UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended December 31, 2006

[  ] Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from _____ to _____

Commission File Number 1-10869

(Exact name of registrant, as specified in its charter)

(Address of principal executive offices) (Zip code),

(Registrant’s telephone number, including area code)

________________________________________________________

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X    No       

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.) (Check one):

Large accelerated filer                                               Accelerated filer     X                                      Non-accelerated filer         

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)

Yes        No   X   

The number of shares outstanding (including shares held by affiliates) of the registrant’s common stock, par value $0.01 per share at January 25, 2007 was 25,284,623.

TABLE OF CONTENTS

ITEM 1: FINANCIAL STATEMENTS

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets (unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets (unaudited), Continued

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations (unaudited)

UQM TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (unaudited)

See accompanying notes to consolidated financial statements.

Notes to Consolidated Financial Statement

We have historically derived significant revenue from a few key customers. Revenue from Invacare Corporation totaled $285,959 and $425,804 and $148,620 and $681,000 for the quarters and nine months ended December 31, 2006 and 2005, respectively, which was 17 percent and 9 percent and 13 percent and 21 percent of total revenue, respectively. Revenue from Lippert Components, Inc. totaled $180,248 and $763,752 for the quarter and nine months ended December 31, 2006, which was 10 percent and 16 percent of total revenue, respectively. We had no revenue from Lippert Components, Inc. for the quarter and nine months ended December 31, 2005.

These customers also represented 27 percent and 13 percent of total accounts receivable as of December 31, 2006 and March 31, 2006, respectively. Inventories purchased and processed for these customers’ products, consisting of raw materials, work-in-progress and finished goods totaled $250,961 and $63,474 as of December 31, 2006 and March 31, 2006, respectively.

Contract services revenue derived from contracts with agencies of the U.S. Government and from subcontracts with U.S. Government prime contractors totaled $573,702 and $1,670,513 and $548,070 and $1,130,996 for the quarters and nine months ended December 31, 2006 and 2005, respectively. Accounts receivable from government-funded contracts represented 24 percent and 50 percent of total accounts receivable as of December 31, 2006 and March 31, 2006, respectively.

In January 2004, we committed to a plan to exit our contract electronics manufacturing business whose results were reported as the electronic products segment. In May 2004, we completed the divestiture of equipment and inventory of this business. We are the primary obligor on a lease for the facility previously occupied by this divested business. The facility has been subleased at a rental rate below that provided for in the master lease. At December 31, 2006 liabilities and commitments of discontinued operations totaled $11,868, all of which was associated with the lease commitment. We have also recorded accounts receivable from discontinued operations of $58,224 reflecting rent payments earned but not paid under the sublease.

The operating results of this business for the quarters and nine months ended December 31, 2006 and 2005 have been reported separately as discontinued operations. Loss from discontinued operations does not include allocations of general corporate overheads, which have been allocated to other business segments. Operating results of all prior periods presented have been adjusted to reflect the contract electronics manufacturing business as discontinued operations.

Statement of Financial Accounting Standards No. 128, Earnings per Share, requires presentation of both basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing income or loss available to common stockholders by the weighted average number of common shares outstanding during the periods presented. Diluted earnings per share is computed by dividing income or loss available to common stockholders by all outstanding and potentially dilutive shares during the periods presented, unless the effect is antidilutive. At December 31, 2006 and 2005, options to purchase 2,818,659 and 3,180,558 shares of common stock, respectively, and warrants to purchase 157,267 and 447,088 shares of common stock, respectively, were outstanding. For the quarters and nine months ended December 31, 2006 and 2005, respectively, options and warrants for 1,779,112 and 1,503,576, and 1,819,269 and 1,839,269 shares, respectively, were not included in the computation of diluted loss per share because the option or warrant exercise price was greater than the average market price of the common stock. In-the-money options and warrants determined under the treasury stock method to acquire 140,359 shares and 366,320 shares, and 501,540 shares and 456,937 shares, of common stock for the quarters and nine months ended December 31, 2006 and 2005, respectively, were potentially includable in the calculation of diluted loss per share but were not included, because to do so would be antidilutive.

At December 31, 2006, we had two reportable segments: technology and power products. Our reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different business strategies. The technology segment encompasses our technology-based operations including core research to advance our technology, application and production engineering and product development and job shop production of prototype components. The power products segment encompasses the manufacture and sale of motors and electronic controllers. As discussed in note 9, we discontinued our electronic products segment in fiscal year 2004, and accordingly, the financial results of this operation are no longer reported in continuing operations in all periods presented. Salaries of the executive officers and corporate general and administrative expense are allocated to our segments annually based on a variety of factors including revenue level of the segment and administrative time devoted to each segment by senior management. The percentages allocated to the technology segment and power products segment were 52 percent and 48 percent for the quarter and nine months ended December 31, 2006, and were 74 percent and 26 percent for the quarter and nine months ended December 31, 2005, respectively.

Intersegment sales or transfers, which were eliminated upon consolidation, were nil and $38,280, and $14,181 and $62,391 for the quarters and nine months ended December 31, 2006 and 2005, respectively.

