Ocean Power Technologies, Inc. Annual Report 2006

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FY2006 Annual Report · Ocean Power Technologies, Inc.

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OCEAN POWER TECHNOLOGIES, INC.

Annual Report

For Year Ended 30 April 2006

“Making Waves In Power”

-turning wave power into
commercial reality-

CONTENTS

Letter from Chairman & CEO

Independent Auditors’ Report

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Stockholders’

Equity and Comprehensive Loss

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Company Information

Page 3

Page 5

Page 6

Page 7

Page 8

Page 9

Page 10

Page 22

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC.

Dear Shareholder:

In accord with the rules of the Alternative Investment Market of the London Stock
exchange, we are pleased to issue the consolidated financial statements of Ocean Power
Technologies, Inc. as of April 30, 2006 and for the two years then ended, as audited by KPMG
LLP, the Company’s independent auditors.

The highlights of our recent results are as follows:

•

In fiscal 2006 revenues were $1.7 million as compared to $5.4 million in fiscal 2005. The
decrease in revenues was primarily attributable to delays in contract approvals for the
Company’s wave power project for the US Navy in Hawaii, the completion of a development
and construction contract with Lockheed Martin in the first quarter of fiscal 2006 and the
determination by Lockheed not to proceed with a further project that would have involved
the Company’s autonomous PowerBuoy® System. This was partially offset by revenues
from a contract with the US Department of Homeland Security to design and study an
autonomous PowerBuoy system for offshore marine surveillance, under which Lockheed is
a subcontractor to OPT.

In response to this reduction in revenues, during fiscal 2006 the Company refocused its
engineering and development resources on product development for its current 40kW rated
PowerBuoy system and began efforts to increase the maximum rated output of the system
to 150kW. Product development costs were $4.2 million in fiscal 2006 compared to $0.9
million in fiscal 2005. In addition, selling, general and administrative costs increased,
primarily attributable to additional marketing personnel and to increased professional fees,
as the Company expanded its sales and marketing effort. Selling, general and
administrative costs were $3.2 million in fiscal 2006, compared to $2.6 million in fiscal 2005.

• The Company incurred a net loss of $7.1 million in fiscal 2006 compared to a net loss of

$0.4 million in the prior fiscal year primarily due to the decrease in revenues, the increase in
product development costs and the increase in selling, general and administrative costs.

• At July 31, 2006, our contract backlog (order book) was $5.5 million compared to $2.4

million at April 30, 2006. This backlog consists of the aggregate anticipated revenue
remaining to be earned from the uncompleted portions of our existing customer contracts.

• At July 31, 2006, our cash, cash equivalents and certificates of deposit were $31.1 million

compared to $32.4 million at April 30, 2006.

• OPT has successfully completed for the New Jersey Board of Public Utilities a 12-month

testing of a PowerBuoy five miles off the coast of New Jersey. These tests have allowed us
to monitor the system and evaluate its performance in actual wave conditions. It has
provided us with valuable operational data as well as important marketing opportunities.
These tests are an important milestone in the commercialization of OPT’s PowerBuoy.

Annual Report and Accounts 2006

• As an important element of its business strategy, OPT continues to pursue the construction
of demonstration wave power stations to encourage market adoption of its wave power
technology:

⎯ In February 2006, OPT was approved by the South West of England Regional

Development Agency to install a 5MW demonstration wave power station off the
coast of Cornwall, England.

Developments Since the End of Fiscal 2006

•

In July 2006, OPT entered into its first commercial construction contract with affiliates of
Iberdrola S.A. and Total S.A. and with two Spanish governmental agencies for the first
phase of the construction of a 1.39 MW wave power station off the coast of Santona, Spain.
OPT and affiliates of Iberdrola and Total are also assessing the viability of a 2 to 5 MW
wave power station off the coast of France.

In July 2006, OPT filed an application with the US Federal Energy Regulatory Commission
for a permit to evaluate the feasibility of a location off the coast of Oregon for a 50 MW wave
power station.

In September 2006, OPT entered into a marketing cooperation agreement with Lockheed
Martin to identify marketing opportunities for use of OPT’s autonomous PowerBuoy system
to power Lockheed Martin equipment in remote locations.

