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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 September 30, 2005March 31, 2006
or
/ / Transition report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-6890
MECHANICAL TECHNOLOGY INCORPORATED
(Exact name of registrant as specified in its charter)
New York | 14-1462255 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
431 New Karner Road, Albany, New York 12205
(Address of principal executive offices) (Zip Code)
(518) 533-2200
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
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. Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act). YesAct. (Check one):
Large accelerated filer¨ Accelerated filerx NoNon-accelerated filer¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨Nox
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class | Outstanding at |
Common Stock, $.01 Par Value |
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MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
INDEX
Part I. FINANCIAL INFORMATION | Page No. |
Item 1. Financial Statements Financial Statements of Mechanical Technology Incorporated and Subsidiaries | |
Condensed Consolidated Balance Sheets - |
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Condensed Consolidated Statements of Operations - Three |
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Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income - |
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Condensed Consolidated Statements of Cash Flows - |
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Notes to Condensed Consolidated Financial Statements (Unaudited) |
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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Item 4. Controls and Procedures |
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Part II. OTHER INFORMATION | |
Item 1. Legal Proceedings |
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Item 1A. Risk Factors | 31 |
Item 2. |
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Item 3. Defaults Upon Senior Securities |
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Item 4. Submission of Matters to a Vote of Security Holders |
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Item 5. Other Information |
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Item 6. Exhibits |
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Signatures |
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2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2005 (Unaudited)March 31, 2006 and December 31, 20042005 (Unaudited)
(Dollars in thousands)
Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, | |
2005 | 2004 | 2006 | 2005 | |
Assets | Assets | |||
Current Assets: | ||||
Cash and cash equivalents | $13,582 | $22,545 | $ 9,654 | $11,230 |
Securities available for sale | 25,115 | 17,678 | 16,950 | 18,947 |
Accounts receivable, less allowances of $0 in 2005 and $58 in 2004 | 1,154 | 1,772 | ||
Accounts receivable, less allowances of $1 in 2006 and $0 in 2005 | 728 | 998 | ||
Other receivables - related parties | - | 3 | 171 | 3 |
Inventories | 1,017 | 1,136 | ||
Inventories, net | 1,006 | 1,058 | ||
Prepaid expenses and other current assets | 603 | 504 | 830 | 451 |
Total Current Assets | 41,471 | 43,638 | 29,339 | 32,687 |
Long Term Assets: | ||||
Securities available for sale - restricted | - | 16,497 | ||
Property, plant and equipment, net | 2,650 | 2,884 | 2,453 | 2,495 |
Deferred income taxes | 8,575 | 3,811 | 5,405 | 6,085 |
Total Assets | $52,696 | $66,830 | $37,197 | $41,267 |
Liabilities and Shareholders' Equity | Liabilities and Shareholders' Equity | |||
Current Liabilities: | ||||
Accounts payable | $ 779 | $ 375 | ||
Accrued liabilities | 1,959 | 1,672 | ||
Accrued liabilities - related parties | - | 2 | ||
Income taxes payable | 107 | 65 | ||
Deferred income taxes | 5,405 | 6,108 | ||
Total Current Liabilities | 8,250 | 8,222 | ||
Long-Term Liabilities: | ||||
Total Liabilities | 8,250 | 8,222 | ||
Commitments and Contingencies | ||||
Minority interests | 85 | 129 | ||
Shareholders' Equity | ||||
Common stock, par value $.01 per share, authorized 75,000,000; | ||||
39,139,600 issued in 2006 and 38,965,937 issued in 2005 | 391 | 390 | ||
Paid-in-capital | 122,323 | 122,095 | ||
Accumulated deficit | (85,149) | (81,718) | ||
Accumulated Other Comprehensive Income: | ||||
Unrealized gain on securities available for sale, net of tax | 5,051 | 5,983 | ||
Restricted stock grants - unearned compensation | - | (80) | ||
Common stock in treasury, at cost, 8,040,736 shares in 2006 and 2005 | (13,754) | (13,754) | ||
Total Shareholders' Equity | 28,862 | 32,916 | ||
Total Liabilities and Shareholders' Equity | $ 37,197 | $ 41,267 |
The accompanying notes are an integral part of the condensed consolidated financial statements.
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MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2005 (Unaudited) and December 31, 2004
(Dollars in thousands, except share data)
Sept. 30, | Dec. 31, | |
2005 | 2004 | |
Liabilities and Shareholders' Equity | ||
Current Liabilities: | ||
Accounts payable | $ 177 | $ 13 |
Accrued liabilities | 1,690 | 3,287 |
Accrued liabilities - related parties | 4 | - |
Income taxes payable | 6 | 40 |
Deferred income taxes | 8,402 | 5,486 |
Total Current Liabilities | 10,279 | 8,826 |
Long-Term Liabilities: | ||
Derivative liability | - | 1,125 |
Other credits | 24 | 24 |
Total Liabilities | 10,303 | 9,975 |
Commitments and Contingencies | ||
Minority interests | 215 | 1,271 |
Shareholders' Equity: | ||
Common stock, par value $.01 per share, authorized 75,000,000; issued 38,940,937 at September 30, 2005 and 38,650,949 at December 31, 2004 | 389 | 387 |
Paid-in-capital | 121,902 | 121,033 |
Accumulated deficit | (77,380) | (66,624) |
Accumulated Other Comprehensive Income: | ||
Unrealized gain on securities available for sale, net of taxes | 11,132 | 14,542 |
Restricted stock grant - unearned compensation | (111) | - |
Common stock in treasury, at cost, 8,040,736 shares at September 30, 2005 and December 31, 2004 | (13,754) | (13,754) |
Total Shareholders' Equity | 42,178 | 55,584 |
Total Liabilities and Shareholders' Equity | $ 52,696 | $ 66,830 |
The accompanying notes are an integral part of the condensed consolidated financial statements.
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MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share data)
Three months ended | Nine months ended | |||
Sept. 30, | Sept. 30, | Sept. 30, | Sept. 30, | |
2005 | 2004 | 2005 | 2004 | |
Revenues: | ||||
Product revenue | $ 1,428 | $ 1,642 | $ 4,116 | $ 4,452 |
Funded research and development revenue | 792 | 175 | 1,496 | 754 |
Total revenues | 2,220 | 1,817 | 5,612 | 5,206 |
Operating costs and expenses: | ||||
Cost of product revenue | 563 | 686 | 1,682 | 1,956 |
Research and product development expenses: | ||||
Funded research and product development | 877 | 881 | 2,989 | 2,576 |
Unfunded research and product development | 1,216 | 2,352 | 4,677 | 6,331 |
Total research and product development expenses | 2,093 | 3,233 | 7,666 | 8,907 |
Selling, general and administrative expenses | 2,187 | 1,526 | 7,729 | 4,890 |
Operating loss | (2,623) | (3,628) | (11,465) | (10,547) |
Loss on derivatives | - | (2,635) | (10,407) | (2,424) |
Gain on sale of securities available for sale | 490 | - | 10,125 | 3,129 |
Other income, net | 116 | 41 | 325 | 60 |
Loss before income taxes and minority interests | (2,017) | (6,222) | (11,422) | (9,782) |
Income tax (expense) benefit | (145) | 2,473 | (408) | 3,854 |
Minority interests in losses of consolidated subsidiary | 253 | 356 | 1,074 | 930 |
Net loss | $ (1,909) | $(3,393) | $(10,756) | $ (4,998) |
Loss per Share (Basic and Diluted): | ||||
Loss per share | $ (0.06) | $ (0.12) | $ (0.35) | $ (0.17) |
Three months ended | ||
Mar. 31, | Mar. 31, | |
2006 | 2005 | |
Product revenue | $ 1,513 | $ 1,403 |
Funded research and development revenue | 45 | 324 |
Total revenue | 1,558 | 1,727 |
Operating costs and expenses: | ||
Cost of product revenue | 539 | 602 |
Research and product development expenses: | ||
Funded research and product development | 210 | 1,055 |
Unfunded research and product development | 2,350 | 1,605 |
Total research and product development expenses | 2,560 | 2,660 |
Selling, general and administrative expenses | 3,060 | 3,034 |
Operating loss | (4,601) | (4,569) |
Loss on derivatives | - | (3,234) |
Gain on sale of securities available for sale | 1,266 | - |
Other income, net | 71 | 100 |
Loss before income taxes and minority interests | (3,264) | (7,703) |
Income tax (expense) benefit | (569) | 1,209 |
Minority interests in losses of consolidated subsidiary | 402 | 440 |
Net loss | $ (3,431) | $(6,054) |
Loss per Share (Basic and Diluted): | ||
Loss per share | $ (0.11) | $ (0.20) |
The accompanying notes are an integral part of the condensed consolidated financial statements.
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4
MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
Nine months ended | Three months ended | |||
Sept. 30, | Sept. 30, | Mar. 31, | ||
2005 | 2004 | 2006 | 2005 | |
COMMON STOCK | ||||
Common Stock | ||||
Balance, beginning | $ 387 | $ 35,776 | $ 390 | $ 38,651 |
Change in par value to $.01 from $1 per share effective June 28, 2005 | - | (35,419) | - | (38,264) |
Issuance of shares - options | 1 | 2 | 1 | - |
Issuance of shares - private placement | 1 | 14 | ||
Balance, ending | $ 389 | $ 373 | $ 391 | $ 387 |
PAID-IN-CAPITAL | ||||
Paid-In Capital | ||||
Balance, beginning | $ 121,033 | $ 68,708 | $ 122,095 | $ 82,769 |
Change in par value to $.01 from $1 per share effective June 28, 2005 | - | 35,419 | - | 38,264 |
Issuance of shares - options | 251 | 201 | 265 | - |
Stock-based compensation - shares | 248 | - | ||
MTI MicroFuel Cell investment | 155 | 344 | (358) | (5) |
Private placement, net of expenses | (46) | 7,232 | - | (45) |
Derivative tax asset | - | 695 | ||
Stock-based compensation - options | 180 | - | ||
Share-based compensation | 401 | 51 | ||
Stock option exercises recognized differently for financial reporting and tax purposes | 81 | 130 | - | 2 |
Elimination of unearned compensation due to change in accounting principle | (80) | - | ||
Balance, ending | $121,902 | $112,729 | $122,323 | $121,036 |
ACCUMULATED DEFICIT | ||||
Accumulated Deficit | ||||
Balance, beginning | $ (66,624) | $ (62,433) | $ (81,718) | $ (66,624) |
Net loss | (10,756) | (4,998) | (3,431) | (6,054) |
Balance, ending | $ (77,380) | $ (67,431) | $ (85,149) | $ (72,678) |
ACCUMULATED OTHER COMPREHENSIVE INCOME: | ||||
UNREALIZED GAIN ON SECURITIES AVAILABLE FOR SALE, NET OF TAXES | ||||
Accumulated Other Comprehensive Income (Loss): | ||||
Unrealized Gain (Loss) on Securities Available for Sale, Net of Taxes | ||||
Balance, beginning | $ 14,542 | $ 19,944 | $ 5,983 | $ 14,542 |
Less reclassification adjustment for gains included in net income | (4,939) | (1,248) | ||
Change in unrealized gain on securities available for sale, net of taxes | 1,529 | (2,869) | ||
Less reclassification adjustment for gains included in net income (net of taxes of $526 in 2006) | (491) | - | ||
Change in unrealized gain on securities available for sale (net of taxes of $0 in 2006 | (441) | 1,645 | ||
Balance, ending | $ 11,132 | $ 15,827 | $ 5,051 | $ 16,187 |
RESTRICTED STOCK GRANT - UNEARNED COMPENSATION | ||||
Restricted Stock Grants - Unearned Compensation | ||||
Balance, beginning | $ - | $ - | $ (80) | $ - |
Issuance of shares | (125) | |||
Grants amortization | 14 | - | ||
Elimination of unearned compensation due to change in accounting principle | 80 | - | ||
Balance, ending | $ (111) | $ - | $ - | |
TREASURY STOCK | ||||
Treasury Stock | ||||
Balance, beginning | $ (13,754) | $(13,729) | $(13,754) | |
Stock acquisition | - | (25) | ||
Balance, ending | $ (13,754) | $(13,754) | $ (13,754) | $(13,754) |
SHAREHOLDERS' EQUITY | ||||
Total Shareholders' Equity | ||||
Balance, ending | $ 42,178 | $ 47,744 | $ 28,862 | $ 51,178 |
TOTAL COMPREHENSIVE (LOSS) INCOME: | ||||
Total Comprehensive (Loss) Income: | ||||
Net loss | $ (10,756) | $ (4,998) | $ (3,431) | $ (6,054) |
Other comprehensive loss (income): | ||||
Less reclassification adjustment for gains included in net income | (4,939) | (1,248) | ||
Less reclassification adjustment for gains included in net income, net of taxes | (491) | - | ||
Change in unrealized gain on securities available for sale, net of taxes | 1,529 | (2,869) | (441) | 1,645 |
Total comprehensive loss | $ (14,166) | $ (9,115) | $ (4,363) | $ (4,409) |
The accompanying notes are an integral part of the condensed consolidated financial statements.
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5
MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Nine months ended | Three months ended | |||
Sept. 30, 2005 | Sept. 30, 2004 | Mar. 31, 2006 | Mar. 31, 2005 | |
Operating Activities | ||||
Net loss | $ (10,756) | $ (4,998) | $ (3,431) | $ (6,054) |
Adjustments to reconcile net loss to net cash used by operations: | ||||
Loss on derivatives | 10,407 | 2,424 | - | 3,234 |
Minority interests in losses of consolidated subsidiary | (1,074) | (930) | (402) | (440) |
Depreciation and amortization | 947 | 657 | 281 | 303 |
Gain on sale of securities available for sale | (10,125) | (3,129) | (1,266) | - |
Allowance for bad debts | (58) | - | (1) | - |
Loss on disposal of fixed assets | 8 | 34 | 21 | 3 |
Deferred income taxes | 506 | (3,820) | 503 | (1,234) |
Stock based compensation | 491 | - | 401 | 51 |
Changes in operating assets and liabilities: | ||||
Accounts receivable | 676 | (230) | 271 | 241 |
Other receivables - related parties | 3 | - | (168) | 3 |
Inventories | 119 | 201 | 52 | 18 |
Prepaid expenses and other current assets | (99) | (105) | (379) | (348) |
Accounts payable | 164 | (112) | 404 | 628 |
Income taxes payable | (34) | - | 42 | (8) |
Accrued liabilities - related parties | 4 | 5 | (2) | 9 |
Accrued liabilities | (1,597) | 870 | 287 | (286) |
Net cash used by operating activities | (10,418) | (9,133) | (3,387) | (3,880) |
Investing Activities | ||||
Purchases of property, plant and equipment | (721) | (1,248) | (262) | (202) |
Proceeds from sale of property plant equipment | 2 | - | ||
Proceeds from sale of securities available for sale | 1,969 | 3,804 | 1,805 | - |
Net cash provided by investing activities | 1,248 | 2,556 | ||
Net cash provided (used) by investing activities | 1,545 | (202) | ||
Financing Activities | ||||
Gross proceeds from private placement | - | 10,000 | ||
Costs of private placement | (45) | (1,015) | - | (45) |
Purchase of common stock for treasury | - | (25) | ||
Proceeds from stock option exercises | 252 | 203 | 266 | - |
Proceeds from subsidiary stock issuances | - | 2,193 | ||
Net cash provided by financing activities | 207 | 11,356 | ||
(Decrease) increase in cash and cash equivalents | (8,963) | 4,779 | ||
Net cash provided (used) by financing activities | 266 | (45) | ||
Decrease in cash and cash equivalents | (1,576) | (4,127) | ||
Cash and cash equivalents - beginning of period | 22,545 | 12,380 | 11,230 | 22,545 |
Cash and cash equivalents - end of period | $ 13,582 | $ 17,159 | $ 9,654 | $ 18,418 |
The accompanying notes are an integral part of the condensed consolidated financial statements.
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6
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In the opinion of management of Mechanical Technology Incorporated (the "Company"), the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and contain all adjustments, consisting of normal, recurring adjustments, necessary for a fair statement of results for such periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year.
Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004, as amended.2005.
The information presented in the accompanying condensed consolidated balance sheet as of December 31, 20042005 has been derived from the Company's December 31, 20042005 audited consolidated financial statements.statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. All other information has been derived from the Company's unaudited condensed consolidated financial statements for the periods as of and ended September 30, 2005March 31, 2006 and 2004.2005.
2. Significant Accounting Policies
Revenue Recognition
The Company applies the guidance within SEC Staff Accounting Bulletin ("SAB") No. 104,Revenue Recognition,which superceded SAB No. 101,Revenue Recognition in Financial Statements,in the evaluation of its contracts to determine when to properly recognize revenue. Under SAB No. 104, revenue is recognized when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery has occurred or services have been rendered, the sales price is determinable, and collectibility is reasonably assured.
Product Revenue
Product revenue is recognized when there is persuasive evidence of an arrangement, the collection of a fixed fee is probable or determinable, delivery of the product to the customer or distributor has occurred, at which time title generally is passed to the customer or distributor, all of which generally occur upon shipment of the product. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied.
The Company defers recognition of its initial micro fuel cell product-related revenue at the time of delivery and recognizes revenue as the continued warranty obligations expire. The costs associated with the product and warranty obligations are expensed as they are incurred. The Company's initial shipment of its micro fuel cell product is a customer specific arrangement that includes fuel cell systems and continued warranty support. While contract terms require payment upon delivery of the fuel cell system and are not contingent on the achievement of specific milestones or other substantive performance, the continuing obligation to warranty the product results in the Company deferring recognition of product-related revenue and recognizing product-related revenue when the warranty obligations expire. The warranty on the product is for a period of fifteen months. When micro fuel cell product-related revenue qualifies for revenue recognition it will be recorded in the Consolidated Statements of Operations in the line titled "Other income (expenses), net."
As the Company gains commercial experience, including field experience relative to warranty based on the sales of its initial products, in future periods, the Company may recognize product-related revenue upon delivery of the product or may continue to defer recognition, based on application of appropriate guidance within SAB No. 104, or changes in the manner contractual agreements are structured, including agreements with distribution partners.
