Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For thequarterly period ended March 31, 2010**

 

**OR**

 

| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                to                 **

 

**Commissionfile number: 001-34463**

 

**A123 Systems, Inc.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                                                                      | ** ** | **04-3583876**                        |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or  organization)                                                  |       | (I.R.S. Employer  Identification No.) |
|                                                                                                              |       |                                  |
| **A123  Systems, Inc.**

**Arsenal  on the Charles**

**321  Arsenal Street**

**Watertown,  Massachusetts** | ** ** | **02472**                             |
| (Address of principal  executive offices)                                                                         |       | (Zip Code)                            |

 

**617-778-5700**

(Registrant’s telephonenumber, including area code)

 

 

(Former name, formeraddress and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x  No o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding12 months (or for such shorter period that the registrant was required tosubmit and post such files). Yes o  No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):

 

| Large accelerated  filer  o               |   | Accelerated filer   o         |
|------------------------------------------------|--------|------------------------------------|
|                                           |   |                               |
| Non-accelerated  filer  x                 |   | Smaller reporting  company  o |
| (Do not check if a  smaller reporting company) |   |                               |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of May 7, 2010, there were 104,341,278 sharesof the registrant’s Common Stock, par value $.001 per share, outstanding.

 

 

 

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**A123Systems, Inc.Quarterly Report on Form 10-QFor the Quarterly Period Ended March 31, 2010**

 

**INDEX**

 
| ** **                                                                                          | ** ** | **PAGE**   |
|-----------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                          | ** ** | **NUMBER** |
| **PART I.  FINANCIAL INFORMATION**                                                             |
|                                                                                                |       |       |
| ITEM 1:  Financial Statements (Unaudited)                                                           |       |       |
| Condensed  Consolidated Balance Sheets                                                              |       | 1          |
| Condensed Consolidated  Statements of Operations                                                    |       | 2          |
| Condensed Consolidated Statements of Stockholders’  (Deficit) Equity                           |       | 3          |
| Condensed Consolidated Statements of Cash Flows                                                     |       | 4          |
| Notes to Condensed Consolidated Financial Statements                                                |       | 5          |
|                                                                                                |       |       |
| ITEM 2: Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       | 14         |
| ITEM 3: Quantitative and Qualitative Disclosures about  Market Risk                                 |       | 23         |
| ITEM 4T: Controls and Procedures                                                                    |       | 24         |
|                                                                                                |       |       |
| **PART II.  OTHER INFORMATION**                                                                |
| ITEM  1: Legal Proceedings                                                                          |       | 24         |
| ITEM  1A: Risk Factors                                                                              |       | 26         |
| ITEM 2: Unregistered Sales of Equity Securities and  Use of Proceeds                                |       | 46         |
| ITEM 6:  Exhibits                                                                                   |       | 47         |
| Signatures                                                                                          |       | 48         |
|                                                                                                |       |       |
| EX-31.1  CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act                   |       |       |
| EX-31.2  CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act                   |       |       |
| EX-32.1  CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act                   |       |       |
| EX-32.2  CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act                   |       |       |

 

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**Part I. Financial Information**

 

**Item 1. Financial Statements**

 

**A123Systems, Inc.Condensed Consolidated Balance Sheets(in thousands, except share and per share data)**

**(Unaudited)**

 
| ** **                                                                                                                                                                                           | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **2009**              | ** ** | **2010**           | ** ** |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| **ASSETS**                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **         | ** ** |
| Current assets:                                                                                                                                                                                      |       |                  |       |               |       |
| Cash and cash equivalents                                                                                                                                                                            |       | $                     | 457,122    |               | $          | 410,517 |   |
| Restricted cash                                                                                                                                                                                      |       | 1,742                 |       | 824                |       |
| Accounts receivable, net                                                                                                                                                                             |       | 17,718                |       | 16,543             |       |
| Inventory                                                                                                                                                                                            |       | 37,438                |       | 33,809             |       |
| Prepaid expenses and other current assets                                                                                                                                                            |       | 8,895                 |       | 8,368              |       |
| Total current assets                                                                                                                                                                                 |       | 522,915               |       | 470,061            |       |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| Property, plant and equipment, net                                                                                                                                                                   |       | 71,662                |       | 78,132             |       |
| Goodwill                                                                                                                                                                                             |       | 9,581                 |       | 9,581              |       |
| Intangible assets, net                                                                                                                                                                               |       | 1,254                 |       | 878                |       |
| Other assets                                                                                                                                                                                         |       | 11,698                |       | 16,988             |       |
| Restricted cash                                                                                                                                                                                      |       | 980                   |       | 2,237              |       |
| Investment (including cash held in escrow)                                                                                                                                                           |       | —                |       | 18,553             |       |
| Total assets                                                                                                                                                                                         |       | $                     | 618,090    |               | $          | 596,430 |   |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                       | ** ** | ** **            | ** ** | ** **         | ** ** |
| Current liabilities:                                                                                                                                                                                 |       |                  |       |               |       |
| Revolving credit lines                                                                                                                                                                               |       | $                     | 8,000      |               | $          | 8,000 |   |
| Current portion of long-term debt                                                                                                                                                                    |       | 6,456                 |       | 5,165              |       |
| Current portion of capital lease obligations                                                                                                                                                         |       | 411                   |       | 504                |       |
| Accounts payable                                                                                                                                                                                     |       | 16,475                |       | 17,127             |       |
| Accrued expenses                                                                                                                                                                                     |       | 11,689                |       | 14,960             |       |
| Other current liabilities                                                                                                                                                                            |       | 1,859                 |       | 2,013              |       |
| Deferred revenue                                                                                                                                                                                     |       | 7,543                 |       | 2,883              |       |
| Deferred rent                                                                                                                                                                                        |       | 58                    |       | 36                 |       |
| Total current liabilities                                                                                                                                                                            |       | 52,491                |       | 50,688             |       |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| Long-term debt, net of current portion                                                                                                                                                               |       | 7,438                 |       | 6,079              |       |
| Capital lease obligations, net of current portion                                                                                                                                                    |       | 193                   |       | 506                |       |
| Deferred revenue, net of current portion                                                                                                                                                             |       | 26,142                |       | 25,690             |       |
| Deferred rent, net of current portion                                                                                                                                                                |       | 630                   |       | 1,023              |       |
| Other long-term liabilities                                                                                                                                                                          |       | 2,866                 |       | 4,969              |       |
| Total liabilities                                                                                                                                                                                    |       | 89,760                |       | 88,955             |       |
| ** **                                                                                                                                                                                           | ** ** | ** **            | ** ** | ** **         | ** ** |
| Commitments and contingencies (Note 7)                                                                                                                                                               | ** ** | ** **            | ** ** | ** **         | ** ** |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| Stockholders’ equity:                                                                                                                                                                           |       |                  |       |               |       |
| Preferred stock, $0.001 par value—5,000,000 shares  authorized; 0 shares issued and outstanding at December 31, 2009 and  March 31, 2010                                              |       | —                |       | —             |       |
| Common stock, $0.001 par value—250,000,000 shares  authorized; 102,606,088 and 103,824,477 shares issued and outstanding at  December 31, 2009 and March 31, 2010,  respectively |       | 103                   |       | 104                |       |
| Additional paid-in capital                                                                                                                                                                           |       | 767,694               |       | 776,088            |       |
| Accumulated deficit                                                                                                                                                                                  |       | (238,668              | )          | (267,693           | )          |
| Accumulated other comprehensive loss                                                                                                                                                                 |       | (909                  | )          | (1,057             | )          |
| Total A123 Systems, Inc. stockholders’ equity                                                                                                                                              |       | 528,220               |       | 507,442            |       |
| Noncontrolling interest                                                                                                                                                                              |       | 110                   |       | 33                 |       |
| Total stockholders’ equity                                                                                                                                                                      |       | 528,330               |       | 507,475            |       |
|                                                                                                                                                                                                 |       |                  |       |               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                      |       | $                     | 618,090    |               | $          | 596,430 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

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**A123Systems, Inc.Condensed Consolidated Statements of Operations**

**(inthousands, except per share data)**

**(Unaudited)**

** **
| ** **                                                                   | ** ** | **Three  Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**      | ** ** |
| ** **                                                                   | ** ** | **2009**                | ** ** | **2010** | ** ** |
| Revenue:                                                                     |       |                    |       |   |   |
| Product                                                                      |       | $                       | 20,121     |   | $ | 19,774 |   |
| Services                                                                     |       | 3,099                   |       | 4,694 |   |
| Total revenue                                                                |       | 23,220                  |       | 24,468 |   |
| Cost of revenue:                                                             |       |                    |       |   |   |
| Product                                                                      |       | 19,570                  |       | 22,354 |   |
| Services                                                                     |       | 1,844                   |       | 4,155 |   |
| Total cost of revenue                                                        |       | 21,414                  |       | 26,509 |   |
| Gross profit (loss)                                                          |       | 1,806                   |       | (2,041 | ) |
| Operating expenses:                                                          |       |                    |       |   |   |
| Research and development                                                     |       | 11,227                  |       | 14,116 |   |
| Sales and marketing                                                          |       | 1,982                   |       | 2,800 |   |
| General and administrative                                                   |       | 6,283                   |       | 8,240 |   |
| Production start-up                                                          |       | —                  |       | 1,811 |   |
| Total operating expenses                                                     |       | 19,492                  |       | 26,967 |   |
| Operating loss                                                               |       | (17,686                 | )          | (29,008 | ) |
| Other income (expense):                                                      |       |                    |       |   |   |
| Interest expense, net                                                        |       | (218                    | )          | (218 | ) |
| (Loss) gain on foreign exchange                                              |       | (788                    | )          | 245 |   |
| Unrealized loss on preferred stock warrant  liability                        |       | (48                     | )          | — |   |
| Other income (expense), net                                                  |       | (1,054                  | )          | 27 |   |
| Loss from operations, before tax                                             |       | (18,740                 | )          | (28,981 | ) |
| Provision for income taxes                                                   |       | 144                     |       | 121 |   |
| Net loss                                                                     |       | (18,884                 | )          | (29,102 | ) |
| Less: Net loss attributable to the noncontrolling  interest                  |       | 147                     |       | 77 |   |
| Net loss attributable to A123 Systems, Inc.                             |       | $                       | (18,737    | ) | $ | (29,025 | ) |
| Accretion to preferred stock                                                 |       | (11                     | )          | — |   |
| Net loss attributable to A123 Systems, Inc.  common stockholders        |       | $                       | (18,748    | ) | $ | (29,025 | ) |
|                                                                         |       |                    |       |   |   |
| Net loss per share attributable to common  stockholders - basic and diluted: |       | $                       | (2.02      | ) | $ | (0.28 | ) |
| Weighted average number of common shares  outstanding - basic and diluted    |       | 9,267                   |       | 103,312 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

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**A123Systems, Inc.**

**CondensedConsolidated Statements of Stockholders’(Deficit) Equity**

** (in thousands, except per share data)**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Series B-1  Convertible  Preferred Stock, $0.001  Par Value** | ** ** | **Common  Stock, $0.001  Par Value** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’  (Deficit)** | ** ** | **Noncontrolling** | ** ** | **Comprehensive** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                                               | ** ** | **Shares**                                                           | ** ** | **Amount**                           | ** ** | **Shares**              | ** ** | **Amount**      | ** ** | **Capital**                           | ** ** | **Deficit**                              | ** ** | **Loss**           | ** ** | **Equity**        | ** ** | **Interest** | ** ** | **Loss** | ** ** |
|                                                                     |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| BALANCE - January 1, 2009                                           |       | 1,493                                                                |       | $                                    | 1          |                    | 7,662      |            | $          | 8                                     |       | $                                        | 19,649     |               | $          | (152,889          | )          | $ | (197 | ) | $ | (133,428 | ) | $ | 871 |   |   |   |
| Accretion of redeemable convertible preferred stock  to redemption value |       | —                                                               |       | —                               |       | —                  |       | —          |       | (11                                   | )          | —                                   |       | —             |       | (11               | )          | — |   |   |   |
| Stock-based compensation                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | 1,209                                 |       | —                                   |       | —             |       | 1,209             |       | — |   |   |   |
| Issuance of common stock                                                 |       | —                                                               |       | —                               |       | 22                      |       | —          |       | 11                                    |       | —                                   |       | —             |       | 11                |       | — |   |   |   |
| Comprehensive loss:                                                      |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| Net loss                                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | (18,737                                  | )          | —             |       | (18,737           | )          | (147 | ) | $ | (18,884 | ) |
| Foreign currency translation adjustment                                  |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | —                                   |       | 106                |       | 106               |       | 49 |   | 155 |   |
| Total comprehensive loss                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | —                                   |       | —             |       | —            |       | — |   | $ | (18,729 | ) |
|                                                                     |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| BALANCE - March 31, 2009                                            |       | 1,493                                                                |       | $                                    | 1          |                    | 7,684      |            | $          | 8                                     |       | $                                        | 20,858     |               | $          | (171,626          | )          | $ | (91 | ) | $ | (150,850 | ) | $ | 773 |   |   |   |
|                                                                     |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| BALANCE - January 1, 2010                                           |       | —                                                               |       | $                                    | —     |                    | $          | 102,606         |       | $                                     | 103        |                                     | $          | 767,694            |       | $                 | (238,668   | ) | $ | (909 | ) | $ | 528,220 |   | $ | 110 |   |   |   |
| Stock-based compensation                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | 2,487                                 |       | —                                   |       | —             |       | 2,487             |       | — |   |   |   |
| Issuance of common stock                                                 |       | —                                                               |       | —                               |       | 1,218                   |       | 1               |       | 5,907                                 |       | —                                   |       | —             |       | 5,908             |       | — |   |   |   |
| Comprehensive loss:                                                      |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| Net loss                                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | (29,025                                  | )          | —             |       | (29,025           | )          | (77 | ) | $ | (29,102 | ) |
| Foreign currency translation adjustment                                  |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | —                                   |       | (148               | )          | (148              | )          | — |   | (148 | ) |
| Total comprehensive loss                                                 |       | —                                                               |       | —                               |       | —                  |       | —          |       | —                                |       | —                                   |       | —             |       | —            |       | — |   | $ | (29,250 | ) |
|                                                                     |       |                                                                 |       |                                 |       |                    |       |            |       |                                  |       |                                     |       |               |       |              |       |   |   |   |   |
| BALANCE - March 31, 2010                                            |       | —                                                               |       | $                                    | —     |                    | 103,824    |            | $          | 104                                   |       | $                                        | 776,088    |               | $          | (267,693          | )          | $ | (1,057 | ) | $ | 507,442 |   | $ | 33 |   |   |   |
|                                                                          |            |                                                                      |            |                                      |            |                         |            |                 |            |                                       |            |                                          |            |                    |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to unaudited condensed consolidated financial statements.

 

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**A123 Systems, Inc.**

**Condensed Consolidated Statements ofCash Flows**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three  Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**      | ** ** |
| ** **                                                                   | ** ** | **2009**                | ** ** | **2010** | ** ** |
| Cash flows from operating activities:                                        |       |                    |       |   |   |
| Net loss                                                                     |       | $                       | (18,884    | ) | $ | (29,102 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                    |       |   |   |
| Depreciation and amortization                                                |       | 2,792                   |       | 3,749 |   |
| Noncash rent                                                                 |       | (38                     | )          | 371 |   |
| Noncash foreign exchange loss (gain) on  intercompany loan                   |       | 770                     |       | (335 | ) |
| Impairment of long-lived and intangible assets                               |       | —                  |       | 530 |   |
| Unrealized loss on preferred stock warrant  liability                        |       | 48                      |       | — |   |
| Amortization of debt issuance costs and noncash  interest expense            |       | 19                      |       | — |   |
| Stock-based compensation                                                     |       | 1,209                   |       | 2,487 |   |
| Changes in current assets and liabilities:                                   |       |                    |       |   |   |
| Accounts receivable                                                          |       | (4,710                  | )          | 178 |   |
| Inventory                                                                    |       | (7,755                  | )          | 3,684 |   |
| Prepaid expenses and other assets                                            |       | 1,540                   |       | 42 |   |
| Accounts payable                                                             |       | (919                    | )          | (1,987 | ) |
| Accrued expenses                                                             |       | 47                      |       | (417 | ) |
| Deferred revenue                                                             |       | (324                    | )          | (4,109 | ) |
| Other liabilities                                                            |       | 8                       |       | 944 |   |
| Net cash used in operating activities                                        |       | (26,197                 | )          | (23,965 | ) |
|                                                                         |       |                    |       |   |   |
| Cash flows from investing activities:                                        |       |                    |       |   |   |
| Increase in restricted cash                                                  |       | (2,664                  | )          | (336 | ) |
| Purchases of property, plant and equipment                                   |       | (8,474                  | )          | (13,885 | ) |
| Proceeds from government grant                                               |       | —                  |       | 5,693 |   |
| Purchase of investment (including cash held in  escrow)                      |       | —                  |       | (13,000 | ) |
| Net cash used in investing activities                                        |       | (11,138                 | )          | (21,528 | ) |
|                                                                         |       |                    |       |   |   |
| Cash flows from financing activities:                                        |       |                    |       |   |   |
| Deferred offering costs                                                      |       | (653                    | )          | — |   |
| Proceeds from government grant                                               |       | 3,000                   |       | 1,250 |   |
| Proceeds from exercise of stock options                                      |       | 11                      |       | 503 |   |
| Proceeds from issuance of long-term debt                                     |       | 1,085                   |       | — |   |
| Payments on long-term debt                                                   |       | (1,686                  | )          | (2,691 | ) |
| Payments on capital lease obligations                                        |       | (123                    | )          | (154 | ) |
| Net cash provided by (used in) financing activities                          |       | 1,634                   |       | (1,092 | ) |
|                                                                         |       |                    |       |   |   |
| Effect of foreign exchange rates on cash and cash  equivalents               |       | 98                      |       | (20 | ) |
| Net decrease in cash and cash equivalents                                    |       | (35,603                 | )          | (46,605 | ) |
| Cash and cash equivalents at beginning of period                             |       | 70,510                  |       | 457,122 |   |
| Cash and cash equivalents at end of period                                   |       | $                       | 34,907     |   | $ | 410,517 |   |
| Supplemental cash flow information - cash paid for  interest                 |       | $                       | 242        |   | $ | 253 |   |
| Noncash investing and financing activities:                                  |       |                    |       |   |   |
| Purchase of equipment under capital leases                                   |       | $                       | 156        |   | $ | 560 |   |
| Equipment purchases included in accounts payable  and accrued expenses       |       | $                       | 2,743      |   | $ | 7,556 |   |
| Issuance of common stock for investment                                      |       | $                       | —     |   | $ | 5,553 |   |

 

See notes to unauditedcondensed consolidated financial statements.

 

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**A123 Systems, Inc.**

**Notes to Condensed ConsolidatedFinancial Statements**

**(Unaudited)**

 

**1. Nature of the Business, Basis ofPresentation, and Significant Accounting Policies**

 

A123 Systems, Inc. (the ‘‘Company’’) wasincorporated in Delaware on October 19, 2001 and has its corporate officesin Watertown, Massachusetts. The Company designs, develops, manufactures andsells advanced rechargeable lithium-ion batteries and battery systems andprovides services to government agencies and commercial customers.

 

***Basis of Presentation***—The accompanying condensed consolidatedfinancial statements and the related disclosures as of March 31, 2010 andfor the three months ended March 31, 2009 and 2010 are unaudited and havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“GAAP”) and the applicable rules andregulations of the Securities and Exchange Commission (‘‘SEC’’) for interimfinancial information. Accordingly, they do not include all of the informationand notes required by GAAP for complete financial statements.  These interim condensed consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and notes thereto contained in the Company’s Annual Reporton Form 10-K filed with the SEC on March 15, 2010.  The December 31, 2009 condensedconsolidated balance sheet included herein was derived from the auditedfinancial statements as of that date, but does not include all disclosures,including notes, required by GAAP for complete financial statements.

 

The unaudited interim condensed consolidated financialstatements have been prepared on the same basis as the audited consolidatedfinancial statements and, in the opinion of management, reflect all adjustmentsof a normal recurring nature considered necessary to present fairly the Company’sfinancial position as of March 31, 2010 and results of its operations forthe three months ended March 31, 2009 and 2010, and its cash flows for thethree months ended March 31, 2009 and 2010. The interim results for thethree months ended March 31, 2010 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2010.

 

***Principles of Consolidation***—The accompanying condensed consolidatedfinancial statements include the accounts of the Company and its subsidiaries.All inter-company balances and transactions have been eliminated inconsolidation. The Company’s investment in a variable interest entity (‘‘VIE’’),of which the Company is the primary beneficiary, is consolidated.

 

***Use of Estimates***—The preparation of condensedconsolidated financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assets,liabilities, revenue, expense and related disclosures. The Company basesestimates and assumptions on historical experience and on various other factorsthat it believes to be reasonable under the circumstances. The Companyevaluates its estimates and assumptions on an ongoing basis. The Company’sactual results may differ from these estimates under different assumptions orconditions.

 

***Government Grants***—The Companyrecognizes government grants when there is reasonable assurance that theCompany will comply with the conditions attached to the grant arrangement andthe grant will be received. Government grants are recognized in the condensedconsolidated statements of operations on a systematic basis over the periods inwhich the Company recognizes the related costs for which the government grantis intended to compensate. Specifically, when government grants are related toreimbursements for cost of revenues or operating expenses, the governmentgrants are recognized as a reduction of the related expense in the condensedconsolidated statements of operations. For government grants related toreimbursements of capital expenditures, the government grants are recognized asa reduction of the basis of the asset and recognized in the condensedconsolidated statements of operations over the estimated useful life of thedepreciable asset as reduced depreciation expense.

 

The Company records government grants receivable in the condensedconsolidated balance sheets in prepaid expenses and other current assets orother assets, depending on when the amounts are expected to be received fromthe government agency. Proceeds received from government grants prior toexpenditures being incurred are recorded as restricted cash and other currentliabilities or other long-term liabilities, depending on when the Companyexpects to use the proceeds.

 

The Company classifies in the condensed consolidated statements of cashflows grant proceeds received in advance of spending for qualified expendituresas a cash flow from financing activities, as the proceeds are used to assist infunding future expenditures. Grant proceeds received as reimbursements forcapital expenditures previously incurred are classified in cash flows frominvesting activities and grant proceeds received as reimbursements foroperating expenditures previously incurred are classified in cash flows fromoperating activities.

 

***Revenue Recognition***—The Companyrecognizes revenue from the sale of products and delivery of services,including governmental contracts. Revenue is recognized when all of thefollowing criteria are met: persuasive evidence of an arrangement exists,delivery has occurred or services have been provided, the price to the buyer isfixed or determinable, and collectability is reasonably assured. If salesarrangements contain multiple elements, the Company evaluates the agreements todetermine if separate units of accounting exist within the arrangement. Ifseparate units of accounting exist within an arrangement, the Company allocatesrevenue to each element based on the relative fair value of each of theelements.

 

*ProductRevenue*

 

Product revenue is generally recognized upon transfer of title and riskof loss, which is generally upon shipment, unless an acceptance period exists.In general, the Company’s customary shipping terms are FOB shipping point orfree carrier. In instances where customer acceptance of a product is required,revenue is either recognized (i) upon shipment when the Company is able to

 

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demonstratethat the customer specific objective criteria have been met or (ii) uponthe earlier of customer acceptance or expiration of the acceptance period.

 

The Company provides warranties for its products and records theestimated costs as a cost of revenue in the period the revenue is recorded. TheCompany’s standard warranty period extends one to five years from the date ofsale, depending on the type of product purchased and its application. Thewarranties provide that the Company’s products will be free from defects inmaterial and workmanship and will, under normal use, conform to thespecifications for the product. The warranties further provide that the Companywill repair the product or provide replacement parts at no charge to thecustomer. When the Company is unable to reasonably determine its obligation forwarranty of new products, revenue from the sale of the products is deferreduntil expiration of the warranty period or until such time as the warrantyobligation can be reasonably estimated.

