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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

For the quarterly period ended September 30, 2012

OR

For the transition period from              to            

Commission file number: 001-34463

B456 Systems, Inc.

(Exact name of registrant as specified in its charter)

617-778-5700

(Registrant’s telephone number, including area code)

A123 Systems, Inc.

200 West Street

Waltham, MA 02451

(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 o   No x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

As of October 1, 2012, there were 305,699,542 shares of the registrant’s Common Stock, par value $.001 per share, outstanding.

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B456 Systems, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended September 30, 2012

INDEX

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Part I. Financial Information

Item 1.  Financial Statements

B456 Systems, Inc.

Condensed Consolidated Balance Sheets (Unaudited)

(in thousands, except share and per share data)

See notes to unaudited condensed consolidated financial statements.

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B456 Systems, Inc.

Condensed Consolidated Statements of Operations (Unaudited)

(in thousands, except per share data)

See notes to unaudited condensed consolidated financial statements.

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B456 Systems, Inc.

Condensed Consolidated Statements of Comprehensive Loss (Unaudited)

(in thousands)

See notes to unaudited condensed consolidated financial statements.

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B456 Systems, Inc.

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

(in thousands, except per share data)

See notes to unaudited condensed consolidated financial statements.

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B456 Systems, Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

See notes to unaudited condensed consolidated financial statements.

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B456 Systems, Inc.

Notes to Condensed Consolidated Financial Statements

1. Nature of the Business, Basis of Presentation, and Significant Accounting Policies

B456 Systems, Inc. (the “Company”) was incorporated in Delaware on October 19, 2001 under the name A123 Systems, Inc. (“A123”) and has its corporate offices in Waltham, Massachusetts. Prior to the Sale (as defined below), the Company designed, developed, manufactured and sold advanced rechargeable lithium-ion batteries and battery systems and provided research and development services to government agencies and commercial customers. On March 22, 2013, the Company filed a Certificate of Amendment to the Company’s Restated Certificate of Incorporation, as amended (the “Amendment”) to change its name from A123 Systems, Inc. to B456 Systems, Inc. The change of corporate name was effected to satisfy one of the Company’s obligations under the Asset Purchase Agreement dated December 11, 2012 by and among the Company, certain of its subsidiaries and Wanxiang America Corporation (“Wanxiang”), a subsidiary of Wanxiang Group Corporation (discussed below).

The Company has incurred significant net losses and negative operating cash flows since inception. At September 30, 2012, the Company had an accumulated deficit of $939.4 million, including a $290.5 million net loss incurred for the nine months ended September 30, 2012. The Company had $31.3 million in cash and cash equivalents at September 30, 2012, down from $186.9 million at December 31, 2011.

Chapter 11 Bankruptcy Filing—On October 16, 2012, the Company and all of its domestic subsidiaries filed voluntary petitions for relief under Chapter 11, of Title 11 of the United States Code, in the United States Bankruptcy Court for the District of Delaware. The Company’s intent under the Chapter 11 filing was to, among other things, obtain access to new financing and facilitate one or more transactions, including the sale of certain of its automotive business assets. The Company continued operating its businesses in the ordinary course as it attempted to complete the sale of the automotive assets and continued to actively pursue strategic alternatives for their other businesses. The Company also obtained the necessary relief from the Bankruptcy Court to pay the claims of certain critical, priority and foreign vendors and the vast majority of its employees’ claims in full and on time in accordance with its existing business terms.

On October 16, 2012, the Company and its subsidiaries entered into an asset purchase agreement (the “JCI Asset Purchase Agreement”) with Johnson Controls, Inc. (“JCI”).  Pursuant to the JCI Asset Purchase Agreement,  JCI agreed to acquire the Company’s automotive business assets and certain liabilities, including all of its automotive technology, certain products and customer contracts, its facilities in Livonia and Romulus, Michigan and the Company’s equity interest in Shanghai Advanced Traction Battery Systems Co. Ltd., the Company’s joint venture with SAIC Motor Co., Ltd., for an aggregate purchase price of $116.0 million. Additionally, pursuant to the JCI Asset Purchase Agreement, the Company granted JCI the option to acquire its cathode powder manufacturing facilities in China for an additional purchase price of $9.0 million. The JCI Asset Purchase Agreement was subject to proposed bidding procedures and receipt of higher and better bid(s) at auction (the “Auction”). The JCI Asset Purchase Agreement called for the Company to pay a break-up fee in certain circumstances, including the Bankruptcy Court approving a higher bid at or as a result of the Auction. The Asset Purchase Agreement also provided for the reimbursement of specified expenses of JCI incurred by JCI in connection with the Asset Purchase Agreement. In conjunction with the Asset Purchase Agreement and the Chapter 11 Filing, the Company received a commitment from JCI for $72.5 million in debtor in possession financing (the “JCI DIP Loan Agreement”) to support the Company’s continued operations during the pendency of the bankruptcy case. On the date the agreement was executed, the Company received $15.5 million in financing from JCI.

On November 5, 2012, the Company and Wanxiang entered into an agreement regarding debtor in possession financing (the “Wanxiang DIP Loan Agreement”) pursuant to which Wanxiang provided the Company with $50.0 million in financing to support the Company’s continued operations during the pendency of the Company’s bankruptcy case. As a result of the execution of the Wanxiang DIP Loan Agreement, the JCI DIP Loan Agreement was terminated and all amounts borrowed from JCI were repaid.

On December 6, 7 and 8, 2012, the Company conducted, pursuant to bid procedures approved by the Bankruptcy Court, an auction under Section 363 of the federal Bankruptcy Code for the sale of the Company’s assets (the “Auction”), and announced on December 9, 2012 that it had reached agreement on the terms of an asset purchase agreement with Wanxiang through which Wanxiang would acquire substantially all of the Company’s assets for $256.6 million and an additional asset purchase agreement with Navitas Systems LLC (“Navitas”) through which Navitas would acquire the

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Company’s Ann Arbor Michigan-based government business, including all U.S. military contracts, for $2.25 million (together, the “Proposed Sales”).

On December 11, 2012, the Bankruptcy Court issued an order approving the Proposed Sales, and asset purchase agreements between the Company and Wanxiang (the “Wanxiang APA”) and between the Company and Navitas (the “Navitas APA” and together with the Wanxiang APA, the “Asset Purchase Agreements”) were executed. Under the Wanxiang APA, Wanxiang agreed to acquire the Company’s automotive, grid and commercial business assets, including technology, products, contracts and U.S. facilities in Michigan, Massachusetts and Missouri; its operations in China; and its equity interest in Shanghai Advanced Traction Battery Systems Co., A123’s joint venture with Shanghai Automotive. The sale was subject to certain closing conditions, including approval from the Committee on Foreign Investment in the United States. Under the Navitas APA, Navitas agreed to acquire the Company’s U.S. government business assets, including its technology, products, intellectual property and contracts, as well as the lease for the Company’s facility in Ann Arbor, Michigan. The sale was subject to certain closing conditions, including the completion of the transactions contemplated by the Wanxiang APA as well as Navitas and Wanxiang entering into certain agreements related to the provision of transition services or the license of intellectual property between the companies. As a result of Wanxiang being the successful bidder at the Auction, the JCI Asset Purchase Agreement was terminated, and on December 11, 2012, the Company paid JCI an aggregate of $5.5 million, representing a “Breakup Fee” fee of $2.5 million, as well as expenses of up to $3.0 million required to be reimbursed by the Company.

