UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2005 or
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _____ to _____
Commission file number:
| Electro Energy Inc. | ||
| (Exact name of small business issuer in its charter) | ||
| Florida | 59-3217746 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 30 Shelter Rock Road Danbury, CT | 06810 | |
| (Address of principal executive offices) | ((Zip Code) |
Issuer’s telephone number: (203) 797-2699
Securities Registered Under Section 12(b) of the Exchange Act:None
Securities Registered Under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value
(Title of class)
Check whether the Issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No
As of October 21, 2005, 16,445,807 shares of Common Stock, par value $.001 per share, were outstanding.
Transitional Small Business Disclosure Format (Check one): Yes No
ELECTRO ENERGY INC.
INDEX
| Description | Page Number | |
|---|---|---|
| Part I | FINANCIAL INFORMATION | |
| Item 1 | Financial Statements | 1 |
| Item 2 | Management's Discussion and Analysis or Plan of Operation | 1 |
| Item 3 | Controls and Procedures | 7 |
| Part II | OTHER INFORMATION | |
| Item 1 | Legal Proceedings | 8 |
| Item 2 | Unregistered Sales of Equity Securities and Use of Proceeds | 8 |
| Item 3 | Defaults Upon Senior Securities | 9 |
| Item 4 | Submission of Matters to a Vote of Security Holders | 9 |
| Item 5 | Other Information | 9 |
| Item 6 | Exhibits and Reports on Form 8-K | 9 |
| Signatures | 10 |
Forward-looking Statement Disclaimer
Forward-looking statements in this report, including without limitation, statements related to the Company’s plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) the Company’s plans, strategies, objectives, expectations and intentions are subject to change at any time at the discretion of the Company; (ii) the Company’s plans and results of operations will be affected by the Company’s ability to manage its growth; and (iii) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission.
In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this report.
PART I
Item 1. FINANCIAL STATEMENTS.
The full text of the Company’s unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2005 and 2004 begins on page F-1 of this Report.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
You should read the following discussion and analysis together with the financial statements and related notes included elsewhere in this report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in any forward-looking statements as a result of many factors.
Results of Operations
Three and Nine Months Ended September 30, 2005 Compared to Three and Nine Months Ended September 30, 2004
Net Revenue
Consolidated net revenue for the third quarter of 2005 was $941,472 compared with $1,952,887 for the same period of 2004, a decrease of $1,011,415, or -51.8%. Consolidated net revenue for the nine months ended September 30, 2005 was $2,748,751 compared with $5,459,529 for 2004, a decrease of $2,710,778, or -49.7%. Of the revenue decrease, $2,505,136 was attributable to a reduction of revenues from products produced by Mobile Energy Products, Inc. (“MEP”), whose product manufacturing operations were acquired on October 1, 2003 from EaglePicher Technologies, LLC (“EaglePicher”) and by revenue decreases of $205,642 for the services operations. Consolidated contract backlog as of September 30, 2005 was $3,552,500.
Consolidated net revenue included net revenue pursuant to supply agreements with EaglePicher amounting to $295,298 (57.7% of net revenue) and $778,942 (39.9% of net revenue) for the third quarter of 2005 and 2004, respectively and $554,043 (20.2% of net revenue), and $2,829,911 (51.8% of net revenue) for the nine months ended September 30, 2005 and 2004, respectively. On April 11, 2005, Eagle Picher, Inc. and its affiliates announced its voluntary Chapter 11 bankruptcy filing. Eagle Picher, Inc.‘s public releases state they are in the process of reorganizing, and certain assets will be liquidated to meet financial obligations. We believe the portion of the company which produces batteries is believed to be a viable business entity and is expected to continue operations either as part of a reorganized business or under new ownership because its operations are a part of national defense. In any event the components which we produce are expected to be required to the extent that the need for products that utilize these components continues to exist, and that any successor or reorganized entity places similar orders through us.
Net revenue from products for the third quarter of 2005 was $339,036 compared with $1,085,586 for the same period of 2004, a decrease of $746,550, or -68.8%. Net revenue from products for the nine months ended September 30, 2005 was $588,021 and $3,093,157 for the nine months ended September 30, 2004, a decrease of $2,505,136, or -81.0%. The decrease resulted primarily from a reduction in order volume amounting to $2,275,868 from EaglePicher, whom the Company has a supply agreement in addition to a one time order shipped in the third quarter of 2004 for $309,326, offset by increases in sales to new customers of $80,058. The main cause of the MEP revenue decrease was reduced orders for sinter plaque and strikers. The quantities ordered for these components are a function of EaglePicher demand for the products that utilize these components and inventories on hand. Our supply agreement only provides the Company would be the exclusive supplier of these components to the extent required by EaglePicher for a five year term. We had no advance notice from EaglePicher for the steep decline in orders. At the time we entered into the supply agreement with EaglePicher, we recognized that the level of initial orders was somewhat higher than expected on a year to year basis and was a result of inventory build up at EaglePicher and accelerated demand related to increased military spending in 2004, but there was no reason to anticipate an ultimate decrease in order quantities over the long run. The Company expects this trend to continue into the fourth quarter of 2005 as a result of reduced demand for products that utilize the components we produce and efforts at EaglePicher to reduce inventory for cash flow considerations driven by their recently announced Chapter 11 filing. As of September 30, 2005, we have orders of $27,542 for components from EaglePicher. EaglePicher has not shared with us their expected order needs.
As a result of EaglePicher’s financial status and decreased supply needs, we made certain staff reductions, effective as of second quarter 2005. However, as the overall business plan for the Colorado Springs operation, it is and was always the plan to broaden the product mix and activities to reduce dependence on Eagle Picher component orders. To that end, we have received contracts to develop Lithium and Thermal batteries, are using that capability to develop manufacturing of Nickel-Metal Hydride batteries, and are pursuing orders for Nickel Cadmium batteries in the Colorado Springs facility. Specifically, the Company has received two phase I contracts to develop Lithium batteries with the Navy for $69,943 (June 2004) and the Air Force for $98,647 (March 2005). We have entered into three projects with IN-Q-TEL for $500,000 (March 2004), $450,000 (March 2005), and $800,000 (October 2005) to develop bipolar Lithium batteries. We have received an Air force Phase II $658,000 (March 2005) contract and a phase I $125,000 contract with Sandia National Laboratories to develop Thermal batteries. We are using the Colorado Springs facility in connection with these contracts in order to make efficient use of the operations there and mitigate excess capacity in that facility.
The Company is also utilizing the Colorado Springs facilities and personnel to develop, design and construct equipment that will produce nickel electrodes for our Nickel–Metal Hydride batteries. The Company is funding that effort as a capital expense. The Company has recently received an order for $235,000 for (July 2005) Nickel-Cadmium batteries for Apache Helicopters. Management intends to utilize the Colorado Springs operation to continue to produce components for EaglePicher, produce Nickel-Cadmium batteries, continue the development of Lithium and Thermal and supply these batteries as demand develops. The level of product deliveries anticipated for the fourth quarter of 2005 is significantly below the facility’s capability. However, the Company expects the costs of the Colorado Springs operation for the fourth quarter of 2005 will be covered by contract funding for research and development described above, as well as the anticipated new projects that management is currently pursuing.
In summary, the Company has taken several steps to mitigate excess capacity at the Colorado Springs facility, including staffing adjustments and allocations of personnel to utilize and reduce any excess capacity. The Company has expanded technologies that management is pursuing for business in Colorado Springs from Nickel Cadmium batteries and components supplied to EaglePicher to include Lithium and thermal batteries. In response to EaglePicher’s recent bankruptcy filing and its effect on our relationship with EaglePicher, management has made various operational adjustments within our Colorado Springs facility in an effort to stabilize excess capacity there. In addition, management believes that some expansion of activities there may occur early next year.
