Attached files
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EX-32.1 - COMPOSITE TECHNOLOGY CORP | v173266_ex32-1.htm |
EX-31.1 - COMPOSITE TECHNOLOGY CORP | v173266_ex31-1.htm |
EX-31.2 - COMPOSITE TECHNOLOGY CORP | v173266_ex31-2.htm |
EX-32.2 - COMPOSITE TECHNOLOGY CORP | v173266_ex32-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE
ACT OF 1934
FOR
THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009
o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION
FILE NUMBER 0-10999
COMPOSITE
TECHNOLOGY CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
NEVADA
|
59-2025386
|
|
State or Other Jurisdiction of
Incorporation or Organization)
|
(I.R.S. Employer Identification No.)
|
|
2026 McGaw Avenue, Irvine, CA
|
92614
|
|
(Address of Principal Executive Offices)
|
(Zip Code)
|
(949)
428-8500
(Registrant's
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YES x NO o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). YES o NO o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
See definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer
o
|
Accelerated filer
x
|
Non-accelerated filer
o
(Do not check if a smaller reporting company)
|
Smaller reporting company
o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES o NO x
APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDING
DURING THE PRECEDING FIVE YEARS:
Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court. YES x
NO o
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer's classes of common stock
as of: February 9, 2010
CLASS
|
NUMBER
OF SHARES OUTSTANDING
|
|
Common
Stock, par value $0.001 per share
|
288,269,660
shares
|
COMPOSITE
TECHNOLOGY CORPORATION
Form 10-Q
for the Quarter ended December 31, 2009
Table of
Contents
Page
|
||
PART
I – FINANCIAL INFORMATION
|
||
Item
1 Financial Statements
|
3
|
|
Item
2 Management's Discussion and Analysis of Financial
Condition and Results of Operations
|
25
|
|
Item
3 Quantitative and Qualitative Disclosures About Market
Risk
|
35
|
|
Item
4 Controls and Procedures
|
35
|
|
PART
II – OTHER INFORMATION
|
||
Item
1 Legal Proceedings
|
37
|
|
Item
1A Risk Factors
|
37
|
|
Item
2 Unregistered Sales of Equity Securities and the Use of
Proceeds
|
38
|
|
Item
3 Defaults Upon Senior Securities
|
38
|
|
Item
4 Submission of Matters to a Vote of Security
Holders
|
38
|
|
Item
5 Other Information
|
38
|
|
Item
6 Exhibits
|
39
|
|
SIGNATURES
|
40
|
|
EXHIBITS
|
PART
1 - FINANCIAL INFORMATION
Item
1. Financial Statements
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(IN
THOUSANDS)
December 31, 2009
|
September 30, 2009
|
|||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
CURRENT
ASSETS
|
||||||||
Cash
and Cash Equivalents
|
$
|
13,924
|
$
|
23,968
|
||||
Restricted
Cash, Current Portion (Note 2)
|
5,500
|
5,500
|
||||||
Accounts
Receivable, net of reserve of $92 and $81
|
4,259
|
1,732
|
||||||
Inventory,
net of reserve of $883 and $923
|
4,814
|
4,378
|
||||||
Prepaid
Expenses and Other Current Assets
|
935
|
959
|
||||||
Current
Assets of Discontinued Operations (Note 2)
|
2,723
|
2,522
|
||||||
Total
Current Assets
|
32,155
|
39,059
|
||||||
Property
and Equipment, net of accumulated depreciation of $3,798 and
$3,766
|
3,091
|
3,214
|
||||||
Restricted
Cash, Non-Current (Note 2)
|
11,679
|
11,675
|
||||||
Other
Assets
|
880
|
891
|
||||||
TOTAL
ASSETS
|
$
|
47,805
|
$
|
54,839
|
||||
LIABILITIES
AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
||||||||
CURRENT
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
7,153
|
$
|
7,217
|
||||
Deferred
Revenues and Customer Advances
|
1,587
|
16
|
||||||
Warranty
Provision
|
276
|
258
|
||||||
Notes
Payable – Current, net of discount of $95 and $315
|
8,942
|
8,723
|
||||||
Derivative
Liabilities – Current (Note 1)
|
12
|
—
|
||||||
Current
Liabilities of Discontinued Operations (Note 2)
|
42,008
|
43,469
|
||||||
Total
Current Liabilities
|
59,978
|
59,683
|
||||||
LONG-TERM
LIABILITIES
|
||||||||
Long
Term Portion of Deferred Revenues
|
576
|
561
|
||||||
Long-Term
Portion of Warranty Provision
|
278
|
306
|
||||||
Derivative
Liabilities – Long-Term (Note 1)
|
784
|
—
|
||||||
Non-Current
Liabilities of Discontinued Operations (Note 2)
|
1,334
|
1,120
|
||||||
Total
Long-Term Liabilities
|
2,972
|
1,987
|
||||||
Total
Liabilities
|
62,950
|
61,670
|
||||||
COMMITMENTS
AND CONTINGENCIES
|
||||||||
SHAREHOLDERS’
EQUITY (DEFICIT)
|
||||||||
Common
Stock, $.001 par value 600,000,000 shares authorized 288,108,370 and
288,088,370 issued and outstanding
|
288
|
288
|
||||||
Additional
Paid-in Capital
|
250,038
|
259,755
|
||||||
Accumulated
Deficit
|
(265,471
|
)
|
(266,874
|
)
|
||||
Total
Shareholders’ (Deficit)
|
(15,145
|
)
|
(6,831
|
)
|
||||
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
$
|
47,805
|
$
|
54,839
|
The
accompanying notes are an integral part of these financial
statements.
3
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
(IN
THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
December
31, 2009
|
Three Months Ended
December
31, 2008
|
|||||||
Revenue
|
$
|
2,701
|
$
|
4,360
|
||||
Cost
of Revenue
|
2,483
|
3,082
|
||||||
Gross
Profit
|
218
|
1,278
|
||||||
OPERATING
EXPENSES
|
||||||||
Officer
Compensation
|
569
|
743
|
||||||
General
and Administrative
|
3,864
|
2,237
|
||||||
Research
and Development
|
656
|
673
|
||||||
Sales
and Marketing
|
1,137
|
1,289
|
||||||
Depreciation
& Amortization
|
97
|
90
|
||||||
Total
Operating Expenses
|
6,323
|
5,032
|
||||||
LOSS
FROM OPERATIONS
|
(6,105
|
)
|
(3,754
|
)
|
||||
OTHER
INCOME / (EXPENSE)
|
||||||||
Interest
Expense
|
(893
|
)
|
(458
|
)
|
||||
Interest
Income
|
17
|
11
|
||||||
Other
Expense
|
(265
|
)
|
—
|
|||||
Change
in Fair Value of Derivative Liabilities (Note 1)
|
774
|
—
|
||||||
Total
Other Income / (Expense)
|
(367
|
)
|
(447
|
)
|
||||
Loss
from Continuing Operations before Income Taxes
|
(6,472
|
)
|
(4,201
|
)
|
||||
Income
Tax Expense
|
14
|
3
|
||||||
NET
LOSS FROM CONTINUING OPERATIONS
|
(6,486
|
)
|
(4,204
|
)
|
||||
Loss
from Discontinued Operations, net of tax of $1 and $5 (Note
2)
|
(1,222
|
)
|
(4,132
|
)
|
||||
NET
LOSS
|
(7,708
|
)
|
(8,336
|
)
|
||||
OTHER
COMPREHENSIVE INCOME
|
||||||||
Foreign
Currency Translation Adjustment, net of tax of $0
|
—
|
1,026
|
||||||
COMPREHENSIVE
LOSS
|
$
|
(7,708
|
)
|
$
|
(7,310
|
)
|
||
BASIC
AND DILUTED LOSS PER SHARE
|
||||||||
Loss
per share from continuing operations
|
$
|
(0.02
|
)
|
$
|
(0.02
|
)
|
||
Loss
per share from discontinued operations
|
$
|
(0.01
|
)
|
$
|
(0.01
|
)
|
||
TOTAL
BASIC AND DILUTED LOSS PER SHARE
|
$
|
(0.03
|
)
|
$
|
(0.03
|
)
|
||
WEIGHTED-AVERAGE
COMMON SHARES OUTSTANDING
|
288,101,848
|
287,988,370
|
The
accompanying notes are an integral part of these financial
statements.
4
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(IN
THOUSANDS)
(UNAUDITED)
Three
Months Ended
December 31,
2009
|
Three
Months Ended
December 31,
2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
Net
loss
|
$
|
(7,708
|
)
|
$
|
(8,336
|
)
|
||
Loss
from discontinued operations
|
1,222
|
4,132
|
||||||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Interest
and deferred finance charge amortization related to detachable warrants
and fixed conversion features
|
432
|
272
|
||||||
Depreciation
& amortization
|
126
|
240
|
||||||
Share-based
compensation
|
664
|
1,129
|
||||||
Amortization
of prepaid expenses paid in stock
|
82
|
82
|
||||||
Issuance
of warrants for services
|
57
|
22
|
||||||
Change
in fair value of derivative liabilities
|
(774
|
)
|
—
|
|||||
Bad
debt expense (recovery)
|
(9
|
)
|
—
|
|||||
Inventory
reserve expense
|
336
|
171
|
||||||
Impairment
on obsolete inventory
|
203
|
—
|
||||||
Loss
on disposal of fixed assets
|
90
|
—
|
||||||
Changes
in Assets / Liabilities:
|
||||||||
Restricted
cash
|
(4
|
)
|
—
|
|||||
Accounts
receivable
|
(2,518
|
)
|
1,816
|
|||||
Inventory
|
(975
|
)
|
(242
|
)
|
||||
Prepaids
and other current assets
|
(105
|
)
|
(40
|
)
|
||||
Other
assets
|
14
|
66
|
||||||
Accounts
payable and other accruals
|
(65
|
)
|
(88
|
)
|
||||
Deferred
revenue
|
1,586
|
339
|
||||||
Accrued
warranty liability
|
(10
|
)
|
(9
|
)
|
||||
Net
assets/liabilities of discontinued operations
|
(2,601
|
)
|
(10,470
|
)
|
||||
Cash
used in operating activities – continuing operations
|
(9,957
|
)
|
(10,916
|
)
|
||||
Cash
used in operating activities – discontinued operations
|
—
|
(1,702
|
)
|
|||||
Net
cash used in operating activities
|
$
|
(9,957
|
)
|
$
|
(12,618
|
)
|
||
CASH
FLOW FROM INVESTING ACTIVITIES
|
||||||||
Purchase
of property and equipment
|
$
|
(94
|
)
|
$
|
(156
|
)
|
||
Restricted
cash
|
—
|
693
|
||||||
Cash
provided by (used in) investing activities – continuing
operations
|
(94
|
)
|
537
|
|||||
Cash
used in investing activities – discontinued
operations
|
—
|
(768
|
)
|
|||||
Net
cash used in investing activities
|
$
|
(94
|
)
|
$
|
(231
|
)
|
||
CASH
FLOW FROM FINANCING ACTIVITIES
|
||||||||
Proceeds
from exercise of options
|
$
|
7
|
$
|
—
|
||||
Cash
provided by financing activities
|
$
|
7
|
$
|
—
|
||||
Total
net decrease in cash and cash equivalents
|
$
|
(10,044
|
)
|
$
|
(12,849
|
)
|
||
Cash
and cash equivalents at beginning of period
|
23,968
|
23,085
|
||||||
Cash
and cash equivalents at end of period
|
$
|
13,924
|
$
|
10,236
|
||||
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
||||||||
INTEREST
PAID
|
$
|
185
|
$
|
191
|
||||
INCOME
TAX PAID
|
$
|
7
|
$
|
3
|
The
accompanying notes are an integral part of these financial
statements.
5
SUPPLEMENTAL
DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
During
the three months ended December 31, 2009, the Company:
Issued
300,000 warrants at an exercise price of $0.45 per share in settlement of a
legal dispute.
During
the three months ended December 31, 2008, the Company:
Issued
150,000 warrants at an exercise price of $0.96 per share in settlement of a
disputed financing fee related to the May, 2008 debt financing.
Re-priced
200,000 $1.75 warrants, 200,000 $1.50 warrants, and 200,000 $1.25 warrants to a
strike price of $0.75 per warrant for all three series of warrants. The Company
recorded $22,000 to general and administrative expense for the re-pricing of
these warrants.
6
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Composite
Technology Corporation (the “Company”), originally incorporated in Florida and
reincorporated in Nevada, is an Irvine, CA based company that has operated in
two segments, CTC Cable “Cable” and DeWind “Wind”. As discussed
below, in September 2009, the Company sold substantially all of its Wind
segment, which sold wind turbines under the brand name DeWind. The Cable Segment
sells high efficiency patented composite core electricity conductors known as
"ACCC®
conductor" for use in electric transmission and distribution lines. ACCC®
conductor is commercially available in the United States and Canada through
distribution and purchase agreements; in China through Far East Composite Cable;
in Europe through Lamifil; in the Middle East through Midal Cable; and directly
through CTC Cable worldwide.
BASIS
OF PRESENTATION AND PRINCIPALS OF CONSOLIDATION
The
accompanying unaudited consolidated financial statements of the Company have
been prepared in accordance with accounting principles generally accepted in the
United States of America (US GAAP) for interim financial information and with
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not contain all of the information and footnotes required for complete
financial statements. Interim information is unaudited, however, in the opinion
of the Company's management, the accompanying unaudited, consolidated financial
statements reflect all adjustments (consisting of normal, recurring adjustments)
considered necessary for a fair presentation of the Company's interim financial
information. These financial statements and notes should be read in conjunction
with the audited consolidated financial statements of the Company included in
the Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2009, filed with the Securities and Exchange Commission (SEC) on December 14,
2009.
The
financial statements include the accounts of the Company and its wholly-owned
subsidiaries, the most significant of which is CTC Cable
Corporation.
The
Company consolidates the financial statements of all entities in which the
Company has a controlling financial interest, as defined in US GAAP. All
significant inter-company accounts and transactions are eliminated during
consolidation.
DISCONTINUED
OPERATIONS AND SALE OF DEWIND
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property and
transferred substantially all operating liabilities including supply chain and
operating expense accounts payables and accrued liabilities, warranty related
liabilities for US turbine installations, and deferred revenues. All
of the remaining assets and liabilities of DeWind have been classified as net
assets/liabilities of discontinued operations. All operations of our
former DeWind segment have been reported as discontinued operations. See
discussion at Note 2, including the accounting policies applicable to
our discontinued operations.
REVENUE
RECOGNITION
Revenues
are recognized based on guidance provided by the SEC. Accordingly, our general
revenue recognition policy is to recognize revenue when there is persuasive
evidence of an arrangement, the sales price is fixed or determinable, collection
of the related receivable is reasonably assured, and delivery has occurred or
services have been rendered.
The
Company derives, or seeks to derive revenues from product revenue sales of
composite core, stranded composite core, core and stranded core hardware, and
other electric utility related products.
In
addition to the above general revenue recognition principles prescribed by the
SEC, our specific revenue recognition policies for each revenue source are as
follows:
PRODUCT
REVENUES. Product revenues are recognized when product shipment has been made
and title has passed to the end user customer. Product revenues consist
primarily of revenue from the sale of: (i) stranded composite core and related
hardware to utilities either sold directly by the Company or through a
distribution agreement, and (ii) composite core and related hardware sold to a
cable stranding entity. Revenues are deferred for product contracts where the
Company is required to perform installation services until after the
installation is complete. Our distribution agreements are structured so that our
revenue cycle is complete upon shipment and title transfer of products to the
distributor with no right of return.
7
CTC Cable
sales for the three months ended December 31, 2009 and 2008 consisted of
stranded ACCC®
conductor and ACCC® hardware
sold to end user utilities, sales of ACCC®
conductor core and hardware sold to our Chinese distributor, and sales of
ACCC®
conductor core and ACCC® hardware
to two of our stranding manufacturers. All ACCC® product
related sales were recognized upon delivery of product and transfer of title.
There is no right of return for sales of ACCC®
conductor or ACCC® core to
our Chinese distributor. For ACCC®
conductor product sales made directly by us and not through a manufacturer or
distributor, through a third-party insurance company, we provide the option to
purchase an extended warranty for periods up to five, seven or ten years. We
allocate a portion of sales proceeds to the estimated fair value of the cost to
provide such a warranty. To date, most of our ACCC® related
product sales have been without warranty coverage.
CONSULTING
REVENUE. Consulting revenues are generally recognized as the consulting services
are provided. We have entered into service contract agreements with electric
utility and utility services companies that generally require us to provide
engineering or design services, often in conjunction with current or future
product sales. In return, we receive engineering service fees payable in
cash. For the three months ended December 31, 2009 and 2008, we
recognized no consulting revenues.
