in April 2002. On January 27, 2005, the Company reached a settlement with the landlord of the Anaheim facility in the amount of $240,000 as final settlement for all claims. In addition, the Company has determined that all remaining restructuring liabilities accrued are no longer warranted and that all matters related to the restructuring charge have been settled, therefore the Company has adjusted all remaining balances related to severance costs, facilities cost and equipment costs remaining as of January 1, 2005, resulting in a reduction of accrued restructuring charges of $255,612 and reflected in the Company’s statement of operations for the first fiscal quarter ended January 1, 2005. The Company expects the remaining balance to be paid during the second quarter of fiscal 2005.

The following is a status of the Company’s accrued restructuring costs and the changes for the periods then ended:

	Balance September 30, 2004		Amounts Paid or Assets Disposed Of		Adjustments			Balance January 1, 2005
Severance costs	$	89,353	$	—	$	(89,353	)	$	—
Facility costs	306,320		—		(66,320		)	240,000
Equipment costs	99,939		—		(99,939		)	—
Accrued restructuring costs	$	495,612	$	—	$	(255,612	)	$	240,000

Note J. PRODUCT WARRANTIES

In its Power Systems Division the Company provides a warranty to its customers for most of its products sold. In general the Company’s warranties are for one year after the sale of the product, and in some limited instances two years. The Company reviews its warranty liability quarterly. Factors taken into consideration when evaluating the Company’s warranty reserve are i.) Historical claims for each product, ii.) The development stage of the product, and iii.) Other factors.

The following is a summary of the Company’s accrued warranty activity for the following periods:

	January 1, 2005			September 30, 2004
Balance at beginning of period	$	642,119		$	765,336
Provision	—			35,127
Usage	(28,471		)	(158,344		)
Balance at end of period	$	613,648		$	642,119

Note K. Subsequent Events

On January 18, 2005, the Company announced that Dr. Millard S. Firebaugh had agreed to become the Company’s new President and Chief Operating Officer. Dr. Firebaugh is expected to begin serving in these roles in late February 2005.

On January 27, 2005, the Company settled the outstanding claim brought against it by Donald R. Gililland, Sharon Gililland, Vernon Dunham and Jean Dunham, related to a facility lease. The claim was settled for $240,000 and released the Company from any future obligations. The Company had accrued costs to settle this claim (See Note I. Restructuring Costs). The settlement of this claim is accounted for in the results of operations for the quarter ended January 1, 2005, and will be paid in the Company’s second fiscal quarter.

On January 28, 2005, Dr. Gerald Wilson resigned as a director of the Company. This information was furnished to the Securities and Exchange Commission on a Current Report on Form 8-K, as amended, dated January 28, 2005.

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

Forward-Looking Statement

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 December 22, 2004, we sold 4,848,484 shares of common stock under our universal shelf registration statement directly to several unrelated institutional investors for proceeds of $7,430,000, net of transaction costs. As part of the December 22, 2004 financing we also issued warrants to purchase up to 2,181,818 shares of common stock. These warrants have an exercise price of $2.00 per share. These warrants are immediately exercisable and expire on December 21, 2009. We have valued these warrants at $1,602,954, using the Black-Scholes option pricing model. A portion of the proceeds was used to pay off amounts outstanding on our line of credit.

On December 21, 2004, we amended our existing $6.2 million credit line agreement with Silicon Valley Bank (the “Bank”) through March 1, 2005. During the first quarter of fiscal 2005, we had peak borrowings of $1.7 million on our line of credit. As of January 1, 2005, there are no amounts outstanding on the line of credit.

Effective January 31, 2005, we entered into a new loan agreement with the Bank (the “New Loan”), which replaced our amended loan with the Bank. Under the terms of the New Loan, the Bank will provide us with a credit line of up to $7.0 million. The New Loan is secured by most of the assets of the Company and advances under the New Loan are limited to 80% of eligible receivables and up to $1.0 million based on the levels of eligible inventory. Interest on outstanding borrowings accrues at the Bank’s prime rate of interest plus 2% per annum. In addition we will pay to the Bank a collateral handling fee of $1,000 per month and have agreed to the following additional fees: (i) $25,000 commitment fee; (ii) an unused line fee in the amount of 0.5% per annum; and (iii) an early termination fee of 0.5% of the total credit line if we terminate the New Loan within the first six months. The New Loan contains certain financial covenants relating to tangible net worth, as defined, which we must satisfy in order to continue to borrow from the Bank. The New Loan will expire on January 30, 2006.

