MD&A
Management Discussion and Analysis
For The Year Ended September 30, 2008
The following discussion and analysis (“MD&A”) is restated as of April 30, 2009 and should be read in conjunction with the
Consolidated Financial Statements of Sustainable Energy Technologies Ltd. (“Sustainable”, “Sustainable Energy” or the
“Company”) and notes for the year ended September 30, 2008
Additional information relating to the Company including our Consolidated Financial Statements, MD&A, Annual Information
Form, news releases, and other required filing documents is available on SEDAR at www.sedar.comand on our website at
www.sustainableenergy.com. The aforementioned documents are issued and made available in accordance with legal
requirements but are not incorporated by reference into this MD&A
Forward Looking Information
This MD&A, especially but not limited to this section, contains certain forward-looking statements within the meaning of
National Instruments and other relevant securities legislation relating but not limited to our operations, anticipated financial
performance, business prospects and strategies. Forward-looking information includes statements that are not statements
of historical fact and address activities, events or developments that the Company expects or anticipates will or may occur in
the future, including such things as investment objectives and strategy, the development plans, the Company's intentions,
results of operations, levels of activity, future capital and other expenditures (including the amount, nature and sources of
funding thereof), business prospects and opportunities, construction timetable, extent of solar resources and future growth
and performance. When used in this MD&A, statements to the effect that the Company or its management "believes",
"expects", "expected", "plans", "may", "will", "projects", "anticipates", "estimates", "would", "could", "should", "endeavours",
"seeks", "predicts" or "intends" or similar statements, including "potential", "opportunity", "target" or other variations thereof
that are not statements of historical fact should be construed as forward-looking information. These statements reflect
management's current beliefs with respect to future events and are based on information currently available to management
of the Company. The Company believes the expectations reflected in such forward-looking information are reasonable, but
no assurance can be given that these expectations will prove to be correct and such forward-looking information should not
be unduly relied upon.
In particular we include: statements on the future size of the solar PV market and segments thereof as well as the size of
the solar inverter market; statements concerning our production plans which make assumptions concerning manufactured
costs, sales and average selling prices; and statements concerning factors which we believe may be relevant in assessing
whether our plans are achievable.
Forward-looking information is not a guarantee of future performance and involves a number of risks and uncertainties, only
some of which are described herein. Many factors could cause the Company's actual results, performance or achievements,
or future events or developments, to differ materially from those expressed or implied by the forward-looking information.
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Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking
statements prove incorrect, actual results, performance or achievement may vary materially from those expressed or implied
by the forward-looking information contained in this MD&A. These factors should be carefully considered and readers are
cautioned not to place undue reliance on forward-looking information, which speaks only as of the date of this MD&A. All
subsequent forward-looking information attributable to the Company herein is expressly qualified in their entirety by the
cautionary statements contained in or referred to herein. The Company does not undertake any obligation to release publicly
any revisions to forward-looking information contained in this MD&A to reflect events or circumstances that occur after the
date of this MD&A or to reflect the occurrence of unanticipated events, except as may be required under applicable
securities laws.
BUSINESS PROFILE
Technology and Products
Sustainable Energy designs and manufactures advanced power inverters for the solar power industry.
Advanced power inverters are a critical enabler of all modern solar PV power systems converting the direct current (“DC”)
power output of the solar PV modules into the high quality alternating current (“AC”) power required by the power grid.
Advanced power inverters also optimize the performance of the solar PV modules and maintain the integrity and safety of
the interconnection with the power grid.
We have developed and patented an inverter design which is a breakthrough in solar inverter technology.
Our technology is the only inverter technology which enables grid connected solar PV systems to be designed using a
“parallel” architecture with an industry standard form factor and with electrical conversion efficiencies that meet or exceed
industry leaders. Conventional inverter technologies require that solar panels be arranged in long strings using a “series”
architecture.
• With the series architecture any reduction in power from one panel results in reduced power from all the panels in the
string resulting in a disproportionate reduction in total system output. This will typically be caused by partial shading
from normal building congestion (e.g. from chimneys, parapets, railings, power lines, telecommunications towers, etc)
and from variance in orientation of the panels (building corners and curves)
• The series architecture also requires long strings of panels (10 – 15 per string) all identically matched and oriented to
the sun. In rooftop and building integrated solar applications, the limits of geometry (arranging long strings in a limited
space), the potential for shading from building congestion (HVAC, cornices and parapets, railings etc) and the potential
for variances in orientations (building corners and curves) can severely limit utilization of the available space.
A superior solution is the “parallel” architecture where each panel operates independently of other panels in the string at its
optimum power output. In a parallel architecture, PV panels can be installed one at a time enabling much higher
penetration of the available space. Even the potential for partial shading of one of more panels is less threatening to system
performance, since only the shaded module has reduced performance.
Our technology is proven and commercial. We have built more than 2,000 first generation (“Gen I”) products using a
subcontract manufacturing model. We understand our supply chains and our manufactured cost. More than 1200 units have
been powering a large solar tracker project for more than two years and performing to specification.
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Based on lessons learned we have successfully prototyped a product platform for high volume production which meets
European CE certification standards and is currently undergoing reviews for UL 1741 compliance for North America. Our
plan is to begin trial production runs for two product platforms by mid Q2, 2009. We will manufacture a suite of products
ranging from 2.5 kW to 20kW.
Our manufactured cost estimate is at US$0.20/watt in low volumes. We expect to reduce this to US$0.15 by the end of
2010 and to the US$0.10/watt by 2012. We estimate factory gate prices for conventional inverters below 100kW in the
range of US$0.35 – US$0.57/watt.