For
multiple element contracts where there is no vendor specific objective evidence
(VSOE) or third-party evidence that would allow the allocation of an arrangement
fee amongst various pieces of a multi-element contract, fees received in advance
of services provided are recorded as deferred revenues until additional
operational experience or other VSOE becomes available, or until the contract is
completed.
WARRANTY
PROVISIONS
Warranty
provisions consist of the insured costs and liabilities associated with any
post-sales associated with our ACCC®
conductor and related hardware parts.
Warranties
related to our ACCC® products
relate to conductor and hardware sold directly by us to the end-user
customer. We mitigate our loss exposure through the use of third
party warranty insurance. Warranty related liabilities for time
periods in excess of one year are classified as non-current
liabilities.
USE
OF ESTIMATES
The
preparation of our financial statements conform with US GAAP, which requires
management to make estimates and judgments in applying our accounting policies
that have an important impact on our reported amounts of assets, liabilities,
revenue, expenses and related disclosures at the date of our financial
statements. On an on-going basis, management evaluates its estimates including
those related to accounts receivable, inventories, share-based compensation,
warranty provisions and goodwill and intangibles, as applicable. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from management’s estimates. We believe that the application of our
critical accounting policies requires significant judgments and estimates on the
part of management. We believe that the estimates, judgments and assumption upon
which we rely are reasonable, and based upon information available to us at the
time that these estimates, judgments and assumptions are made. These estimates,
judgments and assumptions can affect the reported amounts of assets and
liabilities as of the date of the financial statements as well as the reported
amounts of revenues and expenses during the period presented. To the extent
there are material differences between these estimates, judgments or assumptions
and actual results, our financial statements will be affected. In many cases,
the accounting treatment of a particular transaction is specifically dictated by
US GAAP and does not require management's judgment in its application. There are
also many areas in which management's judgment in selecting among available
alternatives would produce a materially different result.
Our key
estimates we use that rely upon management judgment include:
-
|
the
estimates pertaining to the likelihood of our accounts receivable
collectability. These estimates primarily rely upon past payment history
by customer and management judgment on the likelihood of future payments
based on the current business condition of each customer and the general
business environment.
|
|
-
|
the
estimates pertaining to the valuation of our inventories. These estimates
primarily rely upon the current order book for each product in inventory
along with management’s expectations and visibility into future sales of
each product in inventory.
|
|
-
|
the
assumptions used to calculate fair value of our share-based compensation
and derivative liabilities, primarily the volatility component of the
Black-Scholes-Merton option-pricing model used to value our warrants and
our employee and non-employee options. This estimate relies upon the past
volatility of our share price over time as well as the estimate of the
option life.
|
|
-
|
goodwill
and intangible valuation. These estimates rely primarily on financial
models reviewed by senior management which incorporate business
assumptions made by management on the underlying products and technologies
acquired and the likelihood that the values assigned during the initial
valuations will be recoverable over time through increased revenues,
profits, and enterprise value. Currently, we have no reportable goodwill
or intangible assets.
|
|
-
|
the
estimates and assumptions used to determine the settlement of certain
accounts related to the sale of the DeWind assets for which a final
accounting has not been completed and which may result in the increase or
decrease of asset reserves or increase or decrease of accrued liabilities,
principally penalty payments, interest, and other costs associated with
the turbine parts suppliers for DeWind turbine parts. See related
discussion at Note 2.
|
8
DERIVATIVE
FINANCIAL INSTRUMENTS
The
Company issues financial instruments in the form of stock options and stock
warrants, and debt conversion features as part of its convertible debt
issuances. The Company has not issued any derivative instruments for hedging
purposes since its inception. The Company uses the specific guidance and
disclosure requirements provided in US GAAP. Generally, freestanding derivative
contracts where settlement is required by physical share settlement or in net
share settlement; or where the Company has a choice of share or net cash
settlement are accounted for as equity. Contracts where settlement is in cash or
where the counterparty may choose cash settlement are accounted for as a
liability. Under current US GAAP, certain of our warrants and debt conversion
features are subject to liability accounting treatment (see discussion below
under “Derivative Liabilities”), while our stock options are considered indexed
to the Company’s stock and are accounted for as equity.
The
values of the financial instruments are estimated using the Black-Scholes-Merton
(Black-Scholes) option-pricing model. Key assumptions used to value options and
warrants granted or issued are as follows (only warrants were issued in
2008):
Three
Months Ended
|
||||||||
December
31,
|
||||||||
2009
|
2008
|
|||||||
Risk
Free Rate of Return
|
0.82-2.30 | % | 1.61-1.89 | % | ||||
Volatility
|
96-108 | % | 75-86 | % | ||||
Dividend
yield
|
0 | % | 0 | % | ||||
Expected
life
|
2-5
yrs
|
2-2.6 yrs
|
Derivative
Liabilities and Change in Accounting Principle
Our
derivative liabilities include fair value based warrant liabilities and debt
conversion features pursuant to US GAAP applied to the terms of the underlying
agreements. The Company issues warrants to purchase common shares of the Company
as additional incentive for investors who purchase unregistered, restricted
common stock or convertible debentures. The fair value of certain warrants
issued and debt conversion features in conjunction with financing events are
recorded as a discount for debt issuances. Certain warrant agreements and debt
conversion arrangements include provisions that require us to record them as a
liability, at fair value, pursuant to Financial Accounting Standards Board
(FASB) accounting rules, including certain provisions designed to protect a
holder’s position from being diluted. The derivative liabilities are
marked-to-market each reporting period and changes in fair value are recorded as
a non-operating gain or loss in our consolidated statement of operations, until
they are completely settled or expire. The fair value of the warrants and debt
conversion features are determined each reporting period using the Black-Scholes
valuation model, using inputs and assumptions consistent with those used in our
estimate of fair value of employee stock options, except that the remaining
contractual life of the warrant is used. Such fair value is affected
by changes in inputs to that model including our stock price, expected stock
price volatility, interest rates and expected term. Refer to “Fair
Value Measurements” below in Note 1 for additional derivative liabilities
disclosures.
For the
three months ended December 31, 2009, we recognized gains of $774,000 related to
the revaluation of our derivative liabilities. The 2009 revaluation
gains resulted mainly from the decrease in our stock price from the prior
quarter.
In
connection with the warrants issued to investors as discussed above, the Company
has issued warrants to compensate for financing fees and other service fees
incurred. Such compensatory warrants are recorded at fair value in
the same manner as non-compensatory warrants, however, the recognized expense is
offset to additional paid-in-capital. Such warrants are considered
equity transactions in accordance with US GAAP. Additionally,
warrants issued without anti-dilution provisions are generally considered equity
transactions in accordance with US GAAP. All of our outstanding warrants
including those subject to liability accounting treatment are further discussed
in Note 8.
Change
in Accounting Principle
Prior to
fiscal 2010, the Company accounted for all warrants issued in conjunction with
financing events as equity in accordance with existing US GAAP.
On
October 1, 2009, the Company adopted new FASB rules related to determining
whether an instrument (or embedded feature) is indexed to an entity’s own
stock. Existing accounting for derivatives and hedging activities
specifies that a contract that would otherwise meet the definition of a
derivative, but is both (a) indexed to the Company’s own stock and (b)
classified in shareholders’ equity, would not be considered a derivative
financial instrument. The new rules provide a two-step model to be
applied in determining whether a financial instrument or an embedded feature is
indexed to an issuer’s own stock and thus able to qualify for the existing scope
exception. In accordance with the new rules, management evaluated
outstanding instruments as of October 1, 2009 and determined all warrants and
debt conversion arrangements with anti-dilution provisions issued in conjunction
with financing events, that are not considered compensatory, are not indexed to
our stock and therefore are to be recorded as liabilities at fair value and
marked-to-market through earnings. Accordingly, as of October 1,
2009, we have adjusted the opening balance of accumulated deficit to effect this
change in accounting principle as follows:
9
(Unaudited,
In Thousands)
|
October 1, 2009
|
|||
Accumulated
Deficit
|
$
|
(266,874
|
)
|
|
Cumulative
Effect of the Change (A)
|
9,111
|
|||
Accumulated
Deficit, as adjusted
|
$
|
(257,763
|
)
|
(A)
|
The
cumulative effect of the change to our Accumulated Deficit was derived
from recognizing mark-to-market fair value revaluation adjustments to the
applicable warrants and debt conversion features from the original
issuance dates through October 1, 2009, in the net gain amount of
$19,284,000. Additionally, the cumulative effect includes
recognition of interest expense from amortization of the debt discount
recorded from the initial valuation of the debt conversion features
through October 1, 2009, in the amount of
$10,173,000.
|
Additionally,
on October 1, 2009, the opening balance of Additional Paid-in Capital includes a
reclassification adjustment to Derivative Liabilities in the amount of
$10,514,000, which represents the aggregate original warrant fair value
previously recorded to equity.
Refer to
“Fair Value Measurements” below in Note 1 for additional derivative liabilities
disclosures.
Share-Based
Compensation
US GAAP
requires that compensation cost relating to share-based payment arrangements be
recognized in the financial statements. US GAAP requires measurement of
compensation cost for all share-based awards at fair value on date of grant and
recognition of compensation over the service period for awards expected to vest.
The fair value of stock options is determined using the Black-Scholes valuation
model. Such fair value is recognized as expense over the service period, net of
estimated forfeitures.
US GAAP
requires that equity instruments issued to non-employees in exchange for
services be valued at the more accurate of the fair value of the services
provided, or the fair value of the equity instruments issued. For equity
instruments issued that are subject to a required service period, the expense
associated with the equity instruments is recorded as the instruments vest or
the services are provided. The Company has granted options and warrants to
non-employees and recorded the fair value of these equity instruments on the
date of issuance using the Black-Scholes valuation model, for options and
warrants not subject to vesting terms. For non-employee option and warrant
grants subject to vesting terms, vested shares are recorded at fair value using
the Black-Scholes valuation model and the associated expense is recorded
simultaneously or as the services are provided. The Company has granted stock to
non-employees for services and values the stock at the more reliable of the
market value on the date of issuance or the value of the services provided. For
stock grants subject to vesting or service requirements, expenses are deferred
and recognized over the more appropriate of the vesting period, or as services
are provided.
SEC
guidance requires share-based compensation to be classified in the same
expense line items as cash compensation. Additionally, the
SEC issued guidance regarding the use of a "simplified" method in
developing an estimate of expected term of "plain vanilla" share options in
accordance with US GAAP rules. The Staff indicated that it will accept a
company's election to use the simplified method, regardless of whether the
company has sufficient information to make more refined estimates of expected
term. The Staff believed that more detailed external information about employee
exercise behavior (e.g., employee exercise patterns by industry and/or other
categories of companies) would, over time, become readily available to
companies; however, the Staff continues to accept, under certain circumstances,
the use of the simplified method. The Company currently uses the simplified
method for “plain vanilla” share options and warrants.
Additional
information about share-based compensation is disclosed in Note 9.
Convertible
Debt
Convertible
debt is accounted for under specific guidelines established in US GAAP. The Company records a
beneficial conversion feature (BCF) related to the issuance of convertible
debt that have conversion features at fixed or adjustable rates that are
in-the-money when issued and records the fair value of warrants issued with
those instruments. The BCF for the convertible instruments is recognized and
measured by allocating a portion of the proceeds to warrants and as a reduction
to the carrying amount of the convertible instrument equal to the intrinsic
value of the conversion features, both of which are credited to paid-in-capital
or liabilities as appropriate. The Company calculates the fair value of warrants
issued with the convertible instruments using the Black-Scholes valuation
method, using the same assumptions used for valuing employee options, except
that the contractual life of the warrant is used. Upon each issuance, the
Company evaluates the variable conversion features and determines the
appropriate accounting treatment as either equity or liability, in accordance
with US GAAP. The Company first allocates the value of the proceeds
received to the convertible instrument and any other detachable instruments
(such as detachable warrants) on a relative fair value basis and then determines
the amount of any BCF based on effective conversion price to measure the
intrinsic value, if any, of the embedded conversion option. Using the effective
yield method, the allocated fair value is recorded as a debt discount or premium
and is amortized over the expected term of the convertible debt to interest
expense. For a conversion price change of a convertible debt issue, the
additional intrinsic value of the debt conversion feature, calculated as the
number of additional shares issuable due to a conversion price change multiplied
by the previous conversion price, is recorded as additional debt discount and
amortized over the remaining life of the debt. The accounting for
debt conversion features subject to liability treatment are further discussed
above in “Derivative Liabilities”.
10
US GAAP
rules specify that a contingent obligation to make future payments or otherwise
transfer consideration under a registration payment arrangement, whether issued
as a separate agreement or included as a provision of a financial instrument or
other agreement, should be separately recognized and measured in accordance with
US GAAP contingency rules. The contingent obligation to make future payments or
otherwise transfer consideration under a registration payment arrangement should
be separately recognized and measured in accordance with said rules, pursuant to
which a contingent obligation must be accrued only if it is more likely than not
to occur. Historically, the Company has not been required to accrue any
contingent liabilities in this regard.
CASH
AND CASH EQUIVALENTS
For the
purpose of the statements of cash flows, the Company considers all highly liquid
investments purchased with original maturities of three months or less to be
cash equivalents.
RESTRICTED
CASH
Restricted
cash represents cash on deposit under control of the Company that secures
standby letters of credit and other payment guarantees for certain
vendors. Restricted cash balances, comprised of cash held in escrow
in connection with the sale of DeWind as discussed in Note 2, were $17,179,000
and $17,175,000 at December 31, 2009 and September 30, 2009, respectively.
During the quarter ended December 31, 2009, we reported an additional $4,000
from interest income, in accordance with the escrow agreement.
ACCOUNTS
RECEIVABLE
The
Company has trade accounts receivable from cable customers. Cable customer
receivables are typically on net 30 day terms. Balances due greater than one
year from the balance sheet date are reclassified to long term assets, as
applicable. Collateral is generally not required for credit extended to
customers. Credit losses are provided for in the financial statements based on
management's evaluation of historical and current industry trends as well as
history with individual customers. Additions to the provision for bad debts are
included in General and Administrative expense on our Consolidated Statements of
Operations and Comprehensive Loss; charge-offs of uncollectible accounts are
made against existing provisions or direct to expense as
appropriate. Although the Company expects to collect amounts due, actual
collections may differ from estimated amounts.
CONCENTRATIONS
OF CREDIT RISK
Financial
instruments which potentially subject the Company to concentrations of credit
risk consist of cash and cash equivalents. The Company places its cash and cash
equivalents with high credit, quality financial institutions. At times, such
cash and cash equivalents may be in excess of the Federal Deposit Insurance
Corporation insurance limit (currently at $250,000 per depositor, per insured
bank for interest bearing accounts). The Company has not experienced any losses
in such accounts and believes it is not exposed to any significant credit risk
on cash and cash equivalents.
INVENTORIES
Inventories
consist of our wrapped and unwrapped manufactured composite core and related
hardware products and raw materials used in the production of those products.
Inventories are valued at the lower of cost or market under the FIFO method.
Cable products manufactured internally are valued at standard cost which
approximates replacement cost. Payments made to third party vendors
in advance of material deliveries are reported as a separate balance sheet line
item, as applicable. Costs for product sold is recorded to cost of
goods sold as the expenses are incurred.
PROPERTY
AND EQUIPMENT
Property
is stated at the lower of cost or realizable value, net of accumulated
depreciation. Additions and improvements to property and equipment are
capitalized at cost. Designated project costs are capitalized to
construction-in-progress as incurred. Depreciation of production equipment is
computed using the units-of-production method based on estimated useful lives of
specific production machinery and equipment and the related units estimated to
be produced over periods ranging from ten to twenty
years. Depreciation for all other assets is computed using the
straight-line method based on estimated useful lives of the assets which range
from three to ten years. Leasehold improvements and leased assets are amortized
or depreciated over the lesser of estimated useful lives or lease terms, as
appropriate. Property is periodically reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Expenditures for maintenance and repairs are charged to
operations as incurred while renewals and betterments are capitalized. Gains or
losses on the sale of property and equipment are reflected in the statements of
operations.
11
Change
in Accounting Estimate
Effective
on October 1, 2009, the Company changed its method of depreciation for
production machinery and equipment from the straight-line method to the
units-of-production method as described above. In accordance with US
GAAP, the Company has accounted for this change in accounting estimate
prospectively beginning in the quarter ended December 31, 2009. For
the three months ended December 31, 2009, the change in our method of
depreciating production machinery and equipment resulted in lowering
depreciation expense, Net Loss from Continuing Operations and Net Loss by
$49,000. For the three months ended December 31, 2009, basic and
diluted earnings per share from continuing operations and net loss were not
affected. See Note 5 for additional information.
