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EX-32.1 - COMPOSITE TECHNOLOGY CORP | v210439_ex32-1.htm |
EX-31.1 - COMPOSITE TECHNOLOGY CORP | v210439_ex31-1.htm |
EX-32.2 - COMPOSITE TECHNOLOGY CORP | v210439_ex32-2.htm |
EX-31.2 - COMPOSITE TECHNOLOGY CORP | v210439_ex31-2.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, 2010
¨ 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, 2011
CLASS
|
NUMBER
OF SHARES OUTSTANDING
|
|
Common
Stock, par value $0.001 per share
|
288,519,660
shares
|
COMPOSITE
TECHNOLOGY CORPORATION
Form 10-Q
for the Quarter ended December 31, 2010
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
|
28
|
|||
Item
3 Quantitative and Qualitative Disclosures About Market
Risk
|
39
|
|||
Item
4 Controls and Procedures
|
39
|
|||
PART
II – OTHER INFORMATION
|
||||
Item
1 Legal Proceedings
|
41
|
|||
Item 1A
Risk Factors
|
41
|
|||
Item
2 Unregistered Sales of Equity Securities and the Use of
Proceeds
|
43
|
|||
Item
3 Defaults Upon Senior Securities
|
43
|
|||
Item
4 (Removed and Reserved)
|
43
|
|||
Item
5 Other Information
|
43
|
|||
Item
6 Exhibits
|
44
|
|||
SIGNATURES
|
45
|
|||
EXHIBITS
|
2
PART
1 – FINANCIAL INFORMATION
Item
1. Financial Statements
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(IN
THOUSANDS, EXCEPT PAR VALUE AND SHARE AMOUNTS)
December 31,
2010
|
September 30,
2010
|
|||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
CURRENT
ASSETS
|
||||||||
Cash
and Cash Equivalents
|
$
|
1,874
|
$
|
2,998
|
||||
Restricted
Cash, Current Portion
|
11,689
|
11,689
|
||||||
Accounts
Receivable, net of reserve of $87 and $217
|
1,112
|
2,339
|
||||||
Inventory
|
2,940
|
3,557
|
||||||
Prepaid
Expenses and Other Current Assets
|
1,016
|
1,111
|
||||||
Current
Assets of Discontinued Operations
|
698
|
2,220
|
||||||
Total
Current Assets
|
19,329
|
23,914
|
||||||
Property
and Equipment, net of accumulated depreciation of $2,811 and
$2,721
|
2,876
|
2,936
|
||||||
Restricted
Cash, Non-Current
|
4,671
|
4,667
|
||||||
Other
Assets
|
680
|
778
|
||||||
TOTAL
ASSETS
|
$
|
27,556
|
$
|
32,295
|
||||
CURRENT
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
7,801
|
$
|
6,012
|
||||
Deferred
Revenue and Customer Advances
|
163
|
1,386
|
||||||
Warranty
Provision
|
294
|
306
|
||||||
Derivative
Liabilities – Current
|
1
|
2
|
||||||
Loan
Payable – Current, net of discount of $926 and $919
|
9,074
|
9,081
|
||||||
Current
Liabilities of Discontinued Operations
|
35,443
|
38,507
|
||||||
Total
Current Liabilities
|
52,776
|
55,294
|
||||||
LONG-TERM
LIABILITIES
|
||||||||
Long-Term
Portion of Deferred Revenue
|
515
|
514
|
||||||
Long-Term
Portion of Warranty Provision
|
183
|
218
|
||||||
Derivative
Liabilities – Long-Term
|
1,772
|
1,295
|
||||||
Total
Long-Term Liabilities
|
2,470
|
2,027
|
||||||
Total
Liabilities
|
55,246
|
57,321
|
||||||
SHAREHOLDERS'
EQUITY (DEFICIT)
|
||||||||
Common
Stock, $.001 par value; 600,000,000 shares authorized; 288,269,660 and
288,269,660 issued and outstanding, respectively
|
288
|
288
|
||||||
Additional
Paid in Capital
|
252,749
|
252,215
|
||||||
Accumulated
Deficit
|
(280,728
|
)
|
(277,530
|
)
|
||||
Accumulated
Other Comprehensive Income
|
1
|
1
|
||||||
Total
Shareholders’ (Deficit)
|
(27,690
|
)
|
(25,026
|
)
|
||||
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
$
|
27,556
|
$
|
32,295
|
The
accompanying notes are an integral part of these financial
statements.
3
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN
THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
December 31,
|
||||||||
2010
|
2009
|
|||||||
Revenue
|
$
|
5,194
|
$
|
2,701
|
||||
Cost
of Revenue
|
3,783
|
2,573
|
||||||
Gross
Profit
|
1,411
|
128
|
||||||
OPERATING
EXPENSES
|
||||||||
Officer
Compensation
|
607
|
569
|
||||||
General
and Administrative
|
2,074
|
3,864
|
||||||
Research
and Development
|
562
|
656
|
||||||
Sales
and Marketing
|
1,707
|
1,137
|
||||||
Depreciation
and Amortization
|
63
|
97
|
||||||
Total
Operating Expenses
|
5,013
|
6,323
|
||||||
LOSS
FROM OPERATIONS
|
(3,602
|
)
|
(6,195
|
)
|
||||
OTHER
INCOME / (EXPENSE)
|
||||||||
Interest
Expense
|
(670
|
)
|
(893
|
)
|
||||
Interest
Income
|
1
|
17
|
||||||
Other
Income (Expense)
|
21
|
(175
|
)
|
|||||
Change
in Fair Value of Derivative Liabilities
|
(341
|
)
|
774
|
|||||
Total
Other Expense
|
(989
|
)
|
(277
|
)
|
||||
Loss
from Continuing Operations before Income Taxes
|
(4,591
|
)
|
(6,472
|
)
|
||||
Income
Tax Expense
|
—
|
14
|
||||||
NET
LOSS FROM CONTINUING OPERATIONS
|
(4,591
|
)
|
(6,486
|
)
|
||||
Income
(Loss) from Discontinued Operations, net of tax of $0 and
$1
|
1,393
|
(1,222
|
)
|
|||||
NET
LOSS
|
(3,198
|
)
|
(7,708
|
)
|
||||
OTHER
COMPREHENSIVE INCOME
|
||||||||
Foreign
Currency Translation Adjustment, net of tax of $0
|
—
|
—
|
||||||
COMPREHENSIVE
LOSS
|
$
|
(3,198
|
)
|
$
|
(7,708
|
)
|
||
BASIC
AND DILUTED LOSS PER SHARE
|
||||||||
Loss
per share from continuing operations
|
$
|
(0.02
|
)
|
$
|
(0.02
|
)
|
||
Income
(loss) per share from discontinued operations
|
$
|
0.01
|
$
|
(0.01
|
)
|
|||
TOTAL
BASIC AND DILUTED LOSS PER SHARE
|
$
|
(0.01
|
)
|
$
|
(0.03
|
)
|
||
WEIGHTED-AVERAGE
COMMON SHARES OUTSTANDING, BASIC AND DILUTED
|
288,269,660
|
288,101,848
|
The
accompanying notes are an integral part of these financial
statements.
4
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(IN
THOUSANDS)
(UNAUDITED)
Three
Months Ended December 31,
|
||||||||
2010
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
Net
loss
|
$
|
(3,198
|
)
|
$
|
(7,708
|
)
|
||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
(Income)
loss from discontinued operations
|
(1,393
|
)
|
1,222
|
|||||
Interest
and deferred finance charge amortization related to detachable warrants
and fixed conversion features
|
348
|
432
|
||||||
Depreciation
and amortization
|
90
|
216
|
||||||
Share-based
compensation
|
538
|
664
|
||||||
Amortization
of prepaid expenses paid in stock/warrants
|
14
|
82
|
||||||
Issuance
of warrants for services
|
—
|
57
|
||||||
Change
in fair value of derivative liabilities
|
341
|
(774
|
)
|
|||||
Bad
debt expense (recovery)
|
(1
|
)
|
(9
|
)
|
||||
Changes
in Assets / Liabilities:
|
||||||||
Accounts
receivable
|
1,228
|
(2,518
|
)
|
|||||
Inventory
|
616
|
(436
|
)
|
|||||
Prepaids
and other current assets
|
50
|
(105
|
)
|
|||||
Other
assets
|
66
|
14
|
||||||
Accounts
payable and other accruals
|
1,630
|
(65
|
)
|
|||||
Deferred
revenue
|
(1,223
|
)
|
1,586
|
|||||
Accrued
warranty liability
|
(47
|
)
|
(10
|
)
|
||||
Net
assets/liabilities of discontinued operations
|
(149
|
)
|
(2,601
|
)
|
||||
Net
cash used in operating activities
|
$
|
(1,090
|
)
|
$
|
(9,953
|
)
|
||
CASH
FLOW FROM INVESTING ACTIVITIES
|
||||||||
Purchase
of property and equipment
|
$
|
(30
|
)
|
$
|
(94
|
)
|
||
Restricted
cash
|
(4
|
)
|
(4
|
)
|
||||
Net
cash used in investing activities
|
$
|
(34
|
)
|
$
|
(98
|
)
|
||
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
|
$
|
(1,124
|
)
|
$
|
(10,044
|
)
|
||
Cash
and cash equivalents at beginning of period
|
2,998
|
23,968
|
||||||
Cash
and cash equivalents at end of period
|
$
|
1,874
|
$
|
13,924
|
||||
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
||||||||
INTEREST
PAID
|
$
|
322
|
$
|
185
|
||||
INCOME
TAX PAID
|
$
|
—
|
$
|
14
|
The
accompanying notes are an integral part of these financial
statements.
5
SUPPLEMENTAL
DISCLOSURE OF NON-CASH FINANCING ACTIVITES:
During
the three months ended December 31, 2010, the Company:
Re-priced
10,000,000 warrants in connection with the April 2010 debt financing
transaction, which resulted in $135,000 of additional value recorded to debt
discount and derivative liabilities. Additionally, the Company
accrued a fee of $160,000 also recorded to debt discount. These costs
relate to a December 2010 waiver and modification agreement as discussed in Note
9.
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.
6
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE MONTHS ENDED DECEMBER 31, 2010
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. 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. CTC Cable has sales operations in Irvine, California, China,
Europe, the Middle East, and Brazil. ACCC®
conductor is sold in North America directly by CTC Cable to utilities and by
Alcan Cable. ACCC®
conductor is sold elsewhere in the world directly to utilities as well as
through license and distribution agreements with Lamifil in Belgium, Midal Cable
in Bahrain, Far East Composite Cable Co. in China, through two Indonesian
companies, PT KMI Wire and Cable and PT Tranka Kabel, IMSA in Argentina,
Centelsa in Colombia and now through Sterlite in India. ACCC®
conductor has been sold commercially since 2005 and is currently marketed
worldwide to electrical utilities, transmission companies and transmission
design/engineering firms.
BASIS
OF PRESENTATION AND PRINCIPALS OF CONSOLIDATION
The
accompanying Consolidated Financial Statements have been prepared on a going
concern basis as discussed below.
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,
2010, filed with the Securities and Exchange Commission (SEC) on December 14,
2010.
The
financial statements include the accounts of Composite Technology Corporation
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.
GOING
CONCERN
The
Company received a report from its independent auditors for the year ended
September 30, 2010 that includes an explanatory paragraph describing the
uncertainty as to the Company's ability to continue as a going
concern. Such uncertainty has continued through the quarter ended
December 31, 2010. These consolidated financial statements
contemplate the ability to continue as such and do not include any adjustments
that might result from this uncertainty.
During
the year ended September 30, 2010, the Company incurred a net loss of
$19,767,000 and had negative cash flows from operating activities –
continuing operations of $17,358,000. In addition, the Company had an
accumulated deficit of $277,530,000 at September 30, 2010. During the
three months ended December 31, 2010, the Company incurred a net loss of
$3,198,000 and had negative cash flows from operating activities –
continuing operations of $941,000. In addition, the Company had an accumulated
deficit of $280,728,000 at December 31, 2010. The Company's ability
to continue as a going concern is dependent upon its ability to generate
profitable operations in the future and/or to obtain the necessary financing to
meet its obligations and repay its liabilities arising from normal business
operations when they come due. The outcome of these matters cannot be predicted
with any certainty at this time.
Our
principal sources of working capital have been private debt issuances and
historically, the Company has issued registered stock and unregistered,
restricted stock, stock options, and warrants in settlement of both operational
and non-operational related liabilities and as a source of funds.
Since
inception through December 31, 2010, our Cable products business has generated
revenue of approximately $89 million in ACCC®
conductor products. We will require a significant increase in customer orders at
sufficient profit margin levels to cover our expenses and generate sufficient
cash flows from operations. Currently, for fiscal 2011 we have
$17.2 million in firm backlog for delivery through the end of the September 2011
quarter.
7
There is
no guarantee that our products will be accepted or provide a marketable
advantage and therefore no guarantee that our products will ever be profitable.
In addition, management plans to ensure that sufficient capital will be
available to provide for its capital needs with minimal borrowings and may issue
equity securities to ensure that this is the case. However, there is no
guarantee that the Company will be successful in obtaining sufficient capital
through borrowings or selling equity securities. These financial statements do
not include any adjustments to the amounts and classification of assets and
liabilities that may be necessary should the Company be unable to continue
as a going concern.