Opportunity
Current demand forecasts for PV installations estimate that cumulative PV installations could grow from an estimated base at
the end of 12 GW at the end of 2008 to between 43GW and 47GW by the end of 2012 (See: Thin Film PV 2.0 Market
Outlook Through 2012, September 2008 and 2009 Global PV Demand Analysis and Forecast, Anatomy of a Shakeout II
March 18, 2009). The report estimates that commercial PV installations will represent 66%, residential installations will
represent 18% and utility scale projects will represent 16% of total installations.
Growth will be driven by falling solar PV module prices. In the past year, solar module prices have declined by as much as
40%, and many expect them to fall by an additional 20% in the next year (See Reuters March 4, 2009). Falling prices are
driven partly by a slowdown in demand caused by turmoil in debt markets, but primarily by the emergence in high volumes
of much lower cost/watt thin film PV technologies. According to Prometheus thin film production in 2010 will be 4.2 GW up
almost tenfold from 442 MW in 2007.
We estimate factory gate prices for inverters at approximately US US$0.35/watt to US$0.57/watt. We are assuming that
these prices will decline quickly to the US$0.21/watt range by then end of 2012. Assuming an average factory gate price for
inverters of US$0.25/watt total inverters sales over the four year period ending 2012 would represent between US$5.1
billion and US$5.7 billion to the commercial rooftop market and US$1.4 and US$1.6 billion to the residential rooftop
segment.
Our business plan assumes that thin film PV especially CdTe modules, higher efficiency tandem junction a-Si modules and
CIGS based modules will take between 40% and 50% of the commercial rooftop market, based on lower installed cost per
watt and higher internal rates of return, but will take only between 10% and 15% share of the residential market where
buying decision are based on a wider range of non-financial considerations.
This could also be a conservative estimate. It is not well known (and also not well documented) that thin film modules
produce considerably more kilowatt hours per rated watt than crystalline modules in diffuse lighting (cloud and high
overcast conditions) in indirect lighting (early morning and late afternoon) and as ambient temperatures rise above 250C.
The result is higher kilowatt hours per rated watt than conventional crystalline modules. The result is much higher returns
on investment using thin film module than using crystalline modules with the same power rating. We believe that the
market is shifting from a focus on efficiencies and cost per rated watt to more economically oriented criteria such as
payback and return on investment.
We believe that thin film will initially be more successful in Europe and in Ontario, than in the United States due to the
differences in incentive structures. In Europe and Ontario, the internal rate of return is driven almost entirely by actual
installed cost and the power output of the system; whereas in most US markets capital cost based subsidies and the federal
investment tax credit penalize the lower cost/watt of the thin film systems. There is some evidence that US states may
switch to performance based incentives which will favour thin film PV.
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We are also able to deliver the same solutions for crystalline modules which are more suited to the residential market. This
would require a minor product development effort. We have chosen not to address this market at this juncture due to a
lack of resources and complexity. We are also not clear which technologies and approaches will emerge in this market as
the industry restructures in response to thin film PV
Business Strategy
We believe that our best market segment is for commercial and institutional rooftops where investment decisions are driven
mainly by cost (installed cost and long term maintenance costs) and investment yield considerations rather than the
residential markets, where decisions are often made by individual home-owners and independent installers on the basis of
non-financial considerations.
In this application, the combination of the higher performance, better area coverage and lower cost installation of the
parallel architecture and our very low cost should enable us to capture a significant market share. By 2012, annual inverter
sales to the commercial rooftop market could be between $2.1B/yr and $2.5B/yr.
Our strategy for penetrating this market is to provide solutions which enable emerging thin film PV to more rapidly penetrate
the rooftop market. In the process we believe we have the opportunity to make our technologies and products the inverter
solution of choice for thin film rooftop systems. With a significant oversupply conditions, thin film producers must and will
price products to the point that the majority of conventional crystalline producers have zero margin, while still maintaining
relatively higher gross margins for the thin film producers. We believe that this is already happening in the market.
The major hurdle to thin film penetration of the rooftop market is that more space needed to deliver the same power output
as crystalline modules is greater. The limits of geometry and the greater potential for partial shading of the modules create
a relatively serious barrier to penetration of this application. By allowing modules to be installed one at a time, and
mitigating the impact of partial shading on total system output, a parallel architecture offers better area coverage enabling
more modules to be installed in a limited area.
Overcoming this hurdle would enable thin film PV to very rapidly penetrate rooftop markets and potentially drive
conventional crystalline products out of the market. According to the Prometheus study, most thin film technologies will
have gross margins of 50% or more in 2010, whereas conventional crystalline technologies will be under significant margin
pressure and may have gross margins of less than 15%.
Our business plan assumes that thin film will take an average 30% of the rooftop markets overall for the 4-year period
ending in 2012. This would represent total thin film PV installations of between 11GW and 12 GW by the end of 2012.
Assuming an average factory gate price of US$0.25 and an average C$0.82: US$1.00 exchange rate over this period total
thin film inverters sales to the rooftop market would be C$3.35B and C$3.66B over this period
Business Model
Our business model is to build volumes through private label and bundling partnerships in cost and IRR driven markets.
A core element of our business model and strategy is to address our size and lack of track record by distributing our product
under private labels of companies which have market presence and a reputation for high quality products. We believe that
the highest potential is with power supply companies selling UPS systems, but they could also be major suppliers of HVAC
products looking to add to their product lines. In either case, our goal is to gain validation and support of major brand
names.
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We believe that the design and installation simplicity of the parallel architecture enables distribution through mainstream
building products supply channels especially for commercial applications. Combined with the safety and simplicity of the
lower operating voltages the parallel architecture has the potential to take solar PV through mainstream market channels.
