Financial Operations Overview
The following describes certain line items in our consolidated statement of operations and some of the factors that affect our operating results. Revenues
We have historically generated revenues primarily from the development and construction of our PowerBuoy systems for demonstration purposes and, to a lesser extent, from customer-sponsored research and development. For the three months ended July 31, 2008 and 2007, we derived approximately 91% and 69%, respectively, of our revenues from government and commercial development and construction contracts and 9% and 31%, respectively, of our revenues from customer-sponsored research and development. Generally, we recognize revenue under the percentage-of-completion method based on the ratio of costs incurred to total estimated costs at completion. In certain circumstances, revenue under contracts that have specified milestones or other performance criteria may be recognized only when our customer acknowledges that such criteria have been satisfied. In addition, recognition of revenue (and the related costs) may be deferred for fixed-price contracts until contract completion if we are unable to reasonably estimate the total costs of the project prior to completion. Because we have a small number of contracts, revisions to the percentage of completion determination or delays in meeting performance criteria or in completing projects may have a significant effect on our revenue for the periods involved.
Under our agreement for the current phase of construction of a wave power station off the coast of Santoρa, Spain, our revenues are limited to reimbursement for our construction costs without any mark-up and we are required to bear a portion of any cost overruns and to absorb certain other costs as set forth in the agreement. During the fourth quarter of fiscal 2008, we made the decision to absorb additional costs related to the current phase of the project beyond our obligation for the initial cost overruns and certain other costs as set forth in the agreement. This decision was based primarily on the progress of the project to date, the benefits to be derived from a successful initial project and the prospect of incremental contract value to be received in connection with additional work under this contract.
Our revenues for the three months ended July 31, 2008 increased compared to the revenues for the three months ended July 31, 2007. The revenue increase reflected a higher level of activity in connection with our Spain construction contract, our entry into a new contract with the US Navy in June 2007 to provide our PowerBuoy technology to a unique program for data gathering in the ocean and a higher level of activity on our contract for the construction, installation and in-ocean demonstration of our latest 150kW PowerBuoy that will be installed at the European Marine Energy Centre (EMEC) at Orkney, Scotland.
Iberdrola and Total accounted for approximately 50% of our revenues for the three months ended July 31, 2008, and approximately 24% of our revenues for the three months ended July 31, 2007. The US Navy accounted for approximately 41% of our revenues for the three months ended July 31, 2008, and approximately 45% of our revenues for the three months ended July 31, 2007. Since fiscal 2002, the US Navy has accounted for a significant portion of our revenues. We expect that over time, revenues derived from utilities and other non-government commercial customers will increase more rapidly than revenues from government customers and will, within a few years, represent the majority of our revenues.
We currently focus our sales and marketing efforts on coastal North America, the west coast of Europe, the coasts of Australia and the east coast of Japan. During the three months ended July 31, 2008 and 2007, we derived 58% and 56%, respectively, of our revenues from outside the United States. Cost of revenues
Our cost of revenues consists primarily of material, labor and manufacturing overhead expenses, such as engineering expense, equipment depreciation and maintenance and facility related expenses, and includes the cost of PowerBuoy parts and services supplied by third-party suppliers. Cost of revenues also includes PowerBuoy system delivery and deployment expenses and an anticipated loss at completion on our contract for a wave power station off the coast of Spain.
We operated at a gross loss of $0.2 million in both the three months ended July 31, 2008 and 2007. Our ability to operate at a gross profit will depend on the nature of future contracts and on our success at increasing sales of our PowerBuoy systems and our ability to manage costs incurred on fixed price commercial contracts.
Product development costs
Our product development costs consist of salaries and other personnel-related costs and the costs of products, materials and outside services used in our product development and unfunded research activities. Our product development costs primarily relate to our efforts to increase the output of our utility PowerBuoy system, including the 150kW PowerBuoy system and, to a lesser extent, to our research and development of new products, product applications and complementary technologies. We expense all of our product development costs as incurred, except for external patent costs, which we capitalize and amortize over a 17-year period commencing with the issuance date of each patent.