We
believe our cash position as of December 31, 2010 of $1.9 million, current
restricted cash held in escrow of $11.7 million, cash flows generated from our
net accounts receivable balance of $1.1 million and expected cash flows from
revenue orders may not be sufficient to fund operations for the next four
calendar quarters ending December 31, 2011. We anticipate that
additional cash will be needed to fund operations beyond September 2011, absent
a large cash deposit for a future order, and to the extent required, the Company
intends to continue the practice of issuing stock, debt or other financial
instruments for cash or for payment of services until our cash flows from the
sales of our primary products are sufficient to provide cash from operations or
if we believe such a financing event would be a sound business
strategy.
DISCONTINUED
OPERATIONS
On
September 4, 2009, our DeWind subsidiary, subsequently renamed Stribog, 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 U.S. 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.
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. Revenues recorded are shown net of any
sales discounts or similar sales incentives provided to our
customers.
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 in the three months ended December 31, 2010 and 2009 consisted of stranded
ACCC®
conductor and ACCC® hardware
sold to end-user utilities and sales of ACCC® core and
ACCC® hardware
to our stranding manufacturers. All ACCC® product
related sales were recognized upon delivery of product and transfer of
title. 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 extended warranty
coverage. Additionally, all ACCC®
conductor is sold to our end-user customers with a standard three-year product
warranty. The Company purchases a three-year term product warranty liability
insurance policy for all ACCC®
conductor sold directly by the Company to mitigate any product warranty
liability risk. Revenues from ACCC®
conductor sold directly to end-user customers are recorded net of the cost of
the three-year term insurance policy.
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. In the three months ended December 31, 2010 and 2009, we
recognized no consulting revenues.
8
Multiple-element
revenue arrangements are recognized with the overall arrangement fee being
allocated to each element (both delivered and undelivered items) based on their
relative selling prices, regardless of whether those selling prices are
evidenced by vendor specific objective evidence or third-party evidence, or are
based on the Company's estimated selling price. Historically, except
for the product warranty element discussed above, we have not had any
multiple-element revenue arrangements.
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.
Our
ACCC®
conductor is sold to our end-user customers with a standard three-year product
warranty. The Company purchases a three-year term product warranty liability
insurance policy for all ACCC®
conductor sold directly by the Company to mitigate any product warranty
liability risk. All customers have the option to extend this warranty
for to up to ten years upon customer payment of additional insurance
premiums. The insurance policy covers materials costs and labor costs
to replace the ACCC®
conductor in the event of a product warranty claim caused by a product
defect. As such, the purchase of the initial three-year insurance
policy covers significantly all product warranty liability for which the Company
may be exposed under its standard three-year product warranty. To
date, the Company has had no product warranty claims.
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 derivative liabilities, 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
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 for each customer and
management’s 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
(Black-Scholes) 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.
|
|
-
|
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.
|
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 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 where the Company has a
choice of share or net cash settlement are accounted for as equity. Contracts
where settlement is in cash or in net share settlement; or where the
counterparty may choose cash settlement are accounted for as a liability. Under
current US GAAP, certain of our warrants 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.
9
The
values of the financial instruments are estimated using the Black-Scholes
option-pricing model. Key assumptions used to value options and warrants
granted, issued or repriced are as follows:
December 31,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
0.98-1.91
|
%
|
0.82-2.30
|
%
|
||||
Volatility
|
91-100
|
%
|
96-108
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
2-5
yrs
|
2-2.6
yrs
|
Derivative
Liabilities
Currently,
our derivative liabilities include fair value based warrant liabilities pursuant
to US GAAP applied to the terms of the underlying agreements. The Company has
issued warrants to purchase common shares of the Company as additional incentive
for investors who purchase unregistered, restricted common stock, certain debt
obligations 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 statements 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 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” in Note 1 for additional derivative liabilities
disclosures.
For the
three months ended December 31, 2010 and 2009, we recognized a gain/(loss) of
$(341,000) and $774,000, respectively, related to the revaluation of our
derivative liabilities. The 2010 revaluation loss resulted from an
increase in our stock price from the prior quarter and the re-pricing of certain
warrants, as further discussed in Note 10. The 2009 revaluation gain
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 10.
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 employee 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
issued 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.
10
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 the expected term in “plain vanilla”
share options and warrants.
Additional
information about share-based compensation is disclosed in Note 11.
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. As of December 31,
2010, we had no convertible debt outstanding.
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
The
Company considers cash to be restricted cash if it is cash on deposit under
control of the Company that secures standby letters of credit and other payment
guarantees for certain vendors, as well as cash held in jointly controlled
escrow accounts. As of December 31, 2010 and September 30, 2010, restricted cash
consisted of cash held in escrow in connection with the sale of DeWind as
discussed in Note 2, amounting to $16,360,000 and $16,356,000,
respectively. During the three months ended December 31, 2010, 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; 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.
11
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 (FDIC) insurance limit (currently at $250,000 per depositor, per
insured bank, for each account ownership category). All cash and cash
equivalents are FDIC insured, with the exception of the foreign bank 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 are 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 a period of ten 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.
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 in the three months ended December 31, 2010
and 2009.
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.
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 and
liabilities was determined using the following inputs:
12
(Unaudited,
In Thousands)
|
||||||||||||||||
At
December 31, 2010
|
Total
|
Level 1
|
Level 2
|
Level 3
|
||||||||||||
Cash
deposits (1)
|
$
|
66
|
$
|
66
|
$
|
—
|
$
|
—
|
||||||||
Restricted
cash (Note 2)
|
16,360
|
16,360
|
—
|
—
|
||||||||||||
Total
assets
|
$
|
16,426
|
$
|
16,426
|
$
|
—
|
$
|
—
|
||||||||
Derivative
liabilities
|
$
|
1,773
|
$
|
—
|
$
|
—
|
$
|
1,773
|
||||||||
At
September 30, 2010
|
||||||||||||||||
Cash
deposits (1)
|
$
|
66
|
$
|
66
|
$
|
—
|
$
|
—
|
||||||||
Restricted
cash (Note 2)
|
16,356
|
16,356
|
—
|
—
|
||||||||||||
Total
assets
|
$
|
16,422
|
$
|
16,422
|
$
|
—
|
$
|
—
|
||||||||
Derivative
liabilities
|
$
|
1,297
|
$
|
—
|
$
|
—
|
$
|
1,297
|
|
(1)
|
Short-term certificates of
deposit and money market accounts included in cash and cash equivalents in
our consolidated balance
sheets.
|
During
the three months ended December 31, 2010, there were no transfers into or out of
Levels 1 and 2. Financial instruments classified as Level 3 in the
fair value hierarchy as of December 31, 2010 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 or expire. 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” in Note 1.
The
following table summarizes our fair value measurements using significant Level 3
inputs, and changes therein, as of December 31, 2010:
(Unaudited,
In Thousands)
|
Level 3
Derivative Liabilities
|
|||
Balance
as of October 31, 2009
|
$
|
1,570
|
||
Transfers
into/out of Level 3
|
—
|
|||
Initial
valuation of derivative liabilities (1)
|
1,494
|
|||
Change
in fair value of derivative liabilities - expired
|
(221
|
)
|
||
Change
in fair value of derivative liabilities - held
|
(1,546
|
)
|
||
Balance
as of September 30, 2010
|
$
|
1,297
|
||
Transfers
into/out of Level 3
|
—
|
|||
Modification
of derivative liabilities (2)
|
135
|
|||
Change
in fair value of derivative liabilities - held
|
341
|
|||
Balance
as of December 31, 2010
|
$
|
1,773
|
(1)
|
During the year ended September
30, 2010, we issued warrants in connection with the April 2010 debt
financing transaction, which are subject to derivative liability
accounting (see Note 10 “Warrants” for additional
information).
|
|
(2)
|
During the three months ended
December 31, 2010, we re-valued the warrants in connection with the April
2010 debt financing transaction (see Note 10 “Warrants” for additional
information).
|
At
December 31, 2010 and September 30, 2010, 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, restricted cash, accounts receivable and
accounts payable approximate fair value due to the short maturity of these
financial instruments. The carrying amounts reported for debt obligations
approximate fair value due to the effective interest rate of these obligations
reflecting the Company’s current borrowing rate. 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
value.
13
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 Comprehensive Loss include net loss and
foreign currency translation adjustments that arise from the translation of
foreign currency financial statements into U.S. dollars. For the
three months ended December 31, 2010 and 2009, we reported Other Comprehensive
Income (Loss) from continuing operations of zero, respectively.
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 adjustment losses for DeWind through
September 4, 2009 (date of sale), in the amount of $361,000, 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, 2010, other comprehensive income in the amount
of $649,000, derived from DeWind foreign currency translation adjustments, has
been recognized and included as a component of the Income (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, 2010 and 2009, we recorded start-up expenses
in the approximate amount of $0 and $142,000, respectively, which are included
in general and administrative expenses. Our start-up activities
related to professional fees for organization costs incurred.
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 three months ended December 31, 2010.
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.
14
As of
December 31, 2010 and September 30, 2010, the deferred tax assets related
primarily to the Company's net operating loss carry-forwards are fully reserved.
Due to the provisions of Internal Revenue Code Section 382, the Company may not
have any net operating loss carry-forwards available to offset financial
statement or tax return taxable income in future periods as a result of a change
in control involving 50 percentage points or more of the issued and outstanding
securities of the Company.
The
Company will recognize the impact of uncertain 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 recognizes potential accrued interest and penalties related to uncertain
tax positions in income tax expense, as appropriate. During the three months
ended December 31, 2010 and 2009, the Company did not recognize any amount of
income tax expense from potential interest and penalties associated with
uncertain tax positions.
The
Company files consolidated tax returns in the United States Federal
jurisdiction, in California and Texas, as well as foreign jurisdictions
including Germany, the United Kingdom and China. The Company is no longer
subject to U.S. Federal income tax examinations for fiscal years before 2007, is
no longer subject to state and local income tax examinations by tax authorities
for fiscal years before 2006, and is no longer subject to foreign examinations
before 2001.
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. During the quarter ended December 31,
2009, the IRS 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 preliminary IRS findings, the Company recorded
a payroll tax liability in the amount of $1,008,000, which was allocated to
General and Administrative Expense ($560,000), Interest Expense ($277,000) and
Other Expense from penalties ($171,000), during the three months ended December
31, 2009. During the quarter ended June 30, 2010, the Company received a
final determination of adjustment from the IRS. Accordingly, the Company has
begun making payments relating to the assessment arising from the 2001 through
2005 payroll tax audits, which have totaled $394,000 to date. During
the fourth quarter ended September 30, 2010, the IRS provided final adjustments
to interest and penalties and a final payment schedule, which resulted in a
reduction of our payroll tax liability of $253,000. At December 31, 2010, the
remaining payroll tax liability was $361,000, included as a component of
Accounts Payable and Accrued Liabilities (see Note 6).
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, 2010 and 2009 since their
effect would have been anti-dilutive (assumes all outstanding options and
warrants are in-the-money):
(Unaudited)
|
December
31,
|
|||||||
2010
|
2009
|
|||||||
Options
for common stock
|
29,921,634
|
27,916,797
|
||||||
Warrants
for common stock
|
17,600,000
|
23,014,649
|
||||||
Convertible
Debentures, if converted
|
—
|
9,128,566
|
||||||
47,521,634
|
60,060,012
|
RECLASSIFICATIONS
Certain
prior year balances have been reclassified to conform to the current year
presentation.
RECENT
ACCOUNTING PROUNOUNCEMENTS
In
January 2010, FASB issued Accounting Standards Update (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 were effective, and adopted, during the
Company’s second quarter ended March 31, 2010, however the disclosures about
purchases, sales, issuances, and settlements in the roll forward of activity in
Level 3 measurements, will be effective for the Company’s first quarter ending
December 31, 2011. Other than requiring additional disclosures, the full
adoption of this new guidance will not have an impact on our consolidated
financial statements.
15
In
December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805):
Disclosure of Supplementary Pro Forma Information for Business
Combinations (“ASU 2010-29”), which addresses diversity in practice
about the interpretation of the pro forma revenue and earnings disclosure
requirements for business combinations. The amendments in ASU 2010-29 specify
that if a public entity presents comparative financial statements, the entity
should disclose revenue and earnings of the combined entity as though the
business combination(s) that occurred during the current year had occurred as of
the beginning of the comparable prior annual reporting period only. The
amendments in ASU 2010-29 also expand the supplemental pro forma disclosures to
include a description of the nature and amount of material, nonrecurring pro
forma adjustments directly attributable to the business combination included in
the reported pro forma revenue and earnings. The amendments in ASU 2010-29 are
effective prospectively 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, 2010. The new rules become effective for the Company
on October 1, 2011. The adoption of this guidance is not expected to
have a material impact on our consolidated financial statements.
Significant
recent accounting policies adopted or implemented during the three months ended
December 31, 2010
On
October 1, 2010, we adopted new FASB 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 ASU No. 2009-16,
Transfers and Servicing (Topic
860): Accounting for Transfers of Financial Assets. The new rules amended
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 adoption of this standard did
not have an impact on our consolidated financial statements.