 

*ServicesRevenue*

 

Revenue from services is recognized as the services are performed consistentwith the performance requirements of the contract using the proportionalperformance method. Where arrangements include milestones or governmentalapproval that impact the fees payable to the Company, revenue is limited tothose amounts whereby collectability is reasonably assured. The Companyrecognizes revenue earned under time and materials contracts as services areprovided based upon actual costs incurred plus a contractually agreed-uponprofit margin. The Company recognizes revenue from fixed-price contracts usingthe proportional performance method based on the ratio of costs incurred toestimates of total expected project costs in order to determine the amount ofrevenue earned to date. Project costs are based on the direct salary and associatedfringe benefits of the employees on the project plus all direct expensesincurred to complete the project that are not reimbursed by the client. Theproportional performance method is used since reasonably dependable estimatesof the revenues and costs applicable to various stages of a contract can bemade. These estimates are based on historical experience and deliverablesidentified in the contract and are indicative of the level of benefit providedto the Company’s clients. There are no costs that are deferred and amortizedover the contract term.

 

Service revenue includes revenue derived from the execution ofcontracts awarded by the U.S. federal government, other government agencies andcommercial customers. The Company’s research and development arrangements withthe federal government or other government agencies typically require theCompany to provide pure research, in which the Company investigates designtechniques on new battery technologies. The Company’s arrangements withcommercial customers consist of arrangements where the Company is paid toenhance or modify an existing product or to develop or jointly develop a newproduct to meet a customer’s specifications.

 

The Company’s service revenue arrangements generally provide that allpre-existing or newly created intellectual property remains under the ownershipof the respective party, and that all jointly created intellectual property beowned by both parties without a duty to account for or pay royalties to theother party.

 

***Production start-up***—Production start-upexpenses consist of salaries and personnel-related costs, site selection costs,including legal and regulatory costs, rent and the cost of operating aproduction line before it has been qualified for full production, including thecost of raw materials run through the production line during the qualificationphase.  The Company expects to incurproduction start-up expenses related to its facilities in Livonia and Romulus,Michigan. The Livonia facility is expected to begin qualification forproduction in the second half of 2010. The Romulus facility is expected tobegin qualification for production in the first half of 2011.

 

***Fair Value of FinancialInstruments***—Thecarrying amount of cash, cash equivalents, restricted cash, accountsreceivable, accounts payable and accrued expenses approximates fair value dueto the short-term nature of these items. Management believes that the Company’sdebt obligations bear interest at rates which approximate prevailing marketrates for instruments with similar characteristics and, accordingly, thecarrying values for these instruments approximate fair value.

 

Fair value is an exit price, representing the amountthat would be received from the sale of an asset or paid to transfer aliability in an orderly transaction between market participants. As such, fairvalue is a market-based measurement that should be determined based onassumptions that market participants would use in pricing an asset orliability. As a basis for considering such assumptions, GAAP establishes athree-tier value hierarchy, which prioritizes the inputs used in measuring fairvalue as follows: (Level 1) observable inputs such as quoted prices in activemarkets; (Level 2) inputs other than the quoted prices in active markets thatare observable either directly or indirectly; and (Level 3) unobservable inputsin which there is little or no market data, which requires the Company todevelop its own assumptions. This hierarchy requires the Company to useobservable market data, when available, and to minimize the use of unobservableinputs when determining fair value. On a recurring basis, the Company measurescertain financial assets and liabilities at fair value, including the Company’scash equivalents.

 

The Company did not have any material items that aremeasured at fair value on a non-recurring basis under this requirement as of December 31,2009 or March 31, 2010.

 

The following tables show assets and liabilitiesmeasured at fair value on a recurring basis and the input categories associatedwith those assets and liabilities (in thousands):

 

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| ** **         | ** ** | ** **                                 | ** ** | **As  of December 31, 2009**                                      | ** ** |
|--------------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Fair  Value at  December 31, 2009** | ** ** | **Quoted  Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Asset:             |       |                                       |       |                                                                   |       |   |   |   |   |
| Money market funds |       | $                                          | 447,368    |                                                                   | $          | 447,368 |   | $ | — |   | $ | — |   |
|                    |            |                                            |            |                                                                        |            |  |  |  |  |  |  |  |  |

 
| ** **         | ** ** | ** **                         | ** ** | **As  of March 31, 2010**                                         | ** ** |
|--------------------|------------|------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Fair  Value at March  31, 2010** | ** ** | **Quoted  Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Asset:             |       |                               |       |                                                                   |       |   |   |   |   |
| Money market funds |       | $                                  | 398,404    |                                                                   | $          | 398,404 |   | $ | — |   | $ | — |   |
|                    |            |                                    |            |                                                                        |            |  |  |  |  |  |  |  |  |

 

The Company’s cash equivalents consist of money marketfunds that approximate their face value.

 

***Stock-Based Compensation***—The Company accounts for all awards,including employee and director awards, by recognizing compensation expense basedon the fair value of share-based transactions in the condensed consolidatedfinancial statements.  The Companyrecognizes compensation expense over the vesting period using a ratable method(providingthe minimumamount of compensation recorded is equal to the vested portion of the award,requiring a ratable method when necessary) and classifies these amounts in thecondensed consolidated statements of operations based on the department towhich the related employee reports. The Company uses the Black-Scholesvaluation model to calculate the fair value of stock options, utilizing variousassumptions.

 

The Company records equity instruments issued tonon-employees as expense at their fair value over the related service periodand periodically revalues the equity instruments as they vest.

 

***Net Loss Per Share***—Basic net loss per share is computed bydividing net loss by the weighted-average number of common shares outstandingduring the fiscal year. Diluted net loss per share is computed by dividing netloss by the weighted-average number of dilutive common shares outstandingduring the fiscal year. Dilutive shares outstanding are calculated by adding tothe weighted shares outstanding any potential (unissued) shares of common stockand warrants based on the treasury stock method.

 

The following potentially dilutive securities wereexcluded from the calculation of diluted net loss per share, as the effectwould have been anti-dilutive (in thousands):

 
| ** **                                                   | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                   | ** ** | **2009**           | ** ** | **2010** | ** ** |
|                                                         |       |               |       |   |   |
| Convertible preferred stock upon conversion to common  stock |       | 48,164             |       | — |   |
| Warrants to purchase redeemable convertible preferred  stock |       | 126                |       | — |   |
| Warrants to purchase common stock                            |       | 45                 |       | 45 |   |
| Options to purchase common stock                             |       | 8,145              |       | 9,465 |   |
|                                                         |       | 56,480             |       | 9,510 |   |

 

***New Accounting Pronouncements***—In June 2009, the FASB issued newaccounting guidance which modifies the existing quantitative guidance used indetermining the primary beneficiary of a VIE by requiring entities toqualitatively assess whether an enterprise is a primary beneficiary, based onwhether the entity has (i) power over the significant activities of theVIE, and (ii) an obligation to absorb losses or the right to receivebenefits that could be potentially significant to the VIE.  This guidance became effective for all newand existing VIE’s on January 1, 2010. There was no significant impact on the Company’s condensed consolidatedfinancial statements upon adopting this guidance.

 

In October 2009, the FASB issued an update to the accounting andreporting guidance for multiple-deliverable revenue arrangements. The newaccounting guidance removes the separation criterion that objective andreliable evidence of the fair value of the undelivered item must exist for thedelivered items to be considered a separate unit or separate units ofaccounting. The FASB issued update requires an entity to determine the sellingprice of qualifying deliverables based on a hierarchy of evidence. Inconsidering the hierarchy of evidence, the entity must first determine theselling prices by using vendor-specific objective evidence (“VSOE”), if itexists; otherwise, third-party evidence (“TPE”) of selling price must be used.If neither VSOE nor TPE of selling price exists for a deliverable, an entitymust use its best estimate of the selling price for that deliverable inallocating consideration among deliverables in an arrangement.  This update is effective for arrangementsentered into in the fiscal years beginning on or after June 15, 

 

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2010,unless early adoption is elected. The Company is evaluating the potentialimpact, if any, of the adoption of this update on the Company’s condensed consolidatedfinancial statements.

 

In January 2010, the FASB issued an update to the existingdisclosure requirements related to fair value measurements which requiresentities to make new disclosures about recurring or nonrecurring fair valuemeasurements including significant transfers into and out of Level 1 andLevel 2 fair value measurements and information on purchases, sales,issuances, and settlements on a gross basis in the reconciliation ofLevel 3 fair value measurements. This update is effective for annual andinterim periods beginning after December 15, 2009, except for Level 3reconciliation disclosures which are effective for annual periods beginningafter December 15, 2010.  There wasno significant impact on the Company’s condensed consolidated financialstatement disclosures for the adoption of this update as it relates todisclosures about recurring or nonrecurring fair value measurements includingsignificant transfers into and out of Level 1 and Level 2.  The Company is evaluating the potentialimpact, if any, of the adoption of disclosures on purchases, sales, issuances,and settlements on a gross basis for Level 3 fair value measurements.

 

**2.  GovernmentGrants**

 

***Center of Energy and Excellence Grant***

 

In February 2009, the State of Michigan awarded the Company a$10.0 million Center of Energy and Excellence grant. Under the agreement,the State of Michigan will provide cost reimbursement for 100% of qualifiedexpenditures incurred through November 30, 2011. Other than certainstandard conditions, there are no conditions attached to this award that willrequire repayment of amounts received if those conditions are not met. TheCompany received $3.0 million of this grant in March 2009, with theremainder to be paid based on the achievement of certain milestones in thefacility development. The Company used $2.2 million of these funds in the yearended December 31, 2009.  TheCompany used $0.8 million of these funds during the three months ended March 31,2010, of which $0.7 million and $0.1 million was recorded as an offset toproperty, plant, and equipment and operating expenses, respectively.  In addition, the Company incurred allowablecosts of $1.4 million during the three months ended March 31, 2010, whichwas recorded as a receivable in prepaid expense and other current assets and asan offset to property, plant, and equipment.

 

***Michigan Economic Growth Authority***

 

In April 2009, Michigan Economic Growth Authority (“MEGA”) offeredthe Company certain tax incentives, which can be used to offset the MichiganBusiness Tax owed in a tax year, carried forward for the number of yearsspecified by the agreement, or be paid to the Company in cash at the timeclaimed to the extent the Company does not owe a tax. The terms and conditionsof the *High-Tech Credit* wereestablished in October 2009 and the *CellManufacturing Credit* in November 2009.

 

*High Tech Credit*—The *High-Tech Credit* agreement provides theCompany with a 15-year tax credit, beginning with the 2011 fiscal year. Thecredit will be calculated as qualified wages and benefits, multiplied by theMichigan personal income tax rate beginning in the tax year the credit issought. The proceeds to be received by the Company will be based on the numberof jobs created, qualified wages paid and tax rates in effect over the15 year period. The tax credit is subject to a repayment provision in theevent the Company relocates a substantial portion of the jobs outside the stateof Michigan within 15 years from the date the Company first receives thecredit. There is no impact to the condensed consolidated financial statementsas of March 31, 2010.

 

*Cell Manufacturing Credit*—The *Cell Manufacturing Credit* agreementauthorizes a credit for the Company equal to 50% of capital investment expensesrelated to the construction of the Company’s integrated battery cellmanufacturing facilities in Michigan, commencing January 1, 2009, up to amaximum of $100.0 million over a four year period. The credit shall notexceed $25.0 million per year and can be submitted for reimbursementbeginning in tax year 2012. The Company is required to create 300 jobs no laterthan December 31, 2016 for the tax credit to be non-refundable. The taxcredit is subject to a repayment provision in the event the Company relocates51% or more of the 300 jobs outside of the state of Michigan within three yearsafter the last year the tax credit is received. Through March 31, 2010,the Company has incurred $18.7 million in expenses related to theconstruction of the Livonia and Romulus facilities. When the Company has metthe filing requirements for the tax year ending December 31, 2012, theCompany expects to receive $9.4 million in refundable tax credits relatedto these expenses. There is no impact to the condensed consolidated financialstatements as of March 31, 2010.

 

***Michigan Economic Growth Authority Loan***

 

The State of Michigan also granted the Company a low interestforgivable loan of up to $4.0 million effective August 2009 with theobjective of conducting advance vehicle technology operations to promote andenhance job creation within the State of Michigan. To receive advances underthe loan, the Company is required to achieve certain key milestones related tothe development of the manufacturing facility. The note will accrue interest of1% per annum from the date of the initial advance, and the Company will have noobligation to pay any principal or interest until August 2012. If theCompany creates 350 full time jobs by August 2012 and maintains the jobsin the State of Michigan for three years after the end of the loan, the entiredebt will be forgiven. The Company has not yet met the first milestone requiredto receive the initial advance from the loan, and as such, there is no impactto the condensed consolidated financial statements as of March 31, 2010.

 

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***U.S. Department of Energy Battery Initiative***

 

In December 2009, the Company entered into an agreementestablishing the terms and conditions of a $249.1 million grant awardedunder the Department of Energy (“DOE”) Battery Initiative to supportmanufacturing expansion of new lithium-ion battery manufacturing facilities inMichigan. Under the agreement, the DOE will provide cost reimbursement for 50%of qualified expenditures incurred from December 1, 2009 to November 30,2012. The agreement also provides for reimbursement of pre-award costs incurredfrom June 1, 2009 to November 30, 2009. Other than certain standardconditions, there are no conditions attached to this award that will requirerepayment of amounts received if those conditions are not met. For the threemonths ended March 31, 2010, the Company received $6.1 million inreimbursement for costs incurred in 2009. The Company has incurred additional allowable costs in the three monthsended March 31, 2010, entitling the Company to receive $3.1 millionin reimbursement.  The Company recordedthe $3.1 million receivable in prepaid expenses and other current assetsin the consolidated balance sheets of which $2.5 million is an offset todeposits for purchases of equipment, included in other long-term assets in the condensedconsolidated balance sheets, and the remaining $0.6 million as an offsetto operating expenses in the condensed consolidated statements of operations.

 

***Department of Energy, Labor and Economic Growth (“DELEG”)***

 

In December 2009, the State of Michigan awarded the Company$2.0 million to assist in funding the Company’s smart grid stabilizationproject, the purpose of which is to develop and improve the quality ofapplication of energy efficient technologies and to create or expand the marketfor such technologies. The Company received the initial advance of$0.9 million in December 2009, and through March 31, 2010, theCompany incurred $0.1 million in allowable costs which was recorded as anoffset to operating expenses.  TheCompany will receive the remainder of the grant upon expending 90% of theinitial advance.  As of March 31, 2010,$0.8 million is included in short-term restricted cash and other currentliabilities.

 

***City of Livonia Personal Property Tax Exemption***

 

The Company entered into an agreement with the City of Livonia allowing100% exemption from personal property taxes by Livonia on all new personalproperty during the exemption period commencing on December 31, 2009 andcontinuing for fourteen years through December 31, 2023. The Company isrequired to invest at least $24.0 million in personal property and createor locate 350 new jobs in the eligible district to receive the exemption. Ifthe Company relocates operations, jobs or activities outside the City ofLivonia on or before May 31, 2016 such that employment is 175 jobs orless, the Company is required to repay all or a portion of the property taxesexempted. There is no impact to the condensed consolidated financial statementsas of March 31, 2010 as a result of this agreement.

 

**3.  Inventory**

 

Inventory consists of the following (in thousands):

** **
| ** **      | ** ** | **December 31,  2009** | ** ** | **March 31,  2010** | ** ** |
|-----------------|------------|-----------------------------|------------|--------------------------|------------|
| Raw materials   |       | $                           | 7,726      |                     | $          | 6,952 |   |
| Work-in-process |       | 25,139                      |       | 25,215                   |       |
| Finished goods  |       | 4,573                       |       | 1,642                    |       |
|            |       | $                           | 37,438     |                     | $          | 33,809 |   |

 

**4. Property, Plant and Equipment**

 

Property, plant and equipment consists of thefollowing (in thousands):

 
| ** **                                     | ** ** | **December 31,  2009** | ** ** | **March 31,  2010** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Computer equipment and software                |       | $                           | 7,005      |                     | $          | 7,861 |   |
| Furniture and fixtures                         |       | 1,585                       |       | 1,854                    |       |
| Automobiles                                    |       | 385                         |       | 385                      |       |
| Machinery and equipment                        |       | 66,934                      |       | 70,662                   |       |
| Buildings                                      |       | 6,900                       |       | 6,950                    |       |
| Leasehold improvements                         |       | 9,224                       |       | 10,943                   |       |
| Construction in progress                       |       | 8,026                       |       | 11,217                   |       |
| Property, plant and equipment, at cost         |       | 100,059                     |       | 109,872                  |       |
| Less accumulated depreciation and amortization |       | 28,397                      |       | 31,740                   |       |
| Property, plant and equipment, net             |       | $                           | 71,662     |                     | $          | 78,132 |   |

 

TheCompany has deposits for equipment not yet received of $17.0 million and $23.0million at December 31, 2009 and March 31, 2010, respectively, included withinother assets in the condensed consolidated balance sheets.

 

Computer equipment under capital lease consists of thefollowing (in thousands):

 

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| ** **                               | ** ** | **December 31,  2009** | ** ** | **March 31,  2010** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Computer equipment and software, at cost |       | $                           | 1,624      |                     | $          | 1,872 |   |
| Less accumulated depreciation            |       | (855                        | )          | (781                     | )          |
| Computer equipment and software, net     |       | $                           | 769        |                     | $          | 1,091 |   |

 

Depreciation expense for the three months ended March 31,2009 and 2010 was $2.4 million and $3.6 million, respectively.

 

**5.**** Intangible Assets**

 

Intangible assets consist of the following (inthousands):

 
| ** **                   | ** ** | ** **       | ** ** | **December 31,  2009** | ** ** | **March 31,  2010** | ** ** |
|------------------------------|------------|------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                   | ** ** | **Useful  Life** | ** ** | ** **                  | ** ** | **Accumulated**          | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| **Intangible  Asset Class**  | ** ** | **(Years)**      | ** ** | **Gross**                   | ** ** | **Amortization**         | ** ** | **Net** | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Contractual  backlogs        |       | 1-3              |       | $                           | 497        |                     | $          | 497 |   | $ | — |   | $ | 497 |   | $ | 497 |   | $ | — |   |
| Customer  relationships      |       | 5-17             |       | 640                         |       | 394                      |       | 246 |   | 648 |   | 409 |   | 239 |   |
| Patented  technology         |       | 4-5              |       | 2,473                       |       | 1,855                    |       | 618 |   | 2,528 |   | 2,004 |   | 524 |   |
| Specialty-trained  workforce |       | 4                |       | 60                          |       | 44                       |       | 16 |   | 60 |   | 47 |   | 13 |   |
| Trademarks  and trade names  |       | Indefinite       |       | 374                         |       | —                   |       | 374 |   | 102 |   | — |   | 102 |   |
|                         |       |             |       | $                           | 4,044      |                     | $          | 2,790 |   | $ | 1,254 |   | $ | 3,835 |   | $ | 2,957 |   | $ | 878 |   |

 

Amortization expense for intangible assets totaled$0.2 million for three months ended March 31, 2009 and 2010, respectively.The remaining net book value of the intangible assets will be amortized over aweighted-average period of approximately 2.97 years as of December 31,2009.

 

**6. Investment**

 

In January 2010, the Company entered into anagreement to invest approximately $23.0 million, consisting of $13.0 million incash and approximately $10.0 million of the Company’s common stock, in thepreferred stock of a maker of plug-in hybrid electric vehicles in the UnitedStates (the “Automaker”).  As of March31, 2010, the Company had invested $18.6 million in common stock and cash.  Cash consideration of $3.0 million and 213,198of the 479,282 shares issued as stock consideration was held in escrow pendingthe resolutions of various contingencies including the closing of the Automaker’sloan with the DOE as of March 31, 2010. During April 2010, the Automaker’s loan with the DOE was closed andthe remaining consideration was released from the escrow account to the Automaker.   The Company is accounting for its investmentunder the cost method.

 

In conjunction with the investment, the Companyentered into a supply agreement with the Automaker to supply battery systemsfor its plug-in hybrid electric vehicle programs. Through March 31, 2010,the Company has not recorded any revenue or made any shipments of products tothe Automaker.  When the Company beginsshipping product to the Automaker, the Company will recognize revenue withinproduct revenue on the condensed consolidated statements of operations, whenall revenue****recognition criteria are met.

 

**7****. Commitments and Contingencies**

 

***Litigation***—In November 2005,the Company received a letter asserting that it was infringing upon certainU.S. patents. In April 2006, the Company commenced an action in the UnitedStates District Court for the District of Massachusetts seeking a declaratoryjudgment that the patents in question were not infringed by the Company’sproducts and that the patents claiming to be infringed upon are invalid. On September 11,2006, a countersuit was filed against the Company and two of its business partnersin the United States District Court for the Northern District of Texas alleginginfringement of these patents. In October 2006 and January 2007, theU.S. Patent and Trademark Office (“PTO”) granted the Company’s request forreexamination of the two patents. In January and February 2007, thetwo suits were stayed pending the reexamination. The reexaminations of the twopatents were concluded on April 15, 2008 and May 12, 2009,respectively. The Company filed a motion to re-open the litigation in the UnitedStates District Court for the District of Massachusetts on June 11, 2009.On September 28, 2009, the Massachusetts court entered an order denyingthat motion, which the Company appealed on October 27, 2009 to the UnitedStates Court of Appeals for the Federal Circuit.  On July 22, 2009, the Company was sent aproposed Second Amended Complaint which the complainants intend to seek leaveto file with the Texas court in light of the PTO’s reexaminations. On August27, 2009, Hydro-Quebec and UT filed a Motion for Leave to File Second AmendedComplaint and Jury Demand in the United States District Court for the NorthernDistrict of Texas and the Company was granted several unopposed extensions tofile its response. Hydro-Quebec and UT filed for leave to file an AmendedMotion for Leave to File Second Amended Complaint and Jury Demand on April 1,2010 and the Company filed its opposition to this application on April 22,2010. The judge has requested a status hearing with the parties on May 14,2010. The Company has agreed to indemnify two business partners for their legalcosts in defending this litigation and any damages that may be awarded. TheCompany is unable to predict the outcome of this matter, and therefore noaccrual has been established for this contingency.

 

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**8.  IncomeTaxes**

 

The Company provides forincome taxes at the end of each interim period based on the estimated effectivetax rate for the full fiscal year. Cumulative adjustments to the Company’sestimate are recorded in the interim period in which a change in the estimatedannual effective rate is determined.  The Company’s provision for income taxesconsists primarily of foreign taxes.

 

As of December 31, 2009, the Company has provideda liability of $0.6 million for uncertain tax positions related to variousforeign income tax matters which are classified as other long-term liabilitiesin the Company’s condensed consolidated balance sheets. The uncertain tax positionsas of December 31, 2009 exclude interest and penalties of $0.2 millionwhich are classified as other long-term liabilities on the Company’s condensedconsolidated balance sheets. These uncertain tax positions would impact theCompany’s effective tax rate, if recognized. The Company does not expect thatthe amounts of uncertain tax positions will change significantly within thenext 12 months.

 

The Company recognizes interest and penalties accruedrelated to uncertain tax positions in the provision for income taxes. Duringthe three months ended March 31, 2009 and 2010, the Company recognizedapproximately $13,000 and $14,000 in penalties and interest, respectively. TheCompany had approximately $0.2 million for the payment of penalties andinterest accrued at March 31, 2010.

 

**9. Financing Arrangements**

 

**Long-Term Debt**—Long-term debtconsists of the following (in thousands):

 
| ** **                         | ** ** | **December 31,  2009** | ** ** | **March 31,  2010** | ** ** |
|------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| Term loan                          |       | $                           | 12,069     |                     | $          | 10,820 |   |
| Enerland debt                      |       |                        |       |                     |       |
| Term loan 2                        |       | 1,289                       |       | —                   |       |
| Technology funds loan              |       | 107                         |       | 88                       |       |
| Korean government loans            |       | 429                         |       | 336                      |       |
| Total                              |       | 13,894                      |       | 11,244                   |       |
| Less amounts classified as current |       | 6,456                       |       | 5,165                    |       |
| Long-term debt                     |       | $                           | 7,438      |                     | $          | 6,079 |   |

 

***TermLoan***—TheCompany has a term loan agreement with a financial institution that is also acommon shareholder. The Company has a term loan facility under the term loanagreement for $15.0 million.  The term loan facility is repayable over a36-month period and accrues interest at prime plus 0.75%.  As of March 31,2010, the Company has approximately $10.8 million outstanding under this creditfacility.