8
MTI Instruments, Inc. ("MTI Instruments"), a wholly-owned subsidiary of the Company, currently has distributor agreements in place for (1) the domestic sale of its semiconductor products and (2) the international sale of general instrument and semiconductor products in certain global regions. Such agreements grant a distributor the right of first refusal to act as distributor for such products in the distributor's territory. In return, the distributor agrees to not market other products which are considered by MTI Instruments to be in direct competition with MTI Instruments' products. The distributor is allowed to purchase MTI Instruments' equipment at a price which is discounted off the published domestic/international list prices. Such list prices can be adjusted by MTI Instruments during the term of the distributor agreement, but MTI Instruments must provide advance notice at least 90 days before the price adjustment goes into effect. Generally , payment terms with the distributor are standard net 30 days; however, on occasion, extended payment terms have been granted. Title to the product passes to the distributor upon delivery to the independent carrier (standard FOB factory), and the distributor is responsible for any required training and/or service with the end-user. The sale (and subsequent payment) between MTI Instruments and the distributor is not contingent upon the successful resale of the product by the distributor. Distributor sales are covered by MTI Instruments' standard one-year warranty and there are no special return policies for distributors.
Some of MTI Instruments' direct sales, particularly sales of semi-automatic and fully-automated semiconductor metrology equipment, involve on-site customer acceptance and/or training. In those instances, revenue recognition does not take place at time of shipment. Instead, MTI Instruments recognizes the sale after the unit is installed and/or training is performed and an on-site acceptance is given by the customer. Agreed-upon acceptance terms and conditions, if any, are negotiated at time of purchase.
Funded Research and Development Revenue
The Company performs funded research and development for government agencies and commercial companies under both cost reimbursement and fixed-price contracts. Cost reimbursement contracts provide for the reimbursement of allowable costs. On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as the services are performed. In each type of contract, the Company generally receives periodic progress payments or payments upon reaching interim milestones. When the current estimates of total contract revenue for commercial development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as research and development expense as incurred. When government agencies are providing funding the y do not expect the government to be the only significant end user of the resulting products. These contracts do not require delivery of products that meet defined performance specifications, but are best efforts arrangements to achieve overall research and development objectives. Included in accounts receivable are billed and unbilled work-in-progress on contracts. Billings in excess of contract revenues earned are recorded as deferred revenue. While the Company's accounting for government contract costs is subject to audit by the sponsoring entity, in the opinion of management, no material adjustments are expected as a result of such audits. Adjustments are recognized in the period made.Liquidity
The Company has fixed-price contracts with the following entities: Harris Corporation ("Harris"), Cabot Superior Micro Powders ("CSMP"), the U.S. Marines and the U.S. Army. These contracts were all completed by September 30, 2005 and resulted in the following funding amounts upon completion of research tasks (CSMP and the U.S. Marines) or prototypes (Harris and the U.S. Army) of $210,000, $69,907, $150,000 and $249,831, respectively.The Company has two cost-shared contracts with the following entities: the New York State Energy Research and Development Authority ("NYSERDA"); and the Department of Energy ("DOE"). These contracts require that the Company's subsidiaryincurred significant losses as it continues to fund MTI MicroFuel Cells Inc. ("MTI Micro") conductDirect Methanol Fuel Cell ("DMFC") product development and commercialization programs. The Company expects that losses will continue and fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, sales of securities available for sale, the operating results of MTI Instruments and MTI Micro, and the availability, or lack thereof, of equity financing including the additional investment rights issued in connection with the 2004 private placement and the ability to attract government funding resources to fund research and deliver direct methanoldevelopment costs. The Company expects to continue to incur losses as it seeks to develop and commercialize Mobion®fuel cell systems and it expects to continue funding its operations from current cash and cash equivalents, the sales of securities available for sale, proceeds, if any, from the exerci se of additional investment rights issued in connection with the 2004 private placement or other equity financings and government program funding. The Company may also seek to provide additional resources through an equity offering. Additional government revenues and Fletcher's potential exercise of additional investment rights totaling up to an additional $20 million could also provide additional resources, although with an exercise price of $6.023 per share it is unlikely that Fletcher will exercise its right unless our stock price increases. The Company anticipates that it will have to raise additional equity capital to fund its long-term business plan, regardless of whether Fletcher exercises any or all of its additional investment rights.
Pursuant to additional investment rights, Fletcher has the right, but not the obligation, to purchase, in a single purchase or multiple purchases, up to an additional $20 million of our common stock at any time prior to December 31, 2006 at a price per share equal to $6.023 (as adjusted from $6.34), which date and price may be extended and adjusted, respectively, in certain circumstances.
During the three months ended March 31, 2006, the Company sold 303,500 shares of Plug Power common stock with proceeds totaling $1.805 million and gains totaling $1.266 million. These proceeds reflect the Company's previously announced strategy to raise additional capital through the sale of Plug Power stock in order to fund its micro fuel cell ("DMFC") prototypes pursuant to predefined work plansoperations.
At March 31, 2006, the Company had cash, cash equivalents and schedules. The contracts with NYSERDA and DOE resultsecurities available for sale in the following total multi-year contractamount of $26.604 million and working capital of $21.089 million. The failure to raise the funds necessary to finance our future cash requirements could adversely affect the Company's ability to pursue its strategy and could negatively affect the Company's operations in future periods.Management believes it will have adequate resources to fund operations and capital expenditures by MTI Micro:
9
for at least the next twelve months based on current cash and cash equivalents, current cash flow and revenue projections and the potential sale of securities available for sale at current market values.
2. Significant Accounting Policies (Continued)
$2,702,080 and $6,144,094, and resultChanges in total multi-year funding of $1,249,736 and $3,000,000, respectively.significant accounting policies since December 31, 2005 are as follows:
MTI Micro retains ownership of the intellectual property ("IP") generated under each of its federal government contracts and under contracts with Harris and CSMP. Each federal government agency retains a government use license and march-in rights if MTI Micro fails to commercialize technology generated under the contract. In addition, under the NYSERDA contract, MTI Micro has the right to elect to retain any invention made under the NYSERDA contract within six months of invention. NYSERDA also retains rights to a government use license for New York State and its political subdivisions for any inventions made under the contract. In addition, MTI Micro agreed to pay NYSERDA a royalty of 1.5% of the sales price of any product sold incorporating IP developed pursuant to the NYSERDA contract if the product is manufactured by a New York State manufacturer. This royalty increases to 5% if the manufacturer is not deemed to be a New York State manufacturer. In any event, the royalty is subject to a cap equal to two times the total contract funds paid by NYSERDA to MTI Micro as reduced to reflect any New York State jobs created by MTI Micro.
7
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Cost of Product Revenue
Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development arrangements are included in funded research and product development expenses.
Deferred revenue consists of payments received from customers in advance of services performed, products shipped, installation completion or customer acceptance.
WarrantyNet (Loss) Income per Common Share
The Company records a warranty reserve atreports net (loss) income per basic and diluted common share in accordance with SFAS No. 128,Earnings Per Share, which establishes standards for computing and presenting (loss) income per share. Basic earnings per common share are computed by dividing net (loss) income by the time product revenue is recordedweighted average number of common shares outstanding during the reporting period. Diluted (loss) income per share reflects the potential dilution, if any, computed by dividing net income by the combination of dilutive common share equivalents, comprised of shares issuable under outstanding investment rights, warrants and the Company's share-based compensation plans, and the weighted average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money shares, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of a historical rate. The reserveshare, th e amount of compensation cost, if any, for future service that the Company has not yet recognized, and the amount of windfall benefits that would be recorded in additional paid-in capital, if any, when the share is reviewed duringexercised are assumed to be used to repurchase shares in the year and is adjusted, if appropriate, to reflect new product offerings or changes in experience. Actual warranty claims are tracked by product line.
current period.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market.
Stock Based CompensationShare-Based Payments
The Company has two stock-based employee compensation plans and its majority-owned subsidiary, MTI Micro, has one stock-based employee compensation plan, which are described more fully in Note 13, Stock Based Compensation, of the consolidated financial statements for the year ended December 31, 2004.2005.
In December 2004, the Financial Accounting Standards Board (FASB) revised Statement of Financial Accounting Standards ("SFAS") No. 123Accounting (FAS 123R), "Share-Based Payment," which establishes accounting for Stock-Based Compensation,share-based awards exchanged for employee services and requires companies to expense the measurement of theestimated fair value of stock optionsthese awards over the requisite employee service period. On April 14, 2005, the U.S. Securities and Exchange Commission adopted a new rule amending the effective dates for FAS 123R. In accordance with the new rule, the accounting provisions of FAS 123R are effective for the Company and have been adopted by the Company as of January 1, 2006.
Under FAS 123R, share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee's requisite service period. The Company has awards with performance conditions and has no awards with market conditions. The Company adopted the provisions of FAS 123R on January 1, 2006, the first day of the Company's fiscal year, using a modified prospective application, which provides for certain changes to the method for valuing share-based compensation. Under the modified prospective application, prior periods are not revised for comparative purposes. The valuation provisions of FAS 123R apply to new awards and to awards that are outstanding on the effective date and subsequently modified or warrants grantedcancelled. Estimated compensation expense for awards outstanding at the effective date will be recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under FASB Statement No. 1 23, "Accounting for Stock-Based Compensation" (FAS 123).
On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, "Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards." The Company has elected to adopt the alternative transition method provided in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to FAS 123R. The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of FAS 123R.
Prior to the adoption of FAS 123R, the Company accounted for stock-based awards to employees to be included in the consolidated statements of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company accounts for stock-based compensation of employees underand directors using the intrinsic value method ofin accordance with Accounting Principles Board ("APB") Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations and has elected the disclosure-only alternativeas permitted under SFASStatement of Financial Accounting Standards No. 123, as amended by SFAS No. 148,Accounting for Sto ck-Based Compensation-TransitionStock-Based Compensation, (FAS 123). Under the intrinsic value method, stock-based compensation was recognized primarily due to changes in option terms because the exercise price of the Company's and Disclosure.MTI Micro's common stock options granted to employees and directors usually equaled the fair market value of the underlying stock at the date of grant.
Stock-based compensation represents the cost related to stock-based awards granted to employees. The Company measures stock-based compensation cost at grant date, based on the estimated fair value of the award, and recognizes the cost as expense on a straight-line basis (net of estimated forfeitures) over the employee requisite service period. The Company estimates the fair value of stock options using a Black-Scholes valuation model. The expense is recorded in "Selling, general and administrative expenses" and "Unfunded research and product development expenses" in the Consolidated Statements of Operations based on the employees' respective functions.
8
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The Company records deferred tax assets for awards that result in deductions on the Company's income tax returns unless the Company cannot recognize the deduction (i.e. in a net operating loss ("NOL") position), based on the amount of compensation cost recognized and the Company's statutory tax rate. Differences between the deferred tax assets recognized for financial reporting purposes and the actual tax deduction reported on the Company's income tax return are recorded in Additional Paid-In Capital (if the tax deduction exceeds the deferred tax asset) or in the Consolidated Statement of Earnings (if the deferred tax asset exceeds the tax deduction and no additional paid-in capital exists from previous awards). No benefit has been recorded during the three months ended March 31, 2006 as the Company is in a NOL position.
The Company continues to record the fair market value of stock options and warrants granted to non-employees in exchange for services in accordance with Emerging Issues Task Force ("EITF") Issue No. 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, in the condensed consolidated statements of operations. The Company does not intend
Reclassification
Certain 2005 amounts have been reclassified to adoptconform to the transition provisions of SFAS No. 148,Accounting for Stock-Based Compensation-Transition and Disclosure.
The following table illustrates the2006 presentation.The reclassifications have no effect on total revenues, total expenses, net loss and loss per shareor shareholders' equity as if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.previously reported.
10
2. Significant Accounting Policies (Continued)
(Dollars in thousands, except per share data) | Three months ended | Nine months ended | ||
Sept. 30, | Sept. 30, | Sept. 30, | Sept. 30, | |
2005 | 2004 | 2005 | 2004 | |
Net loss, as reported | $(1,909) | $(3,393) | $(10,756) | $(4,998) |
Add: Total stock-based employee compensation | ||||
expense already recorded in financial | ||||
statements, net of related tax effects | 386 | - | 491 | - |
Deduct: Total stock-based employee | ||||
compensation expense determined under fair | ||||
value based method for all awards, net of | ||||
related tax effects | (502) | (1,132) | (1,964) | (1,670) |
Pro forma net loss | $(2,025) | $(4,525) | $(12,229) | $(6,668) |
Loss per share: | ||||
Basic and diluted - as reported | $ (0.06) | $ (0.12) | $ (0.35) | $ (0.17) |
Basic and diluted - pro forma | $ (0.07) | $ (0.15) | $ (0.40) | $ (0.23) |
Accounting for Derivative Instruments
The Company accounts for derivative instrumentsreclassifications impact our Condensed Consolidated Statements of Shareholders' Equity and embedded derivative instruments in accordance with SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138,Accounting for Derivative Instruments and Certain Hedging Activities,which establishes a model for accounting for derivatives and hedging activities. These standards require an entity to recognize all derivatives as either assets or liabilitiesComprehensive Income in the statement of financial position and measure these instruments at fair value. Fair value is estimated usingfollowing ways:
The Company held or has outstanding the following derivative financial instruments:
Sept. 30, | Sept. 30, | Dec. 31, | ||
2005 | 2004 | 2004 | Expiration | |
Derivatives issued: | ||||
Warrants, exercisable beginning February 5, 2005, to purchase the | ||||
Company's common stock issued to Chicago Investment Group, L.L.C. | ||||
at a purchase price of $10.572 per share | 28,377 | 28,377 | 28,377 | February 5, 2006 |
First Investment Right, exercisable beginning April 25, 2004, to | ||||
purchase the Company's common stock issued to Fletcher | ||||
International, Ltd. at a purchase price of $6.34 per share(1) | - | 1,261,830 | - | December 31, 2004 |
Second Investment Right, exercisable beginning December 22, 2004, | ||||
to purchase the Company's common stock issued to Fletcher | ||||
International, Ltd. at a purchase price of $6.023 per share through | ||||
December 31, 2006(1) (3) | 3,320,604 | 3,154,575 | 3,154,575 | December 31, 2006 |
Plug Power Investment Right, exercisable at any time from June 1, 2005 | ||||
through December 31, 2006, to purchase a number of the Company's | ||||
shares of Plug Power common stock (to the extent of the number of | ||||
shares remaining in escrow pursuant to the agreement) equal to | ||||
$10,000,000 divided by the prevailing price per share of Plug Power | ||||
common stock(1) | - | (2) | - | December 31, 2006 |
11
2. Significant Accounting Policies (Continued)
(1) - The Company and Fletcher International, Ltd. entered into an amended private placement agreement on May 4, 2004.
(2)-The exercise price for the Plug Power Investment Right was $10,000,000 less the positive difference between $18,000,000 and the product of 2,680,671 shares multiplied by the prevailing price per share of our common stock on the date Fletcher elects to exercise such right, all divided by the quotient obtained by dividing 10,000,000 by the prevailing price of Plug Power common stock on the date Fletcher elects to exercise such right. This right was fully exercised on June 24, 2005.
(3)-The Company incurred a registration penalty during March 2005 which resulted in a reduction in the exercise price for the Second Investment Right from $6.34 to $6.023 per share.
The Plug Power Investment Right, prior to its exercise, was valued on a quarterly basis using the Black-Scholes Option Pricing model and upon its exercise on June 24, 2005 was valued using the intrinsic value method. Significant assumptions used in the valuation included exercise dates, closing stock prices for the common stock of the Company and Plug Power Inc. ("Plug Power"), volatility of the common stock of the Company and Plug Power, risk-free interest rate and estimated number of shares in escrow. (Losses) gains on derivatives areMTI Micro, previously included in "(Loss) gain on derivatives" in the condensed consolidated statements of operations.
On June 24, 2005, Fletcher International, Ltd. ("Fletcher") notified the Company of Fletcher's election to exercise in full its right to purchase from the Company certain shares of common stock of Plug Power. As a result of this election, Fletcher purchased 1,799,791 shares of Plug Power common stock from the Company at a price of $0.7226 per share, with proceeds to the Company of $1.301 million. This transaction closed on June 28, 2005 and, in connection with this exercise, the Company recognized a loss on the derivative immediately prior to exercise of $7.173 million and a gain on the sale of Plug Power common shares of $9.635 million.
Income Taxes
The Company accounts for taxes in accordance with SFAS No. 109,Accounting for Income Taxes, which requires the use of the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable for future years to differences between financial statement and tax bases of existing assets and liabilities. Under SFAS No. 109, the effect of tax rate changes on deferred taxes is recognized in the income tax provision in the period that includes the enactment date. The provision for taxes is reduced by investment and other tax credits in the years such credits become available. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.
3. Accounts Receivable and Allowance for Doubtful Accounts
Included in accounts receivable areReceivables consist of the following at:
Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, | |
(Dollars in thousands) | 2005 | 2004 | 2006 | 2005 |
U.S. and State Government: | ||||
Amount billed | $ 637 | $ 844 | $ 123 | $ 373 |
Amount billable | 133 | 301 | 74 | 98 |
Retainage | 35 | 11 | 35 | 35 |
Total U.S. and State Government | 805 | 1,156 | 232 | 506 |
Commercial amounts billed | 349 | 674 | ||
Commercial | 497 | 492 | ||
Sub Total | 1,154 | 1,830 | 729 | 998 |
Allowance for bad debts | - | (58) | (1) | - |
Total | $1,154 | $1,772 | $ 728 | $ 998 |
The balances billed but not paid by customers pursuant to retainage provisions in contracts are due upon completion of the contracts and acceptance by the customer. Based on the Company's experience, most retainage amounts are expected to be collected within the ensuing year.
12
4. Inventories
Inventories, net consist of the following at:
Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, | |||||
(Dollars in thousands) | 2005 | 2004 | 2006 | 2005 | ||||
Finished goods | $ 354 | $ 318 | $ 310 | $ 351 | ||||
Work in process | 116 | 100 | 140 | 92 | ||||
Raw materials, components and assemblies, net | 547 | 718 | 556 | 615 | ||||
$1,017 | $1,136 | $1,006 | $1,058 |
9
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5. Securities Available for Sale
Securities available for sale are classified as both current assets and long-term restricted assets and accumulated net unrealized gains (losses) are reported in Other Comprehensive Income.charged to other comprehensive income (loss).