On
October 1, 2010, we adopted new FASB rules which amended 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 adoption of this standard did not have an
impact on our consolidated financial statements.
On
October 1, 2010, we adopted new FASB rules which amended the Accounting
Standards Codification, Revenue Recognition (Topic 605):
Multiple-Element Arrangements. The new rules amended
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. Additionally,
the new guidance will require entities to disclose more information about their
multiple-element revenue arrangements. Except for the product
warranty element discussed above, the adoption of this standard did not have an
impact on our consolidated financial statements.
NOTE
2 – DISCONTINUED OPERATIONS
On
September 4, 2009, our DeWind subsidiary, subsequently renamed Stribog, 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 U.S. 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
In
August, 2009 the Company completed negotiations with Daewoo Shipbuilding and
Marine Engineering (DSME), and signed an Asset Purchase Agreement valued at
$49.5 million in cash. The transaction closed on September 4, 2009
and the Company received approximately $32.3 million in cash paid immediately
with $17.2 million in cash escrowed for the benefit of DSME to provide for
potential reimbursements of net asset value adjustments, breaches of
representations and warranties, and intellectual property claims. The Company
paid legal and transaction fees of $3.3 million out of cash
proceeds. Escrow claims presented by DSME are subject to an
evaluation process, which requires that DSME submit a written claim against the
escrowed funds and which thereby triggering processes for review and dispute by
the Company. Escrowed funds are only released by the escrow agent to
the Company or DSME under either i) mutual written instruction by DSME and the
Company or ii) scheduled escrowed cash releases to the Company at certain points
in time, outlined below, and so long as DSME has not submitted an escrow claim
in excess of the scheduled release amount. All successful escrow
claims by DSME would require DSME to either prove damages or show asset values
less than those represented at the transaction close. Of this cash, $5.5 million
was earmarked to satisfy the supply chain and asset valuation claims of which
$836,000 has been released to date; $7.0 million is scheduled to be released two
years after the close of the transaction in September, 2011 and the remainder to
be released three years after the close of the transaction, in September, 2012.
Other than disputed net asset value adjustments and vendor penalties claimed by
DSME and under discussion, no other claims have been filed to date. 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 DSME may include all, part, or cash amounts in excess of the
remaining $16.4 million escrowed, including potentially an additional $18.5
million up to a total of $34.9 million under certain conditions, as described
below. 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. Under the terms of the asset sale,
the additional initial amount of $17.7 million would be due back to DSME if
significant claims were made by a third party and those claims were adjudicated
against the Company. No such claims have occurred and none are expected to
occur. We have filed a negative declaratory action in German court
that limits the value of our exposure. As such, none of the current
$18.5 million is recorded as a liability. The Company continues to believe
the remaining $16.4 million in escrowed funds will be released per the terms of
the agreement.
In
December, 2009 DSME filed its initial claims which listed a shortfall of $11.65
million from the represented net asset value. The Company
counterclaimed with an analysis that showed the net asset value as $6.8 million
higher than represented and requested an additional cash payment from DSME for
that amount. The discrepancy between the two lists consisted of
supply chain vendor claims, vendor penalties, and differences in accounting
estimates on the valuation of assets. During fiscal 2010, the Company
and DSME representatives met multiple times, beginning in January 2010 and
continuing through April 2010 to resolve the net asset and supply chain claims
differences. At the last meeting, the two parties identified the
remaining key supplier matters that required resolution before settlement of the
initial claims could be achieved. In July 2010, $836,000 was released
from escrow and paid to a vendor to satisfy one of these supplier
claims. To date, none of the other differences remaining between DSME
and the Company have been formally agreed upon by either
party. Either the Company or DSME has the option to require an
external audit to be conducted if an agreement on the disputed matters cannot be
achieved. To date, neither party has elected to exercise this option and both
prefer to work out the discrepancies through cooperation and
negotiation. The Company and DSME continued to have negotiation
meetings into December 2010 to resolve any remaining valuation and supply chain
related discrepancies. In July 2010, the Company received $836,000 of
the escrowed cash leaving $16.4 million remaining in escrow. Accordingly,
we have reported the remaining $16.4 million held in escrow as restricted
cash. Consistent with escrow agreement release dates, at December 31,
2010, we have classified $11.7 million as current and $4.7 million as long-term
(see Note 1 “Restricted Cash”). We had no changes to the status of
the restricted cash related to the DSME transaction during the quarter ended
December 31, 2010. We continued discussions with the DSME team in
December 2010 and January 2011. Additional discussions are expected
to continue into February 2011.
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, 2010
|
September 30, 2010
|
||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
Accounts
Receivable, net
|
$
|
698
|
$
|
2,199
|
||||
Prepaid
Expenses and Other Current Assets
|
—
|
21
|
||||||
TOTAL
ASSETS
|
$
|
698
|
$
|
2,220
|
||||
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
32,462
|
$
|
35,358
|
||||
Deferred
Revenues and Customer Advances
|
2,189
|
2,248
|
||||||
Warranty
Provision
|
792
|
901
|
||||||
TOTAL
LIABILITIES
|
35,443
|
38,507
|
||||||
Net
Liabilities of Discontinued Operations
|
$
|
(34,745
|
)
|
$
|
(36,287
|
)
|
17
Significantly
all of the assets and liabilities of the discontinued operations pertain to
activities outside of the United States. The remaining operations of DeWind,
consist of receipt of license fees from Chinese licensees of older DeWind
technology and satisfaction of the remaining contracts that were not assumed by
DSME, primarily the servicing of warranties related to wind turbines installed
in Europe from 2006 through 2009, most of which are now expired, and one
contract for 10 turbines sold to South America that as yet have not been
installed. At December 31, 2010 and September 30, 2010, included above
in Accounts Payable and Other Accrued Liabilities are net payables related
to formerly consolidated, now insolvent European subsidiaries of approximately
$20 million and $20 million, substantially all of which has been assigned by the
insolvency receiver to FKI, a former owner of DeWind, currently engaged in legal
activities with Stribog Ltd. (see Note 12). At December 31, 2010, the net
payables from insolvent subsidiaries are comprised of assets in the amount of $7
million and liabilities in the amount of $27 million. We did not receive any
update from the insolvency receiver related to the assets and liabilities for
the insolvent subsidiaries during the three months ended December 31, 2010.
At December 31, 2010 and September 30, 2010, also included in Accounts
Payable and Other Accrued Liabilities is a $3.4 million provision to cover
contingent liabilities estimated in connection with the DSME transaction, some
of which are related to escrow claims made by DSME and subject to dispute and
negotiation. Accordingly, where probable and reasonably estimable,
these accruals were included in the Loss on Sale of DeWind. We continue to
maintain this accrual due to the ongoing uncertainties discussed
above.
The
consolidated results of our former DeWind segment have been classified on the
Statements of Operations and Comprehensive Loss, as Income (Loss) from
Discontinued Operations. Summarized results of discontinued
operations are as follows:
Three Months Ended December 31,
|
||||||||
(Unaudited,
In Thousands)
|
2010
|
2009
|
||||||
Revenues
|
$
|
—
|
$
|
309
|
||||
Cost
of Revenues
|
(898
|
)
|
790
|
|||||
Operating
Expenses
|
158
|
1,283
|
||||||
Other
Income
|
(653
|
)
|
(543
|
)
|
||||
Income
Tax Expense
|
—
|
1
|
||||||
Income
(Loss) from Discontinued Operations
|
$
|
1,393
|
$
|
(1,222
|
)
|
Since
September 4, 2009, the Company has had no significant 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.
NOTE
3 – ACCOUNTS RECEIVABLE
Accounts
receivable, net consists of the following:
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Cable
Receivables
|
$
|
1,199
|
$
|
2,556
|
||||
Reserves
|
(87
|
)
|
(217
|
)
|
||||
Net
Accounts Receivable
|
$
|
1,112
|
$
|
2,339
|
NOTE
4 – INVENTORY
Inventories
consist of the following:
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Raw
Materials
|
$
|
1,685
|
$
|
959
|
||||
Work-in-Progress
|
67
|
398
|
||||||
Finished
Goods
|
1,188
|
2,200
|
||||||
Inventory
|
$
|
2,940
|
$
|
3,557
|
18
NOTE
5 – PROPERTY AND EQUIPMENT
Property
and equipment consisted of the following:
(In Thousands)
|
Estimated Useful Lives
|
December 31,
2010
|
September 30,
2010
|
|||||||
|
(unaudited)
|
|||||||||
Office
Furniture and Equipment
|
3-10
yrs
|
$
|
834
|
$
|
832
|
|||||
Production
Equipment
|
10
yrs
|
4,056
|
4,047
|
|||||||
Leasehold
Improvements
|
Lesser
of lease term or 7 yrs
|
797
|
778
|
|||||||
Total
Property
|
5,687
|
5,657
|
||||||||
Accumulated
Depreciation
|
(2,811
|
)
|
(2,721
|
)
|
||||||
Property
and Equipment, net
|
$
|
2,876
|
$
|
2,936
|
Total
depreciation expense was $90,000 and $216,000, for the three months ended
December 31, 2010 and 2009, respectively.
NOTE
6 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities consisted of the following:
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Trade
Payables
|
$
|
5,578
|
$
|
3,949
|
||||
Accrued
Commissions
|
307
|
155
|
||||||
Accrued
Insurance
|
152
|
3
|
||||||
Accrued
Payroll and Payroll Related
|
999
|
829
|
||||||
Accrued
Payroll Tax Liability (A)
|
361
|
427
|
||||||
Deferred
Rent
|
274
|
296
|
||||||
Accrued
Sales Tax
|
128
|
186
|
||||||
Accrued
Other
|
2
|
167
|
||||||
Total
Accounts Payable and Accrued Liabilities
|
$
|
7,801
|
$
|
6,012
|
(A)
|
The
Company accrued a payroll tax liability as a result of an IRS audit (see
Note 1 “Income Taxes” for additional
information).
|
NOTE
7 – DEFERRED REVENUE AND CUSTOMER ADVANCES
Deferred
Revenue includes (i) extended warranties, as opted by the customer (see Note 1
“Revenue Recognition – Product Revenues” for additional information), and (ii)
temporary timing-based revenue deferrals from shipments in transit prior to
title passing to the customer. Customer Advances include all advance cash
payments received from customers. The recorded amounts will remain on
our balance sheet until such time as the revenue cycle is completed and the
amounts are recognized as revenue. Deferred revenue and customer
advances consist of the following:
(In Thousands)
|
December
31,
2010
|
September
30,
2010
|
||||||
(unaudited)
|
||||||||
Deferred
Revenue
|
$
|
678
|
$
|
1,370
|
||||
Customer
Advances
|
—
|
530
|
||||||
Total
Deferred Revenue and Customer Advances
|
678
|
1,900
|
||||||
Less
amount classified in current liabilities
|
163
|
1,386
|
||||||
Long-term
Deferred Revenue
|
$
|
515
|
$
|
514
|
Long-term
deferred revenue is comprised of long-term extended warranties.
19
NOTE
8 – WARRANTY PROVISION
Warranties
relate to our ACCC® products
for 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 (see Note 1 “Warranty Provisions”). We have classified all
warranty provisions considered to be payable within one year as current
liabilities and all warranty provisions considered to be payable greater than
one year as long-term liabilities.
Warranty
provision consisted of:
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Warranty
Provision
|
$
|
477
|
$
|
524
|
||||
Less
amount classified in current liabilities
|
294
|
306
|
||||||
Long-Term
Warranty Provision
|
$
|
183
|
$
|
218
|
The
following table sets forth an analysis of warranty provision
activity:
Three Months
Ended
|
Year Ended
|
|||||||
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Beginning
balance
|
$
|
524
|
$
|
564
|
||||
Additional
reserves recorded to expense
|
182
|
265
|
||||||
Provision
utilized
|
(229
|
)
|
(305
|
)
|
||||
Ending
balance
|
$
|
477
|
$
|
524
|
The
following table summarizes the Company’s debt:
(In Thousands)
|
December 31,
2010
|
September 30,
2010
|
||||||
(unaudited)
|
||||||||
Senior
Secured Loan due April 2012, net of discount of $926 and
$919
|
$
|
9,074
|
$
|
9,081
|
||||
Less
amount classified in current liabilities
|
9,074
|
9,081
|
||||||
Long-Term
Debt
|
$
|
—
|
$
|
—
|
Debt
outstanding or issued during the three months ended December 31, 2010 consists
of:
Senior
Secured Loan Payable:
In April
2010, the Company issued a $10.0 million Senior Secured Loan due in April 2012
and received $9.7 million in cash net of fees and costs of $0.3
million. The loan bears interest at 7.5% payable monthly on balances
secured by qualified accounts receivable of the Company and interest at 12.5%
payable monthly on balances not secured by qualified accounts receivable.