IMPAIRMENT
OF LONG-LIVED ASSETS
Management
evaluates long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If the estimated future cash flow (undiscounted and without
interest charges) from the use of an asset are less than the carrying value, an
impairment would be recorded to reduce the related asset to its estimated fair
value.
We did
not recognize any impairment charges during the three months ended December 31,
2009 and 2008, respectively.
FAIR
VALUE MEASUREMENTS
Fair
value is defined as the price that would be received to sell an asset, or paid
to transfer a liability, in an orderly transaction between market participants
at the measurement date. Assets and liabilities recorded at fair value in the
consolidated balance sheets are categorized based upon the level of judgment
associated with the inputs used to measure their fair value. The fair value
hierarchy distinguishes between (1) market participant assumptions
developed based on market data obtained from independent sources (observable
inputs) and (2) an entity’s own assumptions about market participant
assumptions developed based on the best information available in the
circumstances (unobservable inputs). The fair value hierarchy consists of three
broad levels, which gives the highest priority to unadjusted quoted prices in
active markets for identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3). The three levels of the fair value
hierarchy are described as follows:
Level 1
- Quoted prices in active markets for identical assets or liabilities, and
identical liabilities when traded as an asset in an active market when no
adjustments to the quoted price of the asset are required.
Level 2
- Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of
the assets or liabilities.
Level 3
- Unobservable inputs that are supported by little or no market activity and
that are significant to the fair value of the assets or
liabilities. Inputs are based on management’s best estimate of what
market participants would use in pricing the asset or liability at the
measurement date.
As of
December 31, 2009, the Company held certain assets and liabilities that are
required to be measured at fair value on a recurring basis. The fair value
of these assets was determined using the following inputs:
(Unaudited,
In Thousands)
|
||||||||||||||||
Description
|
Total
|
Level 1
|
Level 2
|
Level 3
|
||||||||||||
Certificates
of deposit (1)
|
$
|
61
|
$
|
61
|
$
|
—
|
$
|
—
|
||||||||
Restricted
cash (Note 2)
|
17,179
|
17,179
|
—
|
—
|
||||||||||||
Total
assets
|
$
|
17,240
|
$
|
17,240
|
$
|
—
|
$
|
—
|
||||||||
Derivative
liabilities
|
$
|
796
|
$
|
—
|
$
|
—
|
$
|
796
|
(1)
|
Short-term
certificates of deposit are included in cash and cash equivalents in our
consolidated balance sheet.
|
Financial
instruments classified as Level 3 in the fair value hierarchy as of December 31,
2009 include derivative liabilities resulting from recent financing
transactions. In accordance with current accounting rules, the derivative
liabilities are being marked-to-market each quarter-end until they are
completely settled. The derivative liabilities are valued using the
Black-Scholes valuation model, using both observable and unobservable inputs and
assumptions consistent with those used in our estimate of fair value of employee
stock options. See “Derivative Liabilities” above in Note 1.
12
The
following table summarizes our fair value measurements using significant Level 3
inputs, and changes therein, for the three months ended December 31,
2009:
(Unaudited,
In Thousands)
|
Level
3
Derivative Liabilities
|
|||
Balance
as of October 1, 2009
|
$
|
1,570
|
||
Transfers
in/out of Level 3
|
—
|
|||
Initial
valuation of derivative liabilities
|
—
|
|||
Change
in fair value of derivative liabilities
|
(774
|
)
|
||
Balance
as of December 31, 2009
|
$
|
796
|
At
December 31, 2009 and September 30, 2009, the Company held no assets or
liabilities that are measured at fair value on a non-recurring
basis.
FAIR
VALUE INFORMATION ABOUT FINANCIAL INSTRUMENTS
US GAAP
regarding fair value disclosures of financial instruments requires disclosure of
fair value information about certain financial instruments for which it is
practical to estimate that value. The carrying amounts reported in our balance
sheet for cash, cash equivalents, accounts receivable, accounts payable, notes
and convertible notes approximate fair value due to the short maturity of these
financial instruments. Derivative liabilities are reported at fair value as
discussed above. Considerable judgment is required to develop such estimates of
fair value. Accordingly, such estimates would not necessarily be indicative of
the amounts that could be realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair amounts.
FOREIGN
CURRENCY TRANSLATION
The
Company’s primary functional currency is the U.S. dollar. Assets and liabilities
of the Company denominated in foreign currencies are translated at the rate of
exchange on the balance sheet date. Revenues and expenses are translated using
the average exchange rate for the period.
COMPREHENSIVE
LOSS
Comprehensive
loss includes all changes in shareholders’ equity (deficit) except those
resulting from investments by, and distributions to, shareholders. Accordingly,
the Company’s Consolidated Statements of Operations and Comprehensive Loss
include net loss, and foreign currency translation adjustments that arise from
the translation of foreign currency financial statements into U.S.
dollars.
In
connection with the sale of DeWind and resulting discontinued operations (see
Note 2), our Consolidated Statement of Operations and Comprehensive Loss for the
year ended September 30, 2009 included a reclassification adjustment of the
accumulated foreign currency translation adjustments for DeWind through
September 4, 2009 (date of sale), to recognize the accumulated adjustments as a
component of the loss from discontinued operations within net loss. Since
inception, other comprehensive income (loss) had been derived from DeWind
foreign currency translation adjustments. For the three months ended December
31, 2009, other comprehensive income in the amount of $534,000, derived from
DeWind foreign currency translations adjustments, has been recognized and
included as a component of the loss from discontinued operations within net
loss.
RESEARCH
AND DEVELOPMENT EXPENSES
Research
and development expenses are charged to operations as incurred.
START-UP
COSTS
US GAAP
defines start-up activities as one-time activities an entity undertakes when it
opens a new facility, introduces a new product or service, conducts business in
a new territory, or with a new class of customer or beneficiary, initiates a new
process in an existing facility or commences some new operation. Start-up
activities include activities related to organizing a new entity (i.e.
organization costs), which include initial incorporation and professional fees
in connection with establishing the new entity. In accordance with US GAAP, we
expense all start-up activities as incurred.
During
the three months ended December 31, 2009 and 2008, we recorded start-up expenses
in the approximate amount of $142,000 and $0, respectively, which are included
in general and administrative expenses. Our start-up activities
related to professional fees for organization costs incurred.
13
DEFINED
CONTRIBUTION PLAN
The
Company maintains a 401(k) plan covering substantially all of its employees who
are at least 21 years old with 1,000 hours of service. Such
employees are eligible to contribute a percentage of their annual eligible
compensation and receive discretionary Company matching
contributions. Discretionary Company matching contributions are
determined by the Board of Directors and may be in the form of cash or Company
stock. To date, the Company has not made any matching contributions
in either cash or Company stock. There were no changes to the 401 (k) plan
during the quarter ended December 31, 2009.
INCOME
TAXES
The
Company accounts for income taxes under the liability method, which requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred income taxes are recognized for the tax
consequences in future years of differences between the tax bases of assets and
liabilities and their financial reporting amounts at each period end based on
enacted tax laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
The
Company will recognize the impact of tax positions in the consolidated financial
statements if that position is more likely than not of being sustained on audit,
based on the technical merits of the position. To date, we have not
recorded any uncertain tax positions.
The
Company files consolidated tax returns in the United States Federal jurisdiction
and in California as well as foreign jurisdictions including Germany and the
United Kingdom. The Company is no longer subject to US Federal income tax
examinations for fiscal years before 2006, is no longer subject to state and
local income tax examinations by tax authorities for fiscal years before 2001,
and is no longer subject to foreign examinations before 2006.
During
fiscal 2008, the Company’s federal returns were selected for examination by the
Internal Revenue Service (IRS) for prior fiscals years ended September 30, 2001
through 2005, all years in which net losses were reported and filed. The
examination has been completed and the Company received a preliminary
determination of adjustment from the IRS. As of December 31, 2009, the IRS has
proposed certain preliminary adjustments related to payroll tax returns filed
during the period under audit. No adjustments were proposed in connection with
our previously filed federal income tax returns. Based on the IRS findings, the
Company has recorded a payroll tax liability in the amount of $1,008,000,
included as a component of Accounts Payable and Accrued Liabilities (see Note
6), which was allocated to General and Administrative Expense ($560,000),
Interest Expense ($277,000) and Other Expense from penalties
($171,000). Payments relating to the assessment arising from the 2001
through 2005 audits will not be made until a final agreement is reached between
the Company and the IRS on such assessments or upon a final resolution resulting
from the administrative appeals process or judicial action. Final
determination of adjustment is expected to be received from the IRS during the
second quarter ending March 31, 2010.
The
Company recognizes potential accrued interest and penalties related to uncertain
tax positions in income tax expense, as appropriate. During the three months
ended December 31, 2009 and 2008, the Company did not recognize any amount of
income tax expense from potential interest and penalties associated with
uncertain tax positions.
LOSS
PER SHARE
Basic
loss per share is computed by dividing loss available to common shareholders by
the weighted-average number of common shares outstanding. Diluted loss per share
is computed similar to basic loss per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Common equivalent shares are excluded from the
computation if their effect is anti-dilutive.
The
following common stock equivalents were excluded from the calculation of diluted
loss per share for the three months ended December 31, 2009 and 2008 since their
effect would have been anti-dilutive:
(Unaudited)
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Options
for common stock
|
27,916,797
|
25,099,270
|
||||||
Warrants
for common stock
|
23,014,649
|
24,115,406
|
||||||
Convertible
Debentures, if converted
|
9,128,566
|
9,037,280
|
||||||
60,060,012
|
58,251,956
|
14
RECLASSIFICATIONS
Certain
prior year balances have been reclassified to conform to the current period
presentation. Additionally, as discussed in Note 2, we have classified all
operations of our former DeWind segment as discontinued operations.
RECENT
ACCOUNTING PRONOUNCEMENTS
In June
2009, the FASB issued new rules related to accounting for transfers of financial
assets. These new rules were incorporated into the Accounting Standards
Codification in December 2009 as discussed in FASB Accounting Standards Update
(ASU) No. 2009-16, Transfers
and Servicing (Topic 860): Accounting for Transfers of Financial Assets.
The new rules amend various provisions related to accounting for transfers and
servicing of financial assets and extinguishments of liabilities, by removing
the concept of a qualifying special-purpose entity and removes the exception
from applying FASB rules related to variable interest entities that are
qualifying special-purpose entities; limits the circumstances in which a
transferor derecognizes a portion or component of a financial asset; defines a
participating interest; requires a transferor to recognize and initially measure
at fair value all assets obtained and liabilities incurred as a result of a
transfer accounted for as a sale; and requires enhanced disclosure; among
others. The new rules become effective for the Company on October 1, 2010,
earlier application is prohibited. The adoption of this standard is not expected
to have a material impact on our consolidated financial statements.
In June
2009, the FASB issued new rules to amend certain accounting for variable
interest entities (VIE). These new rules were incorporated into the
Accounting Standards Codification in December 2009 as discussed in FASB ASU No.
2009-17, Consolidation (Topic
810): Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. The new rules require an enterprise to perform an
analysis to determine whether the enterprise’s variable interest or interests
give it a controlling financial interest in a VIE; to require ongoing
reassessments of whether an enterprise is the primary beneficiary of a VIE; to
eliminate the quantitative approach previously required for determining the
primary beneficiary of a VIE; to add an additional reconsideration event for
determining whether an entity is a VIE when any changes in facts and
circumstances occur such that holders of the equity investment at risk, as a
group, lose the power from voting rights or similar rights of those investments
to direct the activities of the entity that most significantly impact the
entity’s economic performance; and to require enhanced disclosures that will
provide users of financial statements with more transparent information about an
enterprise’s involvement in a VIE. The new rules become effective for the
Company on October 1, 2010, earlier application is
prohibited. The adoption of this standard is not expected to have a
material impact on our consolidated financial statements.
In
October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605):
Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging
Issues Task Force (ASU 2009-13). ASU 2009-13 amends accounting
for revenue arrangements with multiple deliverables, to eliminate the
requirement that all undelivered elements have Vendor-Specific Objective
Evidence (VSOE) or Third-Party Evidence (TPE) before an entity can recognize the
portion of an overall arrangement fee that is attributable to items that already
have been delivered. In the absence of VSOE or TPE of the standalone selling
price for one or more delivered or undelivered elements in a multiple-element
arrangement, entities will be required to estimate the selling prices of those
elements. The overall arrangement fee will be allocated to each element (both
delivered and undelivered items) based on their relative selling prices,
regardless of whether those selling prices are evidenced by VSOE or TPE or are
based on the entity's estimated selling price. Application of the "residual
method" of allocating an overall arrangement fee between delivered and
undelivered elements will no longer be permitted upon adoption of ASU 2009-13.
Additionally, the new guidance will require entities to disclose more
information about their multiple-element revenue arrangements. ASU 2009-13 is
effective prospectively for revenue arrangements entered into or materially
modified in fiscal years beginning on or after June 15,
2010. Early adoption is permitted. If a vendor elects
early adoption and the period of adoption is not the beginning of the entity’s
fiscal year, the entity will be required to apply the amendments in this Update
retrospectively from the beginning of the entity’s fiscal
year. Additionally, vendors electing early adoption will be required
to disclose the following information at a minimum for all previously reported
interim periods in the fiscal year of adoption: revenue, income
before income taxes, net income, earnings per share and the effect of the change
for the appropriate captions presented. We are currently evaluating
the impact this standard will have on our consolidated financial
statements.
In
January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures About Fair
Value Measurements. The ASU requires new disclosures about transfers into
and out of Levels 1 and 2 and separate disclosures about purchases, sales,
issuances, and settlements relating to Level 3 measurements. It also clarifies
existing fair value disclosures about the level of disaggregation of disclosed
assets and liabilities, and about inputs and valuation techniques used to
measure fair value for both recurring and nonrecurring fair value measurements
that fall in either Level 2 or Level 3. The new disclosures and
clarifications of existing disclosures are effective for the Company’s second
quarter ending March 31, 2010, except for the disclosures about purchases,
sales, issuances, and settlements relating to Level 3 measurements, which are
effective for the Company’s first quarter of fiscal year 2012. Other than
requiring additional disclosures, the adoption of this new guidance will not
have a material impact on our consolidated financial statements.
Significant
recent accounting policies adopted or implemented during the three months ended
December 31, 2009
On
October 1, 2009, we adopted a new FASB rule that revises existing business
combination rules. The new rule requires most identifiable assets,
liabilities, non-controlling interests, and goodwill acquired in a business
combination to be recorded at “full fair value.” The new rule applies to all
business combinations, including combinations among mutual entities and
combinations by contract alone. Additionally, all business combinations will be
accounted for by applying the acquisition method. The new rule was effective for
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. The adoption of this standard did not have an impact on
our consolidated financial statements.
15
On
October 1, 2009, we adopted new FASB rules related to accounting for assets
acquired and liabilities assumed in a business combination that arise from
contingencies. The new rules apply to all assets acquired and liabilities
assumed in a business combination that arise from certain contingencies as
defined by the FASB and requires (i) an acquirer to recognize at fair
value, at the acquisition date, an asset acquired or liability assumed in a
business combination that arises from a contingency if the acquisition-date fair
value of that asset or liability can be determined during the measurement
period, otherwise the asset or liability should be recognized at the acquisition
date if certain defined criteria are met; (ii) contingent consideration
arrangements of an acquiree assumed by the acquirer in a business combination be
recognized initially at fair value; (iii) subsequent measurements of assets
and liabilities arising from contingencies be based on a systematic and rational
method depending on their nature and contingent consideration arrangements be
measured subsequently; and (iv) disclosures of the amounts and measurement
basis of such assets and liabilities and the nature of the contingencies. The
new rules were effective for business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning
on or after December 15, 2008. The adoption of this standard did not have
an impact on our consolidated financial statements.
On
October 1, 2009, we adopted new FASB rules related to determining the useful
life of intangible assets. The new rules amend the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under existing FASB
rules for goodwill and other intangible assets. This change is intended to
improve the consistency between the useful life of a recognized intangible asset
outside a business combination and the period of expected cash flows used to
measure the fair value of an intangible asset in a business
combination. The new rules were effective for the financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The requirement for
determining useful lives must be applied prospectively to intangible assets
acquired after the effective date and the disclosure requirements must be
applied prospectively to all intangible recognized as of, and subsequent to, the
effective date. The adoption of this standard did not have an impact
on our consolidated financial statements.
