Sevcon, Inc. (“Sevcon” or “the Company”) is a Delaware corporation organized on December 22, 1987 to carry on the electronic controls business previously performed by Tech/Ops, Inc. Through wholly-owned subsidiaries located in the United States, the United Kingdom, France, South Korea and Japan, the Company designs and sells, under the Sevcon name, microprocessor based controls for zero emission and hybrid electric vehicles. The controls are used to vary the speed and movement of vehicles, to integrate specialized functions and to prolong the shift life of vehicles’ power source. The Company’s customers are manufacturers of on-road, off-road and industrial vehicles including automobiles, buses, fork lift trucks, aerial lifts, mining vehicles, airport ground support vehicles, utility vehicles, sweepers and other battery powered vehicles. Through another subsidiary located in the United Kingdom, Sevcon, Inc. manufactures special metalized film capacitors that are used as components in the power electronics, signaling and audio equipment markets.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normally recurring accruals) necessary to present fairly the financial position of Sevcon, Inc. as of June 28, 2014January 3, 2015 and the results of operations and cash flows for the ninethree months ended June 28, 2014.January 3, 2015. These unaudited interim financial statements should be read in conjunction with the 20132014 annual consolidated financial statements and related notes included in the 20132014 Sevcon, Inc. Annual Report filed on Form 10-K (the “2013“2014 10-K”). Unless otherwise indicated, each reference to a year means the Company’s fiscal year, which ends on September 30.

The results of operations for the ninethree month period ended June 28, 2014January 3, 2015 are not necessarily indicative of the results to be expected for the full year.

Other than the matter referred to below and the new accounting pronouncement set forth in Note 3, thereThere have been no changes since the end of 20132014 to the significant accounting policies followed by Sevcon, Inc.:

Under the Company’s 1996 Equity Incentive Plan (the “Plan”) there were 183,400157,557 shares reserved and available for grant at June 28, 2014.   In the second quarter of 2014 stockholders approved an increase of 150,000 in the number of shares of common stock authorized for issuance under the Plan. In the period ended June 28, 2014, 80,000 shares of restricted stock were granted to management, 28,600 shares were granted to non-employee directors and 5,000 shares under option were cancelled.January 3, 2015.   There were 137,00062,000 shares reserved and available for grant at June 29,December 28, 2013.  There were no options granted or exercised in the periodsquarters ended JuneJanuary 3, 2015 and December 28, 2014 and June 29, 2013.

Recipients of grants must execute a standard form of non-competition agreement. The plan provides for the grant of Restricted Stock, Restricted Stock Units, Options, and Stock Appreciation Rights (“SARs”). SARs may be awarded either separately, or in relation to options granted, and for the grant of bonus shares. Options granted are exercisable at a price not less than fair market value on the date of grant.

A summary of option activity for all plans for the nine months ended JuneThere were no options outstanding or exercisable at January 3, 2015 or December 28, 2014 is as follows:2013

In December 2013,2014, the Company granted 80,00042,000 shares of restricted stock to seveneight employees, which will vest in two equal annual installments so long as the employee is then employed by the Company or as determined by the Compensation Committee. The estimated fair value of the stock on the date of grant was $330,000 based on the fair market value of stock on the date of issue. This unvested compensation is being charged to income on a straight line basis over two years. The charge to income for this employee restricted stock grant will be approximately $41,000 on a quarterly basis.

In December 2014, the Company granted 20,000 shares of restricted stock to three employees, which will vest in five equal annual installments so long as the employee is then employed by the Company or as determined by the Compensation Committee. The estimated fair value of the stock measured on the date of grant was $354,000,$139,000 based on the fair market value of the stock on the date of issue. TheThis unvested compensation is being charged to income on a straight line basis over five years. The charge to income for this employee restricted stock in the first nine months of 2014 was $35,000 and the subsequent chargegrant will be approximately $18,000 on a quarterly basis.

A summary of restricted stock activity for the ninethree months ended June 28, 2014January 3, 2015 is as follows:

Stock-based compensation expense was $98,000$113,000 and $225,000$59,000 for the three and nine month periods ended JuneJanuary 3, 2015 and December 28, 2014 and $47,000 and $215,000 for the three and nine month periods ended June 29, 2013.2013, respectively. At June 28, 2014,January 3, 2015, there was $716,000$992,000 of unrecognized compensation expense related to restricted stock granted under the Plan. The Company expects to recognize that cost over a weighted average period of 3.02.9 years.