Salicru S.A. is the first of several potential relationships. Salicru S.A. has a comprehensive distribution network in Spain and
Portugal with more than 40% of the power supply market significantly mitigating new product resistance. It has
comprehensive technical support capability.
We are devoting most of our marketing resources to supporting the Salicru Gen II roll out in Spain during Q4. Salicru
believes that it has the potential to move 80 MW during 2009 and 2010 and to achieve a 20% market share in Spain by the
end of 2010. Were it able to do so this would represent as $25 – $30 million in sales to Sustainable Energy over this period
and between $20 and $25 million in annual sales to Sustainable Energy for 2011 and subsequent years.
The second element of our marketing strategy is to partner strategically with manufacturers of thin film modules which have
the greatest potential in the rooftop and BIPV markets. The goal is to offer a complete product solution of different
components which can be accessed directly from the suppliers with higher volume discounts. We have early buy in from
several module manufacturers and we are experimenting in Greece via www.thinfilm.gr We will roll out and validate our
models and sales processes in Spain and Greece through the summer and fall of 2009 while seeking similar partners in
France Italy Germany and the United States. In the meantime we anticipate other product solutions seeking to deliver the
parallel architecture will prepare the market in the US.
Our manufacturing model is to focus on delivering a line of high quality but very low cost products using the same power
electronics module. This is a proven model that will enable us to maintain 50% or better product margins while also
maintaining a very low operating cost structure. We intend to outsource manufacturing to contract manufacturers and we
are well advanced with two contract manufacturers to build our Gen II products. To our knowledge we are the only
company in the industry that outsources manufacturing.
Warning Concerning Forward Looking Statements
Our conclusions concerning the size of the addressable rooftop market are based on certain critical assumptions and general
conclusions concerning the future of the solar PV industry, the market segmentation the penetration of certain segments by
emerging thin film PV technologies and estimated factory gate prices for solar inverters in our power ratings. These are
described in greater detail below. We believe that an appreciation of our assessments of the future of the industry and the
other key assumptions is important for our shareholders in understanding the risks and the potential for our business.
Nevertheless the reader is advised that our assumptions and the conclusions that we draw represent forward-looking
statements within the meaning of National Instruments, and the reader is directed to our warning concerning the risk of
reliance on forward looking information. While we believe that the assumptions and expectations reflected in the forwardlooking
information are reasonable, no assurance can be given that these assumptions and expectations will prove to be
correct and such forward-looking information should not be unduly relied upon. The reader is also encouraged to draw his
or her own conclusions regarding the validity of our assumptions and our conclusions.
The reader is cautioned that our ability to realize on the opportunity is highly dependent on our assumptions concerning the
industry but also on our ability to raise sufficient capital to execute on our business plan. In today’s capital markets there is
a considerable risk that we will not be able to do so.
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2008 OPERATIONS REVIEW
Product Sales
During Q1 of 2008, we completed deliveries of our Gen I inverters to the 6MW solar tracker projects developed by Solaer
S.A. The Gen I inverters are performing to specification and product failures were within industry norms. Most were
attributable to quality control factors ranging from failed LED displays to poor connections of the transformers or to bad
batches of components. We are very satisfied with the performance and we have satisfactorily upgraded the testing and
quality control procedures of our contract manufacturer.
We devoted considerable resources to product support during the first half of 2008 to gain better experience with the
products and to maintain our good relationship with our customer. The project can be viewed as a very successful beta site
enabling us to validate our contract manufacturing in high volumes and to gain confidence in the performance reliability of
the product design.
With the successful commissioning of the 6 MW project and the assurance of continued production of the Gen I products we
were in a position to begin marketing in Spain and Greece. The Gen I inverter is not certified for sale in Germany Italy or the
United States being the other large solar PV markets.
During Q2, Spain announced a change to its feed in tariff structure for projects completed after September 30, 2008; but did
not specify the new feed in tariff structure. The result was a virtual collapse of solar product sales (modules and inverters)
for all companies including Sustainable Energy for the balance of the year in that market, except for sales to projects already
in the pipeline for commissioning before September 30, 2008. During Q2 we were able to re-sell larger (100kW) inverters
manufactured by another supplier to a 1.9 MW project.
In Greece, where we had built a sales network beginning with an announced partnership in Q1 2008 with a major product
developer, the Government announced that it would not put into force previously announced feed in tariffs and only recently
did so in January 2009. The result is that there were no solar PV product sales of any consequence by any company
including Sustainable Energy. We continued to invest resources to develop a marketing infrastructure in Greece; and we
have contracted with 4 different systems integrators for distribution of our products. Based on partner forecasts of
permitted projects pending approval, we have a 10 – 12 MW sales pipeline in Greece, the timing of which remains unsettled.
Our expectation is that we will begin deliveries during Q3 or Q4 2009
The changes caught us by surprise. Because we were in the running to secure two large projects and expected to have
orders in excess of forecast production we did not slow production until the beginning of Q3. We have since terminated
production of Gen I inverters, except for a build of 300 electronics modules in order to retain the value of surplus
component inventory. At year end, we had 1,085 finished units in inventory.
Spain has since revised its feed in tariff structure, signaling its intention that new investment in solar PV be directed to
rooftop and building integrated systems by changing the tariff structure to favor building based systems and allocating
entitlements to the incentive pricing to such systems. The reduced tariffs have reduced investment yields dramatically and
the industry is turning to lower cost thin film PV in an attempt to increase yields.
Greece has now lifted the moratorium confirming its tariff structure. We have also begun developing similar sales
partnerships in other countries in the region which have enacted feed in tariffs on entering the European Union and
expected to see growth in sales from these markets during 2009.