On January 18, 2005, we announced that Dr. Millard S. Firebaugh had agreed to become our new President and Chief Operating Officer. Dr. Firebaugh is expected to begin serving in these roles in late February 2005.

On January 27, 2005, we settled the outstanding claim brought against it by Donald R. Gililland, Sharon Gililland, Vernon Dunham and Jean Dunham, related to a facility lease. The claim was settled for $240,000 and released us from any future obligations. We had accrued costs to settle this claim (See Note I. Restructuring Costs). The settlement of this claim is accounted for in the results of operations for the quarter ended January 1, 2005, and will be paid in the second fiscal quarter.

On January 28, 2005, Dr. Gerald Wilson resigned as a director of the Company.

On February 2, 2004, Mr. Ralph M. Norwood resigned as Vice President of Finance, Chief Financial Officer and Treasurer of the Company.

On February 3, 2005, David E. O’Neil was appointed as Vice President of Finance and Treasurer, effective March 1, 2005.

Overview (Executive Summary)

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 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 drivetrains 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 significant 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, 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. Our critical accounting estimates were discussed with our Audit Committee.

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 lapse, unless we can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. When appropriate, 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 January 1, 2005 and September 30, 2004, we have accrued approximately $0.2 and $0.9 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.

Accounts Receivable

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 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, recorded an increase to our valuation reserve and were actively considering offers for this product line. This reserve was based on our assessment of the situation as of that time. We had no orders associated with this reserved inventory and there was no sales force dedicated to the sales and marketing of these products. During the first quarter of fiscal 2004, we decided to terminate discussions about the possible sale of the Shaker product line and focus on generating orders. This decision to retain our Shaker product line was due in part to a significant improvement in our liquidity situation. The restarting of this line of business took some time and in the first quarter of 2004 no shaker units were sold. At the end of the first quarter, the gross inventory for our Shaker product line inventory totaled $2.1 million and our valuation reserve against that inventory was $2.0 million, or 95%. During our second and third quarters of fiscal 2004, we were successful in resuming sales levels of our Shakers. As a result, we used some inventory that we had largely written-down. During the second, third and fourth quarters of fiscal 2004 and through the end of the first quarter of fiscal 2005, we sold inventory that originally had a cost of $0.6 million. For the quarter ended January 1, 2005, we sold inventory that originally had a cost of $0.1 million. As this inventory is used we reduce the valuation reserve on a first in first out and pro rata basis. In addition, we had originally accrued approximately $0.9 million for purchase commitments related to the UPS and Shaker product lines. In the third and fourth quarters of 2004 and through the first quarter of fiscal 2005, we sold products containing approximately $0.2 million of inventory previously reserved related to these purchase commitments. For the quarter ended January 1, 2005, we did not sell any inventory which was previously reserved related to these purchase commitments. 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 largely written-down. 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

Results of Operations

Three Months Ended January 1, 2005 Compared to Three Months Ended December 27, 2003

Product Revenue. Product revenue increased by $2.1 million, or 33%, from $6.2 million in fiscal 2004 to $8.3 million in fiscal 2005. The increase in product revenue was comprised of $1.9 million from our Power Systems division. This increase of $1.9 million in revenue from Power Systems was largely due to increased sales in our Power Conversion products of $2.7 million over that of the same quarter in fiscal 2004, offset in part by a $0.8 million reduction in our Uninterruptible Power Supply (“UPS”) product line revenue. Approximately half of the increase in our power conversion products related to two sales to overseas customers. We also benefited from increases in shipments of power conversion products for photovoltaic applications. The $0.8 million reduction in the UPS product line revenue was due to the fact that no products were sold in the first quarter of fiscal 2005 compared to one 2.2 MW Rotary UPS unit being sold during the first quarter of fiscal 2004.