 

Theterm loan agreement requires the Company to comply with certain financialcovenants, which include a minimum liquidity ratio calculation. The term loanagreement is collateralized by substantially all assets of the Company,excluding intellectual property, property and equipment owned as of December 31,2005 and certain equipment located in China.

 

***Enerland debt***—The Company has the followingoutstanding obligations for its Enerland subsidiary:

 

·*Term loan 2*—On March 5,2008, the Company entered into two loan agreements with a financial institutionin the amounts of $1.3 million and $0.3 million which mature in 2010. The loanshave a variable interest rate.  Term loan2 was paid off during February 2010.

 

·*Technology funds loan*—The Company has atechnology funds loan agreement amounting to $0.1 million with a variableinterest rate. The weighted average interest rate for the loan as of March 31,2010 was 4.66%. The loan matures in August 2011.

 

·*Korean government loans*—As a part of theKorean government’s initiative to promote and encourage the development ofstart-up companies in certain high technology industries, high technologystart-up companies with industry leading technology or products are eligiblefor government loans. Certain grantsare refundable, depending on the successfuldevelopment and commercialization of the technology or products, and a companyreceiving such government grants is required to refund between 20% and 30% ofthe grants received for such development.

 

**Revolving Credit Facilities**—The Company entered into a line ofcredit (“LOC”) for $8.0 million with a financial institution that is also acommon stockholder. The line of credit accrues interest at prime (3.25% at December 31,2009 and March 31, 2010).  Theoutstanding balance at December 31, 2009 and March 31, 2010 was $8.0million. The LOC has a maturity date of September 24, 2010, and theCompany is required to comply with the same financial covenants required underthe Term Loan mentioned above.

 

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**10. Stock-Based Compensation**

 

During 2009, theCompany’s Board of Directors approved the 2009 Stock Incentive Plan (the “2009Plan”) which became effective on the closing of the Company’s initial publicoffering (“IPO”) on September 24, 2009. The 2009 Plan originally provided for the grant of qualified incentivestock options and nonqualified stock options or other awards to the Company’semployees, officers, directors, and outside consultants.  Up to an aggregate of 3,000,000 shares ofCompany’s common stock, subject to increase on an annual basis, are reservedfor future issuance under the 2009 Plan. Shares of common stock reserved for issuance under the Company’s2001Stock Incentive Plan (the “2001 Plan”) that remained available for issuanceimmediately prior to closing of the IPO and any shares of common stock subjectto awards under the 2001 Plan that expired, terminated, or were otherwiseforfeited, canceled or repurchased by the Company prior to being fullyexercised were added to the number of shares available under the 2009 Plan, upto a maximum of 500,000 shares.  During the yearended December 31, 2009,  and thethree months ended March 31, 2010, 378,792 and 121,208 shares from the2001 Plan were added to the number of shares available under the 2009 Plan,respectively.  No additional shares fromthe 2001 Plan will be added to the 2009 Plan. On January 1, 2010, 5,000,000 shares were added to the 2009 Plan inconnection with the annual increase.

 

The stock optionsgenerally vest over a four-year period and expire 10 years from the date ofgrant. Upon option exercise, the Company issues shares of common stock.  As of March 31, 2010,the Company had 8,091,550 stock options available for future grant under the2009 Plan and no stock options available for future grant under the 2001 Plan.

 

The following table presents stock-based compensationexpense included in the Company’s condensed consolidated statements ofoperations (in thousands):

 
| ** **                 | ** ** | **Three  Months Ended** | ** ** |
|----------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **March 31,**      | ** ** |
| ** **                 | ** ** | **2009**                | ** ** | **2010** | ** ** |
|                       |       |                    |       |   |   |
| Cost of sales              |       | $                       | 166        |   | $ | 415 |   |
| Research and development   |       | 601                     |       | 962 |   |
| Sales and marketing        |       | 115                     |       | 298 |   |
| General and administrative |       | 327                     |       | 812 |   |
| Total                      |       | $                       | 1,209      |   | $ | 2,487 |   |

 

The Company has capitalized an immaterial amount ofstock-based compensation as a component of inventory.

 

The following table summarizes stock option activityfor the three months ended March 31, 2010:

 
| ** **                                       | ** ** | **Shares**          | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------------|------------|---------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **(In  thousands)** | ** ** | ** **                             | ** ** | ** **                                          | ** ** | **(In  thousands)**             | ** ** |
|                                             |       |                |       |                                   |       |                                                |       |                            |       |
| Outstanding - January 1, 2010               |       | 10,640              |       | $                                      | 5.98       |                                                | 7.40       |                            | $          | 175,122 |   |
| Granted                                          |       | 89                  |       | 15.36                                  |       |                                                |       |                            |       |
| Exercised                                        |       | (1,000              | )          | 1.36                                   |       |                                                |       |                            |       |
| Forfeited                                        |       | (264                | )          | 7.95                                   |       |                                                |       |                            |       |
| Outstanding - March 31, 2010                |       | 9,465               |       | $                                      | 6.50       |                                                | 7.38       |                            | $          | 70,716 |   |
| Vested or expected to vest - March 31, 2010 |       | 9,258               |       | $                                      | 6.38       |                                                | 7.31       |                            | $          | 70,051 |   |
| Options exercisable - March 31, 2010        |       | 4,976               |       | $                                      | 3.94       |                                                | 6.36       |                            | $          | 48,781 |   |

 

The Companyestimates the fair value of stock options granted using the Black-Scholesoption-pricing model and assumptions as to the fair value of the common stockon the grant date, expected term, expected volatility, risk-free rate ofinterest and an assumed dividend yield. Options are granted with an exercise price equal to the fair value ofthe common stock as of the date of grant. Prior to the Company’s IPO, fair value was determined by the Board ofDirectors.  For awards grantedsubsequent to the Company’s IPO, the fair value of the common stock isgenerally determined based on the closing price of the stock on the NasdaqGlobal Market on the grant date.  In addition,due to the Company’s limited historical data, the Company estimated theexpected volatility of its common stock at the date of grant based on thehistorical volatility of comparable public companies over the option’s expectedterm. The Company calculated the expected life of options using the simplifiedmethod as prescribed by the Stock Compensation Subtopic of the FASBCodification, due to the Company’s limited historical data.  The assumed dividend yield is based upon theCompany’s expectation of not paying dividends in the foreseeable future. Therisk-free rate is based on the U.S. Treasury yield curve in effect at the timeof grant for maturities similar to the expected term. Compensation expense isamortized on a straight-line basis over the requisite service period of theoptions, which is generally four years.

 

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The Black-Scholes model assumptions for the period setforth below is as follows:

 
| ** **              | ** ** | **Three Months Ended**  | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **March 31, 2010** | ** ** |
| Risk-free interest rate |       | 3.15                    | %          |
| Expected life           |       | 6.25                    |       |
| Expected volatility     |       | 73.8                    | %          |
| Expected dividends      |       | 0                       | %          |

 

No options were granted during the three months ended March 31,2009.

 

The weighted average grant date fair value of optionsgranted during the three months ended March 31, 2010 was $10.41. Theintrinsic value of options exercised during the three months ended March 31,2009 and 2010 was $0.2 million and $17.1 million, respectively.

 

As of March 31, 2010, there was approximately$26.7 million of total unrecognized compensation cost related to non-vestedshare-based compensation arrangements granted under the plans, which isexpected to be recognized over a weighted-average period of 2.45 years.

 

The Company received $11,000 and $0.5 million in cashfrom option exercises during the three months ended March 31, 2009 and2010, respectively.

 

**11. Subsequent Events**

 

The Company has evaluated the period from March 31,2010, the date of the financial statements, to the date of the issuance andfiling, and has determined that no material subsequent events have occurredthat would affect the information presented in these financial statements orrequire additional disclosure.

 

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**Item 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

*The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with the unaudited condensed consolidated financial statements andthe related notes thereto included elsewhere in this Quarterly Report on Form 10-Qand the audited consolidated financial statements and notes thereto andmanagement’s discussion and analysis of financial condition and results ofoperations for the year ended December 31, 2009 included in our AnnualReport on Form 10-K filed with the Securities and Exchange Commission, orSEC, on March 15, 2010. This Quarterly Report on Form 10-Q contains “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, or the Exchange Act. These statements are oftenidentified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,”“intend,” “could,” “estimate,” or “continue,” and similar expressions orvariations. Such forward-looking statements are subject to risks, uncertaintiesand other factors that could cause actual results and the timing of certainevents to differ materially from future results expressed or implied by suchforward-looking statements. Factors that could cause or contribute to suchdifferences include, but are not limited to, those discussed in the section titled“Risk Factors,” set forth in Part II, Item 1A of this QuarterlyReport on Form 10-Q and set forth in Part I, Item 1A of our AnnualReport on Form 10-K filed with the SEC on March 15, 2010 andelsewhere in this Quarterly Report. The forward-looking statements in thisQuarterly Report on Form 10-Q represent our views as of the date of thisQuarterly Report on Form 10-Q. We anticipate that subsequent events anddevelopments will cause our views to change. However, while we may elect toupdate these forward-looking statements at some point in the future, we have nocurrent intention of doing so except to the extent required by applicable law.You should, therefore, not rely on these forward-looking statements asrepresenting our views as of any date subsequent to the date of this QuarterlyReport on Form 10-Q.*

 

**Overview**

 

We design, develop, manufacture and sell advanced, rechargeablelithium-ion batteries and battery systems. Our target markets are thetransportation, electric grid services and consumer markets.

 

We market and sell our products primarily through a direct sales force.In the transportation market, we are focusing sales of our batteries andbattery systems to automotive and heavy duty vehicle manufacturers eitherdirectly or through tier 1 suppliers. We work with automotive and heavyduty vehicle manufacturers directly to educate and inform them about thebenefits of our technology for use in hybrid electric vehicles, or HEVs,plug-in hybrid electric vehicles, or PHEVs and electric vehicles, or EVs, andare engaged in design and development efforts with several automotive and heavyduty vehicle manufacturers and tier 1 suppliers. At the same time, we workwith tier 1 suppliers who are developing integrated solutions using ourbatteries. In the electric grid services market, our agreements were initiateddirectly by our sales force. In the consumer market, our sales are made bothdirectly and indirectly through distributors with key accounts managed by oursales personnel. We have entered into an exclusive agreement to license certainof our technology in the field of consumer electronic devices (excluding powertools and certain other consumer products) and expect to receive royalty feeson net sales of licensed products that include our technology. We expect tocontinue to expand our sales presence in Europe and Asia as our business inthose regions continues to grow. We expect international markets to provideincreased opportunities for our products.

 

Our sales cycles vary by product and market segment. Most of ourbatteries and battery systems typically undergo a lengthy development andqualification period prior to commercial production. We expect that the totaltime from customer introduction to commercial production will range up to fiveyears depending on the specific product and market served. Our long andunpredictable sales cycles and the potential large size of battery supply anddevelopment contracts cause our period-to-period financial results to besusceptible to significant variability. Since most of our operating and capitalexpenses are incurred up-front based on the anticipated timing of estimateddesign wins and customer orders, the loss or delay of any such orders couldhave a material adverse effect on our results of operations for any particular period. The variability in ourperiod-to-period results will also be driven by likely period-to-periodvariations in product mix and by the seasonality experienced by some of the endmarkets into which we sell our products.

 

We have been expanding our manufacturing capacity since inception,including the current expansion of our Livonia and Romulus, Michiganfacilities, and we intend to further expand our manufacturing capacity byconstructing more manufacturing lines primarily in Michigan. We intend toaccelerate the expansion of our manufacturing capacity subject to actual andanticipated future demand for our products and the receipt of stimulus fundsfrom the U.S. and state governments.  In the first quarter of 2010, we beganmaking investments against plans to further expand the final assembly capacityof our Michigan facilities.  Based on newdesign wins and our demand estimates, we have approved plans to increase ourcapacity in Michigan, resulting in a worldwide capacity of over 760MWh.  We believe that increases in productioncapacity have had, and will continue to have, a significant effect on ourfinancial condition and results of operations. We have made and continue tomake significant up-front investments in our manufacturing capacity, whichnegatively impact earnings and cash balances, but we expect these investmentswill increase our revenue in the long term.

 

Our research and development efforts are focused on developing newproducts and improving the performance of existing products. We fund ourresearch and development initiatives both from internal and external sources.As part of our development strategy, certain customers fund or partially fundresearch and development efforts to design and customize batteries and battery systemsfor their specific application.

 

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We have continued to experience significant losses since inception, aswe have continued to invest significantly to support the anticipated growth inour business. In particular, we have invested in product development and salesand marketing in order to meet product requirements of our target markets andto secure design wins that may lead to strong revenue growth and general andadministrative overhead to develop the infrastructure to support the business.We have also invested in the expansion of our manufacturing capacity to meetanticipated demand and our battery systems capabilities to provide batterysystems solutions to our customers. As our business grows, the key factors toimproving our financial performance will be revenue growth and revenuediversification into the transportation and electric grid services markets. Ourrevenue growth and revenue diversification will depend on our ability to securedesign wins in the transportation and electric grid services markets. Higherrevenue will also increase gross profit, as higher production volumes willprovide for increased absorption of manufacturing overhead and will reduce, ona percentage basis, the costs associated with increasing our productioncapacity.

 

In December 2009, we executed an agreement with the DOE regardingthe terms and conditions of the $249.1 million grant awarded under the DOE’sBattery Initiative to fund the construction of new lithium-ion batterymanufacturing facilities in Michigan. Under the DOE Battery Initiative, we arerequired to spend up to one dollar of our funds for every incentive dollar received.We are also negotiating a loan under the $25 billion Advanced TechnologyVehicles Manufacturing Loan Program, or the ATVM Program, to support thismanufacturing expansion. Based on the amount of our grant award under the DOEBattery Initiative and the guidelines associated with the ATVM Program, webelieve we will be permitted to borrow up to $233 million under the ATVMProgram. We expect we will be required to spend one dollar of our own funds forevery four dollars we borrow under the ATVM Program. The timing and the amountof any loan we may receive under the ATVM Program are currently not known byus, and, once disclosed to us, are subject to change and negotiation with thefederal government.

 

In October 2009, we entered into a *High-Tech Credit* agreement with the Michigan Economic GrowthAuthority, or MEGA, pursuant to which we are eligible for a 15-year tax credit,beginning with the 2011 fiscal year. This credit has an estimated value of upto $25.3 million, depending on the number of jobs we create in Michigan.In November 2009, we entered into a *CellManufacturing Credit* agreement with MEGA pursuant to which we areeligible for a credit equal to 50% of our capital investment expensescommencing January 2009, up to a maximum of $100 million over afour-year period related to the construction of our integrated battery cellmanufacturing plant. The credit shall not exceed $25 million per yearbeginning with the tax year of 2012. We are required to create 300 jobs nolater than December 31, 2016 in order to receive the refundable taxcredit. The tax credit is subject to a repayment provision in the event werelocate 51% or more of the 300 jobs outside of the State of Michigan withinthree years after the last year we received the tax credit. Through March 31,2010 we have incurred expenses of $18.7 million related to theconstruction of our facility, and we are expecting to receive approximately$9.4 million in refundable tax credits related to these expenses.

 

**Financial Operations Overview**

 

***Revenue***

 

We derive revenue from product sales and providing services.

 

*Product Revenue.*  Product revenue is derived from the sale ofour batteries and battery systems. For the three months ended March 31,2009 and 2010, product revenue represented 87% and 81% of our total revenue, respectively.

 

A significant portion of our revenue is generated from a limited numberof customers. Our two largest customers (BAE Systems and AES EnergyStorage, LLC) accounted for approximately 30% and 56% of our total revenueduring the three months ended March 31, 2009 and 2010, respectively, andwe expect that most of our revenue will continue to come from a relativelysmall number of customers for the foreseeable future. As we increase our focuson the transportation and electric grid markets, BAE Systems and AES EnergyStorage will represent a significant portion of our 2010 revenue, and the lossof BAE Systems or AES Energy as a customer could have a material adverse effecton our short-term revenue. Black & Decker has historically representeda significant portion of our revenue; however, we expect revenue from Black &Decker to continue to decline in future periods as we increase our focus on thetransportation and electric grid markets and Black & Decker engagesadditional suppliers for its battery requirements. In addition, Black &Decker has completed its merger with Stanley Works, and we do not yet know whatimpact, if any, this will have on our relationship with the newly formedStanley Black & Decker.  Weexpect the transportation market to be our largest portion of revenue in thenear and long term.

 

*Services Revenue.*  Services revenue is primarily derived fromcontracts awarded by the U.S. federal government, other government agencies andcommercial customers. These activities range from pure research, in which weinvestigate design techniques on new battery technologies at the request of agovernment agency or commercial customer, to custom development projects inwhich we are paid to enhance or modify an existing product or develop a newproduct to meet a customer’s specifications. We expect to continue to performfunded research and development work and to use the technology developed toadvance our new product development efforts. We expect that revenue fromservices will vary period-to-period depending on the timing of cash paymentsreceived and, if applicable, the achievement of milestones. We expect thatservices revenue will decrease as a percentage of our total revenue due to theexpected increase in product revenue over the long-term.

 

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*Deferred Revenue.*  We record deferred revenue for product salesand services in several different circumstances. These circumstances include (i) theproducts have been delivered or services have been performed but other revenuerecognition criteria have not been satisfied (ii) payments have beenreceived in advance of products being delivered or services being performed and(iii) when all other revenue recognition criteria have been met, but weare not able to reasonably estimate the warranty expense. Deferred revenueincludes customer deposits and up-front fees associated with service arrangements.Deferred revenue expected to be recognized as revenue more than one yearsubsequent to the balance sheet date is classified as long-term deferredrevenue. Deferred revenue will vary depending on the timing and amount of cashreceipts from customers and can vary significantly depending on specificcontractual terms. As a result, deferred revenue is likely to fluctuate fromperiod-to-period. During 2008, we received and recorded as deferred revenue a$25.0 million up-front payment in connection with our license agreementwith Gillette. Under our exclusive license agreement with Gillette, Gillettepaid us an up-front fee of $22.5 million and a support fee of$2.5 million. Gillette will also be required to pay us an additionallicense fee following the completion of a support period. In addition, theagreement requires Gillette to pay us royalty fees on net sales of productsthat include our technology. We have agreed with Gillette that if, during acertain period following execution of the license agreement, we enter into anagreement with a third party that materially restricts Gillette’s licenserights under the license agreement, then we may be required to refund toGillette all license and support fees paid to us by Gillette under the licenseagreement, plus, in certain cases, an additional amount to cover Gillette’scapital and other expenses paid and/or committed by Gillette in reliance uponits rights under the license agreement. Revenue recognition is expected tocommence two years from the date of the agreement, upon successful transfer oftechnology know how to Gillette. The license and support fee will be recognizedon a straight-line basis over the longer of the patent term or the expectedcustomer relationship.

 

***Factors that May AffectComparability***

 

*PublicCompany Expenses.* In September 2009, we completed an initialpublic offering of shares of our common stock. As a result, we are subject to laws, regulations, and requirements thatwe were not required to comply with as a private company, including theSarbanes-Oxley Act of 2002, other SEC regulations and the requirements of theNASDAQ Global Market.  Compliance withthese requirements requires us to increase our general and administrativeexpenses in order to pay consultants, legal counsel and independent registeredpublic accountants to assist us in, among other things, instituting andmonitoring a more comprehensive compliance and board governance function,establishing and maintaining internal control over financial reporting inaccordance with Section 404 of the Sarbanes-Oxley Act of 2002 andpreparing and distributing periodic public reports in compliance with ourobligations under the federal securities laws. In addition, as a public company, it is more expensive for us to obtaindirectors’ and officers’ liability insurance.

 

***Cost of Revenue andGross Profit***

 

Cost of product revenue includes the cost of raw materials, labor andcomponents that are required for the production of our products, as well asmanufacturing overhead costs (including depreciation), inventory obsolescencecharges, and warranty costs.  Rawmaterial costs, which are our most significant cost item over the past twoyears, have historically been stable, but increasing energy costs for some ofour materials are expected to increase this cost. This increase may bepartially offset by process innovation, dual sourcing of materials andincreased volume if we achieve better economies of scale. We incur costsassociated with unabsorbed manufacturing expenses prior to a factory operatingat normal operating capacity. We expect these unabsorbed manufacturing costs,which include certain personnel, rent, utilities, materials, testing anddepreciation costs, to increase in absolute dollars and as a percentage ofrevenue in the near term.

 

Cost of services revenue includes the direct labor costs of engineeringresources committed to funded service contracts, as well as third-partyconsulting, and associated direct material and equipment costs. Additionally,we include overhead expenses such as occupancy costs associated with theproject resources, engineering tools and supplies and program managementexpense.

 

Our gross profit/(loss) is affected by a number of factors, includingthe mix of products sold, customer diversification, the mix between productrevenue and services revenue, average selling prices, foreign exchange rates,our actual manufacturing costs and costs associated with increasing productioncapacity until full production is achieved. As we continue to grow and build outour manufacturing capacity, and as new product designs come into production,our gross profit will continue to fluctuate from period-to-period.

 

***Operating Expenses***

 

Operating expenses consist of research and development, sales andmarketing, general and administrative and production start-up expenses.Personnel-related expenses comprise the most significant component of theseexpenses. We expect to hire a significant number of new employees in order tosupport our anticipated growth. In any particular period, the timing ofadditional hires could materially affect our operating expenses, both inabsolute dollars and as a percentage of revenue.

 

*Research and Development Expenses.*  Research and development expenses consistprimarily of expenses for personnel engaged in the development of new productsand the enhancement of existing products. These expenses also consist of labmaterials, quality assurance activities and facilities costs and other relatedoverhead. We expense all of our research and development costs as they are 

 

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incurred.In the near term, we expect research and development expenses to increase inlarge part due to personnel-related expenses as we seek to hire additionalemployees, as well as contract-related expenses as we continue to invest in thedevelopment of our products. Research and development expense is reported netof any funding received under contracts with governmental agencies andcommercial customers that are considered to be cost sharing arrangements withno contractually committed deliverable. Accordingly, we expect that ourresearch and development expenses will continue to increase in absolute dollarsbut decrease as a percentage of revenue in the long term.

 

*Sales and Marketing Expenses.*  Sales and marketing expenses consistprimarily of personnel-related expenses, travel and other out-of-pocketexpenses for marketing programs, such as trade shows, industry conferences,marketing materials and corporate communications, and facilities costs andother related overhead. We intend to hire additional sales personnel, initiateadditional marketing programs and build additional relationships withresellers, systems integrators and strategic partners on a global basis.Accordingly, we expect that our sales and marketing expenses will continue toincrease in absolute dollars but decrease as a percentage of revenue in thelong term.

 

*General and Administrative Expenses.*  General and administrative expenses consistprimarily of personnel-related expenses related to our executive, legal,finance, human resource and information technology functions, as well as feesfor professional services and allocated facility overhead expenses.Professional services consist principally of external legal, accounting, tax,audit and other consulting services. We expect general and administrativeexpenses to increase as we incur additional costs related to operating as apublicly-traded company, including increased audit and legal fees, costs ofcompliance with securities, corporate governance and other regulations,investor relations expenses and higher insurance premiums, particularly thoserelated to director and officer insurance. In addition, we expect to incuradditional costs as we hire personnel and enhance our infrastructure to supportthe anticipated growth of our business. Accordingly, we expect that our generaland administrative expenses will continue to increase in absolute dollars butdecrease as a percentage of revenue in the long term.

 

*Productionstart-up Expenses. *Productionstart-up expenses consist of salaries and personnel-related costs, siteselection costs, including legal and regulatory costs, rent and the cost ofoperating a production line before it has been qualified for full production,including the cost of raw materials run through the production line during thequalification phase.  We expect to incuradditional production start-up expenses related to our facilities in Livoniaand Romulus, Michigan in the near term. The Livonia facility is expected tobegin qualification for production in the second half of 2010. The Romulusfacility is expected to begin qualification for production in the first half of2011.

 

*Other Income (Expense), Net.*  Other income (expense), net consistsprimarily of interest income on cash balances, interest expense on borrowings,change in fair value of preferred stock warrants and foreign currency-relatedgains and losses. We have historically invested our cash in money marketinvestments. Our interest income will vary each reporting period depending onour average cash balances during the period and the current level of interestrates. Similarly, our foreign currency-related gains and losses will also varydepending upon movements in underlying exchange rates. Upon the closing of ourIPO, all preferred stock warrants were converted to common stock warrants andwe do not expect any gains or losses related to the change in the fair value ofpreferred stock warrants going forward.

