Attached files
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EX-31.2 - COMPOSITE TECHNOLOGY CORP | v192759_ex31-2.htm |
EX-31.1 - COMPOSITE TECHNOLOGY CORP | v192759_ex31-1.htm |
EX-32.2 - COMPOSITE TECHNOLOGY CORP | v192759_ex32-2.htm |
EX-32.1 - COMPOSITE TECHNOLOGY CORP | v192759_ex32-1.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 JUNE 30, 2010
o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION
FILE NUMBER 0-10999
COMPOSITE
TECHNOLOGY CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
NEVADA
|
59-2025386
|
|
State or Other Jurisdiction of
Incorporation or Organization)
|
(I.R.S. Employer Identification No.)
|
|
2026 McGaw Avenue, Irvine, CA
|
92614
|
|
(Address of Principal Executive Offices)
|
(Zip Code)
|
(949)
428-8500
(Registrant's
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YES x NO o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). YES o NO o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
See definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer
o
|
Accelerated filer
x
|
Non-accelerated filer
o
(Do not check if a smaller reporting company)
|
Smaller reporting company
o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES o NO x
APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDING
DURING THE PRECEDING FIVE YEARS:
Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court. YES x
NO o
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer's classes of common stock
as of: August 9, 2010
CLASS
|
NUMBER OF SHARES
OUTSTANDING
|
|
Common
Stock, par value $0.001 per share
|
288,269,660
shares
|
COMPOSITE
TECHNOLOGY CORPORATION
Form 10-Q
for the Quarter ended June 30, 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
|
25
|
Item
3 Quantitative and Qualitative Disclosures About Market
Risk
|
36
|
Item
4 Controls and Procedures
|
36
|
PART
II – OTHER INFORMATION
|
|
Item
1 Legal Proceedings
|
38
|
Item
1A Risk Factors
|
38
|
Item
2 Unregistered Sales of Equity Securities and the Use of
Proceeds
|
39
|
Item
3 Defaults Upon Senior Securities
|
39
|
Item
4 (Removed and Reserved)
|
39
|
Item
5 Other Information
|
39
|
Item
6 Exhibits
|
40
|
SIGNATURES
|
41
|
EXHIBITS
|
2
PART
1 - FINANCIAL INFORMATION
Item
1. Financial Statements
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(IN
THOUSANDS)
June 30, 2010
|
September 30, 2009
|
|||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
CURRENT
ASSETS
|
||||||||
Cash
and Cash Equivalents
|
$
|
7,382
|
$
|
23,968
|
||||
Restricted
Cash, Current Portion (Note 2)
|
5,500
|
5,500
|
||||||
Accounts
Receivable, net of reserve of $87 and $81
|
950
|
1,732
|
||||||
Inventory,
net of reserve of $1,179 and $923
|
3,292
|
4,378
|
||||||
Prepaid
Expenses and Other Current Assets
|
1,225
|
959
|
||||||
Current
Assets of Discontinued Operations (Note 2)
|
1,453
|
2,522
|
||||||
Total
Current Assets
|
19,802
|
39,059
|
||||||
Property
and Equipment, net of accumulated depreciation of $2,600 and
$3,766
|
2,935
|
3,214
|
||||||
Restricted
Cash, Non-Current (Note 2)
|
11,688
|
11,675
|
||||||
Other
Assets
|
894
|
891
|
||||||
TOTAL
ASSETS
|
$
|
35,319
|
$
|
54,839
|
||||
LIABILITIES
AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
||||||||
CURRENT
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
5,480
|
$
|
7,217
|
||||
Deferred
Revenues and Customer Advances
|
1,470
|
16
|
||||||
Warranty
Provision
|
327
|
258
|
||||||
Derivative
Liabilities – Current (Note 1)
|
31
|
—
|
||||||
Notes
Payable – Current, net of discount of $0 and $315
|
—
|
8,723
|
||||||
Current
Liabilities of Discontinued Operations (Note 2)
|
36,182
|
43,469
|
||||||
Total
Current Liabilities
|
43,490
|
59,683
|
||||||
LONG-TERM
LIABILITIES
|
||||||||
Long
Term Portion of Deferred Revenues
|
545
|
561
|
||||||
Long-Term
Portion of Warranty Provision
|
286
|
306
|
||||||
Derivative
Liabilities – Long-Term (Note 1)
|
1,596
|
—
|
||||||
Long-Term
Debt, net of discount of $1,214 and $0
|
8,786
|
—
|
||||||
Non-Current
Liabilities of Discontinued Operations (Note 2)
|
806
|
1,120
|
||||||
Total
Long-Term Liabilities
|
12,019
|
1,987
|
||||||
Total
Liabilities
|
55,509
|
61,670
|
||||||
COMMITMENTS
AND CONTINGENCIES
|
||||||||
SHAREHOLDERS’
EQUITY (DEFICIT)
|
||||||||
Common
Stock, $.001 par value 600,000,000 shares authorized 288,269,660 and
288,088,370 issued and outstanding
|
288
|
288
|
||||||
Additional
Paid-in Capital
|
251,625
|
259,755
|
||||||
Accumulated
Deficit
|
(272,103
|
)
|
(266,874
|
)
|
||||
Total
Shareholders’ (Deficit)
|
(20,190
|
)
|
(6,831
|
)
|
||||
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
|
$
|
35,319
|
$
|
54,839
|
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 SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
June 30,
|
Nine Months Ended
June 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Revenue
|
$
|
583
|
$
|
3,562
|
$
|
7,536
|
$
|
14,124
|
||||||||
Cost
of Revenue
|
742
|
2,931
|
6,466
|
10,063
|
||||||||||||
Gross
Profit (Loss)
|
(159
|
)
|
631
|
1,070
|
4,061
|
|||||||||||
OPERATING
EXPENSES
|
||||||||||||||||
Officer
Compensation
|
546
|
771
|
1,931
|
2,527
|
||||||||||||
General
and Administrative
|
2,824
|
2,162
|
9,814
|
6,629
|
||||||||||||
Research
and Development
|
499
|
499
|
1,645
|
1,910
|
||||||||||||
Sales
and Marketing
|
1,505
|
1,108
|
4,489
|
3,856
|
||||||||||||
Depreciation
& Amortization
|
101
|
93
|
360
|
274
|
||||||||||||
Total
Operating Expenses
|
5,475
|
4,633
|
18,239
|
15,196
|
||||||||||||
LOSS
FROM OPERATIONS
|
(5,634
|
)
|
(4,002
|
)
|
(17,169
|
)
|
(11,135
|
)
|
||||||||
OTHER
INCOME / (EXPENSE)
|
||||||||||||||||
Interest
Expense
|
(613
|
)
|
(461
|
)
|
(1,681
|
)
|
(1,371
|
)
|
||||||||
Interest
Income
|
6
|
2
|
27
|
16
|
||||||||||||
Other
Expense
|
(136
|
)
|
(8
|
)
|
(400
|
)
|
(8
|
)
|
||||||||
Change
in Fair Value of Derivative Liabilities (Note 1)
|
597
|
—
|
1,437
|
—
|
||||||||||||
Total
Other Income / (Expense)
|
(146
|
)
|
(467
|
)
|
(617
|
)
|
(1,363
|
)
|
||||||||
Loss
from Continuing Operations before Income Taxes
|
(5,780
|
)
|
(4,469
|
)
|
(17,786
|
)
|
(12,498
|
)
|
||||||||
Income
Tax Expense
|
—
|
—
|
14
|
4
|
||||||||||||
NET
LOSS FROM CONTINUING OPERATIONS
|
(5,780
|
)
|
(4,469
|
)
|
(17,800
|
)
|
(12,502
|
)
|
||||||||
Income
(Loss) from Discontinued Operations, net of tax of $0, $0, $1 and $(8)
(Note 2)
|
2,376
|
(22,456
|
)
|
3,460
|
(33,413
|
)
|
||||||||||
NET
LOSS
|
(3,404
|
)
|
(26,925
|
)
|
(14,340
|
)
|
(45,915
|
)
|
||||||||
OTHER
COMPREHENSIVE INCOME (LOSS)
|
||||||||||||||||
Foreign
Currency Translation Adjustment:
|
||||||||||||||||
Unrealized
Holding Gain (Loss) Arising During Period
|
—
|
(1,566
|
)
|
—
|
658
|
|||||||||||
Other
Comprehensive Income (Loss), net of tax of $0, $0, $0 and
$0
|
—
|
(1,566
|
)
|
—
|
658
|
|||||||||||
COMPREHENSIVE
LOSS
|
$
|
(3,404
|
)
|
$
|
(28,491
|
)
|
$
|
(14,340
|
)
|
$
|
(45,257
|
)
|
||||
BASIC
AND DILUTED LOSS PER SHARE
|
||||||||||||||||
Loss
per share from continuing operations
|
$
|
(0.02
|
)
|
$
|
(0.01
|
)
|
$
|
(0.06
|
)
|
$
|
(0.04
|
)
|
||||
Income
(loss) per share from discontinued operations
|
$
|
0.01
|
$
|
(0.08
|
)
|
$
|
0.01
|
$
|
(0.12
|
)
|
||||||
TOTAL
BASIC AND DILUTED LOSS PER SHARE
|
$
|
(0.01
|
)
|
$
|
(0.09
|
)
|
$
|
(0.05
|
)
|
$
|
(0.16
|
)
|
||||
WEIGHTED-AVERAGE
COMMON SHARES OUTSTANDING
|
288,269,660
|
287,988,370
|
288,201,292
|
287,988,370
|
The
accompanying notes are an integral part of these financial
statements.
4
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(IN
THOUSANDS)
(UNAUDITED)
Nine Months Ended June
30,
|
||||||||
2010
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES
|
||||||||
Net
loss
|
$
|
(14,204
|
)
|
$
|
(45,915
|
)
|
||
(Income)
loss from discontinued operations
|
(3,460
|
)
|
33,413
|
|||||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Interest
and deferred finance charge amortization related to detachable warrants
and fixed conversion features
|
881
|
818
|
||||||
Depreciation
& amortization
|
486
|
722
|
||||||
Share-based
compensation
|
2,085
|
3,762
|
||||||
Amortization
of prepaid expenses paid in stock/warrants
|
204
|
246
|
||||||
Issuance
of warrants for services
|
57
|
22
|
||||||
Issuance
of stock for services
|
45
|
—
|
||||||
Expense
related to modification of stock warrants
|
—
|
7
|
||||||
Change
in fair value of derivative liabilities
|
(1,437
|
)
|
—
|
|||||
Bad
debt expense
|
32
|
—
|
||||||
Inventory
reserve expense and inventory impairment charges
|
1,166
|
171
|
||||||
Loss
on disposal of fixed assets
|
90
|
—
|
||||||
Loss
on foreign exchange
|
(136
|
)
|
—
|
|||||
Changes
in Assets / Liabilities:
|
||||||||
Accounts
receivable
|
750
|
1,454
|
||||||
Inventory
|
(79
|
)
|
820
|
|||||
Prepaids
and other current assets
|
(283
|
)
|
(251
|
)
|
||||
Other
assets
|
34
|
61
|
||||||
Accounts
payable and other accruals
|
(1,738
|
)
|
484
|
|||||
Deferred
revenue
|
1,438
|
(166
|
)
|
|||||
Accrued
warranty liability
|
50
|
145
|
||||||
Net
assets/liabilities of discontinued operations
|
(2,982
|
)
|
(10,927
|
)
|
||||
Cash
used in operating activities – continuing operations
|
(17,001
|
)
|
(15,134
|
)
|
||||
Cash
used in operating activities – discontinued operations
|
—
|
(4,687
|
)
|
|||||
Net
cash used in operating activities
|
$
|
(17,001
|
)
|
$
|
(19,821
|
)
|
||
CASH
FLOW FROM INVESTING ACTIVITIES
|
||||||||
Purchase
of property and equipment
|
$
|
(195
|
)
|
$
|
(710
|
)
|
||
Restricted
cash
|
(13
|
)
|
693
|
|||||
Cash
used in investing activities – continuing operations
|
(208
|
)
|
(17
|
)
|
||||
Cash
used in investing activities – discontinued
operations
|
—
|
(806
|
)
|
|||||
Net
cash used in investing activities
|
$
|
(208
|
)
|
$
|
(823
|
)
|
||
CASH
FLOW FROM FINANCING ACTIVITIES
|
||||||||
Proceeds
from exercise of stock options
|
$
|
7
|
$
|
—
|
||||
Proceeds
from senior secured debt agreements (net of fees of $347 and
$295)
|
9,653
|
4,705
|
||||||
Repayment
of notes payable
|
(9,037
|
)
|
—
|
|||||
Net
cash provided by financing activities
|
$
|
623
|
$
|
4,705
|
||||
Total
net decrease in cash and cash equivalents
|
$
|
(16,586
|
)
|
$
|
(15,939
|
)
|
||
Cash
and cash equivalents at beginning of period
|
23,968
|
23,085
|
||||||
Cash
and cash equivalents at end of period
|
$
|
7,382
|
$
|
7,146
|
||||
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
||||||||
INTEREST
PAID
|
$
|
706
|
$
|
560
|
||||
INCOME
TAX PAID
|
$
|
14
|
$
|
3
|
The
accompanying notes are an integral part of these financial
statements.
5
SUPPLEMENTAL
DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
During
the nine months ended June 30, 2010, the Company:
Issued
300,000 warrants at an exercise price of $0.45 per share valued at $57,000 in
settlement of a legal dispute.
Issued
161,290 shares of common stock to John Brewster, former CTC Cable President,
valued at $45,000 in partial payment of an employment acceptance
bonus.
Issued
600,000 warrants at an exercise price of $0.35 per share valued at $95,000 in
connection with an ongoing service agreement. The Company recorded
$16,000 to general and administrative expense related to services rendered
during the nine months ended June 30, 2010.
Issued
10,000,000 warrants (5 million at an exercise price of $0.29 per share and 5
million at an exercise price of $1.00 per share) for an aggregate value of
$1,494,000 in connection with the April 2010 debt financing
transaction. The Company recorded $1,488,000 (net of $6,000 in cash
consideration) as a debt discount. See Note 8.
During
the nine months ended June 30, 2009, the Company:
Issued
150,000 warrants at an exercise price of $0.96 per share in settlement of a
disputed financing fee related to the May, 2008 debt financing.
Re-priced
200,000 $1.75 warrants, 200,000 $1.50 warrants, and 200,000 $1.25 warrants to a
strike price of $0.75 per warrant for all three series of warrants. The Company
recorded $22,000 to general and administrative expense for the re-pricing of
these warrants.
Issued
4,000,000 warrants at an exercise price of $0.25 per share in conjunction with a
$5,000,000 Bridge Note financing. The Company recorded $726,000 as debt discount
for the warrants issued.
