Description
Zbb Energy Corp. Director PAUL F KOEPPE bought 1,063,157 shares on 6-14-2012 at $ 0.38
BUSINESS OVERVIEW
Our Products
We offer a portfolio of intelligent power management platforms for grid independent, grid interactive and grid conversion environments in a variety of applications around the world.
Advanced Energy Storage
Our ZESS Zinc Bromide flow batteries are modular and scalable, self-contained and front accessible, making them ideal for distributed energy projects whether on or off the grid. The new design has redundant internal features, is easy to maintain and operates indoors or outdoors in the widest ambient temperature range of any flow battery.
Power Electronic Systems
Our Power and Energy Control Center (ZESS POWR PECC) is a patented hybrid power conversion system that can support the integration of nearly any combination of onsite generating sources. When supplied with the Company’s ZESS flow batteries or other energy storage devices, the platform creates an expandable system that independently optimizes the supply of each generating source. This integrated energy management platform is the world’s only platform that is configurable, modular, and scalable for on grid, off grid and grid back-up applications. Each system combines advanced power and energy controls plus energy storage that supports renewable energy sources and other power inputs. Our ZESS POWR system is a factory built and tested system uniquely configured to each customer’s application.
The ZESS POWR PECC can be used with a variety of storage technologies, because the optimal solution for a given application may be a hybridized set of storage solutions. We work with numerous manufacturers of a variety of storage technologies to ensure delivery of the best platform.
Market Opportunities and Challenges
There is little argument that smart energy storage is needed to scale renewable energy on the Smart Grid. Distributed solar is starting to reach grid parity in many places like Hawaii and California, which already are experiencing unstable grid conditions due to the saturation of distributed renewables. This will rapidly increase the opportunity for our products in these markets.
When looking at underdeveloped markets, grid power can be sporadic or completely unavailable and generator fuel supply resources may not be reliable. Furthermore, generators and fuel in storage tanks are susceptible to vandalism and theft. We are focusing on small village power/micro-grids and off grid telecom towers to provide cost effective, reliable renewable power sources and energy storage to reduce the dependence on diesel generators, minimize fuel consumption and optimize the supply of energy in these off grid or weak grid connected applications.
The primary challenge for the intelligent storage industry is trying to meet the lifecycle cost and reliability targets needed for these markets. We are in the final stages of development of our next generation ZESS Zinc Bromide flow battery, version three (V3), which has substantial changes in design, function and a significant reduction in cost of ownership. In April 2011, the Company and Honam Petrochemical formed a joint development partnership to work together to refine the materials and manufacturing process for the V3 battery. We anticipate that the successful commercial launch of the V3 battery module will significantly increase our ability to generate orders and increase revenues.
In addition, meeting our customer’s requirements demands very high production standards and certifications. For example, military orders typically contain exacting specifications. Similarly, any installation that is interconnected with a utility network requires the interconnection to have passed UL 1741 certification. Accordingly, one of our top priorities is achieving this certification for the POWR PECC. Achieving UL 1741 certification of the POWR PECC grid tie inverter is expected to be a significant competitive advantage in getting new orders and building backlog since no other manufacturer of a power and energy control system currently has this certification.
The United States and governments throughout the world are implementing renewable energy mandates, tax credits, matching investments, and other incentives related to renewable energy and energy efficiency including the energy storage sector.
Some of the biggest challenges we face are gaining market acceptance and adoption of newer technology/products and reaching the renewable energy, utility and other markets that we target. To be successful, we must also develop a reputation of reliability, quality service, and continually drive down the total cost of ownership of our products.
Intellectual Property
Our proprietary technologies and know-how (“Intellectual Property”) comprise some of our most important assets. We protect our Intellectual Property primarily through maintenance of trade secrets via appropriate corporate policies and procedures and implementation of appropriate technical and physical security measures.
In 2009, we filed a patent application for our ZESS POWR Power and Energy Control Center (PECC) which issued in August 2011. We also are evaluating multiple technologies related to the Tier products and developments for potential additional patent applications.
Advanced Engineering and Development
Currently, our primary advanced engineering initiatives are the development of our ZESS Zinc Bromide flow battery, version three (V3), new versions of the POWR PECC and power electronic and control technologies from our Tier group that support the POWR PECC as well as products for the renewable energy, alternative energy, and power quality markets. The goal of these projects is to substantially reduce the manufacturing costs of the products and to increase the performance of the products. In addition, new versions of the PECC are needed to cost effectively serve market segments like telecom. Our advanced engineering and development expense and cost of engineering and development revenues totaled approximately $4.0 million and $4.1 million in the years ended June 30, 2011 and 2010, respectively. We also had engineering and development revenues of approximately $0.9 million and $0.6 million in the years ended June 30, 2011 and 2010, respectively.
Employees
The Company currently has 54 employees, of which 39 are located at our U.S. manufacturing and corporate headquarters in Wisconsin, 12 are located at our Tier Electronics facility and three are employed at our Research and Development facility in Australia. We expect staffing numbers to significantly increase as our business grows and new production equipment is deployed in accordance with our business expansion plans.
CEO BACKGROUND
James H. Ozanne , age 68, has served as a Director of RSC Holdings Inc., one of the largest equipment rental providers in North America, since May 2007, and is the Lead Independent Director of RSC. Mr. Ozanne also serves as a Director of the Bank of Maine and an advisor to Amherst Securities. Mr. Ozanne has served in executive positions in the financial services industry since 1972. During this time he has held the positions of Chief Financial Officer, President, Chief Executive Officer and Chairman of several leasing, rental, and consumer finance businesses ranging from full service railcar leasing to general equipment finance and grocery pallet rental. He also served as Executive Vice President of GE Capital responsible for the Consumer Finance and Operating Lease/Asset Management business units. Mr. Ozanne was most recently a Director of Financial Security Assurance Holdings Ltd. and Distributed Energy Systems Corp. He was Vice Chairman and Director of Fairbanks Capital Corp. from 2001 through 2005. He was also Chairman of Source One Mortgage Corporation from 1997 to 1999. Previously, he was President and Chief Executive Officer of Nation Financial Holdings and its predecessor, US WEST Capital.
We believe Mr. Ozanne’s qualifications to sit on our Board of Directors include his extensive knowledge of business, accounting and finance issues gained through his experience serving as an officer and director of various mortgage, finance, asset management, and venture capital organizations and his years of experience serving as the chief executive officer of several public companies.
Richard A. Payne , age 56, has served as a director since 1998 and previously held the position of chairman of the board from 2004 to 2008. Mr. Payne also serves as a director and chairman of the board of ZBB PowerSav Holdings Limited, the entity through which we are executing our China joint venture (our “Hong Kong Holding Company”). Mr. Payne is the principal of Richard Payne & Associates and is a commercial lawyer who has practiced as a corporate and commercial attorney in Australia since 1982. Mr. Payne has been a director of the Broome International Airport Group of companies since 2001. Richard Payne & Associates acted as a legal adviser to the Company and its predecessor in Australia between 1993 and 2005. Mr. Payne received his Bachelor of Jurisprudence (Hons) in 1980 and a Bachelor of Law in 1981 from the University of Western Australia.