On
October 1, 2009, we adopted a new FASB rule related to non-controlling interests
in consolidated financial statements. The new rule requires the ownership
interests in subsidiaries held by parties other than the parent to be treated as
a separate component of equity and be clearly identified, labeled, and presented
in the consolidated financial statements. The new rule was effective for fiscal
years beginning on or after December 15, 2008 and interim periods within
those fiscal years. Earlier adoption was prohibited. The adoption of this
standard did not have an impact on our consolidated financial
statements. On October 1, 2009, we also adopted related guidance,
FASB ASU No. 2010-2, Consolidation (Topic 810):
Accounting and Reporting for Decreases in Ownership of a Subsidiary – a Scope
Clarification, which amended certain provisions of the preceding new
guidance for non-controlling interests and changes in ownership interests of a
subsidiary, specifically related to an entity that experiences a decrease in
ownership in a subsidiary. The new guidance clarifies the scope of
the decrease in ownership provisions. The adoption of this standard
did not have an impact on our consolidated financial statements.
On
October 1, 2009, we adopted new FASB rules related to determining whether an
instrument (or embedded feature) is indexed to an entity’s own
stock. Existing accounting for derivatives and hedging activities,
specifies that a contract that would otherwise meet the definition of a
derivative but is both (a) indexed to the Company’s own stock and (b) classified
in shareholders’ equity in the statement of financial position would not be
considered a derivative financial instrument. The new rules provide a
new two-step model to be applied in determining whether a financial instrument
or an embedded feature is indexed to an issuer’s own stock and thus able to
qualify for the existing scope exception. The new rules were
effective for the first annual reporting period beginning after December 15,
2008, and early adoption is prohibited. The adoption of this new
standard caused a change in our accounting principles, as discussed above in
Note 1 “Derivative Liabilities and Change in Accounting Principle”.
On
October 1, 2009, we adopted the FASB ASU No. 2009-5, Fair Value Measurements and
Disclosures (Topic 820)—Measuring Liabilities at Fair Value, which
changed the fair value accounting for liabilities. These changes clarify
existing guidance that in circumstances in which a quoted price in an active
market for the identical liability is not available, an entity is required to
measure fair value using either a valuation technique that uses a quoted price
of either a similar liability or a quoted price of an identical or similar
liability when traded as an asset, or another valuation technique that is
consistent with the principles of fair value measurements, such as an income
approach (e.g., present value technique) or a market approach. This guidance
also states that both a quoted price in an active market for the identical
liability and a quoted price for the identical liability when traded as an asset
in an active market when no adjustments to the quoted price of the asset are
required, are Level 1 fair value measurements. The adoption of this ASU did not
have an impact on our consolidated financial statements.
NOTE
2 – DISCONTINUED OPERATIONS AND SALE OF DEWIND
As of
December 31, 2009, all operations of our former DeWind segment have been
classified as discontinued operations.
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property and
transferred substantially all operating liabilities including supply chain and
operating expense accounts payables and accrued liabilities, warranty related
liabilities for US turbine installations, and deferred revenues. All
of the remaining assets and liabilities of DeWind have been classified as net
assets or liabilities of discontinued operations. All operations of
our former DeWind segment have been reported as discontinued
operations.
16
The sale
of DeWind was valued at $49.5 million in cash. The Company received
approximately $32.3 million in cash with $17.2 million in cash escrowed to cover
certain contingent liabilities. Of the escrowed cash, $5.5 million is
expected to be released within one year after the achievement of certain
milestones and $11.7 million is expected to be released over time periods that
may be as late as 2012 under certain conditions. The purchase price is further
subject to adjustment based on delivery of the value of the assets transferred
net of liabilities assumed. The Company has placed the $17.2 million
in cash in escrow to indemnify the buyer if claims are made against them by
third parties and those claims are determined to be valid and
enforceable. Our intention is to vigorously defend against any such
claims should they occur. Defense of such claims may result in
additional costs to maintain the Company’s interest in the restricted cash or to
limit potential liability. In the event that claims are successful,
the balance payable to the buyer may include all, part, or cash amounts in
excess of the $17.2 million escrowed, including potentially an additional $17.7
million up to a total of $34.9 million under certain conditions, which are not
expected by the Company. If such claims are successfully made, this
would result in additional losses on the DeWind sale transaction and could
require a substantial refund of the proceeds received. The Company
believes the $17.2 million in escrow will be released per the terms of the
agreement. Accordingly, at December 31, 2009, we have classified the $17.2
million held in escrow as restricted cash, with $5.5 million as current and
$11.7 million as long-term.
The
consolidated assets and liabilities of our former DeWind segment have been
classified on the balance sheet as Net Liabilities of Discontinued
Operations. The asset and liabilities comprising the balances, as
classified in our balance sheets, consist of:
(In Thousands)
|
December 31, 2009
|
September 30, 2009
|
||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
Accounts
Receivable, net
|
$
|
2,408
|
$
|
2,461
|
||||
Prepaid
Expenses and Other Current Assets
|
315
|
61
|
||||||
TOTAL
ASSETS
|
$
|
2,723
|
$
|
2,522
|
||||
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
38,221
|
$
|
39,356
|
||||
Deferred
Revenues and Customer Advances
|
2,785
|
2,869
|
||||||
Warranty
Provision
|
1,002
|
1,244
|
||||||
Total
Current Liabilities
|
42,008
|
43,469
|
||||||
Long-Term
Portion of Warranty Provision
|
1,334
|
1,120
|
||||||
Total
Liabilities
|
43,342
|
44,589
|
||||||
Net
Liabilities of Discontinued Operations
|
$
|
(
40,619
|
)
|
$
|
(
42,067
|
)
|
17
Except
for former intercompany loans, significantly all of the assets and liabilities
of the discontinued operations pertain to activities outside of the United
States, primarily for turbines sold and installed in Europe and South America
and technology licenses to Chinese customers. At December 31, 2009 and
September 30, 2009, included above in Accounts Payable and Other Accrued
Liabilities are net payables related to formerly consolidated, now
insolvent European subsidiaries of approximately $22 million and $22 million,
respectively, substantially all of which has been assigned by the insolvency
receiver to a third party. As of December 31, 2009, the net payables from
insolvent subsidiaries are comprised of assets in the amount of $8 million and
liabilities in the amount of $30 million. We did not receive an update from the
insolvency receiver related to the assets and liabilities for the insolvent
subsidiaries during the quarter ended December 31, 2009.
The
consolidated net loss from operations of our former DeWind segment has been
classified on the statements of operations and comprehensive loss, as Loss from
Discontinued Operations. Summarized results of discontinued operations are as
follows:
Three Months Ended December 31,
|
||||||||
(Unaudited,
In Thousands)
|
2009
|
2008
|
||||||
Revenues
|
$
|
309
|
$
|
6,058
|
||||
Cost
of Revenues
|
790
|
5,813
|
||||||
Operating
Expenses
|
1,283
|
4,444
|
||||||
Other
Income
|
(543
|
)
|
(72
|
)
|
||||
Income
Tax Expense
|
1
|
5
|
||||||
Loss
from Discontinued Operations
|
$
|
(1,222
|
)
|
$
|
(4,132
|
)
|
Since
September 4, 2009, the Company has had no continuing involvement with our former
DeWind segment; any subsequent cash flows are directly related to the
liquidation of the remaining assets and liabilities. No corporate
overhead has been allocated to discontinued operations.
18
NOTE
3 - ACCOUNTS RECEIVABLE
Accounts
receivable, net consists of the following:
(In Thousands)
|
December 31,
2009
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Cable
Receivables
|
$
|
4,351
|
$
|
1,813
|
||||
Reserves
|
(92
|
)
|
(81
|
)
|
||||
Net
Accounts Receivable
|
$
|
4,259
|
$
|
1,732
|
During
the quarter ended December 31, 2009, we recognized large sales from two North
American customers and one South American customer, which significantly
increased our cable receivables balance at December 31, 2009.
NOTE
4 – INVENTORY
Inventories
consist of the following:
(In Thousands)
|
December 31,
2009
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Raw
Materials
|
$
|
2,038
|
$
|
2,040
|
||||
Work-in-Progress
|
—
|
—
|
||||||
Finished
Goods
|
3,659
|
3,261
|
||||||
Gross
Inventory
|
5,697
|
5,301
|
||||||
Reserves
|
(883
|
)
|
(923
|
)
|
||||
Net
Inventory
|
$
|
4,814
|
$
|
4,378
|
19
NOTE
5 – PROPERTY AND EQUIPMENT
Property
and equipment consisted of the following:
(In Thousands)
|
Estimated Useful
Lives
|
December 31,
2009
|
September 30,
2009
|
|||||||||
(unaudited)
|
||||||||||||
Office
Furniture and Equipment
|
3-10
yrs
|
$
|
953
|
$
|
936
|
|||||||
Production
Equipment
|
10-20
yrs
|
5,179
|
4,994
|
|||||||||
Construction-in-Progress
|
—
|
—
|
302
|
|||||||||
Leasehold
Improvements
|
Lesser of lease term or
7 yrs
|
757
|
748
|
|||||||||
Total
Property
|
6,889
|
6,980
|
||||||||||
Accumulated
Depreciation
|
(3,798
|
)
|
(3,766
|
)
|
||||||||
Property
and Equipment, net
|
$
|
3,091
|
$
|
3,214
|
Depreciation
expense was $126,000 and $240,000, for the three months ended December 31, 2009
and 2008, respectively. During the quarter ended December 31, 2009,
the Company changed its method of depreciating Production Equipment, which
included applying an estimated useful life of 10-20 years as compared to a range
of 3-10 years applied in prior periods. Refer to discussion in Note 1
“Property and Equipment – Change in Accounting Estimate”.
NOTE
6 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities consisted of the following:
(In Thousands)
|
December 31,
2009
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Trade
Payables
|
$
|
3,334
|
$
|
4,179
|
||||
Accrued
Commissions
|
635
|
667
|
||||||
Accrued
Insurance
|
53
|
441
|
||||||
Accrued
Payroll and Payroll Related
|
805
|
541
|
||||||
Accrued
Payroll Tax Liability (A)
|
1,008
|
—
|
||||||
Accrued
Interest
|
183
|
183
|
||||||
Deferred
Rents
|
114
|
133
|
||||||
Accrued
Sales Tax
|
128
|
128
|
||||||
Accrued
Other
|
893
|
945
|
||||||
Total
Accounts Payable and Accrued Liabilities
|
$
|
7,153
|
$
|
7,217
|
(A)
|
During
the quarter ended December 31 2009, the Company accrued a payroll tax
liability as a result of an IRS audit (see “Income Taxes” in Note 1 for
additional information).
|
NOTE
7 – DEFERRED REVENUES AND CUSTOMER ADVANCES
The
Company records all cash proceeds received from customers on orders and extended
warranties, as opted by the customer, to deferred revenues and customer advances
until such time as the revenue cycle is completed and the amounts are recognized
into revenues. Deferred revenues and customer advances consist of the
following:
(In Thousands)
|
December 31,
2009
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Deferred
Revenues
|
$
|
2,163
|
$
|
563
|
||||
Customer
Advances
|
—
|
14
|
||||||
Total
Deferred Revenues and Customer Advances
|
2,163
|
577
|
||||||
Less
amount classified in current liabilities
|
1,587
|
16
|
||||||
Long-term
Deferred Revenues
|
$
|
576
|
$
|
561
|
20
Long-term
deferred revenue is comprised of long-term extended warranties.
NOTE 8 –
SHAREHOLDERS’ EQUITY (DEFICIT)
COMMON
STOCK
The
following issuances of common stock were made during the quarter ended December
31, 2009:
CASH
During
the quarter ended December 31, 2009 the Company received $7,000 in cash from the
exercise of 20,000 consultant options.
WARRANTS
The
Company issues warrants to purchase common shares of the Company either as
compensation for consulting services, or as additional incentive for investors
who purchase unregistered, restricted common stock or Convertible Debentures.
The value of warrants issued for compensation is accounted for as a non-cash
expense to the Company at the fair value of the warrants issued. The value of
warrants issued in conjunction with financing events is either a reduction in
paid in capital for common stock issuances or as a discount for debt issuances.
The Company values the warrants at fair value as calculated by using the
Black-Scholes option-pricing model. See Note 1 “Derivative
Liabilities” for additional warrants accounting and disclosure.
The
following table summarizes the Warrant activity for the three months ended
December 31, 2009:
(Unaudited)
|
Number
of
Warrants
|
Weighted-Average
Exercise
Price
|
||||||
Outstanding,
September 30, 2009
|
22,934,649 | $ | 0.95 | |||||
Granted
|
300,000 | 0.45 | ||||||
Exercised
|
— | — | ||||||
Cancelled
|
(220,000 | ) | 1.10 | |||||
OUTSTANDING,
December 31, 2009
|
23,014,649 | $ | 0.94 | |||||
EXERCISABLE,
December 31, 2009
|
23,014,649 | $ | 0.94 |
On
November 13, 2009 we issued 300,000 warrants with a strike price of $0.45 per
warrant and a two-year life in settlement of a legal dispute. We
valued the warrants at $57,000 using the Black-Scholes-Merton option pricing
model and the following assumptions:
Dividend
rate = 0%
Risk free
return of 0.82%
Volatility
of 108%
Market
price of $0.37 per share
Maturity
of 2 years
Management
has reviewed and assessed the warrants issued during the three months ended
December 31, 2009 and determined that they do not qualify for treatment as
derivatives under applicable US GAAP rules.
NOTE 9 –
EQUITY BASED COMPENSATION
The
Company historically has issued equity based compensation in the form of stock
options to its employees and consultants via option grants. The Company uses the
guidelines of the FASB which require fair value calculations of the grant and
recognition of the cost of employee services received in exchange for the award
over the period the employee is required to perform the services.
The
values of the financial instruments are estimated using the Black-Scholes
option-pricing model. Key assumptions used during the three months ended
December 31, 2009 and 2008 to value options granted are as
follows:
21
Three Months Ended
|
||||||
December 31,
|
||||||
2009
|
2008
|
|||||
Risk
Free Rate of Return
|
2.18-2.30
|
% |
n/a
|
|||
Volatility
|
96
|
% |
n/a
|
|||
Dividend
yield
|
0
|
% |
n/a
|
|||
Expected
life
|
5 years
|
n/a
|
Our
computation of expected volatility for the three months ended December 31, 2009
is based on historical volatility over the expected life of the options granted.
Our computation of expected life is based on historical exercise patterns
pursuant to SEC guidelines. The interest rate for periods within the contractual
life of the award is based on the U.S. Treasury yield curve in effect at the
time of grant.
Share-based
compensation included in the results of operations for the three months ended
December 31, 2009 and 2008 is as follows:
(Unaudited,
In Thousands)
|
Three Months Ended December 31,
|
|||||||
2009
|
2008
|
|||||||
Cost
of Product Sold
|
$
|
18
|
$
|
16
|
||||
Officer
Compensation
|
327
|
492
|
||||||
Selling
and marketing
|
85
|
237
|
||||||
Research
and development
|
52
|
167
|
||||||
General
and administrative
|
182
|
217
|
||||||
Totals
|
$
|
664
|
$
|
1,129
|
The
Company recorded $69,000 and $423,000 of equity-based compensation into
discontinued operations for the quarters ended December 31, 2009 and 2008
respectively.
As of
December 31, 2009, there was $4.3 million of total unrecognized compensation
cost related to non-vested share-based compensation arrangements related to
stock options. The costs are expected to be recognized over a weighted-average
period of 1.6 years. For options that vest on a quarterly basis, the
actual vesting is used to calculate the compensation expense. For
options vesting on other than a quarterly basis, an estimate of the forfeiture
rate, between 0% and 15%, is used to calculate the expense, which is then
trued-up on each vesting occurrence.
Significantly
all of our existing options are subject to time of service vesting. Our stock
options vest either on an annual or a quarterly basis for options subject to
time of service vesting or for specific performance for option vesting tied to
performance criteria. For the remainder of fiscal 2010, we expect share-based
compensation expense related to employee stock options, of approximately
$2,000,000 before income taxes. Such amounts may change as a result of
additional grants, forfeitures, modifications in assumptions and other
factors.
Certain
options granted under the 2008 Plan may be exercised at any time for restricted
stock of the Company if not otherwise prohibited by the Company’s Board of
Directors. Any 2008 Plan option exercises for unvested options have
restricted stock issued that is earned according to the terms of the option
agreement that gave rise to the restricted stock issuance. The
Company has the right, but not the obligation, to repurchase restricted stock
that is unearned as of the date of any optionee’s termination. As of
December 31, 2009 all of the 2008 Plan option grants were exercisable. To date,
no restricted stock has been issued under the 2008 Plan. Of the 2008
plan options exercisable, 3,351,712 options were vested and exercisable into
unrestricted stock.
