For the Company's less than wholly owned subsidiary, Sevcon New Energy Technology (Hubei) Company Limited, the Company first analyzes whether this joint venture subsidiary is a variable interest entity (a “VIE”) in accordance with ASC 810 and if so, whether the Company is the primary beneficiary requiring consolidation. A VIE is an entity that has (i) insufficient equity to permit it to finance its activities without additional subordinated financial support or (ii) equity holders that lack the characteristics of a controlling financial interest. VIEs are consolidated by the primary beneficiary, which is the entity that has both the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits from the entity that potentially could be significant to the entity. Variable interests in a VIE are contractual, ownership, or other financial interests in a VIE that change with changes in the fair value of the VIE’s net assets. The Company continuously re-assesses (i) whether the entity is a VIE, and (ii) if the Company is the primary beneficiary of the VIE. If it is determined that the entity in which the Company holds its interest qualifies as a VIE and the Company is the primary beneficiary, it is consolidated.

Based on the Company's analysis for its 50% owned joint venture, the Company has determined that it is a VIE and that the Company is the primary beneficiary. While the Company owns 50% of the equity interest in this subsidiary, the other 50% is owned by a local unrelated third party, and the joint venture agreement with that third party provides the Company with greater voting rights. Accordingly, the Company consolidates its joint venture under the VIE rules and reflects the third party’s 50% interest in the consolidated financial statements as a non-controlling interest. The Company records this non-controlling interest at its initial fair value, adjusting the basis prospectively for their share of the respective consolidated investments’ net income or loss or equity contributions and distributions. This non-controlling interest is not redeemable by the equity holders and is presented as part of permanent equity. Income and losses are allocated to the non-controlling interest holder based on its economic ownership percentage.

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 January 3,April 4, 2015 and the results of operations and cash flows for the three monthsand six month periods ended January 3,April 4, 2015. These unaudited interim financial statements should be read in conjunction with the 2014 annual consolidated financial statements and related notes included in the 2014 Sevcon, Inc. Annual Report filed on Form 10-K (the “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 three and six month periodperiods ended January 3,April 4, 2015 are not necessarily indicative of the results to be expected for the full year.

There have been no changes since the end of 2014 to the significant accounting policies followed by Sevcon, Inc.

In December 2014, the Company granted 42,000 shares of restricted stock to eight 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 grantin the first six months of 2015 was $41,000 and the subsequent charge 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 on the date of grant was $139,000 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 five years. The charge to income for this employee restricted stock grantin the first six months of 2015 was $7,000 and the subsequent charge will be approximately $7,000 on a quarterly basis.

In February 2015, the Company granted 30,600 shares of restricted stock to nine non-employee directors, which will vest on the day before the 2016 annual meeting providing that the grantee remains a director of the Company, or as otherwise determined by the Compensation Committee. The aggregate fair value of the stock measured on the date of grant was $225,000, based on the closing sale price of the stock on the date of grant. Compensation expense is being charged to income on a straight line basis over the twelve month period during which the forfeiture conditions lapse. The charge to income for these restricted stock grants in the first six months of fiscal 2015 was $19,000 and the subsequent charge will be approximately $56,000 on a quarterly basis.

A summary of restricted stock activity for the threesix months ended January 3,April 4, 2015 is as follows:

Stock-based compensation expense was $113,000$146,000 and $59,000$259,000 for the three and six month periods ended January 3,April 4, 2015 and December 28, 2013,$68,000 and $127,000 for the three and six month periods ended March 29, 2014, respectively. At January 3,April 4, 2015, there was $992,000$1,071,000 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 2.92.5 years.

Basic earnings 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 and unvested restricted 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 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 2014 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:

 

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.

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 January 3,April 4, 2015 approximates fair value due to the short-term nature of these instruments. The fair value of the Company’s long termcurrent portion of long-term debt at January 3,April 4, 2015 approximated $15,000$4,000 (the carrying value on the consolidated balance sheet at January 3,April 4, 2015) based on recent financial market pricing. The long termcurrent portion of long-term debt represented a levelLevel 2 liability in accordance with the fair value hierarchy described in Note 8.9.