Net revenue from services for the third quarter of 2005 was $602,436 compared with $867,301 for the same period of 2004, a decrease of $264,865, or -30.5%. Net revenue from services for the nine months ended September 30, 2005 was $2,160,730 compared with $2,366,372 for 2004, a decrease of $205,642, or -8.7%. The primary reasons for the decrease in the research and development services operations business related to reduced revenues from the U. S. Army and U.S. Department of Energy where the timing of the services provided within the contract term were more substantial in the prior year in addition to a reversal of revenues of $41,414 previously recorded in the fourth quarter of 2004 associated with the Company’s expectation of recovering additional costs expended for general administration and overhead costs due to concluding fixed price contracts where the funds are deemed insufficient and the expenses cannot be recovered, offset by an increase related to the addition of a development agreement entered into on March 31, 2005 with a private venture capital firm generating revenues of $139,941 (net of a $10,059 discount recorded in connection with the amortization of the value of warrants issued as an inducement to enter into the development agreement) during the nine months ended September 30, 2005. See Related Parties below.
The underlying government and commercial contracts pertaining to net revenue from services for the periods mentioned are primarily with the U.S. Air Force, U.S. Army, U.S. Navy, Department of Energy, and commercial customers with performance periods that commenced July 1, 2000 and continue through March 31, 2007 requiring deliverables involving periodic status reports and in certain cases prototypes. Most government contracts are negotiated as cost plus fixed fee (“CPFF”), while others are firm fixed price (“FFP”), milestone or cost plus cost share (“CPCS”) type contracts. Commercial orders are contracted by purchase order (“PO”). At the completion of each contract and after all contract requirements have been met, a final invoice is submitted, audited, and satisfied. In the event overhead and general and administrative rates are recalculated at less than billed amounts, a credit is issued to the buying party. In past history, the Company has received complete contract funding on all awards as agreed.
Gross (Loss) Profit
Consolidated gross loss for the third quarter of 2005 was $52,753 (-5.6% of net revenue) compared to gross profit of $366,412 (18.8% of net revenue) for the same period of 2004, a decrease of $419,165. Consolidated gross loss for the nine months ended September 30, 2005 was $791,275 (-28.8% of net revenue) compared to gross profit of $ 856,752 (15.7% of net revenue) for the nine months ended September 30, 2004, a decrease of $1,648,027, or - -192.4%. The gross profit decrease was primarily due to operating below planned capacity in the first nine months of 2005. As a result, the Company’s operating margin included unabsorbed overhead incurred in the first nine months of 2005.
Gross loss from products for the third quarter of 2005 was $53,080 (-15.7% of net revenue from products) compared to gross profit of $198,923 (18.3% of net revenue from products) for the same period of 2004. Gross loss from products for the nine months ended September 30, 2005 was $628,198 (-106.8% of net revenue from products) and gross profit from products for the nine months ended September 30, 2004 was $542,669 (17.5% of net revenue from products). MEP operated below planned capacity in the first nine months of 2005. As a result, the Company’s operating margin included unabsorbed overhead incurred in the first nine months of 2005. The Company expects this trend to continue into the fourth quarter of 2005.
The components of costs of revenues for products include direct materials, direct labor, and an operating overhead allocation based upon direct labor usage. An operating overhead cost pool is estimated to support the forecasted manufacturing activities in advance of the year. The overhead is assigned as product is produced based upon direct labor usage using an absorption method. Any unabsorbed overhead is expensed in the period incurred.
Gross profit from services for the third quarter of 2005 was $327 (0.1% of net revenue from services) compared to gross profit of $167,489 (19.3% of net revenue from services) for the same period of 2004. Gross loss from services for the nine months ended September 30, 2005 was $163,077 (-7.5% of net revenue from services) compared to gross profit of $314,083 (13.3% of net revenue from services) for the nine months ended September 30, 2004. The gross profit from services primarily pertains to gross profit earned on the Company’s research and development contracts with the U.S. government and its agencies. The typical gross profit attainable under these contracts ranges from 6-10%. However, the Company has taken on certain contracts on a cost only basis or at a loss in order to satisfy quality results. The Company believes that its participation in these contracts will benefit the Company’s technological advancement and generation of commercial revenues in the long-term. The decrease in net revenue from services over prior year resulted in a $30,373 decrease in gross profit. In connection with this decrease, the Company’s overhead is running beyond recoverable negotiated rates by $284,081, contributing to the decrease in gross profit. The Company reversed revenues of $41,414 previously recorded in 2004 associated with its expectation of recovering additional costs expended for general administration and overhead costs due to concluding fixed price contracts where the funds are deemed insufficient and the expenses cannot be recovered. The Company generated revenues from services of $356,578 from an extension of a contract containing a zero profit provision contributing $24,960 toward the change in profit. The decrease in gross profit was also driven by a non-cash expense of $20,119 related to the value of warrants issued in connection with a development agreement entered into on March 31, 2005 with a private venture capital firm. The Company generated revenues from services of $139,941 (net of a $10,059 discount recorded in connection with the amortization of the value of warrants issued as an inducement to enter into the development agreement) from this contract at a zero profit. See Related Parties below. MEP’s manufacturing facility operated below planned capacity in the first nine months of 2005 and part of its workforce transitioned to performing research and development services. As a result, the Company’s operating margin included an allocation of unabsorbed overhead incurred in the period of $66,154.
The components of costs of revenues for services include direct materials, direct labor, an operating overhead allocation based upon direct labor usage, and a general and administrative overhead allocation based upon the percentage of contract costs relative to the total. Overhead and general and administrative expenses are billable at contracted fixed rates during the course of the year. Spending in excess of the contracted amount can be recovered provided there are funds available in the contract sufficient to cover the excess expenses and the adjustment is approved by the Defense Contract Audit Agency. A rate of spending below the billed contracted fixed rates during the course of the year may result in a return of funds to the contract.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses for the third quarter of 2005 were $412,854 (43.9% of net revenue) compared with $510,450 (26.1% of net revenue) for the same period of 2004, a decrease of $97,596. SG&A expenses for the nine months ended September 30, 2005 were $1,535,616 (55.9% of net revenue) compared with $1,040,614 (19.1% of net revenue) for the nine months ended September 30, 2004, an increase of $495,002 .
The increase in SG&A for the nine months ended September 30, 2005 was primarily a result of increasing the Company’s support from professional service providers and increasing its general and administrative staffing to satisfy compliance with reporting requirements as a public company since the reverse merger in June 2004. The increase included accounting and legal services of $185,478, salaries for additional administrative personnel of $106,361, recruiting expenses of $4,214, investor relations expenses of $56,896, other public company related expenses of $43,497, and other expenses of $4,056.
The increase in SG&A for the nine months ended September 30, 2005 included selling expenses of $162,555 and marketing samples of $60,128, for the establishment of a sales and marketing organization to drive revenue generation and diversify the customer base for commercial products and continuity of research and development services contracts. The Company expects to continue to experience similar expenditures throughout 2005.
These increases in SG&A were offset by a non-cash decrease of $128,183 of expense related to the amortization of stock-based compensation expense from the issuance of stock options in 2004 and 2005. The decrease primarily relates to the reversal of the amount previously amortized for certain stock options forfeited in June 2005 offset by the remaining amount of deferred compensation expensed due to the exercise of certain of these stock options in June 2005. The deferred compensation expense related to stock options issued during 2004 was $1,592,178. During the second quarter of 2005, certain of these stock options were forfeited and a related net adjustment of $608,526 was made to lower the deferred compensation amount. During the nine months ended September 30, 2005, the Company recorded $129,835 of deferred compensation expense in connection with stock options issued to consultants. The remaining balance as of September 30, 2005 for deferred compensation expense was $541,926 and will be fully amortized through December 2009.
Research and Development Expenses
Research and development (“R&D”) expenses for the third quarter of 2005 were $246,638 (26.2% of net revenue) compared with $152,150 (7.8% of net revenue) for the same period of 2004, a decrease of $94,488. R&D expenses for the nine months ended September 30, 2005 were $ 301,601 (11.0% of net revenue) compared with $252,150 (4.6% of net revenue) for the nine months ended September 30, 2004. The primary nature of the R&D expenses in the nine months ended September 30, 2005 relate to the research and experimentation with a battery for application with an electric hybrid vehicle. The primary nature of the R&D expenses in the nine months ended September 30, 2004 relate to a milestone contract from a venture capital firm for research of lithium-ion battery technologies. The Company fulfilled its obligation under this contract in the first quarter of 2005.
