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Sevcon, Inc. (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. (Tech/Ops). Through wholly-owned subsidiaries locatedThe accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States England, France, South Koreaof America (U.S. GAAP) for interim financial information and Japanwith the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position of Sevcon, Inc. ( the “Company”) and subsidiaries as of April 1, 2017 and the results of operations and cash flows for the three and six-month periods ended April 1, 2017. The accompanying unaudited consolidated financial statements should be read in conjunction with the 2016 annual consolidated financial statements and related notes included in the 2016 Sevcon, Inc. Annual Report filed on Form 10-K (“2016 10-K”). The results of operations for the three and six-month periods ended April 1, 2017 are not necessarily indicative of the results to be expected for the full year.

During the six-month period ended April 1, 2017 the Company experienced an operating loss of $4,740,000 and a 50% owned joint venture locateddecrease in China,cash of $8,463,000 from $14,127,000 at September 30, 2016 to $5,664,000 at April 1, 2017. This negative performance largely reflected difficult conditions in the Company’s traditional controls markets and through an international dealer network,continuing investment in research and development expense associated with the delivery of the engineering phase of the Company’s new project pipeline. At April 1, 2017 the Company designs and sells, under the Sevcon name, motor controllers for zero emission electric and hybrid vehicles (EVs). The controls are used to vary the speed and movementhad net current assets of vehicles, to integrate specialized functions and to optimize the energy consumption$22,246,000 including cash of $5,664,000. Against this background management has conducted a review of the vehicle's power source. Through a wholly-owned subsidiary in Italy acquired in January 2016,Company’s cash requirements for the next twelve months taking into account existing cash resources, forecasted cash from future operations and existing borrowing facilities. In addition, the Company also designs, manufactureshas explored its options to secure further financing. Based on this assessment of the Company’s cash requirements and sells battery chargersthe financing it believes is available, management believes that the group has sufficient funds available for electric vehicles and power management and uninterrupted power source systemsthe next twelve months for industrial, medical and telecom applications, as well as electronic instrumentation for battery laboratories. Sevcon's customers are manufacturers ofits activities under execution.

Unless otherwise indicated, each reference to a “year” means the Company’s fiscal year, which ends on and off-road vehicles, including cars, trucks, buses, motorcycles, fork lift trucks, aerial lifts, mining vehicles, airport tractors, sweepers and other electrically 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.September 30.

The accompanying unaudited consolidated financial statements include the accounts of the Company’s wholly-owned subsidiaries; Sevcon USA, Inc., Sevcon Ltd, Industrial Capacitors (Wrexham) Ltd., Sevcon Asia Limited, Sevcon Japan KK,, Sevcon Security Corp., Sevcon S.A.S., Sevcon S.r.l. and, Bassi S.r.l., Sevcon Canada Inc. and Sevcon GmbH in accordance with the provisions required by the Consolidation Topic 810 of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).  All material intercompany transactions have been eliminated.

For the Company's less than wholly (50%) owned joint venturewholly-owned subsidiary, Sevcon New Energy Technology (Hubei) Company Limited in China, 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) whetherat each level of the joint venture whether the entity is (i) a VIE, and (ii) if the Company is the primary beneficiary of the VIE. If it is determined that the joint ventureentity 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 thisof 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 the joint venture,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 the third party’stheir 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.

There have been no changes since the end of 20152016 to the significant accounting policies followed by Sevcon, Inc. and subsidiaries.

On January 26, 2016, the Company and its wholly-owned indirect subsidiary, Sevcon S.r.l., (“Sevcon Italy”) entered into a Quota Sale and Purchase Agreement withacquired Bassi Holding S.r.l., (“Bassi Holding”) an Italian limited liability company, and the quota owners of Bassi Holding, to acquire all the outstanding quotas of Bassi, a limited liability company located in Lugo, Italy. Bassiwhich designs, manufactures and sells battery chargers for electric vehicles, and power management and uninterrupted power source systems for industrial, medical and telecom applications, as well as electronic instrumentation for battery laboratories. The principal reasons for theThis acquisition were to enableenables the Company to expand its addressable share of the high-growth electrification market and enhance earnings by adding an immediately accretive business.

