SatCon Technology 10-Q 2011
Documents found in this filing:
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2011
Commission File Number 1-11512
SATCON TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Common Stock, $0.01 Par Value,
119,546,046 shares outstanding as of August 1, 2011.
The accompanying notes are an integral part of these unaudited consolidated financial statements.
SATCON TECHNOLOGY CORPORATION
The accompanying notes are an integral part of these unaudited consolidated financial statements.
SATCON TECHNOLOGY CORPORATION
For the six months ended June 30, 2011
The accompanying notes are an integral part of these unaudited consolidated financial statements.
SATCON TECHNOLOGY CORPORATION
The accompanying notes are an integral part of these unaudited consolidated financial statements.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
(1) Includes $(18,357) related to discontinued operations for the three month period ended June 30, 2010.
The accompanying notes are an integral part of these unaudited consolidated financial statements.
SATCON TECHNOLOGY CORPORATION
JUNE 30, 2011 (2011) AND JUNE 30, 2010 (2010)
Note A. Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of Satcon Technology Corporation and its wholly owned subsidiaries (Satcon Power Systems Canada, Ltd. and Satcon Trading (Shenzhen) Co., Ltd.) and its discontinued operating subsidiaries (Satcon Applied Technology, Satcon Electronics, Inc. and Satcon Power Systems, Inc.) (collectively, the Company) as of June 30, 2011 and for the six months ended June 30, 2011 and 2010, and have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All intercompany accounts and transactions have been eliminated. These unaudited consolidated financial statements, which, in the opinion of management, reflect all adjustments (including normal recurring adjustments) necessary for a fair presentation, should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2010. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for any future interim period or for the entire fiscal year.
Note B. Realization of Assets and Liquidity
The Company has developed a business plan that envisions a continued increase in assets and revenue from the results experienced in the recent past. The Company believes that its existing plan will generate sufficient cash which, along with its existing cash on hand and its credit facility, as modified on June 30, 2011, will enable it to fund operations through at least June 30, 2012.
The Companys funding plans for our working capital needs and other commitments may be adversely impacted if it fails to realize its underlying assumed levels of revenues and expenses, receivables are not collected or if the Company fails to remain in compliance with the covenants of its bank line, subordinated note payable or subordinated convertible notes. If any of these events were to occur, the Company may need to raise additional funds in order to sustain operations by selling equity or taking other actions to conserve its cash position, which could include selling of certain assets, delaying capital expenditures and incurring additional indebtedness, subject to the restrictions in the credit facility with Silicon Valley Bank and the subordinated convertible notes. Such actions would likely require the consent of Silicon Valley Bank, the lender of our subordinated debt, and/or the holder of our subordinated convertible notes, and there can be no assurance that such consents would be given. Furthermore, there can be no assurance that the Company will be able to raise such funds if they are required.
Note C. Significant Accounting Policies and Basis of Consolidation
There have been no material changes from the Significant Accounting Policies and Basis of Presentation previously disclosed in Part II, Item 8, contained within Notes to Consolidated Financial Statements of the Companys Annual Report on Form 10-K for the fiscal year ending December 31, 2010.
Use of Estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, 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 revenue and expenses during the period reported. Management believes the most significant estimates include the net realizable value of accounts receivable and inventory, warranty provisions, the recoverability of long-lived assets, the recoverability of deferred tax assets and the fair value of equity and financial instruments. Actual results could differ from these estimates.
Certain prior-year balances have been reclassified to conform to current-year presentations.
Basis of Consolidation
The consolidated financial statements include the accounts of Satcon Technology Corporation and its wholly owned subsidiaries (Satcon Power Systems Canada, Ltd. and Satcon Trading (Shenzhen) Co., Ltd.) and its discontinued operating subsidiaries (Satcon Applied Technology, Inc., Satcon Electronics, Inc. and Satcon Power Systems, Inc.). All intercompany accounts and transactions have been eliminated in consolidation.
The Company recognizes revenue from product sales when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer has occurred and the Company has determined that collection of the fee is reasonably assured. Title to the product passes upon shipment of the product, as the products are typically shipped FOB shipping point, unless otherwise agreed upon in advance with the customer. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied. When appropriate the Company provides for a warranty reserve at the time the product revenue is recognized. If a contract involves the provision of multiple elements and the elements qualify for separation, total estimated contract revenue is allocated to each element based on the relative fair value of each element provided. The amount of revenue allocated to each element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is recognized on each element as described above.
Cost of product revenue includes materials, labor, overhead, warranty and freight.
Deferred revenue primarily consists of cash received for extended product warranties, preventative maintenance plans and up-time guarantee programs. Deferred revenue also consists of payments received from customers in advance of services performed, product shipped or installation completed. When an item is deferred for revenue recognition purposes, the deferred revenue is recorded as a liability and the deferred costs are recorded as a component of inventory in the consolidated balance sheets.
When the current estimates of total contract revenue for a customer order indicate a loss, a provision for the entire loss on the contract is recorded. For the three and six months ended June 30, 2011 the Company recorded a contract loss on a customer order of approximately $1.1 million. In addition, the Company incurred approximately $4.0 million of costs related to product development. At June 30, 2011 the accrued contract cost were approximately $2.3 million.
Unbilled Contract Costs and Fees and Funded Research and Development Costs in Excess of Billings
Unbilled contract costs and fees represent revenue recognized in excess of amounts billed due to contractual provisions or deferred costs that have not been recognized as revenue or billed to the customer.
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits and highly-liquid investments with maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates market value. At June 30, 2011 and December 31, 2010, the Company had no restricted cash.
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for uncollectible amounts is based primarily on a specific analysis of accounts in the receivable portfolio and historical write-off experience. While management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.
Inventory is valued at the lower of actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory, and costs are determined based on the first-in, first-out method of accounting and include material, labor and manufacturing overhead costs. A significant decrease in demand for the Companys products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, the industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of the inventory and reported operating results. The Company records, as a charge to cost of product revenue, any amounts required to reduce the carrying value to net realizable value.
Subordinated Convertible Notes
The subordinated convertible notes include features that qualify as embedded derivatives, such as (i) the holders right to convert, (ii) the Companys option to force conversion into shares of common stock of the Company, and (iii) the holders prepayment options. The Company has elected to measure the subordinated convertible notes and the embedded derivatives in their entirety at fair value with changes in fair value recognized as either gain or loss. This election was made by the Company after concluding that several of the derivatives cannot be reliably measured nor reliably associated with another derivative that can be reliably measured and determining that the aggregate fair value of the notes to be more meaningful in the context of the Companys financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained such notes.
