Summary of XSUNX INC - Yahoo! Finance

Item 7. Management's Discussion and Analysis or Plan of Operations Cautionary and Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions as described under the "Cautionary Note Regarding Forward-Looking Statements" that appears earlier in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Item 1A: Risk Factors" and elsewhere in this Annual Report on Form 10-K.

The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q and Annual Report on Form 10-K filed by the Company in 2006 and Form 10-KSB in 2005 and any Current Reports on Form 8-K filed by the Company.

Business Overview

XsunX is a thin-film photovoltaic ("TFPV") company that intends to grow its business by manufacturing TFPV amorphous solar modules and selling them into what we believe is a high growth solar market opportunity. Our decision to pursue this strategy is based on our three years of research in the design and use of technologies for the manufacture of TFPV solar cells utilizing amorphous silicon. During this time we have developed the technical capabilities, qualified core staff, and market understanding that we believe will be necessary to establish product manufacturing infrastructure and take our product to market.

We have designed a 125 peak watt TFPV solar module utilizing glass substrates and a proprietary semiconductor manufacturing system which employs the design of a high-throughput, automated, continuous process to produce solar modules in commercial quantities. We believe that these key processes can deliver per watt costs significantly less than those of traditional crystalline silicon solar module manufacturers and allow us to market TFPV modules that will be highly competitive with other thin film offerings.

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Our plan for growth is to build and operate a TFPV solar module manufacturing facility in the state of Oregon. Employing a phased roll-out of manufacturing capacities our baseline production system is scheduled for installation in mid calendar year 2008, the installation of our first 25MW line is scheduled near the end of calendar 2008, and the installation of our 4th 25MW line is scheduled for early 2010. In anticipation of commercial production, we have begun to market our TFPV solar module under the brand name of the XsunX ASI-120. Furthermore, we have successfully developed and implemented a pre-sales reservation program for system installers and large users of solar.

Markets

We believe the solar market represents a high growth opportunity nationally and internationally, both currently and into the foreseeable future. The global demand for electrical energy has experienced significant growth due to growth in populations and the economic vitality of emerging economies. This has created a growing need to diversify and establish new sources of electrical production, and we believe has created tremendous opportunities for growth in the solar market. Within the markets for solar products we anticipate that growth in demand for solar products based on TFPV technologies will out perform the balance of the solar market.

Macro growth drivers for solar energy production products include political support and government subsidies, high energy prices, technical progress having led to cost reductions in manufacturing techniques, and advantages over other renewable energy sources including:

• Proven, commercialized and widely used solar technologies adapting to a host of applications

• Negligible environmental impact

• Reliability, little or no delivery risk

• Maximum power generation coincides with peak energy demands

• Potential for distributed point of use generation

Growth drivers that we believe may allow TFPV to outpace the balance of the solar market include:

• Highly scalable and automated manufacturing processes

• Lower material costs and fewer constraints to sufficient material supplies

• Lower per watt production costs for solar cells and integrated solar modules

Driving our solar module manufacturing plan is what we believe to be the ability to capitalize on long term growth in solar spurred by increasing electrical energy costs and demand. Large markets are developing for commercial operators of private solar farms, utilities meeting green mandates, government subsidized installations, and operators of large commercial and industrial properties. These projects represent large installations typically approaching 1MW or more.

While we believe that the market conditions are excellent for all producers of solar products, we intend to deliver thin film solar products that provide extra value in performance and cost.

Products
Solar Modules

In designing our ASI-120 watt module, we interviewed solar systems integrators and developed a design that we believe provides for a module delivering high power output (relative to other thin films), and size and framing that would allow for the use of many existing mounting systems. In doing so, we believe our modules strike a balance between higher rated power silicon wafer modules and lower rated power thin film modules. Further, we believe the market will dictate retail installed pricing. Systems integrators will look to sell installed watts at market dictated prices, and after accounting for certain fixed installation costs inherent to each of the different solar technologies, they will drive pricing per watt for factory delivered modules to compensate for any added installation costs when using certain technologies.