Our product development costs decreased slightly in the three months ended July 31, 2008 compared to the three months ended July 31, 2007, primarily as a result of the need to allocate more resources to revenue producing activities.
We introduced our current 40kW PowerBuoy system in fiscal 2006. One system was deployed off the coast of New Jersey from October 2005 to October 2006, when it was removed from the ocean for routine maintenance and diagnostic testing. This system was redeployed off the coast of New Jersey in September 2007. Another 40kW system was deployed and tested in Hawaii for the US Navy project during the month of June 2007. Work is currently in progress on the design and construction of two 150kW PowerBuoy systems in connection with projects in the Orkney Islands, Scotland and Oregon.
Selling, general and administrative costs Our selling, general and administrative costs consist primarily of professional fees, salaries and other personnel-related costs for employees and consultants engaged in sales and marketing and support of our PowerBuoy systems and costs for executive, accounting and administrative personnel, professional fees and other general corporate expenses.
Our selling, general and administrative costs increased in the three months ended July 31, 2008 compared to the three months ended July 31, 2007. This increase is due to increased costs related to company growth, the expansion of our sales and marketing capabilities, including increased headcount, and our becoming a public company in the United States in April 2007. We expect our selling, general and administrative costs will continue to increase as we further grow the company and expand our sales operations and our marketing capabilities.
Interest income
Interest income consists of interest received on cash and cash equivalents, investments in commercial bank-issued certificates of deposit and US Treasury bills and notes. Prior to April 30, 2007, most of our cash, cash equivalents and bank-issued certificates of deposit resulted from the remaining proceeds of our October 2003 common stock offering on the AIM market of the London Stock Exchange. On April 30, 2007, we completed our initial public offering in the United States, which resulted in net proceeds to us of $89.9 million. Total cash, cash equivalents and short-term investments were $96.5 million as of July 31, 2008, compared to $112.0 million as of July 31, 2007. We anticipate that our interest income reported in fiscal 2009 will continue to be lower than the comparable periods of the prior fiscal year as a result of the decrease in invested cash and lower interest rates.
Foreign exchange gain (loss)
We transact business in various countries and have exposure to fluctuations in foreign currency exchange rates. Foreign exchange gains and losses arise in the translation of foreign-denominated assets and liabilities, which may result in realized and unrealized gains or losses from exchange rate fluctuations. Since we conduct our business in US dollars and our functional currency is the US dollar, our main foreign exchange exposure, if any, results from changes in the exchange rate between the US dollar and the British pound sterling, the Euro and the Australian dollar.
We invest in certificates of deposit and maintain cash accounts that are denominated in British pounds, Euros and Australian dollars. These foreign-denominated certificates of deposit and cash accounts had a balance of $7.9 million as of July 31, 2008 and $15.0 million as of July 31, 2007, compared to our total certificates of deposits and cash account balances of $96.5 million as of July 31, 2008 and $112.0 million as of July 31, 2007. These foreign currency balances are translated at each month end to our functional currency, the US dollar, and any resulting gain or loss is recognized in our results of operations.
In addition, a portion of our operations is conducted through our subsidiaries in countries other than the United States, specifically Ocean Power Technologies Ltd. in the United Kingdom, the functional currency of which is the British pound sterling, and Ocean Power Technologies (Australasia) Pty Ltd. in Australia, the functional currency of which is the Australian dollar. Both of these subsidiaries have foreign exchange exposure that results from changes in the exchange rate between their functional currency and other foreign currencies in which they conduct business. All of our international revenues for the three months ended July 31, 2008 and 2007 were recorded in Euros, British pound sterling or Australian dollars.
We currently do not hedge our exchange rate exposure. However, we assess the anticipated foreign currency working capital requirements and capital asset acquisitions of our foreign operations and attempt to maintain a portion of our cash, cash equivalents and certificates of deposit denominated in foreign currencies sufficient to satisfy these anticipated requirements. We also assess the need and cost to utilize financial instruments to hedge currency exposures on an ongoing basis and may hedge against exchange rate exposure in the future.