The principal components of the Company's securities available for sale consist of the following at:
(Dollars in thousands, except stock price and share data)
Quoted | ||||||
Market | ||||||
Book | Unrealized | Recorded | Price | |||
Security | Basis | Gain | Fair Value | Per NASDAQ | Ownership | Shares |
September 30, 2005 | ||||||
Plug Power Current | $ 6,562 | $18,553 | $25,115 | $6.80 | 4.31% | 3,693,436 |
December 31, 2004 | ||||||
Plug Power | ||||||
Current | $ 5,141 | $12,537 | $17,678 | $6.11 | 3.95% | 2,893,227 |
Restricted(1) | 4,797 | 11,700 | 16,497 | $6.11 | 3.69% | 2,700,000 |
$ 9,938 | $24,237 | $34,175 | 7.64% | 5,593,227 | ||
(1)In connection with the amended private placement agreement, the Company had deposited 2.7 million shares of | ||||||
Plug Power common stock into escrow. The shares were released from escrow on June 30, 2005. |
Quoted | ||||||
Market | ||||||
Book | Unrealized | Recorded | Price | |||
Security | Basis | Gain | Fair Value | Per NASDAQ | Ownership | Shares |
March 31, 2006 | ||||||
Plug Power | $ 6,023 | $10,927 | $16,950 | $5.00 | 3.94% | 3,389,936 |
December 31, 2005 | ||||||
Plug Power | $ 6,562 | $12,385 | $18,947 | $5.13 | 4.31% | 3,693,436 |
The book basis roll forward of Plug Power securities is as follows:
Plug Power - Current
(Dollars in thousands) | Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, |
2005 | 2004 | 2006 | 2005 | |
Securities available for sale, beginning of period | $ 5,141 | $10,791 | $ 6,562 | $ 5,141 |
Sale of shares | (178) | (853) | (539) | (178) |
Transfer 900,209 shares from restricted on 6/30/05 | 1,599 | - | - | 1,599 |
Transfer 3,000,000 shares to restricted on 1/29/04 | - | (5,330) | ||
Transfer 300,000 shares from restricted on 5/6/04 | - | 533 | ||
Securities book basis | 6,562 | 5,141 | 6,023 | 6,562 |
Unrealized gain on securities available for sale | 18,553 | 12,537 | 10,927 | 12,385 |
Securities available for sale, end of period | $25,115 | $17,678 | $16,950 | $18,947 |
13
5. Securities Available for Sale (Continued)
Plug Power - Restricted
(Dollars in thousands) |
| Dec. 31, |
|
| |
Securities available for sale, beginning of period | $ | $ |
Sale of shares |
|
|
Transfer 900,209 shares to current on 6/30/05 |
|
|
|
|
|
| - |
|
Securities book basis | - |
|
Unrealized gain on securities available for sale | - |
|
Securities available for sale - restricted, end of period | $ - | $ |
Accumulated unrealized gains related to securities available for sale are as follows:
Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, | |
(Dollars in thousands) | 2005 | 2004 | 2006 | 2005 |
Accumulated unrealized gains | $ 18,553 | $24,237 | $ 10,927 | $12,385 |
Accumulated deferred tax expense on unrealized gains | (7,421) | (9,695) | (5,876) | (6,402) |
Accumulated net unrealized gains | $ 11,132 | $14,542 | $ 5,051 | $ 5,983 |
10
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6. Income Taxes
The Company's effective income tax (expense) benefit rate from operations differed from the Federal statutory rate as follows:
Three months ended | Nine months ended | Three months ended | ||||
Sept. 30, | Sept. 30, | Mar. 31, | ||||
2005 | 2004 | 2005 | 2004 | 2006 | 2005 | |
Federal statutory tax rate | 34.00% | 34.00% | 34.00% | 34.00% | ||
State taxes, net of federal tax effect | 13.04 | 6.00 | 6.96 | 5.58 | 4.67 | 5.79 |
Change in valuation allowance | (52.80) | - | (45.53) | - | (39.30) | - |
Disproportionate tax effect of reclassification adjustment for gains included in net income (loss) | (16.12) | - | ||||
Adjustment for projected annual effective tax rate | 1.19 | - | 1.52 | - | - | (24.06) |
Other expense, net | (2.62) | (.25) | (.52) | (.18) | (0.69) | (.03) |
Tax rate | (7.19)% | 39.75% | (3.57)% | 39.40% | (17.44)% | 15.70% |
Income tax (expense) benefit consists of the following:
Three months ended | Nine months ended | |||
(Dollars in thousands) | Sept. 30, | Sept. 30, | Sept. 30, | Sept. 30, |
2005 | 2004 | 2005 | 2004 | |
Operations before minority interest | ||||
Federal | $ - | $ - | $ - | $ 96 |
State | 149 | - | 98 | (62) |
Deferred | (294) | 2,473 | (506) | 3,820 |
Total | $ (145) | $ 2,473 | $ (408) | $ 3,854 |
Income tax benefit (expense) allocated directly to shareholders' equity: | ||||
Change in unrealized (gain) loss on securities available for sale - Deferred tax benefit | $ 277 | $ 2,437 | $ 2,273 | $ 2,745 |
Expenses for employee stock options recognized differently for financial reporting/tax purposes - Federal tax benefit |
41 |
2 |
81 |
130 |
Derivative tax asset - Deferred | - | - | - | 695 |
$ 318 | $ 2,439 | $ 2,354 | $ 3,570 |
14
6. Income Taxes (Continued)
Three months ended | ||
(Dollars in thousands) | Mar. 31, | Mar. 31, |
2006 | 2005 | |
Operations before minority interest | ||
Federal | $ - | $ - |
State | (66) | (25) |
Deferred | (503) | 1,234 |
Total | $ (569) | $ 1,209 |
Income tax benefit (expense) allocated directly to shareholders' equity: | ||
Change in unrealized (gain) loss on securities available for sale: | ||
Deferred tax benefit (expense) | $ - | $ (1,096) |
Tax effect of reclassification adjustment for gains included in net income (loss) | 526 | - |
Expenses for employee stock options recognized differently for financial reporting/tax purposes - Federal tax benefit | - | 2 |
$ 526 | $ (1,094) |
The valuation allowance at September 30, 2005March 31, 2006 and December 31, 20042005 was $7.037$12.798 million and $1.836$10.923 million, respectively. It is anticipated that a full valuation allowance will be required by the end of 2005. The income tax provision for both the threerespectively and nine months ended September 30, 2005 have been adjusted to reflect the projected annual effective tax rate including the anticipated impact ofrepresents a full valuation allowance. The valuation allowance reflects the estimate that it wasis more likely than not that certainthe net operating lossesdeferred tax assets in excess of deferred tax liabilities may not be unavailable to offset future taxable income.realized.
7. Shareholders' Equity
Common Shares
Changes in common shares issued are as follows:
Nine | ||||
Months Ended | Year Ended | Three Months Ended | Year Ended | |
Sept. 30, | Dec. 31, | Mar. 31, | Dec. 31, | |
2005 | 2004 | 2006 | 2005 | |
Balance, beginning | 38,650,949 | 35,776,510 | 38,965,937 | 38,650,949 |
Issuance of shares for stock option exercises | 123,575 | 193,768 | 173,663 | 148,575 |
Issuance of shares for restricted stock grants | 50,000 | - | ||
Issuance of shares for restricted stock grant | - | 50,000 | ||
Issuance of shares for stock grant | 50,000 | - | - | 50,000 |
Issuance of shares for private placementA | 66,413 | 2,680,671 | - | 66,413 |
Balance, ending | 38,940,937 | 38,650,949 | 39,139,600 | 38,965,937 |
A Shares totaling 66,413 were issued on April 20, 2005 as a result of a registration penalty, seePrivatePlacement below. | ||||
AShares totaling 66,413 were issued on April 20, 2005 as a result of a registration penalty. | AShares totaling 66,413 were issued on April 20, 2005 as a result of a registration penalty. |
11
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Treasury Stock
Changes in treasury stock shares are as follows:
Nine | ||
Months Ended | Year Ended | |
Sept. 30, | Dec. 31, | |
2005 | 2004 | |
Balance, beginning | 8,040,736 | 8,035,974 |
Shares acquired for cash | - | 4,762 |
Balance, ending | 8,040,736 | 8,040,736 |
Three Months Ended | Year Ended | |
Mar. 31, | Dec. 31, | |
2006 | 2005 | |
Balance, beginning | 8,040,736 | 8,040,736 |
Balance, ending | 8,040,736 | 8,040,736 |
Warrants Issued
On February 5, 2004, the Company issued to Chicago Investment Group, L.L.C. a warrant to purchase 28,377 shares of the Company's common stock at an exercise price of $10.572 per share. The estimated fair value of this warrant at the date issued was $1.39 per share, using a Black-Scholes Option Pricing ModelBlack Scholes Option-Pricing model and assumptions similar to those used for valuing the Company's stock options. The warrant is exercisable beginningcould not be exercised until February 5, 2005 and expiresexpired unexercised on February 5, 2006.
15
7. Shareholders' Equity (Continued)
Reservation of Shares
The Company has reserved common shares for future issuance as of September 30, 2005March 31, 2006 as follows:
Stock options outstanding |
|
Stock options available for issuance |
|
Additional Investment Rights as required by the amended private placement agreement | 4,150,756 |
Warrants outstanding |
|
Number of common shares reserved |
|
Change in Par Value
On June 28, 2005, shareholders of the Company approved an Amendment to the Company's Restated Certificate of Incorporation, as amended, to reduce the par value of the Company's common stock from $1.00 to $.01 per share. The reduction in the par value of the Company's common stock was effected on the Company's balance sheet by a reduction in the common stock par value account and a corresponding increase in the additional paid-in capital account. The reduction in the par value does not change the number of authorized shares of the Company's common stock.
Private Placement
The Company entered into a financing transaction with Fletcher International, Ltd. ("Fletcher"), on January 29, 2004 and amended the terms of such transaction on May 4, 2004. To date Fletcher has purchased 2,680,671 shares of our common stock pursuant to such financing transaction. In addition, Fletcher has the right to purchase an additional $20 million of the Company's common stock, on one or more occasions, at a price of $6.023
(adjusted from $6.34) All per share at any time prior to December 31, 2006. Fletcher also has the right to receive Company shares without payment upon the occurrence of certain events, including but not limited to, failing to register for resale with the SEC shares purchased by Fletcher on the agreed upon time table, a restatement of the Company's financial statements, change of control of the Company and issuance of securities at a price below Fletcher's purchase price. We have filed registration statements covering all of the shares purchased by Fletcher to date, and in the event of any additional purchases we are obligated to file one or more registration statements covering the resale of such shares.
We filed a registration statement on January 6, 2005 covering the resale of 1,261,829 shares of our common stock purchased by Fletcher on December 22, 2004. The Company failed to meet its contractual obligation with Fletcher to have such registration statement declared effective by March 22, 2005 and therefore under the terms of the Fletcher agreement we were required to issue additional shares of common stock to Fletcher and the exercise price for the Fletcher additional investment rights has been reduced to $6.023 per share. We were required to issue a number of shares of common stock that resulted in Fletcher having effectively made its December 2004 investment at a price per share that was lower than the actual price paid. We refer to this reduced exercise price as the "deemed exercise price." More specifically, for each month during which we fail to satisfy the registration requirement, the deemed exercise price is reduced by $0.317 per share. As a consequence, on April 20, 2005 w e issued 66,413 shares of common stock to Fletcher without any additional payment required by Fletcher, representing a deemed exercise price for Fletcher's December 2004 investment of $6.023 per share. In addition, since we are required to file a registration statement covering the resale of any such additional shares issued to Fletcher, we amended the registration statement initially filed in January 2005 to include the additional 66,413 shares of common stock. That registration statement, covering the resale of 1,328,242 shares of common stock, was declared effective by the SEC on April 21, 2005.
16
7. Shareholders' Equity (Continued)
Plug Power Shares
On June 24, 2005, Fletcher notified the Company of its election to exercise in full its right to purchase from the Company certain shares of common stock of Plug Power. As a result of this election, Fletcher purchased 1,799,791 shares of Plug Power common stock from the Company at a price of $0.7226 per share, with proceeds to the Company of $1.301 million. This transaction closed on June 28, 2005 and, in connection with this exercise, the Company recognized a loss on the derivative immediately prior to exercise of $7.173 million and a gain on the sale of Plug Power common shares of $9.635 million.
The Company had placed 2,700,000 shares of Plug Power common stock in escrow that were available for purchase by Fletcher in certain instances. Fletcher could, on one or multiple occasions, from June 1, 2005 to December 31, 2006, exercise its right to purchase from us a number of shares of Plug Power common stock totaling $10,000,000 divided by the prevailing price (as defined below) per share of Plug Power common stock, but only to the extent of the number of shares remaining in escrow. Commencing immediately after the SEC declared effective on May 20, 2004 the registration statement relating to shares of our common stock owned by Fletcher, we had the right to have 250,000 of such shares released from escrow to us, on a monthly basis, in the event that on any day during such month, the prevailing price of our common stock exceeds $6.343 (which price mayamounts have been adjusted to reflect stock splits, recombinations, stock dividends or the like).
The exercise price for the Plug Power investment right was $10,000,000 less the positive difference between $18,000,000 and the product of the sum of 2,680,671 shares multiplied by the prevailing price per share of our common stock on the date Fletcher elected to exercise such right, all divided by the quotient obtained by dividing 10,000,000 by the prevailing price of Plug Power common stock on the date Fletcher elected to exercise such right. As used herein, a prevailing price is the average of the daily volume-weighted average price per share of common stock during the sixty-business-day period ending three days priorretroactively give effect to the date Fletcher elects to exercise such right, provided however that the price may not exceed the average of the daily volume-weighted average prices for any ten business days within such sixty-business day period.
Additional Investment Rights
The additional investment rights provide Fletcher with the right, but not the obligation, to purchase, in a single purchase or multiple purchases, up to an additional $20 million of our common stock at any time prior to December 31, 2006 at a price per share equal to$6.023 (adjusted from $6.34), which date and price may be extended and adjusted, respectively, in the event that we have not satisfied our contractual obligations with respect to the registration for resale of common stock issued or issuable to Fletcher.
The table below illustrates the number of shares Fletcher would receive upon exercise of its $20 million additional investment right at a price per share equal to $6.023 (adjusted from $6.34) (such exercise price is subject to adjustment as described below under"Adjustment Provisions"). Further, the Company's 2004 private placement agreement with Fletcher provides that the maximum number of shares we could potentially issue to Fletcher is 8,330,411 shares.
Purchase Price MTI Stock Shares Issuable in Exchange for $20 Million Investment $6.023 3,320,604
Adjustment Provisions
The 2004 private placement with Fletcher also provides that the Company may be required to issue additional shares to Fletcher, reduce the exercise prices described above for the additional investment rights and/or extend the investment term upon the occurrence of certain events (each as more fully described below) including:
17
7. Shareholders' Equity (Continued)
Restatementpar value.
In the event we restate any portion of our financial statements prior to January 29, 2005, or prior to the first anniversary of the closing of any additional investment, as the case may be, the exercise price for the additional investment rights may be adjusted to equal the average price (as defined) of our common stock sixty days after we restate our financial statements if the average price of the Company's common stock sixty days after a restatement is five percent lower than the average price three days before the restatement (a "Qualifying Restatement"). In addition, with respect to any investments made prior to the time of the restatement, Fletcher would receive additional shares of common stock such that all such investments will have been effectively made at such adjusted exercise price.8. Loss per Share
The following table illustrates the number of additional shares of common stock Fletcher would receive without any additional payment on its part in the event that the average price of the Company's common stock sixty days after a restatement (as defined) is $4.00 per share and $3.00 per share.
Number of Shares | Qualifying | ||
Investments | Issued at the time of the | Restatement | Additional Shares |
To Date | Original Investments | Price | to be Issued |
$18,000,000 | 2,680,671 | $4.00 | 1,819,329 |
$18,000,000 | 2,680,671 | $3.00 | 3,319,329 |
In response to comments received from the SEC staff of the Division of Corporation Finance, the Company previously amended its current Annual Report on Form 10-K for the year ended December 31, 2004 and its prior
Annual Reports on Form 10-K for the years ended December 31, 2003 and December 31, 2002 to supplement the Company's financial statements with additional financial statements of SatCon Technology Corporation and Plug Power, which were all previously publicly available, and to include certain summary financial information for both companies in the relevant notes to the Company's consolidated financial statements. In the Company's opinion, the above do not constitute restatements for purposes of its agreement with Fletcher.
Change in Control
In the event of a change of control of our company prior to sixty days after the expiration of the additional investment term, we may have to issue additional shares of our common stock to Fletcher and the additional investment rights may be accelerated. If the consideration per share paid to our shareholders in the change of control transaction is less than twice the amount of the price per share paid by Fletcher for any of its investments pursuant to the agreement with Fletcher of the certificate of additional investment rights, then we must issue to Fletcher a number of shares of our common stock such that all of its investments will have been effectively made at a price per share equal to such per share change of control consideration multiplied by 0.5.
Dilutive Issuances
If, after December 31, 2004 and ending December 31, 2006, we issue any equity securities at a price below $7.048 as it relates to the initial $10 million investment and $6.34 as it relates to any additional investments which have been made, the exercise price for the additional investment rights shall be adjusted to provide Fletcher "weighted average" anti-dilution protection and we must issue to Fletcher a number of additional shares such that all prior investments will have been effectively made at such adjusted exercise price.
18
7. Shareholders' Equity (Continued)
Registration Obligations
In the event we fail to satisfy our contractual obligations to register for resale shares of common stock issued or issuable to Fletcher, then we must issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was based on the actual exercise price reduced by five percent for each month in which we fail to satisfy our obligations and adjust the exercise price for the additional investment rights to such lower price. In addition, such failure will result in an extension of the investment term for each day we fail to satisfy our registration obligations. These registration obligations include, among other things, maintaining the effectiveness of registration statements.
As described above, we failed to satisfy the registration requirement for the 1,261,829 shares of common stock purchased by Fletcher on December 22, 2004 until April 21, 2005.
Other
The 2004 private placement also provides Fletcher certain other rights including, but not limited to, indemnification rights with respect to (1) breaches of representations, warranties and covenants contained in the agreements with Fletcher, and (2) misstatements in or omissions from the prospectus and the registration statement relating to shares of our common stock that Fletcher owns or may acquire.