On January 29, 2013, the Proposed Sales were closed with Wanxiang and Navitas.  The Company received $258.6 million of net proceeds in conjunction with this sale, of which $50.0 million was used to repay the funds received under the Wanxiang DIP financing agreement executed November 5, 2012.

On February 6, 2013, the Company filed with the Bankruptcy Court a proposed Joint Plan of Liquidation (the “Proposed Plan”) and related disclosure statement (the “Disclosure Statement”) for the resolution and satisfaction of all claims against and interests in the Company. The Proposed Plan provides for the liquidation of assets of the Estate (i.e., the remaining assets of the Company not purchased by Wanxiang or Navitas, the “Estate”), including the investigation and prosecution of Estate Causes of Action, by a Liquidation Trust to be formed pursuant to the Proposed Plan and a Liquidation Trust Agreement. The Liquidation Trust is to be managed by a Liquidation Trustee as well as by a Liquidation Trust Oversight Committee selected by the Official Creditors’ Committee. The Liquidation Trust shall be responsible for making distributions to holders of claims and, if applicable, interests, as well as all other administrative tasks necessary for ultimate resolution of the Chapter 11 cases, pursuant to the terms of the Proposed Plan and the Liquidation Trust Agreement.

On May 20, 2013 the Proposed Liquidation Plan was approved by the Bankruptcy Court to be effective in June/July 2013.

Basis of Presentation—The accompanying condensed consolidated financial statements and the related disclosures as of September 30, 2012 and for the three and nine months ended September 30, 2011 and 2012 are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 12, 2012. The December 31, 2011 condensed consolidated balance sheet included herein was derived from the audited financial statements as of that date, but does not include all disclosures required by GAAP for complete financial statements.

The interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to present fairly the Company’s financial position as of September 30, 2012 and results of its operations for the three and nine months ended September 30, 2011 and 2012, and its cash flows for the nine months ended September 30, 2011 and 2012.

The financial statements in this Quarterly Report on Form 10-Q have been prepared on a going concern basis and, as such, do not include any adjustments that might arise from the outcome of the Company’s bankruptcy filings discussed above.

Comprehensive Loss—In June 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update 2011-05, Comprehensive Income (Topic 220) as amended, requiring amendments to the disclosure for

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presentation of comprehensive loss. This guidance, effective retrospectively for the interim and annual periods beginning on or after December 15, 2011, requires presentation of total comprehensive loss, the components of net loss and the components of other comprehensive loss either in a single continuous statement of comprehensive loss or in two separate but consecutive statements. In December 2011, the FASB issued an amendment to this guidance which indefinitely defers the requirement to present reclassification adjustments out of accumulated other comprehensive loss either in a single continuous statement of comprehensive loss by component in both the statement in which net loss is presented and the statement in which other comprehensive loss is presented. This guidance is effective for annual periods beginning after December 15, 2011. In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220) — Reporting of Amounts Reclassified out of Accumulative Other Comprehensive Income (ASU 2013-02), which replaces the presentation requirements for reclassifications out of accumulated other comprehensive loss in ASU 2011-05 and ASU 2011-12. ASU 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive loss by component and to present significant amounts reclassified out of accumulated other comprehensive loss by respective line items of net loss if the amount reclassified is required to be reclassified to net loss in its entirety. ASU 2013-02 is effective in periods beginning after December 15, 2012 and should be applied prospectively. The Company adopted the amended guidance to ASC 2011-065 requiring presentation of comprehensive loss in two consecutive financial statements for the nine months ended September 30, 2012. The implementation of this guidance did not have a material impact on the Company’s condensed consolidated results of operations or financial position. The adoption of ASU 2013-02 is not anticipated to have any impact on our financial position, results of operations or cash flows.

Principles of Consolidation—The accompanying condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense and related disclosures. The Company bases estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances. The Company evaluates its estimates and assumptions on an ongoing basis. The Company’s actual results may differ from these estimates under different assumptions or conditions.

Government Grants—The Company recognizes government grants when there is reasonable assurance that the Company will comply with the conditions attached to the grant arrangement and the grant will be received. The Company evaluates the conditions of each individual grant as of each reporting period to ensure that the Company has reached reasonable assurance of meeting the conditions of each grant arrangement and that it is expected that the grant will be received as a result of meeting the necessary conditions. For example, if a grant has conditions where the Company must create and maintain a certain number of jobs, the Company records the grant in the period that it has evaluated and determined that the necessary number of jobs has been created and, based on the Company’s forecasts, it is reasonably assured that the jobs will be maintained during the required employment period. Government grants are recognized in the condensed consolidated statements of operations on a systematic basis over the periods in which the Company recognizes the related costs for which the government grant is intended to compensate. Specifically, when government grants are related to reimbursements for cost of revenues or operating expenses, the government grants are recognized as a reduction of the related expense in the condensed consolidated statements of operations over the period that the Company is required to comply with the conditions of the grants. For government grants related to reimbursements of capital expenditures, the government grants are recognized as a reduction of the basis of the asset and recognized in the consolidated statements of operations over the estimated useful life of the depreciable asset as reduced depreciation expense. For the three and nine months ended September 30, 2011, the Company recorded $4.2 million and $10.3 million, respectively, as a reduction to depreciation expense related to reduced carrying value of property, plant and equipment due to government grants reimbursements. For the three and nine months ended September 30, 2012, the Company recorded $8.8 million and $26.5 million, respectively, as a reduction to depreciation expense related to reduced carrying value of property, plant and equipment due to government grants reimbursements.

The Company records government grant receivables in the condensed consolidated balance sheets in prepaid expenses and other current assets or long-term grant receivable, depending on when the amounts are expected to be received from the government agency. The Company does not discount long-term grant receivables. Proceeds received from government grants prior to expenditures being incurred are recorded as restricted cash and other current liabilities or other long-term liabilities, depending on when the Company expects to use the proceeds.

The Company classifies grant proceeds received in advance of spending for qualified expenditures as a cash flow from financing activities in the condensed consolidated statements of cash flows, as the proceeds are used to assist in funding future expenditures. Grant proceeds received as reimbursements for capital expenditures previously incurred are classified in

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cash flows from investing activities and grant proceeds received as reimbursements for operating expenditures previously incurred are classified in cash flows from operating activities.

Revenue Recognition—The Company earns revenue from the sale of products and delivery of services, including products and services sold under governmental contracts. Revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the price to the buyer is fixed or determinable, and collectability is reasonably assured. When collectability is not reasonably assured, the Company will record a receivable and defer the revenue and costs associated with the delivered product or services until cash is received from the customer.

If a sales arrangement contains multiple elements, the Company evaluates the agreement to determine if separate units of accounting exist within the arrangement. If separate units of accounting exist within the arrangement, the Company allocates revenue to each element based on the relative selling price of each of the elements.

Products Revenue

Products revenue is generally recognized upon transfer of title and risk of loss, which is typically upon shipment, unless an acceptance period exists. The Company’s customary shipping terms are FOB shipping point or free carrier. In instances where customer acceptance of a product is required, revenue is either recognized (i) upon shipment when the Company is able to demonstrate that the customer specific objective criteria have been met or (ii) upon the earlier of customer acceptance or expiration of the acceptance period. The Company’s customers may generally cancel orders at any time prior to product shipment.