Basic and fullyearnings per share is computed by dividing the net income or loss for the period attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the numerator of net income attributable to common stockholders is adjusted by the effect of dilutive securities, including convertible preferred stock using the treasury stock method.  The denominator is increased for the assumed exercise of dilutive options and other potentially dilutive securities, including convertible preferred stock, using the treasury stock method, unless the effect is anti-dilutive.

The Company has two reportable segments: electronic controls and capacitors. The electronic controls segment produces microprocessor based control systems for zero emission and hybrid electric vehicles. The capacitors segment produces metalized film capacitors for sale to electronic equipment manufacturers. Each segment has its own management team and sales force and the capacitors segment has its own manufacturing facility.

The significant accounting policies of the segments are the same as those described above and in Note 1 to the Notes to Consolidated Financial Statements in the 20132014 10-K. Inter-segment revenues are accounted for at current market prices. The Company evaluates the performance of each segment principally based on operating income. The Company does not allocate income taxes, interest income and expense or foreign currency translation gains and losses to segments. Information concerning operations of these businesses is as follows:

The cost of research and development programs is charged against income as incurred and was as follows:in each period.

In recent years the Company has received several awards of research and development grants by the Technology Strategy Board, a public body established by the U.K. government to stimulate technology-enabled innovation.

In 2011, the Company was awarded a research and development grant by the Technology Strategy Board to lead a collaborative project with Cummins Generator Technologies and Newcastle University in the U.K. to develop an innovative electric drive system for electric vehicles using advanced switched reluctance motor technology. The Company recorded grant income from this Technology Strategy Board project of $28,000 and $61,000$8,000 in the three and nine month periods ended June 28, 2014, respectively,first quarter of 2015 associated with research and development expense of $83,000 and $180,000, respectively, in the same periods.$23,000. The Company recorded grant income of $39,000 and $76,000 in the three and nine month periods ended June 29, 2013, respectively,$17,000 associated with research and development expense of $114,000 and $225,000, respectively,$50,000 in respect of this Technology Strategy Board grant in the same periods.first quarter of 2014.

 

In July 2013, the Company was awarded a grant of approximately $480,000 by the Low Emission Transport Collaborative Projects Fund, a U.K. government body. The grant is to develop next-generation controls for high-voltage, low-power applications. This grant will defray part of the research and development expense associated with this project over the period from July 2013 to March 2015. The Company recorded grant income from this project of $103,000 and $339,000 in the three and nine month periods ended June 28, 2014, respectively,first quarter of 2015 of $16,000 associated with research and development expense of $423,000 and $1,392,000, respectively,$66,000. The Company recorded grant income from this project in the same periods.  The Company did not record any grant income or incur anyfirst quarter of 2014 of $97,000 associated with research and development expense in respect of this grant in the first nine months of 2013.$422,000.

The grant income in the first nine monthsquarter of 20142015 and 20132014 was recorded as a reduction of research and development expense.

Sevcon has defined contribution plans covering the majority of its U.S. and U.K. employees in the controls business. There is also a small defined contribution plan covering senior managers in the capacitor business. The Company has frozen the U.K. and U.S. defined benefit plans for which no future benefits are being earned by employees. The Company uses a September 30 measurement date for its defined benefit pension plans.

The following table sets forth the movement in the liability for pension benefits in the ninethree month periods ended JuneJanuary 3, 2015 and December 28, 2014 and June 29, 2013:

Sevcon, Inc. contributed $100,000did not contribute to its frozen U.S. defined benefit plan in the ninethree months ended June 28, 2014;January 3, 2015; it presently anticipates contributing a further $100,000$200,000 to fund its U.S. plan in the remainder of fiscal 2014.2015. In addition, employer contributions to the U.K. defined benefit plan were $329,000$119,000 in the first ninethree months and are estimated to total $500,000$464,000 in 2014.2015.

The table below presents information about the Company’s pension plan assets measured and recorded at fair value as of June 28, 2014January 3, 2015 and indicates the fair value hierarchy of the inputs utilized by the Company to determine the fair values.

Inventories, net of reserve, were comprised of:

The Company's financial instruments consist mainly of cash and cash equivalents, short-term investments, accounts receivable and accounts payable. The carrying amount of these financial instruments as of June 28, 2014January 3, 2015 approximates fair value due to the short-term nature of these instruments. The fair value of the Company’s long term debt at June 28, 2014January 3, 2015 approximated $1,700,000$15,000 (the carrying value on the consolidated balance sheet at June 28, 2014)January 3, 2015) based on recent financial market pricing. The long term debt representsrepresented a level 2 liability in accordance with the fair value hierarchy described in Note 9.8.