8. Loss Per Share
The following issets forth the reconciliation of the numerators and denominators of the basic and diluted loss per share computations:
Three months ended | Nine months ended | |||
Sept. 30, | Sept. 30, | Sept. 30, | Sept. 30, | |
(Dollars in thousands, except shares and per share data) | 2005 | 2004 | 2005 | 2004 |
Loss | $ (1,909) | $ (3,393) | $(10,756) | $(4,998) |
Basic and Diluted Loss per Share: | ||||
Common shares outstanding, beginning of period | 30,754,126 | 29,240,791 | 30,610,213 | 27,740,536 |
Weighted average common shares issued during the period | 29,753 | 1,125 | 82,824 | 1,335,297 |
Weighted average common shares reacquired during the period | - | - | - | (3,233) |
Weighted average shares outstanding, end of period | 30,783,879 | 29,241,916 | 30,693,037 | 29,072,600 |
Loss per weighted average share | $ (0.06) | $ (0.12) | $ (0.35) | $ (0.17) |
Forcomputations for continuing operations for the three and nine months ended September 30, 2005,March 31:
(Dollars in thousands, except shares) | 2006 | 2005 |
Numerator | ||
Loss from continuing operations | $ (3,431) | $ (6,054) |
Denominator | ||
Basic EPS: | ||
Common shares outstanding, beginning of period | 30,925,201 | 30,610,213 |
Weighted average common shares issued during the period | 21,065 | - |
Less: Non-vested restricted stock | (50,000) | - |
Denominator for basic earnings per common share - weighted average common shares | 30,896,266 | 30,610,213 |
Diluted EPS: | ||
Common shares outstanding, beginning of period | 30,925,201 | 30,610,213 |
Weighted average common shares issued during the period | 21,065 | - |
Less: Non-vested restricted stock due to anti-dilutive effect | (50,000) | - |
Denominator for diluted earnings per common share - weighted average common shares | 30,896,266 | 30,610,213 |
12
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
During 2006, options to purchase 3,994,9255,363,371 shares of the Company's common stock at exercise prices ranging from $0.54 to $20.92 per share, additional investment rights to purchase approximately 3,320,604 shares ($20 million20,000,000 divided by $6.023 per share) of common stock with an exercise price of $6.023 per share 50,000 unvested restrictedand options to purchase 68,002 shares of MTI Micro common stock at prices from $2.39 to $4.66 per share were outstanding but were not included in the computation of earnings per share-assuming dilution because the Company incurred a loss from continuing operations during this period and inclusion would be anti-dilutive. Investment rights issued to Fletcher expire on December 31, 2006, subject to extension in certain instances.
During 2005, options to purchase 3,754,250 shares andof the Company's common stock at prices ranging from $0.54 to $20.92 per share, additional investment rights to purchase approximately 3,320,604 shares ($20,000,000 divided by $6.023 per share) of common stock with an exercise price of $6.023 per share, warrants to purchase 28,377 shares of common stock with an exercise price of $10.572 per share were outstanding but were not included in the computations of Loss per Share-assuming dilution because the Company incurred losses during this period and inclusion would be anti-dilutive.
For the three and nine months ended September 30, 2004, options to purchase 3,793,5312,867,818 shares of MTI Micro common stock at exercise prices ranging from $0.54$2.39 to $20.92 per share, additional investment rights to purchase approximately 4,416,405 shares ($28,000,000 divided by $6.34 per share) of common stock with an exercise price of $6.34 per share and warrants to purchase 28,377 shares of common stock with an exercise price of $10.572$4.66 per share were outstanding but were not included in the computationscomputation of Lossearnings per Share-assumingshare-assuming dilution because the Company incurred lossesa loss from continuing operations during this period and inclusion would be anti-dilutive.
19 Warrants for the purchase of 28,377 shares expired unexercised on February 5, 2006. Investment rights issued to Fletcher expire on December 31, 2006, subject to extension in certain instances.
9. Gain on Sale of Securities Available for Sale
The Company sold shares of the following securities and recognized gains and proceeds as follows:
Three months ended | Nine months ended | |||
Sept. 30, | Sept. 30, | Sept. 30, | Sept. 30, | |
(Dollars in thousands, except shares) | 2005 | 2004 | 2005 | 2004 |
Plug Power | ||||
Shares sold | 100,000 | - | 1,899,791 | 380,000 |
Proceeds | $ 668 | $ - | $ 1,969 | $ 3,804 |
Gain on sales | $ 490 | $ - | $10,125 | $ 3,129 |
Three months ended | ||
Mar. 31, | Mar. 31, | |
(Dollars in thousands, except shares) | 2006 | 2005 |
Plug Power | ||
Shares sold | 303,500 | - |
Proceeds | $ 1,805 | $ - |
Gain on sales | $ 1,266 | $ - |
10. Cash Flows - Supplemental Information
Nine months ended | Three months ended | |||
Sept. 30, | Mar. 31, | |||
(Dollars in thousands) | 2005 | 2004 | 2006 | |
Non-cash Operating, Investing and Financing Activities: | ||||
Additional paid-in-capital resulting from stock option exercises treated differently for financial reporting and tax purposes | $ 81 | $ 130 | $ - | $ 2 |
Change in investment and paid-in-capital resulting from other investors' activity in MTI MicroFuel Cells Inc. stock | 155 | 344 | ||
Derivative tax asset | - | 695 | ||
Change in investment and paid-in-capital resulting from other investors' activity in MTI Micro stock | (358) | 46 |
11. Segment Information
The Company operates in two business segments,New Energy andEnergyand Test and Measurement Instrumentation. The New Energy segment is focused on commercializing DMFCs.direct methanol fuel cells ("DMFCs"). The Test and Measurement Instrumentation segment designs, manufactures, markets and services computer-based balancing systems for aircraft engines, high-performancehigh performance test and measurement instruments and systems, and wafer characterization tools for the semiconductor industry. The Company's principal operations are located in North America.
The accounting policies of the New Energy and Test and Measurement Instrumentation segments are the same as those described in the summary of significant accounting policies in the Company's consolidated financial statements (See Note 1) for the year ended December 31, 2004.. The Company evaluates performance based on profit or loss from operations before income taxes, accounting changes, items management does not deem relevant to segment performance, and interest income and expense. Inter-segment sales are not significant.
Summarized financial information concerning the Company's reportable segments is shown in the following table. The "Other" column includes corporate related items and items likesuch as income taxes or unusual
items,unusualitems, which are not allocated to reportable segments. The "Reconciling Items" column includes minority interests in a consolidated subsidiary. In addition,
13
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
segments' noncash items include any depreciation and amortization in reported profit or loss. The New Energy segment figures include the Company's micro fuel cell operations, equity securities of Plug Power, gains (losses) on the sale of these securities and (losses) gains related to the embedded derivative for the purchase of Plug Power common stock and warrants to purchase SatCon common stock.
20
11. Segment Information (Continued)
(Dollars in thousands) | Test and | Condensed | |||
Measurement | Reconciling | Consolidated | |||
New Energy | Instrumentation | Other | Items | Totals | |
Three months ended September 30, 2005 | |||||
Product revenue | $ - | $1,428 | $ - | $ - | $ 1,428 |
Funded research and development revenue | 792 | - | - | - | 792 |
Research and product development expenses | 1,818 | 275 | - | - | 2,093 |
Selling, general and administrative expenses | 643 | 506 | 1,038 | - | 2,187 |
Loss on derivatives | - | - | - | - | - |
Gain on sale of securities available for sale | 490 | - | - | - | 490 |
Segment loss from operations before income taxes and minority interests | (1,862) | (2) | (153) | - | (2,017) |
Segment (loss) profit | (1,862) | (2) | (298) | 253 | (1,909) |
Total assets | 27,855 | 2,042 | 22,799 | - | 52,696 |
Securities available for sale | 25,115 | - | - | - | 25,115 |
Capital expenditures | 203 | 62 | 4 | - | 269 |
Depreciation and amortization | 155 | 17 | 156 | - | 328 |
Three months ended September 30, 2004 | |||||
Product revenue | $ - | $ 1,642 | $ - | $ - | $ 1,642 |
Funded research and development revenue | 175 | - | - | - | 175 |
Research and product development expenses | 2,970 | 263 | - | - | 3,233 |
Selling, general and administrative expenses | 312 | 433 | 781 | - | 1,526 |
Loss on derivatives | (2,635) | - | - | - | (2,635) |
Segment (loss) profit from operations before income taxes and minority interests | (5,994) | 187 | (415) | - | (6,222) |
Segment (loss) profit | (5,994) | 187 | 2,058 | 356 | (3,393) |
Total assets | 53,843 | 1,870 | 6,831 | - | 62,544 |
Securities available for sale | 19,186 | - | - | - | 19,186 |
Securities available for sale - restricted | 17,307 | - | - | - | 17,307 |
Derivative liability | 4,163 | - | - | - | 4,163 |
Capital expenditures | 154 | 23 | 240 | - | 417 |
Depreciation and amortization | 116 | 17 | 110 | - | 243 |
21
11. Segment Information (Continued)
(Dollars in thousands) | Test and | Condensed | |||
Measurement | Reconciling | Consolidated | |||
Nine months ended September 30, 2005 | New Energy | Instrumentation | Other | Items | Totals |
Product revenue | $ - | $4,116 | $ - | $ - | $ 4,116 |
Funded research and development revenue | 1,496 | - | - | - | 1,496 |
Research and product development expenses | 6,815 | 851 | - | - | 7,666 |
Selling, general and administrative expenses | 2,687 | 1,551 | 3,491 | - | 7,729 |
Loss on derivatives | (10,407) | - | - | - | (10,407) |
Gain on sale of securities available for sale | 10,125 | - | - | - | 10,125 |
Segment loss from operations before income taxes and minority interests | (10,283) | (258) | (881) | - | (11,422) |
Segment (loss) profit | (10,283) | (258) | (1,289) | 1,074 | (10,756) |
Total assets | 27,855 | 2,042 | 22,799 | - | 52,696 |
Securities available for sale | 25,115 | - | - | - | 25,115 |
Capital expenditures | 555 | 99 | 67 | - | 721 |
Depreciation and amortization | 436 | 49 | 462 | - | 947 |
Nine months ended September 30, 2004 | New Energy | ||||
Product revenue | $ - | $4,452 | $ - | $ - | $ 4,452 |
Funded research and development revenue | 754 | - | - | - | 754 |
Research and product development expenses | 8,049 | 858 | - | - | 8,907 |
Selling, general and administrative expenses | 1,048 | 1,265 | 2,577 | - | 4,890 |
Loss on derivatives | (2,424) | - | - | - | (2,424) |
Gain on sale of securities available for sale | 3,129 | - | - | - | 3,129 |
Segment (loss) profit from operations before income taxes and minority interests | (8,441) | 149 | (1,490) | - | (9,782) |
Segment (loss) profit | (8,441) | 149 | 2,364 | 930 | (4,998) |
Total assets | 53,843 | 1,870 | 6,831 | - | 62,544 |
Securities available for sale | 19,186 | - | - | - | 19,186 |
Securities available for sale - restricted | 17,307 | - | - | - | 17,307 |
Derivative liability | 4,163 | - | - | - | 4,163 |
Capital expenditures | 662 | 59 | 527 | - | 1,248 |
Depreciation and amortization | 318 | 50 | 289 | - | 657 |
(Dollars in thousands) | Test and | Condensed | |||
Measurement | Reconciling | Consolidated | |||
New Energy | Instrumentation | Other | Items | Totals | |
Three months ended March 31, 2006 | |||||
Product revenue | $ - | $1,513 | $ - | $ - | $ 1,513 |
Funded research and development revenue | 45 | - | - | - | 45 |
Research and product development expenses | 2,253 | 307 | - | - | 2,560 |
Selling, general and administrative expenses | 1,087 | 536 | 1,437 | - | 3,060 |
Gain on sale of securities available for sale | 1,266 | - | - | - | 1,266 |
Segment loss from operations before income taxes and minority interests | (2,760) | 52 | (556) | - | (3,264) |
Segment (loss) profit | (2,760) | 52 | (1,125) | 402 | (3,431) |
Total assets | 19,061 | 1,734 | 16,402 | - | 37,197 |
Securities available for sale | 16,950 | - | - | - | 16,950 |
Capital expenditures | 224 | 27 | 11 | - | 262 |
Depreciation and amortization | 140 | 22 | 119 | - | 281 |
Three months ended March 31, 2005 | |||||
Product revenue | $ - | $1,403 | $ - | $ - | $ 1,403 |
Funded research and development revenue | 324 | - | - | - | 324 |
Research and product development expenses | 2,391 | 269 | - | - | 2,660 |
Selling, general and administrative expenses | 1,375 | 479 | 1,180 | - | 3,034 |
Loss on derivatives | (3,234) | - | - | - | (3,234) |
Segment loss from operations before income taxes and minority interests | (7,336) | (49) | (318) | - | (7,703) |
Segment (loss) profit | (7,336) | (49) | 891 | 440 | (6,054) |
Total assets | 46,746 | 2,204 | 16,171 | - | 65,121 |
Securities available for sale | 19,095 | - | - | - | 19,095 |
Securities available for sale - restricted | 17,820 | - | - | - | 17,820 |
Derivative liability | 4,359 | - | - | - | 4,359 |
Capital expenditures | 134 | 22 | 46 | - | 202 |
Depreciation and amortization | 138 | 15 | 150 | - | 303 |
The following table presents the details of "Other" segment profit:
Three months ended | Nine months ended | Three months ended | ||||
(Dollars in thousands) | Sept. 30, | Sept. 30, | Mar. 31, | |||
2005 | 2004 | 2005 | 2004 | 2006 | 2005 | |
Corporate and Other (Expense) Income: | ||||||
Corporate and other (expenses) income: | ||||||
Depreciation and amortization | $(156) | $ (110) | $ (462) | $ (289) | $(119) | $ (150) |
Interest income | 88 | 4 | 207 | 27 | 101 | 54 |
Income tax (expense) benefit | (145) | 2,473 | (408) | 3,854 | (569) | 1,209 |
Other expense, net | (85) | (309) | (626) | (1,228) | (538) | (222) |
Total corporate and other (expense) income | $(298) | $2,058 | $(1,289) | $ 2,364 | ||
Total corporate and other (expenses) income | $(1,125) | $ 891 |
12. Related Party Transactions
The Company purchases materials from E.I. du Pont de Nemours and Company ("DuPont"), a shareholder in MTI Micro, suchMicro. Such purchases totaled $95 thousand$0 and $318$43 thousand for the ninethree months ended September 30,March 31, 2006 and 2005, and 2004, respectively. The Company has a liability to DuPont for materials purchases totaling $4$0 and $9 thousand, as
22
12. Related Party Transactions (Continued)
of September 30, 2005 and a net receivable totaling $2 thousandrespectively as of March 31, 2006 and December 31, 2004. This liability is2005. These liabilities are included in the financial statement line "Accrued liabilities - related parties." The net receivable is included in the financial statement line "Other receivables - related parties."
14
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
13. Effect of Recent Accounting Pronouncements
In November 2004,March 2006, the Financial Accounting Standards Board ("FASB")(FASB) issued SFAS No. 156, "Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140," that provides guidance on accounting for separately recognized servicing assets and servicing liabilities. In accordance with the provisions of SFAS No. 156, separately recognized servicing assets and servicing liabilities must be initially measured at fair value, if practicable. Subsequent to initial recognition, the Company may use either the amortization method or the fair value measurement method to account for servicing assets and servicing liabilities within the scope of this Statement. An entity should adopt the Statement as of the beginning of its first fiscal year that begins after September 15, 2006. The Company will adopt SFAS No. 156 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the Company's Consolidated Financial Statements.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140," to permit fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation in accordance with the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company will adopt SFAS No. 155 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the Company's Consolidated Financial Statements.
In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, "Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)", that will become effective beginning third quarter of 2006. FSP FIN No. 46(R)-6 clarifies that the variability to be considered in applying Interpretation 46(R) shall be based on an analysis of the design of the variable interest entity. The adoption of this FSP is not expected to have a material effect on the Company's Consolidated Financial Statements.
In the first quarter of 2006, the Company adopted SFAS No. 154, "Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS No. 154 changed the requirements for the accounting for and reporting of a voluntary change in accounting principle. The adoption of this Statement did not affect the Company's Consolidated Financial Statements in the period of adoption. Its effects on future periods will depend on the nature and significance of any future accounting changes subject to this statement.
Beginning January 2006, the Company adopted SFAS No. 151,Inventory "Inventory Costs-an amendment of ARB No. 43, Chapter 4(4."FAS 151"), which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. SFAS No. 151 requires idle facility expenses, freight, handling costs and wasted material (spoilage) costscertain abnormal expenditures to be recognized as current-period charges.expenses in the current period versus being capitalized in inventory. It also requires that allocationthe amount of fixed production overheadsoverhead allocated to the costs of conversioninventory be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is in the process of evaluating the impactadoption of this standard on its consolidated financial statements.
In December 2004, SFAS No. 123 (revised 2004),Share-Based Payment, (SFAS No. 123R) was issued. In March 2005 the SEC issued Staff Accounting Bulletin No. 107 (SAB 107). SAB 107 expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments basedstatement did not have a material effect on the grant-dateCompany's Consolidated Financial Statements.
Beginning January 2006, the Company adopted SFAS Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, which is an interpretation of SFAS Statement No. 143, Accounting for Asset Retirement Obligations. The interpretation requires a liability for the fair value of a conditional asset retirement obligation be recognized if the fair value of the award.liability can be reasonably estimated. The grant-date fair valueadoption of employee share options and similar instruments will be estimated using option-pricing models adjusted forthis statement did not have a material effect on the unique characteristics of those instruments. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. In April 2005, the SEC delayed the implementation of SFAS 123R for public companies until the first annual period beginning after June 15, 2005. SFAS 123R is required to be adopted byCompany's Consolidated Financial Statements.
Beginning January 2006, the Company as of January 1, 2006.
The Company currently utilizes a closed form option-pricing model to measure the fair value of stock-based compensation for employees. SFAS 123R permits the use of this model or other models such as a lattice model. The Company has not yet determined which model it will use to measure the fair value of share-based grants to employees upon the adoption of SFAS 123R. The effect of expensing stock options in accordance with the original SFAS 123 is presented above under Note 2, Significant Accounting Policies. SFAS 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This presentation may reduce net operating cash flows and increase net financing cash flows in periods after the effective date. The amount of this excess tax deduction benefit was $81 thousand and $130 thousand in the nine months ended September 30, 2005 and 2004, re spectively. The unvested value of share awards to be amortized into the operating statement is approximately $3.242 million as of September 30, 2005.
