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CPTCQ.OB > SEC Filings for CPTCQ.OB > Form 10-Q on 3-May-2005All Recent SEC Filings

Show all filings for COMPOSITE TECHNOLOGY CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for COMPOSITE TECHNOLOGY CORP


3-May-2005

Quarterly Report


ITEM 2- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing at the beginning of this report. The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended September 30, 2004 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on December 23, 2004.

The following discussion and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as "anticipates," "expects," "believes," "plans," and similar terms. Our actual results could differ materially from any future performance suggested in this report as a result of factors, including those discussed in "Factors That May Affect Future Operating Results" and elsewhere in this report and in our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2004. All forward-looking statements are based on information currently available to Composite Technologies and we assume no obligation to update such forward-looking statements, except as required by law. Service marks, trademarks and trade names referred to in this Form 10-Q are the property of their respective owners.

OVERVIEW

We develop and market composite related products for the electrical utility industry and provide engineering, product design, and other services related to the design and installation of our products to the global electrical utility industry that are designed to improve the performance and capacity of transmission and distribution electrical grids. Our principal product is our proprietary patent pending composite reinforced conductor known as Aluminum Conductor Composite Core, or ACCC cable. Our ACCC cable is designed to transmit more power than conventional cables of the same diameter, create energy savings through less line losses under comparable operating conditions, and significantly reduce sag caused by overheating due to power overloads. We believe that ACCC cable enables utility companies, power producers and transmission or distribution owners to easily replace transmission lines using standard installation techniques and equipment without modification to existing towers and in many cases avoid the deployment of new towers and the establishment of easements, all of which may be costly, time consuming, controversial and harmful to the environment.

ACCC cable is now commercially available for sale in the U.S. and Canadian markets through a strategic partnership with an existing cable manufacturer, General Cable Industries, Inc., and worldwide, on a limited basis, directly from the Company.

Our marketing strategy for ACCC is to penetrate the domestic U.S. and Canadian markets through our strategic partnership with General Cable and to negotiate similar partnerships globally to market the product internationally. Our product and production development strategy is to develop and market follow-on products serving the utility industry using our proprietary composite materials technologies by taking initial concepts to commercially promising prototype, then moving to small scale production, making relevant product modifications to optimize the combination of manufacturability and performance. Following optimization, pilot production is organized to mimic factory conditions under close monitoring. During this process, the optimal commercial production parameters and product design are documented so that the technology will be available for licensing or transfer to third parties or subsidiaries in a full scale factory launch.

At the beginning of the first quarter of Fiscal 2005, on October, 2, 2004, our wholly owned subsidiary, CTC Cable Corporation, entered into two separate agreements for the manufacture and distribution of our proprietary ACCC cable with General Cable Industries, Inc., the principal U.S. operating subsidiary of General Cable Corporation.

Under the Purchase Agreement, General Cable has been granted exclusive manufacturing rights to wrap, or apply aluminum strand around our ACCC composite core, providing a finished ACCC conductor cable in Canada and the U.S. to be installed and operated in the U.S. and Canada. Pursuant to the terms of this agreement, we have agreed to purchase articles, materials, services or equipment from General Cable for the manufacture of ACCC conductor cable at prices no higher than prices that General Cable would provide to its best commercial customer, subject to General Cable's right to modify prices upon material increases in any of General Cable's raw material costs. General Cable has agreed to certify that its materials, equipment and services covered by the purchase orders comply with the utility cable industry standard specifications and manufacturing processes as well as our specifications. It also warrants for a time period of 12 months after installation, excluding all other warrants, that the wrapped products sold under the purchase orders will meet government approved specifications in the U.S. or Canada and will comply with all specifications and standards agreed upon with CTC in writing. This warranty is not effective more than 20 months from the date of our invoice covering the products. Under the terms of this agreement, General Cable's liability is limited to replacement of any wire or cable that does not substantially meet the manufacturing specifications or fails during normal use within one year from the date of installation and such failure was caused by defects in material or workmanship at time of shipment. Our liability is limited to replacement of products within the warranty period that are defective due to failure of the core to meet applicable specifications or failure to perform as part of a finished product. The agreement terminates on December 31, 2007, unless terminated earlier in the event General Cable is unable to supply products or we are unable to accept delivery of products due to causes beyond our or General Cable's control.