The Company accounted for this acquisition as a business combination using the acquisition method of accounting. During the six monthsthree and six-month periods ended April 1, 2017 the Company recognized no expense for acquisition-related items. During the three and six-month periods ended April 2, 2016 the Company incurred $1.4 million in costsrecognized expense for acquisition-related items, of $1,101,000 and expenses related$1,417,000, respectively.

For more information on this acquisition, refer to Note 2 to the Company’s acquisition of Bassi that are included in the consolidated statement of operations.

The unaudited consolidated pro forma results for the six monththree and six-month periods ended April 1, 2017 and April 2, 2016 and April 4, 2015 are set out in the tableshown below.  The pro forma consolidated results combine the results of operations of the Company and Bassi as though Bassi had been acquired on October 1, 20142015 and include amortization charges for the acquired intangibles and interest expense related to the Company’s borrowings to finance the acquisition. The 2016unaudited pro forma results for the three and six-month periods ended April 2, 2016 were adjusted to exclude $1,417,000include $266,000 and $535,000, respectively, of acquisition costs related to Bassiintangible assets amortization expense associated with the business combination and $97,000$127,000 and $253,000, respectively, of non-recurringinterest expense relating to the fair value adjustmentscredit facility entered into in order to partially fund the Bassi acquisition, date inventory and propertyto exclude $1,101,000 and equipment. $1,417,000, respectively, of acquisition-related expense.

The unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved if the acquisition had taken place on October 1, 2014.2015.

Under the Company’s 1996 Equity Incentive Plan (the “Plan”) there were 336,99069,641 shares reserved and available for grant at April 2, 2016.1, 2017. There were 139,578 shares reserved and available for grant at September 30, 2015.12,165 options exercised in 2017.

The Plan,, which is shareholder-approved, permits the grant of Restricted Stock, Restricted Stock Units, Optionsrestricted stock, restricted stock units, stock options and Stock Appreciation Rightsstock appreciation rights (“SARs”). SARs may be awarded either separately, or in relation to options granted, and for the grant of bonus shares. The Company believes that such awards better align the interests of the employees with those of its shareholders. Options granted are exercisable at a price not less than fair market value on the date of grant. Recipients of grants of options must execute a standard form of non-competition agreement.

The Company estimated the fair values of its stock options using the Black-Scholes-Merton option-pricing model, which was developed for use in estimating the fair values of stock options. Option valuation models, including the Black-Scholes-Merton option-pricing model, require the input of assumptions, including stock price volatility. Changes in the input assumptions can materially affect the fair value estimates and ultimately how much the Company recognizes as stock-based compensation expense. The fair values of the Company’s stock options were estimated at the grant dates.

The weighted average input assumptions used and resulting fair values of stock options at April 1, 2017, were as follows for fiscal 2016:follows:

The expected term represents the period of time that options are expected to be outstanding. As the Company does not have sufficient historical evidence for determining the expected term of the stock option awards granted, the expected life assumption has been determined using the simplified method, which is an average of the contractual term of the option and its ordinary vesting period.

The Company bases the risk-free interest rate assumption on zero-coupon U.S. treasury instruments appropriate for the expected term of the stock option grants.

The expected stock price volatility for the Company’s common stock is estimated based on the historic volatility of the Company’s common stock for a period equivalent to the expected term of the stock option grants.

The Company bases the expected dividend yield assumption on the fact that there is no present intention to pay cash dividends. Therefore an expected dividend yield of zero has been used.

In December 2015, the Compensation Committee awarded performance-based equity compensation to nine executives and managers, including the principal executive officer and principal financial officer, consisting of 38,460 shares in the form of stock options. The performance options have an exercise price of $9.94 per share, representing the average of the highest intraday bid and ask quotes for the Company’s common stock on the date of grant, December 16, 2015, and the preceding four trading days. The performance options will vest subject to the Company meeting an earnings per share target applicable to fiscal year 2018 set by the Compensation Committee so long as the employee is then employed by the Company.  The Company estimated the fair values of its stock options using the Black-Scholes-Merton option-pricing model. The estimated fair value of the stock options on the date of the grant was $185,000 based onand is being recognized over the fair market valuerequisite service period of the award. The unrecognized compensation is being expensed over three years. The expense for these employee stock option grants was $14,394 and $28,818 for the three and six-month periods ended April 1, 2017, respectively. The expense for these employee stock option grants was $13,602 and $16,260 for the three and six-month periods ended April 2, 2016, respectively.