Funded research and development and other revenue. Funded research and development and other revenue decreased by $1.1 million, or 55%, from $2.0 million in fiscal 2004 to $0.9 million in fiscal 2005. This decrease was primarily attributable to less overall business in our Applied Technology Division, delays in starting-up several existing contracts, a decrease in revenue of $0.6 million from a Naval program which existed in fiscal 2004, and a decrease in revenue of $0.3 million from a contract with General Atomics to deliver power converter and control assemblies for the RV Triton, a British research vessel, combined with efforts focused on completing the EDO contract, which took away from our ability to work on other opportunities. (See Note H. Commitments and Contingencies – Contract Losses). These factors coupled with significant increased efforts expended on marketing and business development resulted in lower funded research and development and other revenue for the quarter ended January 1, 2005 as compared to the quarter ended December 27, 2003.

Cost of product revenue. Cost of product revenue increased by $2.0 million, or 38%, from $5.2 million in fiscal 2004 to $7.2 million in fiscal year 2005. The increase was primarily attributable to higher material costs associated with the increase in sales volume and, to a lesser extent, higher manufacturing costs and a shift in our product mix to higher cost products being sold. In addition, during the quarter we incurred approximately $0.1 million related to the commissioning of a sale in our Power Systems Division to a foreign customer. These increases were offset, in part, by products sold which contained certain materials which had been substantially written down or reserved which resulted in reduced costs. This improved gross margin by less than $0.1 million during the quarter ended January 1, 2005. As a result of these higher materials and manufacturing costs, gross margin declined from 16% in fiscal 2004 to 13% in fiscal 2005.

Funded research and development and other revenue expenses. Funded research and development and other revenue expenses decreased by $0.7 million, or 50%, from $1.4 million in fiscal 2004 to $0.7 million in fiscal 2005. The gross margin on funded research and other revenue decreased from 30% in fiscal 2004 to 18% in fiscal 2005. This decrease is a partly attributable to the efforts being applied to the EDO contract for which there is no revenue recorded during the quarter, the different mix of contract types, program overruns and, to a lesser extent, program execution inefficiencies . (See Note H. Commitments and Contingencies – Contract Losses).

Unfunded research and development expenses. We expended approximately $43,000 on unfunded research and development in fiscal 2005 compared with approximately $1,000 spent in fiscal 2004. The spending in the first quarter of fiscal 2005 was related to unfunded engineering in our Power Systems Division.

Selling, general and administrative expenses. Selling, general and administrative expenses increased by approximately $0.3 million, or 14%, from $2.2 million in fiscal 2004 to $2.5 million in fiscal 2005. The increase was primarily the result of approximately $0.3 million incurred as a result of increased head count and payroll related costs across all operating units and the effects of foreign currency exchange rates related to our Canadian subsidiary as compared to the first quarter of fiscal 2004, offset by approximately $45,000 in lower corporate costs as compared to the first quarter of 2004.

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

Restructuring costs. During April 2002, we commenced a restructuring plan designed to streamline our production base, improve efficiency and enhance our competitiveness and recorded a restructuring charge of $1.5 million. As of September 30, 2004 the balance of the restructuring accrual was $495,612. On January 27, 2005 we agreed to settle our outstanding lawsuit with the landlord of the Anaheim, California facility for $240,000, for which approximately $300,000 had been allocated. As a result of this settlement and our evaluation of the remaining restructuring charges we recorded a benefit in our statement of operations for the period ended January 1, 2005 in the amount of $255,612. (See Note I. Restructuring costs).

Net unrealized gain on warrants to purchase common stock. We had approximately $22,000 unrealized gain on warrants to purchase common stock in fiscal year 2005 compared to an unrealized gain of approximately $43,000 in fiscal year 2004. 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 January 1, 2005 and December 27, 2003. 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 Mechanical Technology Incorporated warrants in accordance with SFAS No. 133.

Other (expense). Other expense was approximately $18,000 for first quarter of fiscal year 2005.

Interest expense. Interest expense was approximately $0.2 million for fiscal year 2005 compared with $0.3 million for fiscal year 2004. Interest expense in fiscal 2005 includes non-cash interest of approximately $0.2 million associated with our December 2004 financing and the related anti-dilution effects on the Series B preferred stock and warrants issued with the Series B preferred stock. In addition, during the quarter we had borrowing under the Amended Loan with our Bank, interest expense related to our line of credit during the quarter was approximately $16,000, and there are no outstanding amounts under the line at January 1, 2005.