6
COMPOSITE
TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Composite
Technology Corporation (the “Company”), originally incorporated in Florida and
reincorporated in Nevada, is an Irvine, CA based company that has operated in
two segments, CTC Cable “Cable” and DeWind “Wind”. As discussed
below, in September 2009, the Company sold substantially all of its Wind
segment, which sold wind turbines under the brand name DeWind. The Cable segment
sells high efficiency patented composite core electricity conductors known as
"ACCC®
conductor" for use in electric transmission and distribution
lines. ACCC®
conductor is sold in North America directly by CTC Cable to
utilities. ACCC®
conductor is sold elsewhere in the world directly to utilities as well as
through license and distribution agreements with Lamifil in Belgium, Far East
Composite Cable Company in China, and through two Indonesian companies PT Tranka
Cable and PT KMI Cable and now through Alcan Cable in the U.S. and
Canada. 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 unaudited consolidated financial statements of the Company have
been prepared in accordance with accounting principles generally accepted in the
United States of America (US GAAP) for interim financial information and with
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not contain all of the information and footnotes required for complete
financial statements. Interim information is unaudited, however, in the opinion
of the Company's management, the accompanying unaudited, consolidated financial
statements reflect all adjustments (consisting of normal, recurring adjustments)
considered necessary for a fair presentation of the Company's interim financial
information. These financial statements and notes should be read in conjunction
with the audited consolidated financial statements of the Company included in
the Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2009, filed with the Securities and Exchange Commission (SEC) on December 14,
2009.
The
financial statements include the accounts of the Company and its wholly-owned
subsidiaries, the most significant of which is CTC Cable
Corporation.
The
Company consolidates the financial statements of all entities in which the
Company has a controlling financial interest, as defined in US GAAP. All
significant inter-company accounts and transactions are eliminated during
consolidation.
DISCONTINUED
OPERATIONS AND SALE OF DEWIND
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property and
transferred substantially all operating liabilities including supply chain and
operating expense accounts payables and accrued liabilities, warranty related
liabilities for US turbine installations, and deferred revenues. All
of the remaining assets and liabilities of DeWind have been classified as net
assets/liabilities of discontinued operations. All operations of our
former DeWind segment have been reported as discontinued operations. See
discussion at Note 2.
REVENUE
RECOGNITION
Revenues
are recognized based on guidance provided by the SEC. Accordingly, our general
revenue recognition policy is to recognize revenue when there is persuasive
evidence of an arrangement, the sales price is fixed or determinable, collection
of the related receivable is reasonably assured, and delivery has occurred or
services have been rendered.
The
Company derives, or seeks to derive revenues from product revenue sales of
composite core, stranded composite core, core and stranded core hardware, and
other electric utility related products.
In
addition to the above general revenue recognition principles prescribed by the
SEC, our specific revenue recognition policies for each revenue source are as
follows:
PRODUCT
REVENUES. Product revenues are recognized when product shipment has been made
and title has passed to the end user customer. Product revenues consist
primarily of revenue from the sale of: (i) stranded composite core and related
hardware to utilities either sold directly by the Company or through a
distribution agreement, and (ii) composite core and related hardware sold to a
cable stranding entity. Revenues are deferred for product contracts where the
Company is required to perform installation services until after the
installation is complete. Our distribution agreements are structured so that our
revenue cycle is complete upon shipment and title transfer of products to the
distributor with no right of return.
CTC Cable
sales for the three and nine months ended June 30, 2010 and 2009 consisted of
stranded ACCC®
conductor and ACCC® hardware
sold to end user utilities and sales of ACCC®
conductor 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 warranty coverage.
7
CONSULTING
REVENUE. Consulting revenues are generally recognized as the consulting services
are provided. We have entered into service contract agreements with electric
utility and utility services companies that generally require us to provide
engineering or design services, often in conjunction with current or future
product sales. In return, we receive engineering service fees payable in
cash. For the three and nine months ended June 30, 2010 and 2009, we
recognized no consulting revenues.
Currently,
multiple element contracts where there is no vendor specific objective evidence
(VSOE) or third-party evidence (TPE) that would allow the allocation of an
arrangement fee amongst various pieces of a multi-element contract, fees
received in advance of services provided are recorded as deferred revenues until
additional operational experience or other VSOE or TPE becomes available, or
until the contract is completed.
WARRANTY
PROVISIONS
Warranty
provisions consist of the insured costs and liabilities associated with any
post-sales associated with our ACCC®
conductor and related hardware parts.
Warranties
related to our ACCC® products
relate to conductor and hardware sold directly by us to the end-user
customer. We mitigate our loss exposure through the use of third
party warranty insurance. Warranty related liabilities for time
periods in excess of one year are classified as non-current
liabilities.
USE
OF ESTIMATES
The
preparation of our financial statements conform with US GAAP, which requires
management to make estimates and judgments in applying our accounting policies
that have an important impact on our reported amounts of assets, liabilities,
revenue, expenses and related disclosures at the date of our financial
statements. On an on-going basis, management evaluates its estimates including
those related to accounts receivable, inventories, share-based compensation,
warranty provisions and goodwill and intangibles, as applicable. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from management’s estimates. We believe that the application of our
accounting policies requires significant judgments and estimates on the part of
management. We believe that the estimates, judgments and assumption upon which
we rely are reasonable, and based upon information available to us at the time
that these estimates, judgments and assumptions are made. These estimates,
judgments and assumptions can affect the reported amounts of assets and
liabilities as of the date of the financial statements as well as the reported
amounts of revenues and expenses during the period presented. To the extent
there are material differences between these estimates, judgments or assumptions
and actual results, our financial statements will be affected. In many cases,
the accounting treatment of a particular transaction is specifically dictated by
US GAAP and does not require management's judgment in its application. There are
also many areas in which management's judgment in selecting among available
alternatives would produce a materially different result.
Our key
estimates we use that rely upon management judgment include:
|
-
|
the estimates pertaining to the
likelihood of our accounts receivable collectability. These estimates
primarily rely upon past payment history by customer and management
judgment on the likelihood of future payments based on the current
business condition of each customer and the general business
environment.
|
|
-
|
the estimates pertaining to the
valuation of our inventories. These estimates primarily rely upon the
current order book for each product in inventory along with management’s
expectations and visibility into future sales of each product in
inventory.
|
|
-
|
the assumptions used to calculate
fair value of our share-based compensation and derivative liabilities,
primarily the volatility component of the Black-Scholes-Merton
(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, forfeiture rates 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 convertible debt
issuances. The Company has not issued any derivative instruments for hedging
purposes since its inception. The Company uses the specific guidance and
disclosure requirements provided in US GAAP. Generally, freestanding derivative
contracts where settlement is required by physical share settlement or 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.
8
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:
Nine Months Ended
|
||||||||
June 30,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
0.82-2.60
|
%
|
0.50-2.54
|
%
|
||||
Volatility
|
95.0-108
|
%
|
75-116
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
2-5
yrs
|
.5-5
yrs
|
Derivative
Liabilities and Change in Accounting Principle
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 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” below in Note 1 for additional derivative liabilities
disclosures.
For the
three and nine months ended June 30, 2010, we recognized gains of $597,000 and
$1,437,000, respectively, related to the revaluation of our derivative
liabilities. The 2010 revaluation gains resulted mainly from the
decrease in our stock price from the prior year and from expired arrangements
during the year.
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 9.
Change
in Accounting Principle
Prior to
fiscal 2010, the Company accounted for all warrants issued in conjunction with
financing events as equity in accordance with existing US GAAP.
On
October 1, 2009, the Company adopted new FASB rules related to determining
whether an instrument (or embedded feature) is indexed to an entity’s own
stock. Current accounting for derivatives and hedging activities
specifies that a contract that would otherwise meet the definition of a
derivative, but is both (a) indexed to the Company’s own stock and (b)
classified in shareholders’ equity, would not be considered a derivative
financial instrument. The new rules provide a two-step model to be
applied in determining whether a financial instrument or an embedded feature is
indexed to an issuer’s own stock and thus able to qualify for the existing scope
exception. In accordance with the new rules, management evaluated
outstanding instruments as of October 1, 2009 and determined all warrants and
debt conversion arrangements with anti-dilution provisions issued in conjunction
with financing events, that are not considered compensatory, are not indexed to
our stock and therefore are to be recorded as liabilities at fair value and
marked-to-market through earnings. Accordingly, as of October 1,
2009, we have adjusted the opening balance of accumulated deficit to effect this
change in accounting principle as follows:
(Unaudited, In Thousands)
|
October 1, 2009
|
|||
Accumulated Deficit
|
$
|
(266,874
|
)
|
|
Cumulative
Effect of the Change (A)
|
9,111
|
|||
Accumulated
Deficit, as adjusted
|
$
|
(257,763
|
)
|
|
(A)
|
The cumulative effect of the
change to our Accumulated Deficit was derived from recognizing
mark-to-market fair value revaluation adjustments to the applicable
warrants and debt conversion features from the original issuance dates
through October 1, 2009, in the net gain amount of
$19,284,000. Additionally, the cumulative effect includes
recognition of interest expense from amortization of the debt discount
recorded from the initial valuation of the debt conversion features
through October 1, 2009, in the amount of
$10,173,000.
|
9
Additionally,
on October 1, 2009, the opening balance of Additional Paid-in Capital includes a
reclassification adjustment to Derivative Liabilities in the amount of
$10,514,000, which represents the aggregate original warrant fair value
previously recorded to equity.
Refer to
“Fair Value Measurements” below in Note 1 for additional derivative liabilities
disclosures.
Share-Based
Compensation
US GAAP
requires that compensation cost relating to share-based payment arrangements be
recognized in the financial statements. US GAAP requires measurement of
compensation cost for all share-based awards at fair value on date of grant and
recognition of compensation over the service period for awards expected to vest.
The fair value of stock options is determined using the Black-Scholes valuation
model. Such fair value is recognized as expense over the service period, net of
estimated forfeitures.
US GAAP
requires that equity instruments issued to non-employees in exchange for
services be valued at the more accurate of the fair value of the services
provided, or the fair value of the equity instruments issued. For equity
instruments issued that are subject to a required service period, the expense
associated with the equity instruments is recorded as the instruments vest or
the services are provided. The Company has granted options and warrants to
non-employees and recorded the fair value of these equity instruments on the
date of issuance using the Black-Scholes valuation model, for options and
warrants not subject to vesting terms. For non-employee option and warrant
grants subject to vesting terms, vested shares are recorded at fair value using
the Black-Scholes valuation model and the associated expense is recorded
simultaneously or as the services are provided. The Company has granted stock to
non-employees for services and values the stock at the more reliable of the
market value on the date of issuance or the value of the services provided. For
stock grants subject to vesting or service requirements, expenses are deferred
and recognized over the more appropriate of the vesting period, or as services
are provided.
SEC
guidance requires share-based compensation to be classified in the same
expense line items as cash compensation. Additionally, the
SEC issued guidance regarding the use of a "simplified" method in
developing an estimate of expected term of "plain vanilla" share options in
accordance with US GAAP rules. The Staff indicated that it will accept a
company's election to use the simplified method, regardless of whether the
company has sufficient information to make more refined estimates of expected
term. The Staff believed that more detailed external information about employee
exercise behavior (e.g., employee exercise patterns by industry and/or other
categories of companies) would, over time, become readily available to
companies; however, the Staff continues to accept, under certain circumstances,
the use of the simplified method. The Company currently uses the simplified
method for the expected term in “plain vanilla” share options and
warrants.
Additional
information about share-based compensation is disclosed in Note 10.
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 June 30, 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.
10
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 June 30, 2010 and September 30, 2009, restricted cash
consisted of cash held in escrow in connection with the sale of DeWind as
discussed in Note 2, amounting to $17,188,000 and $17,175,000,
respectively. During the nine months ended June 30, 2010, we reported an
additional $13,000 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.
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 is recorded to cost of
goods sold as the expenses are incurred.
PROPERTY
AND EQUIPMENT
Property
is stated at the lower of cost or realizable value, net of accumulated
depreciation. Additions and improvements to property and equipment are
capitalized at cost. Designated project costs are capitalized to
construction-in-progress as incurred. Depreciation of production equipment is
computed using the units-of-production method based on estimated useful lives of
specific production machinery and equipment and the related units estimated to
be produced over periods ranging from ten to twenty
years. Depreciation for all other assets is computed using the
straight-line method based on estimated useful lives of the assets which range
from three to ten years. Leasehold improvements and leased assets are amortized
or depreciated over the lesser of estimated useful lives or lease terms, as
appropriate. Property is periodically reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Expenditures for maintenance and repairs are charged to
operations as incurred while renewals and betterments are capitalized. Gains or
losses on the sale of property and equipment are reflected in the statements of
operations.
Change
in Accounting Estimate
Effective
on October 1, 2009, the Company changed its method of depreciation for
production machinery and equipment from the straight-line method to the
units-of-production method as described above. In accordance with US
GAAP, the Company accounted for this change in accounting estimate prospectively
beginning on October 1, 2009. See Note 5 for additional
information.
IMPAIRMENT
OF LONG-LIVED ASSETS
Management
evaluates long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If the estimated future cash flow (undiscounted and without
interest charges) from the use of an asset are less than the carrying value, an
impairment would be recorded to reduce the related asset to its estimated fair
value.
We did
not recognize any impairment charges during the nine months ended June 30, 2010
and 2009, respectively.
11
FAIR
VALUE MEASUREMENTS
Fair
value is defined as the price that would be received to sell an asset, or paid
to transfer a liability, in an orderly transaction between market participants
at the measurement date. Assets and liabilities recorded at fair value in the
consolidated balance sheets are categorized based upon the level of judgment
associated with the inputs used to measure their fair value. The fair value
hierarchy distinguishes between (1) market participant assumptions
developed based on market data obtained from independent sources (observable
inputs) and (2) an entity’s own assumptions about market participant
assumptions developed based on the best information available in the
circumstances (unobservable inputs). The fair value hierarchy consists of three
broad levels, which gives the highest priority to unadjusted quoted prices in
active markets for identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3). The three levels of the fair value
hierarchy are described as follows:
Level 1
- Quoted prices in active markets for identical assets or liabilities, and
identical liabilities when traded as an asset in an active market when no
adjustments to the quoted price of the asset are required.
Level 2
- Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of
the assets or liabilities.
Level 3
- Unobservable inputs that are supported by little or no market activity and
that are significant to the fair value of the assets or
liabilities. Inputs are based on management’s best estimate of what
market participants would use in pricing the asset or liability at the
measurement date.
As of
June 30, 2010, 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:
(Unaudited,
In Thousands)
|
||||||||||||||||
Description
|
Total
|
Level 1
|
Level 2
|
Level 3
|
||||||||||||
Cash
deposits (1)
|
$
|
66
|
$
|
66
|
$
|
—
|
$
|
—
|
||||||||
Restricted
cash (Note 2)
|
17,188
|
17,188
|
—
|
—
|
||||||||||||
Total
assets
|
$
|
17,254
|
$
|
17,254
|
$
|
—
|
$
|
—
|
||||||||
Derivative
liabilities
|
$
|
1,627
|
$
|
—
|
$
|
—
|
$
|
1,627
|
(1)
|
Short-term certificates of
deposit and money market accounts included in cash and cash equivalents in
our consolidated balance
sheet.
|
During
the nine months ended June 30, 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 June 30, 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” above in Note 1.