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We have focused on the development of thin film amorphous technologies and products due to what we perceive as inherent advantages of amorphous silicon over other solar absorbers in regards to conversion efficiencies. Amorphous silicon produces more power earlier in the day and later into the evening because it requires less incident light than many other technologies. Amorphous silicon also exhibits less thermal coefficient degradation effects when operating in hot climates. In contrast, other thin film and conventional silicon wafer technologies degrade at significant rates of approximately 10% to 20% conversion loss of peak rated performance when operating at normal temperatures of 65 degrees centigrade.

We plan to deposit two separate solar cell layers of amorphous silicon on to a glass substrate. This is to increase the amount of absorbed and converted solar energy in our modules. Based on previous experimental and limited commercial use of our thin film deposition recipes, we anticipate the finished solar module to produce 7.9% frame to frame efficiency delivering approximately 125 peak watts of direct current "DC" power. We believe that we may be able to improve conversion efficiencies through the use of derivative forms of amorphous and other proprietary cell structures.

We anticipate that we can present the superior per-rated-watt-performance of amorphous in "real world" operating conditions as a competitive strength over the factory-rated performance of various other solar technologies. We believe these factors will influence the purchasing decision process of large solar power farms and utility size installations.

Planned Manufacturing Capacities
Production Line Features

The core feature of our plan revolves around the design of an efficient mass production system. The design utilizes an in-line vertical glass coating system processing two balanced and independent lines simultaneously. This design incorporates material handling, cell deposition, laser segmentation, cleaning, and module packaging functions necessary to convert an inexpensive piece of 100cm X 160cm sheet glass into a complete solar module in less than three hours. Our process uses only a fraction of the semiconductor material that would be necessary to produce crystalline silicon solar modules.

Phased Production Build Out and Planned Capacities

In the 2008 calendar year, we anticipate completing the assembly and installation of a small scale baseline production system and initiating construction and commissioning our first full scale 25MW system. We further anticipate that the baseline production system will generate limited solar module production in 2008 for use in fueling our sales channel and establish product recognition for larger quantity sales in 2009. We anticipate completing the assembly of and commissioning our first 25MW line between December 2008 and January 2009. Near the end of the 2008 calendar year, we plan to launch the build-out of the first of three additional 25MW systems necessary to eventually bring our capacity to 100MW. Barring assembly delays, the first of these lines is slated to come on-line in November 2009, the second in January 2010, and the final 25MW in March 2010. We intend to use the balance of the 2010 year to continue to work to improve system utilization, add shifts, and increase module yields to bring our production to peak capacities of 100MW or more of annualized solar module production. To complete each new production line, we plan to use a systematic replication process that is designed to enable us to add production lines rapidly and efficiently, and achieve operating metrics that are comparable to the performance of our initial 25MW system.

Production Line Planned Utilization and Production Costs

Each system, or line, has an estimated annualized initial module production capacity of approximately 25 megawatts, "MW" per annum, based on an initial 58% system utilization (the percentage of system utilization in each 7 day by 24 hour period) and 80% yield (the percentage of product meeting saleable specifications). We plan to ramp-up system utilization and yield to industry standards of 80% & 85% respectively over the course of the first full year of production in 2009, thereby increasing total production capacities per line to an anticipated 33MW. Initial per watt production costs during ramp-up of operations in the 2009 period are anticipated to be $1.58 per watt. As we improve system utilization and production yield in 2009, we anticipate our production costs will lower to $1.38 in 2010 and $1.19 in 2011. By continuing to expand production and improve solar energy conversion efficiencies and manufacturing processes, we believe we can further reduce our manufacturing costs per watt and improve our cost advantage over traditional crystalline silicon solar module manufacturers.

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Sales and Marketing

Solar systems installers looking to satisfy the module needs of these large and long term projects are looking for opportunities to secure access to modules supplies. We believe that the design and performance of our solar module is ideally suited for use in these project types, and we further believe that our module production capacities can be pre-sold well into the future.