Set out below is an analysis of other accrued expenses at January 3,April 4, 2015 and September 30, 2014, which shows separately any items in excess of 5% of total current liabilities:

Sevcon, Inc. is involved in various legal proceedings in the ordinary course of business but believes that it is remote that the outcome will be material to operations.

The Company maintains a directors' retirement plan which provides for certain retirement benefits to non-employee directors. Effective January 1997 the plan was frozen and no further benefits are being accrued. While the cost of the plan 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 buying deferred annuities at January 3,April 4, 2015 and September 30, 2014 was $161,000$158,000 and $162,000, respectively.

Minimum rental commitments under all non-cancelable leases are as follows for the years ended September 30,  2015 - $213,000; 2016 - $205,000; 2017 - $205,000; 2018 - $208,000; 2019 - $194,000 and $3,405,000 thereafter.

The U.K. subsidiaries of the Company have given to a bank a security interest in certain leasehold and freehold property assets as security for overdraft facilities of $1,380,000.$1,300,000. There were no amounts outstanding on the overdraft facilities at January 3,April 4, 2015 and at September 30, 2014. The obligations under a secured revolving credit facility entered into in 2011 by the U.S. subsidiary of the Company, are guaranteed by the Company and are secured by all of the assets and a pledge of all of the capital stock, of Sevcon USA, Inc. The total amount outstanding under this revolving credit facility was $0 at January 3,April 4, 2015 and $1,700,000 at September 30, 2014.

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.

No material subsequent events were identified that require recognition or disclosure in 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 January 3,April 4, 2015, there have been no material changes to the critical accounting estimates described in the Company’s 2014 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.

 

All of these factors, and others resulting from the current economic situation, may have a material adverse  impact on the Company’s results.

The following table compares the results by segment for the three months ended January 3,April 4, 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 firstsecond quarter of 2015 were $9,933,000$10,340,000 compared to $9,049,000$9,170,000 in the same quarter last year, a 10%13% increase year-over-year. This improvementyear-on-year.  Nearly all of our growth this quarter was indriven by increased customer demand for the flexible and easily adaptable power train solutions we have been developing for an expanding range of on-road, four-wheel, applications. Although the majority of our controls business and reflected the start-up of new electrification programs withincremental on-road original equipment manufacturers (OEMs), volume production with newsales were for electric vehicle (EV) customers and hybrid on-road applications. Invehicle applications, there is also a growing demand for our next generation of products in other electrification applications such as hybridization in off-road sectors for improved performance and efficiency. Foreign exchange was a major influence on reported sales in the firstsecond quarter. Foreign currency fluctuations decreased reported sales by $833,000, or 9%, mainly due to a stronger U.S. Dollar compared with the Euro and the British Pound than in the second quarter of fiscal 20152014. Excluding the impact of foreign currency fluctuations, sales would have been 22% higher than the prior-year period.

Sales in the Company’s traditional off-road markets of aerial work platform and fork lift truck applications were largely flat compared with the same period last year. Sales to the mining sector continue to be slow as was airport ground support business, with sales to both sectors showing a double digit decline compared to the second quarter of 2014. In contrast, we recognized initialare beginning to gain business in the agriculture and construction sectors in Europe and South America, driven largely by interest in our new line of high voltage, low power inverters.

In the on-road sector, sales for two wheel applications were down 15% in the second quarter compared to the prior year, which reflects the on-going global volatility in demand in that market. In the four-wheel, on-road, sector, sales almost doubled compared to the same period in 2014. This growth was largely due to product shipments for bus and truck applications in Europe as well as the recognition of engineering revenue forrevenues and progress made on an integrated starter generatorelectrification project with a large German manufacturer of trucks, buses, engines and transportation solutions.  The Company’s Chinese joint venture continues to make good progress. This follows our investment two years ago when we startedjoint venture is initially targeting on-road electric and hybrid vehicle applications, marketing and selling principally to Chinese Tier 1 automotive suppliers. We anticipate the initial sales, related to pre-production orders, to lead to larger shipments. We expect to see larger production orders and volume shipments related to a business development teamnumber of projects in GermanyChina coming to fruition later in 2015 and in future years. It is an example of execution on our on-going electrification strategy. Foreign currency was a major factoranticipated that the joint venture will enable the Company to develop relationships with additional new customers in China in what is rapidly becoming the quarter, primarily due to the strength of the U.S. Dollar versus the Euroworld’s largest market for two- and British Pound; adjusted for currency, our total sales for the first quarter of 2015 increased 13% year-over-year.four-wheel electric vehicles.