Under the Distribution Agreement, General Cable is appointed a non-exclusive distributor for the marketing and sale of all ACCC cable wrapped by General Cable that conform with applicable industry standards for the U.S. and Canadian markets only. Pursuant to the terms of the agreement, General Cable has agreed, at its expense, to assist CTC in promotional and marketing activities in the U.S. and Canada, coordinate its sales efforts with CTC and establish and maintain a place of business as necessary to provide customer support and marketing coverage in the U.S. and Canada. The agreement grants General Cable a license to use trademarks and trade names used by CTC for the term of the agreement. This agreement terminates on December 31, 2007 and automatically renews from year to year, unless either party gives prior written notice of non-renewal or earlier termination pursuant to the terms of the agreement. General Cable has the right to terminate the agreement at any time without cause upon 90-day prior written notice. General Cable or CTC may terminate the agreement upon uncured breach by the other party or in the event General Cable is unable to supply products or we are unable to accept delivery of products due to causes beyond our or General Cable's control. The agreement automatically terminates in the event of either party's bankruptcy or insolvency, or if performance is impossible or commercially impracticable.

These agreements represent the conclusion of the initial phase of the introduction of our bare overhead conductor ACCC product range in that they provide the framework for the products to be made available in commercial quantities produced by General Cable. We believe the General Cable relationship provides an important level of comfort to customers regarding the stability of supply and consistency and viability of production since they are an established manufacturer and distributor with long standing market relationships. The agreements also mark the beginning of a new phase of our operations in which the focus will be on production of the core for supply to cable manufacturers worldwide and sales of the ACCC products to end users.

Throughout the first quarter of 2005, we have concentrated on improving the operational mechanics of our relationship with General Cable, culminating, subsequent to the quarter end, on January 18, 2005, with the announcement of the introduction of the TransPowr ACCC/TW bare overhead conductor. The TransPowr ACCC/TW bare overhead conductor integrates General Cable's ACSS/TW technology and our carbon and glass fiber core technology that is at the center of our ACCC product range.

TransPowr ACCC/TW bare overhead conductor is the product with which we intend to begin full scale commercial introduction of the ACCC product into the transmission and distribution conductor market.

In addition, we provide consulting services relating to the planning of overhead electrical transmission power lines and utility services, including undertaking preliminary feasibility analysis and strategic advice regarding location and for scope as well as advice regarding the establishment of production facilities for the production of products used in the Electrical Transmission Industry. We currently, however, are not concentrating our efforts to increase our consulting business and instead are focused on the commercialization of the ACCC Cable.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations is based upon the condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expense during the periods. These estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. We have identified those critical accounting policies used in reporting our financial position and results of operations based upon a consideration of those accounting policies that involve the most complex or subjective decisions or assessment. We consider the following to be our critical policies.

Revenue Recognition
Revenues are recognized based on guidance provided in the Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial Statements," as amended (SAB 104). Accordingly, our general revenue recognition policy is to recognize revenue when there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured, and delivery has occurred or services have been rendered.
The Company derives, or seeks to derive revenues from two sources:
(1) Product revenue which includes revenue from the sale of composite core, wrapped composite core, and other electric utility related products.
(2) Consulting revenue, which includes engineering, product design, and service fees that we receive under customer agreements related to the installation and design of our product sale solutions. In addition to the above general revenue recognition principles prescribed by SAB 104, our specific revenue recognition policies for each revenue source are more fully described below.