OPT continues to develop and commercialize its proprietary technology for the
generation of electrical power by harnessing the renewable energy of ocean waves. OPT’s
PowerBuoy system is based on modular, ocean-going buoys, which have been ocean tested for
nearly a decade and which are “intelligent” systems capable of responding to differing wave
conditions. We are encouraged by our progress in expanding our market opportunities and in
developing our core PowerBuoy technology, and believe that the Company’s systems have the
potential to provide cost competitive, clean electrical power on a large scale.

The alternative energy marketplace is expanding rapidly. Worldwide interest can be seen in the
policies put forward by national and local governments, and in the focus of many utilities and
energy-producing companies. OPT is well-positioned, from the standpoint of its technology and
its marketing efforts, to take advantage of the accelerating movement to diversify the world’s
sources of energy.

Seymour S. Preston III
Chairman

Dr. George W. Taylor
Chief Executive Officer

Annual Report and Accounts 2006

INDEPENDENT AUDITORS’ REPORT

Independent Auditors’ Report

The Board of Directors
Ocean Power Technologies, Inc.:

We have audited the accompanying consolidated balance sheets of Ocean Power
Technologies, Inc. and subsidiaries as of April 30, 2005 and 2006, and the related
consolidated statements of operations, stockholders’ equity and comprehensive loss, and
cash flows for the years then ended. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the
United States of America. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Ocean Power Technologies, Inc. and subsidiaries
as of April 30, 2005 and 2006, and the results of their operations and their cash flows for the
years then ended, in conformity with U.S. generally accepted accounting principles.

As further discussed in Note 1 (b), the Company has restated its consolidated statement of
cash flows for the year ended April 30, 2005.

/s/ KPMG LLP

October 30, 2006

Philadelphia, Pennsylvania
USA

Annual Report And Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

Assets

April 30,

2005

2006

Current assets:

Cash and cash equivalents
Certificates of deposit
Accounts receivable
Unbilled receivables
Other current assets

Total current assets

Property and equipment, net
Patents, net of accumulated amortization of $137,693 and

$157,451, respectivel
Other noncurrent assets

Total assets

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable
Accrued expenses
Unearned revenues
Other current liabilities

Total current liabilities

Long-term debt

Deferred credits

13,584,814
25,202,362
668,424
822,037
464,582

31,957,209
482,156
—
211,000
331,139

40,742,219

32,981,504

427,613

544,285

334,809
91,746

372,448
97,901

41,596,387

33,996,138

876,968
1,891,483
16,788
53,773

2,839,012

245,844

675,000

242,624
1,726,870
14,405
111,576

2,095,475

233,959

600,000

Total liabilities

3,759,856

2,929,434

Commitments and contingencies (note 13)

Stockholders’ equity:

Preferred stock, $0.001 par value; authorized 5,000,000

shares; none issued or outstanding

Common stock, $0.001 par value; authorized 105,000,000

shares; issued and outstanding 51,512,953 and 51,711,941
shares as of April 30, 2005 and 2006, respectively

Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive loss

Total stockholders’ equity

—

51,513
59,377,593
(21,553,242)
(39,333)

51,712
59,679,236
(28,632,153)
(32,091)

37,836,531

31,066,704

Total liabilities and stockholders’ equity

41,596,387

33,996,138

See accompanying notes to consolidated financial statements.

Annual Report And Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

Revenues
Cost of revenues

Gross profit (loss)

Product development costs
Selling, general, and administrative costs

Operating loss

In
Ot
Fo

terest income
her income
reign exchange gain (loss)

Loss before income taxes

come tax benefit

Net loss

ee accompanying notes to consolidated financial statements.

Years ended April 30,
2006
2005

5,365,235
5,170,521

194,714

904,618
2,553,911

1,747,715
2,059,318

(311,603)

4,224,997
3,190,687

(3,263,815)

(7,727,287)

1,297,156
1,545
1,507,145

1,408,361
74,294
(978,242)

(457,969)

(7,222,874)

29,335

143,963

(428,634)

(7,078,911)

Annual Report And Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss

Balance, April 30, 2004

Net loss
Foreign currency translation adjustment

Total comprehensive loss

Compensation related to stock option grants issued to employees
Compensation related to stock option grants issued for services
Adjustment for shareholder reduction in shares held
Proceeds from exercise of stock options

Balance, April 30, 2005

Net loss
Foreign currency translation adjustment

Total comprehensive loss

Compensation related to stock option grants issued to employees
Compensation related to stock option grants issued for services
Shares issued for amounts received in prior years
Proceeds from exercise of stock options