In terms of geography, the sales growth in the controls business segment, was largely driven by Europe where revenues increased 18% from the same period last yearsales were up mid-single digits year-on-year in part due to higher shipments to on-road customers as well as by the initial engineering revenue from the large German on-road OEM contract. In North America sales increased 7% driven largely by volume shipments for controls to on-road OEM’s and to electrification projects in our “Other EV segment”. These increases year-over-year more than offset a 60% reduction in sales for North American mining applications. Mining continues to be challenging sector due to the global decline in this industry and in coal mining in particular. Our first-quarter sales in the Far East were largely flat year-over-year, although there was continued progress withup slightly driven in part by shipments in our Chinese joint venture, (JV) which continues to ship product prototypes designed specifically forwhile sales in Europe showed a 29% improvement compared with the unique requirements of the Chinese market.

Gross profit of $4,009,000$4,561,000 was 40.4%44.1% of sales in the firstsecond quarter, compared to $3,832,000$3,602,000 or 42.3%39.3% of sales in the same quarter last year. The decreaseincrease in the gross profit percentage compared to the prior year was largely due to deteriorationimproved sales mix in both the sales mixcontrols business and the capacitor business including, in the controls business, as well as fixed overhead costs being a higher percentagethe impact of salesrevenues from engineering projects in the first quarter of 2015 compared to the prior year quarter.Europe.

Selling, researchgeneral and administrative expenseexpenses in the firstsecond quarter increased by $263,000 from the second quarter of fiscal 2014, reflecting the additional cost of the Chinese joint venture in 2015 as well as increased investment in sales resources, including the hiring of new staff, compared to 2014. Research and development expense increased $218,000 compared to the second quarter last year. This increase partly reflects the impact of reduced grant income recorded in the second quarter of 2015, which was $3,727,000, an increase of $605,000, or 19%, compared to$134,000 lower than in the same period last year. The Company recorded grant income of $24,000 in the first quarter of 2015 compared to $115,000 in the first quarter in the prior year; this grant income was recorded as a reduction of research and development expense in each year. Excluding grant income, expenses grew $514,000 year-on-year reflecting increasedIn addition, there has been continued investment in salesengineering and engineeringresearch and development resources, including the hiring of additional staff. This investment wasengineering staff in response to the increased pipeline of project work. Engineering and research and development expense as a percentage of total sales was 12.6% in the second quarter of fiscal 2015, compared with 11.8% in the same period last year.

There was operating income for the second quarter of $674,000 compared with $196,000 in the same period last year.  The table on page 17 shows the favorable and unfavorable percentage change for each income statement line item due to the impact of foreign currency exchange rate movements and volume impacts. The $478,000 recorded increase in operating income for the three month period to April 4, 2015 reflects a net decrease in operating income of $10,000 from a combination of higher order intakegross profit of  $797,000 and  strong top-line growth. Foreign currency fluctuations decreased reportedhigher operating expenseexpenses of $807,000, offset by $93,000,an increase in operating profit of $488,000, or 3%250%, due to favorable foreign currency fluctuations. The significant currency impact was due to a stronger U.S. Dollar compared to the Euro and the British Pound than in the prior year period, which both reduced the U.S. Dollar denominated value of inventory purchased in Euros and also reduced the reported U.S. Dollar value of operating expenses incurred in British Pounds and Euros.

Included in other income and expense of $32,000 for the quarter was a foreign currency gain of $235,000, compared with a foreign currency loss of $39,000 in the second quarter of last year. This reflects the impact of the stronger U.S. Dollar compared with the Euro and the British Pound than in the firstsecond quarter of fiscal 2014.2014, which reduced the Company’s U.S. Dollar recorded cost of purchasing inventory in Euros.

Engineering and research and development expense, net of grants receivable, as a percentage of total sales was 12.4%The Company recorded in the firstsecond quarter a non-cash charge of fiscal 2015, compared with 10.3% in$200,000 arising from the first quarter of last year. This increase reflects our on-going commitmentadjustment to product development and improvement as well as the lower grants receivable in 2015 compared with the prior year.