In December 2004, the FASB issuedadopted SFAS No. 153,Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29. SFAS No. 153 which addresses the measurement of exchanges of non-monetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for non-monetary asset exchanges in fiscal periods beginning after June 15, 2005. The Company isadoption of this statement did not affect the Company's Consolidated Financial Statements in the processperiod of evaluatingadoption. Its effects on future periods will depend on the impactnature and significance of any future transactions subject to this standard on its consolidated financial statements.
In May 2005, SFAS No. 154,Accounting Changes and Error Corrections - replacement of APB Opinion No. 20 and FASB Statement No. 3, (SFAS No. 154) was issued. SFAS No. 154 changes the accounting for and reporting of a change in accounting principle by requiring retrospective application to prior periods' financial statements of changes in accounting principle unless impracticable. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of SFAS No. 154 to have a material impact on its results of operations, financial position or cash flows.
In June 2005, the FASB's Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 05-6,Determining the Amortization Period for Leasehold Improvements (EITF 05-6). The guidance requires that
23
13. Effect of Recent Accounting Pronouncements (Continued)
leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The Company does not believe that the adoption of EITF 05-6 will have a significant effect on its financial statements.statement.
14. Commitments and Contingencies
Lawrence
On September 9, 1998, Barbara Lawrence, the Lawrence Group, Inc. ("Lawrence"), and certain other Lawrence-related entities ("Plaintiffs") initially filed suit in the Bankruptcy Court and the United States District Court for the Northern District of New York which were subsequently consolidated in the District Court, against First Albany Corporation ("FAC"), Mechanical Technology Incorporated, Dale Church, Edward Dohring and Beno Sternlicht, Alan Goldberg and George McNamee (former(three former Directors of the Company), Marty Mastroianni (former President and Chief Operating Officer of the
15
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Company), and 33 other individuals ("Defendants") who purchased a total of 820,909 (2,462,727 shares post split) shares of the Company's common stock from the Plaintiffs. The case concerns the Defendants' 1997 purchase of Mechanical Technology Incorporated shares from the Plaintiffs at the price of $2.25 per share ($0.75 per share post split). FAC acted as Placement Agent for the Defendants in the negotiati onnegotiation and sale of the shares and in proceedings before the Bankruptcy Court for the Northern District of New York, which approved the sale in September 1997.
Plaintiffs claim that the Defendants failed to disclose material inside information concerning Plug Power, LLC to the Plaintiffs and therefore the $2.25 per share ($0.75 per share post split) purchase price was unfair. Plaintiffs are seeking damages of $5 million plus punitive damages and costs. In April 1999, Defendants filed a motion to dismiss the amended complaint, which was denied by the Bankruptcy Court. On appeal in October 2000, Plaintiffs' cause of action was dismissed by the United States District Court for the Northern District of New
York. In November 2000, Plaintiffs filed an appeal of that dismissal with the United States Court of Appeals for the Second Circuit. In June 2002, the Second Circuit Court of Appeals reversed the District Court decision and remanded the case for further consideration of the Plaintiff's claims as motions to modify the Bankruptcy Court sale order. The Plaintiff's claims have now been referred back to Bankruptcy Court for such consideration. In September 2003, the Bankruptcy Court issued an order permitting Plaintiffs to conduct limited discovery concerning how First Albany formed an opinion about the Company's stock up until the date the Stock Purchase Agreement was executed. Discovery has commenced.
The Company believes the claims have no merit and intends to defend them vigorously.The Company cannot predict theoutcome of the claims nor reasonably estimate a range of possible loss given the current status of the litigation. Accordingly, no amounts have been reserved for this matter.
Leases
The Company and its subsidiaries lease fourcertain manufacturing, laboratory and office facilities. The leases generally provide for the Company to pay either an increase over a base year level for taxes, maintenance, insurance and other costs of the leased properties or the Company's allocated share of insurance, taxes, maintenance and other costs of leased properties. The leases contain renewal provisions.
Future minimum rental payments required under non-cancelable operating leases are (dollars in thousands): $97$244 remaining in 2005; $386 in 2006, $3312006; $322 in 2007, $319 in 2008, $289 in 2009, and $0 thereafter.
24
14. Commitments and Contingencies (Continued)in 2010.
Warranties
ABelow is a reconciliation of changes in product warranty liabilities is as follows:
Nine months ended | Year ended | |
Sept. 30, | Dec. 31, | |
(Dollars in thousands) | 2005 | 2004 |
Balance, January 1 | $38 | $ 28 |
Accruals for warranties issued | 20 | 38 |
Accruals related to pre-existing warranties (including changes in estimates) | - | (16) |
Settlements made (in cash or in kind) | (16) | (12) |
Balance, end of period | $ 42 | $ 38 |
Three months ended | Year ended | |
Mar. 31, | Dec. 31, | |
(Dollars in thousands) | 2006 | 2005 |
Balance, January 1 | $20 | $ 38 |
Accruals for warranties issued | 5 | 30 |
Accruals related to pre-existing warranties (including changes in estimates) | - | (31) |
Settlements made (in cash or in kind) | (1) | (17) |
Balance, end of period | $ 24 | $ 20 |
Licenses
The Company licenses, on a non-exclusive basis, certain DMFC technology from Los Alamos National Laboratory ("LANL"). Under this agreement, the Company is required to pay future minimum annual license fees of $250 thousand yearly through 2019.
Effective, July 6, 2005, MTI Micro entered into an exclusive field-of-use patent license agreement with LANL. Under this agreement, MTI Micro paid a non-refundable License Issue Fee of $30 thousand upon execution of thesuch agreement.
Under both LANL licenses, license payments made in any year can be applied against royalties due and total annual fees in any year shall not exceed $1 million. Also under both LANL licenses, once products are being sold, royalties will be based on 2% of the first $50 million of net sales, 1% on net sales in excess of $50 million but less than $100 million and .5% on net sales in excess of $100 million Any royalties due shall not exceed 2% of net sales.
16
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Under the NYSERDA contract, MTI Micro agreed to pay NYSERDA a royalty of 1.5% of the sales price of any product sold incorporating IP developed pursuant to the NYSERDA contract if the product is manufactured by a New York State manufacturer. This royalty increases to 5% if the manufacturer is not deemed to be a New York State manufacturer. In any event, the royalty is subject to a cap equal to two times the total contract funds paid by NYSERDA to MTI Micro as reduced to reflect any New York State jobs created by MTI Micro.
Employment Agreements
The Company has employment agreements with certain employees that provide severance payments, andcertain other payments, accelerated vesting and exercise extension periods of certain options upon termination of employment under certain circumstances, as defined in
the applicable agreements. As of September 30, 2005,March 31, 2006, the Company's potential minimum obligation to these employees was approximately $.784 million.
Investment Company Act
The Company's securities available for sale constitute investment securities under the Investment Company Act of 1940 (the "Investment Company Act"). In general, a company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of its total assets, subject to certain exclusions and exemptions.
Investment companies are subject to registration under, and compliance with, the Investment Company Act unless a particular exemption or safe harbor provision applies. If the Company were to be deemed an investment company, the Company would become subject to the requirements of the Investment Company Act. As a consequence, the Company would be prohibited from engaging in certain businesses or issuing certain securities, certain of the Company's contracts might be voidable, and the Company might be subject to civil and criminal penalties for noncompliance.
Until 2001, the Company qualified for a safe harbor exemption under the Investment Company Act based upon the level of its ownership of shares of Plug Power and its influence over Plug Power's management or policies. However, since the Company began selling shares of Plug Power, this safe harbor exemption is no longer available.
25
14. Commitments and Contingencies (Continued)
On December 3, 2001, the Company made an application to the SEC requesting that they either declare that the Company is not an investment company because it is primarily engaged in another business or exempt it from the provisions of the Investment Company Act. The Company amended this application on October 20, 2003. On July 18, 2005, the Company requested that the application be withdrawn following discussions and other communications with the SEC staff in which the staff expressed the view that the application was no longer necessary. Since the value of the Company's interests in Plug Power has decreased in relation to its total assets, the Company believes that it is not an investment company subject to the regulations of the Investment Company Act.
If the Company was deemed to be an investment company and could not find another safe harbor or exemption and failed to register as an investment company, the SEC could require the Company to sell its interest in Plug Power, until the value of these securities is further reduced in relation to the Company's total assets. This could result in sales of the Company's securities in quantities of shares at depressed prices and the Company may never realize anticipated benefits from, or may incur losses on, these sales. Further, the Company may be unable to sell some securities due to contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, the Company may incur tax liabilities when selling assets.
Contract Losses
During 2004, MTI Micro entered into a fixed price-cost type completion contract with the U.S. Army. The contract, which totaled $250 thousand, permitted monthly cost progress payments and called for the delivery of five DMFC power system units. These prototypes required substantial engineering to meet the performance requirements of the customer. At the end of 2004,customer and at March 31, 2005, MTI Micro forecasted that the contract would be completed during 2005 andhad accrued $540 thousand for the then anticipated cost needed to be incurred to complete the project.contract. The expected overrun is currently estimated at $775 thousand and the accrued anticipated cost to complete the project is $11 thousand as of September 30, 2005 andcontract was $540 thousand as of December 31, 2004. Through monthly reports, MTI Micro updates the customercompleted on accomplishments, technical issues, financial status, forecast to complete and anticipated solutions.
November 25, 2005. Additionally, other contracts had forecasted costs in excess of contract values as of DecemberMarch 31, 2004.2005. As of the end of 2004,March 31, 2005, MTI Micro had accrued $17 thousand for the anticipated cost overruns for the projects and asprojects. As of September 30, 2005March 31, 2006, no amounts are accrued for the anticipated costslosses to complete other projects.open contracts.
15. Subsequent Events
Sale of Securities Available for Sale
From April 1 through May 9, 2006, the Company sold available for sale securities as follows:
(Dollars in thousands) | ||
Number of | Proceeds | |
Company | Shares Sold | from Sales |
Plug Power | 600,000 | $3,568 |
16. Stock Based Compensation
Stock-based incentive awards are provided to employees and directors under the terms of the Company's 1999 Employee Stock Incentive Plan ("1999 Plan") and the 1996 Stock Incentive Plan ("1996 Plan") (the "Plans"). Awards under the Plans have generally included at-the-money options and restricted stock grants.
The Company also issued awards under the MTI MicroFuel Cells Inc. 2001 Employee, Director and Consultant Stock Option Plan (Amended and Restated as of September 23, 2004) ("2001 MTI Micro Plan") and ceased making grants under the 2001 MTI Micro Plan during 2005 and has determined that it will make no new option awards under this Plan in the future.
A majority of stock-based compensation expense for the quarter ended March 31, 2006 was generated from stock options. Stock options are awards which allow the employee to purchase shares of the Company's common stock at a fixed price. Stock options issued to employees generally vest 25% per year beginning one year after grant. Options issued to members of the MTI Board generally vest upon grant and MTI Micro options issued to members of the MTI Micro Board generally vest 50% per year beginning one year after grant. Certain options granted may be exercisable immediately or begin vesting immediately. Restricted stock awards generally vest one year after the date of grant. Option exercise prices are generally equal to but are not less than 85 percent of the market value of the Company's common stock on the date of grant, or for MTI Micro options based on fair values as determined by the MTI Micro Board. Unexercised options generally terminate ten years after date of grant.
Prior to January 1, 2006, the Company had elected to follow APB Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations, in accounting for employee stock-based compensation and to provide the disclosures required under SFAS No. 123,Accounting for Stock Based Compensation. APB Opinion No. 25 requires no recognition of compensation expense for most of the stock-based compensation arrangements provided by the Company, namely, broad-based employee option grants
17
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
where the exercise price is equal to or not less than 85 percent of the market value at the date of grant. However, APB Opinion No. 25 requires recognition of compensation expense for variable award plans over the vesting periods of such plans, based upon the then-current market values of the underlying stock. In contrast, SFAS No. 123 requires recognition of compensation expense for grants of stock, stock options, and other equity instruments, over the vesting periods of such grants, based on the estimated grant-date fair values of those grants. Under the intrinsic-value-based method, compensation cost is the excess, if any, of the market value of the stock at grant over the amount an employee must pay to acquire the stock.
Compensation expense related to the intrinsic value of performance-based, unrestricted and restricted stock awards was recorded in "Selling, general and administrative expenses" in the Consolidated Statements of Operations for each of the following periods:
(Dollars in thousands) | Three months ended |
March 31, | |
2005 | |
Stock options | 51 |
Total stock-based compensation expense | $ 51 |
Share-Based Compensation Information under FAS 123R
As discussed in Note 2, "Significant Accounting Policies" effective January 1, 2006, the Company adopted the fair value recognition provisions for stock-based awards granted to employees using the modified prospective application method provided by FAS 123R. Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period.
The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of FAS 123R and SEC Staff Accounting Bulletin No. 107 ("SAB 107"). Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of the Company's stock, the risk-free rate and the Company's dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company.
The fair value of each stock option grant was estimated at the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used for options granted:
Three Months Ended | |
March 31, | |
2006 | |
Option term (years)* | 5.2 |
Volatility** | 79.80% |
Risk-free interest rate (zero coupon U.S. treasury note) | 4.95% |
Dividend yield | 0% |
Weighted-average fair value per option granted | $ 2.48 |
* The Option term is the number of years that the Company estimates, based upon history, that options will be outstanding prior to exercise or forfeiture.
** The Company's estimates of expected volatility are principally based on daily price changes of the Company stock over the expected option term, as well as the additional requirements included in the provisions of FAS 123R and the guidance provided by SAB 107.
The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company's employee stock options. The dividend yield assumption is based on the Company's history and expectation of future dividend payouts and may be subject to substantial change in the future. The forfeiture rate is based on the Company's historical option cancellation information.
18
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As share-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it should be reduced for estimated forfeitures. FAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 9.5% (annualized) in the first quarter of fiscal 2006 based on historical experience. In the Company's pro forma information required under FAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred. The cumulative effect for the change in forfeitures was immaterial to be presented separately.
Total share-based compensation expense, related to all of the Company's share-based awards, recognized for the three months ended March 31, 2006 was comprised as follows (in thousands):
Three Months Ended | |
March 31, 2006 | |
Unfunded research and product development | $ 100 |
Selling, general and administrative | 301 |
Share-based compensation expense before taxes | 401 |
Related income tax benefits | - |
Share-based compensation expense, net of taxes | $401 |
Impact on basic and diluted EPS | $(.01) |
Total unrecognized compensation costs related to non-vested awards as of March 31, 2006 is $2.314 million and is expected to be recognized over a weighted-average period of approximately 1.25 years.
The Company recorded $55 thousand in share-based compensation expense during the three months ended March 31, 2006 related to share-based awards granted during fiscal 2006. In addition, as of January 1, 2006, the adoption of FAS 123R resulted in the elimination of unearned compensation related to restricted stock (contra equity account) against additional paid in capital totaling approximately $80 thousand.
Presented below is a summary of the Company's stock option plans' activity for the three months ended March 31, 2006:
Options Outstanding | ||
Weighted | ||
Average | ||
Number | Exercise Price | |
Outstanding | Per Share | |
Shares under option, beginning | 5,041,242 | $ 3.76 |
Granted | 514,750 | 3.66 |
Exercised | (173,663) | 1.53 |
Canceled | (18,958) | 4.02 |
Shares under option, ending | 5,363,371 | 3.82 |
Options exercisable, ending | 4,063,366 | 3.93 |
Remaining shares available for granting of options | 874,063 | |
The following table summarizes information for options outstanding and exercisable at March 31, 2006:
19
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Options Outstanding | Options Exercisable | |||||
Weighted | ||||||
Average | Weighted | Weighted | ||||
Exercise | Remaining | Average | Average | |||
Price | Contractual | Exercise | Exercise | |||
Range | Number | Life | Price | Number | Price | |
$ 0.54 - $ 0.77 | 197,121 | 1.3 | $ 0.69 | 197,121 | $ 0.69 | |
$ 0.98 - $ 1.34 | 470,000 | 2.3 | $ 1.28 | 470,000 | $ 1.28 | |
$ 1.65 - $ 2.04 | 530,575 | 4.9 | $ 1.87 | 454,637 | $ 1.85 | |
$ 2.49 - $ 3.68 | 2,397,508 | 7.9 | $ 3.06 | 1,339,191 | $ 2.95 | |
$ 3.74 - $ 4.83 | 651,667 | 5.0 | $ 4.15 | 613,667 | $ 4.14 | |
$ 6.01 - $ 6.40 | 846,000 | 6.4 | $ 6.17 | 718,250 | $ 6.17 | |
$ 9.25 - $ 12.97 | 210,500 | 4.2 | $10.64 | 210,500 | $10.64 | |
$ 20.92 | 60,000 | 1.7 | $20.92 | 60,000 | $20.92 | |
5,363,371 | 6.1 | $ 3.82 | 4,063,366 | $ 3.93 |
The aggregate intrinsic value for the Company's options outstanding and exercisable as of March 31, 2006 is $4.426 million and $3.708 million, respectively. The aggregate intrinsic value represents the total pretax intrinsic value, based on the Company's closing stock price of $3.75 as of March 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date.
The number and weighted average fair value of restricted stock for the period ended March 31, 2006 is as follows:
Weighted | ||
Number | Average | |
Nonvested restricted stock, beginning | 50,000 | $ 2.49 |
Granted | - | - |
Vested | - | - |
Canceled | - | - |
Nonvested restricted stock, ending | 50,000 | $ 2.49 |
Presented below is a summary of the 2001 MTI Micro stock option plans activity for the three months ended March 31 2006:
Options Outstanding | ||
Weighted | ||
Average | ||
Number | Exercise Price | |
Outstanding | Per Share | |
Shares under option, beginning | 78,461 | $3.22 |
Granted | - | - |
Exercised | - | - |
Canceled | (10,459) | 2.46 |
Shares under option, ending | 68,002 | 3.34 |
Options exercisable | 37,085 | 2.94 |
The following table summarizes information for MTI Micro's options outstanding and exercisable at March 31, 2006:
Outstanding Options | Options Exercisable | |||||
Weighted | Weighted | Weighted | ||||
Exercise | Average | Average | Average | |||
Price | Remaining | Exercise | Exercise | |||
Range | Number | Contractual Life | Price | Number | Price | |
$ 2.39 - $2.55 | 37,334 | 7.45 | $ 2.51 | 28,209 | $ 2.54 | |
$ 2.76 - $3.80 | 4,501 | 7.42 | $ 3.03 | 2,542 | $ 3.12 | |
$ 4.06 - $4.66 | 26,167 | 8.32 | $ 4.57 | 6,334 | $ 4.66 | |
68,002 | 7.78 | $ 3.34 | 37,085 | $ 2.94 |
20
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The aggregate intrinsic value for MTI Micro options outstanding and exercisable as of March 31, 2006 is $1 thousand and $0, respectively. The aggregate intrinsic value represents the total pretax intrinsic value, based on MTI Micro's estimated fair value of $2.50 as of March 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date.