The
following table summarizes our fair value measurements using significant Level 3
inputs, and changes therein, for the nine months ended June 30,
2010:
(Unaudited,
In Thousands)
|
Level 3
Derivative Liabilities
|
|||
Balance
as of October 1, 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
|
(1,216
|
)
|
||
Balance
as of June 30, 2010
|
$
|
1,627
|
(1)
|
During
the nine months ended June 30, 2010, we issued warrants in connection with
a debt financing transaction, which are subject to derivative liability
accounting (see Note 9 “Warrants” for additional
information).
|
At June
30, 2010 and September 30, 2009, the Company held no assets or liabilities that
are measured at fair value on a non-recurring basis.
12
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, accounts
payable and debt obligations approximate fair value due to the short maturity of
these financial instruments. Derivative liabilities are reported at fair value
as discussed above. Considerable judgment is required to develop such estimates
of fair value. Accordingly, such estimates would not necessarily be indicative
of the amounts that could be realized in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value.
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 both the
three and nine months ended June 30, 2010, we reported no Other Comprehensive
Loss from continuing operations. For the three and nine months
ended June 30, 2009, we reported Other Comprehensive Income (Loss) from
discontinued operations foreign currency translation adjustments of $(1,566,000)
and $658,000, 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 adjustments for DeWind through
September 4, 2009 (date of sale), to recognize the accumulated adjustments as a
component of the loss from discontinued operations within net loss. Since
inception, other comprehensive income (loss) had been derived from DeWind
foreign currency translation adjustments. For the three and nine months ended
June 30, 2010, other comprehensive income in the amounts of $2,921,000 and
$5,611,000, respectively, 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 and nine months ended June 30, 2010, we recorded start-up expenses in
the amounts of $10,000 and $169,000, respectively, which are included in general
and administrative expenses. Our start-up activities related to
professional fees for organization costs incurred. No start-up
expenses were incurred during fiscal 2009.
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 nine months ended June 30, 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.
13
No
provisions for income taxes were made for the three months ended June 30, 2010
and 2009, respectively. We made provisions for income taxes of
$14,000 and $4,000 for the nine months ended June 30, 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 June 30, 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.
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 and nine
months ended June 30, 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
and in California as well as foreign jurisdictions including Germany and the
United Kingdom. The Company is no longer subject to US Federal income tax
examinations for fiscal years before 2006, is no longer subject to state and
local income tax examinations by tax authorities for fiscal years before 2001,
and is no longer subject to foreign examinations before 2006.
During
fiscal 2008, the Company’s federal returns were selected for examination by the
Internal Revenue Service (IRS) for prior fiscals years ended September 30, 2001
through 2005, all years in which net losses were reported and filed. The
examination has been completed. 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 $285,000 to
date. As of June 30, 2010, the remaining payroll tax liability is
$723,000, included as a component of Accounts Payable and Accrued Liabilities
(see Note 6). During the fourth quarter ending September 30, 2010,
the IRS is expected to provide further adjustment to interest and penalties and
a final payment schedule, however based on the information available today, our
existing provisions are adequate.
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 and nine months ended June 30, 2010 and 2009 since
their effect would have been anti-dilutive (assumes all outstanding options and
warrants are in-the-money):
(Unaudited)
|
June 30,
|
|||||||
2010
|
2009
|
|||||||
Options
for common stock
|
26,816,024
|
26,611,499
|
||||||
Warrants
for common stock
|
17,900,000
|
22,934,649
|
||||||
Convertible
Debentures, if converted
|
—
|
9,037,280
|
||||||
44,716,024
|
58,583,428
|
RECLASSIFICATIONS
Certain
prior year balances have been reclassified to conform to the current period
presentation. Additionally, as discussed in Note 2, we have classified all
operations of our former DeWind segment as discontinued
operations. During the three and nine months ended June 30, 2010, we
reclassified production equipment dies valued at $103,000 from other current
assets to property and equipment based on management’s re-evaluation of its
estimated useful life.
RECENT
ACCOUNTING PRONOUNCEMENTS
In June
2009, the FASB issued new rules related to accounting for transfers of financial
assets. These new rules were incorporated into the Accounting Standards
Codification in December 2009 as discussed in FASB Accounting Standards Update
(ASU) No. 2009-16, Transfers
and Servicing (Topic 860): Accounting for Transfers of Financial Assets.
The new rules amend various provisions related to accounting for transfers and
servicing of financial assets and extinguishments of liabilities, by removing
the concept of a qualifying special-purpose entity and removes the exception
from applying FASB rules related to variable interest entities that are
qualifying special-purpose entities; limits the circumstances in which a
transferor derecognizes a portion or component of a financial asset; defines a
participating interest; requires a transferor to recognize and initially measure
at fair value all assets obtained and liabilities incurred as a result of a
transfer accounted for as a sale; and requires enhanced disclosure; among
others. The new rules become effective for the Company on October 1, 2010,
earlier application is prohibited. The adoption of this standard is not expected
to have a material impact on our consolidated financial
statements.
14
In June
2009, the FASB issued new rules to amend certain accounting for variable
interest entities (VIE). These new rules were incorporated into the
Accounting Standards Codification in December 2009 as discussed in FASB ASU No.
2009-17, Consolidation (Topic
810): Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. The new rules require an enterprise to perform an
analysis to determine whether the enterprise’s variable interest or interests
give it a controlling financial interest in a VIE; to require ongoing
reassessments of whether an enterprise is the primary beneficiary of a VIE; to
eliminate the quantitative approach previously required for determining the
primary beneficiary of a VIE; to add an additional reconsideration event for
determining whether an entity is a VIE when any changes in facts and
circumstances occur such that holders of the equity investment at risk, as a
group, lose the power from voting rights or similar rights of those investments
to direct the activities of the entity that most significantly impact the
entity’s economic performance; and to require enhanced disclosures that will
provide users of financial statements with more transparent information about an
enterprise’s involvement in a VIE. The new rules become effective for the
Company on October 1, 2010, earlier application is
prohibited. The adoption of this standard is not expected to have a
material impact on our consolidated financial statements.
In
October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605):
Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging
Issues Task Force (ASU 2009-13). ASU 2009-13 amends accounting
for revenue arrangements with multiple deliverables, to eliminate the
requirement that all undelivered elements have Vendor-Specific Objective
Evidence (VSOE) or Third-Party Evidence (TPE) before an entity can recognize the
portion of an overall arrangement fee that is attributable to items that already
have been delivered. In the absence of VSOE or TPE of the standalone selling
price for one or more delivered or undelivered elements in a multiple-element
arrangement, entities will be required to estimate the selling prices of those
elements. The overall arrangement fee will be allocated to each element (both
delivered and undelivered items) based on their relative selling prices,
regardless of whether those selling prices are evidenced by VSOE or TPE or are
based on the entity's estimated selling price. Application of the "residual
method" of allocating an overall arrangement fee between delivered and
undelivered elements will no longer be permitted upon adoption of ASU 2009-13.
Additionally, the new guidance will require entities to disclose more
information about their multiple-element revenue arrangements. ASU 2009-13 is
effective prospectively for revenue arrangements entered into or materially
modified in fiscal years beginning on or after June 15,
2010. Early adoption is permitted. If a vendor elects
early adoption and the period of adoption is not the beginning of the entity’s
fiscal year, the entity will be required to apply the amendments in this Update
retrospectively from the beginning of the entity’s fiscal
year. Additionally, vendors electing early adoption will be required
to disclose the following information at a minimum for all previously reported
interim periods in the fiscal year of adoption: revenue, income
before income taxes, net income, earnings per share and the effect of the change
for the appropriate captions presented. We expect to adopt this
standard on October 1, 2010 and are currently evaluating the impact this
standard will have on our consolidated financial statements.
In
January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures About Fair
Value Measurements . The ASU requires new disclosures about transfers
into and out of Levels 1 and 2 and separate disclosures about purchases, sales,
issuances, and settlements relating to Level 3 measurements. It also clarifies
existing fair value disclosures about the level of disaggregation of disclosed
assets and liabilities, and about inputs and valuation techniques used to
measure fair value for both recurring and nonrecurring fair value measurements
that fall in either Level 2 or Level 3. The new disclosures and
clarifications of existing disclosures 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.
Significant
recent accounting policies adopted or implemented during the nine months ended
June 30, 2010
On
October 1, 2009, we adopted a new FASB rule that revises existing business
combination rules. The new rule requires most identifiable assets,
liabilities, non-controlling interests, and goodwill acquired in a business
combination to be recorded at “full fair value.” The new rule applies to all
business combinations, including combinations among mutual entities and
combinations by contract alone. Additionally, all business combinations will be
accounted for by applying the acquisition method. The new rule was effective for
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. The adoption of this standard did not have an impact on
our consolidated financial statements.
On
October 1, 2009, we adopted new FASB rules related to accounting for assets
acquired and liabilities assumed in a business combination that arise from
contingencies. The new rules apply to all assets acquired and liabilities
assumed in a business combination that arise from certain contingencies as
defined by the FASB and requires (i) an acquirer to recognize at fair
value, at the acquisition date, an asset acquired or liability assumed in a
business combination that arises from a contingency if the acquisition-date fair
value of that asset or liability can be determined during the measurement
period, otherwise the asset or liability should be recognized at the acquisition
date if certain defined criteria are met; (ii) contingent consideration
arrangements of an acquiree assumed by the acquirer in a business combination be
recognized initially at fair value; (iii) subsequent measurements of assets
and liabilities arising from contingencies be based on a systematic and rational
method depending on their nature and contingent consideration arrangements be
measured subsequently; and (iv) disclosures of the amounts and measurement
basis of such assets and liabilities and the nature of the contingencies. The
new rules were effective for business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning
on or after December 15, 2008. The adoption of this standard did not have
an impact on our consolidated financial statements.
15
On
October 1, 2009, we adopted new FASB rules related to determining the useful
life of intangible assets. The new rules amend the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under existing FASB
rules for goodwill and other intangible assets. This change is intended to
improve the consistency between the useful life of a recognized intangible asset
outside a business combination and the period of expected cash flows used to
measure the fair value of an intangible asset in a business
combination. The new rules were effective for the financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The requirement for
determining useful lives must be applied prospectively to intangible assets
acquired after the effective date and the disclosure requirements must be
applied prospectively to all intangible recognized as of, and subsequent to, the
effective date. The adoption of this standard did not have an impact
on our consolidated financial statements.
On
October 1, 2009, we adopted a new FASB rule related to non-controlling interests
in consolidated financial statements. The new rule requires the ownership
interests in subsidiaries held by parties other than the parent to be treated as
a separate component of equity and be clearly identified, labeled, and presented
in the consolidated financial statements. The new rule was effective for fiscal
years beginning on or after December 15, 2008 and interim periods within
those fiscal years. Earlier adoption was prohibited. The adoption of this
standard did not have an impact on our consolidated financial
statements. On October 1, 2009, we also adopted related guidance,
FASB ASU No. 2010-2, Consolidation (Topic 810):
Accounting and Reporting for Decreases in Ownership of a Subsidiary – a Scope
Clarification , which amended certain provisions of the preceding new
guidance for non-controlling interests and changes in ownership interests of a
subsidiary, specifically related to an entity that experiences a decrease in
ownership in a subsidiary. The new guidance clarifies the scope of
the decrease in ownership provisions. The adoption of this standard
did not have an impact on our consolidated financial statements.
On
October 1, 2009, we adopted new FASB rules related to determining whether an
instrument (or embedded feature) is indexed to an entity’s own
stock. Existing accounting for derivatives and hedging activities,
specifies that a contract that would otherwise meet the definition of a
derivative but is both (a) indexed to the Company’s own stock and (b) classified
in shareholders’ equity in the statement of financial position would not be
considered a derivative financial instrument. The new rules provide a
new two-step model to be applied in determining whether a financial instrument
or an embedded feature is indexed to an issuer’s own stock and thus able to
qualify for the existing scope exception. The new rules were
effective for the first annual reporting period beginning after December 15,
2008, and early adoption is prohibited. The adoption of this new
standard caused a change in our accounting principles, as discussed above in
Note 1 “Derivative Liabilities and Change in Accounting Principle”.
On
October 1, 2009, we adopted the FASB ASU No. 2009-5, Fair Value Measurements and
Disclosures (Topic 820)—Measuring Liabilities at Fair Value, which
changed the fair value accounting for liabilities. These changes clarify
existing guidance that in circumstances in which a quoted price in an active
market for the identical liability is not available, an entity is required to
measure fair value using either a valuation technique that uses a quoted price
of either a similar liability or a quoted price of an identical or similar
liability when traded as an asset, or another valuation technique that is
consistent with the principles of fair value measurements, such as an income
approach (e.g., present value technique) or a market approach. This guidance
also states that both a quoted price in an active market for the identical
liability and a quoted price for the identical liability when traded as an asset
in an active market when no adjustments to the quoted price of the asset are
required, are Level 1 fair value measurements. The adoption of this ASU did not
have an impact on our consolidated financial statements.
On
January 1, 2010, we adopted the FASB ASU No. 2010-06, Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures About Fair
Value Measurements, which currently requires new disclosures about
transfers into and out of Levels 1 and 2. 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. Other than requiring additional disclosures,
the adoption of this new guidance did not have an impact on our consolidated
financial statements.
NOTE
2 – DISCONTINUED OPERATIONS AND SALE OF DEWIND
As of
June 30, 2010, all operations of our former DeWind segment have been classified
as discontinued operations.
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property and
transferred substantially all operating liabilities including supply chain and
operating expense accounts payables and accrued liabilities, warranty related
liabilities for US turbine installations, and deferred revenues. All
of the remaining assets and liabilities of DeWind have been classified as net
assets or liabilities of discontinued operations. All operations of
our former DeWind segment have been reported as discontinued
operations.
The sale
of DeWind was valued at $49.5 million in cash. The Company received
approximately $32.3 million in cash with $17.2 million in cash escrowed to cover
certain contingent liabilities. Of the escrowed cash, $5.5 million is
expected to be released within one year after the achievement of certain
milestones and $11.7 million is expected to be released over time periods that
may be as late as 2012 under certain conditions. The purchase price is further
subject to adjustment based on delivery of the value of the assets transferred
net of liabilities assumed. The Company has placed the $17.2 million
in cash in escrow to indemnify the buyer if claims are made against them by
third parties and those claims are determined to be valid and
enforceable. Our intention is to vigorously defend against any such
claims should they occur. Defense of such claims may result in
additional costs to maintain the Company’s interest in the restricted cash or to
limit potential liability. In the event that claims are successful,
the balance payable to the buyer may include all, part, or cash amounts in
excess of the $17.2 million escrowed, including potentially an additional $17.7
million up to a total of $34.9 million under certain conditions, which are not
expected by the Company. If such claims are successfully made, this
would result in additional losses on the DeWind sale transaction and could
require a substantial refund of the proceeds received. The Company
believes the $17.2 million in escrow will be released per the terms of the
agreement. Accordingly, at June 30, 2010, we have classified the $17.2
million held in escrow as restricted cash, with $5.5 million as current and
$11.7 million as long-term (see Note 1 “Restricted Cash”).