PRODUCT SALES. Product revenues are generally recognized when product shipment has been made and title has passed to the end user customer. Product revenues consist primarily of revenue from the sale of: (i) wrapped composite core to utilities either sold directly by the Company or through our distributor, ii) composite core sold to a cable wrapping partner not subject to a distributor agreement and where title passes to the partner, or iii) cable core hardware sold to utility companies. For most product sales, we expect that the terms of sales generally will not contain provisions that will obligate us to provide additional products or services after installation to end users.. We recognize revenue: (i) upon shipment when products are shipped FOB shipping point or (ii) upon delivery at the customer's location when products are shipped FOB destination.

CONSULTING REVENUE Consulting revenues are generally recognized as the consulting services are provided. We have entered into service contract agreements with electric utility and utility services companies that generally require us to provide engineering or design services, often in conjunction with current or future product sales. In return, we receive engineering service fees payable in cash. For multiple element contracts where there is no vendor specific objective evidence (VSOE) that would allow the allocation of an arrangement fee amongst various pieces of a multi-element contract, fees received in advance of services provided are recorded as deferred revenues until additional operational experience or other vendor specific objective evidence becomes available, or until the contract is completed.

During its history, the Company has entered into revenue bearing contracts of a long term (greater than one year) duration. Due to a lack of operational history resulting in low reliability of estimates on interim rates of completion of such contracts, revenues associated with long term contracts are recognized on the completed-contract method of accounting. Under this method, billings and costs are accumulated during the period of installation, but no revenues are recorded before the completion of the work. Costs of revenues are capitalized and are recorded in other current assets. Provisions for estimated losses on uncompleted contracts are made at the time such losses are determined. Operating expenses, including indirect costs and administrative expenses, are charged as incurred to periodic income and not allocated to contract costs.

Development Stage Enterprise

The Company is a development stage company as defined in Statement of Financial Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by Development Stage Enterprises." The Company is devoting substantially all of its present efforts to establish a new business, and its planned principal operations have not yet commenced. All losses accumulated since inception, have been considered as part of the Company's development stage activities.

Stock-Based Compensation

The Company accounts for Stock Based Compensation according to the guidelines of Staff Accounting Bulletin No. 107 which incorporates the interaction between Statement of Financial Accounting Standards Statement 123 and certain SEC rules and regulations. SFAS No. 123, "Accounting for Stock Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," defines a fair value based method of accounting for stock-based compensation. However, SFAS No. 123 allows an entity to continue to measure compensation cost related to stock and stock options issued to employees using the intrinsic method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25,"Accounting for Stock Issued to Employees." Entities electing to remain with the accounting method of APB No. 25 must make pro forma disclosures of net income and earnings per share as if the fair value method of accounting defined in SFAS No. 123 had been applied. The Company has elected to account for its stock-based compensation to employees using the intrinsic value method under APB No. 25. In December 2004, SFAS No. 123 was revised and eliminated the ability to account for share based compensation transactions using the intrinsic value method under APB Opinion No. 25, effective the first interim or annual period beginning after June 15, 2005 for public companies. The effective date for the Company will be beginning fourth quarter of fiscal 2005.

The Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation cost other than that required to be recognized by APB No. 25, the difference between the fair value of the Company's common stock at the grant date and the exercise price of the options has been recognized. Had compensation cost for the Company's Stock Plan been determined based on the fair value at the grant date for awards consistent with the provisions of SFAS No. 123, the Company's net loss and loss per share for the three months ended December 31, 2004 and 2003 would have been increased to the pro forma amounts indicated below:

                                       Three months
                                      end March 31,       Three months end        Six months end         Six months end
                                           2005            March 31, 2004         March 31, 2005         March 31, 2004
                                     -----------------    ------------------    -------------------    -------------------
Net loss, as reported                     (4,439,709)          $(3,374,667)           (10,117,459)           $(5,152,433)
Deduct total stock based employee
compensation expense determined
under fair value method for all
awards, net of tax                          (329,269)             (296,711)              (748,511)              (649,098)
                                     -----------------    ------------------    -------------------    -------------------