Foreign Currency Translation
As of April 1, 2010, the Company determined that the functional currency of its foreign subsidiary was the US dollar. As the functional currency changed from the foreign currency to the reporting currency, the translation adjustments as of April 1, 2010 remains as a component of accumulated other comprehensive income (loss). Prior to this determination, the functional currency was the local currency, assets and liabilities were translated at the rates in effect at the balance sheet dates, while stockholders equity (deficit) including the long-term portion of intercompany advances was translated at historical rates. Statements of operations and cash flow amounts were translated at the average rate for the period. Translation adjustments were included as a component of accumulated other comprehensive income (loss). The Company records the impact from foreign currency transactions as a component of other income (expense). Foreign currency gains and losses were a charge of $0.2 million and $0.2 million and a charge of $0.3 million and $0.4 million for the three and six months ended June 30, 2011 and June 30, 2010, respectively. All foreign currency transaction gains and losses were recorded as a component of other income (loss), net.
Foreign Currency Hedges
The Company uses foreign currency contracts to manage its exposure to changes in foreign currency exchange rates associated with our foreign currency denominated receivables. The Company primarily hedges foreign currency exposure to the Euro. The Company does not engage in trading, market making or speculative activities in the derivatives markets. The foreign currency contracts utilized by the Company do not qualify for hedge accounting treatment, and as a result, any fluctuations in the value of these foreign currency contracts are recognized in other loss (income) in our consolidated statements of operations as incurred. The fluctuations in the value of these foreign currency contracts do, however, largely offset the impact of changes in the value of the underlying risk that they are intended to economically Hedge. As of April 18, 2011, the Company entered into a foreign currency hedge with a bank with a notational amount of approximately $1.6 million, which matured on July 18, 2011.
The following table shows the fair value of our foreign currency hedge at June 30, 2011 and December 31, 2010:
The following table shows the changes in the fair value of our foreign currency contract recorded in net loss during the three and six month periods ended June 30, 2011:
(a) The Company recorded transaction losses associated with the re-measurement of its foreign denominated assets of $203,017 and $230,792 in the three and six months ended June 30, 2011. Transaction losses were included in Other loss (income) in the consolidated statements of operations. The net impact of transaction (losses) gains associated with the re-measurement of the foreign denominated assets and the gains (losses) incurred on the foreign currency hedge was a net loss of $82,913 and $241,100 for the three and six month period ended June 30, 2011, respectively.
The Company accounts for income taxes utilizing the asset and liability method for accounting and reporting for income taxes. Under this method, deferred tax assets and deferred tax liabilities are recognized based on temporary differences between the financial reporting and income tax basis of assets and liabilities using statutory rates. In addition, the Company is required to establish a valuation allowance against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
The Company is allowed to recognize the tax benefits of uncertain tax positions only where the position is more likely than not to be sustained assuming examination by tax authorities. The amount recognized is the amount that represents the largest amount of tax benefit that is greater than 50% likely of being ultimately realized. A liability is recognized for any benefit claimed, or expected to be claimed, in a tax return in excess of the benefit recorded in the financial statements, along with any interest and penalties (if applicable) on that excess. In addition, the Company is required to provide a tabular reconciliation of the change in the aggregate unrecognized tax benefits claimed, or expected to be claimed, in tax returns and disclosure relating to the accrued interest and penalties for unrecognized tax benefits. Discussion is also required for those uncertain tax positions where it is reasonably possible that the estimate of the tax benefit will change significantly in the next twelve months.
As of December 31, 2010, the Company had federal and state net operating loss (NOL) carry forwards and federal and state R&D credit carry forwards, which may be available to offset future federal and state income tax liabilities which expire at various dates through 2031. Utilization of the NOL and R&D credit carry forwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future provided by Sections 382 or 383 of the Internal Revenue Code of 1986, as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and R&D credit carry forwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a rolling three-year period. Since the Companys formation, the Company has raised capital through the issuance of capital stock on several occasions (both pre and post initial public offering) which, combined with the purchasing shareholders subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, or could result in a change of control in the future upon subsequent disposition.
The Company commissioned a study to determine whether Sections 382 or 383 could limit the use of our carryforwards in this manner. After completing this study in 2010, the Company has concluded that the limitation will not have a material impact on its ability to utilize its net operating loss or credit carryforwards. In January 2011, the Companys board of directors adopted a shareholder rights agreement designed to protect the Companys ability to use the NOLs for income tax purposes. However, the adoption of the shareholder rights agreement cannot guarantee complete protection against an ownership change and it remains possible that one may occur. See Note S. Shareholder Rights Agreement.
The tax years 1996 through 2010 remain open to examination by major taxing jurisdictions to which the Company is subject, which are primarily in the United States, as carryforward attributes generated in years past may still be adjusted upon examination by the Internal Revenue Service or state tax authorities if they are or will be used in a future period. The Company is currently not under examination by the Internal Revenue Service or any other jurisdiction for any tax years. The Company did not recognize any interest and penalties associated with unrecognized tax benefits in the accompanying financial statements. The Company would record any
such interest and penalties as a component of interest expense. The Company does not expect any material changes to the unrecognized benefits within 12 months of the reporting date.
Accounting for Stock-based Compensation
The Company has several stock-based compensation plans, as well as stock options issued outside of such plans as an inducement to engage new executives. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the service period.
The Company uses the Black-Scholes valuation model for valuing options. This model incorporates several assumptions, including volatility, expected life and discount rate. The Company uses historical volatility as it believes it is more reflective of market conditions and a better indicator of volatility. The Company uses historical information in the calculation of expected life for its plain-vanilla option grants. If the Company determines that another method used to estimate expected volatility is more reasonable than the Companys current methods, or if another method for calculating these input assumptions is prescribed by authoritative guidance, the fair value calculated for share-based awards could change significantly. Higher volatility and longer expected lives would result in an increase to share-based compensation determined at the date of grant.
The Company recognized the full impact of its stock-based compensation plans in the consolidated financial statements for the three and six months ended June 30, 2011 and 2010 and did not capitalize any such costs on the consolidated balance sheets, as such costs that qualified for capitalization were not material. The following table presents stock-based compensation expense, including amounts related to employees participation in the Employee Stock Purchase Plan (ESPP) of approximately $0.3 million and $0.4 million for the three and six months ended June 30, 2011, respectively (See Note R, Employee Benefit Plan), included in the Companys consolidated statement of operations:
Compensation expense associated with the granting of stock options to employees is being recognized on a straight-line basis over the service period of the option. In instances where the actual compensation expense would be greater than that calculated using the straight-line method, the actual compensation expense is recorded in that period.