Interest (Income) Expense
Interest income, net for the third quarter of 2005 was $1,965, compared with interest expense, net of $7,079 for the same period of 2004, a decrease of $9,044. Interest income, net for the nine months ended September 30, 2005 was $13,249, compared with interest expense, net of $287,259 for the nine months ended September 30, 2004, a decrease of $300,508. The decrease was primarily related to the accretion of deferred interest related to the notes payable to related parties for the nine months ended September 30, 2004. Concurrent with the merger, the Company converted its notes payable to related parties and related accrued interest amounting to $1,100,000 and $86,000 respectively, into shares of its common stock. The notes carried interest at 10% per annum and were due on demand maturing in November 2004.
Net Loss
Net loss for the third quarter of 2005 was $710,280, compared to a net loss of $303,267 for the same period of 2004. Net loss for the nine months ended September 30, 2005 was $2,615,243 compared to net loss of $723,271 for the nine months ended September 30, 2004.
Net Loss Attributable to Common Stockholders
Net loss attributable to common stockholders for the third quarter of 2005 was $710,280 or $0.05 per share (basic and diluted) compared with $779,763 or $0.06 per share (basic and diluted) for the same period of 2004. Net loss attributable to common stockholders for the nine months ended September 30, 2005 was $2,615,243 or $0.19 per share (basic and diluted) compared with $4,467,303 or $0.45 per share (basic and diluted) for the same period of 2004.
The Company recorded a one-time, non-cash item to recognize deemed dividends on preferred stock in the amount of $3,744,032. Of this amount, $3,290,216 resulted from the beneficial conversion of the underlying shares of common stock associated with issuance of new series A convertible preferred stock and detachable warrants in June and July 2004. An additional $453,816 resulted from the conversion of old EEI series A convertible preferred stock into shares of common stock.
Related Parties
The Company has agreements with certain related parties who provide consulting services to the Company. Related party services of an administrative nature were included in general and administrative-related parties as an operating expense in the amount of $32,579 for the nine months ended September 30, 2005 compared with $68,970 for the nine months ended September 30, 2004. The Company has an agreement with the owner of E.F.S. Management Systems, a shareholder of the Company’s common stock, to provide accounting services. The Company has an agreement with Jack T. Brown, a shareholder of the Company’s common stock, to provide consulting services.
On March 31, 2005, the Company entered into a development agreement to receive a total of $450,000 in cash funding from In-Q-Tel, a shareholder of the Company’s common stock, for intended use in the research and development of certain battery technologies. The contract provides for scheduled payments to the Company if it performs certain research and development activities over a 24-month period. The Company has entered into a sub-contract agreement with Rutgers University to perform certain of these activities for $350,000. In connection with this development agreement, the Company entered into an agreement whereby the Company will issue warrants to In-Q-Tel containing certain cashless provisions to purchase up to 15,000 shares of the Company’s common stock upon exercise. The warrants are exercisable at $9.06 per share over a four-year period expiring in March 2009. The weighted average fair value of the warrants at the date of issuance using the Black Scholes option-pricing model is estimated at $5.58 per warrant. The total estimated value of the warrants, amounting to $83,767 was recorded as cost of services-related parties expense and other accrued liability. Further, a deferred contract cost and additional paid-in capital was recorded as of the date of issuance. The number of warrants that are exercisable are directly proportional to the amount of the scheduled payments that are received by the Company for performance of the development agreement.
The weighted average fair value of the warrants using the Black Scholes option-pricing model was revalued on September 30, 2005 at $2.01 per warrant. Accordingly, the total estimated value of the warrants was reduced by $53,589 to $30,178. The amount was recorded as a reduction of cost of services-related parties expense and other accrued liability. Further, a reduction of deferred contract cost and additional paid-in capital was recorded. During the nine months ended September 30, 2005, the Company achieved certain milestones and recognized $150,000 of gross revenue from services rendered related to this development agreement. The relative value of the warrants of $10,059 was recorded as a reduction to cost of services-related parties expense and other accrued liability. In addition, a discount to revenue and a reduction in deferred contract costs was recorded. As of September 30, 2005 the remaining deferred contract cost was $20,119.
Financial Condition
Liquidity and Capital Resources
The Company’s working capital, current ratio and long-term debt to equity ratio are as follows:
| As of September 30, 2005 | As of December 31, 2004 | |||
| Working capital | $ 2,169,027 | $ 3,971,928 | ||
| Current ratio | 3.91 | 7.37 | ||
| Long-term debt to equity ratio | 8.9% | 6.1% | ||
The Company has a non-interest bearing note payable to EaglePicher requiring three annual installments of $150,000 that commenced in October 2004 and is secured by assets acquired in connection with the purchase of its Colorado Springs energy business. As of September 30, 2005, the note payable had a face value of $300,000 with a remaining discount to fair value of $8,333. During the nine months ended September 30, 2005, the Company accreted an additional $10,480 of interest at an effective rate of 5%, increasing the fair value of the note payable to $291,667. On October 3, 2005, the Company paid the second annual installment of $150,000.
The Company has a note payable with Connecticut Innovations, Incorporated (“CII”) in the amount of $183,579. The note payable has a three-year term, maturing in December 2007, with principal payments of $61,193 plus applicable interest at a fixed rate of 5% to be made annually on December 31st.
During the nine months ended September 30, 2005, warrants were exercised for proceeds of $594,096 in exchange for 737,996 shares of common stock. As of September 30, 2005, 1,308,636 warrants are outstanding with expiration dates ranging from July 16, 2007 through March 31, 2009. The maximum potential future proceeds from the exercise of the warrants outstanding are $2,711,592. The weighted average exercise price of the outstanding warrants is $2.07.
During the nine months ended September 30, 2005, options were exercised for proceeds of $490,552 for 1,267,671 shares of common stock. As of September 30, 2005, 1,281,601 options are outstanding. The maximum potential future proceeds from the exercise of the options vested and in-the-money as of September 30, 2005 is $475,735.
The Company’s government contracts are each individually negotiated under their own terms and conditions with reference to the Federal Acquisition Regulations and are typically fully funded cost-reimbursement type. There is usually an 85% limitation placed on the fixed fee whereby 15% is withheld by the government until all contract requirements are satisfied and closeout documents submitted. There are no obligations for royalties.
Net cash used in operating activities totaled $2,598,400 and $1,061,819 for the nine months ended September 30, 2005 and 2004, respectively. During the nine months ended September 30, 2005, the Company began to build inventory components primarily for future use in generating revenue from services in anticipation of pending contract awards. The Company made certain advance payment to suppliers for equipment in the amount of $242,863. The Company made certain pre-payments of deferred items associated with sales of its common stock and its due diligence of a potential asset purchase amounting to $11,696 and $58,315, respectively. The Company accrued expenses primarily relating to legal and accounting services in connection with the preparation of its SEC filings.
The Company invested $644,172 in equipment for the nine months ended September 30, 2005, compared with $35,831 for the nine months ended September 30, 2004. Current year equipment additions relate primarily to the construction in progress for production equipment for the development of its nickel metal hydride and lithium-ion product lines. Prior year additions relate primarily to the purchase of electronic data processing and lab equipment.
Cash expected to be generated from operating activities, together with funds available resulting from the proceeds of the private placement of series A convertible preferred stock, are expected, under current conditions, to be sufficient to finance the Company’s planned operations over the next twelve months. Over that same period, the Company expects to make an investment of $250,000 in plant, property, and equipment to expand its manufacturing capabilities to manufacture its patented bipolar nickel-metal hydride batteries.
On May 13, 2005, the Company entered into a non-binding letter of intent with Topspin Partners, LP., a merchant bank (“Topspin”). If the acquisition contemplated by the letter of intent is consummated, the Company would purchase from an affiliate of Topspin all of the operating assets relating to a lithium-ion and nickel based rechargeable cell and battery manufacturing facility located near Gainesville, Florida. The Company will not assume any liabilities or obligations of Topspin in the proposed acquisition. The Company has agreed to issue under a proposed asset purchase agreement an aggregate of 5,500,000 unregistered shares of the Company’s common stock (the “Consideration Shares”). The Consideration Shares will be subject to lock-up restrictions for one year after the closing of the acquisition. Additionally, the Company will have an option to enter into triple net equity leases with Topspin for the use of the facilities housing the lithium-ion assets (the “Property”), at discounted rental rates, offset by the issuance to Topspin of warrants to purchase 1,000,000 additional shares of the Company’s common stock. The Company will also obtain an option to purchase the leased facilities at fair market value. The Company and Topspin have extended the exclusivity period under their letter of intent to November 13, 2005.