Target Market

Our primary target market for our TFPV solar modules will be applications for On-Grid (facilities tied to conventional power distribution infrastructure) application of 1MW in size and above. Typical applications and buyers would include:

• Solar Farms

- License Holders in Germany, Spain & Canada

- US installers servicing commercial and utility scale installations

• Government Agencies (DOD)

- Bureau of Land Management

- Department of Defense

• Power Purchase Agreements

- Renewable Ventures

• Utility Companies

- Meeting Green Mandates

• Large Commercial Installations

Sales & Distribution

In anticipation of commercial production, we have developed a pre-sales reservation program, based upon the solar module manufacturing industry's policy of pre-selling manufacturing capacity to system installers and large users of solar. This is intended to aid in building a sales channel, loading that channel with customers interested in purchasing our future module production, and developing brand presence and recognition as early as possible. The program enables qualified, interested parties to specify the amount of solar module capacity they anticipate purchasing at favorable per watt pricing. As of the date of this report, we have signed reservation agreements with solar system integrators indicating interest in over 100MW of production in calendar 2008, 2009, 2010. Our agreements provide for the payment of a 5% deposit based on the 2009 calendar year purchase commitment either prior to, or not later than, 30 days after the delivery by XsunX to the reserving party of commercial samples for evaluation. The information in this paragraph is designed to summarize the general terms of the pre-sales reservation program and market opportunities. It is not intended to provide guidance about our future operating results, including revenues or profitability.

Plan of Operations

At present, we anticipate the majority of our product and operations development efforts for the period ending September 2008 and the foreseeable future thereafter, will focus on establishing and expanding facilities necessary to manufacture our TFPV solar modules for commercial sale. Areas of specific focus and capital expenditures include:

(a) Establishment of a baseline production system to produce full size (100cm ×
160cm) sample modules; and

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(b) Lease and preparation of facilities necessary to house and operate, at minimum, our first of four proposed 25MW manufacturing lines; and

(c) The placement of orders with select vendors for the core and sub-system components necessary to begin assembly leading to the commissioning of the first of four planned 25MW manufacturing lines; and

(d) Continued R&D efforts to establish enhanced solar cell deposition methods and reduce manufacturing costs.

For the year ending September 30, 2008 the Company has developed a plan of operations requiring approximately $20,080,316 that commits 38% of its budget or $12,773,974 towards initial Manufacturing Equipment and Sub-systems, another 11% of its budget or $3,578,594 to General and Administrative functions as well as working capital needs, another 8% of its budget or $2,725,098 to facilities including lease payments and manufacturing lease hold improvements and another 3% of its budget or $1,002,649 to the development of new manufacturing devices, techniques and other research and development. The planned expenditures are consistent with our anticipated costs associated with the placement of equipment order deposits, ongoing progress payments, facility lease hold improvements for general office facilities and manufacturing sub-system infrastructure, and operations support for an approximate annual manufacturing capacity of 25MW.

The Company may change any or all of the budget categories in the execution of its business attempts. None of the items is to be considered fixed or unchangeable.

The Company will need additional capital to fund its budget. To support the completion of the our planned initial 25MW of manufacturing capacity, associated production start-up costs, establish a replication process designed to enable us to add the balance of our proposed 75MW of additional production capacity, and fund operations as we attempt to generate initial sales and revenues, we may seek to obtain additional financing of approximately $25,000,000 from equity and/or debt placements. To support these and future operational plans, we may elect to attempt to secure loans and/or grants offered by the State of Oregon where we intend to establish our manufacturing facilities. No representation is made that any funds will be available when needed or on terms that acceptable to the Company. In the event funds cannot be raised when needed, the Company may not be able to carry out its business plan, may never achieve sales or income, and could fail in business as a result of these uncertainties.

Management believes the summary data and audit presented herein is a fair presentation of the Company's results of operations for the periods presented. Due to the Company's change in primary business focus and new business opportunities these historical results may not necessarily be indicative of results to be expected for any future period. As such, future results of the Company may differ significantly from previous periods.