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Changing Industry Dynamics and a Revised Marketing Strategy
Towards the end of Q2 of 2008, we developed the view that emerging thin film technologies would play a much more
significant role in the industry and that our parallel architecture was ideally suited to these technologies for rooftop settings.
This view was not accepted by many and we tested our hypotheses during Q3 and Q4 2008, culminating in a very successful
trade show in Valencia Spain in the first week of September, 2008.
It is now clear to all that thin film solar is disrupting the solar power industry, and many believe that it will become a
dominant force in the industry. It is also now becoming clear to us that the parallel architecture is a very powerful concept
and can be viewed as a disruptive technology changing the current paradigms for rooftop systems. We have developed
relationships with many of the leading thin film module manufacturers and we are receiving a positive endorsement of the
value of our parallel architecture for building based systems.
During Q3 and into Q4 we began developing a series of distribution relationships which would enables us to use Spain as a
test market for our Gen II products in the rooftop application.
By the end of Q4, 2008 we had:
• Entered into an agreement with Copcisa S.A., one of Spain’s largest construction companies to develop and market thin
film bundles consisting of PV modules our inverter and wiring harnesses to the Spanish building trades. The agreement
contemplates an exclusive joint venture for Spain.
• Entered into a co-marketing agreement with Ingeteam S.A., one of the world’s largest suppliers of solar inverters for
thin film and solar concentrator applications
We have since:
• Entered into a co-marketing agreement with Solaer S.A., a leading project developer to roll out and demonstrate thin
film PV to the Spanish market using our parallel architecture. The agreement is important in two respects: it is with our
first customer validating our product; and it will give us hands on experience in installer preferences in this market
• Begun arranging trials to demonstrate the value proposition and to secure endorsement of our platform for use with the
leading thin film PV modules in the market. We have trials planned with PV module manufacturers and systems
integrators in Germany, Spain, Greece, Canada and Taiwan.
• Entered into a private labeling agreement with Salicru S.A., one of Europe’s leading power electronics companies
securing a lead order for Gen II units valued at approximately $6.2 million targeting the Spanish thin film rooftop
market; and
• Contracted with Salicru S.A. to outsource a customer service and product support base for Southern Europe.
During 2008, we also devoted resources to developing our second generation version of our inverter platform. Gen II uses
the same basic power electronics circuits and software platform proven and optimized in Gen I at a lower cost and with
better performance and reliability. As noted earlier our low voltage technology enables us to achieve what we believe will
be the lowest manufactured cost in its class in the industry.
We have since completed the first production prototypes for the Gen II version of our inverter and have begun European
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and North American permitting processes.. We are targeting fiscal Q3 for trial production runs with commercial production
by the end of fiscal Q3 2009 or early fiscal Q4.
We are planning to offer two basic platforms – the ELV (50v-120v) will address CdTe products, some CIGS products and
most single junction a-Si products. It will enable systems using these products to fall into the extra low voltage classification
in Europe treating the systems more as a building product than a power plant. The LV (70v-150v) will address the
remaining CIGS products in the market and the higher efficiency a-Si products coming into the market this year and next.
During 2008 we learned that our parallel architecture and the very fast control loops of the inverter may offer material
performance advantages to both low and high concentration PV systems. During Q3 we reached an agreement with Opel
International a developer of a high concentration PV module the City of Medicine Hat and Climate Change Central an Alberta
based NGO to demonstrate the inverter with the Opel CPV modules in Medicine Hat. We also entered into an agreement
with KlanTech S.A. a Barcelona based electronics controls company to integrate our inverter into a CPV tracker solution for a
major project developer in Spain.
The Medicine Hat project is now underway and KlanTech has recently indicated that it may order up to 500 inverters for its
CPV tracker solution. Two other CPV module developers have also taken inverters on trial for their systems. We are
committing only minimal resources to this initiative until there is better visibility on the market potential for CPV trackers.
BUSINESS OUTLOOK
Overview
The current economic crisis will slow growth in solar this year due to greater difficulty in accessing capital markets. This
could negatively impact our projections for sales in 2009 and conceivably in 2010 if the credit markets do not stabilize by
that time. We believe that very large utility scale projects will be more difficult to finance by anyone other than the utilities
themselves until the current North American and European banking crises resolve themselves. Nevertheless MW scale
projects are being financed in Europe although there is a greater focus on yields driving more project developers to thin film.
Our focus is smaller commercial building based projects. In Spain we are focusing on projects where the investment is less
than €100,000. These are being financed albeit with larger equity components and with a balance sheet to support the
financing. Thin film serves this market with its materially (500 – 700 basis points) better investment yields and 50% lower
up-front costs.
Our goals are very Euro-centric for the next 12 months aimed at building for 2010, and beyond in Europe but more
significantly in the United States. In the end European solar projects represent the best credits in the market: mandated 25
year utility contracts to purchase everything the owner can produce at fixed prices from a very reliable source with double
digit yields. Our plan is to launch our products in the US in Q4 with a view to building sales into 2010. Our markets during
this period will be in Spain, southern France and Greece; possibly in Germany depending on available resources. Spanish
and Greek banks, while not immune to financial turmoil, are generally in much better shape than North American banks
Our revenue goals over the next 12 months are modest and we are targeting 2010 to be the base for revenue growth. Our
30MW pipeline is more than double our forecast sales for calendar 2009. While some projects will not be financed, we are
confident that we will achieve these goals. We continue to receive RFQ’s building confidence in the pipeline.
2009 Plan
2009 will see us take our new suite of Gen II products to the market during Q4.