Net loss, pro forma                       (4,768,978)          $(3,671,378)           (10,865,970)          $ (5,801,531)
                                     -----------------    ------------------    -------------------    -------------------

Earnings per common share
Basic, as reported                             (0.04)                (0.03)                 (0.09)                 (0.05)
Basic, pro forma                               (0.04)                (0.04)                 (0.10)                 (0.06)
Diluted, as reported                           (0.04)                (0.03)                 (0.09)                 (0.05)
Diluted, pro forma                             (0.04)                (0.04)                 (0.10)                 (0.06)

Principles of Consolidation

The consolidated financial statements include the accounts of CTC and its wholly owned subsidiaries (collectively, the "Company"). All significant inter-company accounts and transactions are eliminated in consolidation.

Research and Development Expenses

Research and development expenses are charged to operations as incurred.

Accounts Receivable

The Company has a $2,500,000 account receivable from one entity relating to engineering services provided during fiscal 2004 for an electrical line project in Kansas. The Company has received a progress payment on this receivable in April, 2005 and has entered into a payment schedule for repayment of the entire receivable by July, 2005.

Loss Per Share

The Company utilizes SFAS No. 128, "Earnings per Share." Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.

The following common stock equivalents were excluded from the calculation of diluted loss per share for the three months ended March 31, 2005 and 2004 since their effect would have been anti-dilutive:

                                                        March 31
                                              -----------------------------
                                                  2005            2004
                                              -------------    ------------
              Convertible Debentures             8,982,036               0
              Options for common stock           6,790,336       6,890,398
              Warrants                          11,211,616      12,789,569

Concentration of Credit Risk

The Company has a $2,500,000 account receivable from one entity relating to engineering services provided during fiscal 2004. The Company has received a progress payment on this receivable in April, 2005 and has entered into a payment schedule for repayment of the entire receivable by July, 2005.

RESULTS OF OPERATIONS

PRODUCT SALES

PRODUCT REVENUES Product revenues consist of revenue from the sale of ACCC Cable products to utility companies on a "trial" basis so these customers can verify our claims that the ACCC Cable is technologically superior to existing cable technology. From inception through March 31, 2005 there have been no substantial sales of our ACCC Cable products. There were no product revenues for the quarter ended March 31, 2005. Product revenues increased from $0 for the six months ending March 31, 2004 to $46,485 for the six months ending March 31, 2005. The dollar increase was due to increased ACCC cable trials by utility companies. Revenue of $564,750 from one project has been deferred, with associated costs capitalized, pending completion of the project.

CONSULTING REVENUES Consulting revenues since inception consisted of $2,500,000 for a single consulting contract that was completed during the three months ending September 30, 2004. No consulting contracts were completed during either the six months ended March 31, 2004 or 2005. While this contract provided us with significant revenues, we currently are not concentrating our efforts to increase our consulting business and instead are focused on increasing our product revenues through commercialization of the ACCC Cable. As a result, we do not believe that consulting revenues will be maintained or grow.

COST OF PRODUCT REVENUES Cost of product revenues for the six months ending March 31, 2005 represented materials costs to produce ACCC cable. Cost of product revenues increased from $0 for the six months ending March 31, 2004 to $30,894 for the six months ending March, 2005. The dollar increase was due to increased ACCC cable trials by utility companies. There were no product revenues or costs associated with product revenues for the three months ending March 31, 2004 or 2005.

COST OF CONTRACT REVENUE Cost of contract revenue consists primarily of salaries for engineers and expenses for consultants, supplies, equipment, depreciation and facilities associated with contract projects. Our total engineering costs are allocated between cost of contract revenue and research and development expense. In a given period, the allocation of engineering costs between cost of contract revenue and research and development is a function of the level of effort expended on each.

Cost of contract revenue since inception consisted of costs related to the single consulting contract that was completed during the three months ending September 30, 2004. No consulting contracts were completed during either the three or six months ended March 31, 2004 or 2005 and accordingly, no costs of contract revenue were recorded for the respective quarters.