The
following table summarizes the Stock Plan stock option activity as of December
31, 2009:
(Unaudited)
|
|
2002 Plan
Number of
Options
|
|
|
2008 Plan
Number of
Options
|
|
|
Total Number of
Options
|
|
|
Average
Exercise
Price
|
|
||||
Outstanding, September 30, 2009
|
|
|
16,212,156
|
9,688,808
|
25,900,964
|
$
|
0.35
|
|||||||||
Granted
|
—
|
2,140,000
|
2,140,000
|
0.35
|
||||||||||||
Exercised
|
(20,000
|
)
|
—
|
(20,000
|
)
|
0.35
|
||||||||||
Cancelled
|
(27,916
|
)
|
(76,251
|
)
|
(104,167
|
)
|
0.35
|
|||||||||
Outstanding,
December 31, 2009
|
16,164,240
|
11,752,557
|
27,916,797
|
$
|
0.35
|
|||||||||||
Exercisable
, December 31, 2009
|
14,545,142
|
11,752,557
|
26,297,699
|
$
|
0.35
|
22
The
weighted-average remaining contractual life of the options outstanding at
December 31, 2009 was 6.5 years. The exercise prices of the options outstanding
at December 31, 2009 ranged from $0.25 to $1.00, and information relating to
these options is as follows (unaudited):
Range
of
Exercise
Prices
|
Stock Options
Outstanding
|
Stock
Options
Exercisable
|
Weighted
Average
Remaining
Contractual
Life in years
|
Weighted
Average
Exercise Price
of Options
Outstanding
|
Weighted Average
Exercise Price of
Options
Exercisable
|
|||||||||||||||
$0.25-0.34
|
728,000 | 728,000 | 7.0 | $ | 0.25 | $ | 0.25 | |||||||||||||
$0.35-$0.49
|
27,159,397 | 25,540,299 | 6.5 | $ | 0.35 | $ | 0.35 | |||||||||||||
$1.00-$1.49
|
29,400 | 29,400 | 1.1 | $ | 1.00 | $ | 1.00 | |||||||||||||
Total
|
27,916,797 | 26,297,699 |
NOTE
10 – LITIGATION
DeWind
Ltd.v. FKI Plc. and FKI Engineering Ltd.
On
October 30, 2009 the Company’s wholly owned subsidiary, DeWind Ltd., filed an
action for negative declaration in the Court of Lubeck, Germany against FKI
(Case No. 23568 Lubeck) to set the value of the intellectual property of DeWind
GmbH that had been transferred to DeWind Ltd. in August, 2008 and to verify the
propriety of the transfer. The intellectual property had been transferred
under the terms of a DeWind intercompany agreement for 500,000 Euros ($698,000
at January 29, 2010 exchange rates) prior to the DeWind GmbH insolvency filing.
FKI claims the value of the intellectual property is significantly higher
and as a result, that the transfer was improperly conducted. The Company
believes that fair market value was paid for this intellectual
property. FKI was formally served in November, 2009 on this negative
declaratory relief action. DeWind Ltd. has not recorded a liability
associated with the difference in the price paid by DeWind Ltd. and any value
claimed by FKI, as it is uncertain whether the court will uphold or deny the
compensation paid by DeWind Ltd. for the intellectual property.
On or
about January 21, 2010, FKI Engineering Ltd. and FKI Engineering, formerly FKI
Plc., filed an action against Stribog Ltd., formerly DeWind Ltd., in the
Commercial Court, Queen’s Bench Division, United Kingdom (Case No. 2010 Folio
61). FKI’s claim is brought pursuant to an assignment agreement
executed by the insolvency administrator assigning FKI the right to pursue
claims on behalf of DeWind GmbH for amounts allegedly owed to DeWind GmbH from
various companies. FKI claims that DeWind Ltd. is in breach of an
August 1, 2005 business transfer agreement where DeWind GmbH agreed to sell and
DeWind Ltd. agreed to purchase the assets of DeWind GmbH. FKI claims
that DeWind GmbH is owed approximately 46,681,543 Euros ($65,195,000 at January
29, 2010 exchange rates). DeWind Ltd. disputes that it owes any funds
to DeWind GmbH and is vigorously contesting the validity of this
allegation.
FKI
PLC and FKI Engineering Ltd v. Composite Technology Corporation
On April
30, 2009, FKI PLC and FKI Engineering Ltd. (FKI) filed a petition with the
United States District Court, Central District of California, under 28 U.S.C.
§1782(a) (Case No. CV-09-5975-ABC(CFE) ), asking the Court to permit FKI to
proceed with certain discovery in the United States against the Company for use
in the DeWind GmbH and DeWind Holdings insolvency
proceedings. On August 28, 2009, the Court entered an
order requiring the Company to produce all responsive documents no later than
September 4, 2009. On September 4, 2009, the Company produced
documents in compliance with the Court’s order. Thereafter, FKI filed
a motion with the Court claiming that the Company failed to fully comply with
the August 28, 2009 order. On December 8, 2009, the Court issued an
order requiring the Company to pay FKI $51,000 for attorney’s fees and costs
incurred by FKI together with a $1,000 penalty for every day from November 19,
2009 until the August 28, 2009 order was fully complied with. The
Company believes that it fully complied with both the August 28, 2009 and the
December 8, 2009 orders and has appealed the magistrate’s ruling.
Composite
Technology Corporation and CTC Cable Corporation v. Mercury Cable & Energy,
LLC, Ronald Morris, Edward Skonezny, Wang Chen, and “Doe” Defendants 1-100
(“Mercury”)
On August
15, 2008 the Company filed suit in the Superior Court of the State of
California, County of Orange, Central Justice Center (Case No. 30-2008 00110633)
against the Mercury parties including multiple unknown “Doe” defendants,
expected to be named in discovery proceedings, claiming Breach of Contract,
Unfair Competition, Fraud, Intentional Interference with Contract, and
Injunctive Relief. Several of the Mercury parties had filed a claim
under the Company’s Chapter 11 bankruptcy proceedings which was settled during
the bankruptcy and which provided for certain payments from the Mercury parties
to the Company for sales made to China. The settlement agreement
included non-compete agreements and stipulated the need to maintain
confidentiality for the Company’s technology, processes, and business
practices. The Company claims that the Mercury parties have taken
actions, which violate the Settlement Agreement and the Bankruptcy Court Order,
including the development of and attempting to market similar conductor products
and misusing confidential information and the Company further claims that the
Settlement Agreement was entered into with fraudulent intent. The
Company claims that the Mercury parties engaged in unlawful, unfair, and
deceptive conduct and that these actions were performed with malice and with
intent to cause injury to the Company. The Company is asking for
actual damages, punitive damages, and attorney’s fees. No estimate of
such damages can be made at this time and no accrual for such fees is included
in the Company’s financial statements at December 31, 2009.
23
On
December 5, 2008, Defendants filed a cross-complaint against CTC and some of the
Company's officers. Defendants served the cross-complaint only on the Company
(i.e., none of the individual cross-defendants have been served). The Company
filed several motions aimed at dismissing certain of the cross-claims, which
resulted in the Defendants filing several amended pleadings. On May 12, 2009 the
Court granted the Company’s motion directed to the sixth cause of action
contained in the second amended cross-complaint, and dismissed that claim with
prejudice. The Defendants’ cross-complaint asserts claims for fraud
in inducing the settlement agreement, rescission of the settlement agreement,
breach of the settlement agreement, accounting, and declaratory
relief.
On March
2, 2009, the Company’s subsidiary, CTC Cable Corporation ("CTC Cable"), filed a
lawsuit against Mercury Cable & Energy, LLC ("Mercury") in the United States
District Court for the Central District of California, Southern Division (Case
No. SA CV 09-261 DOC (MLGx)), seeking damages for infringement of CTC Cable's
United States Patent No. 7,368,162 (’162) and United States Patent No. 7,211,319
(‘319), and for infringement of a CTC Cable copyright
registration. The Company is asking for actual damages, treble
damages, attorneys fees, interest, costs and injunctive relief. No
estimate of such damages can be made at this time and no accrual for the
Company’s future fees and costs is included in the Company's financial
statements at December 31, 2009.
In
response to this lawsuit, Mercury has requested the United States Patent and
Trademark Office reexamine the '162 and '319 patents and requested the Court to
stay the patent and copyright lawsuit pending the Patent Office's final
reexamination of CTC's patents. The Court granted Mercury's request
to stay the lawsuit pending the Patent Office’s final decisions. CTC's copyright
infringement claim is also stayed pending the Patent Office’s
decisions.
On
November 4, 2009, the Patent Office issued a first Office Action in the
re-examination of the '319 patent. As is common practice, the Patent
Office has initially rejected most of the claims based on the prior art patents
submitted with Mercury's reexamination request pending response by CTC. However,
the Patent Office did confirm the validity of claim 17 of reexamination request.
CTC is currently preparing a full and complete response to this Office Action.
On November 23, 2009, Mercury issued a press release falsely stating that the
Patent Office “invalidated” 28 of 29 claims contained in the '319
patent. Contrary to Mercury's latest press release, the Office Action
did not serve to invalidate any claims of the patent and all of the Company’s
patent claims being reexamined are in force during the pendency of the
reexamination.
In
Re Composite Technology Corporation Derivative Litigation (Brad Thomas v. Benton
Wilcoxon, Michael Porter, Domonic J. Carney, Michael McIntosh, Stephen Bircher,
Rayna Limited, Keeley Services Limited, Ellsford Management Limited, Laikadog
Holdings Limited, James Carkulis, and Does 1 through 1000 (including D. Dean
McCormick, III, CPA as Doe 1, John P. Mitola, as Doe 2, and Michael K. Lee, as
Doe 3) and Nominal Defendant Composite Technology Corporation)
On June
26, 2009 Mr. Brad Thomas, alleged to be a shareholder of the Company, filed a
shareholder derivative complaint in the Superior Court of the State of
California, County of Orange (Case No. 30-2009-00125211) for damages and
equitable relief. The complaint asserts claims for negligence, gross
negligence, breach of fiduciary duty, waste, mismanagement, gross mismanagement,
abuse of control, negligent misrepresentation, intentional misrepresentation,
fraudulent promise, constructive fraud, and violations of the California
Corporations Code, and seeks an accounting, rescission and/or
reformation. The facts focus on the Company’s acquisition of its
DeWind subsidiary and also related self-interested transactions, accounting
deficiencies and misstatements. Certain of the defendants are current
directors and/or officers or past officers of the Company. Under the
Company’s articles of incorporation and bylaws, the Company is obligated to
provide for indemnification for director and officer liability.
On
October 13, 2009, the Company and the individual defendants filed demurrers
(motions to strike) to the Complaint on the grounds that Plaintiff Thomas did
not make a written demand on the Company’s board of directors prior to filing
the Complaint as required under Nevada law and that any decisions made by the
individual director/office defendants in relation to the subject matter of the
Complaint are protected under the business judgment rule. Prior to
the scheduled hearing on the demurrer, Plaintiff Thomas filed a First Amended
Complaint on or about November 11, 2009 naming three additional current board
members. In addition, on October 20, 2009, the Company filed a Motion
to Stay Discovery in this matter on the grounds that Plaintiff Thomas should not
be permitted to conduct discovery until such time as the dispute over the
sufficiency of the First Amended Complaint is decided by the Court. On January
22, 2010, the Company filed another demurrer (motion to strike) to the First
Amended Complaint on the same grounds as the original demurrers. On
January 27, 2010, the Court conducted a hearing on the merits of the demurrer
and took the matter under submission. A ruling is expected within the
next few weeks. The Court further ordered that all discovery in the
matter is stayed pending its ruling on the demurrer. The
Company has not reserved any amounts for this litigation as the amounts are
undeterminable and are further eligible for reimbursement under existing
insurance policies.
NOTE
11 – SEGMENT INFORMATION
As of
December 31, 2009, we manage and report our operations through one business
segment: CTC Cable. During the year ended September 30, 2009 we
revised our segments to reflect the disposal of DeWind. DeWind comprised our
previously reported Wind segment, which has been presented as discontinued
operations in our Consolidated Financial Statements (see Note
2). When applicable, segment data is organized on the basis of
products. Historically, the Company evaluates the performance of its operating
segments primarily based on revenues and operating income, any transactions
between reportable segments are eliminated in the consolidation of reportable
segment data.
24
Located
in Irvine, California with sales personnel located near Portland, Oregon and
Atlanta, Georgia, CTC Cable produces and sells ACCC®
conductor and related ACCC® hardware
products for the electrical transmission market. ACCC®
conductor production is a two step process. The Irvine operations produce the
high strength, light weight composite “core” which is then shipped to one of
four cable manufacturers in Canada, Belgium, China, or Bahrain where the core is
stranded with conductive aluminum wire to become ACCC®
conductor. ACCC®
conductor is sold both through a distribution agreement in the US and Canada,
into China through our distribution agreement with Far East Composite
Cable, as well as directly by CTC Cable to utility customers
worldwide. ACCC®
conductor has been sold commercially since 2005 and is currently marketed
worldwide to electrical utilities and transmission companies.
The
Company operates and markets its services and products on a worldwide
basis:
(Unaudited,
In Thousands)
|
Three Months Ended December 31,
|
|||||||
2009
|
2008
|
|||||||
Europe
|
$ | 88 | $ | 732 | ||||
China
|
— | 2,378 | ||||||
Other
Asia
|
7 | 9 | ||||||
North
America
|
1,177 | 715 | ||||||
South
America
|
1,429 | 1 | ||||||
Mexico
|
— | 525 | ||||||
Total
Revenue
|
$ | 2,701 | $ | 4,360 |
All
long-lived assets, comprised of property and equipment, are located in the
United States.
For the
three months ended December 31, 2009, three customers represented 93.0% of
revenue (two the U.S. at 40.0% and one in Chile, South America at
53.0%). For the three months ended December 31, 2008, four customers
represented 95.0% of revenue (one in China at 54.5%, one in Europe at 16.5%, one
in Canada at 12.0% and one in Mexico at 12.0%). No other customer
represented greater than 5% of consolidated revenue.
NOTE
12 – SUBSEQUENT EVENTS (Unaudited)
Management
evaluated all activity of the Company through February 9, 2010 (the issue date
of the consolidated financial statements) and concluded that no subsequent
events have occurred that would require recognition in the consolidated
financial statements or disclosure in the notes to financial statements, except
as disclosed below.
On
January 31, 2010 the Company repaid in full all outstanding Convertible Notes
payable. A total of $9,037,000 plus interest for the month of
January, 2010 was repaid.
On
December 4, 2009 Daewoo Shipbuilding and Marine Engineering (DSME) provided
the Company with a preliminary net asset value calculation in accordance with
the terms and conditions of the Asset Purchase Agreement dated September 4,
2009. The Company responded with an adjusted net asset value
calculation on December 16, 2009. In January, 2010 the Company and
DSME had a series of meetings to discuss the differences. Final
negotiations and resolution of all differences is expected during the March,
2010 quarter.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
You
should read the following discussion and analysis of our financial condition and
results of operations together with our interim financial statements and the
related notes appearing at the beginning of this report. The interim financial
statements and this Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the financial
statements and notes thereto for the year ended September 30, 2009 and the
related Management's Discussion and Analysis of Financial Condition and Results
of Operations, both of which are contained in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on December 14,
2009.
The
following discussion and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Forward-looking statements can
be identified by words such as “anticipates,” “expects,” “believes,” “plans,”
and similar terms. Our actual results could differ materially from any future
performance suggested in this report as a result of factors, including those
discussed in “Factors That May Affect Future Operating Results” and elsewhere in
this report and in our Annual Report on Form 10-K for the fiscal year ended
September 30, 2009. All forward-looking statements are based on information
currently available to Composite Technology Corporation and we assume no
obligation to update such forward-looking statements, except as required by law.
Service marks, trademarks and trade names referred to in this Form 10-Q are the
property of their respective owners.
25
OVERVIEW
The
financial results for the quarter ended December 31, 2009 reflected revenue
declines caused by significant order reductions from customers in China, Mexico,
and Europe. These declines were partially offset by order increases
from North and South American customers. CTC Cable business growth slowed due to
the continuing worldwide economic downturn that resulted in delays of several
anticipated line projects that had specified ACCC®
conductor in both new international markets and the United
States. This resulted in a decrease to 155 kilometers of
ACCC® products
shipped in the December, 2009 quarter from 562 kilometers in the December, 2008
quarter. The decrease in shipments resulted in significant decreases
in production levels during the quarter for our manufacturing plant in
Irvine. While our individual sales at historical standard costs were
in line with historical margins, the historically low utilization of our plant
resulted in a much less efficient allocation of our fixed overhead and trained
production labor force. If order levels and production levels
increase, the Company expects to see gross margins in line with historical
levels.