Set out below is an analysis of other accrued expenses at June 28, 2014January 3, 2015 and September 30, 2013,2014, which shows separately any items in excess of 5% of total current liabilities:

At June 28, 2014,January 3, 2015 the Company had $42,000$15,000 outstanding under a U.K. bank loan entered into in April 2010, with a fixed interest rate of 6.8%. The loan, which was entered into by the U.K. metalized film capacitor subsidiary to purchase an item of capital equipment, is denominated in British Pounds. The loan agreement provides for equal monthly installments of $4,000 comprising interest and principal for a five year period commencing in May 2010. The total amount outstanding at June 28, 2014 of $42,000January 3, 2015, $15,000, is shown in the current liabilities section of the accompanying consolidated balance sheet under current debt, representing the principal element of the loan installments in the year ending on JuneSeptember 30, 2015. The fair market value of the debt at June 28, 2014January 3, 2015 was $42,000.$15,000.

The Company’s wholly owned subsidiary, Sevcon USA, Inc., has a $3,500,000 secured revolving credit facility with RBS Citizens National AssociationBank, for working capital and general corporate purposes. The loan and security agreement will expire on June 14, 2017 when allany outstanding principal and unpaid interest at that time will be due and payable in full.  The facility may be paid before maturity in whole or in part at the option of Sevcon USA, Inc., without penalty or premium.  Interest on the loan is payable monthly, and in the third quarter of 2014, was calculated at a margin of 3.125% over LIBOR. Under the facility, Sevcon USA, Inc. must maintain, on a quarterly basis, a debt to tangible net worth ratio of no more than 2.40:1 and a debt service coverage ratio of no less than 1.25:1 for each rolling twelve-month period. Upon entering intoInterest on the revolving credit facility, Sevcon USA, Inc. drew down $1,700,000, which was theloan is payable monthly, and is calculated at a margin of 3.125% over LIBOR.  The total amount outstanding under this credit facility at June 28, 2014.  This $1,700,000 is shown in the accompanying consolidated balance sheet under long-term debt. The carrying value of the debt approximated to fair value based on current interest rates.January 3, 2105 was $0 and at September 30, 2014 was $1,700,000.

In July 2014, the Company’s U.K. bank renewed the overdraft facilities of the Company’s U.K. controls and capacitor subsidiaries. The Company’s U.K. controls and capacitor subsidiaries each have multi-currency overdraft facilities which together total $1,530,000$1,380,000 and which are secured by real estate owned by those companies. In common with bank overdrafts in Europe, theThe renewal of the facilities is for a twelve month period although in line with normal practice in Europe, they can be withdrawn on demand by the bank. The facilities were unused at June 28,January 3, 2015 and at September 30, 2014.

During the third quarter of 2014, the Company received the required government approvalsSevcon, Inc. is involved in China to formally establish a joint-venture company which will source from Sevcon and supply, market and sell in China, current and future Sevcon products for on-road electric and hybrid vehicle applications. The joint-venture company, in which Sevcon and Risenbo Technology Company Limited each own a 50% stake, will operate as Sevcon New Energy Technology Company Limited. Risenbo Technology Company Limited is a subsidiary of a Chinese Tier 1 automotive supplier based in Hubei Province. The activities of the joint-venture companyvarious legal proceedings in the third quarter have been limited to the investment of initial capital of $320,000 by each party to the joint-venture, the sourcingordinary course of business premises andbut believes that it is remote that the hiring of engineering and sales and marketing staff. The financial statements of the joint-venture company have been consolidated with the Company’s as at June 28, 2014.outcome will be material to operations.

Sales inThe Company maintains a directors' retirement plan which provides for certain retirement benefits to non-employee directors. Effective January 1997 the third quarter of 2014 did not reflect any shipments associated with the joint-venture company; it is anticipated that initial shipments will commence in the fourth quarter of 2014. In addition, in the fourth quarter, the Company will recognize the initial establishment costs of the joint-venture agreement,plan was frozen and no further benefits are being accrued. While the cost of sourcing business premises and the hiringplan has been fully charged to expense, the plan is not separately funded. The estimated maximum liability which has been recorded based on the cost of initial staff.buying deferred annuities at January 3, 2015 and September 30, 2014 was $161,000 and $162,000, respectively.