The technology segment leases office, production and laboratory space in a building owned by the power products segment based on a negotiated rate for the square footage occupied. Intercompany lease payments were $46,041 and $138,123 and $46,041 and $138,123 for the quarters and nine months ended December 31, 2006 and 2005, respectively, and were eliminated upon consolidation.

The following table summarizes significant financial statement information for continuing operations of each of the reportable segments as of and for the quarter ended December 31, 2006:

The following table summarizes significant financial statement information for continuing operations of each of the reportable segments as of and for the quarter ended December 31, 2005:

The following table summarizes significant financial statement information for continuing operations of each of the reportable segments as of and for the nine months ended December 31, 2006:

The following table summarizes significant financial statement information for continuing operations of each of the reportable segments as of and for the nine months ended December 31, 2005:

Employment Agreements

We have entered into employment agreements with two of our officers, one of which expires on December 31, 2007 and one of which expires on December 31, 2010. The aggregate future compensation under these employment agreements, including future services payable on expected extensions thereof and potential retirement and severance payouts, is $2,062,450 at December 31, 2006. Of this amount, $136,835 and $171,814 has been recorded as short-term and long-term deferred compensation under executive employment agreements, respectively.

Lease Commitments

In May 2004 we completed the divestiture of equipment and inventory of our contract electronic manufacturing business. We are the primary obligor on an operating lease for the facility previously occupied by this divested business. The facility has been subleased at a rental rate below that provided for in the master lease. As of December 31, 2006 the future sublease payments total $54,000 over the remaining term of the sublease which is less than the future minimum lease payments due under our master lease of $66,036 over the remaining lease term which expires on March 31, 2007. Accordingly, we have recorded a liability of $11,868 which is equal to the present value of the difference between our obligation under the master lease and the sublease payments to be received under the sublease, or $12,036. We have also recorded accounts receivable from discontinued operations of $58,224 reflecting rent payments earned but not paid under the sublease.

We also had certain equipment leases which expired by their terms on various dates through January 2006. Rental expense under these leases for the quarter and nine months ended December 31, 2006 was zero, versus $48,927 and $106,155 for the quarter and nine months ended December 31, 2005, respectively.

Litigation

We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, and based on current available information, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial position, results of operations or cash flow, although there can be no assurance that adverse developments in these matters could not have a material impact on a future reporting period.

In June 2006, the FASB issued Interpretation ("FIN") No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN No. 48 are effective for us during the fiscal year beginning April 1, 2007. We have not yet determined the impact of adopting this standard.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires additional disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for us during the fiscal year beginning April 1, 2008. We have not yet determined the impact of adopting this standard.

In September 2006, the FASB issued SFAS No. 158, "Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)."SFAS No. 158 requires an employer to recognize a plan’s overfunded or underfunded status in its balance sheets and recognize the changes in a plan’s funded status in comprehensive income in the year which the changes occur. These provisions of SFAS No. 158 are effective for our fiscal year ending March 31, 2007. In addition, SFAS No. 158 requires an employer to measure plan assets and obligations that determine its funded status as of the end of its fiscal year, with limited exceptions. This provision of SFAS No. 158 is effective for our fiscal year ending March 31, 2009. We have not yet determined the impact of adopting this standard.

In September, 2006 the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 ("SAB 108"), "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." Historically, there have been two widely used methods for quantifying the effects of financial statement misstatements. These methods are referred to as the "roll-over" and "iron-curtain" method. The "roll-over" method quantifies the amount by which the current year income statement is misstated. Exclusive reliance on an income statement approach can result in the accumulation of errors on the balance sheet that may or may not have been material to any individual income statement, but which may misstate one or more balance sheet accounts. The "iron curtain" method quantifies the error as the cumulative amount by which the current year balance sheet is misstated. Exclusive reliance on a balance sheet approach can result in disregarding the effects of errors in the current year income statement that result from the correction of an error existing in previously issued financial statements. SAB 108 provides that prior year uncorrected immaterial misstatements be evaluated under both the "roll-over" and "iron-curtain" approaches. In the event a misstatement, is deemed material to the current period financial statements and the related financial statement disclosures under either approach, SAB 108 requires that the misstatement be corrected by either retroactively adjusting prior financial statements as if the dual approach had always been used, or by correcting it in the current period financial statements by presenting the cumulative effect of the prior period errors as an adjustment to the beginning balance of accumulated deficit and the related assets or liabilities for the current fiscal year. The provisions of SAB 108 are effective for fiscal years ending after November 15, 2006. We plan to adopt SAB 108 using the cumulative effect transition method in connection with the preparation of our annual financial statements for the fiscal year ending March 31, 2007. As a result, we expect to record a cumulative effect charge to accumulated deficit of approximately $210,000 and a corresponding increase to the liability for long-term deferred compensation under executive employment agreements to the beginning balances as of April 1, 2006. The accompanying financial statements do not include these adjustments.