During
the quarter, the Company hired John P. Brewster as Chief Commercial Officer of
Composite Technology Corporation and President of CTC Cable
Corporation. Mr. Brewster brings over thirty years of U.S. and
international utility operations and business development experience in a senior
management capacity. The Company believes that Mr. Brewster will be
instrumental in our domestic and international business development expansion
strategy.
In
February 2010, CTC Cable signed multi-year distribution and manufacturing
agreements with Alcan Cable. The distribution agreement calls for
Alcan to distribute ACCC®
conductor to certain of their customers. In exchange for exclusive
relations with certain large Alcan customers in the U.S., Alcan has agreed to
purchase minimum quantities of ACCC®
conductor during calendar year 2010 and potentially through 2012. The
distribution agreement provides CTC Cable with an immediate additional market
presence in the U.S. CTC Cable expects that the Alcan Cable
distribution agreement will provide revenue orders beginning later in
2010. The manufacturing agreement calls for Alcan to receive a
license to strand ACCC®
conductor for delivery in North America after certification requirements are
met, which is expected later in 2010.
CTC Cable
Division
Located
in Irvine, California with sales operations in Irvine, California, China,
Europe, the Middle East, and Brazil, CTC Cable produces and sells ACCC®
conductor products and related ACCC® hardware
products. ACCC®
conductor production is a two step process. The Irvine operations produce the
high strength, light weight, composite ACCC® core,
which is then shipped to one of seven conductor stranding licensees in the U.S.,
Canada, Belgium, China, Indonesia or Bahrain where the core is stranded with
conductive aluminum to become ACCC®
conductor. ACCC®
conductor is sold in North America directly by CTC Cable to
utilities. ACCC®
conductor is sold elsewhere in the world directly to utilities as well as
through license and distribution agreements with Lamifil in Belgium, Far East
Composite Cable Company in China, Midal in Bahrain, and through two Indonesian
companies PT Tranka Cable and PT KMI Cable and now through Alcan Cable in the
U.S. ACCC®
conductor has been sold commercially since 2005 and is currently marketed
worldwide to electrical utilities, transmission companies and transmission
design/engineering firms.
RECENT
DEVELOPMENTS
Looking
forward into the remainder of fiscal 2010, we expect to continue our focus on
penetrating new markets, monetizing existing markets through follow-on orders,
continue to leverage our new and existing distributors, and restart our
currently lagging Chinese market. To assist us in these endeavors, on
December 14, 2009 the Company announced the hiring of John P. Brewster as Chief
Commercial Officer of Composite Technology Corporation and President of CTC
Cable Corporation. Mr. Brewster brings over thirty years of U.S.
utility operations and business development experience in a senior management
capacity, including employment with NRG Energy Inc. as Executive VP of
Operations of both domestic and international activities. Most
recently, he served as Executive Vice President and Chief Operating Officer of
Calera Corporation, a startup company dedicated to reversing global warming by
capturing and storing greenhouse gases, where he continues as a senior
advisor. The Company believes that Mr. Brewster will be instrumental
in our domestic and international sales expansion strategy.
The sales
efforts of CTC Cable’s sales, marketing, and business development teams are
beginning to pay dividends from investments in prior years. Revenues
to customers outside of China increased 36% from the December, 2008 quarter as
the customer base continues to expand. Our team has focused on
negotiating additional stranding relationships and distribution agreements
worldwide. Most recently, in February 2010, CTC Cable signed
multi-year distribution and manufacturing agreements with Alcan Cable. In
exchange for exclusive sales and marketing relations with certain large U.S.
based customers, Alcan has agreed to purchase minimum quantities of ACCC®
conductor during calendar year 2010 and potentially through 2012. CTC Cable
expects that the Alcan Cable distribution agreement will provide revenue orders
beginning later in 2010. The agreements are expected to provide CTC Cable with a
U.S. based stranding manufacturer later in 2010 and for an immediately improved
market presence in the U.S.
We will
continue to work to expand our ACCC®
conductor production capacity through stranding and manufacturing agreements
with targeted manufacturers worldwide. Discussions with new stranding
partners are underway at multiple locations worldwide in particular with several
additional stranding manufacturers and distributors in China, South America, and
Mexico. Additional sales efforts are also underway in the Middle
East, Europe, India, and Africa.
26
CTC Cable
Revenues were as follows for the three months ended December 31, 2009 and
2008:
(Unaudited,
In Thousands - except kilometer related amounts)
|
Three
Months Ended
December
31,
|
|||||||
2009
|
2008
|
|||||||
Europe
|
$
|
88
|
$
|
732
|
||||
China
|
—
|
2,378
|
||||||
Other
Asia
|
7
|
9
|
||||||
North
America
|
1,177
|
715
|
||||||
South
America
|
1,429
|
1
|
||||||
Mexico
|
—
|
525
|
||||||
Total
Revenue
|
$
|
2,701
|
$
|
4,360
|
||||
Kilometers
shipped
|
155
|
562
|
||||||
Revenue
per kilometer
|
$
|
14,226
|
$
|
6,357
|
The
increase in revenues per kilometer was due to nearly all of the December 2009
quarter sales from ACCC®
conductor while 2008 had more ACCC® core
sales including all of the $2.4 million sold to China. Our firm order
backlog as of December 31, 2009 was $6.5 million. We have not
included any Alcan Cable orders in our backlog figures.
Our gross
margins for the December 2009 quarter were negatively impacted by several
factors. During the December 2009 quarter, we sold primarily
ACCC®
conductor, which carries lower margins per revenue dollar. In
addition, our plant utilization was inefficient during the quarter due to the
low production levels. Our plant carries significant fixed costs for
rent and to provide for the trained labor force necessary to build our ACCC® core
including our production teams, quality assurance, and infrastructure
groups. During the December 2009 quarter, we produced at less than
10% plant capacity while our expected cost allocation is based on plant
utilization in excess of 20%. This resulted in negative production cost
variances that will be reduced with additional plant
production. Finally, we had higher than normal scrap costs due to a
one-time write-off of inventoried ACCC®
core.
CTC Cable
operating expenses increased from the December 2008 quarter due to a $0.5
million increase in expenses, primarily related to reallocation of personnel and
overhead costs to general and administrative expenses from production related
expenses which are normally recorded to inventory and costs of sales and which
were caused by the low plant utilization.
DeWind Asset
Sale
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property. The
sale of the DeWind net assets was for $49.5 million in cash. The
Company received approximately $32.3 million in cash in fiscal 2009 with $17.2
million in cash placed in escrow to cover certain contingent
liabilities and adjustments based on delivery of the value of the net value of
the assets transferred, after liabilities. Of the cash in escrow,
$5.5 million is expected to be released in fiscal 2010 after the achievement of
certain milestones and $11.7 million is expected to be released over time
periods that may be as late as 2012 under certain conditions. The asset sale
agreement calls for a true-up mechanism on the fair value of the assets sold.
The Company and DSME are currently finalizing the value of the assets
transferred and expect to mutually agree to a value during the quarter ended
March 31, 2010.
As of
December 31, 2009, the remaining assets and liabilities of the discontinued
operations consist of the following:
(Unaudited,
In Thousands)
|
December 31, 2009
|
|||
ASSETS
|
||||
Accounts
Receivable, net
|
$
|
2,408
|
||
Prepaid
Expenses and Other Current Assets
|
315
|
|||
TOTAL
ASSETS
|
$
|
2,723
|
||
LIABILITIES
|
||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
38,221
|
||
Deferred
Revenues and Customer Advances
|
2,785
|
|||
Warranty
Provision
|
2,336
|
|||
Total
Liabilities
|
43,342
|
|||
Net
Liabilities of Discontinued Operations
|
$
|
(
40,619
|
)
|
27
Significantly
all of the assets and liabilities of the discontinued operations pertain to
activities outside of the United States, primarily for turbines sold and
installed in Europe and South America and technology licenses to Chinese
customers. At December 31, 2009, included above in Accounts Payable
and Other Accrued Liabilities are net payables related to formerly consolidated,
now insolvent European subsidiaries of approximately $22 million, substantially
all of which has been assigned by the insolvency receiver to FKI, a former owner
of DeWind engaged in discovery and threats of litigation with Stribog Ltd.,
formerly DeWind Ltd. As of December 31, 2009, the
net payables to insolvent subsidiaries are comprised of assets in the
amount of $8 million and liabilities in the amount of $30 million. We did not
receive an update from the insolvency receiver related to the assets and
liabilities for the insolvent subsidiaries during the quarter ended December 31,
2009.
RESULTS
OF OPERATIONS
The
following table presents a comparative analysis of Revenue, Cost of Revenues,
and Gross Margins for continuing operations, our CTC cable
division:
Three
Months Ended
December
31,
|
||||||||
(Unaudited,
In Thousands)
|
2009
|
2008
|
||||||
Product
Revenue
|
$
|
2,701
|
$
|
4,360
|
||||
Cost
of Revenue
|
$
|
2,483
|
$
|
3,082
|
||||
Gross
Margin
|
$
|
218
|
$
|
1,278
|
||||
Gross
Margin %
|
8.1
|
%
|
29.3
|
%
|
PRODUCT
REVENUE: Product revenues decreased $1.7 million, or 38%, from $4.4
million in 2008 to $2.7 million for the three months ended December 31,
2009.
The
decrease for the three months ended December 31, 2009 was primarily related to a
significant decline in shipments of 340 km of ACCC® products
to China.
COST OF
REVENUE: Cost of revenue represent materials, labor, freight, product cost
depreciation and allocated overhead costs to produce ACCC®
conductor, ACCC® core,
and related hardware. Cost of revenue decreased $0.6 million, or 19%,
from $3.1 million in 2008 to $2.5 million for the three months ended December
31, 2009.
Cost of
revenue and resultant gross margin: The three months ended December 31,
2009 gross margin percentage decreased primarily due to production
inefficiencies as a result of significant idle production capacity, and
inventory reserves recorded in the quarter.
The
following table presents a comparative analysis of operating expenses for
continuing operations:
Three Months Ended December
31,
|
||||||||||||||||||||||||
2009
|
2008
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
Officer
Compensation
|
$ | 569 | $ | — | $ | 569 | $ | 743 | $ | — | $ | 743 | ||||||||||||
General
and Administrative
|
2,607 | 1,257 | 3,864 | 1,499 | 738 | 2,237 | ||||||||||||||||||
Research
and Development
|
— | 656 | 656 | — | 673 | 673 | ||||||||||||||||||
Sales
and Marketing
|
— | 1,137 | 1,137 | — | 1,289 | 1,289 | ||||||||||||||||||
Depreciation
and Amortization
|
— | 97 | 97 | — | 90 | 90 | ||||||||||||||||||
Total
Operating Expenses
|
$ | 3,176 | $ | 3,147 | $ | 6,323 | $ | 2,242 | $ | 2,790 | $ | 5,032 |
OFFICER
COMPENSATION: Officer Compensation represents CTC Corporate expenses and
consists primarily of salaries, consulting fees paid in cash, and the fair value
of stock grants issued to officers of the Company. Officer compensation
decreased $0.2 million, or 23%, from $0.7 million in 2008 to $0.6 million for
the three months ended December 31, 2009. The decrease from 2008 to
2009 was primarily due to lower fair value share-based compensation expense for
vested stock options.
GENERAL
AND ADMINISTRATIVE: General and administrative expense consists primarily of
salaries and employee benefits for administrative personnel, professional fees,
facilities costs, insurance, travel, share-based compensation charges and any
expenses related to reserves for uncollectible receivables. G&A expense
increased $1.6 million, or 73%, from $2.2 million in 2008 to $3.9 million for
the three months ended December 31, 2009.
28
The
increase of $1.6 million for the three months ended December 31, 2009 was due to
a $1.1 million increase from corporate and $0.5 million increase from
Cable. The corporate related G&A increase is derived primarily
from increases in professional service fees, start-up costs related to the
organization of a new entity, and payroll taxes accrued in connection with an
IRS payroll tax audit as discussed in Note 1 (“Income Taxes”) to the
consolidated financial statements. The $0.5 million increase in Cable
related G&A is derived primarily from $0.5 million in headcount and
facilities costs due to significant idle capacity during the three months ended
December 31, 2009.
RESEARCH
AND DEVELOPMENT: Research and development expenses consist primarily
of salaries, consulting fees, materials, tools, and related expenses for work
performed in designing and developing of manufacturing processes for the
Company's products. Research and Development expenses decreased slightly by
$17,000, or 3%, from $0.7 million in 2008 and remained flat for the three months
ended December 31, 2009.
The
slight net decrease of $17,000 for the three months ended December 31, 2009 was
due to decreases in headcount costs and R&D product testing costs, offset by
higher share-based compensation charges and professional service
fees.
SALES AND
MARKETING: Sales and marketing expenses consist primarily of salaries,
consulting fees, materials, travel, and other expenses performed in marketing,
sales, and business development efforts for the Company. Sales and marketing
expenses decreased $0.2 million, or 12%, from $1.3 million in 2008 to $1.1
million for the three months ended December 31, 2009.
The
decrease of $0.2 million for the three months ended December 31, 2009 was
primarily related to a $0.2 million decrease in share-based compensation
charges, with equally offsetting decreases and increases primarily in headcount
costs and professional services fees, respectively.
DEPRECIATION
AND AMORTIZATION: Depreciation and amortization expense consists of the
depreciation and amortization of the Company's capitalized assets used in
operations, excluding product cost depreciation (refer to cost of revenue
discussion above). Depreciation expense increased $7,000, or 8%, from
$90,000 in 2008 to $97,000 for the three months ended December 31, 2009. The
increase was due to minor increases in the fixed asset base.
INTEREST
EXPENSE: Interest expense consists of the cash interest payable on the Company’s
Convertible Note and the amortization of the Convertible Note discount recorded
for the value of the warrants and conversion features issued in conjunction with
the Convertible Notes.
The
increase of $435,000 for the three months ended December 31, 2009, or 95%, was
primarily due to 1) interest charges resulting from an IRS payroll tax audit as
discussed in Note 1 (“Income Taxes”) to the consolidated financial statements,
and 2) the adoption of a new accounting principle (see Note 1 “Derivative
Liabilities and Change in Accounting Principle”) which resulted in additional
amortization from a newly recorded discount in connection with the convertible
debt issued in February 2007.
As of
December 31, 2009 our debt balance consisted of principal debt at 8% interest,
less unamortized debt discounts of $95,000, for a net debt balance of
approximately $9.0 million.
INTEREST
INCOME: The interest income changes from period to period are due to changes in
the underlying cash balances. Interest income increased by $6,000 in
the three months ended December 31, 2009 compared to the same period in the
prior year. The cash level at December 31, 2009 was higher than
December 31, 2008 primarily due to the DeWind sale in September
2009.
CHANGE IN
FAIR VALUE OF DERIVATIVE LIABILITIES: Refer to discussion at Note 1 (“Derivative
Liabilities”) to the consolidated financial statements.
INCOME
TAXES: We made provisions for income taxes of $14,000 and
$3,000 for the three months ended December 31, 2009 and 2008, respectively.
We have determined that due to our continuing operating losses as well as the
uncertainty of the timing of profitability in future periods, we should fully
reserve our deferred tax assets. As of December 31, 2009, our deferred tax
assets continued to be fully reserved. We will continue to evaluate, on a
quarterly basis, the positive and negative evidence affecting our ability to
realize our deferred tax assets.
EFFECTS
OF INFLATION: We are subject to inflation and other price risks arising from
price fluctuations in the market prices of the various raw materials that we use
to produce our products. Price risks are managed through cost-containment
measures. Except as noted below, we do not believe that inflation risk or other
price risks with respect to raw materials used to produce our products are
material to our business, financial position, results of operations or cash
flows. Due to a decrease in demand for composite quality carbon materials
worldwide in particular in the aerospace and defense industries and despite a
restricted supply of high quality carbon due to a limited number of suppliers,
the Company experienced a price decline in unit costs of such
carbon. However, the Company may be exposed to raw material price
increases or carbon material shortfalls should demand increase with the
worldwide economic recovery and if additional suppliers or supplies do not
become available. We cannot quantify any such price or material impacts at this
time.
29
EFFECTS
OF EXCHANGE RATE CHANGES: We are subject to price risks arising from exchange
rate fluctuations in the functional currency of our European subsidiaries,
primarily the Euro and the UK Sterling. We currently do not hedge the
exchange rate risk related to our assets and liabilities and do not hedge the
exchange rate risk related to expected future operating
expenses.