Exercises of Employee Stock Options
The total intrinsic value of options exercised during the three months ended March 31, 2006 was $380 thousand. The total cash received or receivable from employees as a result of employee stock option exercises for the three months ended March 31, 2006 was approximately $266 thousand. In connection with these exercises, the tax benefits realized by the Company for the three months ended March 31, 2006 was zero.
The Company settles employee stock option exercises with newly issued shares of Company common stock.
Pro Forma Information under FAS 123 for Periods Prior to Fiscal 2006
Prior to adopting the provisions of FAS 123R, the Company recorded estimated compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion 25 (APB 25), "Accounting for Stock Issued to Employees" and provided the required pro forma disclosures of FAS 123. Because the Company generally established the exercise price based on the fair market value of the Company's stock at the date of grant, the stock options generally had no intrinsic value upon grant, and therefore estimated expense was recorded primarily for grant modifications prior to adopting FAS 123R. Each accounting period, the Company reported the potential dilutive impact of stock options in its diluted earnings per common share using the treasury-stock method. Out-of-the-money stock options (i.e., the average stock price during the period was below the strike price of the stock option) were not included in diluted earnings per common share as their ef fect was anti-dilutive.
For purposes of pro forma disclosures under FAS 123 for the three months ended March 31, 2005, the estimated fair value of the stock options was assumed to be amortized to expense over the stock options' vesting periods. The pro forma effects of recognizing estimated compensation expense under the fair value method on net income and earnings per common share for the three months ended March 31, 2005 were as follows:
(Dollars in thousands, except per share data) | Three Months Ended |
March. 31, | |
2005 | |
Net loss, as reported | $(6,054) |
Add: Total stock-based employee compensation | |
expense already recorded in financial | |
Statements, net of related tax effects | 44 |
Deduct: Total stock-based employee | |
compensation expense determined under fair | |
value based method for all awards, net of | |
related tax effects | (452) |
Pro forma net loss | $(6,462) |
Loss per share: | |
Basic and diluted - as reported | $ (0.20) |
Basic and diluted - pro forma | $ (0.21) |
The pro forma effects of estimated share-based compensation expense on net income and earnings per common share for the three months ended March 31, 2005 were estimated at the date of grant using the Black-Scholes option-pricing model based on the following assumptions (annualized percentages):
21
MECHANICAL TECHNOLOGY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended | |
March 31, 2005 | |
Stock Option | |
Volatility | 80.80% |
Risk-free interest rate | 3.96% |
Dividend yield | 0.00% |
Expected life (years) | 5.0 |
The Black-Scholes weighted average estimated fair value of stock options granted during the three months ended March 31, 2005 was $3.226 per share.
17. Issuance of Stock by Subsidiary
MTI Micro was formed on March 26, 2001. As2001 and as of September 30, 2005,March 31, 2006, the Company owns approximately 89%91% of MTI Micro's outstanding common stock.
On March 31, 2006, MTI Micro issued 1,400,000 shares of its common stock at a price of $2.50 per share to the Company in connection with the conversion of its $3.5 million loan receivable to equity.
The increasedecrease in the Company's paid-in-capital related to the Company's investmentof $(358) thousand in MTI Micro totaling $155 thousand for the period ended September 30, 2005,2006 represents the changes in the Company's equity investment in MTI Micro, which resulted from stock-based compensation and third-party stock transactionsthe anti-dilutive impact of the Company's investments in MTI Micro.Micro stock and the equity impact of share-based compensation accounting.
26
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This information should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 21 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2005 contained in our 2005 Annual Report on Form 10-K.
In addition to historical information, the following discussion contains forward-looking statements that involveare subject to risks and uncertainties whichuncertainties. Actual results may cause the Company's actual results, performance or achievements to be materially differentdiffer substantially from those expressed or implied by such forward-looking statements. See "Statement Concerning Forward-Looking Statements" on pages 36referred to herein due to a number of factors, including but not limited to risks described in the section entitled Risk Factors and 37.elsewhere in this Quarterly Report.
Overview
The CompanyMechanical Technology Incorporated, ("MTI" or the "Company"), a New York corporation, was incorporated in 1961. MTI operates in two segments, the New Energy segment which is primarily engaged in the development and commercialization of Mobion® cord-free advanced portable power systemsconducted through its subsidiary MTI MicroFuel Cells Inc. ("MTI Micro"), a majority-owned subsidiary, and the Test and Measurement Instrumentation segment, which is conducted through MTI Instruments, Inc. ("MTI Instruments"), a wholly owned subsidiary.
At its MTI Micro subsidiary, the Company is primarily focused on the development and commercialization of advanced cord-free rechargeable power pack technology for portable electronics. MTI Micro has developed a patented, proprietary direct methanol fuel cell ("DMFC") technology called Mobion®, which generates electrical power using up to 100% methanol as fuel. MTI Micro's Mobion® technology is intended to replace current Lithium-Ion and similar rechargeable battery systems used by original equipment manufacturers (OEMs) in many hand held electronic devices such as PDAs, Smartphones and different accessories. The Company believes that if commercialized, Mobion® could eventually have higher energy density and therefore provide multiple times the design, manufacture,benefits of existing Lithium-Ion batteries. When and saleif Mobion®fuel cells are ready to be sold in mass-commercial markets, they should be able to power a wireless electronic device for longe r periods of time than Lithium Ion batteries without recharging/refueling, and be instantly refueled without the need for a power outlet or a lengthy recharge.
At its MTI Instruments subsidiary, the Company designs, manufactures, and sells high-performance test and measurement instruments and systems through its subsidiarysystems. MTI Instruments Inc. ("MTI Instruments"). was incorporated as a subsidiary on March 8, 2000 and operates three product groups: general dimensional gaging, semiconductor and aviation. These products consist of electronic, computerized gaging instruments for position, displacement and vibration applications within the design, manufacturing and test markets; semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers within the semiconductor market; and engine balancing and vibration analysis systems for both military and commercial aircraft.
MTI also co-founded and retains a minority interest in Plug Power Inc. ("Plug Power") (Nasdaq: PLUG), a designer and developer of clean, reliable, on-site energy products.
Our cash requirements depend on numerous factors, including completion of our product development activities, ability to commercialize our systems, based on proton exchange membrane fuel cells.market acceptance of our systems and other factors. We expect to pursue the expansion of our operations through internal growth and strategic partnerships.
MTI Micro designs and develops Mobion®fuel cell systems for portable power applications. A micro fuel cell is a portable power source that converts chemical energy into useable electrical energy. MTI Micro is developing a micro fuel cell that uses methanol, a common alcohol, as its fuel. The Company believes direct methanol fuel cell ("DMFC") systems could potentially have an energy densitySeveral key indicators of five to ten times that of Li-Ion batteries. The Company believes that, when commercialized, DMFC systems should be able to power a wireless electronic device for longer periods of time than Li-Ion batteries without recharging/refueling. In addition, Mobion®fuel cell systems may be instantly refueled eliminating the need for a power outlet or a lengthy recharge.
MTI Micro's fuel cell technology platform can be customized to provide portable power for a number of applications depending on the power level, required run time and size requirements. In December 2004, MTI Micro shipped its first low volume production of Mobion®fuel cell systems for use in hand held Radio Frequency Identification tag readers. Although this product shipment was an important milestone, the Company and MTI Micro recognize that significant technical, engineering, manufacturing, cost and marketing challenges remain before Mobion®fuel cells can become commercially viable or available.
MTI Instruments has three product groups: aviation, general gaging and semiconductor. These product groups provide: electronic, computerized general gaging instruments for position, displacement and vibration applications; and semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers and vibration analysis systems for aircraft engines. MTI Instruments' strategy is to continue to enhance and expand its product offerings with the goal of increasing market share and profitability. MTI Instruments' largest customers include the U.S. Air Force and industry leadersour liquidity are summarized in the computer, electronic, semiconductor, automotive, aerospace, aircraft and bioengineering fields.following table:
MTI Instruments' engine balancing and vibration analysis system primarily serves the aviation industry, both in the commercial and military sectors. These systems perform a number of vibration analysis and engine balancing functions typically for large turbofan engines on the flight-line and in test cells. In addition, MTI Instruments' engine balancing and vibration analysis system has been used for the first time in an industrial turbo machinery application.
MTI Instruments' general gaging product line employs three sensing technologies - capacitance, fiber optics and laser triangulation - to measure displacement, position, thickness, vibration and other dimensional measurement applications. The advantages of each technology are generally related to the requirements of specific applications, which typically transcend the capabilities of conventional measuring techniques. End-users cover a broad range of industrial markets, as well as research labs, universities and the government agencies.
MTI Instruments' semiconductor tools compete in the wafer metrology segment of the semiconductor equipment market. Product models include manual units, semi-automated units and fully automated systems that measure thickness, total thickness variation, bow, warp, site and global flatness. These metrology and inspection tools
27
cover a broad range of applications both on the front-end and back-end of the manufacturing process. End-users of these tools include both wafer manufacturers (foundries) and device (chip) manufacturers.
(Dollars in thousands) | Three months ended March 31, | |
2006 | 2005 | |
Unrestricted cash, cash equivalents and marketable securities | $26,604 | $37,513 |
Working capital | 21,089 | 32,290 |
Net loss | (3,431) | (6,054) |
Net cash used in operating activities | (3,387) | (3,880) |
Purchase of property, plant and equipment | (262) | (202) |
From inception through September 30, 2005,March 31, 2006, the Company has incurred net losses of $77.380$85.149 million and expects to incur losses as it continues micro fuel cell product development and commercialization programs. The Company expects that losses will continue and fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, gains on sales of securities available for sale and the operating results of MTI Instruments and MTI Micro.
Critical Accounting Policies and Significant Judgments and Estimates
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in
23
the United States of America. Note 1 to the Company's 20042005 annual consolidated financial statements includes a summary of the Company's most significant accounting policies. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an ongoing basis, the Company evaluates its estimates and judgments, including those related to revenue recognition, inventories, securities available for sale, income taxes, share-based compensation and derivatives. Management bases its estimates 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 these estimates under different assumptions or conditions. OurM anagement discussed our critical accounting estimates were discussed with our Audit Committee.
Share-Based Payments.We grant options to purchase our common stock to our employees and directors under our stock option plans. The benefits provided under these plans are share-based payments subject to the provisions of revised Statement of Financial Accounting Standards No. 123 (FAS 123R), "Share-Based Payment." Effective January 1, 2006, we use the fair value method to apply the provisions of FAS 123R with a modified prospective application which provides for certain changes to the method for valuing share-based compensation. The valuation provisions of FAS 123R apply to new awards and to awards that are outstanding on the effective date and subsequently modified or cancelled. Under the modified prospective application, prior periods are not revised for comparative purposes. Share-based compensation expense recognized under FAS 123R for the three months ended March 31, 2006 was $.401 million. At March 31, 2006, total unrecognized estimated compensation expense relate d to non-vested awards granted prior to that date was $2.314 million, which is expected to be recognized over a weighted average period of 1.25 years.
Upon adoption of FAS 123R, we began estimating the value of share-based awards on the date of grant using a Black-Scholes option-pricing model (Black-Scholes model). Prior to the adoption of FAS 123R, the value of each share-based award was estimated on the date of grant using the Black-Scholes model for the pro forma information required to be disclosed under FAS 123. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.
If factors change and we employ different assumptions in the application of FAS 123R in future periods, the compensation expense that we record under FAS 123R may differ significantly from what we have recorded in the current period. Therefore, we believe it is important for investors to be aware of the high degree of subjectivity involved when using option pricing models to estimate share-based compensation under FAS 123R. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions, are fully transferable and do not cause dilution. Because our share-based payments have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect our estimates of fair values, in our opinion, existing valuation models, including the Black-Scholes, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a ris k that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that is significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee share-based awards is determined in accordance with FAS 123R and the Securities and Exchange Commission's Staff Accounting Bulletin No. 107 (SAB 107) using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
Estimates of share-based compensation expenses are significant to our financial statements, but these expenses are based on the aforementioned option valuation model and will never result in the payment of cash by us.
The guidance in FAS 123R and SAB 107 is relatively new, and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of share-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.
Theoretical valuation models and market-based methods are evolving and may result in lower or higher fair value estimates for share-based compensation. The timing, readiness, adoption, general acceptance, reliability and testing of these methods is uncertain. Sophisticated mathematical models may require voluminous historical information, modeling expertise, financial
24
analyses, correlation analyses, integrated software and databases, consulting fees, customization and testing for adequacy of internal controls.
For purposes of estimating the fair value of stock options granted during the three months ended March 31, 2006 using the Black-Scholes model, we used the historical volatility of our stock for the expected volatility assumption input to the Black-Scholes model, consistent with the guidance in FAS 123R and SAB 107.
The risk-free interest rate is based on the risk-free zero-coupon rate for a period consistent with the contractual life of the option in effect at the time of grant.
We do not currently pay nor do we anticipate paying dividends but we are required to assume a dividend yield as an input to the Black-Scholes model.
The expected option term is estimated using both historical term measures and projected termination estimate.
Discussion and Analysis of Results of Operations
Results of Operations for the Three and Nine Months Ended September 30, 2005March 31, 2006 Compared to the Three and Nine Months Ended September 30, 2004March 31, 2005
The following is management's discussion and analysis of certain significant factors, which have affected the Company's results of operations for the three and nine months ended September 30, 2005March 31, 2006 compared to the three and nine months ended September 30, 2004.March 31, 2005.
Product Revenue.Product revenue in the Test and Measurement Instrumentation segment for the three months ended September 30, 2005 decreasedMarch 31, 2006 increased in comparison to the same period in 20042005 by $.214$.110 million, or 13%7.8%, to $1.428$1.513 million. This decreaseincrease is the result of decreasescapacitance product sales, which have more than doubled since last year ($654 thousand in sales2006 versus $305 thousand in 2005) due to semiconductor customers$268 thousand of $.434 million partially offset by increasesnew business and increased shipments to our distributor in sales toSingapore. This increase offsets a 23% drop in aviation customers of $.187 million and general gaging customers of $.033 million. The decrease in semiconductor sales reflects the shipment of two manual gages during the third quarter of 2005 as compared to three OEM machines, one manual gage, two semi-automated units and one AutoScan unit for the same period in 2004. The increase in sales to aviation customers includes $.319 million of Air Force purchases for new systems and the development and issuance ofrevenue stemming from a technical manual, which is partially offset by a comparative$250 thousand decline in Air Force activity under the upgradeongoing Retrofit and Maintenance contract of $.056 million and a $.085 million dropwith the US Air Force ($271 thousand in commercial unit shipments. The increase in general instrument sales is primarily due to increases in capacitance shipments of $.131 million and a $.024 million increase in the parts and service business, which are offset by declines in fiber-optic, OEM and laser shipment sales of $.083 million, $.028 million and $.011 million, respectively.
Product revenue in the Test and Measurement Instrumentation segment for the nine months ended September 30, 2005 decreased in comparison to the same period in 2004 by $.336 million, or 7.5%, to $4.116 million. This decrease is the result of decreases in sales to semiconductor customers of $.742 million partially offset by increases in sales to general gaging customers of $.274 million and aviation customers of $.132 million. The decrease in semiconductor sales reflects the shipment of four manual gages, one semi-automated unit and two OEM machines during the first nine months of 2005 as2006 compared to eleven manual gages, four semi-automated units, two AutoScan units and four OEM machines for the same period$521 thousand in 2004. The increase in general instrument sales is primarily due to a $.392 million increase in capacitance product sales related to a new customer and an increase in business from a Japanese distributor. The increase in sales to aviation customers includes new buy activity by both the U.S. Air For ce of $.283 million and commercial customers of $.069 million partially offset by a decline in business under the U.S. Air Force upgrade contract of $.237 million.2005).
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Information regarding government contracts included in product revenue is as follows:
Total Contract | |||||
Revenues | Revenues | Revenues | Orders | ||
(Dollars in thousands, except contract values) | Three Months | Three Months | Contract | Received | |
Ended | Ended | to Date | to Date | ||
Contract | Expiration | Mar. 31, 2006 | Mar. 31, 2005 | Mar. 31, 2006 | Mar. 31, 2006 |
$8.8 million Air Force Retrofit and Maintenance of | |||||
PBS 4100's | 06/20/2008 | $ 271 | $ 521 | $ 5,481 | $ 5,565 |
(Dollars in thousands, except contract values)
Revenues | Revenues | Revenues | Total Contract | ||
Nine months | Nine months | Contract to | Orders Received | ||
Ended | Ended | Date | to Date | ||
Contract | Expiration | Sept. 30, 2005 | Sept. 30, 2004 | Sept. 30, 2005 | Sept. 30, 2005 |
$8.8 million Retrofit | |||||
and Maintenance of | |||||
PBS 4100's | 06/20/2008 | $ 1,126 | $1,363 | $ 4,784 | $ 5,037 |
$3.1 million PBS | |||||
Units and Accessory Kits | 09/30/2004 | $ - | $ 111 | $ 2,469 | $ 2,469 |
Funded Research and Development Revenue.Funded research and development revenue in the New Energy segment for the three months ended September 30, 2005 increasedMarch 31, 2006 decreased in comparison to the same period in 20042005 by $.617$.279 million to $.792$.045 million, a 352.6% increase.an 86.1% decrease. The increasedecrease in revenue is primarily the result of increasessuspension of $.270 million from theexisting Department of Energy ("DOE") contract, $.150 million from(DOE) funding for 2006 and the Harris Corporation ("Harris") contract, $.250 million from the U.S. Army contractcompletion of other programs which were active in 2005 including NYSERDA, Marine Corps. and $.041 million from the U.S. Marines contract partially offset by the Army Research Laboratories contract's completion in 2004 when it contributed $.055 million and a decrease from the National Institute of Standards and Technology ("NIST") contract's completion in 2004 when it contributed $.037 million in revenue.