Common shares

Amount

Additional
paid-in
capital

Accumulated
deficit

Accumulated
other
comprehensive
(loss) income

Stockholders’
equity

51,165,758 $

51,166

58,959,616

(21,124,608)

(32,928)

37,853,246

—
—

—
—
(13,971)
361,166

—
—

—
—
(14)
361

—
—

(428,634)
—

—
(6,405)

131,500
53,174
14
233,289

—
—
—
—

(428,634)
(6,405)

(435,039)

131,500
53,174
—
233,650

51,512,953

51,513

59,377,593

(21,553,242)

(39,333)

37,836,531

—
—

—
—
27,322
171,666

—
—

—
—
27
172

—
—

(7,078,911)
—

—
7,242

44,000
85,139
49,973
122,531

—
—
—
—

(7,078,911)
7,242

(7,071,669)

44,000
85,139
50,000
122,703

Balance, April 30, 2006

51,711,941 $

51,712

59,679,236

(28,632,153)

(32,091)

31,066,704

See accompanying notes to consolidated financial statements.

Annual Report And Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Cash flows from operating activities:

Net loss
Adjustments to reconcile net loss to net cash used in

operating activities:

Foreign exchange (gain) loss
Depreciation and amortization
Compensation expense related to stock option grants
Realization of deferred credits
Changes in operating assets and liabilities:

Accounts receivable
Unbilled receivables
Other current assets
Accounts payable
Accrued expenses
Unearned revenues
Other current liabilities

Years ended April 30,
2005
2006
(Restated)

(428,634)

(7,078,911)

(1,507,145)
140,984
184,674
—

(621,499)
(268,216)
(239,274)
404,491
708,022
(246,890)
—

978,242
233,132
129,139
(75,000)

668,424
611,037
161,505
(632,778)
(121,840)
(2,383)
57,803

Net cash used in operating activities

(1,873,487)

(5,071,630)

Cash flows from investing activities:
Purchases of certificates of deposit
Maturities of certificates of deposit
Purchases of equipment
Payments of patent costs
Investments in joint ventures and other noncurrent assets

(58,050,287)
33,573,254
(435,488)
(125,414)
(78,399)

(62,677,400)
87,397,606
(330,047)
(57,396)
(30,747)

Net cash (used in) provided by investing activities

(25,116,334)

24,302,016

Cash flows from financing activities:

Proceeds from exercise of stock options

Cash provided by financing activities

Effect of exchange rate changes on cash and

cash equivalents

Net (decrease) increase in cash and

cash equivalents

Cash and cash equivalents, beginning of year

Cash and cash equivalents, end of year

Supplemental disclosure of noncash transactions:

Issuance of shares in connection with amounts received in

prior years

See accompanying notes to consolidated financial statements.

233,650

122,703

1,500,740

(980,694)

(25,255,431)

18,372,395

38,840,245

13,584,814

31,957,209

—

50,000

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(1) Background

(a) Organization

Ocean Power Technologies, Inc. (the Company) was incorporated on April 19, 1984
in the State of New Jersey and commenced active operations in 1994. The
Company develops and is commercializing proprietary systems that generate
electricity by harnessing the renewable energy of ocean waves. The Company
markets and sells its products in the United States and internationally.

(b) Restatement

The Company has restated its consolidated statement of cash flows for the year
ended April 30, 2005 to correct the presentation in the statement of cash flows of the
effect of exchange rate changes on cash balances held in foreign currencies.
Pursuant to Statement of Financial Accounting Standards (SFAS) No. 95, Statement
of Cash Flows, the statement of cash flows should report the effect of exchange rate
changes on cash balances held in foreign currencies as a separate part of the
reconciliation of the change in cash and cash equivalents during the period.
Previously, the effect was included in the net cash used in operating activities. This
matter had no impact on the consolidated balance sheet as of April 30, 2005 or the
consolidated statements of operations or changes in stockholders’ equity for the year
then ended. The impact of this matter on the previously issued consolidated
statement of cash flows for the year ended April 30, 2005 is as follows –

Net cash used in operting activities
Effect of exchange rate changes on cash

and cash equivalents

As reported
(366,342)

(6,405)

Adjustment
(1,507,145)

1,507,145

As adjusted

(1,873,487)

1,500,740

(2) Summary of Significant Accounting Policies

(a) Consolidation

During the year ended April 30, 2001, the Company established a wholly owned
subsidiary based in Australia. In July 2001, the Company sold 11.76% of the
subsidiary for approximately $1,020,000 in cash, less costs of approximately
$56,000. During the year ended April 30, 2005, the Company established a wholly
owned subsidiary based in the United Kingdom. The accompanying consolidated
financial statements include the accounts of the Company and its subsidiaries. All
significant intercompany transactions have been eliminated.