Results of Operations
Three Months Ended July 31, 2008 Compared to Three Months Ended July 31, 2007
   The following table contains selected statement of operations information,
which serves as the basis of the discussion of our results of operations for the
three months ended July 31, 2007 and 2008:

                                     Three Months Ended                      Three Months Ended                         Change 2008
                                        July 31, 2007                           July 31, 2008                          to 2007 Period
                                                    As a % of                               As a % of
                                  Amount            Revenues              Amount            Revenues             $ Change           % Change

Revenues                       $    555,704                100 %       $  1,786,628                100 %       $  1,230,924               222 %
Cost of revenues                    804,992                145            1,948,146                109            1,143,154               142

Gross loss                         (249,288 )              (45 )           (161,518 )               (9 )             87,770               (35 )

Operating expenses:
Product development costs         1,815,734                327            1,702,949                 95             (112,785 )              (6 )
Selling, general and and
administrative costs              1,996,602                359            2,551,816                143              555,214                28

Total operating expenses          3,812,336                686            4,254,765                238              442,429                12

Operating loss                   (4,061,624 )             (731 )         (4,416,283 )             (247 )           (354,659 )               9
Interest income                   1,444,286                260              547,592                 30             (896,694 )             (62 )
Foreign exchange gain
(loss)                              179,494                 32              (24,473 )               (1 )           (203,967 )            (114 )


Net loss                       $ (2,437,844 )             (439 )%      $ (3,893,164 )             (218 )%      $ (1,455,320 )              60 %

Revenues
Revenues increased by $1.2 million in the three months ended July 31, 2008, or 222%, to $1.8 million as compared to $0.6 million in the three months ended July 31, 2007. The increase in revenues was primarily attributable to the following factors:
• Revenues relating to our utility PowerBuoy system increased by $0.8 million due to an increase in on-going work on our Hawaii project for the US Navy, work on the first phase of construction of a 1.39MW wave power station off the coast of Spain and work on the design, manufacture and installation of a wave power station consisting of a single 150kW PowerBuoy device in Orkney, Scotland.

• Revenues relating to our autonomous PowerBuoy system increased $0.4 million as a result of work on our $1.7 million contract with the US Navy to provide our PowerBuoy technology to a program for data gathering in the ocean.

Cost of revenues
Cost of revenues increased by $1.1 million, or 142%, to $1.9 million in the three months ended July 31, 2008, as compared to $0.8 million in the three months ended July 31, 2007. This increase in cost of revenues reflected the higher level of activity on revenue-bearing contracts and the recognition of an additional $0.2 million of anticipated loss at completion on our contract for a wave power station off the coast of Spain. The additional anticipated loss was recognized based on a change in estimated costs associated with this contract and our decision in the fourth quarter of fiscal 2008 to absorb additional costs beyond our contractual obligation for initial cost overruns and certain other costs as set forth in the contract.
Product development costs
Product development costs decreased slightly to $1.7 million in the three months ended July 31, 2008, as compared to $1.8 million in the three months ended July 31, 2007, primarily as a result of the need to allocate more resources to revenue producing activities. Product development costs are primarily attributable to our work to increase the power output of our utility PowerBuoy system, including the 150kW PowerBuoy system. We anticipate that our product development costs related to the planned increase in the output of our utility PowerBuoy system will increase significantly over the next several years and that the amount of these expenditures will not necessarily be affected by the level of revenue generated over that time period.