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We intend to present our products as a key enabler for thin film PV on commercial rooftop applications. While we will sell
products to crystalline applications we believe we are best served by identifying ourselves with this application. This defines
our markets as those which are cost and IRR driven and our marketing approach as enhancing cost and investor returns
We are targeting a simultaneous roll out of the ELV and LV Gen II products by the end of Q3 or early Q4. Rollout entails
certification testing (which is underway) and trial production runs and we are on schedule. Subject to the availability of
financial resources our preference is two 100 unit runs with two contract manufacturers – 4th Quadrant and Plexus a large
US based contract manufacturer.
Our plan is to use Spain as a test market to demonstrate the value of the parallel architecture and to validate our
assumptions concerning the ability to distribute products through building product supply channels and unspecialized
construction companies. A key goal is to build experience with the private label model and our strategic marketing
relationships with thin film suppliers in order to replicate it in other markets including France, Italy and the US.
France has just announced new feed in tariffs at €0.45/kWh for all commercial and industrial buildings with no cap and
€0.55/kWh where solar PV is integrated into the building envelope. Ground based systems remain at €0.30/kWh. Italy is
focused on smaller building integrated systems with base tariff of €0.43/kWh for systems >20kW but €0.35/kW for ground
based systems. We have had early discussions with a large power supply company in that market
We intend to use Ontario to demonstrate the value proposition within the North American market by the end of Q4. Ontario
is the first major North American market to adopt the European feed in tariff approach to PV incentives for both commercial
and residential systems with strong biases for rooftops. We believe that this will be a cost and IRR driven market in the
same way as the European market.
We are committed to liquidating our current product inventory through existing channels in Greece and Spain. We are
targeting larger scale projects and are partnering with two thin film module companies for this purpose. We also have a
pipeline of 8 – 10 MW in Greece
As is the case with any new product and with a new company, there is a significant risk of market acceptance by the
customer. In particular there is additional risk due to our small capitalization and distance from our first markets. We have
developed our business model with this risk in mind. We do not intend to put our products into conventional distribution
channels which requires product and customer support resources that are beyond our means. Instead our model
contemplates a series of private label agreements with established companies which have the market presence the
reputation and the resources to provide customer and product support. In Spain where we will test our products we are
partnering with a well established company with an established reputation for quality and customer support.
Management Discussion of Financial Results
Accounting Pronouncements
• International Financial Reporting Standards (“IFRS”) - In January 2006, the CICA Accounting Standards Board
(“AcSB”) adopted a strategic plan for the direction of accounting standards in Canada. As part of the plan, accounting
standards in Canada for public companies are expected to converge with IFRS by the end of calendar 2011. The
Company continues to monitor and assess the impact of convergence of Canadian GAAP and IFRS.
• Section 3064 –“Goodwill and Intangible Assets”, which establishes standards for disclosing information about an
entity’s goodwill and intangible assets by profit-oriented enterprises, was adopted on October 1, 2008. It also defines
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the standards required in the measurement and recognition of research and development phases of an enterprise. The
adoption of this new Section by the Company on its financial statements but did not have a material impact on its
consolidated financial statements.
• Section 3031 – “Inventories”, which replaces Section 3030, was adopted on October 1, 2008. The new section
prescribes measurement of inventories at the lower of cost and net realizable value. It provides guidance on the
determination of cost, prohibiting the use of the last in, first out method (LIFO), and requires the reversal of previous
write-downs when there is a subsequent increase in the value of inventories. This new standard did not have a
significant impact on the Company’s consolidated financial statements other than for incremental disclosures.
Revenues
Revenues for the year were down $480,134 to $1,524,159 from $2,004,263 for 2007. Of these revenues, $1,382,505 was
for product sales by comparison to $1,912,900 for 2007. Gen I product sales accounted for $603,055 in 2008 ($1,924,901
in 2007) and $692,522 in 2008 (nil in 2007) was realized on the resale of larger power central inverters.
Revenue for 2007 was from sales to a single customer and the majority of the Gen I sales in 2008 were from the same
client. The contract has now been completed.. The balance of the revenues were realized from the resale of higher power
(100kW) inverters manufactured by another inverter company totaling $692,522; interest, engineering fees related to an
inverter developed for NGK Spark Plug and the proceeds of sale of component parts to our contract manufacturer.
A year end adjustment was made to the sales figures for the year to reflect the foreign exchange rate at the time of the sale
rather than an average rate for the period. This adjustment reduced sales by $55,417 and was recorded in the 4th Quarter.
Product sales in the 4th Quarter were inconsequential at $27,142 by comparison to $673,538 for the same period of 2007.
The products were sold in Spain and Slovenia. The products were sold in Spain and Slovenia.
The decline in product sales was attributable to a Spanish government announcement during Q2, that it would change to its
feed in tariff structure for solar projects completed after September 30, 2008; but did not specify the new feed in tariff
structure. The result was a virtual collapse of solar product sales (modules and inverters) for all companies including
Sustainable Energy for the balance of the year in that market, other than previously committed deliveries.
Also, contributing to lower sales was the continued moratorium in Greece which has now been lifted.
Costs of Goods Sold/Margins
Cost of sales for the year was $1,686,852 by comparison to $2,136,109 for 2007. Of this $466,333 was attributable to Gen
I inverters and $518,858 was attributable to resold product. Costs of sales also include the cost of components sold to our
contract manufacturer at a loss during the second quarter of fiscal 2008, The average cost of goods sold for the Gen I units
during 2008 was $1,721 resulting in a total gross margin of $115,114 on the 271 units delivered and the gross margin on
the resold product was $148,849. The gross margin for the delivered units is calculated on a direct cost basis and does not
reflect the other charges to cost of sales.