Mr. Payne’s longstanding quality service as a member of our Board of Directors, as well as his significant experience serving on the boards of directors of other companies and legal expertise, make him a valuable member of our board of directors. In addition, his residence in Australia and experience with transactions in Asia uniquely qualify him to serve as chairman of our Hong Kong Holding Company.
Jeffrey A. Reichard , age 53, has served as a director since January 2011. Mr. Reichard has served as ZBB's Vice President, Electronics Development since January 2011. Mr. Reichard founded Tier Electronics, LLC in June of 2003 and currently serves as its President. Tier Electronics specializes in power converters and conversion systems for alternative energy and power quality applications and operates as a wholly-owned subsidiary of the Company. From June 2000 to June 2002, Mr. Reichard served as Vice President of R&D at American Superconductor (AMSC), a leader in renewable energy, providing proven, megawatt-scale wind turbine designs and electrical control systems. Mr. Reichard founded Integrated Electronics in March 1996, and rapidly grew the company by developing products at the leading edge of innovation, and offered significant price and performance advantages. Acquired by American Superconductor in 2000, Integrated Electronics developed the converter that became the standard for AMSC’s power quality products. Mr. Reichard holds a Bachelors of Science degree in Electrical Engineering from Marquette University.
Mr. Reichard is a well-known expert and visionary in the area of power electronics design. With his significant knowledge and experience in the power electronics industry, he provides the Board of Directors with keen insight into the business and product opportunities afforded by this important market.
Richard A. Abdoo , age 67, has served as a director since August 2009. Mr. Abdoo is president of R.A. Abdoo & Co. LLC, an environmental and energy consulting firm. Prior to starting this business, he was chairman and chief executive officer of Wisconsin Energy Corporation from 1991 until his retirement in 2004. He also served as President from 1991 to April 2003 and joined the company in 1975 as Director of Strategic Planning. During his administration, Wisconsin Energy Corporation grew to become a Fortune 500 company through a series of mergers and acquisitions. He merged Wisconsin Electric and Wisconsin Natural Gas Company into a single utility in 1996, acquired WICOR, Inc. and its Wisconsin Gas subsidiary in 2000, and later that same year introduced the company’s Power the Future plan to meet the future energy needs of southeastern Wisconsin. Mr. Abdoo currently serves on the boards of AK Steel Corp and NiSource. Mr. Abdoo served on the boards of Renegy Holdings, Inc. and M&I Marshall & Ilsley Corporation until 2009. Throughout his career, he has also been a champion of humanitarian causes. He is currently a member of St. Jude’s Children’s Research Hospital’s Professional Advisory Board. Mr. Abdoo received a master’s degree in economics in 1969 from University of Detroit and a bachelor’s degree in electrical engineering from University of Dayton in 1965. A registered professional engineer in Michigan, Ohio, Pennsylvania and Wisconsin, he is also a longtime member of the American Economic Association. In 2000, Mr. Abdoo was awarded the Ellis Island Medal of Honor, presented to Americans of diverse origins for their outstanding contributions to their own ethnic groups and to American society. Honorees typically include U.S. presidents, Nobel Prize winners and leaders of industry.
Mr. Abdoo’s extensive knowledge of the energy and energy services industries, and his extensive experience serving on the boards of directors of other companies qualify him to serve as a member of our Board of Directors.
Manfred E. Birnbaum , age 78, has served as a director since June 2007. Since 1994, Mr. Birnbaum has been an independent management consultant in the energy and power industries. Mr. Birnbaum’s consulting services include assistance on divestitures, contract dispute resolution, technology licensing, and developing marketing strategies. From 1982 to 1985, Mr. Birnbaum was chief executive officer of English Electric Corp., a wholly owned subsidiary of General Electric Company of England. Prior to that, Mr. Birnbaum held various senior management positions at Westinghouse Electric Corporation between 1958 and 1982. Mr. Birnbaum serves as a director of STW Resources Holding Corp., which provides customized water reclamation services and expects to be publicly traded soon. Mr. Birnbaum earned a B.A. in mechanical engineering from Polytechnic Institute, of the City University of New York in 1957 and a Masters Degree in electrical engineering from the University of Pennsylvania.
Mr. Birnbaum’s longstanding quality service as a member of our Board of Directors, as well as his significant experience serving as chief executive officer of English Electric Corp., gives him an understanding of the role of the board of directors and management. He also brings to the Board of Directors expertise and leadership skills he has acquired as an executive and consultant in the energy and power industries.
Eric C. Apfelbach , age 50, has served as a Director since January 2010. Mr. Apfelbach has served as the Company’s President and Chief Executive Officer since January 7, 2010. From December 2008 until September 2009, Mr. Apfelbach served as President and CEO of M2E Power, Inc., a start-up technology company. From August 2003 until November 2008, Mr. Apfelbach served as President, CEO and a member of the board of directors, including Chairman from 2004 to 2008, of Virent Energy Systems, Inc., a catalytic biofuel company. From August 1999 until June 2003, Mr. Apfelbach served as President and CEO and Chairman of the board of directors from May 2000 to April 2003 of Alfalight, Inc., a high-power diode laser company he co-founded that serves the telecom, medical, military and industrial markets. From October 1997 until August 1999, Mr. Apfelbach served as Vice President of Global Sales and Marketing of Planar Systems (NYSE AMEX:PLNR), Inc., a company that designs and manufactures flat-panel displays. Mr. Apfelbach currently serves as a director of Xolve, Inc., Wedge Technologies, LLC and the Wisconsin Technology Council. Mr. Apfelbach holds a Bachelors of Science degree in Chemical Engineering from the University of Wisconsin.
Mr. Apfelbach brings extensive business and leadership experience to the Board of Directors. With his significant knowledge of and breadth of experience in the high technology industry in general and the alternative energy industry in particular, he provides the Board of Directors with a vital understanding of our business.
Paul F. Koeppe , age 62, has served as a Director since November 2009 and as Chairman since September 2010. Mr. Koeppe was President, CEO and founder of Superconductivity, Inc., a manufacturer of superconducting magnetic energy storage systems from 1988 to 1997 when it was acquired by American Superconductor, an electricity solutions company. He then served as Executive Vice President of Strategic Planning for American Superconductor until his retirement in 2001. From 1993 to 1995, Mr. Koeppe was acting CEO and chairman of the executive committee of the board of directors of Best Power, Inc., a supplier of uninterruptible power supply equipment. Mr. Koeppe also serves as a member of the Board of Directors of Incontact, a Company specializing in the development and marketing of contact center software. Mr. Koeppe has also served as a member of the Board of Directors at Distributed Energy Systems Corp., from 2003 to 2010 and also as a member of the Board of Directors at Northern Power Systems from 1998 to until 2003 when Northern was acquired by Distributed Energy Systems Corp Prior to founding Superconductivity, Inc. Mr. Koeppe worked for Wisconsin Power and Light Company for 15 years in a variety of functions. He has earned a Bachelor’s Degree in Business Administration from Lakeland College and Associate Degrees in Materials Management and Electrical Power Technology.