 

*Provision for Income Taxes.*  Through March 31, 2010, we incurred netlosses since inception and have not recorded provisions for U.S. federal incometaxes since the tax benefits of our net losses have been offset by valuationallowances.

 

We have recorded a tax provision for foreign taxes associated with ourforeign subsidiaries and state income taxes where our net operating lossdeductions are limited by statutes.

 

**Watt Hours Operating Metric**

 

We measure our product shipments in watt hours, or Wh,which refers to the aggregate amount of energy that could be delivered in asingle complete discharge by a battery. We calculate Wh for each of our batterymodels by multiplying the battery’s amp hour, or Ah, storage capacity by thebattery’s voltage rating. For example, our 26650 battery is a 2.3 Ah batterythat operates at 3.3 V, resulting in a 7.6 Wh rating. We determine a battery’sAh storage capacity at a specific discharge rate and a specific depth ofdischarge. We do this by charging the battery to its top voltage and bydischarging it to zero capacity (2 volt charge level). The Wh metric allows usand our investors to measure our manufacturing capacity and shipments,regardless of battery voltages and Ah specifications, utilizing a uniform andconsistent metric.

 

**CertainTrends and Uncertainties**

 

The following representsa summary of certain trends and uncertainties, which could have a significantimpact on our financial condition and results of operations. This summary isnot intended to be a complete list of potential trends and uncertainties thatcouldimpact ourbusiness in the long or short term. The summary, however, should be consideredalong with the factors identified in the section titled “*Risk Factors*” set forth in Part II,Item 1A of this Quarterly Report on Form 10-Q and in Part I,Item 1A of our Annual Report on Form 10-K filed with the SEC on March 15,2010, and elsewhere in this report.

 

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|   | · | We believe that our  future revenues depend on our ability to develop, manufacture and market  products that improve upon existing battery technology and gain market  acceptance. If our battery technology is not adopted by our customers, or if  our battery technology does not meet industry requirements for power and  energy storage capacity in an efficient and safe design, our batteries will  not gain market acceptance.                                                                                                                   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | · | We build our  manufacturing capacity based on our projection of future development and  supply agreement wins. Increases in production capacity, have had, and will  continue to have, an effect on our financial condition and results of  operations. Our business revenues and profits will depend upon our ability to  enter into and complete development and supply agreements, successfully  complete these capacity expansion projects, achieve competitive manufacturing  yields and drive volume sales consistent with our demand expectations. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | · | Our revenues are  expected to continue to come from a relatively small number of customers for  the foreseeable future. The loss of our most significant customer or several  of our smaller customers could materially harm our business.                                                                                                                                                                                                                                                                                                                |

 

**CriticalAccounting Policies**

 

Our financial statementsare prepared in accordance with accounting principles generally accepted in theUnited States of America. The preparation of our financial statements andrelated disclosures requires us to make estimates, assumptions and judgmentsthat affect the reported amount of assets, liabilities, revenue, costs andexpenses, and related disclosures. We base our estimates and assumptions onhistorical experience and other factors that we believe to be reasonable underthe circumstances. We evaluate our estimates and assumptions on an ongoingbasis. Our actual results may differ from these estimates under differentassumptions and conditions. Our most critical accounting policies are listedbelow.

 
| ·     |       | Revenue recognition;                                    |
|------------|------------|---------------------------------------------------------|
|       |       |                                                    |
| ·     |       | Product warranty obligations;                           |
| ** ** | ** ** | ** **                                              |
| ·     |       | Inventory;                                              |
|       |       |                                                    |
| ·     |       | Impairment of goodwill and acquired intangible  assets; |
|       |       |                                                    |
| ·     |       | Impairment of long-lived assets;                        |
|       |       |                                                    |
| ·     |       | Government grants;                                      |
|       |       |                                                    |
| ·     |       | Stock-based compensation;                               |
|       |       |                                                    |
| ·     |       | Grants to non-employees;                                |
|       |       |                                                    |
| ·     |       | Income taxes.                                           |

 

During the three monthsended March 31, 2010, there were no significant changes in our criticalaccounting policies or estimates. See our Annual Report on Form 10-K forthe year ended December 31, 2009, filed with the SEC on March 15,2010, for additional information about these critical accounting policies, aswell as a description of our other significant accounting policies.

 

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**Resultsof Consolidated Operations**

 

The following table setsforth selected condensed consolidated statements of operations data for each ofthe periods (in thousands):

 
| ** **                                                         | ** ** | **Three  Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                         | ** ** | **March 31,**      | ** ** |
| ** **                                                         | ** ** | **2009**                | ** ** | **2010** | ** ** |
| ** **                                                         | ** ** | ** **              | ** ** | ** ** | ** ** |
| Revenue:                                                           |       |                    |       |   |   |
| Product                                                            |       | $                       | 20,121     |   | $ | 19,774 |   |
| Services                                                           |       | 3,099                   |       | 4,694 |   |
| Total revenue                                                      |       | 23,220                  |       | 24,468 |   |
| Cost of revenue:                                                   |       |                    |       |   |   |
| Product                                                            |       | 19,570                  |       | 22,354 |   |
| Services                                                           |       | 1,844                   |       | 4,155 |   |
| Total cost of revenue                                              |       | 21,414                  |       | 26,509 |   |
| Gross profit (loss)                                                |       | 1,806                   |       | (2,041 | ) |
| Operating expenses:                                                |       |                    |       |   |   |
| Research and development                                           |       | 11,227                  |       | 14,116 |   |
| Sales and marketing                                                |       | 1,982                   |       | 2,800 |   |
| General and administrative                                         |       | 6,283                   |       | 8,240 |   |
| Production start-up                                                |       | —                  |       | 1,811 |   |
| Total operating expenses                                           |       | 19,492                  |       | 26,967 |   |
| Operating loss                                                     |       | (17,686                 | )          | (29,008 | ) |
| Other income (expense):                                            |       |                    |       |   |   |
| Interest expense, net                                              |       | (218                    | )          | (218 | ) |
| (Loss) gain on foreign exchange                                    |       | (788                    | )          | 245 |   |
| Unrealized loss on preferred stock warrant  liability              |       | (48                     | )          | — |   |
| Other income (expense), net                                        |       | (1,054                  | )          | 27 |   |
| Loss from operations, before tax                                   |       | (18,740                 | )          | (28,981 | ) |
| Provision for income taxes                                         |       | 144                     |       | 121 |   |
| Net loss                                                           |       | (18,884                 | )          | (29,102 | ) |
| Less: Net loss attributable to the noncontrolling  interest        |       | 147                     |       | 77 |   |
| Net loss attributable to A123 Systems, Inc.                   |       | (18,737                 | )          | (29,025 | ) |
| Accretion to preferred stock                                       |       | (11                     | )          | — |   |
| Net loss attributable A123 Systems, Inc.  common stockholders |       | $                       | (18,748    | ) | $ | (29,025 | ) |
|                                                               |       |                    |       |   |   |
| **Other Operating Data:**                                          |       |                    |       |   |   |
| Shipments (in watt hours, or Wh) (in thousands)                    |       | 10,635                  |       | 16,252 |   |

 

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*Three Months Ended March 31,2009 and 2010*

 

**Revenue**

 
| ** **     | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **     | ** ** | **2009**                              | ** ** | **2010**   | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **     | ** ** | **(Dollars  in thousands)**           | ** ** |
| **Revenue**    | ** ** | ** **                            | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Product        |       |                                  |       |       |       |              |       |   |   |
| Transportation |       | $                                     | 13,079     |       | $          | 10,250            |       | $ | (2,829 | ) | -21.6 | % |
| Consumer       |       | 7,042                                 |       | 4,284      |       | (2,758            | )          | -39.2 | % |
| Electric grid  |       | —                                |       | 5,240      |       | 5,240             |       | 100.0 | % |
| Total product  |       | 20,121                                |       | 19,774     |       | (347              | )          | -1.7 | % |
| Services       |       | 3,099                                 |       | 4,694      |       | 1,595             |       | 51.5 | % |
| Total revenue  |       | $                                     | 23,220     |       | $          | 24,468            |       | $ | 1,248 |   | 5.4 | % |

 

*ProductRevenue.*Thedecrease in product revenue was primarily due to decrease of $2.8 million insales to customers in the transportation industry and a decrease of $2.8million in sales to customers in the consumer industry.  These decreases were partially offset by anincrease in sales to customers in the electric grid industry of $5.2 million.  The decrease in sales to customers in thetransportation industry is due to a decrease of sales to Mercedes-BenzHighPerformanceEnginesof $4.7 million.  Sales to othertransportation customers increased by $1.9 million.  The decrease in sales to customers in theconsumer industry is due to a decrease of sales to Black & Decker andits affiliates of $4.5 million and a decrease in sales generated by Enerland of$0.3 million, which was attributable to the decline in demand for our radiocontrolled products.  Sales to otherconsumer customers increased by $2.0 million.

 

*ServicesRevenue.*Theincrease in services revenue was related to the increase in revenue related togovernment agency research contracts. The increase was primarily due to a newproject award granted.

 

**Cost of Revenue and Gross Profit(Loss)**

 
| ** **                | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                | ** ** | **2009**                              | ** ** | **2010**   | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                | ** ** | **(Dollars  in thousands)**           | ** ** |
| **Cost of revenue**       |       |                                  |       |       |       |              |       |   |   |
| Product                   |       | $                                     | 19,570     |       | $          | 22,354            |       | $ | 2,784 |   | 14.2 | % |
| Services                  |       | 1,844                                 |       | 4,155      |       | 2,311             |       | 125.3 | % |
| Total cost of revenue     |       | $                                     | 21,414     |       | $          | 26,509            |       | $ | 5,095 |   | 23.8 | % |
| **Gross profit (loss)**   |       |                                  |       |       |       |              |       |   |   |
| Product                   |       | $                                     | 551        |       | $          | (2,580            | )          | $ | (3,131 | ) | -568.2 | % |
| Services                  |       | 1,255                                 |       | 539        |       | (716              | )          | -57.1 | % |
| Total gross profit (loss) |       | $                                     | 1,806      |       | $          | (2,041            | )          | $ | (3,847 | ) | -213.0 | % |

 

*Cost of Product Revenue*. The increase in cost of product revenuewas primarily due to an unfavorable change in the mix of products sold in thethree months ended March 31, 2010. In addition, due to low factoryutilization, unabsorbed manufacturing expenses were $4.9 million for the threemonths ended March 31, 2010.

 

*Cost of Services Revenues*. The increase in costs of servicesrevenue resulted from the increase in services revenues.

 

*Product Gross Profit (Loss).* We experienced a product gross lossduring the three months ended March 31, 2010, primarily due to low factoryutilization. Our future gross profit will be affected by numerous factors,including the build-out of our manufacturing capacity and the timing of theproduction of new product designs. For example, unabsorbed manufacturingexpenses were $4.9 million during the three months ended March 31, 2010.As a result, our gross profit or loss will vary significantly from period-toperiod going forward.  In addition, grossprofit decreased due to an unfavorable change in the mix of products sold inthe three months ended March 31, 2010, as the three months ended March 31,2009 included the sale of higher margin products in comparison to the threemonths ended March 31, 2010.

 

*Services Gross Profit*. Services gross profit decreased due tothe increase in the cost of services and the timing of project 

 

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milestones.

 

**Operating Expenses**

** **
| ** **                 | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                 | ** ** | **2009**                              | ** ** | **2010**   | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                 | ** ** | **(Dollars  in thousands)**           | ** ** |
| **Operating expenses**     |       |                                  |       |       |       |              |       |   |   |
| ** **                 |       |                                  |       |       |       |              |       |   |   |
| Research and development   |       | $                                     | 11,227     |       | $          | 14,116            |       | $ | 2,889 |   | 25.7 | % |
| Sales and marketing        |       | 1,982                                 |       | 2,800      |       | 818               |       | 41.3 | % |
| General and administrative |       | 6,283                                 |       | 8,240      |       | 1,957             |       | 31.1 | % |
| Production start-up        |       | —                                |       | 1,811      |       | 1,811             |       | 100.0 | % |
| Total operating expenses   |       | $                                     | 19,492     |       | $          | 26,967            |       | $ | 7,475 |   | 38.3 | % |

 

*Research and DevelopmentExpenses.* Aportion of research and development expenses was offset primarily bycost-sharing funding. Our research and development expenditures are summarizedas follows:

 
| ** **                                       | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **2009**                              | ** ** | **2010**   | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                       | ** ** | **(Dollars  in thousands)**           | ** ** |
| **Research and development  expenditures**       |       |                                  |       |       |       |              |       |   |   |
| ** **                                       |       |                                  |       |       |       |              |       |   |   |
| Aggregated research and development expenditures |       | $                                     | 12,010     |       | $          | 14,655            |       | $ | 2,645 |   | 22.0 | % |
| Research and development reimbursements          |       | 783                                   |       | 539        |       | (244              | )          | -31.2 | % |
| Research and development expenses                |       | $                                     | 11,227     |       | $          | 14,116            |       | $ | 2,889 |   | 25.7 | % |

 

The increase in researchand development expenses for the three months ended March 31, 2010compared to the three months ended March 31, 2009 was primarilyattributable to an increase of $1.0 million in personnel-related expensesassociated with an increase in research and development personnel who primarilyfocus on manufacturing process improvement, material science chemistry andbattery and battery systems technology, in addition to an increase in generalproduct development and other research and development expenses of $1.9million. Research and development expense as a percentage of revenue was 48% inthe three months ended March 31, 2009, compared to 58% in the three monthsended March 31, 2010.

 

*Sales and Marketing Expenses.* The increase in sales and marketingexpenses for the three months ended March 31, 2010 compared to the threemonths ended March 31, 2009 was primarily attributable to an increase of$0.4 million in personnel-related expenses associated with an increase in salesand marketing personnel, in addition to an increase in marketing expenses relatedto trade shows, public relations, advertising, and other sales and marketingrelated expenses of $0.4 million.  Salesand marketing expense was 9% of revenue for the three months ended March 31,2009, compared to 11% for the three months ended March 31, 2010.

 

*General and AdministrativeExpenses*. Theincrease in general and administrative expenses for the three months ended March 31,2010 compared to the three months ended March 31, 2009 was primarily dueto an increase in personnel-related expenses of $1.4 million, associated withan increase in general and administrative personnel, and an increase in othergeneral and administrative expenses of $0.6 million.  General and administrative expense was 27% ofrevenue for the three months ended March 31, 2009, compared to 34% for thethree months ended March 31, 2010.

 

*Productionstart-up. *Productionstart-up expenses for the three months ended March 31, 2010 were due tocosts incurred related to our manufacturing expansion at our Livonia andRomulus, Michigan facilities.  Productionstart-up expenses consisted primarily of facility and personnel costs during the three monthsended March 31, 2010.  Theproduction start-up expenses were offset by approximately $0.3 million of governmentgrant funding.

 

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**Other Income (Expense), Net**

 
| ** **                                            | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                            | ** ** | **2009**                              | ** ** | **2010**   | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                            | ** ** | **(Dollars  in thousands)**           | ** ** |
| **Other income (expense), net**                       |       |                                  |       |       |       |              |       |   |   |
| ** **                                            |       |                                  |       |       |       |              |       |   |   |
| Interest expense, net                                 |       | $                                     | (218       | )          | $          | (218              | )          | $ | — |   | 0.0 | % |
| (Loss) gain on foreign exchange                       |       | (788                                  | )          | 245        |       | 1,033             |       | 131.1 | % |
| Unrealized loss on preferred stock warrant  liability |       | (48                                   | )          | —     |       | 48                |       | -100.0 | % |
| Total other income (expense), net                     |       | $                                     | (1,054     | )          | $          | 27                |       | $ | 1,081 |   | -102.6 | % |

 

Thechange in interest, net for the three months ended March 31, 2010 was dueto an increase in interest income due to higher average cash balances offset byan increase in interest expense due to the total debt outstanding andadditional borrowings which occurred between March 31, 2009 and March 31,2010. The increase in net foreign exchange gains for the three months ended March 31,2010 is due to the effect of currency exchange rate changes on transactionsthat are non U.S. dollar denominated and charged or credited to earnings. Thedecrease in unrealized loss on preferred stock warrant liability was due to theconversion of the preferred stock warrants to common stock warrants in connectionwith our IPO.

 

*Provision for Income Taxes.* The provision for income taxes for thethree months ended March 31, 2009 and 2010 was primarily related toforeign and state income taxes. We did not report a benefit for federal incometaxes in the condensed consolidated financial statements as the deferred taxasset generated from our net operating loss has been offset by a full valuationallowance because it is more likely than not that the tax benefits of the netoperating loss carry forward may not be realized.

 

**Liquidity and Capital Resources**

 

The following table setsforth the major sources and uses of cash for each of the periods set forthbelow (in thousands):

 
| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                     | ** ** | **2009**                              | ** ** | **2010** | ** ** |
| Net cash used in operating activities                          |       | $                                     | (26,197    | ) | $ | (23,965 | ) |
| Net cash used in investing activities                          |       | (11,138                               | )          | (21,528 | ) |
| Net cash provided by (used in) financing activities            |       | 1,634                                 |       | (1,092 | ) |
| Effect of foreign exchange rates on cash and cash  equivalents |       | 98                                    |       | (20 | ) |
| Net decrease in cash and cash equivalents                      |       | $                                     | (35,603    | ) | $ | (46,605 | ) |

 

As of March 31,2010, we had cash and cash equivalents of $410.5 million and accountsreceivable of $16.5 million.  During thethree months ended March 31, 2010, we received proceeds from governmentgrants of $7.3 million.  In 2010 andbeyond, we expect to use a significant portion of our cash for capitalexpenditures to increase manufacturing capacity in anticipation of increaseddemand for our products, including the current expansion of our manufacturingfacilities in Michigan.

 

***Cash Flows From Operating Activities***

 

Operating activities used$24.0 million of net cash during the three months ended March 31, 2010. Weincurred a net loss of $29.1 million in the three months ended March 31,2010, which included non-cash share-based compensation expense of $2.5 millionand depreciation and amortization of $3.7 million. Changes in asset andliability accounts used $1.7 million of net cash during the three months ended March 31,2010.

 

Operating activities used$26.2 million of net cash during the three months ended March 31,2009. We incurred a net loss of $18.9 million in the three months ended March 31,2009, which included non-cash share-based compensation expense of$1.2 million and depreciation and amortization of $2.8 million.Changes in asset and liability accounts used $12.1 million of net cashduring the three months ended March 31, 2009.

 

Weanticipate negative cash flow from operations in the near future as we continueto support the anticipated growth of our business.

 

***Cash Flows From Investing Activities***

 

Cash flows from investingactivities primarily relate to capital expenditures to support our growth.

 

Cash used in investingactivities totaled $21.5 million during the three months ended March 31,2010 and consisted of capital 

 

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expenditures of $13.9 million primarily related to thepurchase of manufacturing equipment, expenditures of $13.0 million related tothe purchase of a long-term investment and amounts held in escrow, receipt ofgovernment grant proceeds of $5.7 million, and an increase in restricted cash$0.3 million.

 

Cash used in investingactivities totaled $11.1 million during the three months ended March 31,2009 and consisted of capital expenditures of $8.5 million primarily related tothe purchase of manufacturing equipment and an increase in restricted cash of$2.7 million.

 

We anticipatehigher capital expenditure levels in future periods as we continue to fund theexpansion of our facilities to support the anticipated growth of ourbusiness.  Additionally in futureperiods, we anticipate investing cash in joint ventures and other equityinvestments in order to establish strategic relationships.

 

***Cash Flows From Financing Activities***

 

Cash flows from financingactivities totaled $1.1 million during the three months ended March 31,2010 and included proceeds from government grants of $1.3 million and proceedsfrom exercise of stock options of $0.5 million. These proceeds were partiallyoffset by repayments on long-term debt of $2.7 million, and repayments oncapital lease obligations of $0.2 million. In future periods, we expectfinancing activities such as proceeds from grants, equity offerings and debtissuances to be a significant source of cash.

 

Cash flows from financing activities totaled $1.6million during the three months ended March 31, 2009 and included proceedsfrom government grants of $3.0 million and proceeds from issuance oflong-term debt of $1.1 million. These proceeds were partially offset byrepayments on long-term debt of $1.7 million and $0.7 million of deferredoffering costs.

 

**Off-BalanceSheet Arrangements**

 

We did not have duringthe periods presented, and we do not currently have, any off-balance sheetarrangements, as defined under SEC rules, such as relationships withunconsolidated entities or financial partnerships, which are often referred toas structured finance or special purpose entities, established for the purposeof facilitating financing transactions that are not required to be reflected onour balance sheet.

 

**ContractualObligations**

 

Our contractualobligations relate primarily to borrowings under long-term debt obligations, capitalleases, operating leases, and purchase obligations which include agreements orpurchase orders to purchase goods or services that are enforceable and legallybinding.  A table summarizing the amountsand estimated timing of these future cash payments was provided in our AnnualReport on Form 10-K for the year ended December 31,2009.  During the three months ended March 31, 2010, there wereno material changes outside the ordinary course of business in our contractualobligations or the estimated timing of the future cash payments, except asnoted below.

 

The following is asummary of our purchase obligations as of March 31, 2010:

 
| ** **                                   | ** ** | ** **          | ** ** | **Payments  Due in**   | ** ** |
|----------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **Total**           | ** ** | **Less  than  1 Year** | ** ** |
| ** **                                   | ** ** | **(in  thousands)** | ** ** |
| Capital expenditure purchase obligations (1) |       | 97,151              |       | 97,151                 |       |
|                                         |       | $                   | 97,151     |                   | $          | 97,151 |   |
|                                              |            |                     |            |                        |            |  |  |

 

----

(1) Capitalexpenditure purchase obligations include agreements or purchase orders topurchase capital goods that are enforceable and legally binding and specify allsignificant terms. Purchase obligations exclude agreements that are cancelablewithout penalty.

 

**ITEM****3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

*Foreign Currency Exchange Risk.*  As a result of our foreign operations, wehave significant expenses, assets and liabilities that are denominated inforeign currencies. A significant number of our employees are located in Asia.Therefore, a substantial portion of our payroll as well as certain otheroperating expenses are paid in the China RMB and South Korean Won.Additionally, we purchase materials and components from suppliers in Asia.While we pay these suppliers in U.S. dollars, their costs are typically basedupon the local currency of the country in which they operate. All of ourrevenues are received in U.S. dollars because our customer contracts generallyprovide that our customers will pay us in U.S. dollars.

 

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Asa consequence, our gross profit, operating results, profitability and cashflows are adversely impacted when the dollar depreciates relative to otherforeign currencies. We have a particularly significant currency rate exposureto changes in the exchange rate between the RMB and South Korean Won to theU.S. dollar. For example, to the extent that we need to convert U.S. dollarsfor our operations, appreciation of the RMB or South Korean Won against theU.S. dollar would have an adverse effect on the amount we receive from theconversion.

 

Wehave not used any forward contracts or currency borrowings to hedge ourexposure to foreign currency exchange risk.

 

*Interest Rate Sensitivity.*  We had cash and cash equivalents totaling$410.5 million as of March 31, 2010, and $457.1 million as of December 31,2009. Our exposure to interest rate risk primarily relates to the interestincome generated by excess cash invested in highly liquid investments withmaturities of three months or less from the original dates of purchase. Thecash and cash equivalents are held for working capital purposes. We have notused derivative financial instruments in our investment portfolio. We have notbeen exposed, nor do we anticipate being exposed, to material risks due tochanges in market interest rates. Declines in interest rates, however, willreduce future investment income. If overall interest rates had declined by upto 100 basis points during the year ended December 31, 2009 and the threemonths ended March 31, 2010, our interest income would have decreased byapproximately $0.2 million and $30,000, respectively, assuming consistentinvestment levels.

 

Interestrate risk also refers to our exposure to movements in interest rates associatedwith our interest bearing liabilities. The interest bearing liabilities aredenominated in U.S. dollars and the interest expense is based on the primeinterest rate plus an additional margin, depending on the respective lendinginstitutions. If the prime rate had increased by 100 basis points during theyear ended December 31, 2009 and the three months ended March 31,2010, our interest expense would have increased by approximately$0.2 million and $0.1 million, respectively, assuming consistent borrowinglevels.