The proposed acquisition is subject to continuing due diligence review by the Company, as well as a requirement that Topspin maintains the lithium-ion assets and the Property in the ordinary course of business and there are no material adverse changes in those assets or the Property prior to the closing. The acquisition is also subject to the Company’s ability to obtain financing on terms acceptable to the Company. On August 8, 2005, the Company entered into a one-year agreement with an investment banking firm to act as the Company’s sole placement agent in connection with the structuring, issuance and sale of securities of the Company to obtain financing. No assurance can be given that any of the conditions to closing will be satisfied or that the proposed transactions will be consummated.
Item 3. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the filing date of this report (the “Evaluation Date”), concluded that the Company’s disclosure controls and procedures were effective and designed to ensure that material information relating to the Company is accumulated and would be made known to them by others as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Controls
The Company does not believe that there are significant deficiencies in the design or operation of its internal controls that could adversely affect its ability to record, process, summarize and report financial data. Although there were no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the Evaluation Date, the Company’s senior management, in conjunction with its Board of Directors, continuously reviews overall company policies and improves documentation of important financial reporting and internal control matters. The Company is committed to continuously improving the state of its internal controls, corporate governance and financial reporting.
Limitations on the Effectiveness of Controls
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure or internal controls will prevent all errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II
Item 1. LEGAL PROCEEDINGS.
None.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On June 9, 2004, the Company completed a “reverse merger” transaction, in which the Company caused EEI Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of the Company, to be merged with and into Electro Energy, Inc., a Delaware corporation engaged in the business of developing, manufacturing and commercializing high-powered, rechargeable bipolar nickel-metal hydride batteries for use in a wide range of applications (hereinafter referred to as “EEI”). As a result of the merger, EEI became the Company’s wholly-owned subsidiary with EEI’s former security holders acquiring a majority of the outstanding shares of the Company’s common stock. The reverse merger was consummated under Delaware law, pursuant to an Agreement of Merger and Plan of Reorganization, dated May 7, 2004 (the “Merger Agreement”), as discussed below. Concurrently with the closing of the reverse merger, the Company completed a private placement to new investors of shares of its series A convertible preferred stock and warrants to purchase common stock.
During the year ended December 31, 2004, the Company sold an aggregate of 5,501 units in a private placement financing for gross proceeds of $5,501,000. Each unit consists of one share of series A convertible preferred stock and a warrant to purchase shares of common stock. Each share of preferred stock is convertible initially into 400 shares of our common stock, and each warrant entitles the holder to purchase 200 shares of common stock at an exercise price of $2.50 per share for three years after the date of closing.
The shares of series A convertible preferred stock and the warrants issued in the private placement have customary anti-dilution protection in the event of stock dividends, stock splits, combinations of shares, recapitalizations or other like events.
The private placement was made solely to “accredited investors,” as that term is defined in Regulation D under the Securities Act of 1933. The shares of series A convertible preferred stock and warrants to purchase common stock were not registered under the Securities Act of 1933, or the securities laws of any state, and were offered and sold in reliance on the exemption from registration afforded by Section 4(2) and Regulation D (Rule 506) under the Securities Act of 1933 and corresponding provisions of state securities laws.
The Company expects to use the net proceeds of the private placement to finance the commercialization of its battery technologies approximately as follows:
| Application of Proceeds | Amount | Percentage of Proceeds | |
|---|---|---|---|
| Research and Development | $ | 300,000 | 5% |
| Manufacturing | 2,250,000 | 41% | |
| General and Administrative | 350,000 | 6% | |
| Sales and Marketing | 1,050,000 | 19% | |
| Transaction Costs(1) | 911,000 | 17% | |
| Working Capital | 390,000 | 7% | |
| Capital Markets Initiatives(2) | 250,000 | 5% | |
| Total | $ | 5,501,000 | 100% |
| (1) | Includes fees of $377,000 payable to the placement agent for the private placement, Brookshire Securities, and $150,000 payable to Matrix USA, LLC. |
| (2) | Includes amounts to be used for expenditures related to being a public company such as creating investor awareness, and held in a separate bank account pending utilization in each case as approved by our financial advisor. |
The Company reserves the right to modify the allocation of proceeds.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. OTHER INFORMATION.
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
| Exhibit No. | Description | |
|---|---|---|
| 31.1 | Section 302 Certification of Chief Executive Officer.(1) | |
| 31.2 | Section 302 Certification of Chief Financial Officer.(1) | |
| 32.1 | Section 906 Certification of Chief Executive Officer.(1) | |
| 32.2 | Section 906 Certification of Chief Financial Officer.(1) | |
| (1) Filed herewith. | ||
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ELECTRO ENERGY INC. | |||
| By: | /s/ Martin G. Klein | ||
| Name: Martin G. Klein | |||
| Date: November 9, 2005 | Title: Chairman and Chief Executive Officer | ||
ELECTRO ENERGY INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
| Condensed Consolidated Balance Sheets as of September 30, 2005 (unaudited) and December 31, 2004 | F-2 |
| Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2005 and 2004 (unaudited) | F-4 |
| Condensed Consolidated Statements of Changes in Stockholders' Equity for the nine months ended September 30, 2005 (unaudited) | F-5 |
| Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 (unaudited) | F-6 |
| Notes to Condensed Consolidated Financial Statements (unaudited) | F-8 |
| ELECTRO ENERGY INC. AND SUBSIDIARIES | |||||
| CONDENSED CONSOLIDATED BALANCE SHEETS | |||||
| ASSETS | |||||
| As of September 30, 2005 (UNAUDITED) | As of December 31, 2004 | ||||
| CURRENT ASSETS | |||||
| Cash and cash equivalents | $ | 1,364,532 | $ | 3,372,486 | |
| Accounts receivable, net of allowance for doubtful accounts of $5,652 and $20,554, respectively | 736,472 | 851,632 | |||
| Inventories | 400,835 | 244,492 | |||
| Prepaid expenses and other current assets | 411,597 | 126,475 | |||
| Total Current Assets | 2,913,436 | 4,595,085 | |||
| PROPERTY AND EQUIPMENT, Net | 1,111,075 | 533,273 | |||
| SECURITY DEPOSIT | 8,471 | 8,471 | |||
| TOTAL ASSETS | $ | 4,032,982 | $ | 5,136,829 | |
| The accompanying notes are an integral part of these condensed consolidated financial statements. | |||||
| ELECTRO ENERGY INC. AND SUBSIDIARIES | |||||
| CONDENSED CONSOLIDATED BALANCE SHEETS | |||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | |||||
| As of September 30, 2005 (UNAUDITED) | As of December 31, 2004 | ||||
| CURRENT LIABILITIES | |||||
| Current maturities of long-term debt | $ | 211,193 | $ | 211,193 | |
| Accounts payable | 219,147 | 144,425 | |||
| Accounts payable - related parties | 3,000 | 7,525 | |||
| Interest payable | 6,885 | - | |||
| Accrued expenses and other current liabilities | 304,184 | 260,014 | |||
| Total Current Liabilities | 744,409 | 623,157 | |||
| OTHER LIABILITIES | |||||
| Long term debt, less current maturities | 264,053 | 253,573 | |||
| Deferred rent | 65,130 | 84,660 | |||
| Total Other Liabilities | 329,183 | 338,233 | |||
| TOTAL LIABILITIES | 1,073,592 | 961,390 | |||
| COMMITMENTS AND CONTINGENCIES | |||||
| STOCKHOLDERS' EQUITY | |||||
| Preferred stock, $0.001 par value, 10,000 shares authorized; | |||||
| Series A Convertible Preferred Stock, 5,600 shares designated; | |||||
| 5,501 shares issued, 197 and 4,951 outstanding in 2005 and 2004, respectively ($197,000 and $4,951,000 liquidation preference) | - | 5 | |||
| Common stock, $0.001 par value, 50,000,000 shares | |||||
| authorized; 16,354,720 shares issued and outstanding in 2005, 12,447,453 shares issued and outstanding in 2004 | 16,355 | 12,448 | |||