In addition, the Company evaluates its relationships with other entities to identify
whether they are variable interest entities as defined by Financial Accounting
Standards Board (FASB) Interpretation No. 46(R), Consolidation of Variable Interest
Entities (FIN 46R), and to assess whether it is the primary beneficiary of such
entities. If the determination is made that the Company is the primary beneficiary,
then that entity is included in the consolidated financial statements in accordance
with FIN 46R.

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(b) Use of Estimates

The preparation of the consolidated financial statements requires management of the
Company to make a number of estimates and assumptions relating to the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the period. Significant items subject to
such estimates and assumptions include the recoverability of the carrying amount of
property and equipment and patents; valuation allowances for receivables and
deferred income tax assets; and percentage of completion of customer contracts for
purposes of revenue recognition. Actual results could differ from those estimates.

The Company recognizes revenue on government and commercial contracts under
the percentage-of-completion method. The percentage of completion is determined
by relating the costs incurred to date to the estimated total costs. The cumulative
effects resulting from revisions of estimated total contract costs and revenues are
recorded in the period in which the facts requiring revision become known. Upon
anticipating a loss on a contract, the Company recognizes the full amount of the
anticipated loss in the current period. During the year ended April 30, 2005, the
Company recorded a provision of $21,000 related to an anticipated loss on a
contract. Reserves related to loss contracts in the amounts of approximately
$806,000 and $785,000 are included in accrued expenses in the accompanying
consolidated balance sheets as of April 30, 2005 and 2006, respectively.

Unbilled receivables represent expenditures on contracts, plus applicable profit, not
yet billed. Unbilled receivables are normally billed and collected within one year.
Billings made on contracts are recorded as a reduction of unbilled receivables, and
to the extent that such billings exceed costs incurred plus applicable profit, they are
recorded as unearned revenues.

(d) Cash Equivalents

Cash equivalents consist of investments in short-term financial instruments with
maturities of three months or less from the date of purchase.

(e) Property and Equipment

Property and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization is calculated using the straight-line
method over the estimated useful lives (three to seven years) of the assets.
Leasehold improvements are amortized using the straight-line method over the
shorter of the estimated useful life of the asset or the remaining lease term.
Expenses for maintenance and repairs are charged to operations as incurred.
Depreciation expense was approximately $112,000 and $213,000 for the years
ended April 30, 2005 and 2006, respectively.

(f) Foreign Exchange Gains and Losses

The Company has invested in certain certificates of deposit and has maintained cash
accounts that are denominated in British pound sterling, Euros, and Australian

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

dollars. Such certificates of deposit and cash accounts had a balance of
approximately $21,788,000 and $16,724,000 as of April 30, 2005 and 2006,
respectively. Such positions may result in realized and unrealized foreign exchange
gains or losses from exchange rate fluctuations, which are included in foreign
exchange gain (loss) on the accompanying consolidated statements of operations.

(g) Patents

External costs related to the filing of patents, including legal and filing fees, are
capitalized. Amortization is calculated using the straight-line method over the life of
the patents (17 years). Expenses for the development of technology are charged to
operations as incurred. Amortization expense was approximately $29,000 and
$20,000 for the years ended April 30, 2005 and 2006, respectively. Amortization
expense for the next five fiscal years related to amounts capitalized for patents as of
April 30, 2006 is estimated to be approximately $20,000 per year.

(h) Other Assets

Other assets consist of deposits and an investment in a joint venture. The carrying
value of the investment in the joint venture was approximately $53,000 and $52,000
as of April 30, 2005 and 2006, respectively. The Company evaluated the nature of
the joint venture against the provisions of FIN 46R and determined that the joint
venture does not need to be consolidated in the Company’s consolidated financial
statements.