Mr. Koeppe’s extensive executive, managerial and leadership experience, including many years in the energy services industry, positions him well to serve as a member of our Board of Directors. His business acumen and experience on the boards of directors of numerous companies make him a valuable addition to our Board of Directors.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
ZBB Energy Corporation (“We,” “Us,” “Our,” “ZBB” or the “Company”) develops and manufactures distributed energy storage solutions based upon the Company’s proprietary zinc bromide rechargeable electrical energy storage technology.
We provide advanced electrical power management platforms targeted at the growing global need for distributed renewable energy, energy efficiency, power quality, and grid modernization. We and our power electronics subsidiary, Tier Electronics, have developed a portfolio of intelligent power management platforms that directly integrate multiple renewable and conventional onsite generation sources with rechargeable zinc bromide flow batteries and other storage technology. We also offer advanced systems to directly connect wind and solar equipment to the grid and systems that can form various levels of micro-grids. Tier Electronics participates in the energy efficiency markets through its hybrid vehicle control systems, and power quality markets with its line of regulation solutions. Together, these platforms solve a wide range of electrical system challenges in global markets for utility, governmental, commercial, industrial and residential end customers. A developer and manufacturer of its modular, scalable and environmentally friendly power systems (“ZESS POWR™”), the Company was founded in 1998 and is headquartered in Wisconsin, USA with offices also located in Perth, Western Australia.
On January 21, 2011 (“Closing Date”), we entered into an Asset Purchase Agreement under which we acquired substantially all of the net assets of Tier Electronics LLC (“Seller”) used in connection with the Seller’s business of developing, manufacturing, marketing and selling power electronics products for and to original equipment manufacturers in various industries. The purchase price was comprised of (1) a $1.35 million promissory note issued by the Company, (2) 800,000 shares of the Company’s common stock, and (3) payment of approximately $245,000 of Seller’s obligations. The promissory note is in the principal amount of $1,350,000 and bears interest at a fixed annual rate equal to eight percent. The principal balance of the note is payable in three equal installments of $450,000 on the first, second and third anniversaries of the Closing Date. Accrued interest is payable monthly. Tier Electronics LLC operates as a wholly owned subsidiary of the Company.
On April 8, 2011, we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Honam Petrochemical Corporation (“Honam”), a division of LOTTE Petrochemical, pursuant to which we agreed with Honam to collaborate on the further technical development of our third generation ZESS Zinc Bromide flow battery module (the “Version 3 Battery Module”). Pursuant to the Collaboration Agreement, Honam is required to pay us a total of $3 million dollars as follows: (1) $1 million within 10 days following execution of the Collaboration Agreement (subsequently received on April 19, 2011); (2) $500,000 by June 30, 2011 (subsequently received on June 30, 2011); (3) $1.2 million by October 10, 2011 and (4) $300,000 within 10 days after a single Version 3 Battery Module is set up at Honam’s research and development center. Pursuant to the Collaboration Agreement, the parties are required to negotiate a license agreement under which upon the completion of the collaboration project and the receipt by the Company of all payments due under the Collaboration Agreement, the Company shall grant to Honam: (1) a fully paid-up, exclusive and royalty-free license to sell and manufacture the Version 3 Battery Module in Korea and (2) non-exclusive rights to sell the Version 3 Battery Module in Japan, Thailand, Taiwan, Malaysia, Vietnam and Singapore. In connection with such non-exclusive rights, Honam is required to pay a royalty to the Company.
On August 30, 2011, we entered into agreements providing for establishment of a joint venture to develop, produce, sell, distribute and service advanced storage batteries and power electronics in China (the “Joint Venture”). Joint venture partners include PowerSav, Inc., AnHui Xinlong Electrical Co. and Wuhu Huarui Power Transmission & Transformation Engineering Co.
The Joint Venture will be established upon receipt of certain governmental approvals from China which are anticipated to be received in November 2011. The Joint Venture will operate through a jointly-owned Chinese company located in Wuhu City, Anhui Province named Anhui Meineng Store Energy Co., Ltd. (the “JV Company”). The JV Company will initially assemble and ultimately manufacture the Company’s products for sale in the power management industry on an exclusive basis in mainland China and on a non-exclusive basis in Hong Kong and Taiwan.
In connection with the Joint Venture, on August 30, 2011 the Company and certain of its subsidiaries entered into the following agreements:
• Joint Venture Agreement of Anhui Meineng Store Energy Co., Ltd. (the “China JV Agreement”) by and between ZBB PowerSav Holdings Limited, a Hong Kong limited liability company (“Hong Kong Holdco”), and Anhui Xinrui Investment Co., Ltd, a Chinese limited liability company; and;
• Limited Liability Company Agreement of ZBB PowerSav Holdings Limited by and between ZBB Cayman Corporation and PowerSav, Inc. (the “Holdco Agreement”).
In connection with the Joint Venture, upon establishment of the JV Company, the Company and certain of its subsidiaries will enter into the following agreements:
• Management Services Agreement by and between the JV Company and Hong Kong Holdco (the “Management Services Agreement”);
• License Agreement by and between the Company and the JV Company (the “License Agreement”); and
• Research and Development Agreement by and between the Company and the JV Company (the “Research and Development Agreement”).
Pursuant to the China JV Agreement, it is anticipated that the JV Company will be capitalized with approximately $13.4 million of equity capital. The Company’s only capital contributions to the Joint Venture will be a contribution of technology to the JV Company via the License Agreement valued at approximately $4.0 million. The Company’s indirect interest in the JV Company will equal approximately 33%.
The Company’s investment in the JV Company will be made through Hong Kong Holdco, a holding company being formed with PowerSav and to which the Company will make a cash capital contribution of $200,000. The Company will own 60% of Hong Kong Holdco’s equity interests. The Company will have the right to appoint a majority of the members of the Board of Directors of Hong Kong Holdco and Hong Kong Holdco will have the right to appoint a majority of the members of the Board of Directors of the JV Company.
Pursuant to the Management Services Agreement Hong Kong Holdco will provide certain management services to the JV Company in exchange for a management services fee equal to five percent of the JV Company’s net sales for the first five years and three percent of the JV Company’s net sales for the subsequent three years.
Pursuant to the License Agreement, the Company will grant to the JV Company (1) an exclusive royalty-free license to manufacture and distribute the Company’s ZESS Zinc Bromide flow battery, version three (v3) battery (50KW) and ZESS POWR PECC (up to 250KW) (the “Products”) in mainland China in the power supply management industry and (2) a non-exclusive royalty-free license to manufacture and distribute the Products in Hong Kong and Taiwan in the power supply management industry.
Pursuant to the Research and Development Agreement, the JV Company may request the Company to provide research and development services upon commercially reasonable terms and conditions. The JV Company would pay the Company’s fully-loaded costs and expense incurred in providing such services.