| Additional paid-in capital | 13,465,007 | 12,832,804 | |||
| Deferred compensation expense | (541,926) | (1,175,134) | |||
| Deferred contract costs | (20,119) | - | |||
| Warrant subscription receivable | - | (150,000) | |||
| Accumulated deficit | (9,959,927) | (7,344,684) | |||
| TOTAL STOCKHOLDERS' EQUITY | 2,959,390 | 4,175,439 | |||
| TOTAL LIABILITIES AND | |||||
| STOCKHOLDERS' EQUITY | $ | 4,032,982 | $ | 5,136,829 | |
| The accompanying notes are an integral part of these condensed consolidated financial statements. | |||||
| ELECTRO ENERGY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the Three and Nine Months Ended September 30, 2005 and 2004 | |||||||||||
| Three Months Ended | Nine Months Ended | ||||||||||
| September 30, | September 30, | ||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||
| NET REVENUE | |||||||||||
| Services | $ | 602,436 | $ | 867,301 | $ | 2,160,730 | $ | 2,366,372 | |||
| Products | 339,036 | 1,085,586 | 588,021 | 3,093,157 | |||||||
| TOTAL NET REVENUE | 941,472 | 1,952,887 | 2,748,751 | 5,459,529 | |||||||
| COST OF REVENUE | |||||||||||
| Cost of services | 602,109 | 699,812 | 2,323,807 | 2,052,289 | |||||||
| Cost of products | 392,116 | 886,663 | 1,216,219 | 2,550,488 | |||||||
| TOTAL COST OF REVENUE | 994,225 | 1,586,475 | 3,540,026 | 4,602,777 | |||||||
| GROSS (LOSS) PROFIT | (52,753) | 366,412 | (791,275) | 856,752 | |||||||
| OPERATING EXPENSES | |||||||||||
| Selling, general and administrative (including non cash compensation of $56,916 and $99,511 for the three months ended and $154,517 and $282,700 for the nine months ended September 30, 2005 and 2004, respectively) | 403,854 | 491,580 | 1,503,037 | 971,644 | |||||||
| Selling, general and administrative - related parties | 9,000 | 18,870 | 32,579 | 68,970 | |||||||
| Research and development | 246,638 | 152,150 | 301,601 | 252,150 | |||||||
| TOTAL OPERATING EXPENSES | 659,492 | 662,600 | 1,837,217 | 1,292,764 | |||||||
| OPERATING LOSS | (712,245) | (296,188) | (2,628,492) | (436,012) | |||||||
| INTEREST EXPENSE | |||||||||||
| Interest (income) expense, net | (1,965) | 7,079 | (13,249) | 30,217 | |||||||
| Interest expense - related parties | - | - | - | 257,042 | |||||||
| TOTAL INTEREST (INCOME) EXPENSE | (1,965) | 7,079 | (13,249) | 287,259 | |||||||
| NET LOSS | (710,280) | (303,267) | (2,615,243) | (723,271) | |||||||
| DEEMED DIVIDENDS ON PREFERRED STOCK | - | 476,496 | - | 3,744,032 | |||||||
| NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS | $ | (710,280) | $ | (779,763) | $ | (2,615,243) | $ | (4,467,303) | |||
| NET LOSS PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS - BASIC AND DILUTED | $ | (0.05) | $ | (0.06) | $ | (0.19) | $ | (0.45) | |||
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC AND DILUTED | 15,709,509 | 12,197,453 | 13,919,587 | 9,908,504 | |||||||
| The accompanying notes are an integral part of these condensed consolidated financial statements. | |||||||||||
| ELECTRO ENERGY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) For the Nine Months Ended September 30, 2005 | |||||||||||||||||||
| Series A Convertible Preferred Stock | Common Stock | Additional Paid-In | Deferred Compensation | Deferred Contract | Warrant Subscription | Accumulated | |||||||||||||
| Shares | Amount | Shares | Amount | Capital | Expense | Costs | Receivable | Deficit | Total | ||||||||||
| BALANCE - December 31, 2004 | 4,951 | 5 | 12,447,453 | 12,448 | 12,832,804 | (1,175,134) | - | (150,000) | (7,344,684) | 4,175,439 | |||||||||
| Exercise of employee stock options | - | - | 1,267,671 | 1,267 | 489,255 | - | - | - | - | 490,522 | |||||||||
| Forfeiture of stock options issued to employees | - | - | - | - | (608,526) | 608,526 | - | - | - | - | |||||||||
| Amortization of deferred compensation expense | - | - | - | - | - | 154,517 | - | - | - | 154,517 | |||||||||
| Issuance of stock options | - | - | - | - | 129,835 | (129,835) | - | - | - | - | |||||||||
| Issuance and amortization of warrants | - | - | - | - | 30,178 | - | (20,119) | - | - | 10,059 | |||||||||
| Proceeds from warrant subscription receivable | - | - | - | - | - | - | - | 150,000 | - | 150,000 | |||||||||
| Conversion of preferred stock into common stock | (4,754) | (5) | 1,901,600 | 1,902 | (1,897) | - | - | - | - | - | |||||||||
| Proceeds from exercise of warrants | - | - | 737,996 | 738 | 593,358 | - | - | - | - | 594,096 | |||||||||
| Net loss | - | - | - | - | - | - | - | - | (2,615,243) | (2,615,243) | |||||||||
| BALANCE - September 30, 2005 | 197 | $ | - | 16,354,720 | $ | 16,355 | $ | 13,465,007 | $ | (541,926) | $ | (20,119) | $ | - | $ | (9,959,927) | $ | 2,959,390 | |
| The accompanying notes are an integral part of these consolidated financial statements. | |||||||||||||||||||
| ELECTRO ENERGY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Nine Months Ended September 30, 2005 and 2004 | |||||
| 2005 | 2004 | ||||
| CASH FLOWS FROM OPERATING ACTIVITIES | |||||
| Net loss | $ | (2,615,243) | $ | (723,271) | |
| Adjustments to reconcile net loss to net cash used in operating activities: | |||||
| Deferred rent | (19,530) | 26,855 | |||
| Interest accretion | 10,480 | 224,025 | |||
| Depreciation and amortization | 66,370 | 63,564 | |||
| Deferred expenses, net | 184,695 | 282,700 | |||
| Changes in operating assets and liabilities: | |||||
| Accounts receivable | 115,160 | (497,342) | |||
| Inventories | (156,343) | 58,462 | |||
| Prepaid expenses and other current assets | (285,122) | (360,650) | |||
| Accounts payable | 74,722 | (264,023) | |||
| Accounts payable - related parties | (4,525) | (18,338) | |||
| Interest payable | 6,885 | 11,741 | |||
| Interest payable - related parties | - | (33,177) | |||
| Accrued expenses and other current liabilities | 24,051 | 167,635 | |||
| TOTAL ADJUSTMENTS | 16,843 | (338,548) | |||
| NET CASH USED IN OPERATING ACTIVITIES | (2,598,400) | (1,061,819) | |||
| CASH FLOWS FROM INVESTING ACTIVITIES | |||||
| Purchases of property and equipment | (644,172) | (35,831) | |||
| Payment of security deposit | - | 430 | |||
| NET CASH USED IN INVESTING ACTIVITIES | $ | (644,172) | $ | (35,401) | |
| The accompanying notes are an integral part of these condensed consolidated financial statements. | |||||
| ELECTRO ENERGY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Nine Months Ended September 30, 2005 and 2004 | |||||
| 2005 | 2004 | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | |||||
| Repayments under bank line of credit | - | (100,000) | |||
| Repayments of long term debt | - | (71,269) | |||
| Repayments under notes payable - related parties | - | (50,000) | |||
| Proceeds from issuance of preferred stock and warrants | - | 5,501,000 | |||
| Issuance costs of preferred stock and warrants | - | (910,697) | |||
| Proceeds from issuance of warrants | - | 150,000 | |||
| Proceeds from warrant subscription receivable | 150,000 | 150,000 | |||
| Proceeds from exercise of warrants and employee stock options | 1,084,618 | 7,000 | |||
| NET CASH PROVIDED BY FINANCING ACTIVITIES | 1,234,618 | 4,676,034 | |||
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | (2,007,954) | 3,578,814 | |||
| CASH AND CASH EQUIVALENTS - Beginning | 3,372,486 | 269,970 | |||
| CASH AND CASH EQUIVALENTS - Ending | $ | 1,364,532 | $ | 3,848,784 | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | |||||
| Cash paid for: | |||||
| Interest | $ | - | $ | 84,670 | |
| Income taxes | $ | 7,065 | $ | 300 | |
| SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES | |||||
| Conversion of notes payable and related accrued interest into common stock | $ | - | $ | 1,186,000 | |
| Issuance of warrants in exchange for warrant subscription receivable | $ | - | $ | 350,000 | |
| The accompanying notes are an integral part of these condensed consolidated financial statements. | |||||
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 —The Company
Organization
On June 9, 2004, Electro Energy, Inc. (“EEI”), a Delaware corporation, entered into a merger with MCG Diversified, Inc. (“MCG”), incorporated in December 1993 in the State of Florida. MCG issued 9,497,557 unregistered shares of common stock for 100% of the outstanding common stock of EEI on a one-to-one basis. As MCG did not have any meaningful operations prior to the merger, the transaction was treated as a recapitalization of EEI, and accounted for, on an historical cost basis, for all periods presented. Moreover, the financial statements set forth in this report for all periods, prior to the recapitalization, are the financial statements of EEI and the common stock of EEI has been retroactively restated to give effect to the exchange for MCG common stock. Immediately following the merger, MCG changed its name to Electro Energy Inc. (“New EEI”). On September 29, 2004, EEI changed its name to EEI Technologies, Inc.