(i)

Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, long-lived assets, such as property and equipment, and
purchased intangible assets subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of the asset to estimated
undiscounted future cash flows expected to be generated by the asset. If the carrying
amount of the asset exceeds its estimated future cash flows, then an impairment
charge is recognized by the amount by which the carrying amount of the asset
exceeds the fair value of the asset. Assets to be disposed of would be separately
presented in the consolidated balance sheet and reported at the lower of the carrying
amount or fair value less costs to sell, and are no longer depreciated. The assets
and liabilities of a disposal group classified as held for sale would be presented
separately in the appropriate asset and liability sections of the consolidated balance
sheet. The Company reviewed its long-lived assets for impairment in accordance
with SFAS No. 144 and determined that no impairment charge was necessary for the
years ended April 30, 2005 or 2006.

(j) Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit
risk consist principally of cash balances, bank certificates of deposit, and trade
receivables. The Company invests its excess cash in highly liquid investments

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(principally short-term bank deposits) and does not believe that it is exposed to any
significant risks related to its cash accounts or certificates of deposit.

The table below shows the percentage of the Company’s revenue derived from
significant customers for the periods indicated:

Customer

US Navy

New Jersey Board of Public Utilities

Iberdrola and Total

Lockheed Martin

US Dept. of Interior for Dept. of Homeland Security

Year Ended April 30

2005

2006

57%

61%

32%

22%

----

The loss of, or a significant reduction in revenues from, any of these customers could
significantly impact the Company’s financial position or results of operations. The
Company does not require collateral from its customers.

(k) Stock-Based Compensation

The Company applies the intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations including FASB Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation, an Interpretation
of APB Opinion No. 25, to account for its fixed-plan stock options. Under this
method, compensation expense is recorded only if on the date of grant the market
price of the underlying stock exceeded the exercise price. SFAS No. 123, Accounting
for Stock Based Compensation, and SFAS No. 148, Accounting for Stock-Based
Compensation—Transition and Disclosure, an Amendment of SFAS No. 123,
established accounting and disclosure requirements using a fair-value-based method
of accounting for stock-based employee compensation plans. As permitted by
existing accounting standards, the Company has elected to continue to apply the
intrinsic-value-based method of accounting described above, and has adopted only
the disclosure requirements of SFAS No. 123, as amended. The following table
illustrates the effect on net loss if the fair-value-based method had been applied to all
outstanding and unvested awards in the years ended April 30, 2005 and 2006:

Net loss, as reported
Add stock-based employee compensation expense

included in reported net loss

Deduct total stock-based employee compensation

expense determined under fair-value-based method
for all awards

2005

2006

(428,634)

(7,078,911)

131,500

44,000

(1,367,000)

(680,000)

Pro forma net loss

(1,664,134)

(7,714,911)

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

In accordance with SFAS No. 123, as amended by SFAS No. 148, the fair value of
option grants is estimated on the date of grant using the Black-Scholes option-pricing
model for pro forma footnote purposes with the following weighted-average
assumptions used for grants: dividend yield of 0%; risk-free interest rate of 4% and
4.9% in the years ended April 30, 2005 and 2006, respectively; the expected option
life of 8.9 years and 9.3 years in the years ended April 30, 2005 and 2006,
respectively; and volatility of 80.8% and 72% in the years ended April 30, 2005 and
2006, respectively.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment, which addresses the accounting for transactions in which an entity
exchanges its equity instruments for goods or services, with a primary focus on
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123R is a revision to SFAS No. 123 and supersedes APB
Opinion No. 25 and its related implementation guidance. SFAS No. 123R will require
measurement of the cost of employee services received in exchange for stock
compensation based on the grant-date fair value of the employee stock options.
Incremental compensation costs arising from the subsequent modifications of
awards after the grant date will also be recognized. The Company will adopt SFAS
No. 123R on May 1, 2006 under the modified prospective method of application.
Under that method, the Company will recognize compensation costs for new grants
of share-based awards and awards modified, repurchased or cancelled after the
adoption date. Additionally, compensation cost for the portion of the awards for
which the requisite service had not been rendered that were outstanding as of May
1, 2006 will be recognized in the consolidated statement of operations over the
remaining service period after such date based on the award’s original estimate of
value.

(l) Accounting for Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.