Liquidity and Capital Resources

As of January 1, 2005, we had $8.1 million of cash, of which $1.0 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 January 1, 2005, approximately $3.0 million could have been borrowed based on the level of eligible receivables. Our trade payables, at January 1, 2005, totaled $3.2 million, of which $0.7 million were for invoices over 60 days old. In addition, we had $0.4 million of accrued accounts payable at January 1, 2005 for goods and services received but not yet invoiced.

On December 22, 2004, we sold 4,848,484 shares of common stock under our universal shelf registration statement directly to several unrelated institutional investors for proceeds of $7,430,000, net of transaction costs. As part of the December 22, 2004 financing we also issued warrants to purchase up to 2,181,818 shares of common stock. These warrants have an exercise price of $2.00 per share. These warrants are immediately exercisable and expire on December 21, 2009. We have valued these warrants at $1,602,954, using the Black-Scholes option pricing model. A portion of the proceeds from this financing was used to pay off amounts outstanding on our line of credit.

On December 29, 2004 we filed our Form 10-K with the Securities and Exchange Commission for our fiscal year ended September 30, 2004. At the time of filing our “unaffiliated” market capitalization was below the $75 million required to maintain our universal shelf registration statement and, consequently, we can no longer use that universal shelf registration statement to issue registered securities.

In December 2004 we extended our $6.3 million consolidated line of credit with the Silicon Valley Bank through March 1, 2005.

Effective January 31, 2005, we entered into the New Loan with the Bank. Under the terms of the New Loan, the Bank will provide us with a credit line of up to $7.0 million. The New Loan is secured by most of the assets of the company and advances under the New Loan are limited to 80% of eligible receivables and up to $1.0 million based on the levels of eligible inventory. Interest on outstanding borrowings accrues at the Bank’s prime rate of interest plus 2%

per annum. In addition we will pay to the Bank a collateral handling fee of $1,000 per month and have agreed to the following additional fees: (i) $25,000 commitment fee; (ii) an unused line fee in the amount of 0.5% per annum; and (iii) an early termination fee of 0.5% of the total credit line if we terminate the New Loan within the first six months. The New Loan contains certain financial covenants relating to tangible net worth, as defined, which we must satisfy in order to continue to borrow from the Bank. The New Loan will expire on January 30, 2006.

We anticipate that our current cash together with the ability to borrow under the New Loan will be sufficient to fund our operations at least through September 30, 2005. This assumes that we will achieve our business plan, complete our fixed price contract with EDO Corporation as envisioned and remain in compliance with all New Loan covenants. If, however, we are unable to realize our business plan, are unable to successfully complete our contract with EDO Corporation and are unable to remain in compliance with the New Loan, we may be forced to raise additional funds by selling stock or taking other actions to conserve our cash position.

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, 2004, 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, 2005. 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 ten 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, and borrowings on our line of credit and capital equipment leases.

As of January 1, 2005, our cash and cash equivalents were $8.1 million, including restricted cash and cash equivalents of $1.0 million, an increase of $5.9 million from September 30, 2004. In addition, we had accounts payables and accrued expenses of approximately $8.5 million and deferred revenue of approximately $1.0 million. Cash used in operating activities for the three months ended January 1, 2005 was $1.4 million as compared to $2.5 million for three months ended December 27, 2003.

Operating Activities

Cash used in operating activities during the three months ended January 1, 2005 was primarily attributable to the net loss of $1.4 million, offset by $0.8 million of non-cash items such as depreciation and amortization, increases in allowances for uncollectible accounts, non-cash interest expense related to our December 2004 financing transaction and a $0.8 million decrease in working capital.

Investing Activities

Cash used in investing activities during the three months ended January 1, 2005 was $0.1 million as compared to cash used in investing activities of $24,310 for the three months ended December 27, 2003.

Financing Activities

Cash provided by financing activities for the three months ended January 1, 2005 was approximately $7.4 million as compared to $6.7 million for the three months ended December 27, 2003. Net cash provided by financing activities during the three months ended January 1, 2005 includes $8.0 million of proceeds from the sale of common stock of the Company in the December 2004 financing transaction, net of approximately $0.6 million in transaction related costs. Net cash provided by financing activities during the three months ended December 27, 2003 included $7.0 million in net

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. 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 we will continue to obtain such funds. In addition, our growth opportunities are dependent on our new products penetrating the 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 commercially viable; that competitors will not force prices to unacceptably low levels or take market share from us; or that we can achieve and maintain profitability 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 ten fiscal years, we have experienced losses from operating our businesses. As of January 1, 2005, we had an accumulated deficit of approximately $129.1 million. During the fiscal year ended September 30, 2004, we had a loss from operations of approximately $4.0 million and during the quarter ended January 1, 2005 we had a loss from operations of approximately $1.2 million. If we are unable to operate on a cash flow breakeven basis during 2005, 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.