16
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)
|
June 30, 2010
|
|
|
September 30, 2009
|
||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
Accounts
Receivable, net
|
$
|
1,035
|
$
|
2,461
|
||||
Prepaid
Expenses and Other Current Assets
|
418
|
61
|
||||||
TOTAL
ASSETS
|
$
|
1,453
|
$
|
2,522
|
||||
LIABILITIES
|
||||||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
33,034
|
$
|
39,356
|
||||
Deferred
Revenues and Customer Advances
|
2,207
|
2,869
|
||||||
Warranty
Provision
|
941
|
1,244
|
||||||
Total
Current Liabilities
|
36,182
|
43,469
|
||||||
Long-Term
Portion of Warranty Provision
|
806
|
1,120
|
||||||
Total
Liabilities
|
36,988
|
44,589
|
||||||
Net
Liabilities of Discontinued Operations
|
$
|
(35,535
|
)
|
$
|
(42,067
|
)
|
Except
for former intercompany loans, significantly all of the assets and liabilities
of the discontinued operations pertain to activities outside of the United
States, primarily for turbines sold and installed in Europe and South America
and technology licenses to Chinese customers. At June 30, 2010 and
September 30, 2009, included above in Accounts Payable and Other Accrued
Liabilities are net payables related to formerly consolidated, now
insolvent European subsidiaries of approximately $18 million and $22 million,
respectively, substantially all of which has been assigned by the insolvency
receiver to a third party. As of June 30, 2010, the net payables from insolvent
subsidiaries are comprised of assets in the amount of $7 million and liabilities
in the amount of $25 million. We did not receive an update from the insolvency
receiver related to the assets and liabilities for the insolvent
subsidiaries during the quarter ended June 30, 2010.
The
consolidated net income (loss) from operations of our former DeWind segment has
been classified on the statements of operations, as Income (Loss) from
Discontinued Operations. Summarized results of discontinued
operations are as follows:
Three Months Ended June
30,
|
Nine Months Ended June
30,
|
|||||||||||||||
(Unaudited,
In Thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Revenues
|
$
|
5
|
$
|
431
|
$
|
1,466
|
$
|
16,362
|
||||||||
Cost
of Revenues
|
435
|
959
|
2,094
|
18,795
|
||||||||||||
Operating
Expenses
|
119
|
21,960
|
1,538
|
31,043
|
||||||||||||
Other
(Income) Expense
|
(2,925
|
)
|
(32
|
)
|
(5,627
|
)
|
(55
|
)
|
||||||||
Income
Tax Expense (Benefit)
|
—
|
—
|
1
|
(8
|
)
|
|||||||||||
Income
(Loss) from Discontinued Operations
|
$
|
2,376
|
$
|
(22,456
|
)
|
$
|
3,460
|
$
|
(33,413
|
)
|
Since
September 4, 2009, the Company has had no continuing involvement with our former
DeWind segment; any subsequent cash flows are directly related to the
liquidation of the remaining assets and liabilities. No corporate
overhead has been allocated to discontinued operations.
On
December 4, 2009, DSME provided the Company with a preliminary net asset
value calculation in accordance with the terms and conditions of the Asset
Purchase Agreement dated September 4, 2009. The Company responded
with an adjusted net asset value calculation on December 16, 2009. In
January 2010, the Company and DSME had a series of meetings to discuss the
differences. Negotiations and resolution of all differences continued
during the June 2010 quarter. In July 2010, the Company received
$836,000 of the escrowed cash with $16.4 million remaining in
escrow.
17
NOTE
3 - ACCOUNTS RECEIVABLE
Accounts
receivable, net consists of the following:
(In Thousands)
|
June 30,
2010
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Cable
Receivables
|
$
|
1,037
|
$
|
1,813
|
||||
Reserves
|
(87
|
)
|
(81
|
)
|
||||
Net
Accounts Receivable
|
$
|
950
|
$
|
1,732
|
NOTE
4 – INVENTORY
Inventories
consist of the following:
(In Thousands)
|
June 30,
2010
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Raw
Materials
|
$
|
1,853
|
$
|
2,040
|
||||
Work-in-Progress
|
136
|
—
|
||||||
Finished
Goods
|
2,482
|
3,261
|
||||||
Gross
Inventory
|
4,471
|
5,301
|
||||||
Reserves
|
(1,179
|
)
|
(923
|
)
|
||||
Net
Inventory
|
$
|
3,292
|
$
|
4,378
|
NOTE
5 – PROPERTY AND EQUIPMENT
Property
and equipment consisted of the following:
(In Thousands)
|
Estimated Useful
Lives
|
|
|
June 30,
2010
|
|
|
September 30,
2009
|
|||||
(unaudited)
|
||||||||||||
Office
Furniture and Equipment
|
3-10
yrs
|
$
|
794
|
$
|
936
|
|||||||
Production
Equipment
|
10-20
yrs
|
3,983
|
4,994
|
|||||||||
Construction-in-Progress
|
—
|
—
|
302
|
|||||||||
Leasehold
Improvements
|
Lesser of lease term or 7 yrs
|
758
|
748
|
|||||||||
Total
Property
|
5,535
|
6,980
|
||||||||||
Accumulated
Depreciation
|
(2,600
|
)
|
(3,766
|
)
|
||||||||
Property
and Equipment, net
|
$
|
2,935
|
$
|
3,214
|
Depreciation
expense was $168,000 and $486,000, for the three and nine months ended June 30,
2010, respectively. Depreciation expense was $257,000 and $722,000,
for the three and nine months ended June 30, 2009, respectively. As of
October 1, 2009, the Company changed its method of depreciating production
equipment, which included applying an estimated useful life of 10-20 years as
compared to a range of 3-10 years applied in prior periods. Refer to
discussion in Note 1 “Property and Equipment – Change in Accounting
Estimate”.
NOTE
6 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities consisted of the following:
(In Thousands)
|
|
June 30,
2010
|
|
|
September 30,
2009
|
|||
(unaudited)
|
||||||||
Trade
Payables
|
$
|
1,990
|
$
|
4,179
|
||||
Accrued
Commissions
|
664
|
667
|
||||||
Accrued
Insurance
|
97
|
441
|
||||||
Accrued
Payroll and Payroll Related
|
842
|
541
|
||||||
Accrued
Payroll Tax Liability (A)
|
723
|
—
|
||||||
Accrued
Interest
|
—
|
183
|
||||||
Deferred
Rents
|
246
|
133
|
||||||
Accrued
Sales Tax
|
128
|
128
|
||||||
Accrued
Other
|
790
|
945
|
||||||
Total
Accounts Payable and Accrued Liabilities
|
$
|
5,480
|
$
|
7,217
|
|
(A)
|
During the nine months ended June
30 2010, the Company accrued a payroll tax liability as a result of an IRS
audit (see “Income Taxes” in Note 1 for additional
information).
|
18
NOTE
7 – DEFERRED REVENUES AND CUSTOMER ADVANCES
The
Company records all cash proceeds received from customers on orders and extended
warranties, as opted by the customer, to deferred revenues and customer advances
until such time as the revenue cycle is completed and the amounts are recognized
into revenues. Deferred revenues and customer advances consist of the
following:
(In Thousands)
|
June 30,
2010
|
September 30,
2009
|
||||||
(unaudited)
|
||||||||
Deferred
Revenues
|
$
|
1,368
|
$
|
563
|
||||
Customer
Advances
|
647
|
14
|
||||||
Total
Deferred Revenues and Customer Advances
|
2,015
|
577
|
||||||
Less
amount classified in current liabilities
|
1,470
|
16
|
||||||
Long-term
Deferred Revenues
|
$
|
545
|
$
|
561
|
Long-term
deferred revenue is comprised of long-term extended warranties.
NOTE 8 –
DEBT
The
following table summarizes the Company’s debt structure as of June 30, 2010 and
September 30, 2009:
(In Thousands)
|
June 30, 2010
|
September 30, 2009
|
||||||
Senior
Secured Loan due April 2012, net discount of $1,214 and $0
|
$
|
8,786
|
$
|
—
|
||||
Senior
Convertible 8% Notes due January 2010, net discount of $0 and
$315
|
—
|
8,723
|
||||||
Total
Debt
|
8,786
|
8,723
|
||||||
Less
amount classified in current liabilities
|
—
|
8,723
|
||||||
Long-Term
Debt
|
$
|
8,786
|
$
|
—
|
Debt
outstanding or issued during the nine months ended June 30, 2010 consists
of:
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. 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 9 “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.
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
increased or decreased by the corresponding increase or decrease in deferred
revenues as compared to the March 31, 2010 deferred revenue
balance. As of June 30, 2010, the Company was in compliance with its
debt covenants.
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.
In
January 2010 the Company repaid in full all outstanding Senior Convertible 8%
Notes payable. A total of $9,037,000 plus interest for the month of
January 2010 was repaid.
19
NOTE 9 –
SHAREHOLDERS’ EQUITY (DEFICIT)
COMMON
STOCK
The
following issuances of common stock were made during the nine months ended June
30, 2010:
CASH
During
the nine months ended June 30, 2010 the Company received $7,000 in cash from the
exercise of 20,000 consultant options.
SERVICES
During
the nine months ended June 30, 2010 the Company issued 161,290 shares of common
stock to John Brewster, former CTC Cable President valued at $45,000 at the date
of issuance in partial payment of an employment acceptance bonus.
WARRANTS
The
Company issues warrants to purchase common shares of the Company either as
compensation for consulting services, or as additional incentive for investors
who purchase unregistered, restricted common stock or Convertible Debentures.
The value of warrants issued for compensation is accounted for as a non-cash
expense to the Company at the fair value of the warrants issued. The value of
warrants issued in conjunction with financing events is either a reduction in
paid in capital for common stock issuances or as a discount for debt issuances.
The Company values the warrants at fair value as calculated by using the
Black-Scholes option-pricing model. See Note 1 “Derivative
Liabilities” for additional warrant liability accounting and
disclosure.
The
following table summarizes the Warrant activity for the nine months ended June
30, 2010:
(Unaudited)
|
Number
of Warrants
|
Weighted-Average Exercise
Price
|
||||||
Outstanding, September 30, 2009
|
22,934,649
|
$
|
0.95
|
|||||
Granted
|
10,900,000
|
0.62
|
||||||
Exercised
|
—
|
—
|
||||||
Cancelled
|
(15,934,649
|
)
|
1.11
|
|||||
OUTSTANDING,
June 30, 2010
|
17,900,000
|
$
|
0.59
|
|||||
EXERCISABLE,
June 30, 2010
|
17,500,000
|
$
|
0.59
|
On
November 13, 2009 we issued 300,000 warrants with a strike price of $0.45 per
warrant and a two-year life in settlement of a legal dispute. We
valued the warrants at $57,000 using the Black-Scholes option pricing model and
the following assumptions:
Dividend
rate = 0%
Risk free
return of 0.82%
Volatility
of 108%
Market
price of $0.37 per share
Maturity
of 2 years
On
February 12, 2010 we issued 600,000 warrants with a strike price of $0.35 per
warrant and a three-year life in connection with an ongoing service
agreement. The warrants vest in six equal 100,000 share amounts on a
quarterly basis, beginning on February 12, 2010. We valued the
warrants at $95,000 using the Black-Scholes option pricing model and the
following assumptions:
Dividend
rate = 0%
Risk free
return of 1.40%
Volatility
of 98%
Market
price of $0.28 per share
Maturity
of 3 years
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
20
Management
has reviewed and assessed the warrants issued during the nine months ended June
30, 2010 and, except for the April 12, 2010 warrants, determined that they do
not qualify for treatment as derivatives under applicable US GAAP
rules.
NOTE 10 –
SHARE-BASED COMPENSATION
The
Company historically has issued equity based compensation in the form of stock
options to its employees and consultants via option grants. The Company uses the
guidelines of the FASB which require fair value calculations of the grant and
recognition of the cost of employee services received in exchange for the award
over the period the employee is required to perform the services.
The
values of the financial instruments are estimated using the Black-Scholes
option-pricing model. Key assumptions used during the nine months ended June 30,
2010 and 2009 to value options granted are as follows:
Nine Months Ended
|
||||||||
June 30,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
2.00-2.58
|
%
|
1.67-2.54
|
%
|
||||
Volatility
|
95.6
|
%
|
88-95.6
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
5
years
|
5
years
|
Our
computation of expected volatility for the nine months ended June 30, 2010 is
based on historical volatility over the expected life of the options granted.
Our computation of expected life is based on historical exercise patterns
pursuant to SEC guidelines. The interest rate for periods within the contractual
life of the award is based on the U.S. Treasury yield curve in effect at the
time of grant.
Share-based
compensation included in the results of operations for the three and nine months
ended June 30, 2010 and 2009 is as follows:
Three Months Ended June 30,
|
Nine Months Ended June 30,
|
|||||||||||||||
(Unaudited, In Thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Cost
of Product Sold
|
$
|
23
|
$
|
18
|
$
|
78
|
$
|
63
|
||||||||
Officer
Compensation
|
259
|
528
|
946
|
1,789
|
||||||||||||
Selling
and marketing
|
84
|
100
|
273
|
546
|
||||||||||||
Research
and development
|
10
|
146
|
76
|
647
|
||||||||||||
General
and administrative
|
220
|
170
|
712
|
717
|
||||||||||||
Totals
|
$
|
596
|
$
|
962
|
$
|
2,085
|
$
|
3,762
|
The
Company recorded zero and $89,000 of equity-based compensation into discontinued
operations for the three and nine months ended June 30, 2010,
respectively. The Company recorded $151,000 and $823,000 of
equity-based compensation into discontinued operations for the three and nine
months ended June 30, 2009, respectively.
As of
June 30, 2010, there was $2.4 million of total unrecognized compensation cost
related to unamortized accrued share-based compensation arrangements related to
outstanding employee stock options. The costs are expected to be recognized over
a weighted-average period of 1.8 years. For the remainder of fiscal
2010, we expect share-based compensation expense related to employee stock
options of $537,000 before income taxes. Such amounts may change as a result of
additional grants, forfeitures, modifications in assumptions and other
factors.
Significantly
all of our existing options are subject to time of service
vesting. Our stock options vest either on an annual or a quarterly
basis for options subject to time of service vesting, or 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 15%.
Certain
options granted under the 2008 Plan may be exercised at any time for restricted
stock of the Company if not otherwise prohibited by the Company’s Board of
Directors. Any 2008 Plan option exercises for unvested options have
restricted stock issued that is earned according to the terms of the option
agreement that gave rise to the restricted stock issuance. The
Company has the right, but not the obligation, to repurchase restricted stock
that is unearned as of the date of any optionee’s termination. As of
June 30, 2010 all of the 2008 Plan option grants were exercisable. To date, no
restricted stock has been issued under the 2008 Plan. Of the 2008
plan options exercisable, 4,257,756 options were vested and are exercisable into
unrestricted stock.