 

**ITEM 4T. CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controlsand Procedures.*Our management, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of March 31, 2010. The term “disclosure controls andprocedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that are designedto ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the SEC’s rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bya company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the company’s management, including itsprincipal executive and principal financial officers, as appropriate to allowtimely decisions regarding required disclosure. Management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on the evaluation of our disclosurecontrols and procedures as of March 31, 2010, our chief executive officerand chief financial officer concluded that, as of such date, our disclosurecontrols and procedures were not effective at the reasonable assurance level.

 

*Changesin Internal Controls*. No changes in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)occurred during the quarterly period ended March 31, 2010 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

At December 31,2010, Section 404 of the Sarbanes-Oxley Act will require our management toprovide an assessment of the effectiveness of our internal control overfinancial reporting, and our independent registered public accounting firm willbe required to provide an attestation on the effectiveness of our internalcontrols over financial reporting. We are in the process of performing thesystem and process documentation, evaluation and testing required for managementto make this assessment and for its independent auditors to provide itsattestation report. We have not completed this process or its assessment, andthis process will require significant amounts of management time and resources.In the course of evaluation and testing, management may identify deficienciesthat will need to be addressed and remediated.

 

As disclosed in ourAnnual Report on Form 10-K for the year ended December 31, 2009,filed with the SEC on March 15, 2010, we identified material weaknesses inour internal control over financial reporting. Although we have madeenhancements to our control procedure, the material weaknesses will not beconsidered remediated until our controls are operational for a period of time,tested, and management concludes that these controls are operating effectively.

 

**PART II. OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

In2005 and 2006, we received communications from Hydro-Quebec, a Canadian utilitycompany, alleging that the cathode material of our batteries infringes U.S.Patent No. 5,910,382 and U.S. Patent No. 6,514,640 that had beengranted to The University of Texas, or UT, and that relate to certain electrodematerials used in lithium-ion batteries. We refer to these patents by the lastthree digits of the patent number. The ‘382 and ‘640 patents include claimsthat claim to cover battery cathode material having a particular crystalstructure and chemical formula. We contend that our cathode material has adifferent crystal structure and chemical formula.

 

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Webelieve that UT subsequently licensed the patents to Hydro-Quebec, which inturn licensed the technology to companies that make and sell electrodematerials for batteries. On April 7, 2006, we commenced an action in theUnited States District Court for the District of Massachusetts seeking adeclaratory judgment that our products do not infringe these patents and thatthe patents are invalid. On September 8, 2006, we also requested ex partereexamination of the two patents by the U.S. Patent & TrademarkOffice, or PTO, to determine whether the subject matter they claim ispatentable. The reexamination process does not result in findings ofinfringement. In order to have a patent reexamined, the party of interest mustsubmit prior art that raises a “substantial new question of patentability”. Ifthe PTO determines that there is a substantial new question of patentability,it will order a reexamination. In an ex parte reexamination, a third partyrequesting reexamination does not participate further in the reexaminationproceedings. Once a reexamination is ordered, a new examiner is assigned to thecase and the patent goes through another examination similar in procedure tothe examination it received leading up to the issuance of the patent in thefirst instance. If any claims are rejected in light of the new questionsraised, then the patent owner can narrow or cancel the rejected claims to tryto avoid rejection of the claims. The patent owner can also submit new claims,provided they are not broader than the claims in the original patent. Once thereexamination has been concluded and if any claims are considered patentable, a“Certificate of Reexamination” is issued.

 

OnSeptember 11, 2006, Hydro-Quebec and UT commenced an action in the UnitedStates District Court for the Northern District of Texas against us, one of ourcustomers, Black & Decker, whom we have agreed to indemnify, and oneof our suppliers alleging infringement of the two patents and, in a lateramended complaint, false advertising. The plaintiffs’ complaint allegesinfringement of various claims of the ‘382 Patent and various claims of the ‘640Patent and that we and Black & Decker have engaged in falseadvertising by making representations about the source and nature of ourtechnology. The complaint seeks injunctive relief, including against making,using or selling any product containing the patented technology, actual damagesin an unspecified amount, increased and/or treble damages, interest, costs andattorney fees.

 

InOctober 2006 and January 2007, the PTO granted our requests forreexamination of the two patents. In January and February 2007, thetwo litigations in Massachusetts and Texas were stayed pending the PTOreexaminations. Various motions to dismiss, filed by parties on both sides ofthe dispute, remain undecided.

 

Duringthe reexamination, the PTO rejected all of the original claims of the ‘382Patent as unpatentable. UT then amended the claims of the ‘382 Patent to makethem narrower than the original claims in order to distinguish the claimedinvention from the prior art and added two new and narrower claims. The PTOdetermined that the narrower amended and new claims of the ‘382 Patentsubmitted during reexamination are patentable and concluded the reexaminationof the ‘382 Patent. On April 15, 2008, the PTO issued a reexaminationcertificate with the amended claims and the two new claims. During thereexamination of the ‘640 Patent, the PTO rejected all of the original claimsof the ‘640 Patent as unpatentable. UT then amended the claims of the ‘640Patent to make them narrower than the original claims in order to distinguishthe claimed invention from the prior art.

 

OnDecember 22, 2008, the parties jointly requested that the stay of thelitigation continue pending resolution of the reexamination of the ‘640 Patent.On May 12, 2009, the PTO issued a Reexamination Certificate for the ‘640Patent with the amended narrower claims, thus removing the last condition forstaying this litigation. As a result, while Hydro-Quebec and UT may assert thenarrower claims of the reexamination certificate against any alleged infringer,including us, they are unable to continue to assert the original claims of the ‘382Patent and the ‘640 Patent against us. On June 11, 2009, we filed a motionto reopen the lawsuit in Massachusetts pursuant to the court’s deadline to filewithin 30 days of the conclusion of the PTO’s reexamination. On September 28,2009, the Massachusetts court entered an order denying that motion, which weappealed on October 27, 2009 to the United States Court of Appeals for theFederal Circuit. On July 22, 2009, Hydro-Quebec and UT sent us a proposedSecond Amended Complaint in the Texas litigation that they said they intend toseek leave to file in light of the PTO’s reexaminations. On August 27, 2009,Hydro-Quebec and UT filed a Motion for Leave to File Second Amended Complaintand Jury Demand in the United States District Court for the Northern Districtof Texas and we were granted several unopposed extensions to file our response.Hydro-Quebec and UT filed for leave to file an Amended Motion for Leave to FileSecond Amended Complaint and Jury Demand on April 1, 2010 and we filed ouropposition to this application on April 22, 2010. The judge has requested astatus hearing with the parties on May 14, 2010.

 

Ifeither or both of the lawsuits go forward, we expect that they could take asmuch as two years or more to reach trial, if at all. We believe that we do notinfringe either UT patent, including the ‘382 Patent and the ‘640 Patentfollowing reexamination, and that we have other meritorious defenses, and weintend to continue to vigorously defend our products and intellectual propertyrights. The ‘382 and ‘640 Patents include claims that claim to cover batterycathode material having a particular crystal structure and chemical formula,which Hydro-Quebec and UT claim our cathode material infringes. We believe, andcontend in the lawsuits, that our cathode material has a different crystalstructure and chemical formula that is not covered by the ‘382 and ‘640patents. However, due to the nature of the litigation, we cannot determine thetotal expense or possible loss, if any, that may ultimately be incurred eitherin the context of a trial or as a result of a negotiated settlement. AlthoughHydro-Quebec and UT have not specified in their complaint the nature or extentof their damages, they have asked for injunctive relief and we believe thatthey would likely seek substantial damages that could involve both one-timepayments and on-going amounts. Regardless of the ultimate outcome of thelitigation, it could result in significant legal expenses and diversion of timeby our technical and managerial personnel. The results of these proceedings areuncertain, and there can be no assurance that they will not have a materialadverse effect on our business, operating results, and financial condition.

 

OnFebruary 3, 2010, we received notice that LG Chem, Ltd. or LG Chem,filed applications in the 50th division of Seoul District Court for preliminary injunctionsagainst six former employees who are now employed either by our Enerlandsubsidiary or by us. The applications allege that these former employeesviolated the two year non-competition clause in their employment contracts with

 

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LGChem and that there is a likelihood that they are infringing LG Chem’s tradesecrets by working for a competitor. An initial court hearing was held onFebruary 19, 2010 and a second hearing was held on March 19, 2010. The courthas not rendered a decision on this application to date. Although LG Chem hasnot commenced legal action against us or Enerland, LG Chem’s legal action couldresult in significant legal expenses and diversion of time by our technical andmanagement personnel.

 

**Item 1A.Risk Factors**

 

*Ourbusiness is subject to numerous risks. We caution you that the followingimportant factors, among others, could cause our actual results to differmaterially from those expressed in forward-looking statements made by us or onour behalf in filings with the SEC, press releases, communications withinvestors and oral statements. Any or all of our forward-looking statements inthis Quarterly Report on**Form 10-Q**and in any other public statements we make may turnout to be wrong. They can be affected by inaccurate assumptions we might makeor by known or unknown risks and uncertainties. Many factors mentioned in thediscussion below will be important in determining future results. Consequently,no forward-looking statement can be guaranteed. Actual future results maydiffer materially from those anticipated in forward-looking statements. Weundertake no obligation to update any forward-looking statements, whether as aresult of new information, future events or otherwise. You are advised,however, to consult any further disclosure we make in our reports filed withthe SEC. **For adetailed discussion of the risk factors, refer to Item 1A of our AnnualReport on Form 10-K for the year ended December 31, 2009, which wasfiled with the SEC on March 15, 2010.*

 

**Risks Related to Our Business**

 

***We have had a history of losses, andwe may be unable to achieve or sustain profitability.***

 

Wehave never been profitable. We experienced net losses of $80.5 million for2008, $86.6 million for 2009 and $29.1 million for the three months ended March 31,2010. We expect we will continue to incur net losses in 2010. We expect toincur significant future expenses as we develop and expand our business and ourmanufacturing capacity. In addition, as a public company, we incur additionalsignificant legal, accounting and other expenses that we did not incur as aprivate company. These increased expenditures will make it harder for us toachieve and maintain future profitability. We may incur significant losses inthe future for a number of reasons, including the other risks described in thissection, and we may encounter unforeseen expenses, difficulties, complications,delays and other unknown events. Accordingly, we may not be able to achieve ormaintain profitability.

 

***We have yet to achieve positive cash flow,and our ability to generate positive cash flow is uncertain.***

 

Torapidly develop and expand our business, we have made significant up-frontinvestments in our manufacturing capacity and incurred research anddevelopment, sales and marketing, general and administrative and productionstart-up expenses. In addition, our growth has required a significantinvestment in working capital over the last several years. We have had negativecash flow before financing activities of $76.0 million for 2008,$114.7 million for 2009 and $45.5 million for the three months ended March 31,2010. We anticipate that we will continue to have negative cash flow for theforeseeable future as we continue to make significant future capitalexpenditures to expand our manufacturing capacity and incur increased researchand development, sales and marketing, general and administrative and productionstart-up expenses. Our business will also require significant amounts ofworking capital to support our growth. Therefore, we may need to raiseadditional capital from investors to achieve our expected growth, and we maynot achieve sufficient revenue growth to generate positive future cash flow. Aninability to generate positive cash flow for the foreseeable future or raiseadditional capital on reasonable terms may decrease our long-term viability.

 

***Our limited operating history makes itdifficult to evaluate our current business and future prospects.***

 

Wehave been in existence since 2001, but much of our growth has occurred inrecent periods. Our limited operating history may make it difficult to evaluateour current business and our future prospects. We have encountered and willcontinue to encounter risks and difficulties frequently experienced by growingcompanies in rapidly changing industries, including increasing expenses as wecontinue to grow our business. If we do not manage these risks successfully,our business will be harmed.

 

Inaddition, we are targeting new and emerging markets for our batteries andbattery systems. However, historically, a significant portion of the productsthat we have sold are designed for the consumer tool market, which is a moremature market with different growth prospects than our other target markets.Several of our products are still under development, including a battery inprismatic form designed for use in the automotive industry, and the timing ofthe ultimate release, if any, of new production quality products is notdeterminable. Our efforts to expand beyond our existing markets may neverresult in new products that achieve market acceptance, create additionalrevenue or become profitable. Therefore, our recent historical growthtrajectory may not provide an accurate representation of the market dynamics wemay be exposed to in the future, making it difficult to evaluate our futureprospects.

 

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***The demand for batteries in thetransportation and other markets depends on the continuation of current trendsresulting from dependence on fossil fuels. Extended periods of low gasolineprices could adversely affect demand for electric and hybrid electric vehicles.***

 

Webelieve that much of the present and projected demand for advanced batteries inthe transportation and other markets results from recent increases in the costof oil, the dependency of the United States on oil from unstable or hostilecountries, government regulations and economic incentives promoting fuelefficiency and alternate forms of energy, as well as the belief that climatechange results in part from the burning of fossil fuels. If the cost of oildecreased significantly, the outlook for the long-term supply of oil to theUnited States improved, the government eliminated or modified its regulationsor economic incentives related to fuel efficiency and alternate forms ofenergy, or if there is a change in the perception that the burning of fossilfuels negatively impacts the environment, the demand for our batteries could bereduced, and our business and revenue may be harmed.

 

Gasolineprices have been extremely volatile, and this continuing volatility is expectedto persist. Lower gasoline prices over extended periods of time may lower theperception in government and the private sector that cheaper, more readilyavailable energy alternatives should be developed and produced. If gasolineprices remain at deflated levels for extended periods of time, the demand forhybrid and electric vehicles may decrease, which would have a material adverseeffect on our business.

 

***If we are unable to develop, manufactureand market products that improve upon existing battery technology and gainmarket acceptance, our business may be adversely affected. In addition, manyfactors outside of our control may affect the demand for our batteries andbattery systems.***

 

Weare researching, developing, manufacturing and selling lithium-ion batteriesand battery systems. The market for advanced rechargeable batteries is at arelatively early stage of development, and the extent to which our lithium-ionbatteries will be able to meet our customers’ requirements and achievesignificant market acceptance is uncertain. Rapid and ongoing changes intechnology and product standards could quickly render our products lesscompetitive, or even obsolete if we fail to continue to improve the performanceof our battery chemistry and systems. Other companies that are seeking toenhance traditional battery technologies have recently introduced or aredeveloping batteries based on nickel metal-hydride, liquid lithium-ion andother emerging and potential technologies. These competitors are engaged insignificant development work on these various battery systems. One or more new,higher energy rechargeable battery technologies could be introduced which couldbe directly competitive with, or superior to, our technology. The capabilitiesof many of these competing technologies have improved over the past severalyears. Competing technologies that outperform our batteries could be developedand successfully introduced, and as a result, our products may not competeeffectively in our target markets. If our battery technology is not adopted byour customers, or if our battery technology does not meet industry requirementsfor power and energy storage capacity in an efficient and safe design, ourbatteries will not gain market acceptance.

 

Inaddition, the market for our products depends upon third parties creating orexpanding markets for their end-user products that utilize our batteries andbattery systems. If such end-user products are not developed, if we are unableto have our products designed into these end user products, if the cost ofthese end-user products is too high, or the market for such end-user productscontracts or fails to develop, the market for our batteries and battery systemswould be expected similarly to contract or collapse. Our customers operate inextremely competitive industries, and competition to supply their needs focuseson delivering sufficient power and capacity in a cost, size and weightefficient package. The ability of our customers to adopt new batterytechnologies will depend on many factors outside of our control. For example,in the automotive industry, we depend on our customers’ ability to develop HEV,PHEV and EV platforms that gain broad appeal among end users.

 

Manyother factors outside of our control may also affect the demand for our batteriesand battery systems and the viability of widespread adoption of advancedbattery applications, including:

 

·          performanceand reliability of battery power products compared to conventional and othernon-battery energy sources and products;

 

·          successof alternative battery chemistries, such as nickel-based batteries, lead-acidbatteries and conventional lithium-ion batteries and the success of otheralternative energy technologies, such as fuel cells and ultra capacitors;

 

·          end-users’perceptions of advanced batteries as relatively safe and reliable energystorage solutions, which could change over time if alternative batterychemistries prove unsafe or become the subject of significant product liabilityclaims and negative publicity is generated on the battery industry as a whole;

 

·          cost-effectivenessof our products compared to products powered by conventional energy sources andalternative battery chemistries;

 

·          availabilityof government subsidies and incentives to support the development of thebattery power industry;

 

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·          fluctuationsin economic and market conditions that affect the cost of energy stored bybatteries, such as increases or decreases in the prices of electricity;

 

·          continuedinvestment by the federal government and our customers in the development ofbattery powered applications;

 

·          heightenedawareness of environmental issues and concern about global warming and climate change;and

 

·          regulationof energy industries.

 

***Adverse business or financial conditionsaffecting the automobile industry may have a material adverse effect on ourdevelopment and marketing partners and our battery business.***

 

Muchof our business depends on and is directly affected by the general economicstate of the United States and global automobile industry. The effect of thecontinued economic difficulties of the major automobile manufacturers on ourbusiness is unclear. Two major auto manufacturers have recently gone thrubankruptcy and one of our existing customers has entered into a debtrestructuring process, and it is possible that more of these companies mayencounter financial difficulties. The impact of any such financial difficultieson the automobile industry and its suppliers is unclear and difficult topredict. Possible effects could include reduced spending on alternative energysystems for automobiles, a delay in the introduction of new, or thecancellation of new and existing, hybrid and electric vehicles and programs,and a delay in the conversion of existing batteries to lithium-ion batteries,each of which would have a material adverse effect on our business.

 

Wehave entered into agreements relating to joint design and development effortswith several automotive manufacturers and tier 1 suppliers regarding theirHEV, PHEV and EV development efforts. Certain of these manufacturers andsuppliers have in recent years experienced static or reduced revenues,increased costs, net losses, loss of market share, bankruptcy, labor issues andother business and financial challenges. The viability of the “Big Three”U.S. auto manufacturers, particularly GM and Chrysler, remains unclear. Asa result, these or other automotive manufacturers may discontinue or delaytheir planned introduction of HEVs, PHEVs or EVs as a result of adverse changesin their financial condition or other factors. Automotive manufacturers mayalso seek alternative battery systems from other suppliers which may be morecost-effective or require fewer modifications in standard manufacturingprocesses than our products. We may also experience delays or losses withrespect to the collection of payments due from customers in the automotiveindustry experiencing financial difficulties. For example, one of ourcustomers, Think Global, is experiencing financial difficulties. As a result,we recorded an allowance for bad debt of $1.3 million for the outstandingamounts due from Think and recorded a $2.6 million charge for obsoleteinventory related to this program.

 

***We have experienced rapid growth in recentperiods. If we fail to manage our growth effectively, we may be unable toexecute our business plan, maintain high levels of service or addresscompetitive challenges adequately.***

 

Weincreased our number of full-time employees from 227 at January 1, 2007 to1,608 at March 31, 2010, and our revenue increased from $41.3 millionin 2007 to $91.0 million in 2009. Our growth has placed, and may continueto place, a significant strain on our managerial, administrative, operational,financial, information technology and other resources. We intend to furtherexpand our overall business, customer base, headcount and operations bothdomestically and internationally. Expanding a global organization and managinga geographically dispersed workforce will require substantial management effortand significant additional investment in our infrastructure. We will berequired to continue to improve our operational, financial and managementcontrols and our reporting procedures and we may not be able to do soeffectively. As such, we may be unable to manage our expenses effectively inthe future, which may negatively impact our operating results in any particularquarter.

 

***Because we build our manufacturing capacitybased on our projection of future design wins and supply agreements, ourbusiness revenue and profits will depend upon our ability to enter into andcomplete these agreements, successfully complete these expansion projects,achieve competitive manufacturing yields and drive volume sales consistent withour demand expectations.***

 

Inorder to fulfill the anticipated demand for our products, we invest in capitalexpenditures in advance of actual customer orders, based on estimates of futuredemand. We plan to continue the expansion of our manufacturing capacity acrossmultiple product lines. The build-up of our internal manufacturingcapabilities, such as the current expansions in Livonia and Romulus, Michigan,exposes us to significant up-front fixed costs. If market demand for ourproducts does not increase as quickly as we have anticipated and align with ourexpanded manufacturing capacity, or if we fail to enter into and completeprojected development and supply agreements, we may be unable to offset thesecosts and to achieve economies of scale, and our operating results may beadversely affected as a result of high operating expenses, reduced margins,underutilization of capacity and asset impairment charges. Alternatively, if weexperience demand for our products in excess of our estimates, our installedcapital equipment may be insufficient to support higher production volumes,which could harm our customer relationships and overall reputation. Inaddition, we may not be able to expand our workforce and operations in a timelymanner, procure adequate resources, or locate suitable third-party suppliers,to respond effectively to changes in demand for our existing products or to thedemand for new products requested by our customers, and our

 

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currentor future business could be materially and adversely affected. Our ability tomeet such excess customer demand could also depend on our ability to raiseadditional capital and effectively scale our manufacturing operations.

 

Weutilize standard manufacturing equipment that we modify and customize in orderto meet our production needs. While this equipment may be available fromvarious suppliers, its procurement requires long lead times. Therefore, we mayexperience delays, additional or unexpected costs and other adverse events inconnection with our capacity expansion projects, including those associatedwith potential delays in the procurement and customization of manufacturingequipment.

 

Ifwe are unable to achieve and maintain satisfactory production yields andquality as we expand our manufacturing capabilities, our relationships withcertain customers and overall reputation may be harmed, and our sales coulddecrease.

 

***We may not be able to obtain, or to agreeon acceptable terms and conditions for, all or a significant portion of thegovernment grants, loans and other incentives for which we have applied and mayin the future apply. Our customers and potential customers applying forgovernment grants, loans and other incentives may condition purchases of ourproducts upon their receipt of these funds or delay purchases of our productsuntil their receipt of these funds.***

 

Wehave applied for federal and state grants, loans and tax incentives undergovernment programs designed to stimulate the economy and support theproduction of electric vehicles and advanced battery technologies. Much of ourplanned domestic manufacturing capacity expansion depends on receipt of thesefunds and other incentives, and the failure to obtain these funds or otherincentives could materially and adversely affect our ability to expand ourmanufacturing capacity and meet planned production levels. We anticipate thatin the future there will be new opportunities for us to apply for grants, loansand other incentives from the United States, state and foreign governments. Ourability to obtain funds or incentives from government sources is subject to theavailability of funds under applicable government programs and approval of ourapplications to participate in such programs. The application process for thesefunds and other incentives is and will be highly competitive. While we have beenselected to receive a grant under the DOE Battery Initiative and have receivedsome state incentives, we cannot assure you that we will be successful inobtaining additional grants, loans and other incentives. Moreover, stateincentives depend on the continued availability of state funds. With respect tothe grant which we have been awarded and the grants, loans and other incentiveswe may be awarded, we may not be able to satisfy or continue to satisfy therequirements and milestones imposed by the granting authority as conditions toreceipt of the funds or other incentives, the timing of the receipt of thefunds may not meet our needs and we nevertheless may be unable to successfullyexecute on our business plan. Moreover, not all of the terms and conditionsassociated with these incentive funds have been disclosed to us, and oncedisclosed, there may be terms and conditions with which we are unable to complyor which are commercially unacceptable to us. In addition, the DOE Batteryinitiative grant and any other federal government programs which may makeadditional awards to us will require us to spend a portion of our own funds forevery incentive dollar we receive or are permitted to borrow from thegovernment and will impose time limits during which we must use the fundsawarded to us. If we are unable to raise sufficient additional capital so thatwe are able to receive all of the amounts which have and may be awarded to usin a timely manner, our ability to expand our manufacturing capacity could be materiallyadversely affected. In addition, less than expected actual and anticipatedfuture demand for our products may cause us to slow the pace of the expansionof our manufacturing capacity such that we are not able to use the governmentincentive funds awarded or made available to us in the time periods required bythe granting authorities.

 

Ourcustomers and potential customers applying for these government grants, loansand other incentives may condition purchases of our products upon receipt ofthese funds or delay purchases of our products until receipt of these funds,and if our customers and potential customers do not receive these funds or thereceipt of these funds is significantly delayed, our results of operationscould suffer.