The weighted average grant date fair value of options granted during the three and six months ended June 30, 2011 and 2010 was $2.03 and $2.49, and $1.87 and $2.38, respectively, per option. The fair value of each stock option is estimated on the date of the grant using the Black-Scholes option-pricing model with the following range of assumptions:
(1) The option life for the three and six months ended June 30, 2011 and 2010 was determined using actual option experience.
(2) The stock volatility for each grant is measured using the weighted average of historical daily price changes of the Companys common stock over the most recent period equal to the expected option life of the grant, the historical
short term trend of the option and other factors, such as expected changes in volatility arising from planned changes in the Companys business operations.
(3) The risk-free interest rate for each grant is equal to the U.S. Treasury yield curve in effect at the time of grant for instruments with a similar expected life.
(4) The estimated forfeiture rate for each option grant is between 0% - 6.25%. The Company periodically reviews the estimated forfeiture rate, in light of actual experience.
At June 30, 2011 approximately $12.5 million in unrecognized compensation expense remains to be recognized over a weighted average period of 2.2 years. The table below summarizes the recognition of the deferred compensation expense associated with employee stock options over the next five years as follows:
Concentration of Credit Risk
Financial instruments that subject the Company to concentrations of credit risk principally consist of cash equivalents, trade accounts receivable, unbilled contract costs and deposits in bank accounts. The Company deposits its cash and invests in short-term investments primarily through a national commercial bank. Deposits in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) are exposed to loss in the event of nonperformance by the institution.
The Companys trade accounts receivable and unbilled contract costs and fees are primarily from sales to commercial customers. The Company does not require collateral and has not historically experienced significant credit losses related to receivables, letters of credit or unbilled contract costs and fees from individual customers or groups of customers in any particular industry or geographic area.
Significant customers are defined as those customers that account for 10% or more of total net revenue in a fiscal year or 10% or more of accounts receivable at the end of a fiscal period. The table below details out customers that were considered significant as it pertains to both revenues for the three and six month periods ended June 30, 2011 and 2010 and accounts receivable at June 30, 2011 and December 31, 2010.
** The accounts receivable associated with these customers were backed by irrevocable letters of credit at December 31, 2010.
Research and Development Costs
The Company expenses research and development costs as incurred. Cost of research and development includes costs incurred in connection with both funded research and development and unfunded research and development activities.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net loss and foreign currency translation adjustments prior to the changing of the functional currency of the Companys Canadian subsidiary to the US dollar.
Fair Value of Financial Instruments
The Companys financial instruments consist of cash equivalents, accounts receivable, unbilled contract costs and fees, warrants to purchase shares of common stock, accounts payable, foreign currency hedge, subordinated note payable, subordinated convertible notes and the line of credit. The estimated fair values have been determined through information obtained from market sources and management estimates. The Companys warrant liability, subordinated convertible note and foreign currency hedge are recorded at fair value. See Fair Value Measurements below. The carrying value of the subordinated notes payable, as of June 30, 2011, is not materially different from the fair value of the notes. The estimated fair values of the remaining financial instruments approximate their carrying values at June 30, 2011 and December 31, 2010.
Fair Value Measurements
The Companys financial assets and liabilities are measured using inputs from the three levels of fair value hierarchy which are as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 are as follows:
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 are as follows:
(1) The Companys Level 2 financial liabilities consist of long term investor warrant liabilities comprised of the Warrant As, Warrant Cs, the warrants issued to the investors in connection with the 2007 preferred stock financing (the 2007 Financing Warrants) and the placement agent warrants. The fair value of the Warrant As and Warrant Cs is being estimated using a binomial lattice model and the fair value of the placement agent warrants and the 2007 Financing Warrants is being estimated using the Black-Scholes option pricing model. (see Note K. Warrant Liabilities-Valuation Methodology and Significant Assumptions; Note L - Redeemable Convertible Series B and Series C Preferred Stock; and Warrant Liabilities below).
(2) The Companys Level 2 financial liabilities consist of a foreign currency hedge. The valuation of this instrument is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the hedge. This analysis reflects the contractual terms of the hedge, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.
(3) The Companys Level 3 financial liabilities consist of a subordinated convertible notes. (See Note I.) The valuation of this instrument utilizes a continuous-variable stochastic process in the form of a Monte-Carlo Simulation and includes unobservable inputs supported by little or no market activity such as discount rate applicable to the instruments debt-like feature, probabilities of debt-like and equity-like positions, and various probabilities of occurrences of certain future events. The analysis also includes the contractual terms of instrument in the form of interest rate, timing and extent of principal & interest payments, and time to maturity.
Upon issuance in 2006, the Warrant As, Warrant Bs and Warrant Cs, along with the Placement Agent Warrants (together the Warrants), did not meet the requirements for equity classification, because such warrants (a) must be settled in registered shares, (b) are subject to substantial liquidated damages if the Company is unable to maintain the effectiveness of the resale registration of the shares and (c) provide a cash-out election using a Black-Scholes valuation under various circumstances. Therefore these Warrants are required to be accounted for as freestanding derivative instruments. Changes in fair value are recognized as either a gain or loss in the statement of operations under the caption Change in fair value of warrant liabilities.
The Company determined the fair value of the Warrant As and Warrant Cs and placement agent warrants using valuation models it considers to be appropriate. The Companys stock price has the most significant influence on the fair value of its warrants. An increase in the Companys common stock price would cause the fair values of the warrants to increase, because the exercise price of the warrants is fixed at $1.815 per share, and result in a charge to our statement of operations. A decrease in the Companys stock price would likewise cause the fair value of the warrants to decrease and result in a credit to our statement of operations. See Note K. Warrant Liabilities for valuation discussion.
Redeemable Convertible Series B Preferred Stock
The Company initially accounted for its issuance of Series B Preferred Stock and associated warrants by allocating the proceeds received net of transaction costs based on the relative fair value of the Series B Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities. The Company determined the initial value of the Series B Preferred Stock and investor warrants using valuation models it considers to be appropriate. The Series B Preferred Stock was classified within the liability section of the Companys balance sheet.
In October 2010, the holders of the remaining 75 shares of Series B Preferred Stock converted their shares into common stock, resulting in the issuance of 251,677 shares of common stock.