21
The
following table summarizes the Stock Plan stock option activity for the nine
months ended June 30, 2010:
(Unaudited)
|
|
2002 Plan
Number of
Options
|
|
|
2008 Plan
Number of
Options
|
|
|
Total Number of
Options
|
|
|
Average
Exercise
Price
|
|
||||
Outstanding, September 30, 2009
|
|
|
16,212,156
|
9,688,808
|
25,900,964
|
$
|
0.35
|
|||||||||
Granted
|
—
|
3,765,000
|
3,765,000
|
0.35
|
||||||||||||
Exercised
|
(20,000
|
)
|
—
|
(20,000
|
)
|
0.35
|
||||||||||
Cancelled
|
(52,291
|
)
|
(2,074,792
|
)
|
(2,127,083
|
)
|
0.35
|
|||||||||
Outstanding,
June 30, 2010
|
16,139,865
|
11,379,016
|
27,518,881
|
$
|
0.35
|
|||||||||||
Exercisable
, June 30, 2010
|
15,437,008
|
11,379,016
|
26,816,024
|
$
|
0.35
|
The
weighted-average remaining contractual life of the options outstanding at June
30, 2010 was 6.4 years. The exercise prices of the options outstanding at June
30, 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
|
6.51
|
$
|
0.25
|
$
|
0.25
|
|||||||||||||
$0.35-$0.49
|
26,761,481
|
26,058,624
|
6.40
|
$
|
0.35
|
$
|
0.35
|
|||||||||||||
$0.50-$1.00
|
29,400
|
29,400
|
0.66
|
$
|
1.00
|
$
|
1.00
|
|||||||||||||
Total
|
27,518,881
|
26,816,024
|
NOTE
11 – LITIGATION
FKI
PLC and FKI Engineering Ltd v. Stribog Ltd and De Wind GmbH
On or
about January 21, 2010, FKI Engineering Ltd. and FKI Ltd., 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 Engineering Ltd. and FKI Ltd.’s claim is brought pursuant to
an assignment agreement executed by the German insolvency administrator of
DeWind GmbH assigning to FKI Engineering Ltd. and FKI Ltd. the right to pursue
claims on behalf of DeWind GmbH for amounts allegedly owed to DeWind GmbH by
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 Stribog 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 ($60,695,000 at July 27, 2010 exchange
rates). Stribog Ltd. disputes that it owes any funds to DeWind GmbH
and is vigorously contesting the validity of this allegation.
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 a negative declaration in the Court of Lubeck,
Germany against FKI Engineering Ltd. and FKI Ltd., formerly FKI Plc (“FKI”)(Case
No. 17 O 256/09) 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 alleged 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 EUR 500,000 ($650,000 at July 27, 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 (i) that fair market value
was paid for this intellectual property and the transaction were conducted at
arm’s length, therefore any rights to rescission do not exist and (ii) that the
assignment agreement is invalid. DeWind 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.
22
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 September 20, 2010. It is likely this trial
date will be extended.
CTC
Cable Corporation v. Mercury Cable & Energy, LLC
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 Defendant has 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. Until recently, the
action was stayed pending reexamination of the patents at issue by the United
States Patent and Trademark Office. 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. CTC Cable has filed a motion to amend its complaint to add
additional corporate and individual defendants to this action. CTC
Cable’s motion to amend has not yet been ruled on by the Court.
In
Re Composite Technology Corporation Derivative Litigation (Brad Thomas v. Benton
Wilcoxon, Michael Porter, Domonic J. Carney, Michael McIntosh, Stephen
Bircher, Rayna Limited, Keeley Services Limited, Ellsford Management Limited,
Laikadog Holdings Limited, James Carkulis, and Does 1 through 1000 (including D.
Dean McCormick, III, CPA as Doe 1, John P. Mitola, as Doe 2, and Michael K. Lee,
as Doe 3) and Nominal Defendant Composite Technology Corporation)
On June
26, 2009 Mr. Brad Thomas, alleged to be a shareholder of the Company, filed a
shareholder derivative complaint in the Superior Court of the State of
California, County of Orange (Case No. 30-2009-00125211) for damages and
equitable relief. The complaint asserts claims for negligence, gross negligence,
breach of fiduciary duty, waste, mismanagement, gross mismanagement, abuse of
control, negligent misrepresentation, intentional misrepresentation, fraudulent
promise, constructive fraud, and violations of the California Corporations Code,
and seeks an accounting, rescission and/or reformation. The complaint focuses on
the Company’s acquisition of its DeWind subsidiary and also related
self-interested transactions, accounting deficiencies and misstatements. Certain
of the defendants are current directors and/or officers or past officers of the
Company. Under the Company’s articles of incorporation and bylaws, the Company
is obligated to provide for indemnification for director and officer
liability. Such indemnification is covered by existing Directors and
Officers insurance policies. 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. The
Company has filed a responsive pleading to the Second Amended Complaint and the
discovery process is underway. On July 19, 2010, the Company filed a
Motion for Judgment on the Pleadings seeking to dismiss the action in its
entirety. Trial of this matter is currently scheduled for November 8,
2010. The Company has not reserved any amounts for this litigation as
the amounts are undeterminable and are further eligible for reimbursement under
existing insurance policies.
NOTE
12 – SEGMENT INFORMATION
As of
June 30, 2010, we manage and report our operations through one business segment:
CTC Cable. During the year ended September 30, 2009 we revised our
segments to reflect the disposal of DeWind. DeWind comprised our previously
reported Wind segment, which has been presented as discontinued operations in
our Consolidated Financial Statements (see Note 2). When applicable,
segment data is organized on the basis of products. Historically, the Company
evaluates the performance of its operating segments primarily based on revenues
and operating income, any transactions between reportable segments are
eliminated in the consolidation of reportable segment data.
Located
in Irvine, California with sales operations in the U.S., China, Europe, the
Middle East and Brazil, CTC Cable produces and sells ACCC®
conductor products and related ACCC® hardware
products. ACCC®
conductor production is a two step process. The Irvine operations produce the
high strength, light weight, composite ACCC® core,
which is then shipped to one of our conductor standing licensees in the U.S.,
Canada, Belgium, China, Indonesia or Bahrain where the core is stranded with
conductive aluminum to become ACCC®
conductor. ACCC®
conductor is sold in North America directly by CTC Cable to utilities and
through a license and distribution agreement with 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, Far East
Composite Cable Company in China, and through two Indonesian companies PT Tranka
Cable and PT KMI Cable. ACCC®
conductor has been sold commercially since 2005 and is currently marketed
worldwide to electrical utilities, transmission companies and transmission
design/engineering firms.
23
The
Company operates and markets its services and products on a worldwide
basis:
Three Months Ended June 30,
|
Nine Months Ended June 30,
|
|||||||||||||||
(Unaudited, In Thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Europe
|
$
|
10
|
$
|
118
|
$
|
115
|
$
|
759
|
||||||||
China
|
—
|
2,344
|
181
|
9,897
|
||||||||||||
Other
Asia
|
491
|
421
|
2,112
|
430
|
||||||||||||
North
America
|
6
|
270
|
3,613
|
2,099
|
||||||||||||
South
America
|
76
|
—
|
1,515
|
1
|
||||||||||||
Mexico
|
—
|
409
|
—
|
938
|
||||||||||||
Total
Revenue
|
$
|
583
|
$
|
3,562
|
$
|
7,536
|
$
|
14,124
|
All long-lived assets,
comprised of property and equipment, are located in the United
States.
For the
three months ended June 30, 2010, two customers represented 97% of revenue (one
in Indonesia at 84% and one in Chile at 13%). For the nine months ended
June 30, 2010, five customers represented 91% of revenue (two in the U.S. at
43%, two in Indonesia at 28% and one in Chile at 20%).
For the
three months ended June 30, 2009, four customers represented 95% of revenue (one
in China at 66%, one in Mexico at 11%, one in Indonesia at 12% and one in the
U.S. at 6%). For the nine months ended June 30, 2009, four customers
represented 90% of revenue (one in China at 70%, one in the U.S. at 8%, one in
Mexico at 7% and one in Belgium at 5%). No other customer represented
greater than 5% of consolidated revenue.
NOTE
13 – SUBSEQUENT EVENTS (Unaudited)
Management
evaluated all subsequent events through the issue date of the consolidated
financial statements and concluded that no subsequent events have occurred that
would require recognition in the consolidated financial statements or disclosure
in the notes to financial statements, except as disclosed below.
In July
2010, in connection with the DeWind asset sale (see Note 2), the Company
received $836,000 of the escrowed (restricted) cash leaving $16.4 million
remaining in escrow.
24
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
You
should read the following discussion and analysis of our financial condition and
results of operations together with our interim financial statements and the
related notes appearing at the beginning of this report. The interim financial
statements and this Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the financial
statements and notes thereto for the year ended September 30, 2009 and the
related Management's Discussion and Analysis of Financial Condition and Results
of Operations, both of which are contained in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on December 14,
2009.
The
following discussion and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Forward-looking statements can
be identified by words such as “anticipates,” “expects,” “believes,” “plans,”
and similar terms. Our actual results could differ materially from any future
performance suggested in this report as a result of factors, including those
discussed elsewhere in this report and in our Annual Report on Form 10-K for the
fiscal year ended September 30, 2009. All forward-looking statements are based
on information currently available to Composite Technology Corporation and we
assume no obligation to update such forward-looking statements, except as
required by law. Service marks, trademarks and trade names referred to in this
Form 10-Q are the property of their respective owners.
OVERVIEW
The
financial results for the nine months ended June 30, 2010 reflected revenue
declines over prior year periods caused by significant order reductions from
customers in China, Mexico, and Europe. These declines were partially
offset by order increases from North American, South American, and other Asian
market customers. CTC Cable business growth slowed due to the continuing
worldwide economic downturn that resulted in delays of several anticipated line
projects that had specified ACCC®
conductor in both new international markets and the United States. We
had a decrease of ACCC® products
shipped from 2,379 kilometers in the nine months ended June 30, 2009 to 641
kilometers in the nine months ended June 30, 2010. The decrease in
shipments resulted in significant decreases in production levels during the
quarter ended June 30, 2010 for our manufacturing plant in Irvine,
California. While our individual sales at historical fiscal 2007
through 2009 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 in the near
term, the Company expects to see gross margins in line with historical
levels.
In
January 2010, Composite Technology Corporation repaid $9.0 million to fully
redeem $9.0 million of Senior Convertible Debentures upon their
maturity. Repayment was made out of cash on hand.
In April
2010, Composite Technology Corporation 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. 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 increased or decreased by the
corresponding increase or decrease in deferred revenues as compared to the June
30, 2010 deferred revenue balance. As of June 30, 2010 the Company
was in compliance with its debt covenants.
CTC Cable
Division
Located
in Irvine, California with sales operations in Irvine, California, China,
Europe, the Middle East, and Brazil, CTC Cable produces and sells ACCC®
conductor products and related ACCC® hardware
products. ACCC®
conductor production is a two step process. The Irvine operations produce the
high strength, light weight, composite ACCC® core,
which is then shipped to one of six conductor stranding licensees in the U.S.,
Belgium, China, Indonesia or Bahrain where the core is stranded with conductive
aluminum to become ACCC®
conductor. ACCC®
conductor is sold in North America directly by CTC Cable to utilities and
through a license and distribution agreement with 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, Far East
Composite Cable Company in China, and through two Indonesian companies PT Tranka
Cable and PT KMI Cable. 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
In
February 2010, CTC Cable signed distribution and manufacturing agreements with
Alcan Cable. The distribution agreement calls for Alcan to distribute
ACCC®
conductor to certain of their customers. In order to maintain
exclusive distribution rights with certain Alcan customers in the U.S. and
Canada, Alcan has agreed to purchase minimum quantities of ACCC®
conductor during calendar year 2010 and potentially through 2012, if the
term of the agreement is extended for another two years. The term
of the contract is one year, which may be extended for an additional two years
if Alcan sells a minimum quantity of ACCC®
conductor within the first year and achieves stranding qualifications. CTC Cable
expects that the Alcan Cable distribution agreement will provide revenue orders
beginning later in calendar 2010. The agreements call for Alcan to
receive a license to strand ACCC®
conductor for delivery in North America after certification requirements are
met, which is expected later in calendar 2010. During the June 2010
quarter, CTC Cable continued to work with the Alcan operations team to establish
licensed stranding operations, which are expected in the September 2010
quarter. CTC Cable’s marketing team worked with Alcan’s marketing
team to develop a marketing strategy, expected to be rolled out later in
calendar 2010.
25
Between
March and July 2010, CTC Cable continued to fill key positions to drive business
development expansion strategies and business optimization and to provide
additional sales coverage worldwide. During the quarter, the Company
formed a new subsidiary, CTC Cable Asia, to better serve markets in China,
Southeast Asia, Korea, and Japan. CTC Cable also filled staffing voids in
our business development and operational environment with resource skill-sets
including executive leaders in international sales and
marketing. These individuals added additional international sales
coverage and business development acumen in China, Europe, the Middle East, and
South America, one of whom was the primary driver behind receiving the initial
order in Qatar. Coupled with our existing sales and marketing personnel
and agents, these new resources allow CTC Cable to access a significant portion
of the estimated $10 billion annual transmission conductor
market. The new additions to the CTC Cable team have also worked to
refine the international sales and marketing messaging and to provide focus on
project identification and marketing efforts.
During
the June quarter CTC Cable supplemented its technical skill set through several
key technical hires. In June 2010, CTC Cable hired a new VP of
Research and Development, a PhD who has significant experience in advanced
composite materials design and development. We expect this individual
to be a key manager of, and contributor to, our technical team and he is
undergoing a thorough review of our products and testing protocols as well as
directing new product development. The Company continued to develop a new
twisted pair ACCC®
conductor that we anticipate should have superior engineering advantages over
other similar conductors including General Cable’s T-2®
conductors. We received initial tests results in July 2010 and have
further testing scheduled for later calendar 2010. Also in June 2010,
CTC Cable hired several key leaders and contributors in our utility transmission
design as well as our pre-sales team and our post-sales installation
team.
Looking
forward into the remainder of fiscal 2010, CTC Cable will pursue its domestic
and international business development growth strategy by continuing to expand
its sales channel relationships with regional stranding companies, strategic
consultants, sales agents, and market distributors as well as increasing direct
business development resources at CTC Cable. Through these
strategies, CTC Cable plans to drive revenue by focusing on existing and new
utility project opportunities in its core domestic and international pipeline,
penetrating new developing and emerging markets, leveraging new and existing
distribution channels, and revitalizing the lagging Chinese
market. CTC Cable will also continue its efforts to obtain federal
and state incentives made available to utilities for the use of efficient
transmission conductors, which should be favorable to ACCC®
conductor. To balance the additional resources needed to support CTC
Cable’s growth expansion strategy, the Company is establishing various business
optimization initiatives to further augment its efforts to maintain its
competitive advantage in the marketplace. This entails a realignment
of CTC Cable’s supply chain model to drive certain cost saving opportunities
including moving towards a fixed to variable cost framework that optimizes
operational resources, renegotiating current pricing with key supplier sources
of core production raw materials, outsourcing non-core production activities,
implementing activity-based costing measures for projects to better monitor
performance and maximize profit margins and increasing production efficiency
through enhancement of automation techniques.
Despite
slower than expected sales in the beginning of this year attributable to
customers pushing orders out to the latter half of the calendar year, CTC
Cable’s business development efforts continue to show growth through orders from
new and existing customers. Our first high voltage line in Europe was
energized at 400kV in Germany, which will provide critical high voltage
operating data for the German market, much of which is at 380kV to
400kV. Market penetration continues with sales to new customers
worldwide including a new customer in Qatar announced in June 2010 and a repeat
order to a customer sold through our Engineering and Professional Consulting
(EPC) channel in Africa in July 2010. We are selling our products as
a critical component of an engineered solution and we intend to expand our
efforts to partner with EPC service providers.