(m) Accumulated Other Comprehensive Loss

The functional currency for the Company’s foreign operations is the applicable local
currency. The translation from the applicable foreign currencies to U.S. dollars is
performed for balance sheet accounts using the exchange rates in effect at the
balance sheet date and for revenue and expense accounts using an average
exchange rate during the period. The unrealized gains or losses resulting from such
loss within
translation are
stockholders’ equity.

in accumulated other comprehensive

included

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(n) Recent Accounting Pronouncements

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which requires entities that voluntarily make a change in accounting
principle to apply that change retrospectively to prior periods’ financial statements,
unless this would be impracticable. SFAS No. 154 supersedes APB Opinion No. 20,
Accounting Changes, which previously required that most voluntary changes in
accounting principles be recognized by including the cumulative effect of changing to
the new accounting principle in the current period’s net income or loss. SFAS
No. 154 also makes a distinction between “retrospective application” of an
accounting principle and the “restatement” of financial statements to reflect the
correction of an error. Another significant change in practice under SFAS No. 154 will
be that if an entity changes its method of depreciation, amortization, or depletion of
long-lived, nonfinancial assets, the change must be accounted for as a change in
accounting estimate. Under APB Opinion No. 20, such a change would have been
reported as a change in accounting principle. SFAS No. 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning after
December 15, 2005. Adoption is not expected to have a material effect on the
Company’s financial position or results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty
in income taxes recognized in an enterprise’s financial statements in accordance
with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition
and measurement method for tax positions taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosures and transitions. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Company is
currently analyzing the effects of FIN 48, but does not expect FIN 48 to have a
material effect on its financial position or results of operations.

In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements, or SAB 108.
SAB 108 provides guidance on how prior year misstatements should be taken into
consideration when quantifying misstatements in current year financial statements
for purposes of determining whether the current year’s financial statements are
materially misstated. SAB 108 becomes effective during the Company’s 2007 fiscal
year. The Company does not expect the adoption of SAB 108 to have a material
impact on its consolidated financial statements.

(o) Reclassifications

Certain amounts in the prior year’s financial statements have been reclassified to
conform to the current year presentation.

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(3) Certificates of Deposit

Certificates of deposit with maturities in excess of 90 days from purchase are summarized
as follows:

4.75% due May 26, 2005
2.08% due July 11, 2005
2.90% due July 18, 2005
4.73% due July 18, 2005
3.92% due August 11, 2006

April 30

2005

$ 11,194,039
469,789
8,038,548
5,499,986
—

2006

—
—
—
—
482,156

$ 25,202,362

482,156

(4) Property and Equipment

The components of property and equipment are as follows:

Computers and software
Equipment
Office furniture and equipment
Leasehold improvements

Less accumulated depreciation

April 30

2005

260,698
335,238
206,766
39,358

842,060

(414,447)

427,613

2006

402,037
452,448
233,178
59,358

1,147,021

(602,736)

544,285

(5) Accrued Expenses

Included in accrued expenses at April 30, 2005 and 2006 were contract reserves of
approximately $806,000, and $785,000, respectively, accrued bonuses of approximately
$308,000 and $353,000, respectively, and accrued vacation expense of approximately
$71,000 and $84,000, respectively.

(6) Related-Party Transactions

The Company is obligated to pay royalties to G.W. Taylor, a founding stockholder of the
Company; M.Y. Epstein; and the estate of J.R. Burns (stockholders of the Company)
related to U.S. patent 4404490 entitled, “Power Generation from Waves Near the Surface
of Bodies of Water.” Royalty payments are limited to $925,000 in the aggregate, based on
revenues related to certain piezoelectric-technology, if any, on the basis of 6% of future
licenses sold and 4% of future product sales and development contracts. Through April 30,
2006, approximately $200,000 of royalties had been earned. During the years ended

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

April 30, 2005 and 2006, no royalties were earned pursuant to these agreements, and no
future royalties are expected to be earned. As of April 30, 2005 and 2006, approximately
$26,000 was included in other current liabilities related to these agreements.

In August 1999, the Company entered into a consulting agreement with an individual for
marketing services at a rate of $600 per day of services provided. The individual became a
member of the board of directors in June 2006. The Company expensed approximately
$51,000 and $53,000 during the years ended April 30, 2005 and 2006, respectively, under
this consulting agreement.

Also see note 8 for an additional related-party transaction.

(7) Debt

In the year ended April 30, 2000, the Company received an award of $250,000 from the
State of New Jersey Commission on Science and Technology for the development of a
wave power system that was deployed off the coast of New Jersey. Under the terms of
this award, the Company must repay the amount funded, without interest, by January 15,
2012. The amounts to be repaid each year are determined as a percentage of revenues,
as defined in the loan agreement, which the Company receives that year from its customer
contracts that meet criteria specified in the loan agreement, with any remaining amount
due on January 15, 2012. Based upon the terms of the award, the Company has repaid
approximately $4,000 and is required to repay an additional approximately $12,000 as of
April 30, 2006. The total repayment amount of approximately $16,000 reduced the long-
term debt balance, and the current payment required was recorded in accrued expenses
in the accompanying consolidated balance sheet as of April 30, 2006.