The Company provides warranties for its products and records the estimated costs as a cost of revenue in the period the revenue is recorded. The Company’s standard warranty period extends one to five years from the date of delivery, depending on the type of product purchased and its application. The warranties provide that the Company’s products will be free from defects in material and workmanship and will, under normal use, conform to the specifications for the product. The standard warranties further provide that the Company will repair the product or provide replacement parts at no charge to the customer. The Company’s warranty liability is based on the current field campaign and on projected product failure rates and estimated costs of fulfilling warranty claims. Projections are based on the Company’s actual warranty experience and other known and expected factors. The Company monitors its warranty liability and adjusts the amounts as necessary. When the Company is unable to reasonably determine its obligation for warranty of new products, revenue from the sale of the products is deferred until expiration of the warranty period or until such time as the warranty obligation can be reasonably estimated.

In instances where the Company has deferred revenue due to not meeting all of the revenue recognition criteria but where title has passed to the customer, the Company also defers the associated costs of revenue until such time that it is able to recognize the revenue. Deferred costs of revenue are classified in the condensed consolidated balance sheets as deferred costs under current assets as these are expected to be recognized as cost of revenue in the condensed consolidated statement of operations within one year. As of December 31, 2011 and September 30, 2012, the Company had deferred cost of revenue of $6.3 million and $9.4 million, respectively.

Services Revenue

Revenue from services is recognized as the services are performed consistent with the performance requirements of the contract using the proportional performance method if the Company is able to reasonably estimate the contract cost and progress toward completion of the contract. If the Company does not have the ability to reasonably estimate contract costs or progress toward completion of the contract, the Company defers the related revenue and costs and recognizes the revenues and costs based on the completed performance method. When the completed performance method is used, the excess of accumulated costs over related billings, if any, are classified as an asset and the excess of accumulated billings over related costs, if any, are classified as a liability. The Company classifies the portion of the related asset or liability as long-term if such asset or liability is expected to be recognized beyond one year.

Service revenue includes revenue derived from the execution of contracts awarded by the U.S. Federal government, other government agencies and commercial customers. The Company’s research and development arrangements with the federal government or other government agencies typically require the Company to provide pure research, in which the Company investigates design techniques on new battery technologies. The Company’s arrangements with commercial customers consist of arrangements where the Company is paid to enhance or modify an existing product or to develop a new product to meet a customer’s specifications.

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Other Revenue

Fees to license the use of the Company’s proprietary and licensed technologies are recognized only after both the license period has commenced and the technology has been delivered to the customer. Royalty revenue is recognized when it becomes determinable and collectability is reasonably assured; otherwise the Company recognizes revenue upon receipt of payment. To date, the Company has not recognized any significant royalty revenue.

During the three and nine months ended September 30, 2011, the Company recognized $0.4 million and $0.6 million in license fee revenue. During the three and nine months ended September 30, 2012, the Company recognized $0.6 million and $1.7 million, respectively, in license fee revenue.

Deferred Revenue

The Company records deferred revenue for product sales and services revenue in several different circumstances. These circumstances include when (i) the Company has delivered products or performed services but other revenue recognition criteria have not been satisfied, (ii) payments have been received in advance of products being delivered or services being performed and (iii) all other revenue recognition criteria have been met, but the Company is not able to reasonably estimate the warranty expense. Deferred revenue includes up-front fees associated with services arrangements. Deferred revenue expected to be recognized as revenue more than one year subsequent to the balance sheet date is classified as long-term deferred revenue. Deferred revenue will vary depending on the timing and amount of cash receipts from customers and can vary significantly depending on specific contractual terms.

Currently, the Company has two outstanding technology license agreements with its customers to license certain of its technology in the field of consumer electronic devices (excluding power tools and certain other consumer products) and in the field of manufacturing advance battery systems and modules in the transportation market. In connection with the license agreements, the licensees have paid up front, non-refundable license fees and will pay ongoing royalties based on a percentage of the licensees’ net sales of products that use or embody the licensed technology and know-how. The Company has commenced recognizing revenue on both of the upfront license fees over the longer of the license term or the expected customer relationship.

Deferred revenue related to the license agreements were $34.5 million and $33.1 million as of December 31, 2011 and September 30, 2012, respectively.

Customer Deposits

Customer deposits received from customers related to products where title has not passed are recorded in other liabilities. The Company classifies as long-term the portion of customer deposits that are expected to be recognized beyond one year. Upon transfer of title and when all of the revenue recognition criteria have been met, the Company recognizes the related revenue. If not all of the revenue recognition criteria have been met, but title to the goods has passed to the customer, the Company records the related amount in deferred revenue. As of December 31, 2011 and September 30, 2012, the Company recorded customer deposits of $6.9 million and $3.5 million in other current liabilities, respectively.

Fair Value of Financial Instruments—Except for the convertible notes (the 2016 Notes as defined in Note 8 and the 2013 Senior Notes) outstanding, the carrying amount of all financial instruments approximate their fair values as of December 31, 2011 and September 30, 2012. The carrying amount of cash (Level 1) and restricted cash (Level 1) approximates fair value due to the short-term nature of these items. Cash equivalents, which include money market accounts, are carried at fair value. Management believes that the Company’s debt obligations (Level 2), except for the 2016 Notes outstanding as of December 31, 2011 and September 30, 2012, and the 2013 Senior Notes outstanding as of September 30, 2012, accrue interest at rates which approximate prevailing market rates for instruments with similar characteristics and, accordingly, the carrying values for these instruments approximate fair value. The Company’s outstanding 2016 Notes (Level 2) have an estimated fair value of $51.4 million and $140.7 million as of December 31, 2011 and September 30, 2012 based on available market data. As of December 31, 2011 and September 30, 2012, the 2016 Notes had a carrying value of $140.1 million and $140.7 million reflected in long-term debt in the Company’s condensed consolidated balance sheet, which reflects the face amount of $143.8 million, net of the unamortized discount. The Company’s outstanding 2013 Senior Notes (Level 2) have an estimated fair value of $4.5 million as of September 30, 2012 based on available market data.  As of September 30, 2012, the 2013 Senior Notes had a carrying value of $4.5 million reflected in the current portion of long-term debt in the Company’s condensed consolidated balance sheet, which reflects the face amount of $4.2 million plus $0.3 million of debt discount.

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Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, GAAP establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures certain financial assets and liabilities at fair value, including the Company’s cash equivalents and warrant derivative liability.

Items Measured at Fair Value on a Recurring Basis—The following tables show assets measured at fair value on a recurring basis and the input categories associated with those assets (in thousands):

(1) Included in Other Current Assets.

Cash and cash equivalents include investments in money market fund investments that are measured at fair value on a recurring basis based on quoted prices in active markets for identical assets.

The embedded derivative asset related to the Hudson Bay embedded derivatives are carried at fair value and are classified as Level 3 in the fair value hierarchy due to the use of significant unobservable inputs.

The Company’s warrant derivative liability represents the liability for the January 2012 Warrants and May 2012 Warrants issued to institutional investors (Note 2), and the warrant issued to Wanxiang as part of the bridge financing. The warrant derivative liability related to the January 2012 Warrants, the May 2012 Warrants and the Wanxiang Warrants are carried at fair value and are classified as Level 3 in the fair value hierarchy due to the use of significant unobservable inputs. The embedded derivative liability related to the Wanxiang embedded conversion and redemption features are carried at fair value and are classified as Level 3 in the fair value hierarchy due to the use of significant unobservable inputs.