 

***We rely on a limited number of customersfor a significant portion of our revenue, and the loss of our most significantor several of our smaller customers could materially harm our business.***

 

Asignificant portion of our revenue is generated from a limited number of customers.During each of the years ended December 31, 2008 and 2009 and the threemonths ended March 31, 2010, Black & Decker, together with itsaffiliates, represented 44%, 14% and 6% of our revenue, respectively. We expectrevenue from Black & Decker will continue to decline in 2010 andtherefore represent a smaller percentage of our revenue in future periods. Forthe year ended December 31, 2009 and the three months ended March 31,2010, revenue from BAE Systems represented 35% and 34% of our revenue, respectively.For the year ended December 31, 2009 and the three months ended March 31,2010, revenue from AES Energy accounted for 9% and 21% of our revenue,respectively. Although the composition of our significant customers will varyfrom period to period, we expect that most of our revenue will continue, forthe foreseeable future, to come from a relatively small number of customers. Inaddition, our contracts with our customers do not include long-term commitmentsor minimum volumes that ensure future sales of our products. Consequently, ourfinancial results may fluctuate significantly from period-to-period based onthe actions of one or more significant customers. A customer may take actionsthat affect us for reasons that we cannot anticipate or control, such asreasons related to the customer’s financial condition, changes in the customer’sbusiness strategy or operations, the introduction of alternative competingproducts, or as the result of the perceived quality or cost-effectiveness ofour products. Our agreements with these customers may be cancelled if we failto meet certain product specifications or materially breach the agreement orfor other reasons outside of our

 

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control.In addition, our customers may seek to renegotiate the terms of currentagreements or renewals. The loss of or a reduction in sales or anticipatedsales to our most significant or several of our smaller customers could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

***Our financial results may varysignificantly from period-to-period due to the long and unpredictable salescycles for some of our products, the seasonality of certain end markets intowhich we sell our products, and changes in the mix of products we sell during aperiod, which may lead to volatility in our stock price.***

 

Thesize and timing of our revenue from sales to our customers is difficult topredict and is market dependent. Our sales efforts often require us to educateour customers about the use and benefits of our products, including theirtechnical and performance characteristics. Customers typically undertake asignificant evaluation process that has in the past resulted in a lengthy salescycle for us, typically many months. In some markets such as the transportationmarket, there is usually a significant lag time between the design phase andcommercial production. We spend substantial amounts of time and money on oursales efforts and there is no assurance that these investments will produce anysales within expected time frames or at all. Given the potentially large sizeof battery development and supply contracts, the loss of or delay in thesigning of a contract or a customer order could significantly reduce ourrevenue in any period. Since most of our operating and capital expenses areincurred based on the estimated number of design wins and their timing, they aredifficult to adjust in the short term. As a result, if our revenue falls belowour expectations or is delayed in any period, we may not be able to reduceproportionately our operating expenses or manufacturing costs for that period,and any reduction of manufacturing capacity could have long-term implicationson our ability to accommodate future demand.

 

Ourprofitability from period-to-period may also vary significantly due to the mixof products that we sell in different periods. While we have sold most of ourproducts to date into the consumer market, as we expand our business we expectto sell new battery and battery system products into other markets and forother applications. These products are likely to have different cost profilesand will be sold into markets governed by different business dynamics.Consequently, sales of individual products may not necessarily be consistentacross periods, which could affect product mix and cause gross and operatingprofits to vary significantly.

 

Inaddition, since our batteries and battery systems are incorporated into ourcustomers’ products for sale into their respective end markets, our business isexposed to the seasonal demand that may characterize some of our customers’ ownproduct sales. Because many of our expenses are based on anticipated levels ofannual revenue, our business and operating results could also suffer if we donot achieve revenue consistent with our expectations for this seasonal demand.

 

Asa result of these factors, we believe that quarter-to-quarter comparisons ofour operating results are not necessarily meaningful and that these comparisonscannot be relied upon as indicators of future performance. Moreover, ouroperating results may not meet expectations of equity research analysts or investors.If this occurs, the trading price of our common stock could fall substantiallyeither suddenly or over time.

 

***Our principal competitors have, and anyfuture competitors may have, greater financial and marketing resources than wedo, and they may therefore develop batteries or other technologies similar orsuperior to ours or otherwise compete more successfully than we do.***

 

Competitionin the battery industry is intense. The industry consists of major domestic andinternational companies, most of which have existing relationships in themarkets into which we sell as well as financial, technical, marketing, sales,manufacturing, scaling capacity, distribution and other resources and namerecognition substantially greater than ours. These companies may developbatteries or other technologies that perform as well as or better than ourbatteries. We believe that our primary competitors are existing suppliers ofcylindrical lithium-ion, nickel cadmium, nickel metal-hydride and in somecases, non-starting/lighting/ignition lead-acid batteries. A number of ourcompetitors have existing and evolving relationships with our target customers.For example, Bosch and Samsung formed LiMotive to focus on the development,production and marketing of lithium-ion battery systems for application inhybrid and other electric vehicles, and Dow Chemical recently announced theestablishment of a joint venture with Kokam America and others, pending receiptof government incentive funding, to build a facility in Michigan for themanufacture of lithium polymer batteries for use in HEVs and EVs. In addition,NEC and Nissan entered into a joint venture to develop lithium-ion batteries inprismatic form, Sanyo and Volkswagen agreed to develop lithium-ion batteriesfor HEVs, Sanyo already provides nickel metal hydride batteries for Ford andHonda, and Toyota and Panasonic are engaged in a joint venture to makebatteries for HEVs and EVs. In addition, we expect new competitors will enterthe markets for our products in the future. Potential customers may choose todo business with our more established competitors, because of their perceptionthat our competitors are more stable, are more likely to complete variousprojects, can scale operations more quickly, have greater manufacturing capacity,are more likely to continue as a going concern and lend greater credibility toany joint venture. If we are unable to compete successfully againstmanufacturers of other batteries or technologies in any of our targetedapplications, our business could suffer, and we could lose or be unable to gainmarket share.

 

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***If our products fail to perform as expected,we could lose existing and future business, and our ability to develop, marketand sell our batteries and battery systems could be harmed.***

 

Ourproducts are complex and could have unknown defects or errors, which may giverise to claims against us, diminish our brand or divert our resources fromother purposes. Despite testing, new and existing products have containeddefects and errors and may in the future contain manufacturing or designdefects, errors or performance problems when first introduced, when newversions or enhancements are released, or even after these products have beenused by our customers for a period of time. These problems could result inexpensive and time-consuming design modifications or warranty charges, delaysin the introduction of new products or enhancements, significant increases inour service and maintenance costs, exposure to liability for damages, damagedcustomer relationships and harm to our reputation, any of which may adverselyaffect our business and our operating results.

 

Oursuccess in the transportation market depends, in part, on our ability todesign, develop and commercially manufacture lithium-ion batteries in prismaticform for use in HEVs, PHEVs and EVs currently being developed and that may bedeveloped in the future. The design and development of a lithium-ion battery inprismatic form for use in the automotive industry is complex, expensive,time-consuming and subject to rigorous quality and performance requirements. Ifwe are unable to design, develop and commercially manufacture lithium-ionbatteries in prismatic form that are accepted for use in the automotiveindustry, our business and operating results may be adversely affected.

 

***We entered into a strategic investmentagreement with an early stage entity with which we have a commercialrelationship.***

 

InJanuary 2010, we entered into an agreement to invest approximately $23.0million, consisting of $13.0 million in cash and approximately $10.0 million ofour common stock to Fisker Automotive, Inc., of Fisker, a privately heldcompany.  In exchange, we received sharesof convertible preferred stock in Fisker which are not liquid, and we do notexpect that they will be liquid for some time. Our investment in Fisker exposesus to equity price risk; if Fisker does not execute on its strategic plan, ourinvestment may not be recovered.  Thisinvestment is subject to risk of changes in fair value, which could result in amaterial realized impairment loss.

 

***In the past, we have identified materialweaknesses in our internal control over financial reporting which areunremediated and if we fail to remediate these weaknesses and maintain properand effective internal controls, our ability to produce accurate and timelyfinancial statements could be impaired, which could harm our operating results,our ability to operate our business and investors’ views of us.***

 

Ensuringthat we have adequate internal financial and accounting controls and proceduresin place so that we can produce accurate financial statements on a timely basisis a costly and time-consuming effort that needs to be evaluated frequently. Inconnection with our financial audits, we identified material weaknesses in ourinternal control over financial reporting. A material weakness is defined as adeficiency, or combination of deficiencies, in internal control over financialreporting, such that there is a reasonable possibility that a materialmisstatement of the company’s annual or interim financial statements will notbe prevented or detected on a timely basis by the company’s internal controls.These material weaknesses were as follows:

 

·   wedid not have an adequate number of personnel in our accounting and financedepartment with sufficient technical accounting expertise and, as a result, wecould not evaluate in a timely manner the accounting implications of ourbusiness transactions; and

 

·   wedid not design or maintain effective operating and information technologycontrols over the financial statement close and reporting process in order toensure the accurate and timely preparation of financial statements inaccordance with accounting principles generally accepted in the United States,or GAAP.

 

Weare in the process of taking the necessary steps to remediate the materialweaknesses that we identified and have made enhancements to our controlprocedures; however, the material weaknesses will not be remediated until thenecessary controls have been implemented and are operating effectively. We donot know the specific time frame needed to fully remediate the materialweaknesses identified.

 

Wecannot assure you that our efforts to fully remediate these internal controlweaknesses will be successful or that similar material weaknesses will notrecur.

 

Implementingany appropriate changes to our internal controls may distract our officers andemployees, entail substantial costs to implement new processes and modify ourexisting processes and take significant time to complete. Moreover, thesechanges do not guarantee that we will be effective in maintaining the adequacyof our internal controls, and any failure to maintain that adequacy, or consequentinability to produce accurate financial statements on a timely basis, couldincrease our operating costs and harm our business. In addition, investors’perceptions that our internal controls are inadequate or that we are unable toproduce accurate financial statements on a timely basis may harm our stockprice and make it more difficult for us to effectively market and sell ourproducts to new and existing customers. For a more detailed discussion of ourmaterial weaknesses, see Item 9A, “*Controlsand Procedures”.*

 

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***If our warranty expense estimates differmaterially from our actual claims, or if we are unable to estimate futurewarranty expense for new products, our business and financial results could beharmed.***

 

Ourwarranty for our products ranges from one to five years from the date of sale,depending on the type of product and its application. We expect that in thefuture some of our warranties will extend beyond five years. In the consumermarket, we typically provide a warranty against certain potential manufacturingdefects, which may cause high-rates of self-discharge, inaccurate voltage, andother product irregularities. In the electric grid services and transportationmarkets, we may also provide a warranty against a certain percentage decline inthe initial power and energy density specifications of a particular product.Since we began selling our first products in the consumer market in the firstquarter of 2006 and in the transportation market in the first quarter of 2007,and we have only recently shipped our first product in the electric gridservices market, we have a limited product history on which to base ourwarranty estimates. Because of the limited operating history of our batteriesand battery systems, our management is required to make assumptions and toapply judgment regarding a number of factors, including anticipated rate ofwarranty claims, the durability and reliability of our products, and servicedelivery costs. Our assumptions could prove to be materially different from theactual performance of our batteries and battery systems, which could cause usto incur substantial expense to repair or replace defective products in thefuture and may exceed expected levels against which we have reserved. If ourestimates prove incorrect, we could be required to accrue additional expensesfrom the time we realize our estimates are incorrect and also face asignificant unplanned cash burden at the time our customers make a warrantyclaim, which could harm our operating results.

 

Inaddition, with our new products and products that remain under development, wewill be required to base our warranty estimates on historical experience ofsimilar products testing of our batteries and performance information learnedduring our development activities with the customer. If we are unable toestimate future warranty costs for any new product, we will be required todefer recognizing revenue for that product until we are reasonably able toestimate the associated warranty expense. As a result, our financial resultscould vary significantly from period-to-period.

 

***Product liability or other claims could causeus to incur losses or damage our reputation.***

 

Therisk of product liability claims and associated adverse publicity is inherentin the development, manufacturing, marketing and sale of batteries and batterysystems. Certain materials we use in our batteries, as well as our batteriesand battery systems, could, if used improperly, cause injuries to others.Improperly charging or discharging our batteries could cause fires. Anyaccident involving our batteries or other products could decrease or even eliminatedemand for our products. Because some of our batteries are designed to be usedin vehicles, and because vehicle accidents can cause injury to persons anddamage to property, we are subject to a risk of claims for such injuries anddamages. In addition, we could be harmed by adverse publicity resulting fromproblems or accidents caused by third party products that incorporate ourbatteries. For example, our business and operating results could be harmed byadverse publicity resulting from injury to persons or damage to property causedby a defective electronic system on a battery system manufactured by a thirdparty that incorporates our batteries.

 

Althoughwe have product liability insurance for our products of up to an annualaggregate limit of $102 million, this may be inadequate to cover allpotential product liability claims. In addition, while we often seek to limitour product liability in our contracts, such limits may not be enforceable ormay be subject to exceptions. Any product recall or lawsuit seeking significantmonetary damages either in excess of our coverage, or outside of our coverage,may have a material adverse affect on our business and financial condition. Wemay not be able to secure additional product liability insurance coverage onacceptable terms or at reasonable costs when needed. If we were to experience alarge insured loss, it might exceed our coverage limits, or our insurancecarriers could decline to further cover us or raise our insurance rates tounacceptable levels, any of which could impair our financial position andresults of operations. A successful product liability claim against us couldrequire us to pay a substantial monetary award. We cannot assure you that suchclaims will not be made in the future.

 

***We are subject to financial andreputational risks due to product recalls resulting from product quality andliability issues.***

 

Therisk of product recalls, and associated adverse publicity, is inherent in thedevelopment, manufacturing, marketing, and sale of batteries and batterysystems. Our products and the products of third parties in which our productsare a component are becoming increasingly sophisticated and complicated asrapid advancements in technologies occur, and as demand increases for lighterand more powerful rechargeable batteries. At the same time, product quality andliability issues present significant risks. Product quality and liabilityissues may affect not only our own products but also the third-party productsin which our batteries and battery systems are a component. Our efforts and theefforts of our development partners to maintain product quality may not besuccessful, and if they are not, we may incur expenses in connection with, forexample, product recalls and lawsuits, and our brand image and reputation as aproducer of high-quality products may suffer. Any product recall or lawsuitseeking significant monetary damages could have a material adverse effect onour business and financial condition. A product recall could generate substantialnegative publicity about our products and business, interfere with ourmanufacturing plans and product delivery obligations as we seek to replace orrepair affected products, and inhibit or prevent commercialization of otherfuture product candidates. Although we do have product liability insurance, wedo not have insurance to cover the costs associated with a product recall andthe expenses we would incur in connection with a product recall could have amaterial adverse affect on our operating results.

 

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***We depend on third parties to deliver rawmaterials, parts, components and services in adequate quality and quantity in atimely manner and at a reasonable price.***

 

Ourmanufacturing operations depend on obtaining raw materials, parts andcomponents, manufacturing equipment and other supplies including services fromreliable suppliers in adequate quality and quantity in a timely manner. It maybe difficult for us to substitute one supplier for another, increase the numberof suppliers or change one component for another in a timely manner or at alldue to the interruption of supply or increased industry demand. This mayadversely affect our operations. The prices of raw materials, parts andcomponents and manufacturing equipment may increase due to changes in supplyand demand. In addition, currency fluctuations and a weakening of theU.S. dollar against foreign currencies may adversely affect our purchasingpower for raw materials, parts and components and manufacturing equipment fromforeign suppliers.

 

Wedepend on sole source suppliers or a limited number of suppliers for certainkey raw materials and component parts used in manufacturing and developing ourproducts. We generally purchase raw materials pursuant to purchase ordersplaced from time to time and if we deem necessary, we will enter into long-termcontracts or other guaranteed supply arrangements with our sole or limitedsource suppliers. Therefore, our operating margins may be impacted by pricefluctuations in the commodities we use as raw materials in our batteries. As aresult, our suppliers may not be able to meet our requirements relative to specificationsand volumes for key raw materials, and we may not be able to locate alternativesources of supply at an acceptable cost. In the past, we have experienceddelays in product development due to the delivery of raw materials from oursuppliers that do not meet our specifications. In addition, if a sole sourcesupplier ceased to continue to produce a component with little or no notice tous, our business could be harmed. Any future inability to obtain high qualityraw materials or manufacturing equipment in sufficient quantities oncompetitive pricing terms and on a timely basis, due to global supply anddemand or a dispute with a supplier, may delay battery production, impede ourability to fulfill existing or future purchase orders and harm our reputationand profitability.

 

***Our failure to raise additional capitalnecessary to expand our operations and invest in our products and manufacturingfacilities could reduce our ability to compete successfully.***

 

Wemay require additional capital in the future and we may not be able to obtainadditional debt or equity financing on favorable terms, if at all. If we raiseadditional equity financing, our stockholders may experience significantdilution of their ownership interests, and the per-share value of our commonstock could decline. If we engage in debt financing, we may be required toaccept terms that restrict our ability to incur additional indebtedness andforce us to maintain specified liquidity or other ratios. We are also seekingfederal and state grants, loans and tax incentives some of which we intend touse to expand our operations. We may not be successful in obtaining these fundsor incentives. If we need additional capital and cannot raise or otherwiseobtain it on acceptable terms, we may not be able to, among other things:

 

·   developor enhance our products or introduce new products;

 

·   continueto expand our development, sales and marketing and general and administrativeorganizations and manufacturing operations;

 

·   attracttop-tier companies as customers or as our technology and product developmentpartners;

 

·   acquirecomplementary technologies, products or businesses;

 

·   expandour operations, in the United States or internationally;

 

·   expandand maintain our manufacturing capacity;

 

·   hire,train and retain employees; or

 

·   respondto competitive pressures or unanticipated working capital requirements.

 

***Our inability to obtain federal and stategovernment environmental permits and approvals for our plannedU.S. manufacturing facilities could negatively impact our ability toobtain federal and state incentive funding and materially harm our business.***

 

Pursuantto applicable environmental and safety laws and regulations, we are required toobtain and maintain certain governmental permits and approvals and to complywith applicable federal and state environmental laws and regulations.  There is no guarantee that requireddeterminations, permits and approvals will ultimately be obtained; the failureto obtain required federal and state environmental permits, could have an adverseeffect on our financial results and could also delay or prevent us fromobtaining matching fund reimbursement from the $249.1 million grant wewere awarded under the DOE Battery Initiative, as well as funding under the DOEATVM loan program.

 

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If obtained, permits and approvals may be subject to revocation,modification or denial under certain circumstances. Our operations oractivities could result in administrative or private actions, revocation ofrequired permits or licenses, or fines, penalties or damages, which could havean adverse effect on us. In addition, environmental laws will likely becomemore stringent over time, thereby requiring new capital expenditures andincreases in operating costs.

 

***Our working capital requirementsinvolve estimates based on demand expectations and may decrease or increasebeyond those currently anticipated, which could harm our operating results andfinancial condition.***

 

In order to fulfill the product delivery requirements of our customers,we plan for working capital needs in advance of customer orders. As a result,we base our funding and inventory decisions on estimates of future demand. Ifdemand for our products does not increase as quickly as we have estimated ordrops off sharply, our inventory and expenses could rise, and our business andoperating results could suffer. Alternatively, if we experience sales in excessof our estimates, our working capital needs may be higher than those currentlyanticipated. Our ability to meet this excess customer demand depends on ourability to arrange for additional financing for any ongoing working capitalshortages, since it is likely that cash flow from sales will lag behind theseinvestment requirements.

 

***Credit market volatility andilliquidity may affect our ability to raise capital to finance our operations,plant expansion and growth.***

 

The credit markets have experienced extreme volatility during the lastyear, and worldwide credit markets have remained illiquid despite injections ofcapital by the federal government and foreign governments. Despite the capitalinjections and government actions, banks and other lenders, such as equipmentleasing companies, have significantly increased credit requirements and reducedthe amounts available to borrowers. Companies with low credit ratings may nothave access to the debt markets until the liquidity improves, if at all. Ifcurrent credit market conditions do not improve, we may not be able to accessdebt or leasing markets to finance our plant expansion plans.

 

***We may be unable to successfullyimplement or manage our planned expansion of our domestic manufacturingcapability or realize the expected benefits of our planned expansion.***

 

We expect to aggressively expand our battery manufacturing capacity inthe United States to meet expected demand for our product. Much of our planneddomestic expansion, such as our current expansion in Livonia and Romulus,Michigan, depends upon our receipt of sufficient federal and state incentivefunding. We may not receive the federal and state funding necessary for ourplanned expansion at all or on a timely basis. In addition, such funding couldbe subject to conditions that are commercially unacceptable to us or for whichwe are unable to comply. Even if we succeed in aggressively expanding ourdomestic manufacturing capacity, we may not have enough demand for our productsto justify the increased capacity.

 

Any such expansion will place a significant strain on our seniormanagement team and our financial and other resources. Our proposed expansionwill expose us to greater overhead and support costs and other risks associatedwith the manufacture and commercialization of new products. Our ability tomanage our growth effectively will require us to continue to improve ouroperations and our financial and management information systems and to train,motivate and manage our employees. Difficulties in effectively managing thebudgeting, forecasting and other process control issues presented by such arapid expansion could harm our business, prospects, results of operations andfinancial condition.

 

***We may not be able to successfullyrecruit and retain skilled employees, particularly scientific, technical andmanagement professionals.***

 

We believe that our future success will depend in large part on ourability to attract and retain highly skilled technical, managerial andmarketing personnel who are familiar with our key customers and experienced in thebattery industry. We plan to continue to expand our work force bothdomestically and internationally. Industry demand for such employees,especially employees with experience in battery chemistry and batterymanufacturing processes, however, exceeds the number of personnel available,and the competition for attracting and retaining these employees is intense.This competition will intensify if the advanced battery market continues togrow, possibly requiring increases in compensation for current employees overtime. We compete in the market for personnel against numerous companies,including larger, more established competitors who have significantly greaterfinancial resources than we do and may be in a better financial position tooffer higher compensation packages to attract and retain human capital. Wecannot be certain that we will be successful in attracting and retaining theskilled personnel necessary to operate our business effectively in the future.Because of the highly technical nature of our batteries and battery systems,the loss of any significant number of our existing engineering and projectmanagement personnel could have a material adverse effect on our business andoperating results.

 

***Our future success depends on ourability to retain key personnel.***

 

Our success will depend to a significant extent on the continuedservices of our senior management team, and in particular David Vieau, ourchief executive officer, and Gilbert N. Riley, Jr., our chieftechnical officer. The loss or unavailability of either of these 

 

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individualscould harm our ability to execute our business plan, maintain importantbusiness relationships and complete certain product development initiatives,which could harm our business. We do not have agreements requiring any of oursenior management team to remain with our company. In addition, each of theseindividuals could terminate his or her relationship with us at any time, and wemay be unable to enforce any applicable employment or non-compete agreements.

 

***If we do not continue to form andmaintain economic arrangements with original equipment manufacturers, or OEMs,to commercialize our products, our profitability could be impaired.***

 

Our business strategy requires us to integrate the design of ourproducts into products being developed by OEMs, and therefore to identifyacceptable OEMs and enter into agreements with them. In addition, we will needto meet their requirements and specifications by developing and introducing newproducts and enhanced or modified versions of our existing products on a timelybasis. OEMs often require unique configurations or custom designs for batteriesor battery systems which must be developed and integrated into a product wellbefore the product is launched. This development process requires not onlysubstantial lead time between the commencement of design efforts for acustomized battery system and the commencement of volume shipments of thebattery systems to the customer, but also the cooperation and assistance of theOEMs in order to determine the requirements for each specific application.Technical problems may arise that affect the acceptance of our product by OEMs. Ifwe are unable to design and develop products that meet OEMs’ requirements, wemay lose opportunities to obtain purchase orders, and our reputation may bedamaged. In addition, we may not receive adequate assistance from OEMs tosuccessfully commercialize our products, which could impair our profitability.

 

***Declines in product prices mayadversely affect our financial results.***

 

Our business is subject to intense price competition worldwide, whichmakes it difficult for us to maintain product prices and achieve adequateprofits. Such intense price competition may adversely affect our ability toachieve profitability, especially during periods of decreases in demand. Inaddition, because of their purchasing size, our larger automotive customers caninfluence market participants to compete on price terms. If we are not able tooffset pricing reductions resulting from these pressures by improved operatingefficiencies and reduced expenditures, those pricing reductions may have anadverse impact on our business.