Results of Operations – Year Ended June 30, 2011 Compared with the Year Ended June 30, 2010
Revenue and Other income:
Our revenues for the year ended June 30, 2011 and 2010 were $1,802,610 and $1,545,980, respectively. This increase of $256,630 was due primarily to the inclusion of $772,929 of revenue from Tier Electronics which we acquired in January 2011. In the year ended June 30, 2011, commercial product sales revenues declined by $49,784 and engineering and development revenues increased by $306,414 as compared to the year ended June 30, 2010. The decrease in commercial product sales and revenues is primarily the result of delays in certain orders due to the need for PECC inverter certification to UL standard 1741 and an order that requires field commissioning completion. The increase in engineering and development revenues was due to the commencement of the Collaboration Agreement with Honam Petrochemical in April 2011.
Other income for the year ended June 30, 2011 reflects a decrease in interest income of $51,414 compared to the year ended June 30, 2010, due primarily to decreasing investment balances and lower interest rates on invested funds.
Cost and Expenses and Other Expense:
Total costs and expenses for the years ended June 30, 2011 and 2010 were $10,623,113 and $11,057,919, respectively. This decrease of $434,806 in the year ended June 30, 2011 was primarily due to the following:
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A decrease in costs of product sales of $331,362 due to a decrease in product shipments, a decrease in the cost of engineering and development of $1,299,584 due to the completion of activities required under the AEST contract during the year ended June 30, 2010 and a decrease in other engineering and development contracts;
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A $1,185,121 increase in advanced engineering and development expenses primarily due to an increase in the Company’s engineering and development activities for its next generation battery module and PECC systems;
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$219,213 of impairment and other charges during fiscal year 2011 compared to $903,305 of impairment and other charges during fiscal year 2010;
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An increase of $459,976 in selling, general and administrative expenses due to the inclusion of Tier Electronics’ selling, general and administrative expenses of $571,000 partially offset by a decrease in the Company expenses principally comprised of fundraising, consulting and promotional fees; and
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A $235,135 increase in depreciation and amortization expenses due to the amortization of intangible assets related to the Tier acquisition beginning in January 2011.
Other expenses for the year ended June 30, 2011 and 2010 consisted primarily of interest expenses of $217,810 and $149,521, respectively.
Net Loss:
Our net loss for the year ended June 30, 2011 decreased by $1,157,820 to $8,449,006 from the $9,606,826 net loss for the year ended June 30, 2010. This decrease in loss was primarily the result of the decreases in expenses and the increase in revenues as described above as well as a $579,955 income tax benefit. The credits recognized during fiscal 2011 were $164,640 and $415,315, for expenditures incurred during the years ended June 30, 2011 and 2010, respectively.
Liquidity and Capital Resources
Since our inception, our research, advanced engineering and development, and operations have been primarily financed through debt and equity financings, and government and other research and development contracts. Total paid in capital as of June 30, 2011 was $60,777,286 and $49,770,987 as of June 30, 2010. We had a cumulative deficit of $55,343,683 as of June 30, 2011 compared to a cumulative deficit of $46,894,677 as of June 30, 2010. At June 30, 2011 we had a working capital surplus of $712,109 compared to a June 30, 2010 working capital deficit of $800,204. Our shareholders’ equity as of June 30, 2011 and June 30, 2010 was $4,156,510 and $1,451,277, respectively.
On August 30, 2010 we entered into an amended and restated securities purchase agreement (the “Socius Agreement”) with Socius CG II, Ltd. (“Socius”). Pursuant to the Socius Agreement we have the right over a term of two years, subject to certain conditions, to require Socius to purchase up to $10 million of redeemable subordinated debentures and/or shares of redeemable Series A preferred stock in one or more tranches. The debentures bear interest at an annual rate of 10% and the shares of Series A preferred stock accumulate dividends at the same rate. Both the debentures and the shares of Series A preferred stock are redeemable at our election at any time after the one year anniversary of issuance. Neither the debentures nor the Series A preferred shares are convertible into common stock. Shares of Series A preferred stock were authorized in November 2010. Upon authorization, the outstanding debentures were automatically converted into shares of Series A preferred stock. Under the Socius Agreement, in connection with each tranche Socius is obligated to purchase that number of shares of our common stock equal in value to 135% of the amount of the tranche at a per share price equal to the closing bid price of the common stock on the trading day preceding our delivery of the tranche notice. Socius may pay for the shares it purchases at its option, in cash or with a secured promissory note. Our ability to submit a tranche notice is subject to certain conditions including that: (1) a registration statement covering our sale of shares of common stock to Socius in connection with the tranche is effective and (2) the issuance of such shares would not result in Socius and its affiliates beneficially owning more than 9.99% of our common stock.
During the year ended June 30, 2011 we delivered a total of four tranche notices under the Socius Agreement pursuant to which Socius purchased from us $3,547,168 of debentures and preferred stock. In connection with the tranches, (1) Socius purchased 4,560,977 shares of common stock for a total purchase price of $4,788,675 and at a per share weighted average purchase price of $1.05 and (2) we issued to Socius 893,097 shares of common stock in payment of the commitment fee payable by us under the Socius Agreement. Socius paid for the shares of common stock it purchased with secured promissory notes maturing the later of four years or when we have redeemed all preferred stock issued by us to Socius under the Socius Agreement.
On June 14 and 15, 2011 we entered into Stock Purchase Agreements with certain investors providing for the issuance of a total of 3,049,463 shares of the Company’s common stock for an aggregate purchase price of $2,527,000 at a weighted average price per share of $0.83. The closing took place on June 17, 2011. $200,000 of these shares were purchased by members of the Company’s Board of Directors. $2,849,000 of these shares were offered by the Company pursuant to the 2011 universal shelf registration statement described below. The balance of the shares were sold in a private placement transaction. The net proceeds to the Company, after deducting $153,000 of offering costs, were $2,374,000.
On December 29, 2010 and January 3, 2011 we entered into Stock Purchase Agreements with certain investors providing for the issuance of a total of 2,103,532 shares of the Company’s common stock for an aggregate purchase price of $2,000,000 at a weighted average price per share of $0.95. The closing took place on January 12, 2011. $200,000 of these shares were purchased by members of the Company’s Board of Directors. $1,800,000 of these shares were offered by the Company pursuant to the 2009 universal shelf registration statement described below. The balance of the shares were sold in a private placement transaction. The net proceeds to the Company were $1,945,000.
On October 12, 2010, we entered into Stock Purchase Agreements with certain investors providing for the sale of a total of 3,329,467 shares of the Company’s common stock for an aggregate purchase price of $1,435,000 at a price per share of $0.431 which was the closing price of the Company’s common stock on October 12, 2010. $425,000 of these shares were purchased by members of the Company’s Board of Directors. 2,111,369 of these shares were offered by the Company pursuant to the 2009 universal shelf registration statement described below. The balance of the shares were sold in a private placement transaction. The net proceeds to the Company were approximately $1.3 million.