In calculating total costs of goods sold, the Company includes the average manufactured cost for the product that may
include higher cost components acquired earlier in the product development process. The Company also includes the cost
of components that have been rendered obsolete due to regulatory changes or ongoing changes in the product design in
accordance with industry and accounting practices, warranty expense and inventory adjustments.
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Cost of sales for the 4th Quarter was recorded at $448,943, by comparison to $700,594 for the same period in 2007. This
cost of goods sold in the period was $15,427 for Gen I units and $60,874 for components sold to our contract manufacturer.
The additional costs of sale were represented by charges of $100,261 for warranty expense for the year which was recorded
in this Quarter, an inventory write down of $47,654 for obsolete stock and an inventory adjustment of $274,719 to make the
inventory listing agree with the annual physical count. A yearend adjustment was made to Cost of Sales for the year to
reflect the exchange rate at the time of the transaction rather than the average rate for the period. The adjustment reduced
Cost of Sales for the year by $49,992. The preceding represent non-GAAP disclosure and are included to clarify the charges
included calculating Cost of Sales for the period. Proper controls have been initiated to eliminate future large inventory
adjustments.
All components including finished products acquired from the contract manufacturer are contracted in US dollars as is the
custom around the world. The Canadian dollar equivalent is added to the average manufactured cost at the mid-point
exchange rate when invoiced and entered into the books. As a result changes in the exchange rate can increase or
decrease the average manufactured cost through the year. We did not hedge this risk resulting in lower costs when the
Canadian dollar was higher and higher costs when the Canadian dollar declined.
Administration and Operation Costs
Operating costs, consisting of sales and marketing, engineering and product development and supply chain management
product support and logistics, were $2,319,300 for the year ended September 30, 2008 an increase of $357,293 over the
prior year. The increase is due to higher travel costs of $191,845 and technical support costs for the Scheuten/Solaer project
of $189,237. Operating costs for the 4th Quarter were $725,678 in 2007, an increase of $304,829 over the same period of
the prior year. The increase includes travel of $138,954 related to increased marketing activities, product development of
$126,467 and extra storage facilities of $38,645.
General and administrative costs for the year ending September 30, 2008 were $1,299,499 by comparison to $918,782 for
2007. The increase is due mainly to stock option compensation valued at $192,960, audit and higher than normal
accounting fees due to an untimely departure of the previous controller for $156,136 and an increase in outside consultants
including the Controller. General and administrative costs for the 4th Quarter were $521,273 compared to $158,053 for the
same period of the prior year. The increase is comprised of travel of $17,251, outside consultants at $87,325, filing fees of
$70,691 related to a financing, increased accounting fees of $28,523, and increased rent and operating costs related to the
office of $121,002.
Amortization
Amortization of development costs was virtually unchanged from 2007. Yearly amortization of capital assets increased from
$80,614 for 2007 to $89,505 for 2008, reflecting the acquisition of production test equipment for our contract manufacturer,
and for further testing in Spain.
Interest Expense
The interest expense is in respect of the Energy Northwest Debt which is not paid but accrued. Interest accruals to Energy
Northwest for 2008 were $128,036 for the year; and $49,911 for the 4th Quarter. Energy Northwest takes the position that
the interest should be accrued and compounded; whereas, on the basis of legal advice, we take the position that the
interest payable is calculated as simple interest. Calculated on a simple interest basis the interest accrual to Energy
Northwest would have been $26,636 for the year and $6,714 for the 4th Quarter. Calculated on a simple interest basis the
current amount owing to Energy Northwest is approximately $418,812 by comparison to $784,204 if interest is
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compounded. The amounts shown therefore represent a worst case scenario and do not reflect an acknowledgement on
our part that the higher amount is payable.
Foreign Exchange
Our contract manufacturing is priced in U.S. dollars as is the custom in the electronics industry but our sales are generally
priced in Euros. As a result we are exposed to fluctuations in the Canadian dollar value relative to the U.S. dollar and the
Euro. We do not hedge these exchange risks and have no plans to do so until our volumes are more stable. We do
however attempt to maintain Euro revenues in Europe to pay Euro expenses and we deposit 25% of the contract price for
products with our contract manufacturer. Both of these policies represent a form of partial hedging.
Summary of Quarterly Results
Following is the summary of our quarterly results for the previous 8 Quarters.
As at September 30, 2008:
2008 2007
Qtr 4 Qtr 3 Qtr 2 Qtr 1 Qtr 4 Qtr 3 Qtr 2 Qtr 1
Revenues 28,142 751,140 183,651 561,226 673,538 384,714 627,620 318,391
Net (loss) (1,757,826) (800,537) (965,537) (859,202) (1,140,010) (627,334) (1,148,900) (957,293)
Per share – basic (0.01) (0.02) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
Per share – diluted (0.01) (0.02) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
The decline in revenues from beginning in Q2, 2008 reflects the fact that the Spanish market closed within weeks of our
having product available for sale in that market. During the previous 5 Quarters the Company was focused on a successful
delivery to the 6 MW solar tracker project. Although we began building new Gen I products for sale in Spain they were only
available in the later part of Q1 2008. The market closed in Q2 2008 before any were sold. Revenues in Q3 2008 were
from the resale of 100 kW inverters manufactured by another company which was previously committed and completed
prior to the cutoff of feed in tariffs.
The higher loss in Q4 of each year reflects the recording of certain charges which relate to the entire year. These include
warranty reserves, expenses for obsolete inventory and in the case of Q4 2008 an adjustment for inventory which was
mistakenly accounted for in 2007.
We expect product sales to be lumpy over the next year. While Spain and Greece have begun approving projects changing
pricing dynamics will impact timing of the project installations which define recognition of sales revenues. Because we are
introducing a new product with a new thin film paradigm it is impossible to make any reliable forecast of product sales.