 

***Implementations of new softwareplatforms or modifications to existing platforms may disrupt our business andoperations and could harm our operating results.***

 

The implementation of new software management platforms and theaddition of these platforms at new locations, especially overseas, requiresignificant management time, support and cost. As our business continues todevelop, we expect to add and enhance existing management platforms in theareas of financial, inventory control, engineering, and customer support andwarranty management. We cannot be sure that these platforms will be fully oreffectively implemented on a timely basis, if at all. If we do not successfullyimplement or modify these platforms, our operations may be disrupted and ouroperating expenses could be harmed. In addition, the new systems may notoperate as we expect them to, and we may be required to expend significantresources to correct problems or find alternative sources for performing thesefunctions.

 

***Our inability to effectively andquickly transfer, replicate and scale our new product manufacturing processesfrom low volume prototype production to high volume manufacturing facilities,could adversely affect our results of operations.***

 

Under our manufacturing model, we develop and establish manufacturingprocesses and systems for the low volume prototype production of our newproducts. As demand increases for a product, we transfer these processes andsystems to, and replicate and scale these processes and systems in our highvolume manufacturing facilities. If we are unable to effectively and quicklytransfer, replicate and scale these manufacturing processes and systems, suchas replicating our prismatic pilot facility in Korea to our new facility inLivonia, Michigan, we may be unable to meet our customers’ product quality andquantity requirements and lower our costs of goods sold and our results ofoperations could be adversely affected.

 

In addition, our costs of goods sold for some of our new productsexceed the purchase price for that product paid to us by our customers. If weare unable to decrease unit production costs for these products by increasingvolumes, improving the manufacturing process, reducing transportation andhandling costs or obtaining lower cost raw materials or component parts, wewill not realize a profit from these products and our business will be harmed.

 

***Problems in our manufacturing andassembly processes could limit our ability to produce sufficient batteries tomeet the demands of our customers.***

 

Regardless of the process technology used, the manufacturing andassembly of safe, high-power batteries and battery systems is a highly complexprocess that requires extreme precision and quality control throughout a numberof production stages. Because we outsource the manufacturing and assembly ofone battery model and certain battery systems, we are unable to directlycontrol delivery schedules, quality assurance, manufacturing yields andproduction costs. Any defects in battery packaging, impurities in the electrodematerials used, contamination of the manufacturing environment, incorrectwelding, excess moisture, equipment failure or other 

 

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difficultiesin the manufacturing process could cause batteries to be rejected, therebyreducing yields and affecting our ability to meet customer expectations.

 

As we have scaled up our production capacity, we have experiencedproduction problems that limited our ability to produce a sufficient number ofbatteries to meet the demands of one of our customers in the consumer market.If these or other production problems recur and we are unable to resolve themin a timely fashion, our business could suffer and our reputation may beharmed.

 

***Our failure to cost-effectivelymanufacture our batteries and battery systems in quantities which satisfy ourcustomers’ demand and product specifications and their expectations for productquality and reliable delivery could damage our customer relationships andresult in significant lost business opportunities for us.***

 

We manufacture a substantial percentage of our products rather thanrelying upon third-party outsourcing. To be successful, we mustcost-effectively manufacture commercial quantities of our complex batteries andbattery systems that meet our customer specifications for quality and timelydelivery. To facilitate the commercialization of our products, we will need tofurther reduce our manufacturing costs, which we intend to do by working withmanufacturing partners and by improving our manufacturing and developmentoperations in our wholly-owned operations in China. We manufacture our batteriesand assemble our products in China, Korea, Massachusetts and Michigan. Wedepend on the performance of our manufacturing partners, as well as our ownmanufacturing operations, to manufacture and deliver our products to ourcustomers. If we or any of our manufacturing partners are unable to manufactureproducts in commercial quantities on a timely and cost-effective basis, wecould lose our customers and be unable to attract future customers.

 

In addition, we have recently begun to shift most of our batteryassembly and all of our battery system manufacturing from contractmanufacturing to in-house manufacturing, so our in-house experience withbattery assembly and battery system manufacturing is limited.

 

***We may be unable to complete orintegrate acquisitions effectively, which may adversely affect our growth,profitability and results of operations.***

 

We may pursue acquisitions as part of our business strategy. However,we cannot be certain that we will be able to identify attractive acquisitiontargets, obtain financing for acquisitions on satisfactory terms orsuccessfully acquire identified targets. Additionally, we may not be successfulin integrating acquired businesses into our existing operations and achievingprojected synergies. Competition for acquisition opportunities in the variousindustries in which we operate may rise, thereby increasing our costs of makingacquisitions or causing us to refrain from making further acquisitions. Theseand other acquisition-related factors could negatively and adversely impact ourgrowth, profitability and results of operations.

 

***We entered into a joint venture inChina that, if not successful, could adversely impact our business, businessprospects and operating results.***

 

In December 2009, we formed a joint venture with SAICMotor Co. Ltd., or SAIC, a leading automaker in China. We will have a49 percent minority interest in the joint venture, Shanghai AdvancedTraction Battery Systems Co., Ltd., or ATBS, which is domiciled inShanghai, China. Pursuant to the joint venture agreements, we will supply ATBSwith battery cells and, as requested by ATBS, we will grant necessary advancedtechnology licenses to ATBS for the development, manufacture and service ofbattery systems. As of December 31, 2009, we have not yet made any capitalcontributions to ATBS and operations of ATBS have not yet commenced.

 

The business of ATBS is subject to all the operational risks thatnormally arise for a technology company with global operations pertaining toresearch and development, manufacturing, sales, service, marketing andcorporate functions. In addition, there could be disagreements between us andSAIC with respect to important strategic and operational decisions. Operating abusiness as a joint venture often requires additional organizationalformalities as well as time-consuming procedures for sharing information andmaking decisions. We may be required to pay more attention to our relationshipwith SAIC, as the co-owner of ATBS, and if SAIC ceases to be the co-owner ofATBS, our relationship with ATBS may be adversely affected. Additionally, as weare sharing intellectual property with ATBS we face the risks that we may notbe able to maintain or enforce the rights to our intellectual property.

 

If the joint venture terminates, the joint venture could retaintechnical know how relating to battery systems transferred by us as part of theagreement. Additionally, we would have to find new partners or separatelypursue market opportunities in China which could cause us to incur additionaltime and expense.

 

***Laws regulating the manufacture ortransportation of batteries may be enacted which could result in a delay in theproduction of our batteries or the imposition of additional costs that couldharm our ability to be profitable.***

 

Laws and regulations exist today, and additional laws and regulationsmay be enacted in the future, which impose environmental, health and safetycontrols on the storage, use and disposal of certain chemicals and metals usedin the manufacture of lithium-ion batteries. Complying with any laws orregulations could require significant time and resources from our technicalstaff and possible 

 

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redesignof one or more of our products, which may result in substantial expendituresand delays in the production of one or more of our products, all of which couldharm our business and reduce our future profitability. The transportation oflithium and lithium-ion batteries is regulated both domestically andinternationally. Compliance with these regulations, when applicable, increasesthe cost of producing and delivering our products.

 

***We depend on contracts with theU.S. government and its agencies or on subcontracts with theU.S. government’s prime contractors for revenue and research grants tofund or partially fund our research and development programs, and our failureto retain current or obtain additional contracts could preclude us fromachieving our anticipated levels of revenue growth and profitability, increaseour research and development expenses and delay or halt certain research anddevelopment programs.***

 

Our ability to develop and market some of our products depends uponmaintaining our U.S. government contract revenue and research grantsobtained, which are recorded as incremental revenue and an offset to ourresearch and development expenses, respectively. Many of ourU.S. government contracts are funded incrementally, with funding decisionsmade on an annual basis. Approximately 3.6% of our total revenue and 18.3% ofour research and development expenses during the year ended December 31,2009 were derived from government contracts and subcontracts. Changes in governmentpolicies, priorities or programs that result in budget reductions could causethe government to cancel existing contracts or eliminate follow-on phases inthe future which would severely inhibit our ability to successfully completethe development and commercialization of some of our products. In addition,there can be no assurance that, once a government contract is completed, itwill lead to follow-on contracts for additional research and development,prototype build and test or production. Furthermore, there can be no assurancethat our U.S. government contracts or subcontracts will not be terminatedor suspended in the future. A reduction or cancellation of these contracts, orof our participation in these programs, would increase our research anddevelopment expenses, which could materially and adversely affect our resultsof operations and could delay or impair our ability to develop new technologiesand products.

 

***If we are unable to developmanufacturing facilities for our products in the United States, we may losebusiness opportunities and our customer relationships may suffer.***

 

We believe that developing manufacturing facilities for our products inthe United States is important, in order to address national economicimperatives, such as job creation, as well as to more efficiently address theneeds of our U.S.-based customers. This expansion depends upon our receivingfederal and state financial incentives, primarily in the form of direct grantsand loans, to provide the necessary capital for facilities and equipment. If weare unable to obtain this government assistance on a timely basis and in theamounts requested, we will not be able to scale our capacity meet current andfuture customer demand for our products.

 

***Because of the funding we receivefrom U.S. government entities and our government business initiatives, weare subject to U.S. federal government audits and other regulation, andour failure to satisfy audit requirements or comply with applicable regulationscould subject us to material adjustments or penalties that could negativelyimpact our business.***

 

The accuracy and appropriateness of our direct and indirect costs andexpenses under our contracts with the U.S. government are subject toextensive regulation and audit by appropriate agencies of theU.S. government. These agencies have the right to challenge our costestimates or allocations with respect to any such contract. Additionally,substantial portions of the payments to us under U.S. government contractsare provisional payments that are subject to potential adjustment upon audit bysuch agencies. Adjustments that result from inquiries or audits of ourcontracts could have a material adverse impact on our financial condition orresults of operations. Since our inception, we have not experienced anymaterial adjustments as a result of any inquiries or audits, but there can beno assurance that our contracts will not be subject to material adjustments inthe future.

 

As we grow our government business, we may also need to comply withU.S. laws regulating the export of our products, particularly in ourgovernment business. We cannot be certain of our ability to obtain any licensesrequired to export our products or to receive authorization from theU.S. federal government for international sales or domestic sales toforeign persons. Moreover, the export regimes and the governing policiesapplicable to our business are subject to change. Our failure to comply withthese and other applicable regulations, rules and approvals could resultin the imposition of penalties, the loss of our government contracts or oursuspension or debarment from contracting with the federal government generally,any of which would harm our business, financial condition and results ofoperations.

 

***Our ability to sell our products toour direct, OEM and tier 1 supplier customers depends in part on thequality of our engineering and customization capabilities, and our failure tooffer high quality engineering support and services could have a material adverseeffect on our sales and operating results.***

 

A high level of support is critical for the successful marketing andsale of our products. The sale of our batteries and battery systems ischaracterized by significant co-development and customization work in certainapplications. This development process requires not only substantial lead timebetween the commencement of design efforts for a customized battery system andthe commencement of volume shipments of the battery systems to the customer,but also the cooperation and assistance of the OEMs to determine therequirements for each specific application. Once our products are designed intoan OEM or tier 1 supplier customer’s products or systems, the OEM ortier 1 supplier customer depends on us to resolve issues relating to ourproducts. If we do not 

 

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effectivelyassist our OEM or tier 1 supplier customers in customizing, integratingand deploying our products in their own systems or products, or if we do notsucceed in helping them quickly resolve post-deployment issues and provideeffective ongoing technical support, our ability to sell our products would beadversely affected.

 

In addition, while we have supply and co-development agreements withcustomers located in different regions of the world, we do not have a globallydistributed engineering support and services organization. Currently, any issueresolution related to our products, system deployment or integration ischanneled back to our energy solutions group in Hopkinton, Massachusetts andNovi, Michigan, from which engineers and support personnel are deployed. As wegrow our business with our existing customers and beyond the markets into whichwe currently sell our battery technologies, we may need to increase the size ofour engineering support teams and deploy them closer to our customers. Ourinability to deliver a consistent level of engineering support and overallservice as we expand our operations could have a material adverse effect on ourbusiness and operating results. Moreover, despite our internal quality testing,our products may contain manufacturing or design defects or exhibit performanceproblems at any stage of their lifecycle. These problems could result inexpensive and time-consuming design modifications and impose additional needsfor engineering support and maintenance services as well as significantwarranty charges.

 

***Our past and future operations maylead to substantial environmental liability.***

 

The handling and use of some of the materials used in the developmentand manufacture of our products are subject to federal, state and localenvironmental laws, as well as environmental laws in other jurisdictions inwhich we operate. Under applicable environmental laws, we may be jointly andseverally liable with prior property owners for the treatment, cleanup,remediation and/or removal of any hazardous substances discovered at any propertywe use. In addition, courts or government agencies may impose liability for,among other things, the improper release, discharge, storage, use, disposal ortransportation of hazardous substances. If we incur any significantenvironmental liabilities, our ability to execute our business plan and ourfinancial condition would be harmed. Our facilities or operations could bedamaged or adversely affected as a result of disasters or unpredictable events,including widespread public health problems.

 

Our headquarters, including sales offices and research and developmentcenters, is located in Massachusetts. We also operate manufacturing, logistics,sales and research and development facilities in Michigan, China, Korea andCanada. If major disasters such as earthquakes, fires, floods, hurricanes,wars, terrorist attacks, computer viruses, pandemics or other events occur, orour information system or communications network breaks down or operatesimproperly, our facilities may be seriously damaged, or we may have to stop ordelay production and shipment of our products. We may incur expenses relatingto such damages. In addition, a renewed outbreak of SARS, avian flu, swine fluor another widespread public health problem in China or the United States couldhave a negative effect on our operations.

 

**Risks Related to Intellectual Property**

 

***Third parties have asserted thatthey own or control patents that are infringed by our products.***

 

We are presently involved in two related patent litigations withHydro-Québec involving certain patents it has licensed from The University ofTexas, or UT, related to electrode materials used in lithium-ion batteries.After discussions with Hydro-Québec about the relevance of two of these patentsto our products, we brought an action in the Federal District Court ofMassachusetts seeking a declaratory judgment that our products do not infringethese two UT patents. In response, Hydro-Québec and the UT countersued us inthe Federal Courts in Texas. Both cases are currently stayed pendingre-examination of these patents by the U.S. Patent Office. There-examination of these patents is complete, but the stay continues, althoughthe litigation could resume at any time. For a more detailed discussion of ourpatent litigation, see Item 3 of Part I: “Legal Proceedings.”

 

We believe that we have valid non-infringement defenses against both ofthese patents and that at least one of the patents is invalid. If we were tochallenge the validity of any issued United States patent in court, we would needto overcome a presumption of validity that attaches to every patent. Thisburden is high and would require us to present clear and convincing evidence asto the invalidity of the patent’s claims. There is no assurance that a courtwould find in our favor on infringement or validity and, if this case is notresolved in our favor, we may be required to pay substantial damages. Inaddition, an adverse ruling could cause us, and our customers, developmentpartners and licensees, to stop, modify or delay activities in the UnitedStates such as research, development, manufacturing and sales of products basedon technologies covered by these patents. We would need to develop products andtechnologies that design around these patents or obtain a license to the appropriatepatent. There is no certainty that such design-arounds exist or if they existthat they would be commercially competitive, and there is no certainty that alicense from the appropriate parties could be obtained. Also, the mereexistence, and the uncertainty with respect to the ultimate outcome, of thispatent litigation or any other patent litigation that we may become involvedwith, could cause our current and potential customers, development partners,the federal or state governments and licensees to stop, delay or avoid doingbusiness with us or modify the extent to which they are willing to do businesswith us, and this loss or delay of business could harm our operating resultsand our ability to execute on our business plan.

 

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***Other parties may also bringintellectual property infringement claims against us which would betime-consuming and expensive to defend, and if any of our products or processesis found to be infringing, we may not be able to procure licenses to usepatents necessary to our business at reasonable terms, if at all.***

 

Our success depends in part on avoiding the infringement of other parties’patents and proprietary rights. We may inadvertently infringe existingthird-party patents or third-party patents issued on existing patentapplications. In the United States and most other countries, patentapplications are published 18 months after filing. As a result, there maybe third-party pending patent applications of which we are unaware, and whichwe may infringe once they issue. These third parties could bring claims againstus that, even if resolved in our favor, could cause us to incur substantialexpenses and, if resolved against us, could cause us to pay substantialdamages. Under some circumstances in the United States, these damages could betriple the actual damages the patent holder incurs. If we have suppliedinfringing products to third parties for marketing or licensed third parties tomanufacture, use or market infringing products, we may be obligated toindemnify these third parties for any damages they may be required to pay tothe patent holder and for any losses the third parties may sustain themselvesas the result of lost sales or damages paid to the patent holder. In addition,we may have, and may be required to, make representations as to our right tosupply and/or license intellectual property and to our compliance with laws.Such representations are usually supported by indemnification provisionsrequiring us to defend our customers and otherwise make them whole if welicense or supply products that infringe on third party technologies or violategovernment regulations. Further, if a patent infringement suit were broughtagainst us, we and our customers, development partners and licensees could beforced to stop or delay research, development, manufacturing or sales ofproducts based on our technologies in the country or countries covered by thepatent we infringe, unless we can obtain a license from the patent holder. Sucha license may not be available on acceptable terms, or at all, particularly ifthe third party is developing or marketing a product competitive with productsbased on our technologies. Even if we were able to obtain a license, the rightsmay be nonexclusive, which would give our competitors access to the sameintellectual property.

 

Any successful infringement action brought against us may also adverselyaffect marketing of products based on our technologies in other markets notcovered by the infringement action. Furthermore, we may suffer adverseconsequences from a successful infringement action against us even if theaction is subsequently reversed on appeal, nullified through another action orresolved by settlement with the patent holder. As a result, any infringementaction against us would likely harm our competitive position, be costly andrequire significant time and attention of our key management and technicalpersonnel.

 

***We may be involved in lawsuits toprotect or enforce our patents, which could be expensive and time consuming.***

 

Competitors or others may infringe our patents. To counter infringementor unauthorized use, we may be required to file patent infringement claims,which can be expensive and time-consuming. In addition, in an infringementproceeding, a court may decide that a patent of ours is not valid or isunenforceable, or may refuse to stop the other party from using the technologyat issue on the grounds that our patents do not cover that technology. Anadverse determination of any litigation or defense proceedings could put one ormore of our patents at risk of being invalidated or interpreted narrowly andcould put our patent applications at risk of not issuing.

 

Interference proceedings brought by the United States Patent andTrademark Office may be necessary to determine the priority of inventions withrespect to our patent applications. Litigation or interference proceedings mayfail and, even if successful, may result in substantial costs and be adistraction to our management. We may not be able to prevent misappropriationof our proprietary rights, particularly in countries where the laws may notprotect such rights as fully as in the United States.

 

Furthermore, because of the substantial amount of discovery required inconnection with intellectual property litigation, there is a risk that some ofour confidential information could be compromised by disclosure. In addition,during the course of this litigation, there could be public announcements ofthe results of hearings, motions or other interim proceedings or developments.If securities analysts or investors perceive these results to be negative, itcould have a substantial adverse effect on the price of our common stock.

 

We may not prevail in any litigation or interference proceeding inwhich we are involved. Even if we do prevail, these proceedings can beexpensive and distract our management.

 

***Our patent applications may notresult in issued patents, which may have a material adverse effect on ourability to prevent others from commercially exploiting products similar toours.***

 

Patent applications in the United States are maintained in secrecyuntil the patents are published or are issued. Since publication of discoveriesin the scientific or patent literature tends to lag behind actual discoveriesby several months, we cannot be certain that we are the first creator ofinventions covered by pending patent applications or the first to file patentapplications on these inventions. We also cannot be certain that our pendingpatent applications will result in issued patents or that any of our issuedpatents will afford protection against a competitor. In addition, patent applicationsfiled in foreign countries are subject to laws, rules and procedures thatdiffer from those of the United States, and thus we cannot be certain thatforeign patent applications related to issued U.S. patents will be issued.Furthermore, if these patent applications issue, some foreign countries providesignificantly less effective patent enforcement than in the United States.

 

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The status of patents involves complex legal and factual questions andthe breadth of claims allowed is uncertain. Accordingly, we cannot be certainthat the patent applications that we file will result in patents being issued,or that our patents and any patents that may be issued to us in the near futurewill afford protection against competitors with similar technology. Inaddition, patents issued to us may be infringed upon or designed around byothers and others may obtain patents that we need to license or design around,either of which would increase costs and may adversely affect our operations.

 

***Our patents and other protectivemeasures may not adequately protect our proprietary intellectual property.***

 

We regard our intellectual property, particularly our proprietaryrights in our battery and battery system technology, as critical to oursuccess. We have received a number of patents, and filed other patentapplications, for various applications and aspects of our technology orprocesses and other intellectual property. In addition, we generally enter intoconfidentiality and invention agreements with our employees and consultants.Such patents and agreements and various other measures we take to protect ourintellectual property from use by others may not be effective for variousreasons, including the following:

 

· our pendingpatent applications may not be granted for various reasons, including theexistence of conflicting patents or defects in our applications;

 

· the patents wehave been granted may be challenged, invalidated or circumvented because of thepre-existence of similar patented or unpatented intellectual property rights orfor other reasons;

 

· parties to theconfidentiality and invention agreements may have such agreements declaredunenforceable or, even if the agreements are enforceable, may breach suchagreements;

 

· the costsassociated with enforcing patents, confidentiality and invention agreements orother intellectual property rights may make aggressive enforcement prohibitive;

 

· even if weenforce our rights aggressively, injunctions, fines and other penalties may beinsufficient to deter violations of our intellectual property rights; and

 

· other personsmay independently develop proprietary information and techniques that arefunctionally equivalent or superior to our intellectual proprietary informationand techniques but do not breach our patented or unpatented proprietary rights.

 

***We may be unable to adequatelyprevent disclosure of trade secrets and other proprietary information.***

 

We rely on trade secrets to protect our proprietary technologies,especially where we do not believe patent protection is appropriate orobtainable. However, trade secrets are difficult to protect. We rely in part onconfidentiality agreements with our employees, contractors, consultants,outside scientific collaborators and other advisors to protect our tradesecrets and other proprietary information. These agreements may not effectivelyprevent disclosure of confidential information and may not provide an adequateremedy in the event of unauthorized disclosure of confidential information. Inaddition, others may independently discover our trade secrets or independentlydevelop processes or products that are similar or identical to our tradesecrets, and courts outside the United States may be less willing to protecttrade secrets. Costly and time-consuming litigation could be necessary toenforce and determine the scope of our proprietary rights, and failure toobtain or maintain trade secret protection could adversely affect ourcompetitive business position.

 

**Risks Associated With Doing Business Internationallyand Specifically in China and Korea**

 

***Our substantial internationaloperations subject us to a number of risks, including unfavorable political,regulatory, labor and tax conditions.***

 

We have significant manufacturing facilities and operations in Chinaand Korea that are subject to the legal, political, regulatory and socialrequirements and economic conditions in these jurisdictions. In addition, weexpect to sell a significant portion of our products to customers locatedoutside the United States. Risks inherent to international operations andsales, include, but are not limited to, the following:

 

· difficulty inenforcing agreements, judgments and arbitration awards in foreign legalsystems;

 

· fluctuationsin exchange rates may affect product demand and may adversely affect ourprofitability in U.S. dollars to the extent the cost of raw materials andlabor is denominated in a foreign currency;

 

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· impediments tothe flow of foreign exchange capital payments and receipts due to exchangecontrols instituted by certain foreign governments and the fact that the localcurrencies of these countries are not freely convertible;

 

· inability toobtain, maintain or enforce intellectual property rights;

 

· changes in generaleconomic and political conditions;

 

· changes inforeign government regulations and technical standards, including additionalregulation of rechargeable batteries, power technology, or the transport oflithium or phosphate, which may reduce or eliminate our ability to sell orlicense in certain markets;

 

· requirementsor preferences of foreign nations for domestic products could reduce demand forour products;

 

· trade barrierssuch as export requirements, tariffs, taxes and other restrictions and expenses,which could increase the prices of our products and make us less competitive;and

 

· longer paymentcycles typically associated with international sales and potential difficultiesin collecting accounts receivable, which may reduce the future profitability offoreign sales.