Qualified accounts receivable consist of 80% of current trade accounts
receivable, which amounted to $0.8 million at December 31, 2010. The
loan is collateralized by substantially all of the Company’s assets. The loan
package included an issuance of a total of 10 million warrants to purchase a
like number of the Company’s common stock in two tranches. The first
tranche is for 5 million warrants with a three year life and an exercise price
of $0.29 per warrant. The second tranche is for 5 million warrants
with a five year life and an exercise price of $1.00 per
warrant. Both warrant tranches may be exercised at any time prior to
expiration on a cashless basis and are automatically exercised at expiration on
a cashless basis for shares of the Company. We valued the 10 million
warrants at $1,494,000 using the Black-Scholes option-pricing model (see Note 10
“Warrants”). The value assigned to the warrants issued (net of $6,000 in cash
consideration) was recorded as a debt discount and will be amortized to interest
expense over the two-year life of the loan.
The
issuance of the warrants triggered anti-dilution protection in one series of
previously issued warrants. Previously outstanding warrants with
exercise prices of $0.95 and $0.98 and which expire in May, 2011 were reset by
$0.01 per warrant. We determined this modification, calculated as the
difference in fair value of the warrants immediately before and after the change
in exercise prices, had no significant impact on our results.
20
The loan
has two financial covenants, measured monthly consisting of (i) a liquidity
covenant and (ii) a profitability covenant. The liquidity covenant
requires the maintenance of a minimum of $7.5 million of combined cash and
accounts receivable balances, measured at month-end. The
profitability covenant consists of a maximum accumulated adjusted operating loss
of $5.0 million, measured beginning April 1, 2010. The adjusted
operating loss consists of operating loss, less depreciation, amortization, and
certain other non-cash charges including stock related compensation and is
increased or decreased by the corresponding increase or decrease in deferred
revenues as compared to the March 31, 2010 deferred revenue
balance. At September 30, 2010, the Company was not in compliance
with its covenant.
In the
event of a covenant breach, the lender could declare the loan in default and
thereby pursue remedies included in the loan agreement which may include any or
all of the following: immediate collection of the loan, assignment of cash
receipts, control of the Company’s bank accounts, liquidation of the Company’s
assets in part or in full, or apply the default rate of interest of 18% to the
obligation.
In
December 2010, the Company and lender agreed to amend its debt
covenants. The amendments allow for a temporary waiver of its
covenants until January 15, 2011. The amendments
included: i) a cash waiver fee of $160,000 payable by January 15,
2011; ii) a reduction in the exercise price from $0.29 to $0.24 for 5
million warrants issued to lender expiring in April 2013; and iii) a reduction
in the exercise price from $1.00 to $0.69 for 5 million warrants issued to
lender expiring in April 2015. We determined the value of these
modifications, calculated as the difference in fair value of the warrants
immediately before and after the change in exercise prices, to be $135,000.
Warrant modifications are further discussed in Note 10
“Warrants”. In accordance with US GAAP, the debt modification
costs have been accounted for as an addition to the debt discount in the amount
of $295,000.
Loan
maturity remains April 2012 and monthly interest-only payments at the stated
rates were also unchanged. The Company has made all required interest
payments to date. Additionally, the Company and lender agreed that
any net proceeds released from escrow which are not designated to satisfy escrow
claims and thereby are received as unrestricted cash (see Note 2) to the Company
may be required, at the option of the lender, to be applied to any outstanding
loan interest, waiver fees, or loan principal up to the total remaining
outstanding loan principal. The lender has agreed to waive any
loan prepayment penalties resulting from any loan prepayments resulting from the
amendments.
Due to
these amendments and the Company’s liquidity position, at December 31, 2010 and
September 30, 2010, the loan has been reported as a current
obligation. As of December 31, 2010, the Company was in compliance
with its covenants by way of the conditional waiver signed in December 2010.
The loan
may be prepaid at any time prior to April 12, 2012 with a prepayment penalty of
3% of principal if prepaid in the first year and 1.5% of principal if prepaid in
the second year of the loan.
NOTE
10 – SHAREHOLDERS' EQUITY (DEFICIT)
Preferred
Stock
We have
5,000,000 shares of preferred stock authorized. As of the three
months ended December 31, 2010 there was no preferred stock
outstanding.
Common
Stock
The
Company has 600,000,000 shares of Common Stock authorized. We have
never paid cash dividends on our common stock.
The
Company had no issuances of common stock during the three months ended December
31, 2010.
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, certain debt obligations 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 warrant liability accounting and
disclosure.
21
The
following table summarizes the warrant activity during the three months ended
December 31, 2010:
(Unaudited)
|
Number of
Shares
|
Weighted Average
Exercise Price
|
||||||
Outstanding,
September 30, 2010
|
18,200,000
|
$
|
0.58
|
|||||
Granted
|
—
|
$
|
—
|
|||||
Exercised
|
—
|
$
|
—
|
|||||
Cancelled
|
(600,000
|
)
|
$
|
0.75
|
||||
OUTSTANDING,
December 31, 2010
|
17,600,000
|
$
|
0.48
|
|||||
EXERCISABLE,
December 31, 2010
|
17,100,000
|
$
|
0.48
|
Warrant
issuances and modifications during the three months ended December 31,
2010:
On April
12, 2010 we issued 10,000,000 warrants in two tranches in connection with a debt
financing transaction. The first tranche is for 5 million warrants
with a three-year life and an exercise price of $0.29 per
warrant. The second tranche is for 5 million warrants with a
five-year life and an exercise price of $1.00 per warrant. Both
warrant tranches may be exercised at any time prior to expiration on a cashless
basis and are automatically exercised at expiration on a cashless basis for
shares of the Company. We have determined these warrants are subject
to derivative liability accounting treatment as discussed in Note 1 “Derivative
Liabilities”. The issuance of the warrants triggered anti-dilution
protection in one series of previously issued warrants. Previously
outstanding warrants with exercise prices of $0.95 and $0.98 and which expire in
May, 2011 were reset by $0.01 per warrant. We determined this
modification, calculated as the difference in fair value of the warrants
immediately before and after the change in exercise prices, had no significant
impact on our results. We valued the 10 million warrants at
$1,494,000 using the Black-Scholes option-pricing model and the following
assumptions:
Dividend
rate = 0%
Risk free
return of 1.65% and 2.60%
Volatility
of 95%
Market
price of $0.27 per share
Maturity
of 3 and 5 years
In
December 2010, we modified certain terms of our April 12, 2010 debt financing
arrangement (see Note 9), including reducing the exercise price from $0.29 to
$0.24 for the first tranche of 5 million warrants and reducing the exercise
price from $1.00 to $0.69 for the second tranche of 5 million
warrants. The modification triggered anti-dilution protection in one
series of previously issued warrants. Previously outstanding warrants
with exercise prices of $0.94 and $0.97 and which expire in May, 2011 were reset
by $0.01 per warrant. We determined this modification, calculated as
the difference in fair value of the warrants immediately before and after the
change in exercise prices, had no significant impact on our
results. We determined the modifications of the 10 million warrants
derived an incremental cost of $135,000 using the Black-Scholes option-pricing
model and the following assumptions:
Dividend
rate = 0%
Risk free
return of 0.98% and 1.91%
Volatility
of 100% and 91%
Market
price of $0.24 per share
Maturity
of 2 and 4 years
Management
has reviewed and assessed the warrants issued or modified during the three
months ended December 31, 2010 and determined there are no changes to warrants
that qualify for treatment as derivatives under applicable US GAAP rules, as
discussed in Note 1 “Derivative Liabilities”.
Stock
Options
On May
15, 2001, TTC, a predecessor to the Company, established the 2001 Incentive
Compensation Stock Option Plan (the "TTC Plan"). The TTC Plan was administered
by the Company's Board of Directors. Under the TTC Plan, the Board had reserved
4,764,000 shares of common stock to support the underlying options which may be
granted. As part of TTC's acquisition by the Company on November 3, 2001, the
TTC Plan was terminated, and the options were converted into options to purchase
shares of the Company’s common stock pursuant to the 2002 Non-Qualified Stock
Compensation Plan (the "2002 Stock Plan"). The number of shares reserved
initially under the 2002 Stock Plan was 9,000,000. This number was increased to
14,000,000 on October 24, 2002 and increased to 24,000,000 on April 27, 2006.
The 2002 Stock Plan automatically terminates on May 15, 2021 and no options
under the 2002 Stock Plan may be granted after May 15, 2011.
On
January 11, 2008 the Company’s Board of Directors established the 2008
Non-Qualified Stock Compensation Plan (the “2008 Stock Plan”) which was ratified
by the Shareholders of the Company on March 4, 2008. The number of shares
reserved under the 2008 Stock Plan was established at
25,000,000. The 2008 Stock Plan allows for Incentive Stock Options to
be issued to the Company’s employees or officers and Non-Statutory or
Non-Qualifying Stock Options to be issued to the Company’s employees, officers,
consultants, and directors for a period of 10 years from January 11,
2008. To date, only Non-Qualifying Stock Options have been
issued.
22
The
exercise price of the underlying shares for both the 2002 Stock Plan and 2008
Stock Plan will be determined by the Board of Directors; however, the exercise
price may not be lower than 100% of the mean of the last reported bid and asked
price of the Company's common stock on the grant date as quoted on the NASDAQ
Bulletin Board or any other exchange or organization. The term of each option
will be established by the Board of Directors at the date of issue and may not
exceed 10 years. Option grants to employees, directors, and officers
typically have a vesting schedule of between 3 and 5 years and are based upon
length of service.
Certain
options granted under the 2008 Stock Plan may be exercised at any time for
restricted stock of the Company if not otherwise prohibited by the Company’s
Board of Directors. Shares issued under the 2008 Stock Plan may be
subject to a right of first refusal, one or more repurchase options, or other
conditions and restrictions as determined by the Company’s Board of Directors in
its discretion at the time the option is granted. As of December 31, 2010
all of the 2008 Stock Plan option grants were exercisable. To date, no
restricted stock has been issued under the 2008 Stock Plan. Of the
2008 Stock Plan options exercisable, 7,119,452 options were vested and
exercisable into unrestricted stock as of December 31, 2010.
The
following table summarizes the 2002 Stock Plan and 2008 Stock Plan stock option
activity during the three months ended December 31, 2010:
2002 Plan
Number of
Options
|
2008 Plan
Number of
Options
|
Total Number of
Options
|
Weighted
Average
Exercise
Price
|
|||||||||||||
Outstanding,
September 30, 2010
|
15,812,268
|
14,104,332
|
29,916,600
|
$
|
0.35
|
|||||||||||
Granted
|
—
|
150,000
|
150,000
|
$
|
0.35
|
|||||||||||
Exercised
|
—
|
—
|
—
|
$
|
—
|
|||||||||||
Cancelled
|
(60,904
|
)
|
(84,062
|
)
|
(144,966
|
)
|
$
|
0.35
|
||||||||
Outstanding,
December 31, 2010
|
15,751,364
|
14,170,270
|
29,921,634
|
$
|
0.35
|
|||||||||||
Exercisable
, December 31, 2010
|
15,346,464
|
14,170,270
|
29,516,734
|
$
|
0.35
|
The
weighted-average remaining contractual life of the options outstanding at
December 31, 2010 was 6.3 years. The exercise prices of the options outstanding
at December 31, 2010 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
|
6.00
|
$
|
0.25
|
$
|
0.25
|
|||||||||||||
$
0.35-$0.49
|
29,164,234
|
28,759,334
|
6.27
|
$
|
0.35
|
$
|
0.35
|
|||||||||||||
$
0.50-1.00
|
29,400
|
29,400
|
0.15
|
$
|
1.00
|
$
|
1.00
|
|||||||||||||
Total
|
29,921,634
|
29,516,734
|
During
the three months ended December 31, 2010, the Company granted 150,000 options,
respectively, with a weighted-average grant-date fair value of $0.17 per option,
determined using the Black-Scholes option-pricing model. Additionally, during
the three months ended December 31, 2010, the Company’s vested and cancelled
options had a weighted-average grant-date fair value of $0.42 and $0.13 per
option, respectively; and the Company’s non-vested options at the beginning and
ending of the three month period ended December 31, 2010, had a weighted-average
grant-date fair value of $0.32 and $0.31 per option, respectively.
During
the three months ended December 31, 2010, approximately 505,000 options vested
with an aggregate grant-date fair value of $211,000.
At
December 31, 2010, the Company had 29,516,734 options exercisable with an
aggregate intrinsic value of $3,000, an aggregate exercise value of $10,277,000,
and a weighted-average remaining contractual life of 6.3 years.
23
NOTE
11 – SHARE-BASED COMPENSATION
US GAAP
requires recognition of the cost of employee services received in exchange for
an award of equity instruments in the financial statements over the period the
employee is required to perform the services in exchange for the award. US GAAP
also requires measurement of the cost of employee services received in exchange
for an award based on the grant-date fair value of the award. The fair value of
stock options is determined using the Black-Scholes valuation
model.
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. For granted options and warrants to non-employees,
the fair value of these equity instruments is recorded 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. Common stock grants to non-employees for services are
valued at the stock market value on the date of issuance. For issued 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.