Results of Operations for the Three Fiscal Years Ended September 30, 2007 Compared to Fiscal Years Ended September 30, 2006 and 2005 Revenue, Cost of Goods Sold:

The Company generated insignificant revenues in the period ended September 30, 2007 of $6,880. The Company generated revenue of $8,000 for the same period in 2006 and generated no revenue for the same period in 2005. There were no associated costs of goods sold.

Operating Expenses:

The Company incurred expenses totaling $2,648,359 in fiscal year 2007 as compared to $3,380,087 in 2006 and $1,383,406 in 2005. The decrease of $731,728 was primarily driven by non-cash warrant expenses of $625,947 and loan fees of $628,834 incurred in 2006 that were not incurred in 2007. For the year 2006 as compared to 2005, the increase of $1,996,681 included a onetime non-cash warrant issuance expense of $951,250 for warrants issued in association with the licensure of technologies and the sale by the Company of convertible debentures, and a net increase of $486,833 in loan fee expenses associated with the sale by the Company of convertible dentures.

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Excluding these non-cash items, there was an increase in normal and customary operating expense of $523,053 for the period ending September 30, 2007 as compared to the same period 2006. The primary drivers of this increased are discussed in detail below.

Salaries and Wages:

The Company hired additional staff to implement its commercialization strategy in the fiscal year ended September 30, 2007. This increase in staffing resulted in a total expenditure of $828,711 which is an increase of $553,622 over the same period in 2006 and an increase of $119,853 from 2006 to the same period in 2005. The company expects this trend to continue.

Research and Development:

The Company spent $435,534 in research and development activities during the fiscal year ended September 30, 2007. This represented a decrease of $513,938 as compared to the same period in 2006 and an increase of $448,049 for the year 2006 versus the same period in 2005. This illustrates the Company's ramp up of research and development expenditures during 2005 and 2006. As the Company began to focus on commercializing the technology, the related research and development expenditures declined in 2007.

Professional Services:

Consulting services were $117,751, an increase of $69,901 for the fiscal year ended September 30, 2007 compared to the prior year. This increase was largely driven by the expansion of the Company's Scientific Advisory Board and increased contract engineering expenses related to the efforts to commercialization of the Company's product. The decrease expenditures for the year ending September 30, 2006 versus the same period in 2005 was $273,094 which resulted primarily from the replacement of outside consultants with employees.

Legal and Accounting fees increased $162,185 to $302,478 for the fiscal year ended September 30, 2007. This increase was primarily the result of legal work relating to the Company's attempted acquisition of manufacturing assets, and from enforcing the Company's contact rights with several vendors. Legal and accounting fees were relatively flat for the year ending September 30, 2006 as compared to the same period in 2005, an increase of $33,044.

Travel:

Travel and associated expenses were $158,503 for the fiscal year ended September 30, 2007. This represents an increase of $116,680 as compared to the same period in 2006 and an increase of $30,589 for fiscal year 2006 as compared to the same period in 2005. These increases are due to increased travel directed at sales and business development efforts.

Other Operating Expenses:

Additionally, advertising expenses were $47,573 for the fiscal year 2007, an increase of $38,523 for the same period in 2006, an increase of $5,071 for the same period in 2005. This increase resulted from the Company's increased efforts to generate sales.

Insurance expenses were $66,856 for the fiscal year ended September 30, 2007, an increase of $64,151 from the prior period. This increase was primarily caused by increased coverage and the addition of a directors and officers insurance package. The increase of $1,947 between the fiscal years 2006 and 2005 was primarily driven by increase coverage levels.

For the fiscal year ended September 30, 2007, the Company's consolidated net loss was $(1,289,497) as compared to $(3,441,940) for the same period ended September 30, 2006 and $(1,400,839) for the same period ended September 30, 2005. The decreased net loss in 2007 was primarily related to i) $1,100,000 non-operating settlement of an asset purchase agreement which resulted in cash inflow and a non-operating income ii) a decreased operating expenses of $731,728 as discussed above, iii) increased interest income of $164,699 resulting for the loan to Sencera and iv) decreased interest expense with the conversion of outstanding debentures into equity in 2006. This resulted in a net loss per was of $(0.01) for the twelve months ended September 30, 2007.