CTC Cable
continues its pursuit of relationships with additional suppliers and it is
working with our existing suppliers to expand the support of ACCC®
conductors and hardware into new geographic regions. These expanded
efforts are focused not only on new stranding relationships, but are also
targeted towards developing multiple hardware suppliers. We
anticipate that the availability of ACCC® hardware
from different regions will support our recent efforts to sign agreements with
additional stranding sources. Discussions with new stranding partners are
continuing at multiple locations worldwide in particular with several stranding
manufacturers and distributors in Asia, South America, and Mexico. We
believe the strategy to localize stranding and hardware manufacturing will
provide a solid platform from which to grow cable sales and to provide support
for our worldwide customer base. We intend to couple this local presence with
key relationships to better vertically integrate our ACCC® products
as an engineered solution.
26
CTC Cable
Revenues were as follows for the three and nine months ended June 30, 2010 and
2009:
(Unaudited,
In Thousands -
|
Three Months Ended June
30,
|
Nine Months Ended June
30,
|
||||||||||||||
except
kilometer related amounts)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Europe
|
$
|
10
|
$
|
118
|
$
|
115
|
$
|
759
|
||||||||
China
|
—
|
2,344
|
181
|
9,897
|
||||||||||||
Other
Asia
|
491
|
421
|
2,112
|
430
|
||||||||||||
North
America
|
6
|
270
|
3,613
|
2,099
|
||||||||||||
South
America
|
76
|
—
|
1,515
|
1
|
||||||||||||
Mexico
|
—
|
409
|
—
|
938
|
||||||||||||
Total
Revenue
|
$
|
583
|
$
|
3,562
|
$
|
7,536
|
$
|
14,124
|
||||||||
Kilometers
shipped
|
96
|
665
|
641
|
2,379
|
||||||||||||
Revenue
per kilometer
|
$
|
5,113
|
$
|
4,100
|
$
|
10,127
|
$
|
4,871
|
Total
Revenues for the quarter decreased to $0.6 million as compared to $3.6 million
for the same period in the prior year. One order to a new customer in
Qatar for $0.7 million was completed prior to the quarter end but was shipped in
July 2010 and was not recognized in the June 2010 quarter.
The
worldwide economic downturn continues to effect sales of ACCC®
conductor worldwide and has impacted the timeline for receipt of new cable
orders. Although we have received nearly $4 million in orders in the
month of July 2010 we continue to see project delays as well as a restriction of
customers’ capital required to construct new projects and reconductor lines for
several of our International customers. Throughout 2010, we have received
multiple notices of product design wins for ACCC®
conductor projects but we have not received formal purchase orders and therefore
we do not count such wins as order backlog. Our current order backlog
is approximately $7.1 million for deliveries in the September and December 2010
quarters.
CTC
Cable’s gross margins were negatively impacted by several
factors. Gross margin (loss) for the quarter decreased to (27.3)% as
compared to 17.7% in the prior year. During the June 2010
quarter, we sold primarily ACCC®
conductor, which carries lower margins per revenue dollar. In
addition, our plant utilization was inefficient during the quarter due to the
low production levels. Our plant carries fixed costs for rent and
labor which is based on plant utilization in excess of 20% to build our
ACCC® core
including our production teams, quality assurance, and infrastructure
groups. During the June 2010 quarter, we produced at less than 10%
plant capacity. This resulted in a negative production cost variance
that we anticipate will be reduced as additional expected orders are received
late.
CTC
Cable’s operating expenses increased from the June 2009 quarter by $0.9 million
primarily related to reallocation of personnel and overhead costs to general and
administrative expenses from production related expenses which are normally
recorded to inventory and costs of sales and which were caused by the low plant
utilization, additional headcounts in the business development and operations
environment, higher expenditures associated with pursuing CTC Cable’s efforts to
expand the Company’s domestic and international business development growth
strategy, and litigation related expenditures.
Operating
expenses decreased from the March 2010 quarter by $1.0 million primarily related
to lower officer compensation and the continuing efforts of cost reduction
measures that were begun in the December 2009 quarter including headcount
reductions and overhead-related cost reductions and lower sales commissions on
lower revenue balances.
DeWind Asset
Sale
On
September 4, 2009, our DeWind subsidiary sold substantially all of its existing
operating assets including all inventories, receivables, fixed assets, wind farm
project assets and intangible assets including all intellectual property. The
sale of the DeWind net assets was for $49.5 million in cash. The
Company received approximately $32.3 million in cash in fiscal 2009 with $17.2
million in cash placed in escrow to cover certain contingent liabilities
and adjustments based on delivery of the value of the net value of the assets
transferred, after liabilities. Of the cash in escrow, $5.5 million
is expected to be released in fiscal 2010 after the achievement of certain
milestones and $11.7 million is expected to be released over time periods that
may be as late as 2012 under certain conditions. The asset sale agreement calls
for a true-up mechanism on the fair value of the assets sold.
On
December 4, 2009, DSME provided the Company with a preliminary net asset
value calculation in accordance with the terms and conditions of the Asset
Purchase Agreement dated September 4, 2009. The Company responded
with an adjusted net asset value calculation on December 16, 2009. In
January 2010, the Company and DSME had a series of meetings to discuss the
differences. Negotiations and resolution of all differences continued
during the June 2010 quarter. In July 2010, the Company received
$836,000 of the escrowed cash with $16.4 million remaining in
escrow.
As of
June 30, 2010, the remaining assets and liabilities of the discontinued
operations consist of the following:
(Unaudited,
In Thousands)
|
June 30, 2010
|
|||
ASSETS
|
||||
Accounts
Receivable, net
|
$
|
1,035
|
||
Prepaid
Expenses and Other Current Assets
|
418
|
|||
TOTAL
ASSETS
|
$
|
1,453
|
||
LIABILITIES
|
||||
Accounts
Payable and Other Accrued Liabilities
|
$
|
33,034
|
||
Deferred
Revenues and Customer Advances
|
2,207
|
|||
Warranty
Provision
|
1,747
|
|||
Total
Liabilities
|
36,988
|
|||
Net
Liabilities of Discontinued Operations
|
$
|
(35,535
|
)
|
27
Significantly
all of the assets and liabilities of the discontinued operations pertain to
activities outside of the United States, primarily for turbines sold and
installed in Europe and South America and technology licenses to Chinese
customers. At June 30, 2010, included above in Accounts Payable and
Other Accrued Liabilities are net payables related to formerly consolidated, now
insolvent European subsidiaries of approximately $18 million, substantially all
of which has been assigned by the insolvency receiver to FKI, a former owner of
DeWind engaged in discovery and threats of litigation with Stribog Ltd.,
formerly DeWind Ltd. As of June 30, 2010, the net payables to
insolvent subsidiaries are comprised of assets in the amount of $7 million and
liabilities in the amount of $25 million. We did not receive an update from the
insolvency receiver related to the assets and liabilities for the insolvent
subsidiaries during the quarter ended June 30, 2010.
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 June
30,
|
Nine Months Ended June
30,
|
|||||||||||||||
(Unaudited,
In Thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Product
Revenue
|
$
|
583
|
$
|
3,562
|
$
|
7,536
|
$
|
14,124
|
||||||||
Cost
of Revenue
|
$
|
742
|
$
|
2,931
|
$
|
6,466
|
$
|
10,063
|
||||||||
Gross
Margin (Loss)
|
$
|
(159
|
)
|
$
|
631
|
$
|
1,070
|
$
|
4,061
|
|||||||
Gross
Margin (Loss) %
|
(27.3
|
)%
|
17.7
|
%
|
14.2
|
%
|
28.8
|
%
|
PRODUCT
REVENUE: Product revenues decreased $3.0 million, or 84%, from $3.6
million in 2009 to $0.6 million for the three months ended June 30, 2010, and
decreased $6.6 million, or 47%, from $14.1 million in 2009 to $7.5 million for
the nine months ended June 30, 2010.
The
decrease for the three months ended June 30, 2010 was related to a significant
decline in shipments of 634 km of ACCC®
products, substantially all to China, offset by an increase in shipments of 65
km of ACCC® products
to Indonesia. The decrease for the nine months ended June 30, 2010 was primarily
related to a significant decline in shipments of 2,003 km of ACCC® products
to China, offset by increases in shipments of 264 km of ACCC® products
primarily within North America, South America and Indonesia.
COST OF
REVENUE: Cost of revenue represent materials, labor, freight, product cost
depreciation and allocated overhead costs to produce ACCC®
conductor, ACCC® core,
and related hardware. Cost of revenue decreased $2.2 million, or 75%,
from $2.9 million in 2009 to $0.7 million for the three months ended June 30,
2010, and decreased $3.6 million, or 36%, from $10.1 million in 2009 to $6.5
million for the nine months ended June 30, 2010.
Cost of
revenue and resultant gross margin: The gross margin percentages for the
three and nine months ended June 30, 2010 decreased primarily due to production
inefficiencies as a result of significant idle production capacity, and
inventory reserves recorded in the respective periods.
The
following table presents a comparative analysis of operating expenses for
continuing operations:
Three Months Ended June 30,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
Officer
Compensation
|
$
|
511
|
$
|
35
|
$
|
546
|
$
|
771
|
$
|
—
|
$
|
771
|
||||||||||||
General
and Administrative
|
1,316
|
1,508
|
2,824
|
1,097
|
1,065
|
2,162
|
||||||||||||||||||
Research
and Development
|
—
|
499
|
499
|
—
|
499
|
499
|
||||||||||||||||||
Sales
and Marketing
|
—
|
1,505
|
1,505
|
—
|
1,108
|
1,108
|
||||||||||||||||||
Depreciation
and Amortization
|
2
|
99
|
101
|
—
|
93
|
93
|
||||||||||||||||||
Total
Operating Expenses
|
$
|
1,829
|
$
|
3,646
|
$
|
5,475
|
$
|
1,868
|
$
|
2,765
|
$
|
4,633
|
Nine Months Ended June 30,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
Officer
Compensation
|
$
|
1,735
|
$
|
196
|
$
|
1,931
|
$
|
2,527
|
$
|
—
|
$
|
2,527
|
||||||||||||
General
and Administrative
|
5,510
|
4,304
|
9,814
|
4,224
|
2,405
|
6,629
|
||||||||||||||||||
Research
and Development
|
—
|
1,645
|
1,645
|
—
|
1,910
|
1,910
|
||||||||||||||||||
Sales
and Marketing
|
—
|
4,489
|
4,489
|
—
|
3,856
|
3,856
|
||||||||||||||||||
Depreciation
and Amortization
|
2
|
358
|
360
|
—
|
274
|
274
|
||||||||||||||||||
Total
Operating Expenses
|
$
|
7,247
|
$
|
10,992
|
$
|
18,239
|
$
|
6,751
|
$
|
8,445
|
$
|
15,196
|
28
OFFICER
COMPENSATION: Officer Compensation represents CTC Corporate and Cable expenses
and consists primarily of salaries, consulting fees paid in cash, and the fair
value of stock grants issued to officers of the Company. Officer compensation
decreased $0.2 million, or 29%, from $0.8 million in 2009 to $0.5 million for
the three months ended June 30, 2010, and decreased $0.6 million, or 24%, from
$2.5 million in 2009 to $1.9 million for the nine months ended June 30,
2010. The decreases for the three and nine months ended June 30, 2010
were primarily due to lower fair value share-based compensation expense for
vested stock options, offset by an increase in officer salaries.
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. General and
administrative expense increased $0.7 million, or 31%, from $2.2 million in 2009
to $2.8 million for the three months ended June 30, 2010, and increased $3.2
million, or 48%, from $6.6 million in 2009 to $9.8 million for the nine months
ended June 30, 2010.
The
increase of $0.7 million for the three months ended June 30, 2010 was primarily
from an increase in Cable related general and administrative expense derived
from increases headcount and headcount related costs, and facilities costs due
to significant idle capacity during the three months ended June 30,
2010.
The
increase of $3.2 million for the nine months ended June 30, 2010 was due to a
$1.3 million increase from corporate and $1.9 million increase from
Cable. The corporate related general and administrative expense
increase is derived primarily from increases in professional service fees,
start-up costs related to the organization of a new entity, and payroll taxes
accrued in connection with an IRS payroll tax audit as discussed in Note 1
(“Income Taxes”) to the consolidated financial statements. The Cable
related general and administrative expense increase is derived primarily from
headcount and headcount related costs and facilities costs due to significant
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 were consistent
for the three months ended June 30, 2010, and decreased by $0.3 million, or 14%,
from $1.9 million in 2009 to $1.6 million for the nine months ended June 30,
2010.
The
decrease for the nine months ended June 30, 2010 was primarily due to
significantly lower fair value share-based compensation expense for vested stock
options, partially offset by higher headcount costs, professional service fees
and research and development product testing and validation costs.
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 $0.4 million, or 36%, from $1.1 million in 2009 to $1.5
million for the three months ended June 30, 2010, and increased $0.6 million, or
16%, from $3.9 million in 2009 to $4.5 million for the nine months ended June
30, 2010.
The net
increases for the three and nine months ended June 30, 2010 were primarily
related to increased headcount and headcount related costs, commissions and
incentives expense, and professional service fees, offset by a decrease in
share-based compensation charges.
DEPRECIATION
AND AMORTIZATION: Depreciation and amortization expense consists of the
depreciation and amortization of the Company's capitalized assets used in
operations, excluding product cost depreciation (refer to cost of revenue
discussion above). Depreciation expense increased $8,000, or 9%, from
$93,000 in 2009 to $101,000 for the three months ended June 30, 2010, and
increased $86,000, or 31%, from $274,000 in 2009 to $360,000 for the nine months
ended June 30, 2010. The increases were primarily due to a higher non-production
based asset base compared to the prior year corresponding period.
INTEREST
EXPENSE: Interest expense primarily consists of the cash interest payable on the
Company’s debt obligations and the amortization of the any related debt
discount. Interest expense increased $152,000, or 33%, from $461,000
in 2009 to $613,000 for the three months ended June 30, 2010, and increased $0.3
million, or 23%, from $1.4 million in 2009 to $1.7 million for the nine months
ended June 30, 2010. The increase in the three and nine months ended June 30,
2010 was primarily due to the April 2010 senior secured loan arrangement (refer
to Note 8 to the consolidated financial statements), which carries a higher
average interest rate than the fiscal 2009 obligation. The increase
in the nine months ended June 30, 2010 was also due to additional discount
amortization of a beneficial conversion feature liability recognized in earnings
from October 2009 through January 2010 (refer to Note 1 to the consolidated
financial statements “Derivative Liabilities and Change in Accounting
Principle”).
INTEREST
INCOME: The interest income changes from period to period are due to changes in
the underlying cash and cash equivalent balances. Interest income
increased by $4,000 and $11,000 in the three and nine months ended June 30,
2010, respectively, compared to the same periods in the prior
year. The additional interest income is primarily due to the DeWind
sale proceeds from September 2009.