Funded research and development revenue in the New Energy segment for the nine months ended September 30, 2005 increased in comparison to the same period in 2004 by $.742 million to $1.496 million, a 98.4% increase. The increase is the result of increases of $.640 million from the DOE contract, $.250 million from the U.S. Army contract, $.242 million from the NYSERDA contract, $.150 million from the Harris contract, $.070 million from the Marines contract and $.028 million from the Cabot Superior Micro Powders ("CSMP") NIST subcontract partially offset by decreases from the NIST contract's completion in 2004 when it contributed $.438 million and the Army Research Laboratories contract's completion in 2004 when it contributed $.200 million.(CSMP) subcontract.
Information regarding government contracts included in funded research and development revenue is as follows:
(Dollars in thousands, except contract values)
Revenues | Revenues | Revenues | ||
Nine months | Nine months | Contract | ||
Ended | Ended | to Date | ||
Contract | Expiration | Sept. 30, 2005 | Sept. 30, 2004 | Sept. 30, 2005 |
$3.0 million DOE | 07/31/07 | $ 684 | $ 44 | $ 862 |
$1.250 million NYSERDA(1) | 06/30/06 | $ 242 | $ - | $ 1,048 |
$249.8 thousand Army | 09/30/05 | $ 250 | $ - | $ 250 |
$69.9 thousand Marine | 06/30/05 | $ 70 | $ - | $ 70 |
$210 thousand NIST(2) | 06/30/05 | $ 100 | $ 72 | $ 210 |
$150 thousand Harris | 03/31/05 | $ 150 | $ - | $ 150 |
$200 thousand ARL | 12/31/04 | $ - | $ 200 | $ 200 |
$4.6 million NIST(3) | 09/30/04 | $ - | $ 438 | $ 3,342 |
(Dollars in thousands, except contract values) | Revenues | Revenues | Revenues | ||||
Three | Percentage | Three | Percentage | Contract | |||
Contract | Months | of | Months | of | to Date | ||
Contract | Type | Expiration(5) | Mar. 31, 2006 | 2006 Total | Mar. 31, 2005 | 2005 Total | Mar. 31, 2006 |
$3.0 million DOE | B | 07/31/07 | $ 45 | 100% | $ 151 | 46.6% | $ 1,154 |
$470 thousand SAFT(1) | A | 09/30/06 | $ - | - | $ - | - | $ - |
$1.250 million NYSERDA(2) | B | 06/30/06 | $ - | - | $ 112 | 34.6 | $ 1,135 |
$249.8 thousand Army | A | 09/30/05 | $ - | - | $ - | - | $ 250 |
$69.9 thousand Marine Corps. | A | 03/31/05 | $ - | - | $ 25 | 7.7 | $ 70 |
$210 thousand NIST(3) | A | 06/30/05 | $ - | - | $ 36 | 11.1 | $ 210 |
$150 thousand Harris(4) | A | 06/25/04 | $ - | - | $ - | - | $ 150 |
Total funded research and | |||||||
development revenue | $ 45 | 100.0% | $ 324 | 100.0% |
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(1)This is a subcontract with SAFT America Inc. (SAFT) under the U.S. Army CECOM contract.
(2)Total contract value is $1.250 million consisting of four Phases: Phase I for $500 thousand was from 3/12/02 thru 9/30/03; Phase II for $200 thousand was from 10/28/03 with a completion date of 10/31/04; Phase III for $348 thousand was from 8/23/04 thruthrough 8/31/05; and Phase IV for $202 thousand which commenced on 12/14/04 and expires on 6/30/06. Phases I, II and IIIII have been completed. Phase III final report has been accepted. Retainage will be billed upon acceptance of final report incorporating all threecompleted phases of the contract.
(2)(3) This contract is a subcontract with CSMP under NIST and includes the original contract for $200 thousand and a contract amendment for $10 thousand.
(3)(4)This contract wasincludes the original contract for $200 thousand, an amendment for $50 thousand and a joint venture with DuPont. DuPont's share of2005 amendment reducing the contract revenue was $1.3 million.by $100 thousand.
(5) Dates represent expiration of contract, not date of final billing.
Contract Type A - Fixed Price Contract.
29Contract Type B - Cost Shared Contract.
Cost of Product Revenue.Cost of product revenue in the Test and Measurement Instrumentation segment for the three months ended September 30, 2005March 31, 2006 decreased in comparison to the same period in 20042005 by $.123$.063 million, or 17.9%10.5%, to $.563$.539 million. This decrease coincides withAs a percentage of sales, the lowerquarterly cost of sales volume for the three months ended September 30, 2005 comparedhas dropped seven percentage points due to the same perioda thirteen-point rise in 2004, which included lower semiconductoraverage margins on capacitance product sales and increases in aviation and general gaging sales. due to improved pricing strategies.
Gross profit as a percentage of product revenue increased to 60.6%64.4% for the three months ended September 30, 2005March 31, 2006 from 58.2%57.1% in the prior year. The gross profit percentage increase is primarily attributable to a three-point rise in aviation product margins as a result of increased purchases of new equipment by the U.S. Air Force.
Cost of product revenuehigher sales volume and improved pricing strategies in the Test and Measurement Instrumentation segment for the nine months ended September 30, 2005 decreased in comparison to the same period in 2004 by $.274 million, or 14%, to $1.682 million. This decrease coincides with the lower sales volume for the nine months ended September 30, 2005 compared to the same period in 2004, which included lower semiconductor sales and increases in general gaging and aviation sales. Gross profit as a percentage ofcapacitance product revenue, however, increased to 59.1% for the nine months ended September 30, 2005 from 56.1% in the prior year. The gross profit percentage increase is primarily attributable to a four-point rise in aviation product margins stemming from the growth in government and commercial customer product sales. Furthermore, the margin in 2004 was negatively impacted by the first AutoScan unit sale at a discounted price.line.
Funded Research and Product Development Expenses.Funded research and product development expenses in the New Energy segment decreased by $.004$.845 million, or .5%80.1%, to $.877$.210 million for the three months ended September 30, 2005March 31, 2006 in comparison to the same period in 2004.
Funded research and product development expenses in the New Energy segment increased by $.413 million, or 16%, to $2.989 million for the nine months ended September 30, 2005 in comparison to the same period in 2004.2005. The increaseddecreased costs were attributable to a changeactive contracts in 2005 which are not active in 2006. For the three months ended March 31, 2006 MTI Micro had open contracts under development duringwith DOE and SAFT while in 2005 contracts were with DOE, NYSERDA, NIST (CSMP), ARL and the completion of contracts during 2004. In 2005 MTI Micro is working on contracts for DOE, NYSERDA, the U.S. Marines, the U.S. Army and CSMP while in 2004 contracts were for NIST, CSMP, DOE and ARL.Marine Corps.
Unfunded Research and Product Development Expense. Unfunded research and product development expenses decreasedincreased by $1.136$.745 million, or 48.3%46.4%, to $1.216$2.350 million for the three months ended September 30, 2005March 31, 2006 in comparison to the same period in 2004.2005. This decreaseincrease reflects a $1.148$.707 million decreaseincrease in the New Energy segment reflecting decreasedincreased internal development costs for the development of our micro fuel cell system, for Intermec and development costs in connection with Gillette and potential commercial products. The Intermec initiative was completed during the fourth quarter of 2004products and accounteda $100 thousand non-cash charge for $.807 million of the New Energy segment decrease. Unfunded research and product development costs include the cost of micro fuel cell products warranty activity related to the shipments of its initial fuel cell units at low volume production.share-based compensation. This decrease is partially offset byincrease also includes a $.012$.038 million increase in product development expenses in the Test and Measurement Instrumentation segment. Te stsegment including projects related to the development of a glass thickness gage and Measurement Instrumentation product development includes costs for improvements for the Microtrak II productaviation products design modifications.
Selling, General and a high temperature capacitance gauge to serve the brake rotor market.
Unfunded researchAdministrative Expenses. Selling, general and product developmentadministrative expenses decreasedincreased by $1.654$.026 million, or 26.1%0.86%, to $4.677$3.060 million for the ninethree months ended September 30, 2005March 31, 2006 in comparison to the same period in 2004. This decrease reflects a $1.647 million decrease in the New Energy segment reflecting decreased internal development costs for the development of our micro fuel cell system for Intermec and development costs in connection with Gillette and potential commercial products. The Intermec initiative was completed during the fourth quarter of 2004 and accounted for $1.226 million of the New Energy segment decrease. Unfunded research and product development costs include the cost of micro fuel cell products warranty activity related to the shipments of its initial fuel cell units at low volume production. This decrease also includes a $.007 million decrease in product development expenses in the Test and Measurement Instrumentation segment. Test and Measurement Instrumentation product development includes costs for im provements for the Microtrak II product and a high temperature capacitance gauge to serve the brake rotor market.
30
Selling, General and Administrative Expenses.Selling, general and administrative expenses increased by $.661 million, or 43.3%, to $2.187 million for the three months ended September 30, 2005 in comparison to the same period in 2004. This change is2005. These increases are primarily the result of the following changes: increased salaries and employee benefitsa $.250 million increase in non-cash stock-based compensation charges reflecting the adoption of $.554SFAS No. 123(R) which requires that the fair value of share-based compensation be expensed; a $.323 million relateddecrease in engineering management costs, due in part, to an increase in the number of employees working in governmentcosts directly charged to research and military relations and strategic planning and business development efforts, engineering management, an expanded sales organization at MTI Instruments, anproduct development; a $.175 million increase in corporate support employees related to Sarbanes-Oxley compliance and non-cash stock-based compensation expenses; increased depreciation expense of $.085 million due to an increase in capital expenditures; an increase of $.046 million in consulting and other professional fees related to consultants for government relations financial consulting and information technology;marketing and business development activities; a $.045 million increase in salaries and related benefits (including $.177 million increase related to government relations and business development offset by $.132 million decrease primarily resulting from the clo sing of the California operations and the reduction of the government systems organization); a $.050 million decrease in operating costs related to the closing of the CA office and the consolidation of certain administrative functions; a $.031 million decrease in facilities depreciation due to a lease extension; a $.033 million decrease in public relations costs; and a $.024$.007 million decrease in other expenses, net.
Selling, general and administrative expenses increased by $2.839 million, or 58.1%, to $7.729 million for the nine months ended September 30, 2005 in comparison to the same period in 2004. This change is primarily the result of the following changes: an increase of $.130 million in licensing and patent fees related to agreements with LANL; an increase of $.267 million in consulting and other professional fees including increases of approximately $.444 million of costs related to Sarbanes-Oxley compliance and the SEC review of the Company's filings, $.308 million of costs related to consultants for government relations, financial consulting and information technology partially offset by decreases of $.300 million in advisory fees and $.148 million in legal fees related to the 2004 private placement amendment; increased salaries and employee benefits of $2.052 million related to an increase in the number of employees working in government and military relations and strategic planning and business developmen t efforts, engineering management, an expanded sales organization at MTI Instruments, an increase in corporate support employees related to Sarbanes-Oxley compliance, the addition of Government Systems in September 2004, severance costs and non-cash stock-based compensation expense; increased depreciation expense of $.291 million due to an increase in capital expenditures; and a $.099 million increase in other expenses, net.
Operating Loss.Operating loss for the three months ended September 30, 2005 in comparison to the same period last year decreased by $1.005 million to $2.623 million, a 27.7% decrease. This decrease in operating loss results primarily from decreases in funded and unfunded research and product development expenses and increases in funded research and development revenue partially offset by increases in selling, general and administration expense and decreases in gross profits from product revenues in the Test and Measurement Instrumentation segment.
Operating loss for the nine months ended September 30, 2005March 31, 2006 in comparison to the same period last year increased by $.918$.032 million to $11.465$4.601 million, an 8.7%a less than 1% increase. This increase in operating loss results primarily from increases in selling, general and administration expense and funded research and product development expenses in the New Energy segment as well as decreases in gross profits from product revenues in the Test and Measurement Instrumentation segment partially offset by increases in funded research and development revenue in the New Energy segment and decreases in unfunded research and product development expenses.
Gain on Sale of Securities Available for Sale.Results for the three and nine months ended September 30, 2005March 31, 2006 included a $.490 million and $10.125$1.266 million gain on sale of securities available for sale, respectively, compared tosale. There were no such gains of $0 and $3.129 million, respectively, for the same periodsperiod in 2004.2005. During the three months ended September 30, 2005,March 31, 2006, the Company sold 100,000303,500 shares of Plug Power common stock at aan average price of $6.68$5.95 per share, with proceeds to the Company of $.668$1.805 million. On June 24, 2005, Fletcher notified the
26
Loss on Derivatives.The Company of its election to exercise in full its right to purchase from the Company certain shares of common stock of Plug Power. As a result of this election, Fletcher purchased 1,799,791 shares of Plug Power common stock from the Company at a price of $0.7226 per share, with proceeds to the Company of $1.301 million. This transaction closed on June 28, 2005 and, in connection with this exercise, the Company recognized arecorded no loss on the derivative immediately prior t o exercise of $7.173 millionderivatives during 2006 and a gain on the sale of Plug Power common shares of $9.635 million.
31
Loss on Derivatives.The Company recorded a loss of $0 million and $2.635$3.234 million on derivative accounting for the three months ended September 30,March 31, 2005. The 2005 and 2004, respectively. These results relateresult relates to the embedded derivative for the purchase of Plug Power common stock, which iswas issued as part of the 2004 private placement transaction and the January 2004 expiration of the SatCon warrants.transaction. The embedded derivative, prior to its exercise, was valued on a quarterly basis using the Black-Scholes Option PricingBlack Scholes Option-Pricing model and upon its exercise on June 24, 2005 was valued using the intrinsic value method.
The Company recorded losses of $10.407 million and $2.424 million on derivative accounting for the nine months ended September 30, 2005 and 2004, respectively. These results relate to the embedded derivative for the purchase of Plug Power common stock, which is part of the 2004 private placement transaction and the January 2004 expiration of the SatCon warrants. Changes in derivative fair value for the embedded derivative is calculated using the Black-Scholes Option Pricing Model or upon exercise using the intrinsic value method.
Income Tax (Expense) BenefitThe income tax expense rate for the three months ended September 30, 2005March 31, 2006 was 7.19%17.44% and the income tax benefit rate for the three months ended September 30, 2004March 31, 2005 was 39.75%15.70%. TheThese tax rates are primarily due to losses generated by operations, changes in the valuation allowance, disproportionate effects of reclassification of gains included in net income and the projected annual effective tax rate adjustments. It is anticipated that a full valuation allowance will be required by the end of 2005 and the provision for the three months ended September 30, 2005 has been adjusted to reflect the projected annual effective tax rate including the anticipated impact of a full valuation allowance.
The income tax expense rate for the nine months ended September 30, 2005 was 3.57% and the income tax benefit rate for the nine months ended September 30, 2004 was 39.40%. The tax rates are primarily due to losses generated by operations, changesadjustments made in the valuation allowance and the projected annual effective tax rate adjustments. It is anticipated that a full valuation allowance will be required by the end of 2005 and the provision for the nine months ended September 30, 2005 has been adjusted to reflect the projected annual effective tax rate including the anticipated impact of a full valuation allowance.2005.
The valuation allowance at September 30, 2005March 31, 2006 was $7.037$12.798 million and at December 31, 20042005 was $1.836$10.923 million. The Company determined that it was more likely than not that the ultimate recognition of certain deferred tax assets would not be realized.
Further, as a result of ownership changes in 1996, the availability of $.561$.109 million of net operating loss carry-forwards to offset future taxable income will be limited pursuant to the Internal Revenue Code.Code of 1986, as amended.
Liquidity and Capital Resources
The Company has incurred significant losses as it continues to fund MTI Micro's DMFC product development and commercialization programs. The Company expects that losses will continue and fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, gains on sales of securities available for sale, the operating results of MTI Instruments and MTI Micro, and the availability, or lack thereof, of equity financing including(including the
additional investment rights issued in connection with the 2004 private placement and the ability to attract government funding resourcesresources) to offset research and development costs. As of September 30, 2005,March 31, 2006, the Company had an accumulated deficit of $77.380$85.149 million. During the ninethree months ended September 30, 2005,March 31, 2006, the Company's results of operations resulted in a net loss of $10.756$3.431 million and used cash in operating activities totaling $10.418$3.387 million. This cash use in 20052006 was funded primarily by cash and cash equivalents on hand as of December 31, 20042005 of $22.545$11.230 million. The Company expects to continue to incur losses as it seeks to develop and commercialize Mobion®fuel cell systems and it expects to continue funding its operations from current cash and cash equivalents, the sales of securities available for sale, proceeds, if any, from the exercise of additional investment rights issued in connection with the 2004 private placement or other equity financings and government program fu nding. The Company expects to spend approximately $9.1 million on research and development of Mobion® fuel cells and $1.1 million in research and development on MTI Instruments' products in 2005.
32funding.
There can be no assurance that the Company will not require additional financing during 20052006 or that any additional financing will be available to the Company on terms acceptable to the Company, if at all. Cash used in operations is expected to total approximately $14.7$16.0 million for 2005.2006. Further, cash used for capital expenditures is expected to total approximately $1$2.5 million in 20052006 and will consist of purchases for leasehold improvements, furniture, computer equipment, software and manufacturing and laboratory equipment. The Company believes it will have adequate resources to fund operations and capital expenditures through the thirdsecond quarter of 2007 based on current cash and cash equivalents, current cash flow and revenue projections and the potential sale of securities available for sale at current market values. Proceeds from the sale of securities available for sale are subject to fluctuations in the market value of Plug Power. The Company may also seek to provide additional resources through an equity offering. Govern mentAdditional government revenues and Fletcher's potential exercise of additional investment rights totaling up to an additional $20 million could also provide additional resources.resources, although with an exercise price of $6.023 per share it is unlikely that Fletcher will exercise its right unless our stock price increases. The Company anticipates that it will have to raise additional equity capital to fund its long-term business plan, regardless of whether Fletcher exercises any or all of its additional investment rights.