 

Our business in foreign jurisdictions requires us to respond to rapidchanges in market conditions in these countries. Our overall success as aglobal business depends on our ability to succeed in different legal,regulatory, economic, social and political situations and conditions. We maynot be able to develop and implement effective policies and strategies in eachforeign jurisdiction where we do business. Also, each of the foregoing riskswill likely take on increased significance as we implement plans to expandforeign manufacturing operations.

 

***Since many of our products aremanufactured in China, we own and lease manufacturing facilities in China andthe Chinese market is of growing importance for our products, we face risks ifChina loses normal trade relations status with the United States or if US-Chinatrade relations are otherwise adversely impacted.***

 

We manufacture and export our products from China and own and leasemanufacturing facilities in China. We may also sell our products in China inthe future. Our products sold in the United States have normal trade relationsstatus and are currently not subject to United States import duties. As aresult of opposition to certain policies of the Chinese government and China’sgrowing trade surpluses with the United States, there has been, and in thefuture may be, opposition to normal trade relations status with China. TheUnited States Congress may also introduce China trade legislation targetingcurrency manipulation, which may adversely affect our business in China. Theloss of normal trade relations status for China, changes in current tariffstructures or adoption in the United States of other trade policies adverse toChina, and any retaliatory measures that impact our products in the Chinesemarket, could have an adverse effect on our business.

 

A change in exchange rates mandated by legislation could negativelyimpact the cost of imported raw materials and products.

 

Furthermore, our business and operations may be adversely affected bydeterioration of the diplomatic and political relationships between the UnitedStates and China. If the relationship between the United States and China wereto materially deteriorate, it could negatively impact our ability to control ouroperations and relationships in China, enforce any agreements we have withChinese partners or otherwise deal with any assets or investments we may havein China.

 

***Our ongoing manufacturing operationsin China are complex and having these remote operations may divert management’sattention, lead to disruptions in operations, delay implementation of ourbusiness strategy and make it difficult to establish adequate management andfinancial controls in China. Our plans to grow our business to include sales toChinese customers may necessitate additional management attention toestablishing and maintaining one or more joint venture relationships withChinese parties.***

 

Currently, we have most of our manufacturing operations in China. Wemay not be able to find or retain suitable employees in China and we may haveto train personnel to perform necessary functions for our manufacturing, seniormanagement and development operations. This may divert management’s attention,lead to disruptions in operations and delay implementation of our businessstrategy, all of which could negatively impact our profitability.

 

China has only recently begun to adopt management and financialreporting concepts and practices like those with which investors in the UnitedStates are familiar. We may have difficulty in hiring and retaining employeesin China who have the experience necessary to implement the kind of managementand financial controls that are expected of a United States public company. Ifwe cannot establish and implement such controls, we may experience difficultyin collecting financial data and preparing financial statements, books ofaccount and corporate records and instituting business practices that meet U.S.standards.

 

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Growing our business to include sales to Chinese customers may involveus entering into a Chinese-foreign joint venture with a Chinese partner. AChinese-foreign joint venture can be a complex business arrangement requiringsubstantial management attention to the joint venture relationship. The jointventure will also require capital contributions and due to China’s foreignexchange controls, uncertainty as to the ability to repatriate profits andprincipal out of China.

 

***Because of the relative weakness ofthe Chinese legal system in general, and the intellectual property regime inparticular, we may not be able to enforce intellectual property rights inChina.***

 

The legal regime protecting intellectual property rights in China isweak. Because the Chinese legal system in general, and the intellectualproperty regime in particular, are relatively weak, it is often difficult tocreate and enforce intellectual property rights in China. Accordingly, we maynot be able to effectively protect our intellectual property rights in China.

 

***Enforcing agreements and laws inChina is difficult and may be impossible because China does not have acomprehensive system of laws.***

 

We depend on our relationships with our Chinese manufacturing partners.In China, enforcement of contractual agreements may be sporadic, andimplementation and interpretation of laws may be inconsistent. The Chinesejudiciary is relatively inexperienced in interpreting agreements and enforcingChina’s laws, leading to a higher than usual degree of uncertainty as to theoutcome of any litigation. Even where adequate law exists in China, it may notbe possible to obtain swift and equitable enforcement of such law, or to obtainenforcement of a judgment or an arbitration award by a court of anotherjurisdiction.

 

***The government of China may changeor even reverse its policies of promoting private industry and foreigninvestment, in which case our assets and operations may be at risk.***

 

Our existing and planned operations in China are subject to risksrelated to the business, economic and political conditions in China, whichinclude the possibility that the central government of China will change oreven reverse its policies of promoting private industry and foreign investmentin China. The government of China has exercised and continues to exercisesubstantial control over virtually every section of the Chinese economy throughregulation and state ownership. Many of the current reforms which supportprivate business in China are of recent origin or provisional in nature. Otherpolitical, economic and social factors, such as political changes, changes inthe rates of economic growth, unemployment or inflation, or in the disparitiesof per capita wealth among citizens of China and between regions within China,could also lead to further readjustment of the government’s reform measures. Itis not possible to predict whether the Chinese government will continue to beas supportive of private business in China, nor is it possible to predict howany future reforms will affect our business. For example, if the governmentwere to limit the number of foreign personnel who could work in the country,substantially increase taxes on foreign businesses, eliminate export processingzones, restrict the transportation of goods in and out of the country, adoptpolicies favoring competitors or impose other restrictions on our operations,the impact may be significant.

 

Significantly, a reversal of current liberalizations of foreignexchange controls by the Chinese government could be disruptive and costly toour cross-border operations and our business as a whole.

 

***Business practices in China andKorea may entail greater risk and dependence upon the personal relationships ofsenior management than is common in North America, and therefore some of ouragreements with other parties in China and Korea could be difficult orimpossible to enforce.***

 

The business cultures of China and Korea are, in some respects,different from the business cultures in Western countries and may present somedifficulty for Western investors reviewing contractual relationships amongcompanies in China and Korea and evaluating the merits of an investment.Personal relationships among business principals of companies and businessentities in China and Korea are very significant in their business cultures. Insome cases, because so much reliance is based upon personal relationships,written contracts among businesses in China and Korea may be less detailed andspecific than is commonly accepted for similar written agreements in Westerncountries. In some cases, material terms of an understanding are not containedin the written agreement but exist as oral agreements only. In other cases, theterms of transactions which may involve material amounts of money are notdocumented at all. In addition, in contrast to Western business practices wherea written agreement specifically defines the terms, rights and obligations of theparties in a legally-binding and enforceable manner, the parties to a writtenagreement in China or Korea may view that agreement more as a starting pointfor an ongoing business relationship which will evolve and require ongoingmodification. As a result, written agreements in China or Korea may appear tothe Western reader to look more like outline agreements that precede a formalwritten agreement. While these documents may appear incomplete or unenforceableto a Western reader, the parties to the agreement in China or Korea may feelthat they have a more complete understanding than is apparent to someone who isonly reading the written agreement without having attended the negotiations. Asa result, contractual arrangements in China and Korea may be more difficult toreview and understand.

 

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***China has introduced sweepingreforms to its income tax, turnover tax and other tax laws and regulations.Some of the changes increase the taxes for foreign-invested and otherbusinesses in China will incur on specific types of transactions as well asarising from operations generally in China. Our earnings may be affected by taxadjustments to reflect such changes in the law.***

 

Pursuant to a comprehensive reform of China’s tax system that tookeffect on January 1, 2008, income tax incentives granted toforeign-invested enterprises, and geographically-based incentives, have largelybeen eliminated and have been replaced with incentives designed to encourageenterprises, domestic and foreign-invested alike, in selected industries. Forexample, dividends paid by foreign-invested enterprises to foreign shareholdersare no longer exempt from withholding tax. A 10% withholding tax applies todividends, although the rate is reduced to 5% by certain tax treaties. The taxholidays and tax reduction periods and the reduced national income tax ratethat foreign-invested enterprises engaged in production used to enjoy have alsobeen removed. The tax incentives promised to our wholly foreign-ownedsubsidiaries located in export processing zones at the time of inception willbe phased-out by the end of 2012. At that time, these subsidiaries and any newforeign-invested enterprises we might establish as part of our strategy toexpand the market for our products will no longer have income tax advantagesover Chinese domestic businesses.

 

China’s turnover tax system consists of VAT, consumption tax andbusiness tax. VAT is primarily imposed on import and sales of goods and certainservices, such as repairing, processing and replacement. Export sales areexempt under VAT rules, and an exporter who incurs VAT on the purchase ormanufacture of goods should be able to claim a refund from Chinese taxauthorities. Depending on whether VAT export refund rates are raised or reducedfor relevant goods, exporters might bear part of the VAT they incurred inconjunction with producing the exported goods. To mitigate the effects of theglobal economic downturn on China’s export industry, the PRC Ministry ofFinance and the State Administration of Taxation have raised VAT rebates onnumerous exported labor-intensive and high-value-added products. However, theChinese government may also lower rebate rates in future in response todifferent economic and policy objectives.

 

China has also introduced sweeping VAT policy reforms with effect from January 1,2009, which facilitate China’s shift from a production-based VAT scheme to aconsumption-based system. Generally, the new system reduces the total outputVAT of production enterprises as fixed-asset investment costs related toVAT-eligible output are no longer subject to VAT. However, our VAT costs willdepend on our ability to pass on input VAT to our local suppliers andcustomers. As the relevant VAT law and implementing regulations are new, theremay be a period of adjustment before any cost-savings are realized.

 

Business tax is usually a fee of 3-5 percent levied onservices—such as transport, construction, education, finance, andinsurance—transfer of intangible assets, and sales of fixed assets, none ofwhich are generally eligible for VAT. New business tax regulations, which tookeffect January 1, 2009, may impose business on services exchanged amongChina- and foreign-based entities which previously were not subject to businesstax, and the potential overall impact is to increase the tax burden ofcross-border service transactions.

 

Frequent changes to China’s tax laws can result in uncertainty andunpredictability in financial results of our operations in China. China’s taxlaws are supplemented with detailed implementation rules and circulars.However, the interpretation of the rules may vary among local taxauthorities.

 

**Risks Related to Ownership of Our Common Stock**

 

***We are incurring increased costs anddemands upon management as a result of complying with the laws and regulationsaffecting public companies, which could harm our operating results.***

 

As a public company, we are incurring significant additional legal,accounting and other expenses that we did not incur as a private company,including costs associated with public company reporting requirements. We alsohave incurred and will incur costs associated with current corporate governancerequirements, including requirements under Section 404 and otherprovisions of the Sarbanes-Oxley Act, as well as rules implemented by theSecurities and Exchange Commission, or SEC, and the Nasdaq Global Market. Theexpenses incurred by public companies for reporting and corporate governancepurposes have increased dramatically in recent years. We expect these rules andregulations to substantially increase our legal and financial compliance costsand to make some activities more time-consuming and costly. We are unable tocurrently estimate these costs with any degree of certainty. We also expectthese new rules and regulations may make it more difficult and moreexpensive for us to obtain director and officer liability insurance, and we maybe required to accept reduced policy limits and coverage or incur substantiallyhigher costs to obtain the same or similar coverage previously available. As aresult, it may be more difficult for us to attract and retain qualified individualsto serve on our board of directors or as our executive officers.

 

***An active trading market for ourcommon stock may not develop or be sustained, and you may not be able to resellyour shares at or above the price at which you purchased them.***

 

We have a limited history as a public company. An active trading marketfor our shares may never develop or be sustained. In the absence of an activetrading market for our common stock, investors may not be able to sell theircommon stock at or above the price they paid or at the time that they wouldlike to sell.

 

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***Our stock price may be volatile.***

 

The market price of our common stock could be subject to significantfluctuations, and it may decline below the price at which you purchased it.Market prices for securities of early stage companies have historically beenparticularly volatile. As a result of this volatility, you may not be able tosell your common stock at or above the price you paid. Some of the factors thatmay cause the market price of our common stock to fluctuate include:

 

· fluctuations in ourquarterly financial results or the quarterly financial results of companiesperceived to be similar to us;

 

· fluctuations in our recordedrevenue, even during periods of significant sales order activity;

 

· changes in estimates of ourfinancial results or recommendations by securities analysts;

 

· failure of any of ourproducts to achieve or maintain market acceptance;

 

· product liability issuesinvolving our products or our competitors’ products;

 

· changes in market valuationsof similar companies;

 

· success of competitiveproducts or technologies;

 

· changes in our capitalstructure, such as future issuances of securities or the incurrence of debt;

 

· announcements by us or ourcompetitors of significant services, contracts, acquisitions or strategicalliances;

 

· developments orannouncements related to our application for government stimulus funds;

 

· regulatory developments inthe United States, foreign countries or both;

 

· litigation involving us, ourgeneral industry or both;

 

· additions or departures ofkey personnel;

 

· investors’ generalperception of us; and

 

· changes in general economic,industry and market conditions.

 

In addition, if the market for technology stocks or the stock market ingeneral experiences a loss of investor confidence, the trading price of ourcommon stock could decline for reasons unrelated to our business, financialcondition or results of operations. If any of the foregoing occurs, it couldcause our stock price to fall and may expose us to class action lawsuits that,even if unsuccessful, could be costly to defend and a distraction tomanagement.

 

***A significant portion of our totaloutstanding shares may be sold into the public market in the near future, whichcould cause the market price of our common stock to drop significantly, even ifour business is doing well.***

 

Sales of a substantial number of shares of our common stock in thepublic market could occur at any time after the expiration of the lock-upagreements our stockholders entered into with the underwriters of our initialpublic offering, or IPO. These sales, or the market perception that the holdersof a large number of shares intend to sell shares, could reduce the marketprice of our common stock. On March 29, 2010, 71,111,858 shares of commonstock, subject to a contractual lock-up (which began on the closing of the IPOon September 29, 2009), became freely tradable, subject to any applicablevolume limitations under federal securities laws. Morgan Stanley and Goldman,Sachs & Co., acting as co-representatives of the underwriters,may permit our officers, directors, employees and current stockholders who aresubject to the contractual lock-up to sell shares prior to the expiration ofthe lock-up agreements.

 

In addition, as of December 31, 2009, there were 10,639,961 sharessubject to outstanding options that will become eligible for sale in the publicmarket to the extent permitted by any applicable vesting requirements, thelock-up agreements and Rules 144 and 701 under the Securities Act of 1933,as amended. Moreover, holders of an aggregate of approximately62.0 million shares of our common stock as of December 31, 2009, haverights, subject to some conditions, to require us to file registrationstatements covering their shares and to include their shares in registrationstatements that we may file for ourselves or other stockholders. Holders of anaggregate of approximately 3.3 million additional shares of our common stockas of December 31, 2009, have rights, subject to some 

 

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conditions,to include their shares in registration statements that we may file forourselves or other stockholders. We have also registered all shares of commonstock that we may issue under our equity incentive plans, including 8,091,550shares reserved for future issuance under our equity incentive plans, pursuantto a registration statement that was filed and became immediately effective on March 31,2010. Once we issue these shares, they can be freely sold in the public marketupon issuance.

 

Upon the closing of aprivate placement in connection with a strategic transaction on January 14,2010, we issued 479,282 shares of common stock (of which 213,198 shares remainin escrow at March 31, 2010) to Fisker Automotive Inc., or Fisker. The issuanceof these shares resulted in dilution to stockholders who held our common stockprior to the private placement. All of the shares of common stock released fromescrow are freely tradable pursuant to a registration statement filed with theSEC that was declared effective by the SEC on March 29, 2010.

 

***If securities or industry analystsdo not publish or cease publishing research or reports about us, our businessor our market, or if they change their recommendations regarding our stockadversely, our stock price and trading volume could decline.***

 

The trading market for our common stock will be influenced by theresearch and reports that industry or securities analysts may publish about us,our business, our market or our competitors. If any of the analysts who maycover us change their recommendation regarding our stock adversely, or providemore favorable relative recommendations about our competitors, our stock pricewould likely decline. If any analyst who may cover us were to cease coverage ofour company or fail to regularly publish reports on us, we could losevisibility in the financial markets, which in turn could cause our stock priceor trading volume to decline.

 

***Our management has broad discretionover the use of our cash reserves, if any, and might not apply this cash inways that increase the value of your investment.***

 

Our management has broad discretion to use our cash reserves, if any,and you will be relying on the judgment of our management regarding theapplication of this cash. Our management might not apply our cash in ways thatincrease the value of your investment. We expect to use our cash reserves forcapital expenditures, including capital expenditures related to the expansionof our manufacturing capacity in Michigan, working capital, and other generalcorporate purposes, which may in the future include investments in, oracquisitions of, complementary businesses, joint ventures, partnerships,services or technologies. Our management might not be able to yield asignificant return, if any, on any investment of this cash. You will not have theopportunity to influence our decisions on how to use our cash reserves.

 

***We do not expect to declare anydividends in the foreseeable future.***

 

We do not anticipate declaring any cash dividends to holders of ourcommon stock in the foreseeable future. Consequently, investors may need torely on sales of their common stock after price appreciation, which may neveroccur, as the only way to realize any future gains on their investment.Investors seeking cash dividends should not purchase our common stock.

 

***Anti-takeover provisions containedin our certificate of incorporation and bylaws, as well as provisions ofDelaware law, could impair a takeover attempt.***

 

Our certificate of incorporation, bylaws and Delaware law containprovisions that could have the effect of rendering more difficult ordiscouraging an acquisition deemed undesirable by our board of directors. Ourcorporate governance documents include provisions:

 

· authorizing blank checkpreferred stock, which could be issued with voting, liquidation, dividend andother rights superior to our common stock;

 

· limiting the liability of,and providing indemnification to, our directors and officers;

 

· limiting the ability of ourstockholders to call and bring business before special meetings and to take actionby written consent in lieu of a meeting;

 

· requiring advance notice ofstockholder proposals for business to be conducted at meetings of ourstockholders and for nominations of candidates for election to our board ofdirectors;

 

· controlling the proceduresfor the conduct and scheduling of board of directors and stockholder meetings;

 

· providing the board ofdirectors with the express power to postpone previously scheduled annualmeetings and to cancel previously scheduled special meetings;

 

· establishing a classifiedboard of directors so that not all members of our board are elected at onetime;

 

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· limiting the determinationof the number of directors on our board of directors and the filling ofvacancies or newly created seats on the board to our board of directors then inoffice; and

 

· providing that directors maybe removed by stockholders only for cause.

 

These provisions, alone or together, could delay hostile takeovers andchanges in control of our company or changes in our management.

 

As a Delaware corporation, we are also subject to provisions ofDelaware law, including Section 203 of the Delaware General Corporationlaw, which prevents some stockholders holding more than 15% of our outstandingcommon stock from engaging in certain business combinations without approval ofthe holders of substantially all of our outstanding common stock. Any provisionof our amended and restated certificate of incorporation or bylaws or Delawarelaw that has the effect of delaying or deterring a change in control couldlimit the opportunity for our stockholders to receive a premium for theirshares of our common stock, and could also affect the price that some investorsare willing to pay for our common stock.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

(a) Sales ofUnregistered Securities

 

From the period beginning January 1, 2010 throughMarch 15, 2010, the date we filed a Registration on Form S-8(File No. 333-165489) with the SEC registering shares of common stockissuable under our stock incentive plans, (i) we granted stock options to purchase an aggregate of88,500 shares of our common stock, with exercise prices of $15.36 per share, toemployees and directors pursuant to our 2009 stock incentive plan and (ii) anaggregate of 720,466 shares were issued upon the exercise of stock optionsissued under our 2001 stock incentive plan, at a weighted-average exerciseprice of $0.62 per share, for an aggregate consideration of $448,062.  The securities described in this paragraphwere issued pursuant to written compensatory plans or arrangements with our employees,directors and consultants in reliance on the exemptions provided by either Section 4(2) ofthe Securities Act or Rule 701 promulgated under Section 3(b) ofthe Securities Act.  All securitiesdescribed in this paragraph are deemed restricted securities for purposes ofthe Securities Act. The instruments representing such issued securitiesincluded appropriate legends setting forth that the securities had not beenregistered and the applicable restrictions on transfer.

 

On January 14, 2010, weissued 479,282 shares of common stock (of which 213,198 shares remain in escrowat March 31, 2010) to Fisker in a private placement in connection with astrategic transaction with Fisker.  Inconnection with the issuance, we relied upon the exemption from securitiesregistration afforded by section 4(2) of the Securities Act in that theissuance of shares to Fisker did not involve a public offering.  Fisker represented its intentions to acquirethe shares for investment purposes only and not with a view to, or for sale inconnection with, any distribution thereof. The shares were originally deemed restricted securities for purposes ofthe Securities Act and the stock certificates representing such shares includedappropriate legends setting forth that the shares had not been registered andthe applicable restrictions on transfer. On March 15, 2010, we filed a Registration on Form S-1 (File No. 333-165488)with the SEC registering the shares of common stock issued to Fisker.  This registration statement was declaredeffective by the SEC on March 29, 2010.

 

(b) Use of Proceeds from Public Offering ofCommon Stock

 

On September 29, 2009, we closed our IPO, inwhich 32,407,576 shares of common stock were sold at a price to the public of$13.50 per share. We sold 31,727,075 shares of our common stock in the offeringand selling stockholders sold 680,501 of the shares of common stock in theoffering. The aggregate offering price forall shares sold in the offering, including shares soldby us and the selling stockholders, was $437.5 million. The offer and sale ofall of the shares in the IPO were registered under the Securities Act pursuantto a registration statement on Form S-1 (File No. 333-152871), whichwas declared effective by the SEC on September 23, 2009, and aregistration statement on Form S-1 (File No. 333-162090) filedpursuant to Rule 424(b) of the Securities Act.. The offeringcommenced as of September 23, 2009 and did not terminate before all of thesecurities registered in the registration statement were sold. Morgan Stanley &Co. Incorporated and Goldman, Sachs, & Co. acted as co-representativesof the underwriters. We raised approximately $391.8 million in net proceedsafter deducting underwriting discounts and commissions of $30.0 millionand other estimated offering costs of $6.7 million. No payments were made by usto directors, officers or persons owning ten percent or more of our commonstock or to their associates, or to our affiliates, other than payments in theordinary course of business to officers for salaries and to non-employee directorsas compensation for board or board committee service, or as a result of salesof shares of common stock by selling stockholders in the offering.  There has been no material change in theplanned use of proceeds from our IPO as described in our final prospectus filedwith the SEC pursuant to Rule 424(b). From the effective date of the registration statement through March 31,2010, we used approximately $83.6 million of the net proceedsprimarily to fund our operations and the expansion of our facilities to supportthe anticipated growth of our business. We have invested the remainder of thefunds in a registered money market fund.

 

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(c) Restrictions ondividends

 

We have not paid any cashdividends since inceptions and do not anticipate paying cash dividends in theforeseeable future.  Our term loanrestricts our ability to pay cash dividends.

 

**Item 6.Exhibits**

 

The exhibits listed in the Exhibit Indeximmediately preceding the exhibits are filed (other than exhibits 32.1 and32.2) as part of this Quarterly Report on Form 10-Q and such Exhibit Indexis incorporated herein by reference.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                    | **A123 SYSTEMS, INC.** |
|-------------------------|------------------------|
|                    |                   |
| Date: May 11, 2010 | By:                    | /s/ David P. Vieau |
|                    |                   | David P. Vieau |
|                    |                   | Chief Executive Officer |
|                    |                   | (Principal Executive  Officer) |
|                    |                   |
|                    |                   |
| Date: May 11, 2010 | By:                    | /s/ Michael Rubino |
|                    |                   | Michael Rubino |
|                    |                   | Chief Financial Officer |
|                    |                   | (Principal Financial  and Accounting Officer) |

 

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*EXHIBIT INDEX*

 

Listed and indexed below are all Exhibits filed aspart of this report.

 
| **Exhibit  No.** | ** ** | **Description** |
|------------------|------------|-----------------|
|             |       |            |   |
| 31.1             |       |            | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive  Officer. |
|             |       |            |   |
| 31.2             |       |            | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial  Officer. |
|             |       |            |   |
| 32.1             | +          |            | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, by Chief Executive Officer. |
|             |       |            |   |
| 32.2             | +          |            | Certification pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, by Chief Financial Officer. |

 

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| + | This certification shall not be deemed “filed” for  purposes of Section 18 of the Securities Exchange Act of 1934, or  otherwise subject to the liability of that Section, nor shall it be deemed to  be incorporated by reference into any filing under the Securities Act of 1933  or the Securities Exchange Act of 1934. |
|---|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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