OFFICER COMPENSATION Officer Compensation expense consisted of salaries and employee benefits for our Chief Executive, Chief Operating, and Chief Financial Officers and the Corporate Secretary. Officer Compensation decreased 21% from $90,335 in the second fiscal quarter of 2004 to $71,543 in the second fiscal quarter of 2005. For the six months ended March 31, officer compensation decreased 32% from $185,335 in 2004 to $126,838 in 2005. The dollar decrease was due to fewer officers in 2005.

GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense consisted primarily of salaries and employee benefits for administrative personnel, facilities costs, stock exchange fees and insurance expenses. General and Administrative expense decreased 29% from $1,105,826 in the second fiscal quarter of 2004 to $783,230 in the second fiscal quarter of 2005. For the six months ended March 31, general and administrative expense decreased 12% from $1,568,637 in 2004 to $1,381,837 in 2005.

For the six month period, the dollar decreases are primarily due to the net effect of headcount costs increases offset by facility cost decreases, travel expenditure decreases, and a non recurring non-cash compensation expense in the second fiscal quarter of 2004 relating to modification of stock options exercised on a cashless basis.

LEGAL, PROFESSIONAL, AND CONSULTING EXPENSE Legal, professional, and consulting expense consisted primarily of legal, professional, and financing fees and consultants performing legal and professional services. Legal, Professional, and Consulting expense increased 239% from $386,416 in the second fiscal quarter of 2004 to $1,308,586 in the second fiscal quarter of 2005. For the six months ended March 31, legal, professional, and consulting expense increased 406% from $822,253 in 2004 to $4,164,416 in 2005.

For the six month period, the dollar increase was due to increased litigation and SEC related legal fees and financing costs related to the issuance of the Convertible Debentures in August, 2004 and warrants issued in November, 2004 in exchange for the release of $10MM in restricted cash. For the three month period, the increase was related to increased litigation and SEC related legal fees.

RESEARCH AND DEVELOPMENT EXPENSE Research and development expense consisted primarily of salaries for engineers and product development personnel, expenses for consultants, recruiting, supplies, equipment, and facilities related to engineering projects to enhance and extend our composite materials intellectual property offerings, and our composite materials product technology and processes. Research and Development expense decreased 24% from $1,515,676 in the second fiscal quarter of 2004 to $1,139,749 in the second fiscal quarter of 2005. For the six months ended March 31, research and development expense increased 12% from $1,978,985 in 2004 to $2,219,400 in 2005.

For the six month period, the increase was due to increased research and development employee expenses offset by a reduction in consulting fees. For the three month period, the decrease was due to a reduction in consulting fees and a reduction in expensed supplies and equipment.

SALES AND MARKETING EXPENSE Sales and marketing expense consisted primarily of salaries for sales and marketing personnel, expenses for sales and marketing consultants, equipment, travel, and printed marketing literature and sales materials. Sales and marketing expense decreased 9% from $254,221 in the second fiscal quarter of 2004 to $232,453 in the second fiscal quarter of 2005. For the six months ended March 31, sales and marketing expense decreased 10% from $565,838 in 2004 to $505,242 in 2005.

For the three and six month periods, the decrease was due to reduced expenditure on marketing literature and materials offset by higher employee costs.

DEPRECIATION EXPENSE Depreciation expense consisted of depreciation on capitalized equipment, leasehold improvements, and other capital assets. Depreciation expense increased 466% from $22,046 in the second fiscal quarter of 2004 to $124,952 in the second fiscal quarter of 2005. For the six months ended March 31, depreciation expense increased 656% from $31,238 in 2004 to $236,328 in 2005. The dollar increase was due to a higher depreciable asset base in fiscal 2005 than 2004.

INTEREST INCOME Interest income increased to $5,284 in the second fiscal quarter of fiscal 2005 from $0 in the prior year quarter and to $32,544 for the six months ended March 31, 2005 from $0 in 2004. The increase was due to interest earned on higher cash balances.

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