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

Our financial statements for our fiscal year ended September 30, 2004, 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 33,255,527 shares were issued and outstanding as of February 14, 2005. 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 the 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. In December 2004, we issued 4,848,484 shares of common stock to investors for $1.65 per share and warrants to purchase 2,181,818 shares of common stock to investors; the exercise price for these warrants is $2.00. As of January 1, 2005, none of these warrants have been exercised.

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

As of February 15, 2005, we have reserved 7,494,386 shares of common stock for issuance upon exercise of stock options and warrants, 1,193,020 shares for future issuances under our stock plans and 131,804 shares for future issuances as matching contributions under our 401(k) plan. We have also reserved 900,424 shares of common stock for issuance upon conversion of the outstanding Series B Preferred Stock, which can be converted at any time. As of February 15, 2005, holders of warrants and options to purchase an aggregate of 5,888,783 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. In December 2004, we issued warrants to purchase an additional 2,181,818 shares of common stock. These warrants are immediately exercisable and, upon exercise and are included in the numbers above, the underlying common stock may be transferred at any time subject, in some cases, to Rule 144.

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. In 2003, SatCon received notice from Nasdaq that it was not in compliance with Marketplace Rules. Subsequently, in late 2003, Nasdaq advised SatCon that it had achieved compliance, and SatCon has continued to maintain compliance with the Nasdaq National Market Marketplace Rules for Continued Inclusion since that time. 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 have included development contracts with several customers and the targeting of specific market segments for power and energy management systems. We cannot know if our commercial marketing efforts will be successful in the future. Additionally, we may not be able to develop competitive products, our products may not receive market acceptance, and we may not be able to compete profitably in this market, even if market acceptance is achieved. If our products do not gain market acceptance or achieve commercial viability, we will not attain 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 improvement 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. 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 dependent upon maintaining our U.S. government contract revenue and research grants. Many of our U.S. government contracts are funded incrementally on a year-to-year basis. Approximately 50% of our revenue during fiscal year 2004 was derived from government contracts and subcontracts. Changes in government policies, priorities or programs that result in budget reductions could cause the government to cancel existing contracts or eliminate follow-on phases in the future which would severely inhibit our ability to successfully complete the development and commercialization of our products. In addition, there can be no assurance that, once a government contract is completed, it will lead to follow-on contracts for additional research and development, prototype build and test or production. Furthermore, there can be no assurance that our U.S. government contracts or subcontracts will not be terminated or suspended 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.

Our contracts with the U.S. government are subject to audit by the Defense Contract Audit Agency and other agencies of the government, which may challenge our treatment of direct and indirect costs and reimbursements, resulting in a material adjustment and adverse impact on our financial condition.

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.

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

Many of our patents are the result 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,” which 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.

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

As of February 14, 2005, we held 71 U.S. patents and had 2 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 dates 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 through confidentiality agreements, which all of our employees are required to sign, assigning to us all patent rights and other intellectual property developed by our employees during their employment with us. Our employees have also agreed not to disclose any trade secrets or confidential information without our prior written consent. We also rely on non-disclosure agreement to protect our trade secrets and proprietary knowledge. 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. Failure to maintain the proprietary nature of our technology and information could harm our results of operations and financial condition by reducing or eliminating our technological advantages in the marketplace.

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.

Our success is dependent upon attracting and retaining highly qualified personnel and the loss of key personnel could significantly hurt our business.

To achieve success, we must attract and retain highly qualified technical, operational and executive employees. The loss of the services of key employees or an inability to attract, train and retain qualified and skilled employees, specifically engineering, operations and business development personnel, could result in the loss of business or could otherwise negatively impact our ability to operate and grow our business successfully.

We expect significant competition for our products and services.

In the past, we have 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.

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 deliver our products in accordance with contractual obligations.

On occasion, we agree to fixed price engineering contracts in our Applied Technology Division, which exposes us to losses.