In February 2017, the Compensation Committee awarded performance-based equity compensation to five executives and managers, consisting of 2,800 shares in the form of stock options. The performance options have an exercise price of $11.86 per share, representing the average of the highest intraday bid and ask quotes for the Company’s common stock on the date of issue.grant, February 7, 2017, and the preceding four trading days. The unvestedperformance options will vest on the later of the third anniversary of the grant date or the date the Compensation Committee determines that the Company has met the earnings per share target for fiscal year 2018. The Company estimated the fair values of its stock options using the Black-Scholes-Merton option-pricing model. The estimated fair value of the stock options on the date of the grant was $7,000 and is being recognized over the requisite service period of the award. The unrecognized compensation is being charged to incomeexpensed over three years. The charge to incomeexpense for thisthese employee stock option grant will be approximately $15,000 on a quarterly basis.grants was $1,010 for the three and six-month periods ended April 1, 2017, respectively.

A summary of performance-based option activity under the employee share option planPlan as of April 2, 2016,1, 2017, and changes during the quartersix months then ended, is presented below:

In December 2015, the Company granted 11,540 shares of restricted stock to four employees which will vest subject to the Company meetingachieving the same earnings per share target applicable to fiscal year 2018 as for the stock options disclosed above, so long as the employee is then employed by the Company. The estimated fair value of the stock on the date of the grant was $116,000 based on the fair market value of stock on the date of issue. The unvestedunrecognized compensation is being charged to incomeexpensed over three years. The charge to income for this employee stock option grant will be approximately $10,000 on a quarterly basis.

In March 2017, the Company granted 80,000 shares of restricted stock to incometwo executives, which will vest subject to the Company achieving one or both financial targets for the 2017, 2018 and 2019 fiscal years. The shares of restricted stock shall be divided into six equal tranches (two per year). The estimated fair value of the stock on the date of the grant was $1,106,534 based on the fair market value of stock on the date of issue. The unrecognized compensation is being expensed over three years. Management has assessed the performance criteria relating to these grants and concluded they are likely to be met. Accordingly, the relevant portion of the expense has been recorded through April 1, 2017. The expense for these restricted stock grants was $57,059 for the three and six-month periods ended April 1, 2017.

In August 2016, the Board of Directors awarded the Executive Chairman equity compensation consisting of stock options to purchase 56,700 shares. The options were granted in two tranches. The first tranche, consisting of 36,496 options with an exercise price of $10.93 per share, would vest in twelve substantially equal monthly installments beginning September 2016, and the second tranche, consisting of 20,204 options with an exercise price of $12.35 per share, would vest in twelve substantially equal monthly installments beginning September 2017, in each case so long as the director is in the position of Executive Chairman.  The Company estimated the fair values of its stock options using the Black-Scholes-Merton option-pricing model. The estimated fair value of the stock options on the date of the grant was $211,000.  The Executive Chairman position was terminated on December 6, 2016, as a result of which 12,165 vested options were exercisable for three months, and all un-vested options expired. On February 7, 2017 the director exercised 12,165 options via a cashless exercise in which 8,474 shares were surrendered to pay the exercise price. In the three months and six months ended April 2, 2016.