FutureAs of March 31, 2006, the Company owned 3,389,936 shares of Plug Power common stock. Potential future sales of Plug Power securities will generate taxable income or loss, which is different from book income or loss, due to the tax bases in these assets being significantly different from their book bases. Book and tax bases as of September 30, 2005March 31, 2006 are as follows:
Average Average Security Shares Held Book Cost Basis Tax Basis Plug Power 3,693,436 $1.78 $0.96
Average Average Security Shares Held Book Cost Basis Tax Basis Plug Power 3,389,936 $1.78 $0.96As of September 30, 2005, the Company owned 3,693,436 shares of Plug Power common stock. In connection with the 2004 private placement the Company had placed 2,700,000 of its Plug Power shares in escrow. On June 24, 2005, Fletcher notified the Company of its election to exercise in full its right to purchase from the Company certain shares of common stock of Plug Power. As a result of this election, Fletcher purchased 1,799,791 shares of Plug Power common stock from the Company at a price of $0.7226 per share, with proceeds to the Company of $1.301 million. This transaction closed on June 28, 2005 and, in connection with this exercise, the Company recognized a loss on the derivative immediately prior to exercise of $7.173 million and a gain on the sale of Plug Power common shares of $9.635 million. Additionally, the remaining 900,209 shares of Plug Power common stock were released from escrow on June 30, 2005.
Plug Power stock is currently traded on the Nasdaq National Market and is therefore subject to stock market conditions. When acquired, these securities were unregistered. Plug Power securities are considered "restricted securities" as defined in Rule 144 and may not be sold in the future without registration under the Securities Act, unless in compliance with an available exemption there from.
27
Working capital was $31.192$21.089 million at September 30, 2005,March 31, 2006, a $3.620.$3.376 million decrease from $34.812$24.465 million at December 31, 2004.2005. This decrease is primarily the result of the use of cash in operations offset by increasesand the decrease in the
market value of securities available for sale and numberoffset by proceeds from the sale of shares due to the release from escrow of previously restricted securities.
At September 30, 2005,March 31, 2006, the Company's order backlog was $1.255$1.123 million, compared to $.480$.862 million at December 31, 2004.2005.
33
Inventory and accounts receivable (from product revenues) turnover ratios and their changes for the ninethree months ended September 30March 31 are as follows:
2005 | 2004 | Change | 2006 | 2005 | Change | |
Inventory | 1.80 | 1.80 | - | 2.20 | 1.90 | .30 |
Accounts receivable (from product revenues) | 6.47 | 6.65 | (.18) | 2.10 | 2.03 | .07 |
The decreaseincrease in the accounts receivable turnover ratio is primarily the result of lowerthe timing of sales in 2005during the first quarter of 2006 to the U.S. Air Force, which pays its obligations more quickly than typical commercial accounts.
The increase in the inventory turnover ratio is a result of higher sales volume combined with decrease in average inventory.
Cash flow used by operating activities was $10.418$3.387 million for the ninethree months ended September 30, 2005March 31, 2006 compared with $9.133$3.880 million in 2004.2005. This cash use increasedecrease of $1.285$.493 million reflects increasesdecreases in cash expenditures to fund New Energy segment operations' growth, partially offset byof approximately $.243, coupled with balance sheet changes of $.250 million, which reflect the timing of cash payments and receipts.
Capital expenditures were $.721$.262 million during the first ninethree months of 2005, a decrease2006, an increase of $.527$.060 million from the prior year. Capital expenditures in 20052006 included leasehold improvements, computer equipment, demonstration equipment, software, and manufacturing and laboratory equipment. There were $.019 million in outstandingOutstanding commitments for capital expenditures as of September 30, 2005.March 31, 2006 totaled $74 thousand and include commitments for computer equipment and manufacturing and laboratory equipment. The Company expects to finance these expenditures with current cash and cash equivalents, the sale of securities available for sale, equity financing and other sources, as appropriate and to the extent available.
Pursuant to additional investment rights, Fletcher has the right, but not the obligation, to purchase, in a single purchase or multiple purchases, up to an additional $20 million of our common stock at any time prior to December 31, 2006 at a price per share equal to $6.023 (as adjusted from $6.34), which date and price may be extended and adjusted, respectively, in certain circumstances.
TheDuring 2006, the Company may sellsold 303,500 shares of Plug Power common stock in connection with itsproceeds totaling $1.805 million and gains totaling $1.266 million. These proceeds reflect the Company's previously announced strategy to raise additional capital through the sale of Plug Power stock in order to fund its micro fuel cell operations. Taxes on the net gains are expected to be offset by the Company's operating losses. As of September 30, 2005,March 31, 2006, the Company has estimatedestimates its remaining net operating loss carry forwards to be approximately $36.049$41.669 million.
New Accounting Pronouncements
In November 2004,March 2006, the Financial Accounting Standards Board ("FASB")(FASB) issued SFAS No. 156, "Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140," that provides guidance on accounting for separately recognized servicing assets and servicing liabilities. In accordance with the provisions of SFAS No. 156, separately recognized servicing assets and servicing liabilities must be initially measured at fair value, if practicable. Subsequent to initial recognition, the Company may use either the amortization method or the fair value measurement method to account for servicing assets and servicing liabilities within the scope of this Statement. An entity should adopt the Statement as of the beginning of its first fiscal year that begins after September 15, 2006. The Company will adopt SFAS No. 156 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the company's Consolidated Financial Statements.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140," to permit fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation in accordance with the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The company will adopt SFAS No. 155 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the company's Consolidated Financial Statements.
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In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, "Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)", that will become effective beginning third quarter of 2006. FSP FIN No. 46(R)-6 clarifies that the variability to be considered in applying Interpretation 46(R) shall be based on an analysis of the design of the variable interest entity. The adoption of this FSP is not expected to have a material effect on the Company's Consolidated Financial Statements.
In the first quarter of 2006, the Company adopted SFAS No. 154, "Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS No. 154 changed the requirements for the accounting for and reporting of a voluntary change in accounting principle. The adoption of this Statement did not affect the Company's Consolidated Financial Statements in the period of adoption. Its effects on future periods will depend on the nature and significance of any future accounting changes subject to this statement.
Beginning January 2006, the company adopted SFAS No. 151,Inventory "Inventory Costs-an amendment of ARB No. 43, Chapter 4(4."FAS 151"), which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. SFAS No. 151 requires idle facility expenses, freight, handling costs and wasted material (spoilage) costscertain abnormal expenditures to be recognized as current-period charges.expenses in the current period versus being capitalized in inventory. It also requires that allocationthe amount of fixed production overheadsoverhead allocated to the costs of conversioninventory be based on the normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is in the process of evaluating the impactadoption of this standard on its consolidated financial statements.
In December 2004, SFAS No. 123 (revised 2004),Share-Based Payment, ("SFAS No. 123R") was issued. In March 2005 the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107"). SAB 107 expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments basedstatement did not have a material effect on the grant-dateCompany's Consolidated Financial Statements.
Beginning January 2006, the Company adopted SFAS Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, which is an interpretation of SFAS Statement No. 143, Accounting for Asset Retirement Obligations. The interpretation requires a liability for the fair value of a conditional asset retirement obligation be recognized if the fair value of the award.liability can be reasonably estimated. The grant-date fair valueadoption of employee sharethis statement did not have a material effect on the Company's Consolidated Financial Statements.
options and similar instruments will be estimated using option-pricing models adjusted for the unique
characteristics of those instruments. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. In April 2005, the SEC delayed the implementation of
SFAS 123R for public companies until the first annual period beginning after June 15, 2005. SFAS 123R is required to be adopted byBeginning January 2006, the Company as of January 1, 2006.
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The Company currently utilizes a closed form option-pricing model to measure the fair value of stock-based compensation for employees. SFAS 123R permits the use of this model or other models such as a lattice model. The Company has not yet determined which model it will use to measure the fair value of share-based grants to employees upon the adoption of SFAS 123R. The effect of expensing stock options in accordance with the original SFAS 123 is presented above under Note 2, Significant Accounting Policies. SFAS 123R also requires that the benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This presentation may reduce net operating cash flows and increase net financing cash flows in periods after the effective date. The amount of this excess tax deduction benefit was $81 thousand and $130 thousand in the nine months ended September 30, 2005 and 2004, re spectively. The unvested value of share awards to be amortized into the operating statement is approximately $3.242 million as of September 30, 2005.
In December 2004, the FASB issuedadopted SFAS No. 153,Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29("SFAS No. 153").29. SFAS No. 153 which addresses the measurement of exchanges of non-monetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for non-monetary asset exchanges beginning in our second quarterThe adoption of fiscal 2006. The Company isthis statement did not affect the Company's Consolidated Financial Statements in the processperiod of evaluatingadoption. Its effects on future periods will depend on the impactnature and significance of this standard on its consolidated financial statements.
In May 2005, SFAS No. 154,Accounting Changes and Error Corrections - replacement of APB Opinion No. 20 and FASB Statement No. 3, ("SFAS No. 154") was issued. SFAS No. 154 changes the accounting for and reporting of a change in accounting principle by requiring retrospective application to prior periods' financial statements of changes in accounting principle unless impracticable. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of SFAS No. 154 to have a material impact on its results of operations, financial position or cash flows.
In June 2005, the FASB's Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 05-6,Determining the Amortization Period for Leasehold Improvements ("EITF 05-6"). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The Company does not believe that the adoption of EITF 05-6 will have a significant effect on its financial statements.
Additional Information Concerning Risks
In connection with the 2004 private placement, we may have to (1) sell shares of our common stock at prices which result in substantial dilution to our shareholders, and (2) issue additional shares of our common stock to Fletcher at prices that may be substantially below market value at the time of issuance without any payment required by Fletcher, which would cause our shareholders to suffer additional dilution.
After giving effect to the 1,261,829 shares of common stock we issued to Fletcher on December 22, 2004 (as well as all shares issued or to be potentially issued to Fletcher in connection with our failure to satisfy the registration requirement as discussed in Note 7, Shareholders' Equity), the 2004 private placement provided Fletcher additional investment rights to purchase up to an additional $20 million of our common stock at a price equal to $6.34 per share (subject to adjustment). This price has been reduced to $6.023 per share due to our failure to satisfy the registration requirement, and may be further reduced due to, among other things, continuing failure to satisfy such registration requirement. Any exercise of the additional investment rights could result in sales of our common stock at prices that are below the market price for our common stock at the time the investment right is exercised and could result in substantial dilution to our shareholders.
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Our agreement with Fletcher also provides that Fletcher will receive additional shares of our common stock with respect to shares it already owns, and the exercise price and term relating to unexercised additional investment rights will be adjusted to the benefit of Fletcher, each upon the occurrence of certain events or circumstances, some of which are beyond our control, including:
- issuances of our equity securities at a price below $7.048 per share (which is the price Fletcher paid in connection with its initial $10 million investment) or issuances of our equity securities at a price below $6.34 per share (which was the original exercise price relating to the additional investment rights);
- our failure to satisfy certain requirements relating to registering the resale of shares issued or issuable to Fletcher pursuant to the securities laws;
- a change in control of our Company; and
- a restatement of our financial results.
In any event, 8,330,411 shares is the maximum number of shares of our common stock we may be required to issue to Fletcher, which amount includes the 1,418,842 shares issued on January 29, 2004, the 1,261,829 shares issued on December 22, 2004 and the 66,413 registration penalty shares issued on April 20, 2005.
In connection with the 2004 private placement, we will be responsible for having the resale of shares purchased by Fletcher registered with the SEC within defined time periods andfuture transactions subject to penalties if the shares are not registered with the SEC within those defined time periods.
Pursuant to our agreement with Fletcher, we are obligated, within ten business days after the closing of the purchase of any additional shares by Fletcher pursuant to rights issued in connection with the 2004 Private
Placement, to file a registration statement with the SEC covering the resale of all such shares. We are also obligated to cause each of those registration statements to be declared effective not more than sixty (60) days after the closing of the purchase of such shares, or if the registration statement is reviewed by the SEC, not more than ninety (90) days after the closing of the purchase of such shares. If we fail to file the registration statements or become effective as set forth above, we must issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was based on the actual exercise price reduced by five percent for each month in which we fail to satisfy our obligations and adjust the exercise price for the additional investment rights to such lower price. In addition, such failure may result in an extension of the investment term for each day we fail to satisfy our registration obligations. The Company initially filed a Registrat ion Statement on January 6, 2005 which was within ten business days after the closing of the purchase of additional shares by Fletcher on December 22, 2004. The 90-day deadline for this Registration Statement to be declared effective was March 22, 2005. Since the Registration Statement was declared effective on April 21, 2005, we failed to meet the March 22, 2005 deadline and therefore were required to issue 66,413 additional shares of common stock to Fletcher without any payment required on its part.statement.
Statement Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q and the documents we have filed with the Securities and Exchange Commission that are incorporated by reference into this Form 10-Q contain and incorporate forward-looking
statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Any statements contained, or incorporated by reference, in this Form 10-Q that are not statements of historical fact may be forward-looking statements. When we use the words "anticipates," "plans," "expects," "believes," "should," "could," "may,"
"will" "will" and similar expressions, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements.stat ements. These factors include, among others:
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Readers should not rely on our forward-looking statements. These and other risks are set forth in greater detail in the "Risk Factors" section of our 20042005 Form 10-K, which are incorporated herein by reference, and under the caption "AdditionalPart II Other Information, Concerning Risks"Item 1A: Risk Factors,in this Quarterly Report on Form 10-Q. Except as may be required by applicable law, we do not undertake or intend to update any forward-looking statements after the date of our 2004 Form 10-K, which are incorporated herein by reference.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We develop products in the United States and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign exchange rates or weak economic conditions in foreign markets. Since our sales are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of
the dollar could make our products less competitive in foreign markets. Interest income is sensitive to changes in the general level of U.S. interest rates, particularly since our investments are in cash equivalents. Based on the nature and current levels of our cash equivalents, however, we have concluded that there is no material market risk exposure.
As a result of holding securities available for sale, the Company is exposed to fluctuations in market value. The Company recognizes changes in market value through the balance sheet, however if an other than temporary
market decline were to occur, it could have a material impact on the Company's operating results.
The Company's issued derivatives consist of warrants and rights to purchase shares of the Company's common stock and Plug Power common stock owned by the Company. The fair value of the embedded derivative for the right to purchase Plug Power common stock iswas recorded in the financial statement line titled "Derivative liability."liability" until its exercise date during June 2005. This derivative, prior to its exercise, was valued on a quarterly basis using the Black-Scholes Option Pricing
Black Scholes Option-Pricing model and upon its exercise on June 24, 2005 was valued using the intrinsic value method. The Company recognizes changes in fair value through the operating statement line titled "Loss"Gain (loss) on derivatives." The Company does not use derivative financial instruments for speculative or trading purposes.
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Item 4. Controls and Procedures
The certifications of the Company's Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q include, in paragraph 4 of such certifications, information concerning the Company's disclosure controls and procedures and internal control over financial reporting. Such
certifications should be read in conjunction with the information contained in this Item 4 for a more complete understanding of the matters covered by such certifications.
(a) Evaluation of Disclosure Controls and Procedures
The Company's management, under the supervision of and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and other 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 recorded, processed, summarized, reported and communicated to the company'sCompany's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure in accordance with Exchange Act Rule 13a-15(e). Based on that evaluation, the Company's management, including the Chief Executive OfficerOffic er and the Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report.
The Company's management, including the Chief Executive Officer and the Chief Financial Officer, have concluded that the material weakness in the Company's internal controls over the calculation of the quarterly tax provision in accordance with generally accepted accounting principles as discussed in the Company's Quarterly Report on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005, was remediated as of September 30, 2005. The remedial actions included strengthening internal controls over the preparation and review of income tax accounting procedures through improvements to our organizational structure that provide for a separate individual preparing the tax accrual and the chief financial officer reviewing the tax accrual. Additionally, we implemented a checklist of items considered during the preparation and review of the income tax provision, in order to identify unusual or complex transactions that should be evaluated for the appropriate tax and accounting requirements.
(b) Changes in Internal Control Over Financial Reporting
There have been no changes in the Company's internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the Company's fiscal quarter ended September 30, 2005March 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At any point in time, the Company and its subsidiaries may be involved in various lawsuits or other legal proceedings. Such lawsuits could arise from the sale of products or services or from other matters relating to its regular business activities, compliance with various governmental regulations and requirements, or other transactions or circumstances. The Company does not believe there are any such proceedings presently pending whichthat could have a material adverse effect on the Company's financial condition.
Item 1A. Risk Factors
Our 2005 Form 10-K includes a detailed discussion of our risk factors. These factors could cause our actual result to differ materially from those stated in forward-looking statements contained in this document and elsewhere. Pursuant to the instructions to Form 10-Q, the Company has provided below, only those risk factors that are new or that have been materially amended since the time that we filed our 2005 Form 10-K. Accordingly, the information presented below should be read in conjunction with the risk factors and information disclosed in our 2005 Form 10-K.
We have incurred losses and anticipate continued losses. If we do not become profitable and sustain profitability, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: As of March 31, 2006, we had an accumulated deficit of $85.149 million. For the quarter ended March 31, 2006, our net loss was $3.431 million, which includes a net gain of $1.266 million from sales of securities available for sale and an operating loss of $4.601 million. We expect to continue incurring net losses from operations until we can produce sufficient revenues to cover costs. In order to achieve profitability, we must successfully achieve all or some combination of the following:
Furthermore, we anticipate that we will continue to incur losses until we can produce and sell our fuel cell systems on a large-scale and cost-effective basis. Even if we do achieve profitability, we may be unable to sustain or increase our profitability in the future. Failure to do so will have a material adverse effect on our business plans, prospects, results of operations and financial condition.
Our resources available to fund operations may fluctuate as the value of Plug Power's share price fluctuates. Such price fluctuations could result in our requiring additional funding sooner than anticipated: A primary asset of the Company is the shares of Plug Power common stock it owns. As of March 31, 2006, the Company owned 3,389,936 shares of common stock in Plug Power, which is a publicly traded company. The market price of the Plug Power common stock may fluctuate due to market conditions and other conditions over which the Company has no control. Fluctuations in the market price of Plug Power's common stock may result in a reduction of resources available to fund operations which could result in our requiring additional funding sooner than anticipated.
Item 2. Changes inUnregistered Sales of Equity Securities and Use of Proceeds and Issuer Purchases of Equity Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
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Item 6. Exhibits
Exhibit No. | Description |
31.1 | Rule 13a-14(a)/15d-14(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Steven N. Fischer |
31.2 | Rule 13a-14(a)/15d-14(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Cynthia A. Scheuer |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Steven N. Fischer |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Cynthia A. Scheuer |
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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.
Mechanical Technology Incorporated
(Date) | /s/Steven N. Fischer Steven N. Fischer Chief Executive Officer |
(Date) | /s/Cynthia A. Scheuer Cynthia A. Scheuer Vice President, Chief Financial Officer and Secretary |
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