RECONCILIATION OF NON-GAAP MEASURES
The
following tables present a reconciliation of consolidated non-GAAP EBITDAS
or Earnings before Interest, Taxes, Depreciation & Amortization, and
Share-based Compensation charges for continuing operations for the three months
ended December 31, 2009 and 2008:
The
Company has provided non-GAAP measures such as EBITDAS in the following
management discussion and analysis. The Company uses the non-GAAP information
internally as one of several measures used to evaluate its operating performance
and believes these non-GAAP measures are useful to, and have been requested by,
investors as they provide additional insight into the underlying operating
results viewed in conjunction with US GAAP operating results. For the
non-GAAP EBITDAS measure, a significant portion of non-cash expenses is
excluded, primarily for interest, depreciation and for share-based compensation
charges that are valued based on the share price and volatility at the date of
grant and then expensed as earned, typically upon vesting of service over
time. The material limitation of non-GAAP EBITDAS compared with Net
Income is that significant non-cash expenses are excluded. Management
compensates for such limitation by utilizing EBITDAS only for particular
purposes and that it evaluates EBITDAS in the context of other metrics such as
Net Income when evaluating the Company’s performance and financial condition.
Non-GAAP measures are not stated in accordance with, should not be considered in
isolation from, and are not a substitute for, US GAAP measures. A reconciliation
of US GAAP to non-GAAP results has been provided in the financial tables
below. We will include the change in fair value of derivative
liabilities, asset impairments and warrant modification expense in our
reconciliation as well.
Three Months Ended December
31,
|
||||||||||||||||||||||||
2009
|
2008
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
EBITDAS:
|
||||||||||||||||||||||||
Net
loss from continuing operations
|
$ | (3,474 | ) | $ | (3,012 | ) | $ | (6,486 | ) | $ | (2,692 | ) | $ | (1,512 | ) | $ | (4,204 | ) | ||||||
Depreciation
& Amortization
|
— | 126 | 126 | — | 240 | 240 | ||||||||||||||||||
Share-based
compensation
|
501 | 163 | 664 | 696 | 433 | 1,129 | ||||||||||||||||||
Change
in fair value of derivative liabilities
|
(774 | ) | — | (774 | ) | — | — | — | ||||||||||||||||
Interest
expense, net
|
887 | (11 | ) | 876 | 447 | — | 447 | |||||||||||||||||
Income
tax expense
|
14 | — | 14 | 3 | — | 3 | ||||||||||||||||||
EBITDAS
Loss
|
$ | (2,846 | ) | $ | (2,734 | ) | $ | (5,580 | ) | $ | (1,546 | ) | $ | (839 | ) | $ | (2,385 | ) |
Consolidated
EBITDAS Loss for the three months ended December 31, 2009 for continuing
operations increased by $3.2 million as compared to 2008 due to a $1.3
million increase from corporate and a $1.9 million increase from our Cable
operations. The total increase was primarily due reduced gross margins and
increased operating expenses including additional payroll tax expense in
connection with an IRS audit, increases in professional service fees and
headcount, and increased facilities costs due to significant idle
capacity.
NET
LOSS
The
following table presents the components of our total net loss:
Three Months Ended
December
31,
|
||||||||
(Unaudited,
In Thousands)
|
2009
|
2008
|
||||||
Net
Loss from Continuing Operations
|
$
|
(6,486
|
)
|
$
|
(4,204
|
)
|
||
Loss
from Discontinued Operations (Note 2)
|
(1,222
|
)
|
(4,132
|
)
|
||||
|
|
|||||||
Net
Loss
|
$
|
(7,708
|
)
|
$
|
(8,336
|
)
|
Our
current period net loss decreased by $0.6 million to $7.7 million for the three
months ended December 31, 2009 from $8.3 million in 2008. This net loss increase
is due to:
·
|
A
decrease in Gross Margin from continuing operations of $1.1 million from
2008 to 2009.
|
·
|
An
increase in Total Operating Expense from continuing operations of $1.3
million from 2008 to 2009.
|
·
|
A
decrease in Total Other Expense from continuing operations of $80,000 from
2008 to 2009.
|
30
·
|
A
decrease in Loss from Discontinued Operations of $ 2.9 million from 2008
to 2009.
|
Gross
Margin: As discussed above, the gross margin decrease of $1.1 million is
primarily due to production inefficiencies as a result of significant idle
production capacity, and inventory reserves recorded in the three months ended
December 31, 2009 compared to 2008.
Total
Operating Expense: As detailed above, the total increase in operating expense is
driven by significant increases in general and administrative expenses totaling
$1.6 million, offset by decreases in sales and marketing expenses of $0.2
million and officer compensation of $0.2 million for the three months ended
December 31, 2009 compared to 2008.
Total
Other Expense: As discussed above, the total other expense decrease is primarily
due to a $0.8 million increase in the change in fair value of derivatives
liabilities, offset by additional interest expense of $0.4 million in the three
months ended December 31, 2009 compared to 2008 (refer to discussion
above).
Loss from
Discontinued Operations: As discussed above and detailed in Note 2 to the
consolidated financial statements, the decrease in the loss from discontinued
operations of $2.9 million is derived from the September, 2009 DeWind asset sale
and related discontinuation of the DeWind business segment.
LIQUIDITY
AND CAPITAL RESOURCES
Since
inception, our principal sources of working capital have been private debt
issuances and equity financings.
For the
three months ended December 31, 2009, we had a net loss from continuing
operations of $6.5 million. At December 31, 2009 we had $13.9
million of cash and cash equivalents, which represented a decrease of $10.0
million from September 30, 2009. The decrease was due to cash used in operations
of $10.0 million, cash used in investing activities of $94,000, offset by $7,000
cash provided by financing activities.
Cash used
in operations during the three months ended December 31, 2009 of $10.0 million
was primarily the result of a net loss of $7.7 million, offset by a loss from
discontinued operations of $1.2 million and non-cash charges of $1.2 million
including depreciation and amortization of $0.1 million, a loss on disposal of
fixed assets of $0.1 million, stock related net charges of $1.2 million and
inventory charges of $0.5 million, offset by a non-cash gain from the change in
fair value of derivative liabilities of $0.8 million. Additionally, a negative
change in net assets/liabilities from discontinued operations of $2.6 million
and net cash used for working capital requirements of $2.1 million,
primarily comprised of an increase in inventory related purchases of
$1.0 million, a $2.5 million increase in receivable balances, and
a decrease in accounts payable of $0.1 million, offset by an increase in
deferred revenues of $1.6 million.
Cash used
in investing activities of $94,000 was primarily related to cash used from the
purchase of computer hardware and software, and equipment put in service in
anticipation of increased cable manufacturing activities.
Cash
provided by financing activities of $7,000 was from the exercise of stock
options.
Our cash
position as of December 31, 2009 was $13.9 million. As discussed in
Note 12 (“Subsequent Events”) to the consolidated financial statements, on
January 31, 2010, we repaid all outstanding convertible notes payable in the
principal amount of $9.0 million. Due to the repayment of debt, we
expect to raise additional capital during fiscal 2010. We believe our
current cash position, future capital raises, expected cash flows from revenue
orders, potential recovery of escrowed cash, and value of “in the money”
options and warrants will be sufficient to fund our operations for the next
twelve months ending December 31, 2010 on a consolidated basis. Due
to the sale of substantially all of the DeWind business, recorded as
discontinued operations, the cash requirements of the Company have decreased due
to significantly lower cash operating expenses and the elimination of inventory
purchases for costly wind turbine parts. As CTC Cable has sufficient
production capacity in its existing plant to achieve profitability, it is not
expected that significant capital expenditures will be required to expand
production, as seen in prior years. CTC Cable has also significantly
reduced its reliance on one customer as compared to prior fiscal years, which
has lowered its customer concentration risk. Additionally, as needed,
we intend to continue the practice of issuing stock, debt, or other financial
instruments for cash or for payment of services or debt extinguishment until our
cash flows from the sales of our primary products is sufficient to fully provide
for cash used in operations or if we believe such a financing event would
be a sound business strategy.
CAPITAL
EXPENDITURES
The
Company does not have any material commitments for capital
expenditures.
OFF
BALANCE SHEET ARRANGEMENTS
As of
December 31, 2009, we have no off balance sheet arrangements.
31
CONTRACTUAL
OBLIGATIONS
The
following table summarizes our contractual obligations (including interest
expense) and commitments as of December 31, 2009:
(Unaudited,
In Thousands)
|
Total
|
Less than 1
year
|
1-3 years
|
In excess of 3
Years
|
||||||||||||
Debt
Obligations
|
$
|
9,099
|
$
|
9,099
|
$
|
—
|
$
|
—
|
||||||||
Operating
Lease Obligations
|
$
|
1,124
|
$
|
1,124
|
$
|
—
|
—
|
Not
included in the table above are amounts included on our balance sheet under
Warranty Provisions in the amount of $554,000 at December 31, 2009.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis of our financial condition and results of operations is
based on our Consolidated Financial Statements, which have been prepared in
accordance with accounting principles generally accepted in the United States,
or US GAAP. Critical accounting policies and estimates,
included in Note 1 to the Consolidated Financial Statements, are as
follows:
Revenue
Recognition
Revenues
are recognized based on guidance provided by the SEC. Accordingly, our general
revenue recognition policy is to recognize revenue when there is persuasive
evidence of an arrangement, the sales price is fixed or determinable, collection
of the related receivable is reasonably assured, and delivery has occurred or
services have been rendered.
The
Company derives, or seeks to derive revenues from product revenue sales of
composite core, stranded composite core, core and stranded core hardware, and
other electric utility related products.
In
addition to the above general revenue recognition principles prescribed by the
SEC, our specific revenue recognition policies for each revenue source are as
follows:
PRODUCT
REVENUES. Product revenues are recognized when product shipment has been made
and title has passed to the end user customer. Product revenues consist
primarily of revenue from the sale of: (i) stranded composite core and related
hardware to utilities either sold directly by the Company or through a
distribution agreement, and (ii) composite core and related hardware sold to a
cable stranding entity. Revenues are deferred for product contracts where the
Company is required to perform installation services until after the
installation is complete. Our distribution agreements are structured so that our
revenue cycle is complete upon shipment and title transfer of products to the
distributor with no right of return.
CTC Cable
sales for the three months ended December 31, 2009 and 2008 consisted of
stranded ACCC®
conductor and ACCC® hardware
sold to end user utilities, sales of ACCC®
conductor core and hardware sold to our Chinese distributor, and sales of
ACCC®
conductor core and ACCC® hardware
to two of our stranding manufacturers. All ACCC® product
related sales were recognized upon delivery of product and transfer of title.
There is no right of return for sales of ACCC®
conductor or ACCC® core to
our Chinese distributor. For ACCC®
conductor product sales made directly by us and not through a manufacturer or
distributor, through a third-party insurance company, we provide the option to
purchase an extended warranty for periods up to five, seven or ten years. We
allocate a portion of sales proceeds to the estimated fair value of the cost to
provide such a warranty. To date, most of our ACCC® related
product sales have been without warranty coverage.
CONSULTING
REVENUE. Consulting revenues are generally recognized as the consulting services
are provided. We have entered into service contract agreements with electric
utility and utility services companies that generally require us to provide
engineering or design services, often in conjunction with current or future
product sales. In return, we receive engineering service fees payable in
cash. For the three months ended December 31, 2009 and 2008, we
recognized no consulting revenues.
For
multiple element contracts where there is no vendor specific objective evidence
(VSOE) or third-party evidence that would allow the allocation of an arrangement
fee amongst various pieces of a multi-element contract, fees received in advance
of services provided are recorded as deferred revenues until additional
operational experience or other VSOE becomes available, or until the contract is
completed.
Warranty
Provisions
Warranty
provisions consist of the insured costs and liabilities associated with any
post-sales associated with our ACCC®
conductor and related hardware parts.
32
Warranties
related to our ACCC® products
relate to conductor and hardware sold directly by us to the end-user
customer. We mitigate our loss exposure through the use of third
party warranty insurance. Warranty related liabilities for time
periods in excess of one year are classified as non-current
liabilities.
Use of
Estimates
The
preparation of our financial statements conform with US GAAP, which requires
management to make estimates and judgments in applying our accounting policies
that have an important impact on our reported amounts of assets, liabilities,
revenue, expenses and related disclosures at the date of our financial
statements. On an on-going basis, management evaluates its estimates including
those related to accounts receivable, inventories, share-based compensation,
warranty provisions and goodwill and intangibles, as applicable. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from management’s estimates. We believe that the application of our
critical accounting policies requires significant judgments and estimates on the
part of management. We believe that the estimates, judgments and assumption upon
which we rely are reasonable, and based upon information available to us at the
time that these estimates, judgments and assumptions are made. These estimates,
judgments and assumptions can affect the reported amounts of assets and
liabilities as of the date of the financial statements as well as the reported
amounts of revenues and expenses during the period presented. To the extent
there are material differences between these estimates, judgments or assumptions
and actual results, our financial statements will be affected. In many cases,
the accounting treatment of a particular transaction is specifically dictated by
US GAAP and does not require management's judgment in its application. There are
also many areas in which management's judgment in selecting among available
alternatives would produce a materially different result.
Our key
estimates we use that rely upon management judgment include:
-
|
the
estimates pertaining to the likelihood of our accounts receivable
collectability. These estimates primarily rely upon past payment history
by customer and management judgment on the likelihood of future payments
based on the current business condition of each customer and the general
business environment.
|
|
-
|
the
estimates pertaining to the valuation of our inventories. These estimates
primarily rely upon the current order book for each product in inventory
along with management’s expectations and visibility into future sales of
each product in inventory.
|
|
-
|
the
assumptions used to calculate fair value of our share-based compensation
and derivative liabilities, primarily the volatility component of the
Black-Scholes-Merton option-pricing model used to value our warrants and
our employee and non-employee options. This estimate relies upon the past
volatility of our share price over time as well as the estimate of the
option life.
|
|
-
|
goodwill
and intangible valuation. These estimates rely primarily on financial
models reviewed by senior management which incorporate business
assumptions made by management on the underlying products and technologies
acquired and the likelihood that the values assigned during the initial
valuations will be recoverable over time through increased revenues,
profits, and enterprise value. Currently, we have no reportable goodwill
or intangible assets.
|
|
-
|
the
estimates and assumptions used to determine the settlement of certain
accounts related to the sale of the DeWind assets for which a final
accounting has not been completed and which may result in the increase or
decrease of asset reserves or increase or decrease of accrued liabilities,
principally penalty payments, interest, and other costs associated with
the turbine parts suppliers for DeWind turbine parts. See related
discussion at Note 2 to the consolidated financial
statements.
|
Derivative Financial
Instruments
The
Company issues financial instruments in the form of stock options and stock
warrants, and debt conversion features as part of its convertible debt
issuances. The Company has not issued any derivative instruments for hedging
purposes since its inception. The Company uses the specific guidance and
disclosure requirements provided in US GAAP. Generally, freestanding derivative
contracts where settlement is required by physical share settlement or in net
share settlement; or where the Company has a choice of share or net cash
settlement are accounted for as equity. Contracts where settlement is in cash or
where the counterparty may choose cash settlement are accounted for as a
liability. Under current US GAAP, certain of our warrants and debt conversion
features are subject to liability accounting treatment (see discussion below
under “Derivative Liabilities”), while our stock options are considered indexed
to the Company’s stock and are accounted for as equity.
The
values of the financial instruments are estimated using the Black-Scholes-Merton
(Black-Scholes) option-pricing model. Key assumptions used to value options and
warrants granted or issued are as follows (only warrants were issued in
2008):
Three
Months Ended
|
||||||||
December
31,
|
||||||||
2009
|
2008
|
|||||||
Risk
Free Rate of Return
|
0.82-2.30
|
%
|
1.61-1.89
|
%
|
||||
Volatility
|
96-108
|
%
|
75-86
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
2-5
yrs
|
2-2.6
yrs
|
33
Derivative
Liabilities
Our
derivative liabilities include fair value based warrant liabilities and debt
conversion features pursuant to US GAAP applied to the terms of the underlying
agreements. The Company issues warrants to purchase common shares of the Company
as additional incentive for investors who purchase unregistered, restricted
common stock or convertible debentures. The fair value of certain warrants
issued and debt conversion features in conjunction with financing events are
recorded as a discount for debt issuances. Certain warrant agreements and debt
conversion arrangements include provisions that require us to record them as a
liability, at fair value, pursuant to Financial Accounting Standards Board
(FASB) accounting rules, including certain provisions designed to protect a
holder’s position from being diluted. The derivative liabilities are
marked-to-market each reporting period and changes in fair value are recorded as
a non-operating gain or loss in our consolidated statement of operations, until
they are completely settled or expire. The fair value of the warrants and debt
conversion features are determined each reporting period using the Black-Scholes
valuation model, using inputs and assumptions consistent with those used in our
estimate of fair value of employee stock options, except that the remaining
contractual life of the warrant is used. Such fair value is affected
by changes in inputs to that model including our stock price, expected stock
price volatility, interest rates and expected term. Refer to “Fair
Value Measurements” below in Note 1 for additional derivative liabilities
disclosures.