Redeemable Convertible Series C Preferred Stock
The Company initially accounted for its issuance of Series C Preferred Stock and associated warrants by allocating the proceeds received net of transaction costs based on the relative fair value of the Series C Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion rights contained in the convertible redeemable preferred securities. The Series C Preferred Stock is classified as temporary equity on the balance sheet. The Company determined the initial value of the Series C Preferred Stock and investor warrants using valuation models it considers to be appropriate. The Company used the effective interest method to accrete the carrying value of the Series C Preferred Stock through the earliest possible redemption date (November 8, 2011), at which time the value of the Series C Preferred Stock would have been $30.0 million or 120% of its face value and dividends.
On October 27, 2010, the holders of all of the outstanding shares of Series C Preferred Stock converted their shares and accumulated dividends into common stock, resulting in the issuance of 27,526,344 shares of common stock. To induce the Series C Preferred Stock holders to convert their shares, the Company paid these holders an aggregate $1.25 million in cash upon conversion. The entitlement to a redemption of the Series C Preferred Shares was eliminated upon the holders conversion of the Series C Preferred Stock into common shares in October 2010.
Note D. Discontinued Operations
On January 10, 2010, the Company sold its Applied Technology business unit for approximately $0.7 million in cash, net of closing costs. Prior to the sale, the Applied Technology business unit was reported by the Company as its own operating segment. Operations associated with the Applied Technology business unit have been classified as discontinued operations in the accompanying consolidated statements of operations, and cash flows associated with this segment are included in cash flows from discontinued operations in the consolidated statements of cash flows. The Company evaluated the assets of the Applied Technology business unit and as of December 31, 2009 classified them as held for sale. The Company recorded a gain on the sale of the Applied Technology business unit of approximately $0.5 million in its results of operations for the six months ended June 30, 2010.
Net sales from discontinued operations were $0.1 million for the six months ended June 30, 2010. Net income from discontinued operations was income of approximately $31,000 for the six months ended June 30, 2010.
The Company has not allocated interest to discontinued operations. The Company has also eliminated all intercompany activity associated with discontinued operations.
Note E. Loss Per Share
The following is the reconciliation of the numerators and denominators of the basic and diluted loss per share computations:
As of June 30, 2011 and 2010, shares of common stock issuable upon the exercise of options and warrants were excluded from the diluted average common shares outstanding, as their effect would have been antidilutive. In addition, for the three and six month period ended June 30, 2010, shares of common stock issuable upon the conversion of Series B Preferred Stock and Series C Preferred Stock and related dividends were excluded from the diluted weighted average common shares outstanding as their effect would also have been antidilutive. Basic earnings per share excludes dilution and is computed by dividing income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company, except when the effect would be antidilutive.
The table below summarizes the actual number of options and warrants and convertible preferred stock that were excluded from the calculation above due to their effect being antidilutive:
The table below details out shares of common stock underlying securities for which the securities would have been considered dilutive at June 30, 2011 and 2010, had the Company not been in a loss position:
Note F. Inventory
Inventory components at the end of each period were as follows:
Note G. Property and Equipment
Property and equipment consisted of the following:
Depreciation and amortization expense from continuing operations relating to property and equipment for the three and six months ended June 30, 2011 and 2010 was approximately $0.5 million and $0.9 million and approximately $0.4 million and $0.8 million, respectively.
Note H. Legal Matters
From time to time, the Company is a party to routine litigation and proceedings in the ordinary course of business. Except as described below, the Company is not aware of any current or pending litigation in which the Company is or may be a party that it believes could materially adversely affect the results of operations or financial condition.
The Company is party to various claims and suits pending for alleged damages to persons and property, alleged violations of certain laws and alleged liabilities arising out of matters occurring during the normal operation of its business.
In accordance with ASC 450-20, the Company accrues for legal proceedings when losses become probable and reasonably estimable. As of the end of each applicable reporting period, the Company reviews each of its legal proceedings to determine whether it is probable, reasonably possible or remote that a liability has been incurred and, if it is at least reasonably possible, whether a range of loss can be reasonably estimated under the provisions of ASC 450-20-25-2. In instances where the Company determines that a loss is probable and the Company can reasonably estimate a range of losses the Company may incur with respect to such a matter, the Company records an accrual for the amount within the range that constitutes its best estimate of the possible loss. If the Company is able to reasonably estimate a range but no amount within the range appears to be a better estimate than any other, the Company records an accrual in the amount that is the low end of such range. When a loss is reasonably possible but not probable, the Company will not record an accrual but will disclose its estimate of the possible range of loss where such estimate can be made in accordance with ASC 450-20-25-3. As of June 30, 2011, there were no accruals established related to the Companys outstanding legal proceedings.
The Company offers no prediction of the outcome of any of the proceedings or negotiations described below. The Company is vigorously defending each of these lawsuits and claims. However, there can be no guarantee the Company will prevail or that any judgments against it, if sustained on appeal, will not have a material adverse effect on our business, financial condition, results of operations or cash flows.
FuelCell Arbitration. On February 17, 2011, FuelCell Energy, Inc. (FuelCell Energy) filed a Demand for Arbitration with the American Arbitration Association seeking recovery of damages related to allegedly defective transformers that the Company procured for them. In its Demand for Arbitration, FuelCell Energy asserts that it is entitled to recovery of approximately $2.8 million from the Company. The Company vigorously denies the allegation that the transformers were defective, and has filed a counterclaim seeking recovery of amounts due to it from FuelCell Energy for materials and engineering services that the Company supplied to them totaling approximately $1.4 million. This matter has been submitted to binding arbitration for resolution. Because the arbitration is at an early stage, the Company has not determined a loss is probable.
Class Action Litigation. In July 2011, two purported securities class action complaints were filed against us, our Chief Executive Officer and our former Chief Financial Officer by the following plaintiffs, individually and on behalf of all others similarly situated, in the U.S. District Court, District of Massachusetts: Allan Edwards (filed July 19, 2011) and Larry Ziegler (filed July 21, 2011). The virtually identical complaints are purportedly brought on behalf of persons who acquired our common stock during the period of March 4, 2010, through July 5, 2011, and allege claims against all defendants for violations under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, as well as claims against the individual defendants for violations of Section 20(a) of the Exchange Act. Putative plaintiffs claim that the defendants caused our common stock to trade at artificially inflated prices through false and misleading statements and/or omissions related to our business. The complaints seek compensatory damages for all damages sustained as a result of the defendants actions, including reasonable costs and expenses, and other relief as the court may deem just and proper. The Company believe these allegations are baseless and the Company intends to defend against them vigorously.