 

We generate revenue from two principal activities: 1) research, development and application engineering services that are paid for by our customers; and 2) the sale of motors, generators and electronic controls. The sources of engineering revenue typically vary from year to year and individual projects may vary substantially in their periods of performance and aggregate dollar value. Our product sales consist of both prototype low volume sales, which are generally sold to a broad range of customers, and annually recurring higher volume production for customers. During the fourth quarter last fiscal year we began deliveries of vehicle auxiliary motors to a new customer pursuant to an order for 30,000 units. On October 3, 2006, we announced an additional order from this customer totaling approximately $3 million. During the first quarter of this fiscal year we received an order totaling $1.9 million for an electronic product for hybrid electric vehicles. As a result of shipments against these orders and higher levels of low volume product shipments, product sales for the first quarter, second quarter and third quarter were $476,978, $935,092 and $1,005,691, respectively and totaled $2,417,761 for the nine months ended December 31, 2006. This compares with product sales for the first, second and third quarters last fiscal year of $685,617, and $413,724 and $479,675, respectively, and $1,579,016 for the nine months ended December 31, 2005. Following the end of this quarter we received a production order totaling $9.25 million from Phoenix Motorcars, Inc. for electric propulsion systems.

For the quarter and nine months ended December 31, 2006 contract services revenue derived from funded engineering activities increased to $720,835 and $2,224,315 versus $664,481 and $1,602,345, respectively, for the comparable quarter and nine month period last fiscal year. The increase is attributable to improved utilization of billable personnel and reduced levels of cost overruns on projects during the current fiscal year. Gross profit margins on contract services declined to 1.8 percent for the quarter ended December 31, 2006 versus 17.7 percent for the comparable quarter last fiscal year and rose to 11.2 percent for the nine months ended December 31, 2006 versus a negative 4.9 percent for the comparable period last year. The decline in gross profit margins for the quarter is due to larger than usual material costs and lower levels of overhead absorption. The increase in gross profit margins for the nine month period is due to improved overhead absorption and fewer cost overruns on funded projects. Gross profit margins on product sales declined to 13.9 percent for the quarter ended December 31, 2006 versus 15.0 percent for the comparable quarter last year and declined to 6.2 percent for the nine months ended December 31, 2006 versus 15.2 percent for the comparable period last year. The decrease in gross profit margins is primarily attributable to costs associated with the launch of new production for auxiliary motors and the electronic product discussed above. Expenditures on production engineering activities for the quarter and nine months ended December 31, 2006 declined to $219,071 and rose to $699,960, respectively versus $224,792 and $564,358 for the comparable quarter and nine month period last fiscal year. The decrease for the quarter is attributable to a temporary decrease in staffing levels and the increase is attributable to additional staffing and increased prototype and sample expenses during the nine month period.

Internally funded research and development costs for the quarter and nine months ended December 31, 2006 were $110,919 and $285,400 versus $50,258 and $184,110 for the comparable quarter and nine month period last year. The increase for the quarter and nine month period is due to higher levels of internally funded development activities.

During the first quarter of this fiscal year we implemented the provisions of FAS 123R, which mandates the expensing of costs associated with stock based compensation, including the granting of stock options. FAS 123R requires the expensing of costs arising from the unearned portion of employee stock options issued in previous fiscal years that are earned in the current period as well as compensation costs arising from stock options issued and earned during the current period. During the quarter and nine months ended December 31, 2006 we recorded non-cash compensation expense associated with stock options issued in prior fiscal years totaling $143,054 and $460,286. We also recorded non-cash compensation expense during the quarter and nine months ended December 31, 2006 totaling $141,620 and $298,771 due to the grant of stock options to employees and directors and the issuance of common stock under our employee stock bonus plan. The classification of non-cash compensation expense arising from FAS 123R in our statement of operations for the quarter and nine months ended December 31, 2006 is shown in the following table:

Loss from continuing operations for the quarter and nine months ended December 31, 2006 was $818,297 and $2,468,911, respectively, or $0.03 and $0.10 per common share, versus a loss from continuing operations of $536,106 and $1,799,918, or $0.02 and $0.08 per common share, for the comparable quarter and nine month period last year. The increase in losses for the third quarter versus the comparable quarter last year is generally attributable to reduced gross profit margins on contract services, higher expenditures on research and development activities and the expensing of compensation costs arising from share based compensation detailed in the table above.

During the nine months ended December 31, 2006 the exercise of employee stock options and underwriter warrants resulted in cash proceeds to us of $1,041,867. Cash and cash equivalents at December 31, 2006 declined by $1,856,812 to $2,219,994 versus $4,076,806 at March 31, 2006. The decrease is attributable to cash used in operating activities of $2,122,170 and cash used in investing activities of $583,628 which was partially offset by cash flows from financing activities of $979,820. We expect production engineering expenses to increase substantially and contract services revenue to decline modestly over the next several quarters reflecting a shift in resources to the production launch of propulsion systems deliverable to Phoenix Motorcars, Inc. We also expect cash used in operations to increase substantially as inventories and accounts receivable balances expand due to the execution of this contract. We believe our existing cash and short-term investments, which totaled $8,382,784 at December 31, 2006, will be adequate to fund our operations over at least the next two years.

Cash and cash equivalents and short-term investments were $8,382,784 versus $10,086,200, and working capital (the excess of current assets over current liabilities) was $9,498,419 compared with $10,415,409, at December 31, 2006 and March 31, 2006, respectively. The decrease in cash and short-term investments and working capital is primarily attributable to cash used in operating and investing activities, offset, in part, by cash proceeds from the exercise of stock options and underwriter warrants during the nine months ended December 31, 2006.