We do not believe that the decline in revenues is instructive of the future, except to indicate that there is significant risk
during start-up, and that we are in an industry that is still dependent on government policies. The declines are attributable
almost entirely to government intervention that was untimely from our perspective.
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Our business model attempts to address the startup risks head on by partnering with a market leader and by limiting our
focus to one market where we have strong partners. Over the long term if we are successful in executing our strategy we
believe that the revenue potential is very large for the reasons stated earlier in this discussion.
Operating Loss
Our operating loss (before interest, taxes and depreciation) for the year was $3,684,991 compared to $3,193,782 from the
previous year. The continued operating losses reflect the fact that the Company is just entering its markets and are well
within reasonable expectations for a new product launch in a foreign market. The losses also reflect the shut down on the
Spanish market within 3 months of our having product available for sale in that market and the government imposed
moratorium in Greece that has resulted in no new sales of any consequence in those markets by any inverter company. The
loss for the 4th Quarter was $1,586,902 compared to $1,011,174 for the same period in 2007.
Cash Flow and Liquidity
The net change in non-cash working capital for fiscal 2008 is a reduction of $101,535 compared to $761,236 in 2007. The
major components include the increase in inventory of $416,678, a decrease in trade receivables of $416,840, a decrease in
prepaid expenses of $37,269 and an increase in trade payables of $137,755. The net change for the 4th Quarter was
$868,149 (2007- $508,999) and this was mainly comprised of a decrease in inventory of $489,137, a decrease in trade
receivables of $793,556 and a decrease in trade payables of $338,013.
The change in non-cash working capital in the relation to financing reflects the changes to the interest accrual on the Energy
Northwest long term debt.
The exercise of warrants and stock options resulted in a cash inflow of $1,525,216 (2007- $201,578) for the year and
$1,250,000 (2007- $99,500) for the 4th Quarter ended September 30, 2008. During the period, we offered holders of
common share purchase warrants issued by the Company as part of a Unit Offering on May 16, 2007, and exercisable at
$0.30 per share until November 16, 2008, the right to exercise their warrants at a price of $0.21 per share receiving one
share and one replacement warrant with an exercise price on the replacement warrant of $0.30 per share. A total of, 5.8
million warrants were exercised for a total consideration of $1.2 million. The remaining warrants expired on November 16,
2008.
Bank loan payments of $125,000 were made during the quarter and $500,000 during the year. The loan was fully paid as at
September 30, 2008.
As of September 30, 2008, the Company had cash and cash equivalents of $2,069,581 and finished product inventory at
cost of $1,916,678. Of this total, $1,576,327 represents 1,085 finished products ready for sale and located in Spain or in
bond in China where the products were manufactured. The balance of $340,351 represents other component inventory.
Assuming an average selling price of €0.32/watt and an average exchange rate of $1.6:€1.0, this represents a value of
approximately $2.8 million.
Liquidity and Capital Resources
Liquidity, as measured by working capital, was $3,521,987 at September 30, 2008 by comparison to $5,809,342 at
September 30, 2007. Cash and short term investments totaled $2,069,580 compared to $4,724,487 at September 30, 2007.
At September 30, 2008 the Company’s inverter measured at the lower of cost or market was$1,916,678. Of this total,
$1,576,327 represents 1,085 finished products ($1,452/unit or C$0.29/watt) located in Spain or in bond in China where the
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products were manufactured. The balance of $340,351 represents other component inventory. The current wholesale value
for inverters in our class is between about €0.32 and €0.36/watt or about C$0.50 and C$0.56/watt.
The revenue and earnings prospects for the Company are almost entirely dependent on our success in positioning our
technology and products in the rooftop and BIPV market segments. Our assumptions concerning the industry and the
premises underlying our business strategy are described earlier in this discussion. In order to execute on the strategy we
must raise additional working capital. Some of this may come from the sale of inventory on hand but it is clear that outside
capital must be obtained in order to realize on the value of the Company.
Our base case plan focuses on validating and refining our business model in Spain and replicating the model to other
markets in particular North America. In developing our plan we assume that we will be able to generate between 12 and 15
MW of product sales in Spain Greece and Southern France by the end of calendar 2009 and that we will exit calendar 2009
with an order book supporting quarterly production capacity of 10 – 12MW with two contract manufacturers.
The capital required to execute this strategy is tied increased investment in human resources and to working capital needed
to ramp production in 2009 and 2010. Capital investment is limited to modest amounts for tooling and the addition of
production test equipment for contract manufacturers and modest capital for certification testing. Our most significant
requirements for capital are to build Gen II inverters and to increase our operations and sales marketing head count.
We now expect to be able to borrow the entire amount of capital needed to build Gen II inverters based on credit
enhancements from Export Development Canada at reasonable costs of capital. We also expect to be able to secure
financing for capital expenditures through government support programs aimed at creating new industry. This will limit the
need for new equity capital over the period to be about $5 million. We believe that we will be able to do so on terms that
are attractive to our existing shareholder base,
Shareholders are cautioned that there is no certainty that we will secure export financing and that we will be in a position to
secure the equity investment needed to execute on our strategy.
Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, short term investments, accounts
receivable and advances, accounts payable, bank loan and the Energy Northwest Obligation. The fair value of these
financial instruments other than the Energy Northwest Obligation approximates their carrying value due to their short term
to maturity.