For the
three months ended December 31, 2009, we recognized gains of $774,000 related to
the revaluation of our derivative liabilities. The 2009 revaluation
gains resulted mainly from the decrease in our stock price from the prior
quarter.
In
connection with the warrants issued to investors as discussed above, the Company
has issued warrants to compensate for financing fees and other service fees
incurred. Such compensatory warrants are recorded at fair value in
the same manner as non-compensatory warrants, however, the recognized expense is
offset to additional paid-in-capital. Such warrants are considered
equity transactions in accordance with US GAAP. Additionally,
warrants issued without anti-dilution provisions are generally considered equity
transactions in accordance with US GAAP. All of our outstanding warrants
including those subject to liability accounting treatment are further discussed
in Note 8 to the consolidated financial statements.
Share-Based
Compensation
US GAAP
requires that compensation cost relating to share-based payment arrangements be
recognized in the financial statements. US GAAP requires measurement of
compensation cost for all share-based awards at fair value on date of grant and
recognition of compensation over the service period for awards expected to vest.
The fair value of stock options is determined using the Black-Scholes valuation
model. Such fair value is recognized as expense over the service period, net of
estimated forfeitures.
US GAAP
requires that equity instruments issued to non-employees in exchange for
services be valued at the more accurate of the fair value of the services
provided, or the fair value of the equity instruments issued. For equity
instruments issued that are subject to a required service period, the expense
associated with the equity instruments is recorded as the instruments vest or
the services are provided. The Company has granted options and warrants to
non-employees and recorded the fair value of these equity instruments on the
date of issuance using the Black-Scholes valuation model, for options and
warrants not subject to vesting terms. For non-employee option and warrant
grants subject to vesting terms, vested shares are recorded at fair value using
the Black-Scholes valuation model and the associated expense is recorded
simultaneously or as the services are provided. The Company has granted stock to
non-employees for services and values the stock at the more reliable of the
market value on the date of issuance or the value of the services provided. For
stock grants subject to vesting or service requirements, expenses are deferred
and recognized over the more appropriate of the vesting period, or as services
are provided.
SEC
guidance requires share-based compensation to be classified in the same
expense line items as cash compensation. Additionally, the
SEC issued guidance regarding the use of a "simplified" method in
developing an estimate of expected term of "plain vanilla" share options in
accordance with US GAAP rules. The Staff indicated that it will accept a
company's election to use the simplified method, regardless of whether the
company has sufficient information to make more refined estimates of expected
term. The Staff believed that more detailed external information about employee
exercise behavior (e.g., employee exercise patterns by industry and/or other
categories of companies) would, over time, become readily available to
companies; however, the Staff continues to accept, under certain circumstances,
the use of the simplified method. The Company currently uses the simplified
method for “plain vanilla” share options and warrants.
Additional
information about share-based compensation is disclosed in Note 9 to the
consolidated financial statements.
34
Convertible
Debt
Convertible
debt is accounted for under specific guidelines established in US GAAP. The Company records a
beneficial conversion feature (BCF) related to the issuance of convertible
debt that have conversion features at fixed or adjustable rates that are
in-the-money when issued and records the fair value of warrants issued with
those instruments. The BCF for the convertible instruments is recognized and
measured by allocating a portion of the proceeds to warrants and as a reduction
to the carrying amount of the convertible instrument equal to the intrinsic
value of the conversion features, both of which are credited to paid-in-capital
or liabilities as appropriate. The Company calculates the fair value of warrants
issued with the convertible instruments using the Black-Scholes valuation
method, using the same assumptions used for valuing employee options, except
that the contractual life of the warrant is used. Upon each issuance, the
Company evaluates the variable conversion features and determines the
appropriate accounting treatment as either equity or liability, in accordance
with US GAAP. The Company first allocates the value of the proceeds
received to the convertible instrument and any other detachable instruments
(such as detachable warrants) on a relative fair value basis and then determines
the amount of any BCF based on effective conversion price to measure the
intrinsic value, if any, of the embedded conversion option. Using the effective
yield method, the allocated fair value is recorded as a debt discount or premium
and is amortized over the expected term of the convertible debt to interest
expense. For a conversion price change of a convertible debt issue, the
additional intrinsic value of the debt conversion feature, calculated as the
number of additional shares issuable due to a conversion price change multiplied
by the previous conversion price, is recorded as additional debt discount and
amortized over the remaining life of the debt. The accounting for
debt conversion features subject to liability treatment are further discussed
above in “Derivative Liabilities”.
US GAAP
rules specify that a contingent obligation to make future payments or otherwise
transfer consideration under a registration payment arrangement, whether issued
as a separate agreement or included as a provision of a financial instrument or
other agreement, should be separately recognized and measured in accordance with
US GAAP contingency rules. The contingent obligation to make future payments or
otherwise transfer consideration under a registration payment arrangement should
be separately recognized and measured in accordance with said rules, pursuant to
which a contingent obligation must be accrued only if it is more likely than not
to occur. Historically, the Company has not been required to accrue any
contingent liabilities in this regard.
RECENT
ACCOUNTING PRONOUNCEMENTS
Refer to
Note 1 to the Consolidated Financial Statements.
Item
3. Quantitative and Qualitative Disclosures About Market Risk
Our
exposure to market risk relates primarily to our cash balances and the effect
that changes in interest rates have on the interest earned on that portfolio.
Our convertible notes bear a fixed rate of interest.
As of
December 31, 2009 we did not hold any derivative financial instruments for
speculative or trading purposes. The primary objective of our investment
activities is the preservation of principal while maximizing investment income
and minimizing risk. As of December 31, 2009, we had $13.9 million in cash and
cash equivalents including short-term investments purchased with original
maturities of three months or less. Due to the short duration of these financial
instruments, we do not expect that a change in interest rates would result in
any material loss to our investment portfolio.
Item
4. Controls and Procedures
Evaluation of Disclosure
Controls and Procedures
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act of 1934. Disclosure controls and procedures are controls and
other procedures of a company that are designed to ensure that information
required to be disclosed by a company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the SEC’s rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the company’s management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were ineffective
as of December 31, 2009 because of the material weaknesses identified during
management’s annual assessment of internal control over financial reporting for
the fiscal year ended September 30, 2009.
Internal Control over
Financial Reporting
Refer to
“Item 9A – Controls and Procedures” in our Form 10-K filed with the Securities
and Exchange Commission on December 14, 2009 for management’s annual report on
internal control over financial reporting. The Company’s
management assessed the effectiveness of the Company’s internal control over
financial reporting as of September 30, 2009. In making this
assessment, the Company’s management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control-Integrated Framework. Based on their assessment,
management concluded that, as of September 30, 2009, the Company’s internal
control over financial reporting is not effective based on those criteria,
because of the material weaknesses identified.
35
Changes in Internal Control
over Financial Reporting
There was
no change in our internal control over financial reporting during the first
quarter ended December 31, 2009 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting,
except as noted below.
During
the three months ended December 31, 2009 and through the date of this report,
the Company improved the internal control over financial reporting to address
the material weaknesses identified as of September 30, 2009, as
follows:
In
October 2009, we implemented a share-based compensation and equity
administration software system. Transactions are now processed and reported by a
representative from our legal department and reviewed by our Chief Financial
Officer.
The
Company's management has identified the additional steps necessary to address
the material weaknesses identified as of September 30, 2009, as
follows:
(1)
Hiring additional accounting and operations personnel and engaging outside
contractors with technical accounting expertise, as needed, and reorganizing the
accounting and finance department to ensure that accounting personnel with
adequate experience, skills and knowledge relating to complex, non-routine
transactions are directly involved in the review and accounting evaluation of
our complex, non-routine transactions;
(2)
Involving both internal accounting and operations personnel and outside
contractors with technical accounting expertise, as needed, early in the
evaluation of a complex, non-routine transaction to obtain additional guidance
as to the application of generally accepted accounting principles to such a
proposed transaction;
(3)
Documenting to standards established by senior accounting personnel and the
principal accounting officer the review, analysis and related conclusions with
respect to complex, non-routine transactions;
(4)
Requiring senior accounting personnel and the principal accounting officer to
review complex, non-routine transactions to evaluate and approve the accounting
treatment for such transactions;
(5)
Evaluating an internal audit function in relation to the Company's financial
resources and requirements. We expect to pursue a strategy of outsourcing our
internal audit function in fiscal 2010;
(6)
Invest in additional enhancements to our IT systems including enhancements to
processing manufacturing and inventory transactions, and security over user
access and administration;
(7)
Create policy and procedures manuals for the accounting, finance and IT
functions; and
(8)
Improve our purchasing and accounts payable cycle controls.
The
Company began to execute the remediation plans identified above in the first
fiscal quarter of 2010. These remediation efforts are expected to continue
through fiscal 2010.
36
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings
There
have been no material changes to the Legal Proceedings described in Form 10-K
filed with the Securities and Exchange Commission on December 14, 2009 except as
noted in Note 10. See Note 10 to the consolidated financial statements in
this document.
Item
1A. Risk Factors
The
following risk factors have changed or have been updated for recent information
as compared to the Risk Factors listed in Form 10-K filed with the Securities
and Exchange Commission on December 14, 2009. Such risk factors should be read
in conjunction with the risk factors listed in such Form 10-K.
WE EXPECT
FUTURE LOSSES AND OUR FUTURE PROFITABILITY IS UNCERTAIN.
Prior to
acquiring Transmission Technology Corporation, or TTC, in November 2001, we were
a shell corporation having no operating history, revenues from operations, or
assets since December 31, 1989. We have recorded approximately $78 million in
ACCC product sales since inception. Historically, we have incurred substantial
losses and we may experience significant quarterly and annual losses for the
foreseeable future. We may never become profitable. If we do achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis. We expect the need to significantly increase our
product development and product prototype and equipment prototype production
expenses, as necessary. As a result, we will need to generate significant
revenues and earnings to achieve and maintain profitability.
IF WE
CANNOT RAISE CAPITAL WHEN IT IS NEEDED, WE MAY BE REQUIRED TO REDUCE OR SUSPEND
OPERATIONS OR GO OUT OF BUSINESS ALTOGETHER FOR ONE OR MORE OF OUR OPERATING
SEGMENTS.
We
anticipate that for the foreseeable future, the sales of our ACCC cable may not
be sufficient enough to sustain our current level of operations and that we will
continue to incur net losses. Further, on January 31, 2010 we repaid
$9.1 million in debt and interest on our remaining convertible debt outstanding
at December 31, 2009. For these reasons, we believe that we will need to either
raise additional capital, until such time, if ever, as we become cash-flow
positive. It is highly likely that we will continue to seek to raise money
through public or private sales of our securities, debt financing or short-term
loans, corporate collaborations, asset sales, or a combination of the foregoing.
Our ability to raise additional funds in the public or private markets will be
adversely affected if the results of our business operations are not favorable,
if any products developed are not well-received or if our stock price or trading
volume is low. Additional funding may not be available on favorable terms to us,
or at all. To the extent that money is raised through the sale of our
securities, the issuance of those securities could result in dilution to our
existing stockholders. If we raise money through debt financing, we may be
required to secure the financing with all of our business assets, which could be
sold or retained by the creditor should we default in our payment obligations.
If we cannot sustain our working capital needs with financings or if available
financing is prohibitively expensive, we may not be able to complete the
commercialization of our products. As a result, we may be required to
discontinue our operations without obtaining any value for our products, which
could eliminate stockholder equity, or we could be forced to relinquish rights
to some or all of our products in return for an amount substantially less than
we expended.
Risks
Related To Our Securities
THE PRICE
OF OUR COMMON STOCK IS VOLATILE. VOLATILITY MAY INCREASE IN THE FUTURE, WHICH
COULD AFFECT OUR ABILITY TO RAISE CAPITAL IN THE FUTURE OR MAKE IT DIFFICULT FOR
INVESTORS TO SELL THEIR SHARES.
The
market price of our common stock may be subject to significant fluctuations in
response to our operating results, announcements of new products or market
expansions by us or our competitors, changes in general conditions in the
economy, the financial markets, the electrical power transmission and
distribution industry, or other developments and activities affecting us, our
customers, or our competitors, some of which may be unrelated to our
performance. The sale or attempted sale of a large amount of common stock into
the market may also have a significant impact on the trading price of our common
stock. During the last 12 months, the closing bid prices for our common stock
have fluctuated from a high of $0.75 to a low of $0.15. Fluctuations in the
trading price or liquidity of our common stock may adversely affect our ability
to raise capital through future equity financings.
AS OF
FEBRUARY 1, 2010, 4,728,000 COMMON SHARES ARE ISSUABLE UPON EXERCISE OF ALL
OUTSTANDING OPTIONS, WARRANTS AND CONVERSION OF CONVERTIBLE NOTES FOR LESS THAN
THE MARKET PRICE OF $0.30 PER SHARE. CASH PROCEEDS RESULTING FROM THE FULL
EXERCISE AND CONVERSION OF THESE SECURITIES WOULD BE APPROXIMATELY $1,182,000.
WHILE CURRENT MARKET PRICES ARE BELOW SUBSTANTIALLY ALL OF OUR CONVERTIBLE
EQUITY SECURITIES, INCLUDING OPTIONS AND WARRANTS, A SUBSTANTIAL NUMBER OF
OPTIONS ARE PRICED AT $0.35 PER SHARE. A PRICE INCREASE ABOVE THAT
STRIKE PRICE WOULD RESULT IN APPROXIMATELY 27,900,000 OPTIONS AT $0.35 PER
OPTION OF WHICH. FULL CONVERSION OF SUCH SHARES WOULD INCREASE THE
OUTSTANDING COMMON SHARES BY 9.7% TO APPROXIMATELY 316,000,000
SHARES.
37
The
exercise price or conversion price of outstanding options, warrants and
convertible notes may be less than the current market price for our common
shares. In the event of the exercise of these securities, a shareholder could
suffer substantial dilution of his, her or its investment in terms of the
percentage ownership in us as well as the book value of the common shares held.
At the February 1, 2010 market price of $0.30 per share, 4,728,000 shares would
be exercisable for less than the market prices. Full exercise and conversion of
these below market shares would result in us receiving cash proceeds of
$1,182,000 and would increase the outstanding common shares by 1.6% to
approximately 292,836,000 shares.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
During
the quarter ended December 31, 2009, we issued a warrant to purchase 300,000
shares of our common stock to settle a legal dispute. The exercise
price of the warrant is $0.45 per share. The warrant expires on November 13,
2011.
We relied
upon the exemption from registration as set forth in Section 4(2) of the
Securities Act and/or Rule 506 of Regulation D for the issuance of these
securities. The recipient took its securities for investment purposes without a
view to distribution and had access to information concerning us and our
business prospects, as required by the Securities Act. In addition, there was no
general solicitation or advertising for the acquisition of these
securities.
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders
None.
Item
5. Other Information
None.
38
Item
6. Exhibits
EXHIBIT
INDEX
Number
|
Description
|
|
3.1(1)
|
Articles
of Incorporation of the Company
|
|
3.2(2)
|
Certificate
of Amendment to Articles of Incorporation
|
|
3.2(3)
|
Bylaws
of Composite Technology Corporation, as modified January 6,
2006
|
|
10.1(4)
|
Offer
letter between the Registrant and John Brewster dated December 14,
2009
|
|
31.1(5)
|
Rule
13a-14(a) / 15d-14(a)(4) Certification of Chief Executive
Officer
|
|
31.2(5)
|
Rule
13a-14(a) / 15d-14(a)(4) Certification of Chief Financial
Officer
|
|
32.1(5)
|
Section
1350 Certification of Chief Executive Officer
|
|
32.2(5)
|
Section
1350 Certification of Chief Financial
Officer
|
(1)
Incorporated herein by reference to Form 10-KSB filed as a Form 10-KT with the
U. S. Securities and Exchange Commission on February 14, 2002.
(2)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on December 18, 2007.
(3)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on January 12, 2006.
(4)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on December 18, 2009.
(5) Filed
herewith.
39
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
COMPOSITE
TECHNOLOGY CORPORATION
(Registrant)
Date:
February 9, 2010
|
By: /s/ Benton H
Wilcoxon
|
Benton
H Wilcoxon
|
|
Chief
Executive Officer
(Principal
Executive
Officer)
|
Date:
February 9, 2010
|
By: /s/ Domonic J.
Carney
|
Domonic
J. Carney
|
|
Chief
Financial Officer
(Principal
Financial and
Accounting Officer)
|
40