Key
assumptions used in valuing options granted during the three months ended
December 31, 2010 and 2009 are as follows:
Three Months Ended
|
||||||||
December 31,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
1.18 | % | 2.18-2.30 | % | ||||
Volatility
|
95.6 | % | 95.6 | % | ||||
Dividend
yield
|
0 | % | 0 | % | ||||
Expected
life
|
5
years
|
5
years
|
The fair
value of the Company’s share-based compensation was estimated at the date of
grant using the Black-Scholes option-pricing model, assuming no dividends and
using the valuation assumptions noted in the table above. The risk-free rate is
based on the U.S. Treasury yield curve in effect at the time of grant. The
expected life (estimated period of time outstanding) of the stock options
granted was estimated using the guidance provided by the FASB and SEC, including
historical exercise behavior of employees and the option expiration date. The
estimated volatility for option grants is the historical volatility for the
equivalent look back period for the expected life of the grant. All volatility
calculations were made on a daily basis.
Share-based
compensation included in the results from continuing operations for the three
months ended December 31, 2010 and 2009 was as follows:
(Unaudited,
In Thousands)
|
Three Months Ended December 31,
|
|||||||
2010
|
2009
|
|||||||
Cost
of Revenue
|
$
|
22
|
$
|
18
|
||||
Officer
Compensation
|
240
|
327
|
||||||
Selling
and marketing
|
99
|
85
|
||||||
Research
and development
|
18
|
52
|
||||||
General
and administrative
|
159
|
182
|
||||||
Totals
|
$
|
538
|
$
|
664
|
As of
December 31, 2010, there was $1.9 million of total unrecognized compensation
cost related to unamortized accrued share-based compensation arrangements
related to stock options consisting of $1.4 million related to employee grants
and $0.5 million related to consultant and director grants. The costs are
expected to be recognized over a weighted-average period of 2.0
years. Such amounts may change as a result of additional grants,
forfeitures, modifications in assumptions and other factors.
All of
our existing options are subject to time of service vesting or vesting on the
achievement of specific performance objectives. Our stock options
vest either on an annual or a quarterly basis for options subject to time of
service vesting, or on specific performance measurements for option vesting tied
to performance criteria. Compensation cost is generally calculated on
a daily basis over the requisite service period incorporating actual vesting
period dates, and includes expected forfeiture rates between 0% and
1.2%. Compensation cost is subsequently adjusted upon a termination
and actual forfeiture event, as appropriate.
For the
three months ended December 31, 2010 and 2009, DeWind employee share-based
compensation expense was reported in the Income (Loss) from Discontinued
Operations in the amounts of $0 and $69,000, respectively (see further
discussion at Note 2).
24
Below we
describe the legal proceedings we are currently involved in or which were
resolved during the three months ended December 31, 2010 through the date we
prepared this report:
(i) The FKI related
matters:
FKI
PLC and FKI Engineering Ltd v. Stribog Ltd and De Wind GmbH
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 Stribog Ltd. In
particular, the claim alleges that Stribog 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 Engineering Ltd. and FKI
Ltd. claim that DeWind GmbH is owed approximately 46,681,543 Euros (US
$60,677,000 at November 30, 2010 exchange rates), which sum is comprised by a
claim for principal in the sum of Euros 28,346,590 plus Value Added Tax of Euros
4,542,181, together with either interest of Euros 13,792,772 as at January 21,
2010 (continuing at a daily rate of Euros 7,316.63) or, in the alternative,
statutory interest. Stribog Ltd. disputes that it owes any funds to DeWind GmbH
and is vigorously contesting the validity of this allegation. Amongst other
issues in dispute, the validity of the Assignment is currently subject to
proceedings in both the Luebeck court in Germany (commenced by the company
against FKI in September 2009) and the English courts (commenced by FKI in
January 2010). The Luebeck court is expected to determine the dispute in the
first half of 2011. Stribog also applied to stay the English proceedings on the
basis that the issue was first filed in the German courts. This stay was not
given in May 2010 but the Court of Appeal granted leave to appeal that decision
in October 2010, which is likely to be heard in February 2011.
Stribog
Ltd. (formerly DeWind Ltd.) v. FKI Plc. and FKI Engineering Ltd.
On
September 18, 2009 the Company’s wholly owned subsidiary, Stribog Ltd. (formerly
DeWind Ltd.), filed an action for negative declaration in the Court of Lubeck,
Germany against FKI Engineering Ltd. and FKI Ltd., formerly FKI Plc (“FKI”)
(Case No. 17 O256/09) to obtain a court’s declaration that FKI is not entitled
to any rights to rescission and claims against Stribog Ltd. pursuant to an
assignment agreement executed by the German Insolvency administrator of DeWind
GmbH assigning such rights to FKI. In its defense, FKI states (i) that the
license agreement dated August 1, 2005 and the following transfer of those
licenses for a purchase price of 500,000 Euros (US $650,000 at November 30, 2010
exchange rates) from DeWind GmbH to Stribog Ltd. in August 2008 could be
challenged, in particular as the transferred licenses would have a significant
higher value and (ii) that claims for damages could arise from a sale and
transfer agreement dated August 1, 2005. Any particular amount in this respect
was not provided by FKI. The Company believes that (i) fair market value was
paid for this intellectual property and that the transactions were conducted at
arm’s length, therefore any rights to rescission do not exist and (ii) that the
assignment agreement was invalid. Stribog Ltd. has not recorded a liability as
it is uncertain (i) whether the court decides that such rights to challenge the
transfer exist or not and whether the assignment of such rights to FKI is valid
and (ii) if the court decides that such rights can be claimed by FKI, whether
FKI will challenge the transfer accordingly.
Insolvency
of DeWind GmbH
On August
29, 2008 in Lubeck Local Court – Bankruptcy Court, Lubeck Germany, DeWind GmbH,
an indirect subsidiary of the Company, filed for voluntary insolvency in lieu of
a required recapitalization under German law of approximately 5,000,000 Euros
(US $6,499,000 at November 30, 20010 exchange rates) (Case No. 53a1E 8/08 ). The
DeWind GmbH subsidiary had limited operational function for the DeWind segment,
functioning solely to provide services on wind turbines that remained under
warranty and which warranties were entered into prior to June,
2005.
On
September 18, 2008 an insolvency receiver was appointed and set an initial
reporting date in December, 2008 and which was primarily procedural in nature.
No formal reporting has been received since December, 2008. Since the date of
insolvency, the insolvency receiver has, or is in the process of assigning all
actual and potential claims of DeWind GmbH including without limitation,
potential claims of DeWind GmbH against the Company’s remaining Stribog
subsidiaries, primarily Stribog Ltd, the Company’s remaining operating
subsidiary in the UK. On September 8, 2009, the insolvency receiver for DeWind
GmbH and FKI entered into an Agreement in regard to a Settlement of Claims in
which the insolvency receiver assigned any potential claim DeWind GmbH held
against the Company, DeWind, Inc. and related Company entities to FKI for
undisclosed consideration. All liabilities associated with these potential
claims are recorded in liabilities from discontinued operations. This assignment
has been disputed as discussed above.
25
(ii) The
Mercury related matters :
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 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. Discovery is underway and trial is currently scheduled for June,
2011.
CTC
Cable Corporation v. Mercury Cable & Energy, LLC, Energy Technology
International, General Cable Corporation, Diversified Composites, Ronald Morris,
Edward Skonezny, Wang Chen, and Todd Harris
On March
3, 2009, CTC Cable filed action against Mercury Cable for patent infringement in
the U.S. District Court, Central District of California, Southern Division (Case
No. SACV 09-261 DOC (MLGx)). CTC Cable believes upon information that the
Defendants have infringed, contributed to infringement of, and/or actively
induced infringement by itself and/or through its agents, unlawfully and
wrongfully making, using, offering to sell, and/or selling products and
materials embodying the patented invention within and outside the United States
without permission or license from CTC Cable. In response to this lawsuit,
Mercury 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. The reexamination has now been completed and all original
claims have been upheld with only minor amendments. No claims have been finally
rejected. The discovery stay has now been lifted and CTC Cable is in process of
discovery.
On
October 18, 2010 the Court approved the expansion of the complaint to include
additional defendants including additional Mercury subsidiaries, Mercury’s
strander, General Cable Corporation, Mercury’s core producer Diversified
Composites, and Individuals Morris, Harris, Chen, and Skonezny. 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 September 30, 2010 or December 31, 2010.
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. 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. On March 8, 2010, the Court overruled the demurrer and lifted the
stay on discovery. On March 25, 2010, Plaintiff Thomas filed a Second Amended
Complaint containing substantially the same allegations against the individual
defendants as the previous complaints. On July 19, 2010, the Company filed a
Motion for Judgment on the Pleadings seeking to dismiss the action in its
entirety. On September 7, 2010 the Court heard oral arguments on the Defendants’
Motion for Preliminary Injunction to Enjoin Plaintiff From Service as the
Shareholder Representative of the Company, heard concurrently with the Court’s
own Motion to Review Plaintiff’s Standing. On October 28, 2010 the Honorable
David R. Chaffee dismissed the complaint with prejudice and noted Mercury’s
involvement in the matter.
26
NOTE
13 – SEGMENT INFORMATION
As of
December 31, 2010, we manage and report our operations through one business
segment: CTC Cable. 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.
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 capacity, energy efficient, light weight, patented composite ACCC® core,
which is then shipped to one of nine conductor stranding licensees in the U.S.,
Canada, Belgium, China, Indonesia, India, Argentina, Columbia 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 and by
Alcan Cable. ACCC®
conductor is sold elsewhere in the world directly to utilities as well as
through license and distribution agreements with Lamifil in Belgium, Midal Cable
in Bahrain, Far East Composite Cable Co. in China, through two Indonesian
companies, PT KMI Wire and Cable and PT Tranka Kabel, IMSA in Argentina,
Centelsa in Colombia and now through Sterlite in India. ACCC®
conductor has been sold commercially since 2005 and is currently marketed
worldwide to electrical utilities, transmission companies and transmission
design/engineering firms.
The
Company operates and markets its services and products on a worldwide basis.
Revenues by geographical region are as follows:
(Unaudited, In Thousands)
|
Three Months Ended December 31,
|
|||||||
2010
|
2009
|
|||||||
Europe
|
$
|
342
|
$
|
88
|
||||
China
|
706
|
—
|
||||||
Middle
East
|
203
|
—
|
||||||
Other
Asia
|
24
|
7
|
||||||
North
America
|
3,919
|
1,177
|
||||||
South
America
|
—
|
|
1,429
|
|||||
Total
Revenue
|
$
|
5,194
|
$
|
2,701
|
All
long-lived assets, comprised of property and equipment, are located in the
United States.
For the
three months ended December 31, 2010, four customers represented 96% of revenue
(one in the U.S. at 34%, one in Canada at 42%, one in China at 14% and one in
the Belgium at 6%). 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 at 53.0%). No other customer represented greater than 5% of
consolidated revenue.
NOTE
14 – SUBSEQUENT EVENTS (Unaudited)
None.
27
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, 2010 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,
2010.
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 elsewhere in this report and in our Annual Report on Form 10-K for the
fiscal year ended September 30, 2010. 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.
OVERVIEW
We
develop, produce, market and sell innovative energy efficient and renewable
energy products for the electrical utility industry. We have
conducted our operations in the following two business segments: the CTC Cable
division and the DeWind division. In September, 2009 we sold
substantially all of the assets and liabilities of the DeWind
segment. Accordingly, all operations of our former DeWind segment
have been reported as discontinued operations in the accompanying unaudited
consolidated financial statements and notes thereto.
The
financial results for the quarter ended December 31, 2010 reflected revenue
increases caused by order flow improvement from customers in China, North
America, and the Middle East offset by a decrease in revenues from South
America. CTC Cable business growth improved due to the beginning of
the worldwide economic recovery that resulted in contract awards for several
anticipated line projects that had specified ACCC®
conductor in both new international markets and the United
States. This resulted in an increase to 422 kilometers of ACCC® products
shipped in the December, 2010 quarter from 155 kilometers in the December, 2009
quarter.
Despite
the increase in shipments over the prior year’s quarter, the low production
levels for the quarter ended December 31, 2010 resulted in continued
inefficiencies 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, we expect to
see gross margins in line with historical levels.
In
November 2010 we signed a manufacturing agreement with Sterlite Technologies
Limited located in India. The initial term for the agreement is six years with
options to extend for additional terms. The agreement allows for
Sterlite to be the sole manufacturer of ACCC®
conductor in India as long as Sterlite satisfies certain milestone conditions
including sales and marketing targets, type registration, and minimum purchase
quantities. The agreement does not prevent other stranders from
selling ACCC®
conductor in India. Other than losing their exclusivity within India,
Sterlite is under no obligation to purchase ACCC® core
from the Company currently or in the future and therefore the Company does not
consider this to be a binding purchase agreement. However, if
Sterlite achieves the milestones listed in the contract, we could begin to see
revenues from this agreement by the fourth fiscal quarter of 2011 with
potentially significant and material revenues thereafter. Future
revenues from this transaction cannot be projected with any reasonable accuracy
at this time and none of our current backlog results from this
agreement.