The Company’s embedded derivative asset represents the redemption feature included in the August 2012 Amendment of the 2013 Senior Notes.  The value of the embedded derivative on the date of the amendment (August 8, 2010) was $1.5 million was determined using a lattice valuation model using the following assumptions: (i) the stock price on the date of measurement, (ii) expected term of 0.93 years, (iii) risk-free rate of 0.17%, (iv) expected common stock volatility of 98.5% (v) bond yield rate of 30.0% and (iv) default recovery rate of 35.0%. The value of the embedded derivative on September 30, 2012 of less than $0.1 million was determined using a lattice valuation model using the following assumptions (i) the stock price on the date of measurement, (ii) expected term of 0.09 years, (iii) risk-free rate of 0.06%, (iv) expected common stock volatility of 134.0% (v) bond yield rate of 30.0% and (iv) default recovery rate of 40.0%.

The initial fair value of the January 2012 Warrants at the date of issuance was determined to be $11.9 million using the Black- Scholes option pricing method applying the following assumptions: (i) risk-free rate of 0.31%, (ii) remaining term of 2.5 years, (iii) no dividend yield, (iv) volatility of 79%, (v) the exercise price of $2.71, and (vi) the stock price on the date

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of measurement. As of September 30, 2012, the fair value of the January 2012 Warrants was determined to be $0.8 million using the Black-Scholes option pricing method applying the following assumptions: (i) risk-free rate of 0.22%, (ii) remaining term of 1.83 years, (iii) no dividend yield, (iv) volatility of 106%, (v) the exercise price of $2.71, and (vi) the stock price on the date of measurement. A 10% change in volatility would impact the fair value of the warrant as of September 30, 2012 by $0.1 million. In the event of a change in control, these warrants require a cash payment based on contractually defined inputs. The probability of a change in control has been factored into the valuation of the liability.

The initial fair value of the May 2012 Warrants at the date of issuance was determined to be $7.7 million using the Black- Scholes option pricing method applying the following assumptions: (i) risk-free rate of 0.99%, (ii) remaining term of 5.5 years, (iii) no dividend yield, (iv) volatility of 77%, (v) the exercise price of $1.29, and (vi) the stock price on the date of measurement. As of September 30, 2012, the fair value of the May 2012 Warrant was determined to be $1.7 million using the Black- Scholes option pricing method applying the following assumptions: (i) risk-free rate of 0.62%, (ii) remaining term of 5.15 years, (iii) no dividend yield, (iv) volatility of 78%, (v) the exercise price of $0.42, and (vi) the stock price on the date of measurement. A 10% change in volatility would impact the fair value of the warrant as of September 30, 2012 by $0.2 million. In the event of a change in control, these warrants require a cash payment based on contractually defined inputs. The probability of a change in control has been factored into the valuation of the liability.

The initial fair value of the July 2012 Warrants at the date of issuance was determined to be $4.9 million using a Monte-Carlo simulation methodology applying the following assumptions: (i) risk free rate ranging from 0.06% to 0.07% (ii) remaining term of 2 days to 22 days, (iii) volatility ranging from 98.5% to 136.4% (iv) the exercise price of $0.001, and (vi) the stock price on the date of measurement. The warrants were exercised during July of 2012 resulting in the issuance of 6,662,852 shares of common stock.

The initial fair value of the Wanxiang Warrants at the date of issuance was determined to be $14.1 million using the Monte Carlo simulation methodology by applying the following assumptions: (i) risk-free rate of 0.83%, (ii) remaining term of 5 years, (iii) no dividend yield, (iv) volatility of 86%, (v) the exercise price of $25M, and (vi) the stock price on the date of measurement. As of September 30, 2012, the fair value of the Wanxiang Warrant was determined to be $12.1 million using the Monte Carlo simulation methodology by applying the following assumptions: (i) risk-free rate of 0.60%, (ii) remaining term of 4.88 years, (iii) no dividend yield, (iv) volatility of 86%, (v) the exercise price of $25M, and (vi) the stock price on the date of measurement. A 10% change in volatility would impact the fair value of the warrant as of September 30, 2012 by $0.2 million. In the event of a change in control, these warrants require a cash payment based on contractually defined inputs. The probability of a change in control has been factored into the valuation of the liability.

The Company’s embedded derivative liability represents the liability for the embedded conversion and redemption features within the Wanxiang Notes that are not clearly and closely related to the debt and do not meet the criteria for equity classification. Accordingly, these embedded derivatives are measured at fair value separate from the debt obligation and recorded as a liability. The embedded derivative liability is classified as Level 3 in the fair value hierarchy due to the use of significant unobservable inputs. The initial fair value of the embedded derivatives upon issuance was determined to be $1.1 million using the discounted cash flow model by applying the following assumptions: (i) risk-free rate ranging from 0.00% to 0.32%, (ii) bond yield of 30%, (iii) no dividend yield, (iv) interest rate of 10%, and (v) recovery rate of 71%. As of September 30, 2012, the fair value of the embedded derivatives upon issuance was determined to be $1.2 million using the discounted cash flow model applying the following assumptions: (i) risk-free rate ranging from 0.00% to 0.25%, (ii) bond yield of 35%, (iii) no dividend yield, (iv) interest rate of 10%, and (v) recovery rate of 71%, and (vi). The probability of a change in control and the probability of debt covenant triggers have been factored into the valuation of the embedded derivative liability.

The following table provides a roll forward of the fair value of these assets and liabilities, where fair value is determined by Level 3 inputs (in thousands):

Assets Measured as Level 3 Inputs

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Liabilities Measured as Level 3 Inputs

Items Measured at Fair Value on a Non-Recurring Basis—The following tables show assets measured at fair value on a non-recurring basis and the input categories associated with those assets (in thousands):

In January 2010, the Company entered into an agreement to purchase preferred stock of Fisker Automotive, Inc., a maker of plug-in hybrid electric vehicles in the United States (“Fisker”). The Company invested (i) cash of $13.0 million; and (ii) shares of the Company’s common stock, which, when transferred to Fisker, had a fair market value of $7.5 million. The Company historically accounted for its investment under the cost method. In December 2011, the Company elected not to participate in Fisker’s subsequent stock financing. This election not to participate resulted in the conversion of the

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Company’s preferred shares of Fisker to common shares on a 2:1 ratio. As such, the Company performed an analysis and valuation of its investment in Fisker resulting in an adjusted investment value of $8.9 million as of December 31, 2011. As of September 30, 2012, the fair value of the investment in Fisker was determined to be less than $0.1 million using the option-pricing method applying the following assumptions: (i) risk-free rate of 0.23%, (ii) remaining term of 2.0 years, (iii) no dividend yield, (iv) volatility of 50%, and (v) the exercise price of $1.0. During the three months ended September 30, 2012, the Company updated its analysis and valuation of its investment in Fisker resulting in the recognition of an impairment charge of $6.0 million and $8.9 million for the three and nine months ended September 30, 2012, respectively.