Accounts receivable increased $834,494 to $1,346,903 at December 31, 2006 from $512,409 at March 31, 2006. The increase is primarily attributable to increased product shipments and higher levels of contract services revenue during the nine months ended December 31, 2006. Historically, we have had nominal bad debt expense arising from uncollectible accounts receivable due to the high credit quality of our customers. Accordingly, no allowance for bad debts has been recorded at December 31, 2006 or March 31, 2006, respectively.

Costs and estimated earnings on uncompleted contracts declined $95,150 to $354,894 at December 31, 2006 versus $450,044 at March 31, 2006. The decrease is due to improved billing terms on certain contracts in process at December 31, 2006 versus March 31, 2006. Estimated earnings on contracts in process rose to $229,378 or 9.8 percent of contracts in process of $2,352,261 at December 31, 2006 compared to estimated earnings on contracts in process of $221,382 or 8.2 percent of contracts in process of $2,695,407 at March 31, 2006. The increase in estimated margins on contracts in process is attributable to improved overhead absorption and decreased levels of cost overruns.

Inventories rose $231,549 to $699,034 at December 31, 2006 principally due to higher levels of raw material, and work-in-process inventories which rose $207,721, and $15,352, respectively. The increase in raw materials inventory is attributable to higher levels of production and associated increases in materials purchased. The increase in work-in-process inventory is due to rising revenue levels.

Prepaid expenses and other current assets increased to $220,282 at December 31, 2006 from $118,439 at March 31, 2006 reflecting the prepayment of insurance premium costs on our commercial insurance coverages.

We invested $371,677 for the acquisition of property and equipment during the nine months ended December 31, 2006 compared to $170,717 during the comparable nine month period last fiscal year. The increase in capital expenditures is primarily due to the installation of a semi-automated high volume motor manufacturing cell and equipment for an electronic product production cell.

Patent and trademark costs, net of accumulated depreciation decreased to $496,327 at December 31, 2006 from $552,382 at March 31, 2006 reflecting the systematic amortization of these costs.

Accounts payable increased $115,012 to $649,440 at December 31, 2006 from $534,428 at March 31, 2006, primarily due to higher levels of production and associated increases in materials purchased.

Other current liabilities decreased $79,547 to $229,550 at December 31, 2006 from $309,097 at March 31, 2006. The decrease is primarily attributable to lower levels of accrued legal and accounting fees, and other accrued costs.

Short-term and long-term deferred compensation under executive employment agreements rose $97,788 to $308,649 at December 31, 2006 from $210,861 at March 31, 2006, reflecting the service cost of future retirement and severance payments under employment agreements with executive officers.

Liabilities and commitments of discontinued operations were $11,868 at December 31, 2006 compared to $62,004 at March 31, 2006 reflecting the estimated obligation for future lease payments on subleased facilities of our discontinued electronic products segment for which we are the primary obligor. See also note 9 to the consolidated financial statements.

Billings in excess of costs and estimated earnings on uncompleted contracts increased $217,331 to $438,957 at December 31, 2006 from $221,626 at March 31, 2006 reflecting increased levels of billings on certain engineering contracts in advance of the performance of the associated work during the nine months ended December 31, 2006.

Long-term debt, less current portion decreased $73,281 to $548,404 at December 31, 2006 from $621,685 at March 31, 2006 reflecting principal repayments on the mortgage debt for our Frederick, Colorado facility.

Common stock and additional paid-in capital increased to $251,431 and $71,096,909, respectively, at December 31, 2006 compared to $247,760 and $69,293,461 at March 31, 2006. The increase in additional paid-in capital is attributable to the exercise of stock options and underwriter warrants during the quarter which resulted in cash proceeds to us of $1,041,867 and an increase of $759,057 associated with the recording of non-cash share based payments under FAS 123R.

Continuing operations for the third quarter ended December 31, 2006, resulted in a loss of $818,297, or $0.03 per common share, compared to a loss from continuing operations of $536,106, or $0.02 per common share for the same quarter last year. The increase in the loss from continuing operations for the quarter is primarily attributable to decreased gross profit margins on contract services, higher levels of research and development costs and selling general and administrative expenditures, including non-cash charges arising from the expensing of share based payments under FAS 123R.

Revenue from contract services rose $56,354 or 8.5 percent to $720,835 for the quarter ended December 31, 2006 compared to $664,481 for the comparable quarter last year. The increase is primarily attributable to increased material content in projects during the quarter.

Product sales for the third quarter more than doubled to $1,005,691 compared to $479,675 for the comparable quarter last year. Power Products segment revenue for the quarter ended December 31, 2006 increased to $647,550 compared to $190,124 for the comparable quarter last year. The increase is principally attributable to increasing revenue from vehicle auxiliary motors and the shipments of an electronic product to a hybrid electric vehicle customer. Technology segment revenue for the third quarter increased to $1,078,976 compared to $954,032 for third quarter last fiscal year due to higher levels of contract services revenue and low volume product shipments. Technology segment product revenue for the third quarter increased to $358,141 compared to $289,551 for the third quarter last year, due to increased shipments of propulsion motors and controllers.