Shareholder Derivative Litigation. On August 2, 2011, a shareholder derivative action was brought by plaintiff purportedly on behalf of our company against several of our senior officers and directors, in the U.S. District Court, District of Massachusetts. The complaint alleges that the officer and director defendants breached their fiduciary duties by providing allegedly misleading and inaccurate information regarding our business. The shareholder derivative action generally seeks compensatory damages for all alleged losses sustained as a result of the individual defendants actions, including reasonable costs and expenses, and other relief as the court may deem just and proper. The Company believe that these allegations are baseless and the Company intends to defend against them vigorously.
Note I. Commitments and Contingencies
The Company leases its facilities under various operating leases that expire through October 2016.
Future minimum annual rentals under lease agreements at June 30, 2011 are as follows:
Letters of Credit:
The Company utilized a standby letter of credit to satisfy a security deposit requirement. Outstanding standby letters of credit as of June 30, 2011 and December 31, 2010 were $0.3 million and $0, respectively. The Company is at times required to pledge cash as collateral on outstanding letters of credit. At June 30, 2011 and 2010, no cash was pledged as collateral on outstanding letters of credit.
The Companys employment arrangements with each of its current Chief Executive Officer, Chief Financial Officer, Chief Technology Officer, Executive Vice President of Sales and Marketing, Vice President of Global Operations, Vice President of Quality and Vice President, Administration & Secretary provide that, if his employment is terminated by the Company without cause or is constructively terminated, his salary and medical benefits will be continued for one year thereafter subject to his execution of a release agreement with the Company. In May 2011, the Company terminated the employment of its then Chief Financial Officer. Accordingly the Company has recorded a severance accrual of approximately $0.3 million.
Line of Credit
On February 26, 2008, the Company entered into a Loan and Security Agreement (the Loan Agreement) with Silicon Valley Bank (the Bank). Under the terms of the Loan Agreement, the Bank agreed to provide the Company with a credit line up to $10.0 million. The Companys obligations under the Loan Agreement are secured by substantially all of the assets of the Company and advances under the Loan Agreement are limited to 80% of eligible receivables and the lesser of 25% of the value of the Companys eligible inventory, as defined, or $1.0 million. Interest on outstanding borrowings accrued at a rate per annum equal to the Prime Rate plus one percent (1.0%) per annum, as defined, or the LIBOR Rate plus three and three quarter percent (3.75%) per annum. The Loan Agreement contained certain financial covenants relating to tangible net worth, as defined, which the Company must satisfy in order to borrow under the agreement. In addition, the Company agreed to pay to the Bank a collateral monitoring fee of $750 per month and agreed to the following additional terms: (i) $50,000 commitment fee, $25,000 to be paid at signing of the Loan Agreement and $25,000 to be paid on the one year anniversary of the Loan Agreement; (ii) an unused line fee in the amount of 0.5% per annum of the average unused portion of the revolving line; and (iii) an early termination fee of 0.5% of the total credit line if the Company terminated the Loan Agreement prior to 12 months from the Loan Agreements effective date.
During 2011 and 2010, the Company entered into several amendments to the Loan Agreement. On April 22, 2011, the Company and certain of its subsidiaries entered into an Amended and Restated Credit Agreement (as amended to date, the Amended Loan Agreement) with the Bank, as administrative agent, issuing lender and swingline lender, and such other lenders as set forth from time to time in the Amended Loan Agreement. The Amended Loan Agreement amended and restated the Companys prior Loan Agreement, and provides for a senior secured revolving credit facility of up to $35 million. In addition, the Company may make a one-time request for an additional $15 million to increase the credit facility to an aggregate of $50 million, subject to the approval of the lending group.
Total outstanding debt under the Amended Loan Agreement may not exceed (a) the sum of (1) 80% of the book value of eligible accounts (other than those accounts payable in Euros or Canadian dollars), plus (2) 70% of the book value of eligible accounts payable in Euros or Canadian dollars, plus (3) 80% of the eligible foreign accounts, plus (4) 70% of the eligible Chinese accounts,
plus (5) the lesser of (i) 60% of the cost of eligible inventory or (ii) the net orderly liquidation value of eligible inventory, as adjusted pursuant to the Amended Loan Agreement, less (b) the amount of any reserves established by the Bank.
The Amended Loan Agreement contains restrictions regarding the incurrence of additional indebtedness by the Company or its subsidiaries, the ability to enter into various fundamental changes (such as mergers and acquisitions), the ability to make certain payments or investments, and other limitations customary in senior secured credit facilities. In addition, the Company must comply with certain financial conditions if its liquidity (defined as cash on deposit with the Bank plus availability under the Amended Loan Agreement) is less than $15 million.
Borrowings under the Amended Loan Agreement are permitted to be used for refinancing the amounts outstanding under the existing loan agreement with the Bank, to repay certain fees and expenses, and for ongoing working capital and general corporate purposes. Interest on outstanding indebtedness under the Amended Loan Agreement will accrue at an annual rate equal to (a) the higher of (i) the prime rate and (ii) the federal funds effective rate plus one-half of one percent (0.5%) plus (b) the applicable margin. The initial applicable margin is 0.75%, and is subject to adjustment based on the Companys liquidity in each fiscal quarter such that, if the Companys liquidity is above $35 million, then the applicable margin is reduced to 0.25%.
The obligations of the Company and its subsidiaries under the Amended Loan Agreement are secured under various collateral documents by first priority liens on substantially all of the assets of the Company and certain of its subsidiaries.
The Amended Loan Agreement provides that events of default will exist in certain circumstances, including failure to make payment of principal or interest on the loans when required, failure to perform obligations under the Amended Loan Agreement and related documents, defaults on other indebtedness in excess of $200,000, the occurrence of a change of control of the Company, and certain other events. Upon an event of default, the Bank may accelerate maturity of the loans and enforce remedies under the Amended Loan Agreement and related documents.
The Amended Loan Agreement, if not sooner terminated in accordance with its terms, originally expired on April 23, 2014. On June 30, 2011, in conjunction with the Companys convertible note financing, the Amended Loan Agreement was amended to expire on April 23, 2013.
At June 30, 2011 and December 31, 2010, the Company had $35.0 million and $15.0 million, respectively, outstanding under the Amended Loan Agreement. The rate used was the Banks prime rate of 3.5% plus 0.50% (or 4.0% at June 30, 2011) and the Banks prime rate of 4.0% plus 0.50% (or 4.5% at December 31, 2010). As of June 30, 2011 the Company had $0 available under the line of credit.