On May 1, 2009 we filed a Registration Statement on Form S-3 with the Securities and Exchange Commission (SEC) for a $10 million universal shelf, which was declared effective by the SEC on May 13, 2009. We took this action as a measure in anticipation of our possible future needs to raise additional investment capital to fund additional working capital and further capital expenditures. On August 18, 2009, we used this universal shelf registration statement to complete a registered direct sale of 1,791,667 units at $1.20 per unit consisting of an aggregate of 1,791,667 shares of common stock and warrants to purchase 358,333 shares of common stock at an exercise price of $1.33 per share. The proceeds to the Company after deducting placement agent fees and offering expenses were approximately $1.9 million. On March 9, 2010, we used this universal shelf registration statement to complete a registered direct sale of 2,243,750 units at $.80 per unit consisting of an aggregate of 2,243,750 shares of common stock and warrants to purchase 1,121,875 shares of common stock at an exercise price of $1.04 per share. The proceeds to the Company after deducting placement agent fees and offering expenses were approximately $1.6 million.
In December 2009 we were awarded a $1.3 million Wisconsin Clean Energy Business Loan through the American Recovery and Reinvestment Act. We closed this loan transaction in May 2010 and we had received $1,300,000 under the loan as of December 31, 2010.
In conjunction with our strategic partners we are actively involved in submitting proposals to the Federal Government in response to Funding Opportunity announcements issued as a result of the American Recovery and Reinvestment Act. These proposals cover opportunities for plant expansion, Smart Grid initiative, and renewable energy initiatives as well as research and development opportunities for applications where the Company’s technology could bring a transformational change to market applications that we currently do not address. However, there can be no assurance we will receive any government funding through these activities.
We also have approximately $40 million of net operating loss carryforwards and $14.675 million of Department of Energy sponsored tax credits. The tax credits require the Company to invest approximately $50 million in plant and equipment, which the Company has started but has not completed. We are exploring ways to monetize or to use these benefits. However, there can be no assurance that these efforts will prove successful. We have recorded an income tax refund receivable of $164,640 for the year ended June 30, 2011, related to a refundable Australian research and development tax credit refund for the year ending June 30, 2011.
Our investment capital requirements will depend upon numerous factors, including our ability to control expenses, the progress of our engineering and development programs, the success of our marketing and sales efforts and our ability to obtain alternative funding sources such as government grants. In order to actively manage financing risk, the board of directors has worked with management to carefully consider financing alternatives and to implement cost containment measures. Actions taken by the board of directors and management in fiscal 2011 to date include: 1) execute an overall reduction in controllable expenses to preserve cash resources including continuing our revised non-employee director compensation policy under which fees are paid primarily with equity instead of cash; 2) actively pursue additional sources of capital to fund working capital and operating needs; 3) pursue government grant and federal stimulus package opportunities; 4) file a new $25 million universal shelf registration statement with the SEC as described in further detail below; and 5) pursue potential strategic transactions such as the Tier acquisition, Honam collaboration and China joint venture transaction through which we may grow our business and/or obtain non-dilutive financing.
As described above under the caption “Overview”, in January 2011 we consummated the acquisition of substantially all of the assets of Tier Electronics LLC (“Seller”) used in connection with the Seller’s business of developing, manufacturing, marketing and selling power electronics products for and to original equipment manufacturers in various industries. This acquisition significantly expands our product portfolio, customer base and served market and is expected to add significantly to revenue growth and be accretive to operating cash flows.
As described above under the caption “Overview”, in April 2011 we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Honam Petrochemical Corporation (“Honam”), a division of LOTTE Petrochemical, pursuant to which we agreed with Honam to collaborate on the further technical development of our third generation Zinc Bromide flow battery module (the “Version 3 Battery Module”). Pursuant to the Collaboration Agreement, Honam is required to pay us a total of $3 million dollars as follows: (1) $1 million within 10 days following execution of the Collaboration Agreement (subsequently received on April 19, 2011); (2) $500,000 by June 30, 2011 (subsequently received on June 30, 2011); (3) $1.2 million by October 10, 2011 and (4) $300,000 within 10 days after a V3 single stack is set up at Honam’s research and development center. Through June 30, 2011 Honam had made the first two payments to us totaling $1.5 million.
As described above under the caption “Overview”, in August 2011 we entered into agreements providing for establishment of a joint venture that will develop, produce, sell, distribute and service advanced storage batteries and power electronics in China (the “-JV Company”). The joint venture partners include PowerSav, Inc., AnHui Xinlong Electrical Co. and Wuhu Huarui Power Transmission & Transformation Engineering Co. This joint venture will enable the Company to take its products into this high growth market with exceptional partners and also represents a core component of our global partnership strategy to offer the lowest cost smart storage products available. It is anticipated that the JV Company will be capitalized with approximately $13.4 million of equity capital. The Company’s only capital contributions to the JV Company will be a contribution of technology via a license agreement valued at approximately $4.0 million. The Company’s indirect interest in the JV Company will equal approximately 33%. The Company’s investment in the JV Company will be made through a holding company being formed with PowerSav and to which the Company will make a cash capital contribution of $200,000.
On January 31, 2011 we filed with the SEC a universal shelf registration statement on Form S-3 covering the offer and sale from time to time of up to $25 million of securities, which may include additional securities issued pursuant to the Socius Agreement as well as other equity, debt and other securities as described in the registration statement. The SEC declared this registration statement effective on March 21, 2011. While we do not have any immediate plans to offer securities under this shelf registration, it is intended to give the Company the flexibility to take advantage of financing opportunities as needed or deemed desirable in light of market or other conditions.
We believe we have the necessary financing vehicles in place, including the Socius Agreement described above, to fund the Company through the end of fiscal 2012. However, there can be no assurances that unforeseen circumstances will not jeopardize the Company’s ability to draw on these financing vehicles. Therefore, we are continuing to seek additional sources of funds to add to the financing vehicles already in place. However, we have no commitments to obtain any additional funds, and there can be no assurance such funds will be available on acceptable terms or at all. If we are unable to obtain such needed capital, our financial condition and results of operations may be materially adversely affected and we may not be able to continue operations.
Cash Flows
During fiscal 2011, our cash and cash equivalents increased by $1,674,960 from June 30, 2010.
Our operating activities used net cash of $6,250,742 for the year ended June 30, 2011. Cash used in operations resulted from a net loss of $8,449,006 reduced by $1,878,257 in non-cash adjustments and $320,007 in net changes to working capital. Non-cash adjustments included $866,512 of stock based compensation expense, and $659,432 of depreciation and amortization expense. Net cash provided by changes in working capital was primarily due to a net increase in deferred revenue of $842,828 relating to customer deposits offset by an estimated tax refund receivable of $164,640 related to a refundable Australian research and development credit for qualified expenditures incurred during the fiscal year ended June 30, 2011.
Our investing activities used net cash of $1,975,966 for the year ended June 30, 2011, consisting of $1,750,044 used for the purchase of property and equipment and $225,922 used in connection with our completion of the acquisition of Tier Electronics LLC.
Our financing activities provided net cash of $9,892,123 for the year ended June 30, 2011. Net cash provided by financing activities included $5,495,081 in net proceeds from issuance of common stock, $3,547,168 in proceeds from issuance of debentures notes payable and preferred stock under the Socius Agreement and $1,300,000 of proceeds from issuance of a note payable, offset by repayments of $450,126 of principal on bank loans and notes payable.