Most of our engineering design contracts are structured on a cost-plus basis. However, on occasion we have entered into fixed price contracts, which may expose us to loss. A fixed priced contract, by its very nature, requires cost estimates during the bidding process and throughout the contract, as the program proceeds to completion. Depending upon the complexity of the program, the estimated completion costs could change frequently and significantly during the course of the contract. We regularly involve the appropriate people on the program and finance staffs to arrive at a reasonable estimate of the cost to complete. However, due to unanticipated technical challenges and other factors, there is the potential for substantial cost overruns in order to complete the contract in accordance with the contract specifications. Currently we have only two significant contracts of this type. During the fiscal year ended September 30, 2004, we had recorded losses on these contracts of approximately $0.8 million. No additional losses were recorded on these contracts during the quarter ended January 1, 2005.

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

If our power control products are successful in achieving rapid market penetration, 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 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, financial 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 moderate 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 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 certain of 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 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. If we were found to be a responsible party, we could be held jointly and severably liable for the costs of remedial

actions. 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 electrical 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 upon less upon traditional means of purchasing electricity. We cannot assure you that businesses and consumers will choose to utilize on-site distributed power at levels sufficient to sustain our business in this area. 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;

• 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.

Our quarterly operating results are subject to fluctuations, and if we fail to 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.

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 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.

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 certain products or technology. Failure to comply with these laws could result in enforcement responses by the government, including substantial monetary penalties, denial of export privileges, debarment from government contracts and possible criminal sanctions.

Revenue from sales to our international customers for our fiscal years ended September 30, 2004 and 2003 were $3.7 million and $3.3 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.

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 costs 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.

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

Our loan agreement with Silicon Valley Bank 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

The agreement also 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, any outstanding debt under this agreement could become immediately due and payable, the bank could proceed against any collateral securing indebtedness and our ability to borrow funds in the future may be restricted or eliminated. These restrictions may also limit our ability to pursue business opportunities or strategies that we would otherwise consider to be in the best interests of the company.

Delaware		04-2857552
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

27 Drydock Avenue Boston, Massachusetts		02210
(Address of principal executive offices)		(Zip Code)

PART I. FINANCIAL INFORMATION	2
Item 1. Financial Statements	2
Financial Statements of SatCon Technology Corporation	2
Consolidated Balance Sheets as of January 1, 2005 (Unaudited) and September 30, 2004 (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	21
Item 3. Quantitative and Qualitative Disclosures About Market Risk	39
Item 4. Controls and Procedures	40
PART II. OTHER INFORMATION	41
Item 1. Legal Proceedings	41
Item 2Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3. Defaults Upon Senior Securities	42
Item 4. Submission of Matters to a Vote of Security Holders	42
Item 5. Other Information	42
Item 6. Exhibits	42
Signature	43
Exhibit Index	44

Fiscal Years ended September 30,	Capital Leases		Operating Leases

2005	$	199,645	$	760,476
2006	316,762		852,188
2007	—		888,801
2008	—		900,814
2009	—		852,832
Thereafter	—		520,242
Total	$	516,407	$	4,775,353

	SATCON TECHNOLOGY CORPORATION
Date: February 15, 2005	By:	/s/ DAVID B. EISENHAURE
		David B. Eisenhaure President, Chief Executive Officer and Interim Principal Financial Officer

Exhibit Number		Exhibit

31.1		Certification by Chief Executive Officer and Interim Principal 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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

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

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended January 1, 2005
(Unaudited)

Contract Losses:

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

Our contracts with the U.S. government are subject to audit by the Defense Contract Audit Agency and other agencies of the government, which may challenge our treatment of direct and indirect costs and reimbursements, resulting in a material adjustment and adverse impact on our financial condition.

Item 4. Controls and Procedures

SIGNATURE

EXHIBIT INDEX

SATCON TECHNOLOGY CORPORATIONCONSOLIDATED BALANCE SHEETS

SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS

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

SATCON TECHNOLOGY CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY For the three months ended January 1, 2005 (Unaudited)

Contract Losses:

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

Our contracts with the U.S. government are subject to audit by the Defense Contract Audit Agency and other agencies of the government, which may challenge our treatment of direct and indirect costs and reimbursements, resulting in a material adjustment and adverse impact on our financial condition.

Item 4. Controls and Procedures

SIGNATURE

EXHIBIT INDEX

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

SATCON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended January 1, 2005
(Unaudited)