(8) Deferred Credits

During the year ended April 30, 2003, the Company entered into an agreement under
which the Company received a payment of $75,000, which was included in deferred
credits until the earning process was completed. During the year ended April 30, 2006, the
earning process was completed and the nonrefundable payment of $75,000 has been
included in other income in the accompanying consolidated statement of operations for the
year ended April 30, 2006.

During the year ended April 30, 2001, in connection with the sale of common stock to an
investor, the Company received $600,000 from the investor in exchange for an option to
purchase up to 500,000 metric tons of carbon emissions credits generated by the
Company during the years 2008 through 2012, at a 30% discount from the then-prevailing
market rate. This amount has been recorded in deferred credits in the accompanying
consolidated balance sheets as of April 30, 2005 and 2006. If, by December 31, 2012, the
Company does not become entitled under applicable laws to the full amount of emission
credits covered by the option, the Company is obligated to return the option fee of
$600,000, less the aggregate discount on any emission credits sold to the investor prior to
such date. If the Company receives emission credits under applicable laws and fails to sell
to the investor the credits up to the full amount of emission credits covered by the option,
the investor is entitled to liquidated damages equal to 30% of the aggregate market value
of the shortfall in emission credits (subject to a limit on the market price of emission
credits).

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(9) Common Stock

During the year ended April 30, 2003, the Company sold 37,500 shares of common stock
to an investor at a price of $1.33 per share, which was subject to adjustment based on the
pricing of future financings, if any, during calendar year 2003. Based on the price at which
the Company’s common shares were sold at the time of its offering on the London Stock
Exchange, this adjustment, in the form of a reduction of 13,971 shares issued, was
resolved and recorded in the year ended April 30, 2005.

During the year ended April 30, 1998, under an agreement with a group of investors, the
Company received $50,000 as an advance payment related to a potential future
transaction, which was recorded in accrued expenses. During the year ended April 30,
2006, the Company repaid this amount by issuing 27,322 shares of common stock, in
accordance with the terms of the agreement.

(10) Preferred Stock

In September 2003, and in connection with the Company’s offering on the London Stock
Exchange, the Company’s stockholders authorized 5,000,000 shares of undesignated
preferred stock with a par value of $0.001 per share. At April 30, 2005 and 2006, no
shares of preferred stock had been issued.

(11) Stock Options

Prior to August 2001, the Company maintained qualified and nonqualified stock option
plans. The Company has reserved 5,101,550 shares of common stock for issuance under
these plans. There are no options available for future grant under these plans as of April
30, 2006.

In August 2001, the Company approved the 2001 Stock Plan, which provides for the grant
of incentive stock options and nonqualified stock options. A total of 10,000,000 shares are
authorized for issuance under the 2001 Stock Plan. As of April 30, 2006, the Company
had issued 6,948,807 shares and had 3,051,193 shares of common stock reserved for
issuance under the 2001 Stock Plan. Members of the board of directors, who are not full-
time employees, receive an annual option grant to acquire 25,000 shares. The options are
granted after the annual meeting of shareholders for the year then ended. Vesting of stock
options is determined by the board of directors.

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

Transactions under these option plans are as follows:

Outstanding April 30, 2004
(exercisable 8,809,941)

Forfeited
Exercised
Granted

Outstanding April 30, 2005
(exercisable 9,321,380)

Forfeited
Exercised
Granted

Outstanding April 30, 2006
(exercisable 9,883,626)

Shares under
option

Weighted
average
exercise price

Weighted
average fair
value

10,325,035 $

(464,242)
(361,166)
1,663,250

11,162,877

(740,604)
(171,666)
1,799,750

12,050,357

1.39

1.50
0.65
1.65 $

1.45

1.68
0.71
1.29

1.42

1.39

1.02

The following table summarizes information about stock options outstanding at April 30,
2006:

Range of
exercise prices

$0.27 to $0.77
$0.85 to $1.67
$1.70 to $2.24

Number
outstanding
at April 30,
2006

3,213,345
3,271,647
5,565,365

12,050,357

Weighted
average
remaining
life

Weighted
average
exercise
price

Number
exercisable
at April 30,
2006

Weighted
average
exercise
price

4.3 $
6.5
5.1

0.69
1.33
1.89

3,115,803 $
1,801,533
4,966,290

9,883,626

0.69
1.39
1.90

Certain stock options granted during the years ended April 30, 2005 and 2006 were
granted to employees with exercise prices less than the fair value of the underlying
common stock on the date of grant. Additionally, certain options were granted to
consultants. The Company has charged compensation expense of $180,674 and
$129,139 related to these option grants, which has been included in selling, general, and
administrative costs in the accompanying consolidated statements of operations for the
years ended April 30, 2005 and 2006, respectively.