In
December 2010 we signed a manufacturing agreement with Taihan Electric Wire, LTD
located in South Korea. The initial term for the agreement is one year with
provisions for annual renewal. The agreement allows for Taihan to be
the sole manufacturer of ACCC®
conductor in Korea for sales to the Korean market as long as Taihan satisfies
certain milestone conditions including sales and marketing targets, type
registration, and minimum purchase quantities. The agreement does not
prevent other stranders from selling ACCC®
conductor in Korea. Other than losing termination of the agreement,
Taihan is under no obligation to purchase ACCC® core
from the Company currently or in the future and therefore the Company does not
consider this to be a binding purchase agreement. However, if Taihan
achieves the milestones listed in the contract, we could begin to see revenues
from this agreement by the fourth fiscal quarter of 2011 with additional
revenues thereafter. Future revenues from this transaction cannot be
projected with any reasonable accuracy at this time and none of our current
backlog results from this agreement.
28
In
December, 2010 we were awarded a contract worth approximately $13.9 million for
ACCC®
conductor and hardware with Adminstracion Nacional de Electricidad (“ANDE”) for
the Licitación Pública Internacional ANDE project in Paraguay. This
contract bid award was conditional on the issuance of a performance bond and
negotiation of the payment terms under letters of credit. Since
notification of the contract bid award, we have been negotiating with entities
for the issuance of the specific performance bond required by ANDE, which we
understand is ready to be issued as soon as an administrative review of the
contract is completed by the government in Paraguay due to a request
by the losing bidder. This administrative review should be completed
by February 10, 2011. The contract calls for delivery of the entire
contracted amount within 150 days from the finalization of the contract,
expected to begin soon in February upon successful completion of the
administrative review, the issuance of the performance bond, and the delivery of
an acceptable letter of credit to CTC Cable. We therefore expect to
ship and recognize the entire contracted amount within 150 days beginning with
the quarter ending March 31, 2011. We have included the entire contracted amount
in our firm order backlog as of February 7, 2011.
As of
December 13, 2010, we entered into loan modifications with our senior secured
lender for certain debt covenants resulting in a temporary waiver through
January 14, 2011, refer to detailed discussion of the amendments at Note 9 to
the unaudited interim consolidated financial statements.
CTC Cable
Division
Located
in Irvine, California with sales operations in Irvine, California; Beijing,
China, Europe, the Middle East, India and Brazil, CTC Cable produces and sells
ACCC®
conductor products and related ACCC® hardware
products. ACCC®
conductor production is a two-step process, in which our Irvine operations
produce the high capacity, energy efficient, light weight, patented composite
ACCC®
composite core, that is then shipped to one of nine conductor stranding
licensees in the U.S., Canada, Belgium, China, Indonesia, India, Argentina,
Colombia 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 and by
Alcan Cable. ACCC®
conductor is sold elsewhere in the world directly to utilities as well as
through license and distribution agreements with Lamifil in Belgium, Midal Cable
in Bahrain, Far East Composite Cable Co. in China, PT KMI Wire and Cable and PT
Tranka Kabel in Indonesia, IMSA in Argentina, Centelsa in Colombia and now
through Sterlite in India. 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 2011, we expect to focus on penetrating new
markets, monetize existing markets through follow-on orders, leverage our new
and existing distributors, and restart sales in the Chinese
market. Our goal for 2011 is to land or monetize several long-term
contracts for recurring ACCC® core
sales in strategic locations including India, China, and North
America. In addition to this base of business, we will continue to
open new markets elsewhere in the world and to conclude sales to new and repeat
customers in our existing markets.
Our
revenues for the fiscal 2010 and fiscal 2011 to date have been driven by
individual contracts, as opposed to recurring repeat
orders. Therefore our revenues from quarter to quarter have varied
considerably as the number of sizable contracts changes. Our revenues for the
quarter ended December 31, 2010 of $5.2 million consisted of sales of $0.7
million to our customer in China, and $3.9 million to two customers in North
America, all three of which were repeat customers. The order into
China was our first substantial new order into that market in nearly two
years. The remaining $0.6 million was from five customers around the
world. By comparison, our revenues for the December 31, 2009 quarter
included $1.2 million in North America from five customers, $1.4 million in
South America from one customer, and sales to three other customers totaling
$0.1 million.
To
provide additional insight into our current and future revenues, we provide
additional information below about our sales pipeline and
opportunities.
Sales Pipeline,
Opportunities, and Backlog
We define
our sales pipeline in terms of sales opportunities, sales commitments, sales
orders (backlog), and revenues. Our sales efforts over the past year
have increased with our increased sales and marketing efforts and as of January
31, 2011 we have over $1 billion in worked sales opportunities. Such
opportunities consist of separate, unique transmission conductor projects that
have been identified by our sales and marketing team as opportunities specified
to sell ACCC®
conductor, which have the potential to be designed or installed using ACCC®
conductor within the next 24 months and for which contact points with those
potential customers have been established. Sales opportunities are
listed at the estimated value of potential revenues to CTC Cable and tracked
over time to closure. Opportunities that are being worked by CTC employees and
consultants, which are currently expected to have a likelihood of award to CTC
Cable within the next twelve months, include over 100 separate transmission
projects with a total value of over $400 million. Additional projects
are worked in markets served by engineering consulting companies and stranding
licensees. We expect to close a fraction of the projects listed as
sales opportunities, but to date, our sales volatility, the volatility of the
economic environment and our limited history does not allow for a meaningful
analysis of a reasonable estimate of our closure rate for our sales
opportunities.
29
Purchase
commitments consist of contracts with customers or stranding licensees that
represent agreements to purchase ACCC®
conductor or ACCC® core
over periods of time. The commitments which may be binding
(take-or-pay) which would require delivery, or non-binding commitments which do
not require delivery but which may carry other penalties such as those described
below. We currently have no binding purchase commitments from any of
our customers or stranders. The current commitments represent
non-binding written agreements to purchase minimum quantities of ACCC® products
in exchange for any or all of the following: i) predetermined prices
which may be pegged and adjustable to a certain raw material cost such as
aluminum, ii) for exclusive rights to sales to certain customers, or iii) for
exclusive rights to sales in certain geographic territories. The
extent of the commitment is that these licensees stand to lose any or all of the
commitment benefits described in i) through iii) above if they fail to meet
their minimum quantity orders. The range of potential revenue if all
of our non-binding commitments under our existing manufacturing and distribution
agreements met their minimum quantity orders is between $35 million and $65
million of additional potential ACCC® core
revenue over the next 12 to 18 months depending on core sizes and delivery
schedules. A considerable amount of time and effort has, and is
expected to continue to be, expended to assist our network of stranders to meet
or exceed their minimum commitments.
We define
“firm backlog” as orders from customers or stranding licensees that are
evidenced by a signed contract, purchase order or equivalent purchase document,
or a signed sales order for stranding licensees under purchase commitment with
agreed prices and delivery schedules. We expect our entire firm
backlog to eventually convert to delivered product and therefore
revenues. As of February 7, 2011 for delivery in the remainder of
fiscal 2011 we have $17.2 million in firm backlog for delivery to customers in
North America, South America, Europe, and Indonesia through the end of the
September 2011 quarter. Our comparable backlog for 2010 was $6.5
million.
In
addition to the recovering economy, the adoption of ACCC®
conductor has been positively impacted by a recent regulatory order in North
America. On October 7, 2010 the North American Electric Reliability
Corporation (NERC) issued Order 810, which created a requirement for utilities
with certain transmission and distribution lines to conduct review and
remediation efforts and established substantial penalties for
non-compliance. Unless substantially modified, this edict will result
in substantial expenditures on North American transmission lines over the next
one to two years. We believe that NERC 810 remediation using
ACCC®
conductors provides utilities with a cost-effective solution that is superior to
other more costly and less effective solutions. We have already begun
to market ACCC®
conductor as an alternative with positive initial results including several
utilities who have begun line design work on critical projects and we have
received tentative design wins which are included in our sales opportunities
that are actively being worked by our sales and marketing team. We
expect orders from these opportunities to begin later in 2011 and which we
expect will continue to drive ACCC®
conductor adoption in North America to new and existing customers.
Production
We
currently have sufficient production in our Irvine, CA ACCC® core
facility to handle our expected revenues for the remainder of fiscal year
2011. To the extent required, we have the ability to quickly add
production capacity both through additional equipment into the Irvine facility
or to open new production facilities.
We will
continue to work to expand our ACCC®
conductor production capacity through stranding and manufacturing agreements
with targeted manufacturers worldwide. Discussions with additional
new stranding partners are underway at multiple locations worldwide in
particular with several additional stranding manufacturers and distributors in
China, Korea, and South America. Additional sales efforts are also
underway in the Middle East, Europe, and Africa.
Revenue
CTC Cable
revenues were as follows for the three months ended December 31, 2010 and
2009:
(Unaudited, In Thousands - except kilometer related amounts)
|
Three Months Ended December 31,
|
|||||||
2010
|
2009
|
|||||||
Europe
|
$
|
342
|
$
|
88
|
||||
China
|
706
|
—
|
||||||
Middle
East
|
203
|
—
|
||||||
Other
Asia
|
24
|
7
|
||||||
North
America
|
3,919
|
1,177
|
||||||
South
America
|
—
|
1,429
|
||||||
Total
Revenue
|
$
|
5,194
|
$
|
2,701
|
||||
Kilometers
shipped
|
422
|
155
|
||||||
ACCC®
Core/Conductor Revenue per kilometer
|
$
|
10,843
|
$
|
14,226
|
30
The
decrease in revenues per kilometer was due to a higher proportion of December
2010 sales as ACCC® core
while nearly all of the December 2009 quarter sales were from ACCC®
conductor. Our firm order backlog as of February 7, 2011 was $17.2
million.
Our gross
margins for the December 2010 quarter increased with our increased order and
recognized revenue levels. As a percentage of sales, gross margins
improved to 27% of revenues as compared to 5% of revenues for 2009
quarter. During the December 2010 quarter, we sold a higher
proportion of ACCC® core,
which carries higher margins per revenue dollar than ACCC®
conductor. Additionally, for the December 2010 quarter we had lower
charges to inventory reserves than in the 2009 quarter.
CTC Cable
operating expenses decreased from the December 2009 quarter due to a $0.3
million decrease in expenses, primarily related to lower overhead and other
G&A cost reduction efforts offset by higher sales expenses due to increased
spending efforts to support the increase in our order book and
revenues.
Discontinued Operations –
Stribog (formerly DeWind)
We had no
changes to the status of the restricted cash related to the Daewoo Shipbuilding
and Marine Engineering (DSME) transaction during the quarter ended December 31,
2010. We continued discussions with the DSME team in December 2010
and January 2011. Additional discussions are expected to continue
into February 2011. Refer to Note 2 to the consolidated financial
statements.
The
remaining assets and liabilities of the discontinued operations consist of the
following:
(Unaudited, In Thousands)
|
December 31, 2010
|
|||
ASSETS
|
||||
Accounts
Receivable, net
|
$
|
698
|
||
LIABILITIES
|
||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
32,462
|
||
Deferred
Revenues and Customer Advances
|
2,189
|
|||
Warranty
Provision
|
792
|
|||
Total
Liabilities
|
35,443
|
|||
Net
Liabilities of Discontinued Operations
|
$
|
(34,745
|
)
|
Significantly
all of the assets and liabilities of the discontinued operations pertain to
activities outside of the United States. The remaining operations of DeWind,
consist of receipt of license fees from Chinese licensees of older DeWind
technology and satisfaction of the remaining contracts that were not assumed by
DSME, primarily the servicing of warranties related to wind turbines installed
in Europe from 2006 through 2009, most of which are now expired, and one
contract for 10 turbines sold to South America that as yet have not been
installed. At December 31, 2010, included above in Accounts Payable
and Other Accrued Liabilities are net payables related to formerly
consolidated, now insolvent European subsidiaries of approximately $20 million,
substantially all of which has been assigned by the insolvency receiver to FKI,
a former owner of DeWind, currently engaged in legal activities with the Company
(see Note 12 to the consolidated financial statements). At December 31, 2010,
the net payables from insolvent subsidiaries are comprised of assets in the
amount of $7 million and liabilities in the amount of $27 million. We did not
receive any update from the insolvency receiver related to the assets and
liabilities for the insolvent subsidiaries during the three months ended
December 31, 2010. At December 31, 2010, also included in Accounts Payable
and Other Accrued Liabilities is a $3.4 million provision to cover contingent
liabilities estimated in connection with the DSME transaction, some of which are
related to escrow claims made by DSME and subject to dispute and
negotiation. Accordingly, where probable and reasonably estimable,
these accruals were included in the Loss on Sale of DeWind. We continue to
maintain this accrual due to the ongoing uncertainties discussed at Note 2 to
the consolidated financial statements.
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)
|
2010
|
2009
|
||||||
Product
Revenue
|
$
|
5,194
|
$
|
2,701
|
||||
Cost
of Revenue
|
$
|
3,783
|
$
|
2,573
|
||||
Gross
Margin
|
$
|
1,411
|
$
|
128
|
||||
Gross
Margin %
|
27.2
|
%
|
4.7
|
%
|
31
PRODUCT
REVENUE: Product revenues increased $2.5 million, or 92%, from $2.7
million in 2009 to $5.2 million for the three months ended December 31,
2010.