Gross profit margins for the quarter ended December 31, 2006 declined to 8.9 percent compared to 16.5 percent for the comparable quarter last year primarily due to production launch costs for auxiliary motors and an electronic product for a hybrid electric vehicle and decreased gross profit margins on contract services. Gross profit margin on contract services was 1.8 percent for the third quarter this fiscal year compared to 17.7 percent for the third quarter last year. The decrease is attributable to larger than usual material costs and lower levels of overhead absorption. Gross profit margin on product sales for the third quarter this year was 13.9 percent compared to 15.0 percent for the third quarter last year. The decrease is attributable to costs associated with the launch of new production for auxiliary motors and an electronic product.

Research and development expenditures for the quarter ended December 31, 2006 increased to $110,919 compared to $50,258 for the quarter ended December 31, 2005. The increase is primarily due to higher levels of internally funded development activities.

Production engineering costs were $219,071 for the third quarter versus $224,792 for the same quarter last year. The decrease is attributable to a temporary decrease in staffing levels.

Selling, general and administrative expense for the quarter ended December 31, 2006 was $735,785 compared to $548,653 for the same quarter last year. The increase is primarily attributable to increased accounting and legal expenses and non-cash compensation charges associated with the expensing of share based payments.

Interest income decreased to $106,041 for the third quarter compared to $114,048 for the comparable quarter last year. The decrease is attributable to lower levels of invested balances during the current quarter.

Interest expense decreased to $11,749 for the third quarter versus $15,444 for the comparable quarter last year. The decrease is due to lower average mortgage borrowings outstanding throughout the current quarter.

Continuing operations for the nine months ended December 31, 2006, resulted in a loss of $2,468,911, or $0.10 per common share, compared to a loss from continuing operations of $1,799,918, or $0.08 per common share for the comparable period last year. The increase in the loss from continuing operations for the nine month period is primarily attributable to higher levels of research and development costs, production engineering expenses and selling general and administrative expenditures, including non-cash charges arising from the expensing of share based payments under FAS 123R.

Revenue from contract services rose $621,970 or 39 percent to $2,224,315 for the nine months ended December 31, 2006 compared to $1,602,345 for the comparable period last year. The increase is primarily attributable to improved staff utilization on revenue generating programs and reduced cost overruns on development projects.

Product sales for the nine months ended December 31, 2006 rose 53 percent to $2,417,761 compared to $1,579,016 for the comparable period last year. Power Products segment revenue for the nine months ended December 31, 2006 increased to $1,552,940 compared to $784,341 for the comparable period last year. The increase is principally attributable to increasing revenue from vehicle auxiliary motors and the commencement of shipments of an electronic product to a hybrid electric vehicle customer. Technology segment revenue for the nine months ended December 31, 2006 increased to $3,089,136 compared to $2,397,020 for the comparable period last year due to higher levels of contract services revenue and low volume product shipments. Technology segment product revenue for the nine month period increased to $864,821 compared to $794,675 for the comparable period last year.

Gross profit margins for the nine months ended December 31, 2006 rose to 8.6 percent compared to 5.1 percent for the comparable period last year primarily due to improved overhead absorption associated with increasing revenue levels. Gross profit margin on contract services was 11.2 percent for the nine months ended December 31, 2006 compared to a negative 4.9 percent for the comparable period last year. The increase is attributable to improved overhead absorption and fewer cost overruns on funded development projects. Gross profit margin on product sales for the nine months ended December 31, 2006 was 6.2 percent compared to 15.2 percent for the comparable period last year. The decrease in margins on product sales is attributable to costs associated with the launch of production for auxiliary motors and an electronic product.

Research and development expenditures for the nine months ended December 31, 2006 rose to $285,400 compared to $184,110 for the same period last year. The increase is primarily due to increased levels of internally funded development projects.

Production engineering costs were $699,960 for the nine months ended December 31, 2006 versus $564,358 for the comparable nine month period last year. The increase is attributable to additional staffing, increased prototype and sample expenses and non-cash compensation charges associated with the expensing of share based payments.

Selling, general and administrative expense for the quarter ended December 31, 2006 was $2,188,624 compared to $1,415,706 for the same period last year. The increase is primarily attributable to increased accounting and legal expenses and non-cash compensation charges associated with the expensing of share based payments.

Interest income rose to $344,252 for the nine months ended December 31, 2006 compared to $252,046 for the comparable period last year. The increase is attributable to higher yields on invested balances during the current period.

Interest expense decreased to $36,336 for the nine months ended December 31, 2006 versus $47,860 for the comparable period last year. The decrease is due to lower average mortgage borrowings outstanding throughout the current quarter.

In January 2004, we committed to a plan to exit our contract electronics manufacturing business whose results were reported as the electronic products segment. In May 2004, we completed the divestiture of equipment and inventory of this business. We are the primary obligor on a lease for the facility previously occupied by this divested business. The facility has been subleased at a rental rate below that provided for in the master lease. At December 31, 2006 accounts receivable from discontinued operations totaled $58,224 reflecting rent payments earned but not yet paid under the sublease, and liabilities and commitments of discontinued operations totaled $11,868, all of which was associated with the lease commitment.