The Company conducted its annual goodwill test as of September 30, 2012. The Company assesses goodwill and other intangible assets and long-lived assets for impairment annually as of October 1, or when changes in circumstances indicate that the carrying value may not be recoverable, as required by U.S. generally accepted accounting principles. The goodwill impairment test involves a two-step process. The first step is a comparison of the Company’s fair value to its carrying value. If the Company’s fair value exceeds its carrying value, no further procedures are required. However, if the Company’s fair value is less than its carrying value, an impairment of goodwill may exist, requiring a second step to measure the amount of impairment loss. In this step, the Company’s fair value is allocated to all of the assets and liabilities, including any unrecognized intangible assets, in an analysis to calculate the implied fair value of goodwill in the same manner as if Company was being acquired in a business acquisition. If the implied fair value of goodwill is less than the recorded goodwill, an impairment charge is recorded for the difference. Based on the following facts: (i) challenges in the Company’s industries and its declining sales during the three months ended September 30, 2012, (ii) limited demand for end products that are manufactured with equipment sold by the Company, (iii) the liquidity challenges faced, (iv) the deterioration of its customers financial condition, and (v) the sustained decline in its stock price and a significant decline in its financial outlook for the next few years, the Company determined that sufficient impairment indicators existed to require performance of an additional interim goodwill impairment analysis as of September 30, 2012 as opposed to waiting until October 1, 2012. The results of the first step of the impairment test indicated that goodwill was impaired as of September 30, 2012.  As such, the Company calculated the enterprise value, using the Company’s debt balance of $178.5 million and calculated fair value of its equity of $80.8 million (calculated using the common stock outstanding and Company’s stock price), and determined that the implied fair value of goodwill was substantially lower than the carrying value of goodwill. As a result, the Company recorded a $9.6 million goodwill impairment charge on September 30, 2012.

The following table provides a roll forward of the fair value of these assets, where fair value is determined by Level 3 inputs (in thousands):

Assets Measured as Level 3 Inputs

Net Loss Per Share—Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the fiscal year. Diluted net loss per share is computed by dividing net loss by the weighted-average number of dilutive common shares outstanding during the fiscal year. Dilutive shares outstanding are calculated by adding to the weighted shares outstanding any potential (unissued) shares of common stock and warrants based on the treasury stock method.

The following potentially dilutive securities were excluded from the calculation of diluted net loss per share, as the effect would have been anti-dilutive (in thousands):

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(1)                                 The number of potentially dilutive shares attributable to the 2013 Senior Notes was calculated based on the principal outstanding as of September 30, 2012 and the initial conversion price of $1.18 per share. The conversion price is subject to change as outlined in Note 2, Private Placement.

2. Private Placements

January Registered Direct Offering

On January 25, 2012, the Company sold an aggregate of 12,500,000 units to an institutional investor at a price of $2.034 per unit, with each unit consisting of (i) one share of its common stock (“Common Stock”) and (ii) one warrant to purchase one share of Common Stock (“January 2012 Warrants”), in a registered direct offering for gross proceeds of approximately $25.4 million. The net proceeds to the Company from the sale of the units, after deducting the placement agent’s fees and other estimated offering expenses, was approximately $23.5 million. The January 2012 Warrants have an exercise price of $2.71 per share, and the January 2012 Warrants can be exercised beginning on July 26, 2012 and will expire on July 28, 2014. In the event of a fundamental change, as defined in the Warrants, the Purchasers are entitled to a fair value settlement for the lost option value determined on a Black-Scholes-based calculation with defined assumptions within the agreement. The January 2012 warrants have been accounted for as a liability. The fair value of the January 2012 warrants on the date of issuance was $11.9 million. See Note 1, Fair Value of Financial Instruments. The remaining net proceeds were allocated to common stock. In addition, at any time during both the ten trading days beginning on June 18, 2012 (the “First Option Period”) and the ten trading days beginning on July 23, 2012 (“the Second Option Period”), the Company had the right, subject to certain conditions (including the Company having an arithmetic average of the daily volume weighted average common stock price of greater than $1.00 during the 30 trading days prior to each additional sale option period), to require the investors to purchase in each such period up to an additional 6,250,000 shares of Common Stock, for an aggregate of up to 12,500,000 additional shares of Common Stock. The Company did not meet the required conditions during the First Option Period and therefore did not exercise the purchase right described above. On July 5, 2012, the Company and the institutional investor agreed to terminate the purchase right associated with the Second Option Period. Accordingly, the Company was not able to require the investor to purchase any additional shares.

Private Senior Convertible Notes and Warrants Offering

On May 24, 2012, the Company issued $50.0 million aggregate principal amount of senior convertible notes and warrants to purchase 12,711,864 shares of its common stock to institutional investors (the “2013 Senior Notes” and the “May 2012 Warrants”).

The 2013 Senior Notes and the May 2012 Warrants are detachable and legally separable. See Note 8 for a summary of the material terms on the 2013 Senior Notes.

On August 10, 2012, the Company entered into an amendment to the 2013 Senior Notes Agreement (the “2013 Senior Notes Amendment”), increasing the conversion price of a portion of the Notes at all times on or after August 21, 2012 from 85% of the market price thereof  to 87% of the market price thereof. In consideration of the foregoing, the Amendment changed the first date on which the holders of the Notes may convert up to $30 million of the Notes into shares of common stock at a 15% discount to the market price thereof from August 10, 2012 to August 20, 2012. Additionally, the Amendment changed the required unrestricted cash balance from $40.0 million to $20.0 million. As of September 30, 2012, the Company had $31.3 million of cash and cash equivalents.

The May 2012 Warrants have an exercise price equal to $1.29 per share, and the May 2012 Warrants can be exercised beginning on November 26, 2012 and will expire on November 24, 2017. In the event of a fundamental change, as defined in the Warrants, the Purchasers are entitled to a fair value settlement for the lost option value determined on a Black-Scholes-based calculation with defined assumptions within the agreement. The May 2012 Warrants have customary anti-dilution adjustments as well as an exercise price reset provision upon the issuance of common stock at a per share price

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less than the exercise price currently in effect for the warrant. The May 2012 Warrants have been accounted for as a liability. The fair value of the May 2012 Warrants on the date of issuance was $7.7 million. See Note 1, Fair Value of Financial Instruments. On July 13, 2012, the purchase price of the May 2012 Warrants was adjusted from $1.29 to $0.74 due to a common stock issuance on July 12, 2012. On July 31, 2012, the purchase price of the May 2012 Warrants was further adjusted from $0.74 to $0.42 due to a common stock issuance on July 30, 2012.

The May 2012 Warrants may not be exercised if, after giving effect to the exercise, the Purchasers, together with their affiliates, would beneficially own in excess of 4.99% (the “Maximum Percentage”). The Maximum Percentage may be raised to any other percentage not in excess of 9.99% at the option of the holder of the May 2012 Warrants, upon at least 61-days’ prior notice to the Company, or lowered to any other percentage, at the option of the Purchasers, at any time.

July Registered Direct Offering

On July 10, 2012, the Company sold an aggregate of 7,692,308 shares of the Company’s common stock and warrants to purchase additional shares of such common stock (the “July 2012 Warrants”) for an exercise price of $0.001 per share to certain existing institutional investors (the “Investors”). The Company agreed to sell the common shares at an initial negotiated purchase price of $1.30, subject to adjustment as described below.

Pursuant to the July 2012 Warrants, the Company  issued to the Investors additional shares of common stock such that the Investors would receive the aggregate number of shares of the Company’s common stock equal to (i) $5.0 million divided by 82% of the Volume-weighted average price (“VWAP”) of the Company’s common stock over a period covering July 9, 10 and 11, 2012 or, if lower, 82% of the VWAP of the Company’s common stock on July 11, 2012 and (ii) $5.0 million divided by 82% of the VWAP of the Company’s common stock over a period covering July 25, 26 and 27, 2012 or, if lower, 82% of the VWAP of the Company’s common stock on July 27, 2012.

Pursuant to the July 2012 Warrants, the Company issued to the institutional investors 6,662,852 additional shares of common stock in two separate issuances on July 12, 2012 and July 30, 2012 due to the decrease in the volume weighted average stock price compared to the initial purchase price of $1.30. The Company also paid $2.2 million to the institutional investors due to a limitation on the number of shares that could be settled under the warrants. The net offering proceeds to the Company from the issuance of 14,355,160 shares of common stock, after deducting the placement agent’s fees and other estimated offering expenses of approximately $1.0 million and the cash settlement of $2.2 million on the warrants, were approximately $6.8 million.