On June 16, 2010, the Company entered into a Venture Loan and Security Agreement with Compass Horizon Funding Company LLC (the Lender) pursuant to which the Lender has loaned the Company $12,000,000 (as amended to date, the Subordinated Loan). After the Lenders closing fees and expenses, the net proceeds to the Company were $11,826,500. Interest on the Subordinated Loan will accrue at a rate per annum equal to 12.58%. The Subordinated Loan is currently subordinated to up to $5,000,000 of senior indebtedness, provided that from and after August 31, 2010, the senior indebtedness cannot exceed an amount equal to 80% of the Companys accounts receivable plus 40% of its inventory. The Subordinated Loan is to be repaid over 42 months following the closing. From June 15, 2010 through April 30, 2011, the Company is only required to pay interest on the Subordinated Loan and thereafter the Subordinated Loan will be repaid in 33 substantially equal monthly installments of interest and principal. The Subordinated Loan may be prepaid by the Company by paying all accrued interest through the date of payment, the then outstanding principal balance and a prepayment premium equal to a declining percentage of the principal amount outstanding at the time of prepayment (initially 4% during the first twelve months of the subordinated Loan, decreasing to 3% for the succeeding twelve months and 2% thereafter). In connection with the Subordinated Loan, the Company has issued to the Lender five-year warrants to acquire up to an aggregate of 591,716 shares of the Companys common stock at an exercise price of $2.43 per share (which was the 20-day trailing volume weighted average price of the Companys common stock). On June 30, 2011, the warrants were amended to lower the exercise price to $2.00 per share, resulting in a charge of approximately $0.1 million. The relative fair value of the warrants at issuance was $0.9 million and was recorded as interest expense over the term of the loan. The Company estimated the fair value of the warrants, at time of issuance and when modified, using the Black-Scholes option pricing model using the following assumptions:
The Notes Payable are to be repaid over 42 months as follows:
Subordinated Convertible Notes
On June 29, 2011, the Company entered into a Securities Purchase Agreement (the Purchase Agreement) with the purchaser named therein (the Purchaser) in connection with the private placement (the Private Placement) of $16,000,000 aggregate principal amount of unsecured, subordinated convertible notes (the Convertible Notes). The shares to be issued upon conversion of the Convertible Notes, or as payment of interest on the Convertible Notes in lieu of cash, have been registered under the Securities Act, as of July 27, 2011. The Private Placement closed on June 30, 2011.
Among other terms, the Purchase Agreement provides that (1) the Company will not issue, offer or sell any equity securities of the Company, including convertible securities, subject to certain exceptions, until the date that is 30 days following the earlier of (i) the effectiveness of the Registration Statement covering the shares underlying the Convertible Notes (as described below) and (ii) the six month anniversary of the closing date of the issuance and sale of the Convertible Notes and (2) the Company will not redeem or declare or pay any dividends on, any of its securities without consent of the Purchaser.
The Company also entered into a Registration Rights Agreement with the Purchasers pursuant to which the Company agreed to register the common stock issuable upon conversion of, or the payment of interest on, the Convertible Notes, as further described below. The Company agreed to file a registration statement under the Securities Act within 20 days of the closing of the Private Placement to register the resale of the shares of common stock issuable upon conversion of the Convertible Notes and as payment of interest on the Convertible Notes, which it did. The Company agreed to use its best efforts to cause the registration statement to be declared effective within 70 days following the closing of the Private Placement (or 90 days of the registration statement is reviewed by the Securities and Exchange Commission) and to keep the registration statement effective until the earlier of (1) the date all of the securities covered by the registration statement have been sold, which it did, the Registration Statement was declared effective on July 27, 2011, and (2) the date all of the securities covered by the registration statement may be sold without restriction under Rule 144 promulgated under the Securities Act of 1933, as amended (the Securities Act). If the Company fails to comply with these or certain other provisions, then the Company shall be required to pay liquidated damages of 1% of the aggregate outstanding principal amount of the Convertible Notes for the initial occurrence of such failure and for each subsequent 30 day period in which the failure continues. The net proceeds of the sale of the Convertible Notes were approximately $15.0 million, after deducting placement fees and other offering-related expenses.
The Convertible Notes have an aggregate principal amount of $16 million and are convertible into shares of the Companys common stock at a conversion price of $2.92, subject to adjustment. In addition, the conversion price will be adjusted, on the eleventh trading day following the public announcement of Satcons financial results for the quarter ending September 30, 2011 (the Adjustment Date), to the lower of (i) the then effective conversion price and (ii) 110% of the arithmetic average of the volume weighted average price of the Companys common stock for the ten consecutive trading days ending on the trading day immediately preceding the Adjustment Date. The Convertible Notes are convertible at the option of the holders into shares of the Companys common stock at any time at the then applicable conversion price.
The Convertible Notes mature on July 1, 2013, and bear interest at a rate of 7.0% per annum. Interest is payable monthly, beginning on November 1, 2011, and may be made in cash or, at the option of the Company if certain equity conditions are satisfied, in shares of its common stock. If interest is paid in shares of common stock, the price per share will be at the lower of (i) the then current conversion price and (ii) 88% of the arithmetic average of the volume weighted average price of Satcons common stock for the ten consecutive trading days ending on the trading day immediately preceding the payment date.
If at any time following the Adjustment Date, the closing sale price of Company common stock exceeds 175% of the conversion price for 30 consecutive trading days, then, if certain equity conditions are satisfied, the Company may require the holders of the Convertible Notes to convert all or any part of the outstanding principal into shares of common stock at the then applicable conversion price, provided that the Company may only make a one-time election to force conversion. The Convertible Notes contain certain limitations on optional and mandatory conversion, including that, absent stockholder approval of the transaction, the Company will not issue shares of common stock under the Convertible Notes in excess of 19.99% of the Companys outstanding shares on the closing date.