Intangible Assets
Intangible assets generally result from business acquisitions. The Company accounted for the January 21, 2011 business acquisition by assigning the purchase price to identifiable tangible and intangible assets and liabilities. Assets acquired and liabilities assumed were recorded at their estimated fair values. Other intangible assets consist of a non-compete agreement, license agreement, and trade secrets.
Amortization is recorded for other intangible assets with determinable lives. Other intangible assets are amortized using the straight line method over the three year estimated useful lives of the respective assets.
Goodwill
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized but reviewed for impairment annually as of June 30 or more frequently if events or changes in circumstances indicate that its carrying value may be impaired. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.
Testing for the impairment of goodwill involves a two-step process. The first step of the impairment test requires the comparing of a reporting units fair value to its carrying value. If the carrying value is less than the fair value, no impairment exists and the second step is not performed. If the carrying value is higher than the fair value, there is an indication that impairment may exist and the second step must be performed to compute the amount of the impairment. In the second step, the impairment is computed by estimating the fair values of all recognized and unrecognized assets and liabilities of the reporting unit and comparing the implied fair value of reporting unit goodwill with the carrying amount of that unit’s goodwill.
Impairment of Long-Lived Assets
In accordance with FASB ASC topic 360, "Impairment or Disposal of Long-Lived Assets," the Company assesses potential impairments to its long-lived assets including property, plant and equipment and intangible assets when there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable.
If such an indication exists, the recoverable amount of the asset is compared to the asset’s carrying value. Any excess of the asset’s carrying value over its recoverable amount is expensed in the statement of operations. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate.
Warranty Obligations
The Company typically warrants its products for twelve months after installation or eighteen months after date of shipment, whichever first occurs. Warranty obligations are evaluated quarterly to determine a reasonable estimate for the replacement of potentially defective materials of all energy storage systems that have been shipped to customers.
While the Company actively engages in monitoring and improving its evolving battery and production technologies, there is only a limited product history and relatively short time frame available to test and evaluate the rate of product failure. Should actual product failure rates differ from the Company’s estimates, revisions are made to the estimated rate of product failures and resulting changes to the liability for warranty obligations. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise.
During the year ended June 30, 2010, battery stack manufacturing issues were discovered as result of an internal test failure. As a result, the Company has implemented several manufacturing process changes to eliminate the potential for future failures and has adjusted its warranty obligations accordingly. We will adjust our warranty rates in future periods as these processes are implemented and tested.
Revenue Recognition
Revenues are recognized when persuasive evidence of a contractual arrangement exits, delivery has occurred or services have been rendered, the seller’s price to buyer is fixed and determinable, and collectability is reasonably assured. The portion of revenue related to installation and final acceptance, is deferred until such installation and final customer acceptance are completed. The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in product sales. The Company reports its product sales net of actual sales returns.
For sales arrangements containing multiple elements (products or services), revenue relating to undelivered elements is deferred at the estimated fair value until delivery of the deferred elements. To be considered a separate element, the product or service in question must represent a separate unit under SEC Staff Accounting Bulletin 104, and fulfill the following criteria: the delivered item(s) has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of the undelivered item(s); and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transaction is deferred until all elements are delivered. Revenue from time and materials based service arrangements is recognized as the service is performed.
The portion of revenue related to engineering and development is recognized ratably upon delivery of the goods pertaining to the underlying contractual arrangement or revenue is recognized as certain activities are performed by the Company over the estimated performance period.
The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in net revenues. The Company reports its revenues net of estimated returns and allowances.
Revenues from government funded research and development contracts are recognized proportionally as costs are incurred and compared to the estimated total research and development costs for each contract. In many cases, the Company is reimbursed only a portion of the costs incurred or to be incurred on the contract. Government funded research and development contracts are generally multi-year, cost-reimbursement and/or cost-share type contracts. The Company is reimbursed for reasonable and allocable costs up to the reimbursement limits set by the contract.
Income Taxes
The Company records deferred income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 740, “Accounting for Income Taxes.” This ASC requires recognition of deferred income tax assets and liabilities for temporary differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted tax rates in effect for the year in which the differences are expected to reverse. The Company establishes a valuation allowance when necessary to reduce deferred income tax assets to the amount expected to be realized.
The Company applies a more-likely-than-not recognition threshold for all tax uncertainties as required under ASC Topic 740, which only allows the recognition of those tax benefits that have a greater than fifty percent likelihood of being sustained upon examination by the taxing authorities. The Company’s management has reviewed the Company’s tax positions and determined there were no outstanding or retroactive tax positions with less than a 50% likelihood of being sustained upon examination by the taxing authorities as of June 30, 2011 and June 30, 2010.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
ZBB Energy Corporation (“We,” “Us,” “Our,” “ZBB” or the “Company”) develops and manufactures modular, scalable and environmentally friendly power systems (ZBB EnerSystem™) based upon the Company’s proprietary zinc bromide rechargeable electrical energy storage technology. The following information should be read in conjunction with the financial statements and notes thereto in Part I, Item 1 of this Quarterly Report and with the audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2011 as filed by us with the SEC on September 8, 2011.
We provide advanced electrical power management platforms targeted at the growing global need for distributed renewable energy, energy efficiency, power quality, and grid modernization. We and our power electronics subsidiary, Tier Electronics LLC, have developed a portfolio of intelligent power management platforms that directly integrate multiple renewable and conventional onsite generation sources with rechargeable zinc bromide flow batteries and other storage technology. We also offer advanced systems to directly connect wind and solar equipment to the grid and systems that can form various levels of micro-grids. Tier Electronics LLC participates in the energy efficiency markets through its hybrid vehicle control systems, and power quality markets with its line of regulation solutions. Together, these platforms solve a wide range of electrical system challenges in global markets for utility, governmental, commercial, industrial and residential end customers. The Company was founded in 1998 and is headquartered in Wisconsin, USA with offices also located in Perth, Western Australia.
On January 21, 2011 (“Closing Date”), we entered into an Asset Purchase Agreement under which we acquired substantially all of the net assets of Tier Electronics LLC (“Seller”) used in connection with the Seller’s business of developing, manufacturing, marketing and selling power electronics products for and to original equipment manufacturers in various industries. The purchase price was comprised of (1) a $1,350,000 promissory note issued by the Company, (2) 800,000 shares of the Company’s common stock, and (3) payment of approximately $245,000 of Seller’s obligations. Tier Electronics LLC operates as a wholly-owned subsidiary of the Company.