As note earlier, Energy Northwest takes the position that the interest should be accrued and compounded; whereas, on the
basis of legal advice, we take the position that the interest payable is calculated as simple interest. Calculated on a simple
interest basis, the current amount owing to Energy Northwest as at September 30, 2008 is approximately US$418,812, by
comparison to US$736,895 if interest is compounded. The amounts shown therefore represent a worst case scenario and
do not reflect an acknowledgement on our part that the higher amount is payable. We have had negotiations with Energy
Northwest to settle the entire Obligation based on simple interest and we expect to be able to do so, although there is no
assurance that this will be the case.
Because of the complex nature and the history of the Energy Northwest Obligation, we believe that it is not possible to
reliably measure the fair value of the instrument. In particular, (i) payments under the instrument are dependent on the
sales revenues of the Company over the remaining term of the instrument; (ii) it is not clear that any balance of the
compensation payable to Energy Northwest and unpaid interest remaining unpaid at the end of the term must be paid at
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that time; and (iii) there is an unresolved issue of interpretation of the agreement concerning the calculation of interest (See
Note 8) under the instrument.
We have developed two scenarios which offer alternative fair values for the Energy Northwest Obligation calculated on a
compound interest basis. These are found in footnote 8 to the Financial Statements
Royalties
The Company has contingent obligations to pay royalties to various government agencies in the US and Canada related to
contributions by these agencies to the development of the Company’s technologies and products. With the exception of
contributions from Energy Northwest in respect of which there is a fixed obligation to repay the contribution, the
contributions have been deducted in calculating the Company’s investment in technology development or from the expense
to which they relate. These amounts, plus, in certain cases, an implied return on the investment, are repayable as a
percentage of the Company’s revenues. Since the repayments are tied to the amount of revenues that may be earned in
future periods, repayment of these contributions will be treated as a royalty expense in the period in which the revenue is
earned.
A royalty of ½% of gross revenue after 2001 (maximum $90,000 per year) is payable to Technology Partnership Canada
(“TPC”) until TPC has recovered one and a half times the amount advanced to the Company. A royalty of $3,695 (2007 -
$37,600), payable September 30, 2008, has been accrued in these financial statements. The remaining royalty potentially
payable is $625,993.
A royalty of 1.9% of gross revenue of Sustainable Energy systems realized after October 1, 2008 is payable until TPC has
recovered one and a half times the amount advanced to the Company. The royalty potentially payable is $367,861. There
was no royalty payable in fiscal 2008.
A royalty equal to 2% of revenues in respect of the licensing, selling, marketing or commercialization of any Intellectual
Property is payable to Natural Resources Canada (“NRCan”) until NRCan has received a return of its investment of $100,000.
A royalty of $12,075 (September 30, 2007 - $44,440) has been accrued in these financial statements. The remaining royalty
potentially payable is $78,668.
A royalty of 1% of revenues realized by the US subsidiary of the Company is payable to Energy Northwest until Energy Northwest
has received a total of US$1 million. The company believes that this is based on a 4% royalty payable to the US subsidiary by the
other companies in the group which funded the further commercialization of the original technology.
STG Markets Limited Partnership
The Company carries on its product development and manufacturing operations through STG Markets Limited Partnership
(“STGLP”) (formerly Solar Markets Limited Partnership (“SMLP”)) under license from Sustainable Energy and certain of Sustainable
Energy’s subsidiaries. The General Partner of STGLP is SES which exercises control over STGLP’s operations. The Limited
Partners of STGLP are Sustainable Energy Technologies Ltd. And, from time to time, a variety of different private investors who
have provided capital to STGLP by purchasing limited partnership units (“LP Units”)
As Limited Partners of the Partnership on December 31 of each year, the investors are entitled to deduct their share of non capital
losses of the Partnership for the year to a maximum of $10,000 per LP Unit. As a result their share of non-capital losses is not
available to Sustainable Energy to offset future taxable income realized by it.
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The financial results of STGLP are consolidate with the financial results of Sustainable Energy and shows no minority interest
SES has full control over the operations of STGLP and Sustainable Energy Technologies has at all times the right and
intention to acquire all the LP Units not held by it for any period of time.
Off Balance Sheet Items
The Company has no off-balance sheet financial commitments other than the commitments for operating leases for premise
and equipment, which have been disclosed in the notes to the financial statements.
Transactions with Related Parties
The Company expensed $37,500 (2007 - $37,500) for the 4th Quarter and $150,000 (2007 - $150,000) for the fiscal year
2008 as compensation for consulting services from the Chief Executive Officer provided through a company he owns. The
Chief Executive Officer is also a Director and a major shareholder of the Company. The Chief Executive Officer also
guaranteed the Company’s debt to HSBC Canada to a maximum of $125,000 in exchange for which he was compensated in
the form of bonus warrants exercisable until April 30, 2008 at a price of $0.15 per share. 150,000 bonus warrants were
exercised and 150,000 bonus warrants have expired.
The Company also expensed $19,037 (2007 - $0.00) for the 4th Quarter and $38,815 (2007 - $0.00) for the fiscal year 2008.
This compensation was paid to the Executive Vice-President who is also a Director and shareholder of the Company.
The Board of Directors passed a Resolution in December 2008 that authorized and directed the Company to issue 1,000,000
stock options to the President and CEO, 750,000 stock options to the Executive Vice-President and another 300,000 to a
Director of the Company at an exercise price of $0.20 per share.
Disclosure of Outstanding Share Data
As at January 27, 2009 136,513,215 common shares were issued and outstanding, including 11,100,000 common shares
issued to acquire limited partnerships units of STG Markets Limited Partnership. The Company has 6,200,305 employee
stock options outstanding, of which 3,761,207 options had vested as of September 30, 2008. The weighted average
exercise price of the options is $0.18 per share. As at January 27, 2009, the Company had 5,875,001 common share
purchase warrants outstanding with an exercise price of $0.30 and an expiry date of May 16, 2009.