In preparing these interim consolidated financial statements, the Company has evaluated, for potential recognition or disclosure, events or transactions subsequent to the end of the most recent quarterly period, the issuance date of these financial statements.

Statements in this discussion and analysis about the Company’s anticipated financial results and growth, as well as those about the development of its products and markets, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Important factors that could cause these statements not to be realized include the risks discussed under “Risk Factors” below and others discussed in this report.

As of June 28, 2014,January 3, 2015, there have been no material changes to the critical accounting estimates described in the Company’s 20132014 10-K. However, if the business and economic realities vary from those assumed in these judgments and estimates, actual operating results may differ materially from the amounts derived from these judgments and estimates. In addition, if the continuing worldwide economic troubles continue to have a negative effect on our business, estimates used in future periods may vary materially from those included in the Company’s previous disclosures.

The following table compares the results by segment for the three months ended June 28, 2014January 3, 2015 with the same period in the prior year. The table shows the effect of currency and volume changes in percentage terms:

Sales in the thirdfirst quarter of 20142015 were $9,657,000$9,933,000 compared to $8,675,000$9,049,000 in the same quarter last year, ana 10% increase of $982,000 or 11%.year-over-year. This increaseimprovement was mainly in our controls business and largely reflected higher sales tothe start-up of new electrification programs with on-road original equipment manufacturers (OEMs), volume production with new electric vehicle (EV) customers in our traditional off-road markets of aerial work platform and fork lift truck, as well as higher demand forhybrid on-road applications. WhileIn the first quarter of fiscal 2015 we saw overall sales growthrecognized initial engineering revenue for an integrated starter generator project with a large German manufacturer of 12%trucks, buses, engines and transportation solutions. This follows our investment two years ago when we started a business development team in Germany and is an example of execution on our on-going electrification strategy. Foreign currency was a major factor in the on-road sectorquarter, primarily due to the strength of the U.S. Dollar versus the Euro and British Pound; adjusted for currency, our business, this reflected a mixed result from sales to manufacturers of two-wheel and four-wheel vehicles. Ourtotal sales for the first quarter inof 2015 increased 13% year-over-year.

In terms of geography, the two-wheel, on-road sector were down 39%,  following 32%sales growth in the second quarter, and we expect this business to continue to be volatile from quarter to quarter going forward. In the four-wheel, on-road sector, across all geographies, total sales were up 54% in the quarter. A significant portion of this growth was driven by shipments to a U.S. based manufacturer of hybrid powertrain conversion systems for commercial vans and trucks. Sales to manufacturers of mining equipment were 8% lower in the quarter compared to the prior year, reflecting continued weakness in coal extraction. Foreign currency fluctuations increased reported sales in the third fiscal quarter by $474,000, or 5%, mainly due to a weaker U.S. Dollar compared to both the British Pound and the Euro than in the prior year period, which we expect to continue in the fourth quarter.

In the capacitor business, volumes shipped were 11%2% higher compared to the thirdfirst quarter last year, largely reflecting continuing higher demand from railway signaling customers.

Gross profit of $3,576,000$4,009,000 was 37.0%40.4% of sales in the thirdfirst quarter, compared to $3,237,000$3,832,000 or 37.3%42.3% of sales in the same quarter last year. The decrease in the gross profit percentage achieved in the quarter compared to the prior year reflected improvedwas largely due to deterioration in the sales mix in both the controls business and the capacitor business offset to some extent by some lower margin business in China and the impactas well as fixed overhead costs being a higher percentage of the cost savings implementedsales in the controls division infirst quarter of 2015 compared to the second quarter last year.prior year quarter.

Selling, research and administrative expensesexpense in the third quarter increased by $419,000 compared with the thirdfirst quarter of 2013. Approximately half of the increase reflects additional sales and marketing and engineering and research and development expense, including the hiring of additional staff and the other half of the increase reflects adverse movements in foreign currency due to a weaker U.S. Dollar compared to the British Pound and the Euro than in the prior year period. Engineering and research and development expense as a percentage of total sales2015 was 10.8% in the third quarter of fiscal 2014, compared with 11.2% in the same period last year. In addition, the Company recorded grant income of $132,000 in the third quarter of 2014 compared to $40,000 in the same period last year; this grant income was recorded as a reduction of research and development expense in each year.