Subsequent to April 30, 2006, the Company issued options to purchase 1,849,000 shares
of common stock at an exercise price of $1.38.

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

(12) Income Taxes

The tax effects of temporary differences that give rise to significant portions of the
Company’s deferred tax assets and deferred tax liabilities are presented below.

Deferred tax assets:

Federal net operating loss carryforwards
Foreign net operating loss carryforwards
Research and development tax credits
Stock compensation
Unrealized foreign exchange loss
Accrued expenses
Gross deferred tax assets

Deferred Tax Liabilities:

Property and equipment
Unrealized foreign exchange gain
Gross deferred tax liabilities
Deferred tax assets valuation allowance

Net deferred tax assets

April 30

2005

2006

4,588,000
915,000
295,000
1,426,000
103,000
322,000
7,649,000

(31,000)
---
(31,000
(7,618,000)
----

6,638,000
1,210,000
505,000
1,478,000
----
314,000
10,145,000

(31,000)
(60,000)
(91,000)
(10,054,000)
----

Income tax benefit was $29,335 and $143,963 for the years ended April 30, 2005 and
2006, respectively. The effective income tax rate differed from the percentages computed
by applying the U.S. Federal income tax rate of 34% to loss before income taxes as a
result of the following:

Computed "expected" tax benefit
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal benefit
Federal research and development tax credits
Sale of state loss carryforwards and tax credits
Non-deductible expense
Increase in valuation allowance

April 30

2005
(34)%

(6)%
(6)%
(6)%
9%
37%
(6)%

2006
(34)%

(6)%
(2)%
(2)%
1%
41%
(2)%

In assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will not be realized.
The ultimate realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. As of April 30, 2005 and 2006, based upon the level of historical taxable
losses, valuation allowances of $7,618,000 and $10,054,000, respectively, were recorded
in accordance with the provisions of SFAS No. 109.

Annual Report and Accounts 2006

OCEAN POWER TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

April 30, 2005 and 2006

As of April 30, 2006, the Company had net operating loss carryforwards for federal income
tax purposes of approximately $19,500,000, which begin to expire in 2009. The Company
also had federal research and development credit carryforwards of approximately
$505,000, which begin to expire in 2012. The Tax Reform Act of 1986 contains provisions
that limit the utilization of net operating loss and tax credit carryforwards if there has been
an ownership change, as defined. Such an ownership change, as described in Section
382 of the Internal Revenue Code, may limit the Company’s ability to utilize its net
operating loss and tax credit carryforwards on a yearly basis. As of April 30, 2006, foreign
net operating loss carryforwards were approximately $4,000,000. These losses can be
carried forward indefinitely, but the Company’s ability to utilize these carryforwards may be
limited in the event of an ownership change.

During the years ended April 30, 2005 and 2006, the Company sold a portion of its New
Jersey state net operating loss carryforwards and research and development credits to a
company for net proceeds of approximately $29,000 and $144,000, respectively, resulting
in the recognition of income tax benefits in the accompanying consolidated statements of
operations.

(13) Commitments and Contingencies

(a) Operating Lease Commitments

The Company leases office, laboratory, and manufacturing space in Pennington,
New Jersey, and office space in Warwick, United Kingdom, under operating leases
that expire on various dates through 2013. Rent expense under operating leases
was $154,731 and $295,089 for the years ended April 30, 2005 and 2006,
respectively. Future minimum lease payments under operating leases as of April 30,
2006 are:

Year ending April 30:

2007
2008
2009
2010
2011
Thereafter

233,094
228,722
206,859
206,859
206,859
413,719

1,496,112

(b) Litigation

The Company is involved from time to time in certain legal actions arising in the
ordinary course of business. Management believes that the outcome of such actions
will not have a material adverse effect on the Company’s financial position or results
of operations.

Annual Report and Accounts 2006