Senior Secured Convertible Notes and Warrants

On August 16, 2012, the Company entered into the Securities Purchase Agreement (“Purchase Agreement”) with the Wanxiang Clean Energy USA Corp. (the “Purchaser”) pursuant to which the Purchaser agreed, subject to the satisfaction of certain conditions within 180 days after the date of first advance under the Bridge Loan Facility, to purchase $200 million in aggregate principal amount of the 8.00% Convertible Notes from the Company (the “8.00% Convertible Notes).  The 8.00% Convertible Notes will mature on the fifth anniversary of their issue date.  The Company’s obligations under the 8.00% Convertible Notes are expected to be unconditionally guaranteed by certain of its subsidiaries and secured by substantially all of the Company’s and its subsidiaries’ assets.

The holders of the 8.00% Convertible Notes can convert the principal and accrued interest at any time, subject to limitations, into shares of common stock at a conversion price of equal to $0.60 per share, subject to reduction to $0.24 per share in the event that certain government grants or tax credits cease to be available to the Company and adjusted for stock splits, stock dividends and other similar events.

Under the Purchase Agreement, the Company also agreed to issue warrants (“Convertible Note Warrants”) to the Purchaser. Each Convertible Note Warrant has an exercise price of $115.0 million (subject to a 40% reduction in price in the event that certain government grants or tax credits cease to be available to the Company) and expires on the fifth anniversary of their issue date.  The Convertible Note Warrants, when taken together with the shares of Common Stock issued under the Bridge Warrants, are exercisable for 80% of the outstanding Common Stock of the Company at the time of exercise.

As of September 30, 2012, the Company was in compliance with the covenants and terms of the agreements.

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3. Government Grants

Center of Energy and Excellence Grant

In February 2009, the State of Michigan awarded the Company a $10.0 million Center of Energy and Excellence grant. Under the agreement, the State of Michigan will provide cost reimbursement for 100% of qualified expenditures based on the achievement of certain milestones by March 2012. There are no substantive conditions attached to this award that would require repayment of amounts received if such conditions were not met. The Company received $3.0 million of this grant in March 2009 and $6.0 million of this grant in July 2010, with additional payments to be made based on the achievement of certain milestones in the facility development. Through September 30, 2012, the Company has used $9.1 million of these funds, of which $7.9 million and $1.2 million was recorded as an offset to property, plant and equipment and operating expenses, respectively. For the nine months ended September 30, 2011, $0.1 million was recorded as an offset to operating expenses in the condensed consolidated statements of operations. There was no offset to operating expenses recorded for the three months ended September 30, 2011. For the three and nine months ended September 30, 2012, $0.3 million and $0.8 million were recorded as an offset to operating expenses in the condensed consolidated statements of operations, respectively.

As of September 30, 2012, $0.9 million of these funds were recorded in short term restricted cash and other current liabilities.

Michigan Economic Growth Authority

In April 2009, the Michigan Economic Growth Authority offered the Company certain tax incentives, which can be used to offset the Michigan Business Tax owed in a tax year, carried forward for the number of years specified by the agreement, or be paid to the Company in cash at the time claimed to the extent the Company does not owe a tax. The terms and conditions of the High-Tech Credit were established in October 2009 and the Cell Manufacturing Credit in November 2009.

High Tech Credit—The High-Tech Credit agreement provides the Company with a 15-year tax credit, based on qualified wages and benefits multiplied by the Michigan personal income tax rate beginning with payments made for the 2011 fiscal year. The tax credit has an estimated value of up to $25.3 million, depending on the number of jobs created in Michigan. The proceeds to be received by the Company will be based on the number of jobs created, qualified wages paid and tax rates in effect over the 15 year period. The tax credit is subject to a repayment provision in the event the Company relocates a substantial portion of the jobs outside the state of Michigan on or before December 31, 2026. As of December 31, 2011 and September 30, 2012, the Company recorded undiscounted long-term receivables of $1.0 million and $1.5 million, respectively, with an offsetting balance in other long-term liabilities in the condensed consolidated balance sheet as it is reasonably assured that the Company will comply with the conditions of the tax credit and will receive the proceeds. The balance will be recognized in the condensed consolidated statements of operations over the term that the Company is required to maintain the required number of jobs in Michigan.

Cell Manufacturing Credit—The Cell Manufacturing Credit agreement authorizes a tax credit or cash for the Company equal to 50% of capital investment expenses related to the construction of the Company’s integrated battery cell manufacturing facilities in Michigan, commencing with costs incurred from January 1, 2009, up to a maximum of $100.0 million over a four year period. The tax credit shall not exceed $25.0 million per year and can be submitted for reimbursement beginning in tax year 2012. The Company is required to create 300 jobs no later than December 31, 2016 for the tax credit to be non-refundable. The tax credit is subject to a repayment provision in the event the Company relocates 51% or more of the 300 jobs outside of the state of Michigan within three years after the last year the tax credit is received. Through September 30, 2012, the Company has incurred $200.0 million in qualified expenses related to the construction of the Livonia and Romulus facilities. When the Company has met the filing requirements for the tax year ending December 31, 2012, the Company expects to begin receiving its first annual installment of the $100.0 million in proceeds related to these expenses. As of December 31, 2011 and September 30, 2012, the Company has recorded undiscounted receivables of $100.0 million, as it is reasonably assured that the Company will comply with the conditions of the tax credit and will receive the proceeds. Upon recording the receivables, the Company reduced the basis in the fixed assets acquired in accordance with the tax credit and this will be recognized in the condensed consolidated statements of operations over their estimated useful lives of the depreciable asset as reduced depreciation expense.

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U.S. Department of Energy Battery Initiative

In December 2009, the Company entered into an agreement establishing the terms and conditions of a $249.1 million grant awarded under the U.S. Department of Energy (“DOE”) Battery Initiative to support manufacturing expansion of new lithium-ion battery manufacturing facilities in Michigan. Under the agreement, the DOE will provide cost reimbursement for 50% of qualified expenditures incurred from December 1, 2009 to November 30, 2012. The agreement also provides for reimbursement of pre-award costs incurred from June 1, 2009 to November 30, 2009. There are no substantive conditions attached to this award that would require repayment of amounts received if such conditions were not met. In April 2012, the term of the award was extended by two years through December 2, 2014. Through September 30, 2012, the Company has incurred $266.8 million in qualified expenses, of which 50%, or $133.4 million, are allowable costs for reimbursement, nearly all of which have been reimbursed. For the three months ended September 30, 2011 and September 30, 2012, the Company incurred allowable costs of $8.0 million and $3.1 million, of which $5.2  million was recorded as an offset to property, plant and equipment and $2.8  million recorded as an offset to operating expenses, for the three months ended September 30, 2011, and $2.7 million was recorded as an offset to property, plant and equipment and $0.4 was recorded as an offset to operating expenses, for the three months ended September 30, 2012. For the nine months ended September 30, 2011 and September 30, 2012, the Company incurred allowable costs of $35.9 million and $5.6 million, of which $26.7 million and $4.7 million was recorded as an offset to property, plant and equipment and $9.2 million and $0.9 million as an offset to operating expenses, respectively. As of December 31, 2011 and September 30, 2012, the Company recorded $0.8 million and $0.9 million, respectively, as receivables in prepaid expenses and other current assets in the condensed consolidated balance sheets.