The
increase for the three months ended December 31, 2010 was primarily related to
an increase in shipments of 267 km of ACCC® products
to North America and 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 increased $1.2 million, or 47%,
from $2.6 million in 2009 to $3.8 million for the three months ended December
31, 2010.
Cost of
revenue and resultant gross margin: The three months ended December 31,
2010 gross margin percentage increased primarily due to a change in product mix
to higher margin ACCC® core
products and lower charges to inventory reserves.
The
following table presents a comparative analysis of operating expenses for
continuing operations:
Three Months Ended December 31,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited, In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
Officer
Compensation
|
$
|
487
|
$
|
120
|
$
|
607
|
$
|
569
|
$
|
—
|
$
|
569
|
||||||||||||
General
and Administrative
|
1,107
|
967
|
2,074
|
2,607
|
1,257
|
3,864
|
||||||||||||||||||
Research
and Development
|
—
|
562
|
562
|
—
|
656
|
656
|
||||||||||||||||||
Sales
and Marketing
|
—
|
1,707
|
1,707
|
—
|
1,137
|
1,137
|
||||||||||||||||||
Depreciation
and Amortization
|
2
|
61
|
63
|
—
|
97
|
97
|
||||||||||||||||||
Total
Operating Expenses
|
$
|
1,596
|
$
|
3,417
|
$
|
5,013
|
$
|
3,176
|
$
|
3,147
|
$
|
6,323
|
OFFICER
COMPENSATION: Officer Compensation represents CTC Corporate expenses and
consists primarily of salaries, and the fair value of stock grants issued to
officers of the Company. Officer compensation increased by $38,000 from 2009 to
2010 or 7% due to one additional officer on staff for all of the 2010 quarter as
compared to one month in the 2009 quarter.
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
decreased $1.8 million, or 46%, from $3.9 million in 2009 to $2.1 million for
the three months ended December 31, 2010.
The
decrease of $1.8 million for the three months ended December 31, 2010 was due to
a decrease in non-recurring expenses from 2009 including a $1.5 million decrease
from corporate and $0.3 million decrease from Cable. The
corporate related G&A decrease is derived primarily from decreases in
professional service fees, start-up costs related to the organization of a new
entity, and payroll taxes accrued in 2009 in connection with an IRS payroll tax
audit, as discussed in Note 1 (“Income Taxes”) to the consolidated financial
statements. The $0.3 million decrease in Cable related G&A is
derived primarily from $0.3 million in headcount and facilities costs due to
improvements over prior year expenses which included greater costs caused by
idle capacity.
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 by $94,000, or
14%, from $0.7 million in 2009.
The
decrease of $94,000 for the three months ended December 31, 2010 was due to
decreases in 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 increased $0.6 million, or 50%, from $1.1 million in 2009 to $1.7
million for the three months ended December 31, 2010.
The
increase of $0.6 million for the three months ended December 31, 2010 was
primarily related to increases in headcount costs, commissions on higher revenue
balances, and professional services fees.
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 decreased $34,000, or 35%, from
$97,000 in 2009 to $63,000 for the three months ended December 31,
2010. The decrease was due to decreases in the fixed asset
base.
32
INTEREST
EXPENSE: Interest expense consists of the cash interest payable on the Company’s
debt. For 2009, interest expense consisted of the cash interest on
$9.0 million of Convertible Notes with an 8% coupon rate as well as the non-cash
expense for amortization of the Convertible Note discount recorded for the value
of the warrants and conversion features issued in conjunction with the
Convertible Notes. For 2010, interest expense consisted of the cash
interest on $10.0 million of 2 year Notes at as well as the non-cash expense for
amortization of the Note discount recorded for the value of the warrants
issued.
The
decrease of $223,000 for the three months ended December 31, 2010, or 25%, is
due to higher net financing costs in the prior quarter ended December 31, 2009
compared to fiscal 2010, including $277,000 of accrued interest from an IRS
payroll tax audit (refer to “Income Taxes” in Note 1 to the consolidated
financial statements), which was partially offset by a lower debt balance and
interest rates in effect during the prior quarter ended December 31,
2009.
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. As of December 31, 2010 our debt balance
consisted of principal debt at 12.5% interest less unamortized debt discounts of
$926,000, for a net debt balance of approximately $9.1 million.
INTEREST
INCOME: The interest income changes from period to period are due to changes in
the underlying cash balances. Interest income decreased by $16,000 in
the three months ended December 31, 2010 compared to the same period in the
prior year.
OTHER
INCOME/EXPENSE: For the three months ended December 31, 2010, other
income of $21,000 was primarily comprised of foreign exchange
gains. For the three months ended December31, 2009, other expense of
$175,000 was primarily comprised of foreign exchange losses and $171,000 in
penalties associated with the findings from the examination by the Internal
Revenue Service for prior fiscals years ended September 30, 2001 through 2005
(refer to “Income Taxes” in Note 1 to the consolidated financial
statements).
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 $0 and $14,000 for the
three months ended December 31, 2010 and 2009, 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, 2010, 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.
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, the UK Sterling and the Chinese Yuan. 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, 2010 and 2009:
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 United States generally accepted accounting
principles (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/Loss 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/Loss 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.
33
Three Months Ended December 31,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited, In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
EBITDAS:
|
||||||||||||||||||||||||
Net
loss from continuing operations
|
$
|
(2,589
|
)
|
$
|
(2,002
|
)
|
$
|
(4,591
|
)
|
$
|
(3,474
|
)
|
$
|
(3,012
|
)
|
$
|
(6,486
|
)
|
||||||
Depreciation
and amortization
|
2
|
88
|
90
|
—
|
216
|
216
|
||||||||||||||||||
Share-based
compensation
|
330
|
208
|
538
|
501
|
163
|
664
|
||||||||||||||||||
Change
in fair value of derivative liabilities
|
341
|
—
|
341
|
(774
|
)
|
—
|
(774
|
)
|
||||||||||||||||
Interest
expense, net
|
669
|
—
|
669
|
887
|
(11
|
)
|
876
|
|||||||||||||||||
Income
tax expense
|
—
|
—
|
—
|
14
|
—
|
14
|
||||||||||||||||||
EBITDAS
Loss
|
$
|
(1,247
|
)
|
$
|
(1,706
|
)
|
$
|
(2,953
|
)
|
$
|
(2,846
|
)
|
$
|
(2,644
|
)
|
$
|
(5,490
|
)
|
Consolidated
EBITDAS Loss for the three months ended December 31, 2010 for continuing
operations decreased by $2.5 million as compared to 2009 due to a $1.6
million decrease from corporate and a $0.9 million decrease from our Cable
operations. The total increase was primarily due improved gross margins and
decreased operating expenses.
NET
LOSS
The
following table presents the components of our total net loss:
Three Months Ended
December 31,
|
||||||||
(Unaudited, In Thousands)
|
2010
|
2009
|
||||||
Net
Loss from Continuing Operations
|
$
|
(4,591
|
)
|
$
|
(6,486
|
)
|
||
Income
(Loss) from Discontinued Operations (Note 2)
|
1,393
|
(1,222
|
)
|
|||||
|
|
|||||||
Net
Loss
|
$
|
(3,198
|
)
|
$
|
(7,708
|
)
|
Our
current period net loss decreased by $4.5 million to $3.2 million for the three
months ended December 31, 2010 from $7.7 million in 2009. This net loss decrease
is due to:
|
·
|
An
increase in Gross Margin from continuing operations of $1.3 million from
2009 to 2010.
|
|
·
|
A
decrease in Total Operating Expense from continuing operations of $1.3
million from 2009 to 2010.
|
|
·
|
An
increase in Total Other Expense from continuing operations of $0.7 million
from 2009 to 2010.
|
|
·
|
A
decrease in Loss from Discontinued Operations of $2.6 million from a loss
of $1.2 million in 2009 to a gain of $1.4 million in
2010.
|
Gross
Margin: As discussed above, the gross margin increase of $1.3 million is
primarily due to increased revenues, an improved product mix to higher margin
ACCC® core and
improved production efficiencies.
Total
Operating Expense: As detailed above, the total decrease in operating expense is
driven by significant decreases in general and administrative expenses totaling
$1.8 million, a $0.1 million decrease for officer compensation, offset by an
increase in sales and marketing expenses of $0.6 million for the three months
ended December 31, 2010 compared to 2009.
Total
Other Expense: As discussed above, the total other expense decrease is primarily
due to a $1.1 million change in fair value of derivatives liabilities from a
$0.8 million gain in 2009 to a $0.3 loss in 2010, offset by reduced interest and
other expenses of $0.4 million in the three months ended December 31, 2010
compared to 2009 (refer to discussion above).
34
Loss from
Discontinued Operations: As discussed above and detailed in Note 2 to the
consolidated financial statements, the $2.6 million change from a $1.2 million
loss for 2009 to a $1.4 gain for the December 2010 quarter 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, 2010, we had a net loss from continuing
operations of $4.6 million. At December 31, 2010 we had $1.9 million of cash and
cash equivalents, which represented a net decrease of $1.1 million from
September 30, 2010. The decrease was due to cash used in operations of $1.1
million and cash used in investing activities of $34,000.
Cash used
in operations during the three months ended December 31, 2010 of $1.1 million
was primarily the result of a net loss of $3.2 million and income from
discontinued operations of $1.4 million, offset by net non-cash reconciling
items of $1.2 million (comprised of depreciation and amortization of $0.4
million, common stock related charges of $0.6 million and a loss from the change
in fair value of derivative liabilities of $0.3 million, offset by net inventory
charges of $0.1 million) and net cash provided from working capital of $2.4
million (comprised of positive changes in accounts payable of $1.6 million,
accounts receivable of $1.2 million, inventory of $0.7 million and other assets
of $0.1 million, primarily offset by a negative change in deferred revenue of
$1.2 million). Additionally, cash used in operations was impacted by a negative
change in net assets/liabilities from discontinued operations of $0.1
million.
Cash used
in investing activities during the three months ended December 31, 2010 of
$34,000 was primarily from the purchase of computer hardware/software and
equipment put in service in anticipation of increased cable manufacturing
activities.
We had no
cash provided from, or used in, financing activities during the three months
ended December 31, 2010.
Our cash
position as of December 31, 2010 was $1.9 million. In April 2010, we
raised $10.0 million in senior secured debt, net of $0.3 million in fees (refer
to Note 9 to the consolidated financial statements). Our senior
secured debt agreement includes certain restrictive financial covenants that the
Company was in compliance with, by way of the conditional waiver signed in
December 2010 (see discussion in Note 9 to the consolidated financial
statements). In July 2010, in connection with the DeWind asset sale
(refer to Note 2 to the consolidated financial statements), the Company received
$836,000 of the escrowed cash, which was used to pay a vendor claim, leaving
$16.4 million remaining in escrow, which continues to be held in escrow as of
December 31, 2010. We believe our current cash position, future
capital raises, expected cash flows from revenue orders, potential recovery of
additional 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, 2011 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 as a result of 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. The Company received a report from its independent auditors
for the year ended September 30, 2010 that included an explanatory paragraph
describing the uncertainty as to the Company's ability to continue as a going
concern. As of December 31, 2010, our consolidated financial statements
contemplate the ability to continue as such and do not include any adjustments
that might result from this uncertainty. Therefore, the Company has
conservatively estimated, assuming no additional net cash receipts are generated
from the escrowed cash and, if needed, we do not close a financing transaction
that provides adequate cashflow, that our ability to continue operations after
September 30, 2011 is uncertain (refer to “Going Concern” in Note 1 to the
consolidated financial statements).
CAPITAL
EXPENDITURES
The
Company does not have any material commitments for capital
expenditures.
OFF
BALANCE SHEET ARRANGEMENTS
As of
December 31, 2010, we have no off balance sheet arrangements.
35
CONTRACTUAL
OBLIGATIONS
The
following table summarizes our contractual obligations (including interest
expense) and commitments as of December 31, 2010:
Due in
|
In excess of
|
|||||||||||||||
(Unaudited, In Thousands)
|
Total
|
Year 1
|
In Years 2-3
|
3 Years
|
||||||||||||
Warranty
Provisions (A)
|
$
|
477
|
$
|
294
|
$
|
183
|
$
|
—
|
||||||||
Debt
Obligations (B)
|
$
|
11,615
|
$
|
11,250
|
$
|
365
|
$
|
—
|
||||||||
Operating
Lease Obligations
|
$
|
2,207
|
$
|
991
|
$
|
1,216
|
$
|
—
|
(A)
Warranty provisions are discussed in Note 8 to the consolidated financial
statements.
(B)
Senior secured loan due April 2012 and the related estimated monthly
interest-only payments (see Note 9 to the consolidated financial
statements).
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 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 Securities and Exchange
Commission (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. Revenues recorded are shown net of any sales discounts or
similar sales incentives provided to our customers.
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 in the three months ended December 31, 2010 and 2009 consisted of stranded
ACCC®
conductor and ACCC® hardware
sold to end-user utilities and sales of ACCC® core and
ACCC® hardware
to our stranding manufacturers. All ACCC® product
related sales were recognized upon delivery of product and transfer of
title. 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 extended warranty
coverage. Additionally, all ACCC®
conductor is sold to our end-user customers with a standard three-year product
warranty. The Company purchases a three-year term product warranty liability
insurance policy for all ACCC®
conductor sold directly by the Company to mitigate any product warranty
liability risk. Revenues from ACCC®
conductor sold directly to end-user customers are recorded net of the cost of
the three-year term insurance policy.