The operating results of this business for the quarters ended December 31, 2006 and 2005 have been reported separately as discontinued operations. Loss from discontinued operations does not include allocations of general corporate overheads, which have been allocated to other business segments. Operating results of all prior periods presented have been adjusted to reflect the contract electronics manufacturing business as discontinued operations.

Loss from discontinued operations for the quarter and nine months ended December 31, 2006 was $5,722 and $22,474, respectively, versus earnings from discontinued operations of $18,042 and a loss from discontinued operations of $25,659 for the comparable periods last fiscal year.

Our cash balances and liquidity throughout the quarter and nine months ended December 31, 2006 were adequate to meet operating needs. At December 31, 2006, we had working capital (the excess of current assets over current liabilities) of $9,498,419 compared to $10,415,409 at March 31, 2006.

For the nine months ended December 31, 2006 net cash used in operating activities of continuing operations was $2,122,170 compared to net cash used in operating activities of $1,362,370 for the comparable nine month period last year. The increase in cash used in operating activities was primarily attributable to increased losses and higher levels of accounts receivable, inventories and prepaid expenses and other current assets, which were partially offset by higher levels of accounts payable, and billings in excess of costs and estimated earnings on uncompleted contracts.

Net cash used in investing activities of continuing operations for the nine months ended December 31, 2006 was $583,628 compared to net cash used by investing activities of $4,499,316 for the comparable period last year. The decrease for the current nine month period was due to reduced levels of maturities of short-term securities, which was partially offset by an increase in capital expenditures for equipment.

Net cash provided by financing activities of continuing operations was $979,820 for the nine months ended December 31, 2006 versus $4,139,772 for the same period last year. The decrease reflects the completion of a private placement of our common stock to an institutional investor during the first quarter last year which was partially offset by increased cash proceeds from the exercise of stock options and warrants during the nine months ended December 31, 2006.

We expect to manage our operations and working capital requirements to minimize the future level of operating losses and working capital usage consistent with execution of our business plan; however, we expect production engineering expenses to increase substantially and contract services revenue to decline modestly over the next several quarters reflecting a shift in resources to the production launch of propulsion systems deliverable to Phoenix Motorcars, Inc. We also expect cash used in operations to increase substantially as inventories and accounts receivable balances expand due to the execution of this contract. We cannot provide assurance that we will be successful in achieving our objectives. We believe our available cash resources are sufficient to fund our expected level of operations for at least two years. We have begun, and expect to continue, to make substantial investments from our available cash and short-term investments for additional human resources, manufacturing facilities and equipment, production and application engineering, among other things. We expect to fund our operations over at least the next two years from existing cash and short-term investment balances and from available bank financing, if any. We cannot, however, provide any assurance that our existing financial resources will be sufficient to execute our business plan. If our existing financial resources are not sufficient to execute our business plan, we may issue equity or debt securities in the future. In the event financing or equity capital to fund future growth is not available on terms acceptable to us, we will modify our strategy to align our operation with then available financial resources.

The following table presents information about our contractual obligations and commitments as of December 31, 2006:

(1) Does not include sublease payments of $54,000 over the remaining term of a facility lease.

(2) Includes future salary payments, potential retirement pay, and severance pay obligations.

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that effect the dollar values reported in the consolidated financial statements and accompanying notes. Note 1 to the consolidated financial statements contained in our annual report on Form 10-K for the fiscal year ended March 31, 2006 describes the significant accounting policies and methods used in preparation of the consolidated financial statements. Estimates are used for, but not limited to, allowance for doubtful accounts receivables, potential future lease obligations arising from discontinued operations, recoverability of inventories, costs to complete contracts, and fair value and compensation expense arising from share-based compensation. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in preparation of the consolidated financial statements.

Our trade accounts receivable are subject to credit risks associated with the financial condition of our customers and their liquidity. We evaluate all customers periodically to assess their financial condition and liquidity and set appropriate credit limits based on this analysis. As a result, the collectibility of accounts receivable may change due to changing general economic conditions and factors associated with each customer’s particular business. We have established no reserve for potentially uncollectible trade accounts receivable, which is our best estimate of the amount of trade accounts receivable that we believe are uncollectible due to the foregoing factors. It is reasonably possible, that future events or changes in circumstances could cause the realizable value of our trade accounts receivable to decline materially, resulting in material losses.

In May 2004, we completed the divestiture of equipment and inventory of our electronics product segment. We are the primary obligor on a lease for the facility previously occupied by this divested business. The facility has been subleased at a rental rate below that provided for in the master lease. Accordingly, we have recorded a liability for the present value of the difference between these two amounts which totaled $11,868 at December 31, 2006. We have also recorded accounts receivable from discontinued operations of $58,224 reflecting rent payments earned but not yet paid under the sublease. At this time we believe our currently recorded liabilities for discontinued operations are adequate to cover potential future obligations that may arise. Our estimate of future sublease payments could change materially based on future developments and events. Any change in these estimates could result in a material change in our financial condition and results of operations.