On April 8, 2011, we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Honam Petrochemical Corporation (“Honam”), a division of LOTTE Petrochemical, pursuant to which we agreed with Honam to collaborate on the further technical development of our third generation ZBB EnerStore™, Zinc Bromide flow battery module (the “Version 3 Battery Module”). Pursuant to the Collaboration Agreement, Honam is required to pay us a total of $3 million dollars as follows: (1) $1 million within 10 days following execution of the Collaboration Agreement (subsequently received on April 19, 2011); (2) $500,000 by June 30, 2011 (subsequently received on June 30, 2011); (3) $1.2 million by October 10, 2011 (subsequently received on October 10, 2011) and (4) $300,000 within 10 days after a single Version 3 Battery Module test station is set up at Honam’s research and development center (subsequently received on March 30, 2012). Pursuant to the Collaboration Agreement, the parties are required to negotiate a license agreement under which upon the completion of the collaboration project and the receipt by the Company of all payments due under the Collaboration Agreement, the Company shall grant to Honam: (1) a fully paid-up, exclusive and royalty-free license to sell and manufacture the Version 3 Battery Module in Korea and (2) non-exclusive rights to sell the Version 3 Battery Module in Japan, Thailand, Taiwan, Malaysia, Vietnam and Singapore. In connection with such non-exclusive rights, Honam is required to pay a royalty to the Company.
On August 30, 2011, we entered into agreements providing for establishment of a joint venture to develop, produce, sell, distribute and service advanced storage batteries and power electronics in China (the “Joint Venture”). Joint Venture partners include PowerSav, Inc. (PowerSav), AnHui Xinlong Electrical Co. and Wuhu Huarui Power Transmission & Transformation Engineering Co.
The Joint Venture was established upon receipt of certain governmental approvals from China which were received in November 2011. The Joint Venture operates through a jointly-owned Chinese company located in Wuhu City, Anhui Province named Anhui Meineng Store Energy Co., Ltd. (the “JV Company”). The JV Company will initially assemble and ultimately manufacture the Company’s products for sale in the power management industry on an exclusive basis in mainland China and on a non-exclusive basis in Hong Kong and Taiwan.
The JV Company will be capitalized with approximately $13.6 million of equity capital. The Company’s only capital contribution to the Joint Venture is a contribution of technology to the JV Company via a license agreement and $200,000 in cash. The Company’s indirect interest in the JV Company equals approximately 33%.
The Company’s investment in the JV Company was made through Hong Kong Holdco, a holding company formed with PowerSav and to which the Company will make a cash capital contribution of $200,000 ($100,000 contribution made on December 1, 2011). The Company owns 60% of Hong Kong Holdco’s equity interests.
Pursuant to a license agreement we have granted to the JV Company (1) an exclusive royalty-free license to manufacture and distribute our ZBB EnerStore™, Zinc Bromide flow battery, version three (v3) battery (50KW) and ZBB EnerSection™, POWR PECC (up to 250KW) (the “Products”) in mainland China in the power supply management industry and (2) a non-exclusive royalty-free license to manufacture and distribute the Products in Hong Kong and Taiwan in the power supply management industry.
Risks and Uncertainties
The following discussion of the consolidated financial position and results of operations of the Company should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this form 10-Q and the Company’s annual report filed on form 10-K for the fiscal year ended June 30, 2011. In addition to historical information, this discussion contains forward-looking statements such as statements of the Company’s expectations, plans, objectives and beliefs. These statements use such words as “may,” “will,” “expect,” “anticipate,” “believe,” “plan,” and other similar terminology.
In addition to the risks and uncertainties faced generally by participants in the renewable energy industry, we face the following risks and uncertainties:
â—Ź We currently have sufficient capital to continue operations through June 30, 2012 and will need additional financing.
â—Ź Our stock price could be volatile and our trading volume may fluctuate substantially.
â—Ź We have incurred losses and anticipate incurring continuing losses.
â—Ź Our industry is highly competitive and we may be unable to successfully compete.
● Successful commercialization of our next generation ZBB EnerStore™, Zinc Bromide flow battery, version three (V3) and receipt of UL 1741 certification for the ZBB EnerSection™ POWR PECC are critical component of our growth plans.
â—Ź If our products do not perform as promised, we could experience increased costs, lower margins and harm to our reputation.
â—Ź Our relationships with our strategic partners may not be successful and we may not be successful in establishing additional partnerships, which could adversely affect our ability to commercialize our products and services.
â—Ź Shortages or delay of supplies of component parts may adversely affect our operating results until alternate sources can be developed.
â—Ź We have no experience manufacturing our products on a large-scale basis and may be unable to do so at our manufacturing facilities.
â—Ź We may experience difficulties in integrating the business of Tier Electronics LLC and could fail to realize the potential benefits of the acquisition.
â—Ź Our China joint venture could be adversely affected by the laws and regulations of the Chinese government, our lack of decision-making authority and disputes between us and the Joint Venture.
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Business practices in Asia may entail greater risk and dependence upon the personal relationships of senior management than is common in North America, and therefore some of our agreements with other parties in China and South Korea could be difficult or impossible to enforce.
â—Ź Our success depends on our ability to retain our managerial personnel and to attract additional personnel.
â—Ź We market and sell, and plan to market and sell, our products in numerous international markets. If we are unable to manage our international operations effectively, our business, financial condition and results of operations could be adversely affected.
â—Ź Our financial results may vary significantly from period-to-period due to long and unpredictable sales cycles for some of our products and the cyclical nature of certain end-markets into which we sell our products, which may in turn lead to volatility in our stock price.
â—Ź Businesses and consumers might not adopt alternative energy solutions as a means for obtaining their electricity and power needs, and therefore our revenues may not increase, and we may be unable to achieve and then sustain profitability.
â—Ź The success of our business depends on our ability to develop and protect our intellectual property rights, which could be expensive.
â—Ź We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our business.
● If our shareholders’ equity falls below the minimum requirement, our common stock may be delisted from the NYSE Amex, which would cause our common stock to become less liquid.
â—Ź We have never paid cash dividends and do not intend to do so.
For further information concerning these risks and uncertainties see the Risk Factors sections of our Annual Report on Form 10-K for the year ended June 30, 2011 and in any subsequently filed Quarterly Reports on Form 10-Q.
New Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board (“FASB”) issued an update (“ASU”) to Accounting Standard Codification (“ASC”) Topic 350, “Intangibles — Goodwill and Other.” This ASU amends the guidance in ASC 350-20 on testing for goodwill impairment. The revised guidance allows entities testing for goodwill impairment to have the option of performing a qualitative assessment before calculating the fair value of the reporting unit. The ASU does not change how goodwill is calculated or assigned to reporting units, nor does it revise the requirement to test annually for impairment. The ASU is limited to goodwill and does not amend the annual requirement for testing other indefinite-lived intangible assets for impairment. The ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We will adopt this ASU for our 2012 goodwill impairment testing. We do not expect this ASU to have a material impact, if any, on our consolidated financial statements.
In June 2011, the FASB issued new accounting guidance related to the presentation of comprehensive income (loss) that eliminates the current option to report other comprehensive income (loss) and its components in the statement of changes in equity. Under this guidance, an entity can elect to present items of net income (loss) and other comprehensive income (loss) in one continuous statement or two consecutive statements. This guidance is effective for us beginning July 1, 2012. We do not believe the adoption of this guidance will have a material effect on our consolidated financial statements and related disclosures.