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. In the three months ended December 31, 2010 and 2009, we
recognized no consulting revenues.
Multiple-element
revenue arrangements are recognized with the overall arrangement fee being
allocated to each element (both delivered and undelivered items) based on their
relative selling prices, regardless of whether those selling prices are
evidenced by vendor specific objective evidence or third-party evidence, or are
based on the Company's estimated selling price. Historically, except
for the product warranty element discussed above, we have not had any
multiple-element revenue arrangements.
36
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.
Our
ACCC®
conductor is sold to our end-user customers with a standard three-year product
warranty. The Company purchases a three-year term product warranty liability
insurance policy for all ACCC®
conductor sold directly by the Company to mitigate any product warranty
liability risk. All customers have the option to extend this warranty
for to up to ten years upon customer payment of additional insurance
premiums. The insurance policy covers materials costs and labor costs
to replace the ACCC®
conductor in the event of a product warranty claim caused by a product
defect. As such, the purchase of the initial three-year insurance
policy covers significantly all product warranty liability for which the Company
may be exposed under its standard three-year product warranty. To
date, the Company has had no product warranty claims.
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 derivative liabilities, 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
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.
The 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 for each customer and
management’s 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
(Black-Scholes) 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.
|
|
-
|
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 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 where the Company has a
choice of share or net cash settlement are accounted for as equity. Contracts
where settlement is in cash or in net share settlement; or where the
counterparty may choose cash settlement are accounted for as a liability. Under
current US GAAP, certain of our warrants 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.
37
The
values of the financial instruments are estimated using the Black-Scholes
option-pricing model. Key assumptions used to value options and warrants
granted, issued or repriced are as follows:
December 31,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
0.98-1.91
|
%
|
0.82-2.30
|
%
|
||||
Volatility
|
91-100
|
%
|
96-108
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
2-5
yrs
|
2-2.6
yrs
|
Derivative
Liabilities
Currently,
our derivative liabilities include fair value based warrant liabilities pursuant
to US GAAP applied to the terms of the underlying agreements. The Company has
issued warrants to purchase common shares of the Company as additional incentive
for investors who purchase unregistered, restricted common stock, certain debt
obligations 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 statements 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 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” in Note 1 to the consolidated financial statements for
additional derivative liabilities disclosures.
For the
three months ended December 31, 2010 and 2009, we recognized a gain/(loss) of
$(341,000) and $774,000, respectively, related to the revaluation of our
derivative liabilities. The 2010 revaluation loss resulted from an
increase in our stock price from the prior quarter and the re-pricing of certain
warrants, as further discussed in Note 10 to the consolidated financial
statements. The 2009 revaluation gain 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 10 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 employee 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
issued 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 the expected term in “plain vanilla” share options and
warrants.
38
Additional
information about share-based compensation is disclosed in Note 11 to the
consolidated financial statements.
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. As of December 31,
2010, we had no convertible debt outstanding.
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 PROUNOUNCEMENTS
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 current debt obligations bear a fixed rate of
interest.
As of
December 31, 2010 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, 2010, we had $1.9 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,
2010 because of the material weaknesses identified during management’s annual
assessment of internal control over financial reporting for the year ended
September 30, 2010.
39
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, 2010 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, 2010. In making this
assessment, the Company’s management used the criteria set forth in the
framework established by the Committee of Sponsoring Organizations of the
Treadway Commission entitled “Internal Control – Integrated
Framework”. Based on their assessment, management concluded that, as
of September 30, 2010, the Company’s internal control over financial reporting
is not effective based on those criteria, because of the material weaknesses
identified.
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, 2010 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
The
Company's management has identified the steps necessary to address the material
weaknesses identified as of September 30, 2010, 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)
Evaluating an internal audit function in relation to the Company's financial
resources and requirements;
(5)
Investing in additional enhancements to our IT systems including enhancements to
processing manufacturing and inventory transactions, and security over user
access and administration;
(6)
Creating policy and procedures manuals for the accounting, finance and IT
functions; and
(7)
Improving our purchasing and accounts payable cycle controls.
The
Company began to execute the remediation plans identified above in the first
fiscal quarter of 2011. These remediation efforts are expected to continue
through fiscal 2011.
40
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, 2010. See
Note 12 (“Litigation”) to the consolidated financial statements in this
document, which is incorporated by reference herein.
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, 2010. 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 $89 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 general administrative 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. On April 12, 2010 we raised
$10.0 million of debt that has restrictive debt covenant requirements and which
places limits on our losses and limits our cash spending to minimum cash levels.
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 may 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.
WE HAVE
EXCEEDED THE FINANCIAL THRESHOLDS OF OUR DEBT COVENANTS UNDER OUR SENIOR SECURED
DEBT. THE SENIOR SECURED DEBT ISSUED BY THE COMPANY IN APRIL 2010 INCLUDES
RESTRICTIVE DEBT COVENANTS WHICH MAY LIMIT OUR ABILITY TO OPERATE, OBTAIN
FINANCING, OR WHICH MAY IMPAIR THE ASSETS OF THE COMPANY IN THE EVENT OF A LOAN
DEFAULT.
We
entered into a loan agreement in April 2010 which includes restrictive debt
covenants that include both a liquidity covenant, which requires a minimum
combined cash and accounts receivable balance in excess of $7.5 million, and a
profitability covenant which allows for a maximum level of accumulated non-GAAP
losses after March 31, 2010 of $5 million, adjusted for non-cash items and
timing of revenue recognition. The debt is secured by substantially
all assets of the Company. We are currently in violation of our debt
covenants and may therefore be placed into default by our lenders. If
we cannot cure or renegotiate the debt covenants, or refinance the debt in total
or in part, the lenders could pursue remedies included in the loan agreement
which may include any or all of the following: immediate collection of the loan,
assignment of cash receipts, control of the Company’s bank accounts, or
liquidation of the Company’s assets in part or in full. As of
December 31, 2010, we were in compliance with its covenants by way of a
conditional waiver signed on December 13, 2010.
41
OUR
INDEPENDENT AUDITORS ISSUED AN UNQUALIFIED REPORT AND INCLUDED AN EMPHASIS
PARAGRAPH AS OF AND FOR THE YEAR ENDED SEPTEMBER 30, 2010 WITH RESPECT TO OUR
ABILITY TO CONTINUE AS A GOING CONCERN, AND WE MAY NEVER ACHIEVE
PROFITABILITY.
For the
year ended September 30, 2010, our accountants issued a report relating to our
audited financial statements which contains a qualification with respect to our
ability to continue as a going concern because, among other things, our ability
to continue as a going concern is dependent upon our ability to generate
profitable operations in the future or to obtain the necessary financing to meet
our obligations and repay our liabilities from normal business operations when
they come due. There is no guarantee that the products will be accepted or
provide a marketable advantage, and therefore, no guarantee that the
commercialization will ever be profitable. For the fiscal year ended September
30, 2010, we had a net loss of $19,767,000 and negative cash flows from
operating activities – continuing operations of $17,358,000. During the three
months ended December 31, 2010, the Company incurred a net loss of $3,198,000
and had negative cash flows from operating activities – continuing
operations of $941,000. In addition, the Company had an accumulated deficit of
$280,728,000 at December 31, 2010. As of December 31, 2010, our consolidated
financial statements contemplate the ability to continue as such and do not
include any adjustments that might result from this uncertainty (refer to “Going
Concern” in Note 1 to the consolidated financial statements).
OUR
BUSINESS MAY BE SUBJECT TO INTERNATIONAL RISKS.
We are
pursuing international business opportunities, including in South America,
Europe, Russia, India, China, Mexico, the Middle East, Indonesia, certain far
eastern countries and Africa. As to international business in South America, we
recently received a large order in Paraguay and we expect a significant portion
of our revenue may be derived from that country for the next two
quarters. Our Cable business model has been implemented in the United
States, Canada, Europe, Bahrain, Indonesia, and China. We produce
ACCC® core in
the United States for delivery to our stranding licensees under manufacturing
and distribution agreements for ACCC®
conductor deliveries made to date in the United States and China. Expansion
internationally will depend on our adaptation of this model to other
international markets and may be costly and time consuming. Risks inherent in
international operations in general include:
(i)
unexpected changes in regulatory requirements, export restrictions, tariffs and
other trade barriers;
(ii)
challenges in staffing and managing foreign operations;
(iii)
differences in technology standards, employment laws and business
practices;
(iv)
longer payment cycles and problems in collecting accounts
receivable;
(v)
political instability;
(vi)
changes in currency exchange rates;
(vii)
performance bond requirements;
(viii)
currency exchange controls; and
(ix)
potentially adverse tax consequences.
In
particular, certain of our target markets in the Middle East include Iraq and
Afghanistan in which there is considerable violent instability that may affect
our ability to operate in those markets.
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 fiscal months ending December 31, 2010, the closing
bid prices for our common stock have fluctuated from a high of $0.31 to a low of
$0.17. Fluctuations in the trading price or liquidity of our common stock may
adversely affect our ability to raise capital through future equity
financings.
42
OUR
FUTURE REVENUE IS UNPREDICTABLE AND COULD CAUSE OUR OPERATING RESULTS TO
FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER.
Our
quarterly revenue and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter. Our business
consists of a small number of relatively large dollar transactions and the
timing of revenue recognition is heavily dependent on customer defined delivery
dates and shipping schedules which may impact the timing of revenue
recognition. Historically, our CTC Cable business has had a
significant portion of its revenue sourced from one customer in China and
revenue recognition is determined by shipment of products to this customer
subject to their delivery schedules. Our revenues for much of fiscal
2011 is expected to be sourced from one customer in Paraguay. Since
our revenues may fluctuate and are difficult to predict, and our expenses are
largely independent of revenues in any particular period, it is difficult for us
to accurately forecast revenues and profitability.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item
3. Defaults Upon Senior Securities
None.
Item
4. (Removed and Reserved)
Item
5. Other Information
None.
43
Item
6. Exhibits
EXHIBIT
INDEX
Number
|
Description
|
|
2.1
(4)
|
Asset
Purchase Agreement by and between Daewoo Shipbuilding & Marine
Engineering Co. Ltd. and DeWind, Inc. and the Registrant dated as of
August 10, 2009.
|
|
2.2
(4)
|
Asset
Purchase Agreement by and between Daewoo Shipbuilding & Marine
Engineering Co. Ltd. and DeWind, Ltd. dated as of August 10,
2009.
|
|
2.3
(5)
|
Amendment
No. 1 dated as of September 4, 2009 to the Asset Purchase
Agreement by and between Daewoo Shipbuilding & Marine Engineering
Co. Ltd. and DeWind, Inc. and the Registrant dated as of August 10,
2009.
|
|
2.4
(5)
|
Amendment
No. 1 dated as of September 4, 2009 by and between Daewoo Shipbuilding
& Marine Engineering Co. Ltd. and DeWind, Ltd. dated as of August 10,
2009.
|
|
3.1
(1)
|
Articles
of Incorporation of the Company.
|
|
3.2
(2)
|
Certificate
of Amendment to Articles of Incorporation.
|
|
3.3
(3)
|
Bylaws
of Composite Technology Corporation, as modified January 6,
2006.
|
|
10.1
(6)
|
Conditional
Waiver and Modification to Loan and Security Agreement by and between
Partners for Growth II, L.P., Composite Technology Corporation, CTC Cable
Corporation and CTC Renewables Corporation, dated December 13,
2010.
|
|
10.2
(6)
|
Conditional
Waiver and Modification No. 2 to Loan and Security Agreement by and
between Partners for Growth II, L.P., Composite Technology Corporation,
CTC Cable Corporation and CTC Renewables Corporation, dated December 13,
2010.
|
|
10.3
(6)
|
Amended
and Restated Warrant.
|
|
10.4
(6)
|
Amended
and Restated Warrant.
|
|
31.1
(7)
|
Rule
13a-14(a) / 15d-14(a)(4) Certification of Chief Executive
Officer.
|
|
31.2
(7)
|
Rule
13a-14(a) / 15d-14(a)(4) Certification of Chief Financial
Officer.
|
|
32.1
(7)
|
Section
1350 Certification of Chief Executive Officer.
|
|
32.2
(7)
|
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 August 14, 2009; and to Form 8-K/A filed with the U.S.
Securities and Exchange Commission on December 8, 2010.
(5)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on September 11, 2009; and to Form 8-K/A filed with the U.S.
Securities and Exchange Commission on December 8, 2010.
(6)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on December 17, 2010.
(7) Filed
herewith.
44
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, 2011
|
By: /s/ Benton H
Wilcoxon
|
Benton
H Wilcoxon
|
|
Chief
Executive Officer
|
|
(Principal
Executive Officer)
|
Date:
February 9, 2011
|
By: /s/ Domonic J.
Carney
|
Domonic
J. Carney
|
|
Chief
Financial Officer
|
|
(Principal
Financial and
Accounting Officer)
|
45