The Convertible Notes contain certain covenants and restrictions, including, among others, that, for so long as the Convertible Notes are outstanding, the Company will not incur any indebtedness that is senior to, or on parity with, the Convertible Notes in right of payment, subject to limited exceptions for existing indebtedness. Events of default under the Convertible Notes include, among others, payments defaults, cross-defaults, the Companys common stock is suspended from trading for a period of time or no longer listed on an eligible trading market, and certain bankruptcy-type events involving the Company or any subsidiary. Upon an event of default, the holders may elect to require the Company to redeem all or any portion of the outstanding principal amount of the Convertible Notes for a price equal to the greater of 120% of (i) the amount to be redeemed (as calculated through the redemption date) and (ii) the product of (A) the conversion rate with respect to such amount in effect at such time as the holders deliver a
redemption notice and (B) the greatest closing sale price of the Companys common stock on any trading day during the period starting on the date immediately preceding the event of default and ending on the trading day immediately prior to the date the Company is required to pay the redemption amount. The holders may elect to require the Company to redeem for cash all or any portion of the outstanding principal on the Convertible Notes in connection with a change of control of the Company.
In addition, at any time after the 60th day following the earlier to occur of (i) the first date on which the resale of common stock underlying the Convertible Notes is covered by one or more effective registration statements and (ii) the six month anniversary of the closing of the Private Placement, the Company may redeem all (but not less than all) of the then outstanding amount of the Convertible Notes in cash at a price equal to the greater of 125% of (i) the amount to be redeemed (as calculated through the redemption date) and (ii) the product of (A) the conversion rate with respect to such amount in effect at such time as the Company delivers a redemption notice and (B) the greatest closing sale price of the Companys common stock on any trading day during the period starting on the date notice of redemption is given and ending on the date immediately prior to the redemption, provided that the Company may only deliver one such redemption notice.
Accounting for the Subordinated Convertible Notes
The Company has elected to account for the subordinated convertible notes (Convertible Notes) as an instrument that has the characteristics of a debt host contract containing several embedded derivative features that would require bifurcation and separate accounting as a derivative instrument pursuant to the provisions of ASC 815. The Company has identified all of the derivatives associated with the June 30, 2011 financing, however, several of the derivatives can not be reliably measured nor reliably associated with another derivative that can be reliably measured. As such, the Company has appropriately valued these derivatives as a single contract together with the Convertible Notes. As permitted under ASC 825-10-10 the Company has elected, as of the issuance date to measure the Convertible Notes in their entirety at fair value with changes in fair value recognized as either gain or loss until the notes are settled. This election was made by the Company after determining that the aggregate fair value of the Convertible Notes to be more meaningful in the context of the Companys financial statements than if separate fair values were assigned to each of the multiple embedded instruments contained in such Convertible Notes.
Upon issuance of the Convertible Notes the Company determined the initial carrying value of the Convertible Notes to be $16.0 million. The Convertible Notes were immediately marked to fair value, resulting in a liability in the amount of $16.4 million. The change in fair value related to the Convertible Notes was charged to change in fair value of convertible notes and warrant liabilities in the statement of operations for the period ended June 30, 2011 and totaled approximately $0.4 million. Due to the Convertible Note being carried at fair value in accordance with ASC 825, financing costs associated with obtaining convertible notes have been immediately expensed. The Company paid approximately $1.1 million in related transaction costs, which is recorded as interest expense in the statement of operations for the three and six months ended June 30, 2011.
A summary of changes in the Convertible Notes is as follows:
(1) Amounts included in change in fair value of subordinated convertible notes and warrant liabilities on consolidated statement of operations.
Valuation - Methodology and Significant Assumptions
The process of analyzing/valuing financial and derivative instruments utilizes facts and circumstances as of the measurement date as well as certain inputs, assumptions, and judgment calls that may affect the estimated fair value of the instruments. The estimated fair value of the Convertible Notes is based on a utilization of certain valuation models that consider current and expected stock prices, expected volatility, expected interest rates, scheduled principal and interest payments, expected rate of returns and discount rates, probabilities of occurrences of certain future events, and expected liquidation horizons. Such inputs and assumptions as well as the conclusions of values are subject to significant estimates and actual results may differ.
The methods, inputs, and significant assumptions utilized in estimating the fair value of the Convertible Notes are summarized in the following sections.
A continuous-variable stochastic process in the form of a Monte-Carlo Simulation was utilized to estimate the fair value of the Convertible Notes as of the Issuance Date. Monte Carlo simulation, a process of randomly generating values for uncertain variables, is meant to imitate a real-life system especially when other analyses are too mathematically complex or too difficult to reproduce. This method was used to simulate future expected stock prices, variable strike prices, and the behavior of each of the instruments significant features, as discussed above, as well as the respective outcomes at each particular time in the future - bi-weekly time steps were utilized throughout the maturity of the Convertible Notes as well as daily time steps for purposes of estimating the adjustment to the Conversion price as discussed above. Other valuation methods were considered, such as the Black-Scholes-Merton option-pricing model and a binomial lattice model, but the simulation model was found as most appropriate in the analysis of the Convertible Notes due to the potential variability of the Conversion Price (and its path dependency on stock prices during a period of 10 consecutive trading days prior to the potential adjustment day) and the Companys ability to force conversion should certain condition are met in the future (as discussed above).
The simulation model was first utilized to continuously simulate the expected prices of the Companys common stock at each time step and throughout the remaining life of the instrument. Secondly, an analysis of each of the instruments significant features was conducted at each time step for purposes of determining the respective value of each feature and its affect on the price market participants would be willing to pay for the Convertible Notes. Based on the simulated stock prices, the value of each of the features at each time step, the greater of (or lower of in the case of the options at the Companys hands) the conversion positions, redemption positions, or holding positions (i.e. fair value as of each respective future time step discounted using the applicable effective discount rate) was conducted relative to each time step and from the perspective of the Holders, until a final fair value of the instrument is determined at the time step representing the measurement date. This model requires the following key inputs with respect to the Company and/or instrument:
· The Company expects to pay on time (and in shares of the Companys common stock) all principal and accrued interests due to the Holders on each of the Installment Dates (as discussed above). The dilution effects as a result of the payment in stock vs. cash was assumed to be immaterial to the overall conclusion of the fair value of the instrument as of the valuation date;
· The volatility of the Companys common stock was estimated by considering (i) the annualized daily volatility of the Companys stock prices during the historical period preceding the respective valuation date and measured over a period corresponding to the remaining life of the instrument and (ii) the implied volatility based on the Companys publicly-traded options to buy or sell the shares of the Companys stock;
· The quoted market price of the Companys stock was utilized in the valuations because the authoritative guidance requires the use of quoted market prices without consideration of blockage discounts. The quoted market price may not reflect the market value of a large block of stock;
· The quoted market price of the Companys stock as of measurement dates and expected future stock prices were assumed to reflect the effect of dilution upon conversion of the instruments to shares of common stock;
· The volume weighted average price for the 10 trading days preceding the potential adjustment to the Conversion Price was reasonably approximated by the average of the simulated stock price at each respective time step of the of the simulation model;
· The simulated stock prices at each bi-weekly time steps following the date of the potential adjustment to the Conversion Price were assumed to reasonably approximates the Companys stock prices during a period of 30 consecutive trading days (for purposes of determining whether the price condition underlying the Companys right to force conversion, as discussed above, has been met;
· Based on the Companys historical operations and managements expectations for the foreseeable future, the probability of occurrence during the reaming life of the instrument was assumed diminutive (thus assigned as 5% probability in the simulation model) for events of default and change of control transactions (as defined the Agreement);
· Based on the Companys historical operations and managements expectations for the foreseeable future, equity conditions failures or fundamental transactions (as defined in the Agreement) were not expected to occur during the reaming life of the instrument;
· The date of the potential adjustment date to the Conversion price, as discussed above, was assumed to be based on 45 days following the end of the 3rd calendar quarter of the current year (i.e. November 15, 2011); and
· Based on the Companys historical operations and management expectations for the near future, the Companys stock was assumed to be a non-dividend-paying stock;
The following table details out the principal payments on the convertible notes through maturity.