The condensed consolidated financial statements presented are those of New EEI and its wholly-owned subsidiary, EEI. Additionally, the accounts of EEI include the accounts of Mobile Energy Products, Inc. (“MEP”), a wholly-owned subsidiary incorporated June 11, 2003, from its inception. Collectively, they are referred to herein as the “Company.” On October 1, 2003 the Company, through its MEP subsidiary acquired the Colorado Springs energy business of EaglePicher Technologies, LLC (“EaglePicher”).
Nature of Business
The Company is engaged in the development of products for use in providing energy and specifically focuses upon development of bipolar nickel metal hydride batteries and other battery chemistries and primarily provides contract research and development to the United States Government or its agencies.
Additionally, the Company also has commercially viable products marketed and sold primarily to the United States Government or its agencies. These products include batteries for aircraft, satellite and satellite launch vehicles.
NOTE 2 —Summary of Significant Accounting Policies
Basis of Presentation
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and with Form 10-QSB and Item 310 of Regulation S-B of the Securities and Exchange Commission. Accordingly, they do not contain all the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of the Company’s management, the accompanying condensed consolidated financial statements contain all the adjustments necessary (consisting only of normal recurring accruals) to make the financial position of the Company as of September 30, 2005 and the results of its operations and its cash flows for the three and nine months ended September 30, 2005 and 2004 not misleading. The condensed consolidated financial statements should be read in conjunction with the audited financial statements for the years ended December 31, 2004 and 2003 contained in Form 10-KSB/A filed on April 29, 2005.
Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of results that would be expected for the year ended December 31, 2005.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of New EEI and MEP. All significant intercompany balances and transactions have been eliminated in consolidation.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Reclassifications
Certain accounts in the prior year financial statements have been reclassified for comparative purposes to conform with the presentation in the current year financial statements. These reclassifications have no effect on previously reported income.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and accounts receivable.
The Company maintains its cash accounts at financial institutions with balances, at times, in excess of federally insured limits. As of September 30, 2005, the Company had cash balances in excess of federally insured limits of $ 54,673. The Company also has substantial cash balances which are invested in a money market account with a bank.
Concentrations of credit risk with respect to accounts receivable are limited because the Company’s customers are primarily the United States Government or its agencies. Credit risk with respect to trade accounts receivable from private entities is not significant.
Revenue Recognition
In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. The following policies reflect specific criteria for the various revenues streams of the Company:
Revenue is recognized at the time the product is delivered. Provision for sales returns will be estimated based on the Company’s historical return experience. Revenue is presented net of returns.
Revenue on the Company’s research and development type contracts with the U.S. Government and its’ agencies are typically “cost plus” type contracts that contain a fixed fee element and/or a cost sharing arrangement. The Company is reimbursed for actual material, labor and overhead costs as incurred up to the funding limit of the contract. The Company submits a cost structure annually to the Defense Contract Audit Agency (DCAA) for approval to use the Company’s rates on government contracts. Throughout the life of each contract we estimate the cost to complete. When the Company estimates that a contract will exceed the funding amount management will seek additional funding from our customer or another outside source. Contract terms allow the Company to stop work should additional funding not be available. Should management decide to complete a contract without funding the Company will expense the cost as incurred.
Contracts with milestone billing provisions are fixed cost type contracts. Revenue is recognized once the milestone has been achieved.
Revenue on commercial contracts is recognized when the Company delivers batteries or services have been rendered.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Significant Customers
The Company had three customers with sales of 10% or more of total sales for the nine months ended September 30, 2005. Net sales to the Company’s three major customers, U.S. Airforce Mantech, Sandia National Laboratories, and EaglePicher Technologies, LLC represented approximately 76.5% in the nine months ended September 30, 2005. Accounts receivable from these customers amounted to $426,725 and $407,547 as of September 30, 2005 and December 31, 2004, respectively. The Company had three customers with sales of 10% or more of total sales for the nine months ended September 30, 2004. Net sales to such customers, U.S. Airforce Mantech, Department of Energy, and EaglePicher Technologies, LLC, represented approximately 76.4% in the nine months ended September 30, 2004.
Stock-Based Compensation
As permitted under SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which amended SFAS No. 123 (“SFAS 123”), “Accounting for Stock Based Compensation,” the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation arrangements, as defined by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees,” and related interpretations including Financial Accounting Standards Board Interpretations No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” an interpretation of APB No. 25. For the nine months ended September 30, 2005 and 2004, the Company recorded compensation expense in general administrative expenses amounting to $146,402 and $282,700, respectively, related to stock options granted to employees.
Prior to the merger discussed in Note 1, the Company accounted for options granted to employees by computing proforma compensation cost utilizing the Black Scholes option pricing model and the minimum value method. This method computes the value assigned to the options based on a number of valuation assumptions but excludes the concept of volatility which measures the changes in value that publicly traded securities regularly experience. Pursuant to the aforementioned merger, the Company continues to compute the fair value of newly granted options utilizing the Black Scholes option pricing model but now includes the volatility measure which generally gives rise to a higher amount of proforma compensation than the minimum value method as the volatility utilized in the calculation increases the value of the options and therefore the proforma compensation charge also increases.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table illustrates the effect on net loss if the Company had applied the fair and minimum value recognition provisions of SFAS 123 to stock-based compensation for the three and nine months ended September 30, 2005 and 2004:
| Three Months | Nine Months | |||||||||||
| Ended September 30, | Ended September 30, | |||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||
| Net loss attributable to common stockholders as reported | $ | (710,280) | $ | (779,763) | $ | (2,615,243) | $ | (4,467,303) | ||||
| Add: stock-based employee compensation expense included in reported net loss | 48,801 | 99,511 | 146,402 | 282,700 | ||||||||
| Deduct: total stock-based employee compensation expense determined under fair and minimum value-based methods for all options | (257,879) | (167,881) | (526,865) | (451,417) | ||||||||
| Proforma net loss attributable to common stockholders | $ | (919,358) | $ | (848,133) | $ | (2,995,706) | $ | (4,636,020) | ||||
| Proforma net loss per share attributable to common stockholders (basic and diluted) | $ | (0.06) | $ | (0.07) | $ | (0.22) | $ | (0.47) | ||||
The fair value and minimum value of options at date of grant was estimated using an option-pricing model with the following weighted average assumptions:
| Nine Months Ended September 30, | ||||||||||||
| 2005 | 2004 | |||||||||||
| Expected Life (Years) | 10 | 10 | ||||||||||
| Interest Rate | 3.810% | 3.250% | ||||||||||
| Annual Rate of Dividends | --% | --% | ||||||||||
| Volatility | 115.042% | 177.510% | ||||||||||
The weighted average fair value and minimum value of the options at date of grant using the Black Scholes option-pricing model is estimated at $5.14 and $3.36 per option for the nine months ended September 30, 2005 and 2004, respectively.