4. Inventory

Inventory consists of the following (in thousands):

The Company’s lower of cost or market provision as of December 31, 2011 and September 30, 2012 was $4.9 million and $2.1 million, respectively. The inventory on hand as of September 30, 2012 was written down by $2.1 million to reduce specific inventory items on hand with unit costs that exceed their net realizable value. The net realizable value of inventory is calculated by taking the estimated selling price of the inventory on hand based on customer contracts and forecasted sales and subtracting the remaining costs to complete and dispose of the inventory. As a result of the field campaign launched related to the defective prismatic cells produced at the Livonia, Michigan manufacturing facility, the Company wrote down $15.2  million in inventory that was impacted by the defective prismatic cells during the nine months ended September 30, 2012. See Note 7 for additional details.

5. Investments

Equity-Method Investments

In December 2009, the Company entered into a joint venture agreement with SAIC Motor Co. Ltd. (“SAIC”), an automaker in China, to assist the Company in growing its business and sales in China’s transportation industry and created Shanghai Advanced Traction Battery Systems, Co. Ltd. (the “Joint Venture”). Under the terms of the joint venture agreement, the Company was required to invest $4.7 million into the Joint Venture over a period of approximately 15 months, in return for a 49% interest in the Joint Venture. The Company made the first capital contribution of $1.9 million to the Joint Venture in July 2010 and the second capital contribution of $1.4 million in January 2011. The Company made the final capital contribution of $1.4 million in July 2011. The Company is accounting for its investment under the equity method.

In August 2010, the Company entered into an agreement to transfer certain patents held by the Company to a privately-held company, 24M Technologies, Inc. (“24M”), in return for a 12% ownership interest in 24M. The Company is accounting for its investment under the equity method as it has determined it has significant influence over the operating and

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financial decisions of the third party. The Company has recorded the investment on the condensed consolidated balance sheet at the fair value of the ownership interest received net of accumulated losses recognized under the equity method.

For the three and nine months ended September 30, 2011 and for the three and nine months ended September 30, 2012, the Company recorded a loss of $0.1 million, $0.7 million, $0.2 million and $1.0 million, respectively, in the condensed consolidated statements of operations related to its share of losses in investments accounted for under the equity method.

6. Commitments and Contingencies

Litigation—On April 2, 2012, a class action complaint was filed in the United States District Court for the District of Massachusetts by Scott Heiss, purportedly acting individually and on behalf of other similarly situated persons, against the Company and its CEO, David Vieau, its CFO, David Prystash, and its former Interim CFO, John Granara. The complaint followed the Company’s disclosure in March 2012 of potentially defective prismatic cells used in battery packs and a replacement program for such cells. The complaint attempted to allege that certain of the Company’s disclosures were inaccurate because the potentially defective cells and their replacement were not disclosed earlier. The complaint asserted a claim under Section 10(b) of the Securities Exchange Act of 1934 against the Company and claims under Sections 10(b) and 20(a) of that statute against the individuals. It asserted a purported class period from February 28, 2011 through March 23, 2012.

On April 12, 2012, a similar class action complaint was filed in the United States District Court for the District of Massachusetts by Terry Leon Fike, purportedly acting individually and on behalf of other similarly situated persons, against the same defendants. The complaint made similar allegations and also asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and a purported class period from February 28, 2011 through March 23, 2012.

On June 7, 2012, the Court consolidated the two cases and appointed a lead plaintiff and lead counsel for the asserted class.  On August 31, 2012, plaintiffs filed a consolidated amended complaint.  On October 1, 2012, the Company filed a motion to dismiss the consolidated amended complaint.  On October 22, 2012, the Company notified the Court of the bankruptcy filing, and on October 23, 2012, the Company filed a Notice of Motion Filed in Bankruptcy Court to Stay Litigations as to Non-Debtor Defendants.  In response, plaintiffs requested an extension of time for the filing of briefing related to the pending motion to dismiss as to the non-debtor defendants.  The Court granted the extension.  On January 25, 2013, plaintiffs filed an opposition to the motion to dismiss as to the non-debtor defendants.  The Company filed a reply on February 8, 2013.  On March 14, 2013, the Court granted the Company’s motion to dismiss but gave plaintiffs leave to file a second amended complaint with twenty-one days.  Plaintiffs opted not to file an amended complaint but to dismiss the case instead.  On April 4, 2013, the parties filed a Stipulation of Voluntarily Dismissal with Prejudice.

On May 14, 2012, a putative derivative action was filed in the U.S. District Court for the District of Massachusetts against the Board of Directors and certain others, as well as against the Company as a nominal defendant, captioned, Jane Ahmed v. David P. Vieau, David Prystash, John Granara, Desh Deshpande, Arthur L. Goldstein, Gary E. Haroian, Dr. Paul E. Jacobs, Mark M. Little, Jeff McCarthy and Dr. Bart Riley, 1:12-CV-10865-RGS. The complaint alleged that certain of the Company’s disclosures between February 28, 2011 and March 28, 2012 were materially misleading because they failed to disclose the prismatic cell manufacturing issues and that the individual defendants violated their fiduciary duties and other causes of action on behalf of the Company. The complaint alleged that demand on the Board to take such actions would be “futile” and should be excused. On June 6, 2012, the defendants moved to dismiss the complaint on the ground that demand on the board of directors was required under Delaware law and that plaintiff had not properly pled that demand in this case should be excused as futile. On June 20, 2012, plaintiff opposed that motion, and on June 25, defendants submitted a reply in further support of their motion to dismiss.  On October 15, 2012, the Court held oral argument on the motion to dismiss and took the motion under advisement.  On October 17, 2012, the Company notified the Court of the bankruptcy filing, and on October 23, 2012, the Company filed a Notice of Motion Filed in Bankruptcy Court to Stay Litigations as to Non-Debtor Defendants.  On January 14, 2013, the Court ordered the case stayed pursuant to the order issued on November 8, 2012 by the U.S. Bankruptcy Court for the District of Delaware staying all derivative actions.

On May 15, 2012, the Company received a letter addressed to its Board of Directors from an attorney representing an individual claiming to be a shareholder of the Company. The letter asserted that the Company’s disclosures between November 9, 2010 and March 28, 2012 were materially misleading as a result of the prismatic cell manufacturing issue disclosed in March of 2012 and further asserted that the Board breached its fiduciary duties during this time. The letter made a demand on the Board to investigate the alleged inaccurate statements and to consider potential legal action against those deemed responsible. The Board considered the issues raised in the letter and retained independent counsel to advise them. On

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August 3, 2012 the Board’s counsel responded to the letter on the Board’s behalf indicating that the Board considered the allegations in the demands based on an investigation on behalf of the Board conducted by outside directors with the assistance of counsel and determined that it would not be in the best interest of A123, or its stockholders to commence or maintain an action against any present or former officer or director of A123 concerning the matters alleged in the demand and refused the demands.