29
OTHER
EXPENSE: Other expense primarily consists of foreign exchange losses,
losses on disposal of fixed assets, and penalties associated with the findings
from the examination by the Internal Revenue Service (IRS) for prior fiscals
years ended September 30, 2001 through 2005 (refer to “Income Taxes” in Note 1
above). Other expense increased $128,000 and $392,000 in the three
and nine months ended June 30, 2010, respectively, compared to the same periods
in the prior year. The increases for the three months and nine months
ended June 30, 2010 are primarily due to foreign exchange losses, losses on
disposal of fixed assets, and the IRS penalties mentioned above.
CHANGE IN
FAIR VALUE OF DERIVATIVE LIABILITIES: Refer to discussion at Note 1 (“Derivative
Liabilities”) to the consolidated financial statements.
INCOME
TAXES: No provisions for income taxes were made for the three months
ended June 30, 2010 and 2009, respectively. We made provisions for
income taxes of $14,000 and $4,000 for the nine months ended June 30, 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 June 30, 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 and the UK Sterling. We currently do not hedge the
exchange rate risk related to our assets and liabilities and do not hedge the
exchange rate risk related to expected future operating
expenses.
RECONCILIATION
OF NON-GAAP MEASURES
The
following tables present a reconciliation of consolidated non-GAAP EBITDAS
or Earnings before Interest, Taxes, Depreciation & Amortization, and
Share-Based Compensation charges for continuing operations for the three and
nine months ended June 30, 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 US GAAP operating results. For the
non-GAAP EBITDAS measure, a significant portion of non-cash expenses are
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 also
include the change in fair value of derivative liabilities,
asset impairments and warrant modification expense in EBITDAS and our
reconciliation as applicable.
Three Months Ended June 30,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
EBITDAS:
|
||||||||||||||||||||||||
Net
loss from continuing operations
|
$
|
(1,975
|
)
|
$
|
(3,805
|
)
|
$
|
(5,780
|
)
|
$
|
(2,335
|
)
|
$
|
(2,134
|
)
|
$
|
(4,469
|
)
|
||||||
Depreciation
& Amortization
|
2
|
166
|
168
|
—
|
257
|
257
|
||||||||||||||||||
Share-based
compensation
|
467
|
129
|
596
|
687
|
275
|
962
|
||||||||||||||||||
Change
in fair value of derivative liabilities
|
(597
|
)
|
—
|
(597
|
)
|
—
|
—
|
—
|
||||||||||||||||
Interest
expense, net
|
607
|
—
|
607
|
459
|
—
|
459
|
||||||||||||||||||
Income
tax expense
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||||
EBITDAS
Loss
|
$
|
(1,496
|
)
|
$
|
(3,510
|
)
|
$
|
(5,006
|
)
|
$
|
(1,189
|
)
|
$
|
(1,602
|
)
|
$
|
(2,791
|
)
|
30
Nine Months Ended June 30,
|
||||||||||||||||||||||||
2010
|
2009
|
|||||||||||||||||||||||
(Unaudited,
In Thousands)
|
Corporate
|
Cable
|
Total
|
Corporate
|
Cable
|
Total
|
||||||||||||||||||
EBITDAS:
|
||||||||||||||||||||||||
Net
loss from continuing operations
|
$
|
(7,799
|
)
|
$
|
(10,001
|
)
|
$
|
(17,800
|
)
|
$
|
(8,118
|
)
|
$
|
(4,384
|
)
|
$
|
(12,502
|
)
|
||||||
Depreciation
& Amortization
|
2
|
484
|
486
|
—
|
722
|
722
|
||||||||||||||||||
Share-based
compensation
|
1,592
|
493
|
2,085
|
2,459
|
1,303
|
3,762
|
||||||||||||||||||
Change
in fair value of derivative liabilities
|
(1,437
|
)
|
—
|
(1,437
|
)
|
—
|
—
|
—
|
||||||||||||||||
Interest
expense, net
|
1,667
|
(13
|
)
|
1,654
|
1,354
|
1
|
1,355
|
|||||||||||||||||
Income
tax expense
|
14
|
—
|
14
|
4
|
—
|
4
|
||||||||||||||||||
EBITDAS
Loss
|
$
|
(5,961
|
)
|
$
|
(9,037
|
)
|
$
|
(14,998
|
)
|
$
|
(4,301
|
)
|
$
|
(2,358
|
)
|
$
|
(6,659
|
)
|
Consolidated
EBITDAS Loss for the three months ended June 30, 2010 for continuing
operations increased by $2.2 million as compared to 2009 primarily due to a
$1.9 million increase from our Cable operations. Consolidated EBITDAS
Loss for the nine months ended June 30, 2010 for continuing
operations increased by $8.3 million as compared to 2009 due to a $1.6
million increase from corporate and $6.7 million increase from our Cable
operations. The total increases were primarily due to reduced gross
margins and increased operating expenses including additional payroll tax
expense in connection with an IRS audit, increases in professional service fees
and headcount, and increased facilities costs due to significant idle
capacity.
NET
LOSS
The
following table presents the components of our total net loss:
Three Months Ended June
30,
|
Nine Months Ended June
30,
|
|||||||||||||||
(Unaudited,
In Thousands)
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
Net
Loss from Continuing Operations
|
$
|
(5,780
|
)
|
$
|
(4,469
|
)
|
$
|
(17,800
|
)
|
$
|
(12,502
|
)
|
||||
Income
(Loss) from Discontinued Operations (Note 2)
|
2,376
|
(22,456
|
)
|
3,460
|
(33,413
|
)
|
||||||||||
|
|
|
|
|||||||||||||
Net
Loss
|
$
|
(3,404
|
)
|
$
|
(26,925
|
)
|
$
|
(14,340
|
)
|
$
|
(45,915
|
)
|
Net loss
decreased by $23.5 million to $3.4 million for the three months ended June 30,
2010 from $26.9 million in 2009, and decreased by $31.6 million to $14.3 million
for the nine months ended June 30, 2010 from $45.9 million in
2009. The decreases in net loss are substantially due to the activity
level of our discontinued operations through June 30, 2009 compared to same
period in fiscal 2010. The $31.6 million net loss decrease for the
nine months ended June 30, 2010 was due to:
|
·
|
A decrease in Gross Margin from
continuing operations of $3.0 million from 2009 to
2010.
|
|
·
|
An increase in Total Operating
Expense from continuing operations of $3.0 million from 2009 to
2010.
|
|
·
|
A decrease in Total Other Expense
(including income taxes) from continuing operations of $0.7 million from
2009 to 2010.
|
|
·
|
A decrease from the 2009 Loss
from Discontinued Operations of $36.9 million to
2010.
|
Gross
Margin: As discussed above, the gross margin decrease of $3.0 million was
primarily due to production inefficiencies as a result of significant idle
production capacity, and inventory reserves recorded in the nine months ended
June 30, 2010 compared to 2009.
Total
Operating Expense: As detailed above, the total increase in operating expense of
$3.0 million was primarily driven by significant increases in general and
administrative expenses totaling $3.2 million, offset by decreases in research
and development expenses of $0.3 million and officer compensation of $0.6
million for the nine months ended June 30, 2010 compared to 2009.
Total
Other Expense (including income taxes): As discussed above, the total other
expense decrease is primarily due to the $1.4 million increase in the change in
fair value of derivatives liabilities, offset by additional interest expense of
$0.3 million in the nine months ended June 30, 2010 compared to
2009.
31
Income
(Loss) from Discontinued Operations: As discussed above and detailed in Note 2
to the consolidated financial statements, the decrease from the 2009 loss from
discontinued operations of $36.9 million is derived from the September 2009
DeWind asset sale and related discontinuation of the DeWind business
segment.
LIQUIDITY
AND CAPITAL RESOURCES
Since
inception, our principal sources of working capital have been private debt
issuances and equity financings.
For the
nine months ended June 30, 2010, we had a net loss from continuing operations of
$17.8 million. At June 30, 2010 we had $7.4 million of cash and cash
equivalents, which represented a decrease of $16.6 million from September 30,
2009. The decrease was due to cash used in operations of $17 million, cash used
in investing activities of $0.2 million and cash provided by financing
activities of $0.6 million.
Cash used
in operations during the nine months ended June 30, 2010 of $17 million was
primarily the result of a net loss of $14.2 million and income from discontinued
operations of $3.5 million, offset by net non-cash reconciling items of $3.6
million (comprised of depreciation and amortization of $1.3 million, stock
related net charges of $2.4 million, inventory charges of $1.2 million, a loss
on disposal of fixed assets of $0.1 million and a foreign exchange loss of $0.1
million, offset by a gain from the change in fair value of derivative
liabilities of $1.4 million). Additionally, cash used in operations was impacted
by a negative change in net assets/liabilities from discontinued operations of
$3.0 million, offset by net cash provided from working capital of $0.1 million
(primarily comprised of a negative change in accounts payable of $1.7
million, offset by a positive changes in accounts receivable of $0.7 million and
deferred revenue of $1.4 million).
Cash used
in investing activities during the nine months ended June 30, 2010 of $0.2
million was primarily related to cash used from the purchase of computer
hardware and software, and equipment put in service in anticipation of increased
cable manufacturing activities.
Cash
provided by financing activities during the nine months ended June 30, 2010 of
$0.6 million was derived from the net proceeds received from the April 2010
senior secured loan arrangement of $9.7 million and the exercise of stock
options in the amount of $7,000, offset by the January 2010 repayment notes
payable of $9.0 million.
Our cash
position as of June 30, 2010 was $7.4 million. On January 31, 2010,
we repaid all outstanding convertible notes payable in the principal amount of
$9.0 million. Due to the repayment of debt, we raised an additional
$9.7 million in cash in April 2010 (refer to Note 8 “Debt” to the consolidated
financial statements). As noted in Note 13 “Subsequent Events” 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 leaving $16.4 million remaining
in escrow. 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 June
30, 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 due to significantly lower cash
operating expenses and the elimination of inventory purchases for costly wind
turbine parts. As CTC Cable has sufficient production capacity in its
existing plant to achieve profitability, it is not expected that significant
capital expenditures will be required to expand production, as seen in prior
years. CTC Cable has also significantly reduced its reliance on one
customer as compared to prior fiscal years, which has lowered its customer
concentration risk. Additionally, as needed, we intend to continue
the practice of issuing stock, debt, or other financial instruments for cash or
for payment of services or debt extinguishment until our cash flows from the
sales of our primary products is sufficient to fully provide for cash used
in operations or if we believe such a financing event would be a sound
business strategy.
CAPITAL
EXPENDITURES
The
Company does not have any material commitments for capital
expenditures.
OFF-BALANCE
SHEET ARRANGEMENTS
As of
June 30, 2010, we have no off-balance sheet arrangements.
CONTRACTUAL
OBLIGATIONS
The
following table summarizes our contractual obligations (including interest
expense) and commitments as of June 30, 2010:
(Unaudited,
In Thousands)
|
Total
|
Due in 1
Year
|
In Years 2-3
|
In excess of 3
Years
|
||||||||||||
Warranty
Provisions
|
$
|
613
|
$
|
327
|
$
|
286
|
$
|
—
|
||||||||
Debt
Obligations (A)
|
$
|
12,130
|
$
|
1,217
|
$
|
10,913
|
$
|
—
|
||||||||
Operating
Lease Obligations
|
$
|
2,406
|
$
|
813
|
$
|
1,593
|
—
|
(A)
Senior secured loan due April 2012 and the related estimated monthly
interest-only payments (see Note 8).
During
the June 2010 quarter, the Company renegotiated the lease on its primary
operating facilities and headquarters location in Irvine, CA. The
lease had been scheduled to expire in December 2010 with an option to renew for
an additional five years. The company negotiated a reduced lease rate
and committed to remain in the Irvine, CA location through
2013.
32
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis of our financial condition and results of operations is
based on our Consolidated Financial Statements, which have been prepared in
accordance with accounting principles generally accepted in the United States,
or US GAAP. Critical accounting policies and estimates,
included in Note 1 to the Consolidated Financial Statements, are as
follows:
Revenue
Recognition
Revenues
are recognized based on guidance provided by the SEC. Accordingly, our general
revenue recognition policy is to recognize revenue when there is persuasive
evidence of an arrangement, the sales price is fixed or determinable, collection
of the related receivable is reasonably assured, and delivery has occurred or
services have been rendered.
The
Company derives, or seeks to derive revenues from product revenue sales of
composite core, stranded composite core, core and stranded core hardware, and
other electric utility related products.
In
addition to the above general revenue recognition principles prescribed by the
SEC, our specific revenue recognition policies for each revenue source are as
follows:
PRODUCT
REVENUES. Product revenues are recognized when product shipment has been made
and title has passed to the end user customer. Product revenues consist
primarily of revenue from the sale of: (i) stranded composite core and related
hardware to utilities either sold directly by the Company or through a
distribution agreement, and (ii) composite core and related hardware sold to a
cable stranding entity. Revenues are deferred for product contracts where the
Company is required to perform installation services until after the
installation is complete. Our distribution agreements are structured so that our
revenue cycle is complete upon shipment and title transfer of products to the
distributor with no right of return.
CTC Cable
sales for the three and nine months ended June 30, 2010 and 2009 consisted of
stranded ACCC®
conductor and ACCC® hardware
sold to end user utilities and sales of ACCC®
conductor 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 warranty coverage.
CONSULTING
REVENUE. Consulting revenues are generally recognized as the consulting services
are provided. We have entered into service contract agreements with electric
utility and utility services companies that generally require us to provide
engineering or design services, often in conjunction with current or future
product sales. In return, we receive engineering service fees payable in
cash. For the three and nine months ended June 30, 2010 and 2009, we
recognized no consulting revenues.
Currently,
multiple element contracts where there is no vendor specific objective evidence
(VSOE) or third-party evidence (TPE) that would allow the allocation of an
arrangement fee amongst various pieces of a multi-element contract, fees
received in advance of services provided are recorded as deferred revenues until
additional operational experience or other VSOE or TPE becomes available, or
until the contract is completed.
Warranty
Provisions
Warranty
provisions consist of the insured costs and liabilities associated with any
post-sales associated with our ACCC®
conductor and related hardware parts.
Warranties
related to our ACCC® products
relate to conductor and hardware sold directly by us to the end-user
customer. We mitigate our loss exposure through the use of third
party warranty insurance. Warranty related liabilities for time
periods in excess of one year are classified as non-current
liabilities.
Use of
Estimates
The
preparation of our financial statements conform with US GAAP, which requires
management to make estimates and judgments in applying our accounting policies
that have an important impact on our reported amounts of assets, liabilities,
revenue, expenses and related disclosures at the date of our financial
statements. On an on-going basis, management evaluates its estimates including
those related to accounts receivable, inventories, share-based compensation,
warranty provisions and goodwill and intangibles, as applicable. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from management’s estimates. We believe that the application of our
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.