Loss Per Share
Basic loss per share is computed by dividing the net loss applicable to common shares by the weighted average number of common shares outstanding during the period. The weighted average number of shares has been given retroactive effect to the recapitalization. Diluted loss per share adjusts basic loss per share for the effects of convertible securities, warrants, stock options and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive. The shares issuable upon the conversion of preferred stock, the exercise of stock options and warrants are excluded from the calculation of net loss per share as their effect would be antidilutive.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Securities that could potentially dilute earnings per share (“EPS”) in the future that were not included in the computation of diluted loss per share consist of the following as of September 30, 2005 and 2004:
| 2005 | 2004 | |||
| Preferred stock convertible into common stock | 78,800 | 2,200,400 | ||
| Warrants to purchase common stock | 1,308,636 | 2,129,184 | ||
| Options to purchase common stock | 1,281,601 | 2,332,121 | ||
| Total potential common shares | 2,669,037 | 6,661,705 | ||
NOTE 3 —Inventories
Inventories consists of the following as of September 30, 2005 and December 31, 2004:
| 2005 | 2004 | |||||
| Raw materials | $ | 232,879 | $ | 202,531 | ||
| Work in progress | 167,956 | 41,961 | ||||
| Total | $ | 400,835 | $ | 244,492 | ||
NOTE 4 —Property and Equipment
Property and equipment consists of the following as of September 30, 2005 and December 31, 2004:
| 2005 | 2004 | Useful Lives | |||||||
| Equipment | $ | 1,350,362 | $ | 706,190 | 5 to 7 Years | ||||
| Leasehold improvements | 30,359 | 30,359 | 3 Years | ||||||
| 1,380,721 | 736,549 | ||||||||
| Less: Accumulated depreciation and amortization | 269,646 | 203,276 | |||||||
| Property and Equipment, Net | $ | 1,111,075 | $ | 533,273 | |||||
Depreciation and amortization expense for the nine months ended September 30, 2005 and 2004 was $66,370 and $63,564, respectively, and $21,775 and $25,102 for the three months ended September 30, 2005 and 2004, respectively.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 5 —Long-Term Debt
Long-term debt consists of the following as of September 30, 2005 and December 31, 2004:
| 2005 | 2004 | |||||||
| Note payable to Connecticut Innovations, Incorporated (“CII”) commencing December 2004 and maturing December 2007 with interest at 5% per annum and annual installments of $61,193 | $ | 183,579 | $ | 183,579 | ||||
| Non-interest bearing note payable to EaglePicher Technologies, LLC requiring three annual installments of $150,000 commencing in October 2004 and is secured by assets acquired in connection with the purchase of its Colorado Springs energy business: | ||||||||
| Face Value | 300,000 | 300,000 | ||||||
| Remaining discount to fair value (effective interest rate of 5%) | (8,333) | (18,813) | ||||||
| Fair Value | 291,667 | 281,187 | ||||||
| Total long-term debt | 475,246 | 464,766 | ||||||
| Less: current maturities | 211,193 | 211,193 | ||||||
| �� | Total long-term debt, less current maturities | $ | 264,053 | $ | 253,573 | |||
Interest expense related to the long-term debt of CII amounted to $6,885 and $12,636 for the nine months ended September 30, 2005 and 2004, respectively, and $2,295 and $4,477 for the three months ended September 30, 2005 and 2004, respectively.
Accretion of the discount related to the long-term debt of EaglePicher Technologies, LLC amounted to $10,480 and $15,348 for the nine months ended September 30, 2005 and 2004, respectively, and $3,536 and $5,178 for the three months ended September 30, 2005 and 2004, respectively.
Maturities of long-term debt as of September 30, 2005 are as follows:
| For the Year Ending September 30, | Amount | |
| 2005 | $ | 211,193 |
| 2006 | 202,860 | |
| 2007 | 61,193 | |
| Total | $ | 475,246 |
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 6 —Stockholders’ Equity
Preferred Stock
The Company has authorized 10,000 shares of preferred stock, par value $0.001 per share, of which 5,600, are designated as Series A Convertible Preferred Stock (“Series A Preferred”) as specified in the Certificate of Designation (the “Certificate”).
Each share of Series A Preferred is convertible at the option of the holder and automatically upon the occurrence of certain events, as defined in the Certificate, into 400 shares of the Company’s common stock and has a liquidation preference of $1,000 per share. The conversion rate and liquidation preference are subject to adjustment as specified in the Certificate. Each share of the Series A Preferred is entitled to votes equal to the number of shares of common stock it is convertible into at the time of the voting.
During the nine months ended September 30, 2005, 4,754 shares of Series A Preferred were converted into 1,901,600 shares of common stock.
Common Stock
The Company has authorized 50,000,000 shares of common stock, par value $0.001. As of September 30, 2005, the Company had reserved 3,000,000 shares of common stock for issuance under its 1993 Stock Compensation Plan (the “1993 Plan”), as well as 3,000,000 shares of common stock for issuance under its newly adopted 2005 Stock Compensation Plan (the “2005 Plan”). During the nine months ended September 30, 2005, the Company issued 1,267,761 shares of common stock in connection with the exercise of employee stock options for proceeds of $490,522. In addition, 257,850 employee stock options were forfeited.
During the nine months ended September 30, 2005, warrants were exercised for proceeds of $594,096 in exchange for 737,996 shares of common stock.
Stock Options
On June 28, 2005, the Company adopted its 2005 Plan. The purpose of the 2005 Plan is to enable the Company to attract, retain and motivate key employees, directors and, on occasion, consultants, by providing them with stock options. Stock options granted under the 2005 Plan may be either incentive stock options, as defined in Section 422A of the Internal Revenue Code of 1986, or non-qualified stock options. The Company has reserved 3,000,000 shares of common stock for issuance under the 2005 Plan. The Company granted 475,000 stock options during the nine months ended September 30, 2005, 200,000 of which were issued in connection with an employment agreement, 250,000 issued to directors and employees, and 25,000 of which were issued in connection with a consulting agreement. As of September 30, 2005, unexercised stock options to purchase an aggregate of 1,281,601 shares of common stock have been granted to 26 employees, directors, or consultants under the 1993 Plan and the 2005 Plan, at exercise prices ranging from $.26 to $6.76 per share.
During the nine months ended September 30, 2005, 257,850 employee stock options were forfeited and a related net adjustment of $608,526 was made to lower the deferred compensation amount. The remaining balance of the deferred compensation amount for employee stock options as of September 30, 2005 was $420,206 and will be fully amortized through December 2007.
During the nine months ended September 30, 2005, the company recorded $129,835 of deferred compensation expense in connection with 25,000 stock options issued to consultants of which $8,115 has been amortized. The remaining balance of the deferred compensation amount as of September 30, 2005 was $121,720 and will be fully amortized through June 2009.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Warrants
In March 2004, EEI had issued warrants to purchase 268,594 shares of its EEI Preferred Stock in connection with a contract to receive a total of $500,000 in cash funding from a venture capital firm for intended use in the research and development of certain battery technologies. The Company satisfied its contractual obligations in the first quarter of 2005. The outstanding warrant subscription receivable was collected in full during the nine months ended September 30, 2005.
On March 31, 2005, the Company issued warrants to purchase 15,000 shares of the Company’s common stock in connection with a contract to receive a total of $450,000 in cash funding from a venture capital firm for intended use in the research and development of certain battery technologies. (See Note 7.)