On May 21, 2012, a putative derivative action was filed in Superior Court for the Commonwealth of Massachusetts against the Board of Directors and certain others, as well as against the Company as a nominal defendant, captioned, Murray Sussman v. David P. Vieau, Gururaj Deshpande, Gilbert N. Riley, Jr., Jeffrey McCarthy, Gary E. Haroian, Arthur L. Goldstein, Paul E. Jacobs, Mark M. Little, David Prystash, John Granara, Case No. 12-917. The complaint asserted substantially similar allegations and claims as the Ahmed complaint summarized above, including that demand on the Board of Directors should be excused as futile. On June 11, 2012, the defendants filed a motion asking the court to stay this litigation in favor of the Ahmed derivative case pending in the U.S. District Court for the District of Massachusetts, or, in the alternative, that the complaint should be dismissed on the ground that demand on the board of directors was required under Delaware law and that plaintiff had not properly pled that demand in this case should be excused as futile. On July 16, 2012, the plaintiff filed a memorandum of law in opposition to defendants’ motion to stay the litigation, or in the alternative, to dismiss this action. On July 27, 2012, the defendants filed a reply memorandum of law in further support of their motion to stay, or in the alternative, to dismiss the action. On September 20, 2012, the Court granted the motion to stay pending resolution of the Ahmed derivative action.  On October 23, 2012, the Company notified the Court of the bankruptcy filing.  On October 31, 2012, the Court ordered the case stayed due to the automatic stay provisions of the Bankruptcy Code.

On July 13, 2012, the Company received a demand letter addressed to its Board of Directors from an attorney representing an individual claiming to be a shareholder of the Company. The letter alleges that our disclosures between March 11, 2011 and March 12, 2012 were materially misleading as a result of the prismatic cell manufacturing issue disclosed in March of 2012 and asserted that the Board and certain current and/or former executive officers of the company breached their fiduciary duties. The letter made a demand on the Board to investigate the alleged breach of fiduciary duties to the Company and to consider legal action against those responsible. The Board considered the issues raised in the letter and had its independent counsel advise them. On August 3, 2012, the Board’s counsel responded to the letter on the Board’s behalf indicating that the Board considered the allegations in the demands based on an investigation on behalf of the Board conducted by outside directors with the assistance of counsel and determined that it would not be in the best interest of A123 or its stockholders to commence or maintain an action against any present or former officer or director of the Company concerning the matters alleged in the demand and refused the demands.

The Company intends to defend any litigations vigorously, although the consolidated class action has already been dismissed with prejudice, and expects that the derivative actions will be dismissed with prejudice by the liquidation trustee of the estate once the plan of liquidation has been confirmed by the Bankruptcy Court and becomes effective.  Nonetheless, aside from the class action, which is already dismissed, the Company is unable to determine the outcome of the other matters with certainty and the effect, if any, they may have on its financial position or results of operations. See Note 1 of our financial statements for a discussion of our Chapter 11 Bankruptcy filing and related proceedings.

Royalty Obligations—On October 31, 2011, the Company entered into a Patent Sublicense Agreement with LiFePO4+C Licensing AG as part of a settlement agreement with Hydro-Quebec and the Board of Regents of the University of Texas System, on behalf of the University of Texas at Austin. As partial consideration for the license grants by LiFePO4+C Licensing AG, the Company will be required to pay royalties to LiFePO4+C Licensing AG on a quarterly basis commencing as of January 1, 2012, based on a percentage of the Company’s net sales of cells, electrode systems, and/or complex systems (plus such net sales attributed to any permitted sublicensees of the Company) during such quarterly period. The Company is required to pay royalties on a sliding scale, with a maximum possible royalty rate of 2% of net sales (based on a defined percentage of the Company’s product sales revenue) through the agreement’s term, and based on the fiscal year in which the royalties are calculated and the accrual of total royalty in that fiscal year. Such defined percentage may also be adjusted by mutual agreement if the Company’s standalone cell or electrode system revenues increase significantly in proportion to overall product revenues. During the three and nine months ended September 30, 2012, the Company incurred $0.1 million in royalty obligations related to this agreement.

Restructuring—In February 2012, as part of the Company’s continuing efforts to reduce expenses, the Company decided to close down its facility in Korea while relocating a portion of its new product development and advanced manufacturing engineering teams to other facilities. The Company’s need to align its manufacturing capacity with near-term customer demand and the need to reduce operating expenses are the key factors that drove the decision to restructure. The Company expects to complete the shutdown of its Korean facility in the fourth quarter of 2012. In March 2012, the Company

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recorded $0.8 million as a reserve for discretionary termination benefits for the Company’s Korean employees, in addition to a $1.1 million severance benefits accrual from statutory requirements accounted for in accordance with Accounting Standards Codification (“ASC”) Topic 712, Compensation—Nonretirement Postemployment Benefits. During the three and nine months ended September 30, 2012, the Company paid $0.6  million and $1.6 million, respectively in termination benefits resulting in a severance accrual of $0.4  million remaining as of September 30, 2012. Facility closure and other costs are accounted for in accordance with ASC Topic 420, Exit or Disposal Cost Obligations, and are recorded when the liability is incurred. During the three and nine months ended September 30, 2012, the Company incurred $0.0 million and $0.5 million, respectively, in relocation expenses attributable to the restructuring efforts, of which approximately $0.4 million and $0.5 million were paid during the three and nine months ended September 30, 2012. Additionally, during the nine months ended September 30, 2012, the Company recorded $3.3 million in asset impairment charges and lease remediation costs of $0.7 million related to the Korea facility shutdown. There were no asset impairment charges or lease remediation costs during the three months ended September 30, 2012.

Retention agreements—In February 2012, the Company entered into employment agreements with approximately 40 employees. The agreements provide for severance payments ranging from 6 months to 24 months of salary in connection with a change in control and subsequent termination of employment. Certain of the agreements also provide for the above benefits if the employees’ employment is terminated without cause prior to a change in control. Certain of the agreements also provide for acceleration of vesting of stock options and restricted stock units in the event of a change in control.

No payments have been made under these agreements. Most of the participants, however, received payments for achieving certain financial targets under the Key Employee Incentive Plan (“KEIP”) and Key Employee Retirement Plan (“KERP”) programs which were established in November 2012 by the Bankruptcy Court.

7. Product Warranties

The Company provides for the estimated costs to fulfill customer warranty obligations upon the recognition of the related revenue. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by product failure rates, costs per failure, and supplier warranties on parts delivered to the Company. In developing the warranty estimates for each product, the Company utilizes its failure rate performance for battery systems based on actual warranty experience and an assessment of customer-specific factors that could impact warranty costs.

On March 26, 2012, the Company launched a field campaign to replace battery modules and packs that may have contained defective prismatic cells produced at its Livonia, Michigan manufacturing facility. The cost of this field campaign was estimated at $51.6 million. In addition, the Company recorded an inventory charge of approximately $15.2 million related to inventory produced at its Michigan facilities that may be defective. As a result of this field campaign and the charge for existing prismatic cell inventory, the Company began to rebuild its inventory and manage its backlog for existing customer orders while simultaneously replacing the defective customer modules and packs, which increased net losses and negative operating cash flows.

Based on the history of warranty claims, the Company has been able to identify the types of failures that have occurred, when in the product’s life cycle they have occurred, and the frequency of its occurrence. Should actual product failure rates, costs per failure, or supplier warranties on parts differ from the Company’s estimates, revisions to the estimated warranty liability would be required. During the nine months ended September 30, 2012, the Company recorded an additional charge of $51.6 million, of which $6.6 million represented the write-off of deferred costs associated with deferred revenue, related to the Company’s launch of a field campaign to replace battery modules and packs that may have contained defective prismatic cells produced at its Livonia, Michigan manufacturing facility. There were no additional charges related to the field campaign resulting from the defective prismatic cells produced at its Livonia, Michigan facility for the three months ended September 30, 2012.

Product warranty activity, which is recorded in accrued expenses and other long-term liabilities on the condensed consolidated balance sheets, was as follows (in thousands):

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8. Financing Arrangements

Long-Term Debt—Long-term debt consists of the following (in thousands):