In May 2011, the FASB issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between accounting principles generally accepted in the United States (U.S. GAAP) and International Financial Reporting Standards. This guidance includes amendments that clarify the application of existing fair value measurements and disclosures, in addition to other amendments that change principles or requirements for fair value measurements or disclosures. This guidance is effective for us beginning January 1, 2012. The adoption of this guidance did not have a material effect on our consolidated financial statements and related disclosures.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America and related disclosures require management to make estimates and assumptions.
We believe that the following are our most critical accounting estimates and assumptions the Company must make in the preparation of its consolidated financial statements and related disclosures:
Accounts Receivable
The Company records allowances for doubtful accounts based on customer-specific analysis and general matters such as current assessments of past due balances and economic conditions.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market and consist of raw materials, work-in-progress and finished goods held for resale.
Intangible Assets
Intangible assets generally result from business acquisitions. The Company accounted for the January 21, 2011 acquisition of substantially all of the net assets of Tier Electronics LLC by assigning the purchase price to identifiable tangible and intangible assets and liabilities. Assets acquired and liabilities assumed were recorded at their estimated fair values. Other intangible assets consist of a non-compete agreement, license agreement, and trade secrets.
Amortization is recorded for other intangible assets with determinable lives. Other intangible assets are amortized using the straight line method over the three year estimated useful lives of the respective assets.
Goodwill
Goodwill is recognized as the excess cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed. Goodwill is not amortized but reviewed for impairment annually as of June 30 or more frequently if events or changes in circumstances indicate that its carrying value may be impaired. These conditions could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.
Testing for the impairment of goodwill involves a two-step process. The first step of the impairment test requires the comparing of a reporting units’ fair value to its carrying value. If the carrying value is less than the fair value, no impairment exists and the second step is not performed. If the carrying value is higher than the fair value, there is an indication that impairment may exist and the second step must be performed to compute the amount of the impairment. In the second step, the impairment is computed by estimating the fair values of all recognized and unrecognized assets and liabilities of the reporting unit and comparing the implied fair value of reporting unit goodwill with the carrying amount of that unit’s goodwill.
Impairment of Long-Lived Assets
In accordance with FASB ASC Topic 360, "Impairment or Disposal of Long-Lived Assets," the Company assesses potential impairments to its long-lived assets including property, plant and equipment and intangible assets when there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable.
If such an indication exists, the recoverable amount of the asset is compared to the asset’s carrying value. Any excess of the asset’s carrying value over its recoverable amount is expensed in the statement of operations. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate.
Warranty Obligations
The Company typically warrants its products for twelve months after installation or eighteen months after date of shipment, whichever first occurs. Warranty costs are provided for estimated claims and charged to cost of product sales as revenue is recognized. Warranty obligations are also evaluated quarterly to determine a reasonable estimate for the replacement of potentially defective materials of all energy storage systems that have been shipped to customers.
While the Company actively engages in monitoring and improving its evolving battery and production technologies, there is only a limited product history and relatively short time frame available to test and evaluate the rate of product failure. Should actual product failure rates differ from the Company’s estimates, revisions are made to the estimated rate of product failures and resulting changes to the liability for warranty obligations. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise.
During the year ended June 30, 2010, battery stack manufacturing issues were discovered as a result of an internal test failure. As a result, the Company has implemented several manufacturing process changes to eliminate the potential for future failures and has adjusted its warranty obligations accordingly. We will adjust our warranty rates in future periods as these processes are implemented and tested.
Revenue Recognition
Revenues are recognized when persuasive evidence of a contractual arrangement exits, delivery has occurred or services have been rendered, the seller’s price to buyer is fixed and determinable, and collectability is reasonably assured. The portion of revenue related to installation and final acceptance, is deferred until such installation and final customer acceptance are completed.
For sales arrangements containing multiple elements (products or services), revenue relating to undelivered elements is deferred at the estimated fair value until delivery of the deferred elements. To be considered a separate element, the product or service in question must represent a separate unit under SEC Staff Accounting Bulletin 104, and fulfill the following criteria: the delivered item(s) has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of the undelivered item(s); and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transaction is deferred until all elements are delivered. Revenue from time and materials based service arrangements is recognized as the service is performed.
The portion of revenue related to engineering and development is recognized ratably upon delivery of the goods or services pertaining to the underlying contractual arrangement or revenue is recognized as certain activities are performed by the Company over the estimated performance period.
The Company charges shipping and handling fees when products are shipped or delivered to a customer, and includes such amounts in net revenues. The Company reports its revenues net of estimated returns and allowances.
Revenues from government funded research and development contracts are recognized proportionally as costs are incurred and compared to the estimated total research and development costs for each contract. In many cases, the Company is reimbursed only a portion of the costs incurred or to be incurred on the contract. Government funded research and development contracts are generally multi-year, cost-reimbursement and/or cost-share type contracts. The Company is generally reimbursed for reasonable and allocable costs up to the reimbursement limits set by the contract.
Income Taxes
The Company records deferred income taxes in accordance with FASB ASC Topic 740, “Accounting for Income Taxes.” This ASC requires recognition of deferred income tax assets and liabilities for temporary differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted tax rates in effect for the year in which the differences are expected to reverse. The Company establishes a valuation allowance when necessary to reduce deferred income tax assets to the amount expected to be realized.
The Company applies a more-likely-than-not recognition threshold for all tax uncertainties as required under FASB ASC Topic 740, which only allows the recognition of those tax benefits that have a greater than fifty percent likelihood of being sustained upon examination by the taxing authorities.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. These estimates and assumptions 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 amount of revenues and expenses during the reporting period. It is reasonably possible that the estimates we have made may change in the near future. Significant estimates underlying the accompanying consolidated financial statements include those related to:
â—Ź the timing of revenue recognition;
â—Ź the allowance for doubtful accounts;
â—Ź provisions for excess and obsolete inventory;
â—Ź the lives and recoverability of property, plant and equipment and other long-lived assets such as goodwill and other intangible assets;
â—Ź contract costs and reserves;
â—Ź warranty obligations;
â—Ź income tax valuation allowances;
â—Ź stock-based compensation; and
â—Ź fair values of assets acquired and liabilities assumed in a business combination.
Results of Operations
Three months ended March 31, 2012 compared with the three months ended March 31, 2011:
Revenue and Other income:
Our revenues for the three months ended March 31, 2012 and March 31, 2011 were $1,645,291 and $205,971, respectively. This increase of $1,439,320 was the result of a $723,954 increase in commercial product sales and a $715,366 increase in engineering and development revenues as compared to the three months ended March 31, 2011. The increase in commercial product sales principally consisted of sales of ZBB EnerStore and ZBB EnerSection systems, and sales attributable to our Tier Electronics Power Conversion Systems business which we acquired in January 2011. Engineering and development revenues for the 2012 period consisted primarily of revenue recognized under the Honam Collaboration agreement which is being recognized over the estimated performance period through June 2012.
Other income for the three months ended March 31, 2012 reflects an increase in interest income of $821 compared to the three months ended March 31, 2011, due primarily to increased investment balances and $702 equity in loss of investee company.
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Fund Letters