NOTE 7 —Related Parties
Consulting Services
Certain stockholders and parties related to stockholders have provided consulting services to the Company for various technical and general and administrative services. Consulting fees incurred amounted to $32,579 and $68,970 for the nine months ended September 30, 2005 and 2004, respectively, and $18,870 and $9,000 for the three months ended September 30, 2005 and 2004, respectively. Amounts due to these related parties as of September 30, 2005 and December 31, 2004 were $3,000 and $7,525, respectively.
Development Agreement
On March 31, 2005, the Company entered into a development agreement to receive a total of $450,000 in cash funding from a private venture capital firm, a shareholder of the Company’s common stock, for intended use in the research and development of certain battery technologies. The contract provides for scheduled payments to the Company if it performs certain research and development activities over a 24-month period. The Company has entered into a sub-contract agreement with Rutgers University to perform certain of these activities for $350,000. In connection with this development agreement, the Company entered into an agreement whereby the Company will issue warrants containing certain cashless provisions to purchase up to 15,000 shares of the Company’s common stock upon exercise. The warrants are exercisable at $9.06 per share over a four-year period expiring in March 2009. The weighted average fair value of the warrants at the date of issuance using the Black Scholes option-pricing model is estimated at $5.58 per warrant. The total estimated value of the warrants, amounting to $83,767, was recorded as cost of services-related parties expense and other accrued liability. Further, a deferred contract cost and additional paid-in capital was recorded as of the date of issuance. The number of warrants that are exercisable are directly proportional to the amount of the scheduled payments that are received by the Company for performance of the development agreement.
The weighted average fair value of the warrants using the Black Scholes option-pricing model was revalued on September 30, 2005 at $2.01 per warrant. Accordingly, the total estimated value of the warrants was reduced by $53,589 to $30,178. The amount was recorded as a reduction of cost of services-related parties expense and other accrued liability. Further, a reduction of deferred contract cost and additional paid-in capital was recorded. During the nine months ended September 30, 2005, the Company received an installment of cash funding and recognized $150,000 of gross revenue from services rendered related to this development agreement. The relative value of the warrants of $10,059 was recorded as a reduction to cost of services-related parties expense and other accrued liability. In addition, a discount to revenue and a reduction in deferred contract costs was recorded. As of September 30, 2005 the remaining deferred contract cost was $20,119.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 8 —Commitments and Contingencies
Operating Leases
The Company conducts its operations from two facilities one that is leased under a noncancelable operating lease expiring in March 2010 requiring minimum monthly payments of $23,875, and one that is leased on a month to month basis through July 2006 requiring minimum monthly payments of $9,448, respectively. Rental expense related to facilities under operating leases amounted to $279,069 and $213,592 for the nine months ended September 30, 2005 and 2004, respectively, and $93,356 and $93,042 for the three months ended September 30, 2005 and 2004, respectively.
Future minimum rental payments under the above noncancelable operating leases are as follows:
| For the Year Ending December 31, | Amount | |
| 2005 | $ | 71,625 |
| 2006 | 286,500 | |
| 2007 | 286,500 | |
| 2008 | 286,500 | |
| 2009 | 286,500 | |
| Thereafter | 71,625 | |
| $ | 1,289,250 | |
Supply Agreement
The Company has entered into a five-year agreement to supply EaglePicher with certain products at agreed-upon prices. Under the agreement, the Company is the sole source supplier for components for battery power systems used in military satellites and military aircraft. Pricing under the agreement is fixed, subject to possible adjustment under periodic value engineering reviews and based on material cost escalations. The agreement is renewable upon the mutual consent of the parties. The agreement expires September 2008 with renewal options annually thereafter. Net sales to EaglePicher represented approximately 20.2% and 51.8% of total sales for the nine months ended September 30, 2005 and 2004, respectively. Accounts receivable from EaglePicher amounted to $266,968 and $50,228 as of and September 30, 2005 and December 31, 2004, respectively. On April 11, 2005 Eagle Picher, Inc. and its affiliates announced its voluntary Chapter 11 bankruptcy filing.
Executive Compensation
The Company entered into an employment agreement effective January 1, 2004 through December 31, 2005 with its President and Chief Operating Officer. The agreement provided for compensation of $235,000 per annum, 343,800 stock options, certain other benefits and severance payments under certain circumstances, including termination of employment. Effective March 22, 2005, the Board of Directors accepted the resignation of Michael Eskra as Director, President, and Chief Operating Officer. In accordance with the employment agreement, the Company paid him 30 days compensation.
ELECTRO ENERGY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Employment Agreement
Effective May 2, 2005 (“Effective Date”), the Company entered into an Employment Agreement (the “Agreement”) with Michael E. Reed, pursuant to which Mr. Reed will serve as the Company’s President and Chief Operating Officer. Mr. Reed’s employment will be at-will, and will carry an annual base salary of $190,000. Mr. Reed will be eligible for an annual bonus based on goals and objectives set by the Board of Directors in consultation with him. In addition, the Company has agreed to reimburse Mr. Reed for routine expenses in connection with his relocation to the Danbury, Connecticut area, plus an amount not to exceed $15,000 for temporary living expenses. In accordance with the Agreement, Mr. Reed received options to purchase 200,000 shares of common stock (See Note 6) of the Company under the 2005 Plan vesting in equal installments over four years, commencing on the Effective Date with an exercise price of $6.76.
Letter of Intent to Acquire Assets
On May 13, 2005, the Company entered into a non-binding letter of intent with Topspin Partners, LP., a merchant bank (“Topspin”). If the acquisition contemplated by the letter of intent is consummated, the Company would purchase from an affiliate of Topspin all of the operating assets relating to a lithium-ion and nickel based rechargeable cell and battery manufacturing facility located near Gainesville, Florida. The Company will not assume any liabilities or obligations of Topspin in the proposed acquisition. The Company has agreed to issue under a proposed asset purchase agreement an aggregate of 5,500,000 unregistered shares of the Company’s common stock (the “Consideration Shares”). The Consideration Shares will be subject to lock-up restrictions for one year after the closing of the acquisition. Additionally, the Company will have an option to enter into triple net equity leases with Topspin for the use of the facilities housing the lithium-ion assets (the “Property”), at discounted rental rates, offset by the issuance to Topspin of warrants to purchase 1,000,000 additional shares of the Company’s common stock. The Company will also obtain an option to purchase the leased facilities at fair market value. The Company and Topspin have extended the exclusivity period under their letter of intent to November 13, 2005.
The proposed acquisition is subject to continuing due diligence review by the Company, as well as a requirement that Topspin maintains the lithium-ion assets and the Property in the ordinary course of business and there are no material adverse changes in those assets or the Property prior to the closing. The acquisition is also subject to the Company’s ability to obtain financing on terms acceptable to the Company. On August 8, 2005, the Company entered into a one-year agreement with an investment banking firm to act as the Company’s sole placement agent in connection with the structuring, issuance and sale of securities of the Company to obtain financing. No assurance can be given that any of the conditions to closing will be satisfied, or that the proposed transactions will be consummated.
NOTE 9 –Subsequent Events
On October 17, 2005, the Company entered into a Stock Purchase Agreement with In-Q-Tel, Inc. and one of its affiliates (In-Q-Tel), pursuant to which In-Q-Tel has agreed to purchase 241,692 shares of unregistered common stock of EEEI and warrants to purchase 75,829 shares of unregistered common stock of EEEI at an exercise price of $3.11 per share. The warrants were valued at $160,000 using a Black-Scholes model. The total purchase price for the stock and warrants is $800,000 and is expected to be paid over the course of 14 months following the closing, conditioned upon EEEI achieving certain development milestones. On October 17, 2005, the Company issued 30,208 shares of unregistered common stock and 9,476 warrants in connection with this agreement. EEEI intends to direct the proceeds toward research and development to demonstrate the incorporation of Bipolar Li-ion Cell Technology into Bipolar Lithium Ion Batteries.
As of October 21, 2005, 2,000 and 58,879 shares of common stock have been issued in connection with the exercise of stock options for proceeds of $2,327 and the exercise of warrants for proceeds of $96,875, respectively.