We maintain raw material inventories of electronic components, motor parts and other materials to meet our expected manufacturing needs for proprietary products and for products manufactured to the design specifications of our customers. Some of these components may become obsolete or impaired due to bulk purchases in excess of customer requirements. In addition we maintain work-in-process and finished goods inventories for the products we manufacture. Accordingly, we periodically assess our inventories for potential impairment of value based on then available information, expectations and estimates and establish impairment reserves for estimated declines in the realizable value. The actual realizable value of our inventories may differ materially from these estimates based on future occurrences. It is reasonably possible that future events or changes in circumstances could cause the realizable value of our inventories to decline materially, resulting in material impairment losses.

We recognize revenue on the development projects funded by our customers using the percentage-of-completion method. Under this method, contract services revenue is based on the percentage that costs incurred to date bear to management’s best estimate of the total costs to be incurred to complete the project. Many of these contracts involve the application of our technology to customers’ products and other applications with demanding specifications. Management’s best estimates have sometimes been adversely impacted by unexpected technical challenges requiring additional analysis and redesign, failure of electronic components to operate in accordance with manufacturers published performance specifications, unexpected prototype failures requiring the purchase of additional parts and a variety of other factors that may cause unforeseen delays and additional costs. It is reasonably possible that total costs to be incurred on any of the projects in process at December 31, 2006 could be materially different from management’s estimates, and any modification of management’s estimate of total project costs to be incurred could result in material changes in the profitability of affected projects or result in material losses on any affected projects.

In the first quarter of fiscal 2007, we adopted SFAS No. 123(R), which requires the measurement at fair value and recognition of compensation expense for all share-based payment awards. We use the Black-Scholes-Merton option pricing model to estimate the fair value of employee stock options consistent with the provisions of SFAS No. 123(R). Option pricing models, including the Black-Scholes-Merton model, require the use of input assumptions, including expected volatility, expected life, expected dividend rate, and expected risk-free rate of return. We use the simplified calculation of expected life described in the SEC’s Staff Accounting Bulletin 107, due to changes in the vesting terms and contractual life of current option grants compared to our historical grants. If we change our option pricing input assumptions based on future events or determine that a different method of determining expected life was more reasonable than our current methods, or if another method for calculating these input assumptions was prescribed by authoritative guidance, the fair value calculated for share-based awards could change significantly.

In addition, SFAS No. 123(R) requires us to develop an estimate of the number of share-based awards which will be forfeited due to employee turnover. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported share-based compensation. Any such adjustments may affect our gross margin, research and development expenses, production engineering and selling, general and administrative expenses. The expense we recognize in future periods could also differ significantly from the current period and/or our forecasts due to changing circumstances.

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange and interest rates. We do not use financial instruments to any degree to manage these risks and do not hold or issue financial instruments for trading purposes. All of our product sales, and related receivables are payable in U.S. dollars. We are not subject to interest rate risk on our debt obligations.

We conducted an evaluation of the effectiveness of the design and operation of our "disclosure controls and procedures" (Disclosure Controls) as defined by Rule 13a-15(e) of the Exchange Act as of the end of the period covered by this Quarterly Report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO).

Attached as exhibits to this Quarterly Report are certifications of the CEO and the CFO, which are required by Rule 13a-15(b) of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. To the extent that components of our internal control over financial reporting are included within our Disclosure Controls, they are included in the scope of our periodic controls evaluation.

Our management, including the CEO and CFO, do not expect that our Disclosure Controls or our internal control over financial reporting will prevent all errors and all fraud. Our control system, has been designed to provide reasonable assurance of achieving their objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

The evaluation of our Disclosure Controls included a review of the controls’ objectives and design, the Company’s implementation of the controls and the effect of the controls on the information generated for use in this Quarterly Report. In the course of the controls evaluation, we sought to identify data errors, control problems or acts of fraud and confirm that appropriate corrective action, including process improvements, were being undertaken. This type of evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning control effectiveness can be reported in our Quarterly Reports on Form 10-Q and in our Annual Report on Form 10-K. Many of the components of our Disclosure Controls are also evaluated on an ongoing basis by personnel in our finance organization.

The overall goals of these various evaluation activities are to monitor our Disclosure Controls, and to modify them as necessary. Among other matters, we also considered whether our evaluation identified any "significant deficiencies" or "material weaknesses" in our internal control over financial reporting, and whether we had identified any acts of fraud involving personnel with a significant role in our internal control over financial reporting. This information was important both for the controls evaluation generally, and because item 5 in the certifications of the CEO and CFO require that the CEO and CFO disclose that information to our Board’s Audit Committee and to our independent auditors. In the professional auditing literature, a "significant deficiency" is an internal control deficiency that, alone or in the aggregate with others, results in more than a remote likelihood that a misstatement of a company’s financial statements that is more than inconsequential in amount will not be prevented or detected. Auditing literature defines a "material weakness" as a significant deficiency that, alone or in the aggregate with others, results in more than a remote likelihood that a material misstatement in a company’s financial statements will not be prevented or detected. During the course of our evaluation this quarter, we identified a few internal control procedures that should be changed to improve the effectiveness of our internal controls. We do not believe that any of the internal control procedures we expect to improve represented a material weakness, or is reasonably likely to materially affect, our internal control over financial reporting in a manner requiring disclosure in accordance with Item 308(c) of Regulation S-K.