In February 2016, the Company granted 29,700 shares of restricted stock, representing 3,300 shares to nineeach of the non-employee directors and the then emeritus directors of the Company, 26,400 of which will vestvested on the day before the 2017 annual general meeting providing that the grantee remains a director of the Company, or as otherwise determined by the Compensation Committee.meeting. The aggregate fair value of the stock measured on the date of the grant was $292,000 based on the closing sale price of the stock on the date of grant. Subsequent to this, 3,300 of these granted shares of restricted stock were cancelled and returned to the Plan following the resignation of a director. Compensation expense is being charged to incomewas recognized on a straight linestraight-line basis over the twelve monthtwelve-month period during which the forfeiture conditions lapse.to February 2017.  The charge to incomeexpense for these restricted stock grants inwas $43,208 and $108,020 for the first six months of fiscal 2016three and six-month periods ended April 1, 2017, respectively. The expense for these restricted stock grants was $22,000$21,604 for the three and the subsequent charge will be approximately $65,000 on a quarterly basis.six-month periods ended April 2, 2016.

In February 2015,2017, the Company granted 30,600145,000 shares of restricted stock to nine non-employee directors,eleven employees, which vestedwill vest one-third each year on the third business day beforeafter the 2016 annual meeting.announcement of the Company’s results for the first quarter of fiscal 2018, 2019 and 2020. The aggregate fair value of the stock measured on the date of the grant was $225,000,$2,039,020 based on the closing sale price of the stock on the date of grant. Compensation expense was charged to incomeis being recognized on a straight linestraight-line basis over the twelve month requisite service period during which the forfeiture conditions lapsed.lapse. The charge to incomeexpense for these restricted stock grants in 2015 was $131,000$56,639 for the three and six-month periods ended April 1, 2017.

In February 2017, the Company granted 24,800 shares of restricted stock, representing 3,100 shares to each of the non-employee directors and the charge inemeritus director of the six monthsCompany, which will vest on the day before the 2018 annual general meeting providing that the grantee remains a director or an emeritus director of the Company, or as otherwise determined by the Compensation Committee.  The aggregate fair value of the stock measured on the date of the grant was $344,244 based on the closing sale price of the stock on the date of grant.  Compensation expense is being recognized on a straight-line basis over the twelve-month period during which the forfeiture conditions lapse. The expense for these restricted stock grants was $28,865 for the three and six-month periods ended April 1, 2017.

In March 2017, the Company granted 12,800 shares of restricted stock representing 1,600 shares to each of the non-employee directors and the emeritus director of the Company, which will vest on the day before the 2018 annual general meeting providing that the grantee remains a director or an emeritus director of the Company, or as otherwise determined by the Compensation Committee.   The aggregate fair value of the stock measured on the date of the grant was $192,000 based on the closing sale price of the stock on the date of grant.  Compensation expense is being recognized on a straight-line basis over the twelve-month period during which the forfeiture conditions lapse. The expense for these restricted stock grants was $16,000 for the three and six-month periods ended April 2 2016 was $94,000.1, 2017.

For the purposes of calculating average issued shares for basic earnings per share, these shares are only considered to be outstanding when the forfeiture conditions lapse and the shares vest.

A summary of restricted stock and stock option activity, including both performance basedperformance-based awards and time-based awards, for the six monthssix-month period ended April 2, 20161, 2017, is as follows:

Basic earnings per share is computed by dividing the net income or loss for the period 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 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.

Basic and diluted net incomeloss per common share for the three and six monthsix-month periods ended April 1, 2017 and April 2, 2016, and April 4, 2015 wereis calculated as follows:

The significant accounting policies of the segments are the same as those described abovein Note 2 and in 2016 10-K Note 1 to the Notes to Consolidated Financial Statements in the 2015 10-K.1. 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,corporate expense, acquisition expenses, interest income and expense, or foreign currency translation gains and gain/losses, interest income or income taxes to segments. Information concerning operations of these businesses is as follows:

 

InInformation concerning operations of the electronic controls segment, revenues derive fromreportable segments is as follows:

The cost of research and development programs is charged against income as incurred and wasamounted to $1,827,000 and $3,268,000 for the three and six-month periods ended April 1, 2017, respectively, net of U.K. government grants received, “above the line” tax credits arising from U.K. government research and development incentives as follows:

In 2015 the Company was awarded a grant of approximately $625,000 by the U.K. Regional Growth Fund, a U.K. government body.  The grant is to develop an innovative range of low voltage motor controls which are designed to serve the emerging needs for on-road, automotive electrification.  The grant includes a commitment to create or safeguard a total of twenty jobs at the Company’s U.K. facility over the period of the project.  The Company recorded grant income from this project of $193,000, which was offset against the Company’s research and development expense on this project of $844,000 for the three months ended April 1, 2017. The Company recorded grant income from this project of $281,000 which was offset against the Company’s research and development expense on this project of $1,206,000, for the six months ended April 1, 2017. The Company recorded grant income from this project of $64,000 which was offset against the Company’s research and development expense on this project of $137,000, for the three months ended April 2, 2016. The Company recorded grant income from this project of $94,000 which was offset against the Company’s research and development expense on this project of $302,000, for the six months ended April 2, 2016

During 2015 through 2017, the Company participated in a U.K. government research and development arrangement which allows U.K. companies to receive an additional available tax credit subject to meeting certain qualifying conditions. The credit is a percentage, which currently ranges from 11% to 14.5% depending on circumstances, of qualifying research and development expenditure in the period. The credit discharges income tax the Company would have to pay or allows companies without an income tax liability to receive a refund payment from the U.K. government. For the three and six month periodmonths ended April 1, 2017 the Company recorded $217,000 (three months ended April 2, 2016 associated with- $0) and $351,000 (six months ended April 2, 2016 - $0), respectively, as a reduction in research and development expense of $302,000, in the period.unaudited consolidated statements of operations. The Company did not record any expense or granthad an income in respecttax receivable balance of $885,000 at April 1, 2017 from this projectinitiative (September 30, 2016 - $985,000), which is included within prepaid expenses and other current assets on the unaudited consolidated balance sheets.

The Company’s effective tax rate of 15.3% is significantly lower than the U.S. statutory rate of 34% primarily due to the fact that certain current year operating losses in the six monthU.K. have been foregone in exchange for a cash refund, and in addition the local statutory rate in certain countries in which the Company operates, notably the U.K. (19%) and Italy, (24%) is lower than the U.S. statutory rate.

During the six-month period ended April 4,1, 2017, the Company’s deferred tax assets increased by $961,000. The Company continues to assess the need for a valuation allowance against these assets. In assessing the continuing need for a valuation allowance the Company has assessed the available means of recovering its deferred tax assets, including the ability to carryback net operating losses, the existence of reversing temporary differences, the availability of tax planning strategies, and available sources of future taxable income, including a revised estimate of future sources of pre-tax income. The Company has historically had profitable operations. The Company’s current projections reflect future profitable operations. Since the majority of the Company’s deferred tax assets relate to operations in countries where net operating losses have unlimited carry forwards, the Company has concluded that no valuation allowance is required on these deferred tax assets.

During the second quarter of 2017, the U.S. Internal Revenue Service initiated an audit of the Company’s U.S. federal income tax return for the period ended September 30, 2015.

Sevcon Inc. 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 capacitorcapacitors business.  The Company has frozen 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 Company’s French subsidiary, Sevcon S.A.S., has a liability to pay its employees a service and salary basedsalary-based award when they reach retirement age and leave the Company’s employment.employment at retirement age. This unfunded liability, which is unfunded, is recognizedrecorded in accrued expenses, was $205,000 and was $166,000 and $148,000$198,000 at April 2,1, 2017 and September 30, 2016, and April 4, 2015, respectively. The obligation to pay this award is a French legal requirement and is only payable if the employee is employed by the Company when they retire; if they leave the Company prior to that time the award is no longer payable.requirement.

The Company’s Italian subsidiary, Bassi S.r.l., has a liability to pay its employees a severance indemnity, ‘Trattamento di fine Rapporto’ (“TFR”) when they leave the Company’s employment.  TFR, which is mandatory for Italian companies, is deferred compensation and is based on the employees’ years of service and the compensation earned by the employee during the service period.  TFR is considered a “Defined Benefit Plan”This unfunded liability, recorded in other long-term liabilities, was $991,000 and the related liability is recognized in the consolidated balance sheet within “Liability for pension benefits”.  This liability, which is unfunded, was $1,262,000$987,000 at April 2, 2016.1, 2017 and September 30, 2016, respectively.