33
Our key
estimates we use that rely upon management judgment include:
|
-
|
the estimates pertaining to the
likelihood of our accounts receivable collectability. These estimates
primarily rely upon past payment history by customer and management
judgment on the likelihood of future payments based on the current
business condition of each customer and the general business
environment.
|
|
-
|
the estimates pertaining to the
valuation of our inventories. These estimates primarily rely upon the
current order book for each product in inventory along with management’s
expectations and visibility into future sales of each product in
inventory.
|
|
-
|
the assumptions used to calculate
fair value of our share-based compensation and derivative liabilities,
primarily the volatility component of the Black-Scholes-Merton
(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, forfeiture rates 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 convertible debt
issuances. The Company has not issued any derivative instruments for hedging
purposes since its inception. The Company uses the specific guidance and
disclosure requirements provided in US GAAP. Generally, freestanding derivative
contracts where settlement is required by physical share settlement or in net
share settlement; or where the Company has a choice of share or net cash
settlement are accounted for as equity. Contracts where settlement is in cash or
where the counterparty may choose cash settlement are accounted for as a
liability. Under current US GAAP, certain of our warrants are subject to
liability accounting treatment (see discussion below under “Derivative
Liabilities”), while our stock options are considered indexed to the Company’s
stock and are accounted for as equity.
The
values of the financial instruments are estimated using the Black-Scholes
option-pricing model. Key assumptions used to value options and warrants
granted, issued or repriced are as follows:
Nine Months Ended
|
||||||||
June 30,
|
||||||||
2010
|
2009
|
|||||||
Risk
Free Rate of Return
|
0.82-2.60
|
%
|
0.50-2.54
|
%
|
||||
Volatility
|
95.0-108
|
%
|
75-116
|
%
|
||||
Dividend
yield
|
0
|
%
|
0
|
%
|
||||
Expected
life
|
2-5
yrs
|
.5-5
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 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 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 and nine months ended June 30, 2010, we recognized gains of $597,000 and
$1,437,000, respectively, related to the revaluation of our derivative
liabilities. The 2010 revaluation gains resulted mainly from the
decrease in our stock price from the prior year and from expired arrangements
during the year.
34
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 9 to the consolidated financial statements.
Share-Based
Compensation
US GAAP
requires that compensation cost relating to share-based payment arrangements be
recognized in the financial statements. US GAAP requires measurement of
compensation cost for all share-based awards at fair value on date of grant and
recognition of compensation over the service period for awards expected to vest.
The fair value of stock options is determined using the Black-Scholes valuation
model. Such fair value is recognized as expense over the service period, net of
estimated forfeitures.
US GAAP
requires that equity instruments issued to non-employees in exchange for
services be valued at the more accurate of the fair value of the services
provided, or the fair value of the equity instruments issued. For equity
instruments issued that are subject to a required service period, the expense
associated with the equity instruments is recorded as the instruments vest or
the services are provided. The Company has granted options and warrants to
non-employees and recorded the fair value of these equity instruments on the
date of issuance using the Black-Scholes valuation model, for options and
warrants not subject to vesting terms. For non-employee option and warrant
grants subject to vesting terms, vested shares are recorded at fair value using
the Black-Scholes valuation model and the associated expense is recorded
simultaneously or as the services are provided. The Company has granted stock to
non-employees for services and values the stock at the more reliable of the
market value on the date of issuance or the value of the services provided. For
stock grants subject to vesting or service requirements, expenses are deferred
and recognized over the more appropriate of the vesting period, or as services
are provided.
SEC
guidance requires share-based compensation to be classified in the same
expense line items as cash compensation. Additionally, the
SEC issued guidance regarding the use of a "simplified" method in
developing an estimate of expected term of "plain vanilla" share options in
accordance with US GAAP rules. The Staff indicated that it will accept a
company's election to use the simplified method, regardless of whether the
company has sufficient information to make more refined estimates of expected
term. The Staff believed that more detailed external information about employee
exercise behavior (e.g., employee exercise patterns by industry and/or other
categories of companies) would, over time, become readily available to
companies; however, the Staff continues to accept, under certain circumstances,
the use of the simplified method. The Company currently uses the simplified
method for the expected term in “plain vanilla” share options and
warrants.
Additional
information about share-based compensation is disclosed in Note 10 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 June 30, 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 PRONOUNCEMENTS
Refer to
Note 1 to the Consolidated Financial Statements.
35
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
June 30, 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 June 30, 2010, we had $7.4 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 June 30, 2010 because of the material weaknesses identified during
management’s annual assessment of internal control over financial reporting for
the fiscal year ended September 30, 2009.
Internal Control over
Financial Reporting
Refer to
“Item 9A – Controls and Procedures” in our Form 10-K filed with the Securities
and Exchange Commission on December 14, 2009 for management’s annual report on
internal control over financial reporting. The Company’s
management assessed the effectiveness of the Company’s internal control over
financial reporting as of September 30, 2009. In making this
assessment, the Company’s management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control-Integrated Framework. Based on their assessment,
management concluded that, as of September 30, 2009, the Company’s internal
control over financial reporting is not effective based on those criteria,
because of the material weaknesses identified.
Changes in Internal Control
over Financial Reporting
There was
no change in our internal control over financial reporting during the third
quarter ended June 30, 2010 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting,
except as noted below.
During
the nine months ended June 30, 2010 and through the date of this report, the
Company improved the internal control over financial reporting to address
certain material weaknesses identified as of September 30, 2009, as
follows:
(1) In
January 2010, we implemented a share-based compensation and equity
administration software system. Transactions are now processed and reported by
the accounting department, our legal department reviews contractual terms, and
accounting executives perform a complete review of inputs and outputs prior to
recording in the general ledger.
(2) In
March 2010, we implemented a financial planning and analysis (FP&A) process,
which included creating a complete consolidated and departmental fiscal 2010
annual budget. Departmental and executive management are now
reviewing budget to actual data on a monthly basis. Additionally,
accounting management reviews the FP&A results, assists with the process and
records accounting adjustments when appropriate.
The
Company's management has identified the additional steps necessary to address
the material weaknesses identified as of September 30, 2009, as
follows:
(1)
Hiring additional accounting and operations personnel and engaging outside
contractors with technical accounting expertise, as needed, and reorganizing the
accounting and finance department to ensure that accounting personnel with
adequate experience, skills and knowledge relating to complex, non-routine
transactions are directly involved in the review and accounting evaluation of
our complex, non-routine transactions;
36
(2)
Involving both internal accounting and operations personnel and outside
contractors with technical accounting expertise, as needed, early in the
evaluation of a complex, non-routine transaction to obtain additional guidance
as to the application of generally accepted accounting principles to such a
proposed transaction;
(3)
Documenting to standards established by senior accounting personnel and the
principal accounting officer the review, analysis and related conclusions with
respect to complex, non-routine transactions;
(4)
Requiring senior accounting personnel and the principal accounting officer to
review complex, non-routine transactions to evaluate and approve the accounting
treatment for such transactions;
(5)
Evaluating an internal audit function in relation to the Company's financial
resources and requirements;
(6)
Invest in additional enhancements to our IT systems including enhancements to
processing manufacturing and inventory transactions, and security over user
access and administration;
(7)
Create policy and procedures manuals for the accounting, finance and IT
functions; and
(8)
Improve our purchasing and accounts payable cycle controls.
The
Company began to execute the remediation plans identified above in the first
fiscal quarter of 2010. These remediation efforts are expected to continue
through fiscal 2010.
37
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings
There
have been no material changes to the Legal Proceedings described in Form 10-K
filed with the Securities and Exchange Commission on December 14, 2009. See
Note 11 (“Litigation”) to the Consolidated Financial Statements in this
document.
Item
1A. Risk Factors
The
following risk factors have changed or have been updated for recent information
as compared to the Risk Factors listed in Form 10-K filed with the Securities
and Exchange Commission on December 14, 2009. Such risk factors should be read
in conjunction with the risk factors listed in such Form 10-K.
WE EXPECT
FUTURE LOSSES AND OUR FUTURE PROFITABILITY IS UNCERTAIN.
Prior to
acquiring Transmission Technology Corporation, or TTC, in November 2001, we were
a shell corporation having no operating history, revenues from operations, or
assets since December 31, 1989. We have recorded approximately $82 million in
ACCC® product
sales since inception. Historically, we have incurred substantial losses and we
may experience significant quarterly and annual losses for the foreseeable
future. We may never become profitable. If we do achieve profitability, we may
not be able to sustain or increase profitability on a quarterly or annual basis.
We expect the need to significantly increase our product development and product
prototype and equipment prototype production expenses, as necessary. As a
result, we will need to generate significant revenues and earnings to
achieve and maintain profitability.
IF WE
CANNOT RAISE CAPITAL WHEN IT IS NEEDED, WE MAY BE REQUIRED TO REDUCE OR SUSPEND
OPERATIONS OR GO OUT OF BUSINESS ALTOGETHER FOR ONE OR MORE OF OUR OPERATING
SEGMENTS.
We
anticipate that for the foreseeable future, the sales of our ACCC® cable
may not be sufficient enough to sustain our current level of operations and that
we will continue to incur net losses. Further, on January 31, 2010 we
repaid $9.1 million in debt and interest on our remaining convertible debt
outstanding at December 31, 2009. 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 will be adversely affected if the results
of our business operations are not favorable, if any products developed are not
well received or if our stock price or trading volume is low. Additional funding
may not be available on favorable terms to us, or at all. To the extent that
money is raised through the sale of our securities, the issuance of those
securities could result in dilution to our existing stockholders. If we raise
money through debt financing, we may be required to secure the financing with
all of our business assets, which could be sold or retained by the creditor
should we default in our payment obligations. If we cannot sustain our working
capital needs with financings or if available financing is prohibitively
expensive, we may not be able to complete the commercialization of our products.
As a result, we may be required to discontinue our operations without obtaining
any value for our products, which could eliminate stockholder equity, or we
could be forced to relinquish rights to some or all of our products in return
for an amount substantially less than we expended.
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. If we were to violate the
debt covenants, 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.
WE DEPEND
ON KEY PERSONNEL IN A COMPETITIVE MARKET FOR SKILLED EMPLOYEES AND FAILURE TO
ATTRACT AND RETAIN QUALIFIED EMPLOYEES COULD SUBSTANTIALLY HARM OUR
BUSINESS.
We rely
to a substantial extent on the management, marketing and product development
skills of our key employees, particularly Benton H Wilcoxon, our Chief Executive
Officer, Marv Sepe, our Chief Operating Officer, and DJ Carney, our Chief
Financial Officer. During the quarter ended June 30 2010 John
Brewster, President of CTC Cable Corporation, resigned to pursue other interests
and the Company is actively recruiting his replacement. If Messrs.
Wilcoxon, Sepe, or Carney were unable to provide services to us for whatever
reason, or if Mr. Brewster’s replacement is not recruited in a timely manner,
our business would be adversely affected. Neither Mr. Wilcoxon, Mr.
Sepe, nor Mr. Carney has entered into an employment agreement with the
Company. In addition, our ability to develop and market our products
and to achieve profitability will depend on our ability to attract and retain
highly talented personnel. We face intense competition for personnel
from other companies in the electrical utility industry. The loss of
the services of our key personnel or the inability to attract and retain the
additional, highly talented employees required for the development and
commercialization of our products, may significantly delay or prevent the
achievement of product development, may cause us to incur additional expenses to
recruit and train new personnel and could have a material adverse effect on our
business, financial condition and results of operations.
Risks
Related To Our Securities
THE PRICE
OF OUR COMMON STOCK IS VOLATILE. VOLATILITY MAY INCREASE IN THE FUTURE, WHICH
COULD AFFECT OUR ABILITY TO RAISE CAPITAL IN THE FUTURE OR MAKE IT DIFFICULT FOR
INVESTORS TO SELL THEIR SHARES.
The market price of our common stock may be subject to significant
fluctuations in response to our operating results, announcements of new products
or market expansions by us or our competitors, changes in general conditions in
the economy, the financial markets, the electrical power transmission and
distribution industry, or other developments and activities affecting us, our
customers, or our competitors, some of which may be unrelated to our
performance. The sale or attempted sale of a large amount of common stock into
the market may also have a significant impact on the trading price of our common
stock. During the last 12 months from June 30, 2010, the closing bid prices for
our common stock have fluctuated from a high of $0.73 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.
38
AS
OF AUGUST 5,
2010,
WHILE CURRENT MARKET PRICES ARE BELOW SUBSTANTIALLY ALL OF OUR CONVERTIBLE
EQUITY SECURITIES, INCLUDING OPTIONS AND WARRANTS, A SUBSTANTIAL NUMBER OF
OPTIONS ARE PRICED AT $0.35 PER SHARE OR BELOW. A PRICE INCREASE
ABOVE THAT STRIKE PRICE WOULD RESULT IN APPROXIMATELY 26,800,000 OPTIONS AT
$0.35 PER OPTION OF WHICH FULL CONVERSION OF SUCH SHARES WOULD INCREASE THE
OUTSTANDING COMMON SHARES BY 9.3% TO APPROXIMATELY
315,070,000
SHARES.
The exercise price of
outstanding options and warrants may be less than the current market price for
our common shares. In the event of the exercise of these securities, a
shareholder could suffer substantial dilution of his, her or its investment in
terms of the percentage ownership in us as well as the book value of the common
shares held. At the August 5, 2010 market price of $0.20 per share, no shares
would be exercisable for less than the current market
price.
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.
39
Item
6. Exhibits
EXHIBIT
INDEX
Number
|
Description
|
|
3.1(1)
|
Articles
of Incorporation of the Company
|
|
3.2(2)
|
Certificate
of Amendment to Articles of Incorporation
|
|
3.2(3)
|
Bylaws
of Composite Technology Corporation, as modified January 6,
2006
|
|
10.1(4)
|
Offer
letter between the Registrant and John Brewster dated December 14,
2009
|
|
10.2(5)
|
Loan
and Security Agreement among the Company, CTC Cable Corporation, CTC
Renewables Corporation and Partners
for Growth II, L.P. dated as of April 12, 2010
|
|
10.3(5)
|
Warrant
Purchase Agreement between the Company and Partners for Growth II, L.P.
dated April 12, 2010
|
|
10.4(5)
|
Intellectual
Property Security Agreement among the Company, CTC Cable Corporation, CTC
Renewables Corporation and Partners for Growth II, L.P. dated
April 12, 2010
|
|
10.5(6)
|
Form
of 2010 Composite Technology Corporation Omnibus Incentive
Plan
|
|
10.6(6)
|
Cross-Corporate
Continuing Guaranty and Security Agreement among the Company, CTC Cable
Corporation, CTC Renewables Corporation and Stribog, Inc. dated
April 12, 2010
|
|
10.7(6)
|
Warrants
related to Warrant Purchase Agreement between the Company and Partners for
Growth II, L.P. dated April 12, 2010
|
|
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 December 18, 2009.
(5)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on April 16, 2010.
(6)
Incorporated herein by reference to Form 8-K filed with the U.S. Securities and
Exchange Commission on April 30, 2010.
(7) Filed
herewith.
40
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
COMPOSITE
TECHNOLOGY CORPORATION
|
|
(Registrant)
|
|
Date:
August 9, 2010
|
By: /s/ Benton H
Wilcoxon
|
Benton
H Wilcoxon
|
|
Chief
Executive Officer
(Principal
Executive
Officer)
|
Date:
August 9, 2010
|
By: /s/ Domonic J.
Carney
|
Domonic
J. Carney
|
|
Chief
Financial Officer
(Principal
Financial and
Accounting Officer)
|
41