Selling, general and administrative costs Selling, general and administrative costs increased $0.6 million, or 28%, to $2.6 million for the three months ended July 31, 2008, as compared to $2.0 million for the three months ended July 31, 2007. The increase was attributable to an increase of $0.2 million in professional fees, franchise taxes and costs incurred as a result of our becoming a public company in the United States, and $0.4 million in additional payroll and incentive-based costs related to company growth.
Interest income
Interest income decreased by $0.9 million, or 62%, to $0.5 million for the three months ended July 31, 2008, compared to $1.4 million for the three months ended July 31, 2007, due to a decrease in invested cash and lower interest rates.
Foreign exchange gain (loss)
Foreign exchange loss was $24,000 for the three months ended July 31, 2008, compared to a foreign exchange gain of $0.2 million for the three months ended July 31, 2007. The difference was primarily attributable to the relative change in value of the British pound sterling compared to the US dollar during the two periods.
Liquidity and Capital Resources
Since our inception, the cash flows from customer revenues have not been sufficient to fund our operations and provide the capital resources for the planned growth of our business. For the three years ended April 30, 2008, our revenues were $9.1 million, our net losses were $31.4 million and our net cash used in operating activities was $26.2 million. Over that same period, we raised $90.4 million in financing activities, including $89.9 million from the closing of our United States initial public offering on April 30, 2007.
At July 31, 2008, our total cash, cash equivalents and short-term investments were $96.5 million. Our cash and cash equivalents are highly liquid investments with maturities of three months or less at the date of purchase and consist primarily of term deposits with large commercial banks, Treasury bills and an investment in a money market fund. Our short-term investments consist primarily of certificates of deposits and Treasury bills with fixed maturity dates of more than 90 days but less than one year from the date of purchase, and other investments with current maturities of less than one year.
During the three months ended July 31, 2008, a $12.2 million US Treasury note was reclassified from long-term investments to short-term investments, since as of July 31, 2008 the period remaining until maturity was less than one year.
The primary drivers of our cash flows have been our ability to generate revenues and decrease losses related to our contracts, as well as our ability to obtain and invest the capital resources needed to fund our development.
Net cash used in operating activities was $4.2 million for the three months ended July 31, 2008 and $3.3 million for the three months ended July 31, 2007. The change was primarily the result of an increase in net loss of $1.5 million. The increase in net loss was partially offset by a decrease in cash used by operating assets and liabilities of $0.5 million.
Net cash used in investing activities was $10.9 million for the three months ended July 31, 2008 and $1.4 million for the three months ended July 31, 2007. The change was primarily the result of a net increase in purchases of securities with maturities longer than 90 days during the three months ended July 31, 2008. Also, there was a $0.2 million increase in purchases of equipment during the three months ended July 31, 2008 as compared to the three months ended July 31, 2007.
Net cash used in financing activities was $43,000 for the three months ended July 31, 2008, compared to net cash used in financing activities of $0.8 million for the three months ended July 31, 2007. The cash used during the three months ended July 31, 2007 was primarily to pay accrued expenses related to our initial public offering in the United States.
We expect to devote substantial resources to continue our development efforts for our PowerBuoy systems and to expand our sales, marketing and manufacturing programs associated with the commercialization of the PowerBuoy system. Our future capital requirements will depend on a number of factors, including:
• the cost of development efforts for our PowerBuoy systems;

• the success of our commercial relationships with Iberdrola, Total and the US Navy;

• the cost of manufacturing activities;

• the cost of commercialization activities, including demonstration projects, product marketing and sales;

• our ability to establish and maintain additional commercial relationships;

• the implementation of our expansion plans, including the hiring of new employees;

• potential acquisitions of other products or technologies; and

• the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs.

We believe that our current cash, cash equivalents and investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures at least through fiscal 2010. If existing resources are insufficient to satisfy our liquidity requirements or if we acquire or license rights to additional product technologies, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or convertible securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us. If we are unable to obtain required financing, we may be required to reduce the scope of our planned product development and marketing efforts, which could harm our financial condition and operating results.
Off-Balance Sheet Arrangements
Since inception, we have not engaged in any off-balance sheet financing activities.