Based upon the controls evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this Quarterly Report, our Disclosure Controls were effective, at the reasonable assurance level, in: 1) identifying material information required to be disclosed in Exchange Act Reports; 2) providing that material information is recorded, processed, summarized and reported within the time periods specified by the SEC; and 3) providing that material information relating to the Company and its consolidated subsidiaries is made known to management, including the CEO and CFO.

PART II-OTHER INFORMATION

We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, and based on current available information, the ultimate disposition of these matters is not expected to have a material adverse effect on our financial position, results of operations or cash flow, although there can be no assurance that adverse developments in these matters could not have a material impact on a future reporting period.

Before investing in our securities you should carefully consider the following factors and other information in this document and the information incorporated by reference.

We have incurred significant net losses. For the quarter and nine months ended December 31, 2006 and 2005, our net loss was $824,019 and $2,491,385 and $518,064 and $1,825,577, respectively. Our net loss for each of the last three fiscal years were as follows:

We have had accumulated deficits as follows:

In the future we plan to make additional investments in product development and commercialization, which is likely to cause us to remain unprofitable.

Our net loss for the quarter and nine months ended December 31, 2006 was $824,019 and $2,491,385 versus a net loss for the comparable quarter and nine months last year of $518,064 and $1,825,577, respectively. At December 31, 2006, our cash and short-term investments totaled $8,382,784. If our losses continue, operations could consume some or all of our cash balances. We expect to make additional investments in human resources, manufacturing facilities and equipment, production and application engineering, among other things, in order to compete in conventional markets and the emerging market for hybrid electric vehicles. We cannot assure, however, that our existing cash resources will be sufficient to complete our business plan. Should our existing cash resources be insufficient, we may need to secure additional funding. We cannot assure you, however, that funding will be available on terms acceptable to us, if at all.

Some of our technology has been developed under government funding by United States government agencies. In some cases, government agencies in the United States can require us to obtain or produce components for our systems from sources located in the United States rather than foreign countries. Our contracts with government agencies are also subject to the risk of termination at the convenience of the contracting agency and in some cases grant "march-in" rights to the government. March-in rights are the right of the United States government or the applicable government agency, under limited circumstances, to exercise a non-exclusive, royalty-free, irrevocable worldwide license to any technology developed under contracts funded by the government to facilitate commercialization of technology developed with government funding. March-in rights can be exercised if we fail to commercialize the developed technology. The implementation of restrictions on our sourcing of components or the exercise of march-in rights by the government or an agency of the government could restrict our ability to commercialize our technology.

In developing electric motors for use in vehicles and other applications, we face competition from very large domestic and international companies, including the world’s largest automobile manufacturers. These companies have far greater resources to apply to research and development efforts than we have, and they may independently develop motors that are technologically more advanced than ours. These competitors also have much greater experience in and resources for marketing their products.

We believe our proprietary systems are suited for a wide range of electric and hybrid electric vehicle platforms. We currently expect to make substantial investments in human resources, manufacturing facilities and equipment, production and application engineering, among other things, to capitalize on the anticipated expansion in demand for products related to this market area. However, our experience in this market area is limited. Our sales in this area will depend in part on the market acceptance of and demand for our proprietary propulsion systems and future products. We cannot be certain that we will be able to introduce or market our products, develop other new products or product enhancements in a timely or cost-effective manner or that our products will achieve market acceptance.

Our ability to compete effectively against other companies in our industry will depend, in part, on our ability to protect our proprietary technology. Although we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be successful in doing so. We have historically pursued patent protection in a limited number of foreign countries where we believe significant markets for our products exist or where potentially significant competitors have operations. It is possible that a substantial market could develop in a country where we have not received patent protection and under such circumstances our proprietary products would not be afforded legal protection in these markets. Further, our competitors may independently develop or patent technologies that are substantially equivalent or superior to ours. We cannot assure that additional patents will be issued to us or, if they are issued, as to the scope of their protection. Patents granted may not provide meaningful protection from competitors. Even if a competitor’s products were to infringe patents owned by us, it would be costly for us to pursue our rights in an enforcement action, it would divert funds and resources which otherwise could be used in our operations and we cannot assure that we would be successful in enforcing our intellectual property rights. In addition, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country where we may operate or sell our products in the future. If third parties assert technology infringement claims against us, the defense of the claims could involve significant legal costs and require our management to divert time and attention from our business operations. If we are unsuccessful in defending any claims of infringement, we may be forced to obtain licenses or to pay royalties to continue to use our technology. We may not be able to obtain any necessary licenses on commercially reasonable terms or at all. If we fail to obtain necessary licenses or other rights, or if these licenses are costly, our results of operations may suffer either from reductions in revenues through our inability to serve customers or from increases in costs to license third-party technologies.

Because our motors are designed to be used in vehicles, and because vehicle accidents can cause injury to persons and property, we are subject to a risk of claims for product liability. We carry product liability insurance of $1 million covering all of our products. If we were to experience a large insured loss, it might exceed our coverage limits, or our insurance carriers could decline to further cover us or raise our insurance rates to unacceptable levels, any of which could impair our financial position and results of operations.

Exhibits

31.1 Certification of Chief Executive Officer

31.2 Certification of Chief Financial Officer

32.1 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxely Act of 2002

Reports on Form 8-K

NONE.