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The increase of $2,041,101 between the 2006 and 2005 periods resulted from a one time non-cash warrant issuance expense of $951,250 for warrant expenses accounted for in the period ended September 30, 2006, and a net increase of $486,833 in loan fee expenses associated with the sale by the Company of convertible dentures. Excluding the one time non-cash warrant expense and net loan fee expenses, in the comparative analysis between the periods, results in an increase of $578,017 in net loss for the period ended September 30, 2006 as compared to the same period 2005. The net loss per share was less than $(0.02) for the twelve month period ended September 30, 2006 and $(0.01) for the same period in 2005.

Due to the Company's change in primary business focus in October 2003 and the developing nature of its business opportunities these historical results may not necessarily be indicative of results to be expected for any future period. As such, future results of the Company may differ significantly from previous periods. Since inception in 1997 the Company has an accumulated deficit totaling ($10,460,850) at September 30, 2007.

Liquidity and Capital Resources

Working Capital at September 30, 2007 was $1,515,437 as compared to $4,065,524 for the same period in 2006 and as compared to a working capital (deficit) of $(718,380) at September 30, 2005. There were insignificant operating cash flows totaling $6,880 during the twelve months ended September 30, 2007 and $8,000 in the same period in 2006 and zero in the same period in 2005.

Cash and cash equivalents at September 30, 2007 were $1,828,125 a decrease of $(2,826,098) from the same period in 2006. Cash and cash equivalents at September 30, 2006 were $4,654,223, an increase of $4,398,370 from September 30, 2005.

During the year ended, September 30, 2007, the Company used $1,289,497 net cash in operating activities as compared to $1,942,278 net cash in operating activities for the year ending September 30, 2006 and compared to using $1,049,650 net cash for the year ended, September 30, 2005.

The Company used $843,416 for operating activities during the year ended September 30, 2007 as compared to $1,942,278 for the same period in 2006. The decrease of $1,098,862 resulted primarily from a reduced net loss of $2,152,443 offset by warrant expense and issuance of common stock for interest of $867,330, change in pre-paid expenses of $563,871 and to accounts payable of $826.293.

The increase of $892,628 in use of cash for operating activities between the 2006 and 2005 periods resulted from one time non-cash expenses for a warrant issuance expense of $951,250, an expense of $31,500 for the issuance of stock in lieu of cash for services, and $241,383 in expenses for the issuance of stock in lieu of cash for the payment of accrued interest associated with the sale of debentures by the Company accounted for in the period ended September 30, 2006. Excluding these one time non-cash expenses, in the comparative analysis between the periods, results in a decrease of $331,505 in net cash used in operations for the period ended September 30, 2006 compared to the same period 2005. This decrease of net cash used in operations was primarily due to a decrease in consulting expenses of $273,094 in the 2006 period.

For the twelve months ended, September 30, 2007, the Company's capital needs have primarily been met from the proceeds of (i) the issuance of Common Stock for Debenture conversion and; (ii) the issuance of Common Stock for warrant conversion. Total cash provided by financing activities for the period ended September 30, 2007 decreased to $135,000. For the period ended September 30, 2006 total cash provided by financing activity increased to $8,171,250 from $1,380,170 for the same period ended September 30, 2005. The decrease of $8,036,250 is a result of financing activity in fiscal year 2006 that was not required to execute on the business plan in 20007. Additionally, $135,000 was received by the Company for 900,000 warrants that were exercised by a consultant. The increase of $6,791,080 between the 2006 and 2005 periods was mainly attributable to an increase of $5,000,000 from the conversion of a debenture into common stock and $3,171,250 in the conversion of warrants for common stock.

On November 1, 2007, XsunX signed a $21 million common stock purchase agreement with Fusion Capital Fund II, LLC, an Illinois limited liability Company ("Fusion Capital"). Upon signing the agreement, XsunX received $1,000,000 from Fusion Capital as an initial purchase under the $21 million commitment in exchange for 3,333,332 shares of our common stock. The shares were issued in a transaction exempt from

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registration pursuant to Section 4(2) of the Securities Act of 1933. . . .