Note J. Product Warranties
The Company provides a warranty to its customers for most of its products sold. In general the Companys warranties are for one year after the sale of the product and five years for photovoltaic inverter product sales. The Company reviews its warranty liability quarterly. The Companys estimate for product warranties is based on an analysis of actual expenses by specific product line and estimated future costs related to warranty. Factors taken into consideration when evaluating the Companys warranty reserve are (i) historical claims for each product, (ii) the development stage of the product, (iii) volume increases, (iv) life of warranty and (v) other factors. To the extent actual experience differs from the Companys estimate, the provision for product warranties will be adjusted in future periods. Such differences may be significant.
Accrued warranty is included in other accrued expenses on the Companys consolidated balance sheets. The following is a summary of the Companys accrued warranty activity for the following periods:
Note K. Warrant Liabilities
Warrants Issued in Connection with the July 2006 Financing
In connection with the July 19, 2006 private placement of $12.0 million aggregate principal amount of senior secured convertible notes (which notes were subsequently retired by cash redemption in November 2007), the Company issued the following Warrant As, Warrant Bs, Warrant Cs and Placement Agent Warrants:
The Warrant As originally entitled the holders thereof to purchase up to an aggregate of 3,636,368 shares of the Companys common stock at a price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants. The period prior to six months from the date of the warrants is hereinafter referred to as the non-exercise period. The exercise price and the number of shares underlying these warrants are subject to adjustment for stock splits, stock dividends, combinations, distributions of assets or evidence of indebtedness, mergers, consolidations, sales of all or substantially all assets, tender offers, exchange offers, reclassifications or compulsory share exchanges.
If a change of control of the Company occurs, as defined, the holders may elect to require the Company to purchase the Warrant As for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant A.
For so long as any Warrant As remain outstanding, the Company may not issue any common stock or common stock equivalents at a price per share less than $1.65. In the event of a breach of this provision, the holders may elect to require the Company to purchase the Warrant As for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant A. As a result of the November 8, 2007 and December 20, 2007 preferred stock financing, as described in Note L below, the holders were entitled for a limited period of time (45 days after each issuance) to exercise this right. During fiscal 2007, the Company paid approximately $1.4 million to redeem Warrant As representing 1,242,426 shares of common stock. During 2008, the Company paid approximately $0.4 million to redeem Warrant As representing 303,031 shares of common stock. (See table below for assumptions used in valuing the warrants redeemed). During the six month period ended June 30, 2011, warrants to purchase 580,303 shares of common stock were exercised. As of June 30, 2011 and December 31, 2010, Warrant As to purchase 556,061 and 1,136,364 shares of common stock were outstanding, respectively.
If the closing bid price per share of common stock for any 20 consecutive trading days exceeded 200% of the exercise price, then, if certain conditions were satisfied, including certain equity conditions, the Company had the right to require the holders of the Warrant As to exercise up to 50% of the unexercised portions of such warrants (as discussed below, this right was exercised in 2010 and 2011). If the closing bid price per share of common stock for any 20 consecutive trading days exceeds 300% of the exercise price,
then, if certain equity conditions are satisfied, the Company may require the holders of the Warrant As to exercise all or any part of the unexercised portions of such warrants.
The Warrant Bs entitled the holders thereof to purchase up to an aggregate of 3,636,368 shares of the Companys common stock at a price of $1.68 per share for a period of 90 trading days beginning six months from the date of such warrants. As a result of an amendment, the expiration date of the Warrant Bs was extended to August 31, 2007.
On July 17, 2007, the holders of the Warrant Bs exercised such warrants in full, acquiring 3,636,638 shares of common stock at $1.31 per share. The Company received proceeds of approximately $4.8 million. To entice the holders of the Warrant Bs to exercise such warrants the Company reduced the exercise price from $1.68 to $1.31 per share. As a result of reducing the exercise price the Company recorded a charge to operations in 2007 related to the warrant modification of approximately $0.9 million to change in fair value of the Convertible Notes and warrants on the accompanying statement of operations. Pursuant to the original terms of the Warrant Bs, upon exercise of the Warrant Bs, the warrant holders were entitled to receive additional warrants (Warrant Cs) to purchase a number of shares of common stock equal to 50% of the number of shares of common stock purchased upon exercise of the Warrant Bs. As a result of the full exercise of the Warrant Bs, the holders received Warrant Cs to purchase 1,818,187 shares of common stock at an exercise price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants.
As discussed above, upon the exercise of the Warrant Bs, the holders were entitled to receive additional warrants (the Warrant Cs). The Warrant Cs originally entitled the holders thereof to purchase up to an aggregate of 1,818,187 shares of our common stock at a price of $1.815 per share for a period beginning six months from the date of such warrants and ending on the seventh anniversary of the date of such warrants. The period prior to six months from the date of the warrants is hereinafter referred to as the non-exercise period. The exercise price and the number of shares underlying these warrants are subject to adjustment for stock splits, stock dividends, combinations, distributions of assets or evidence of indebtedness, mergers, consolidations, sales of all or substantially all assets, tender offers, exchange offers, reclassifications or compulsory share exchanges. If a change of control of the Company occurs, as defined, the holders may elect to require the Company to purchase the Warrant Cs for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant C.
For so long as any Warrant Cs remain outstanding, the Company may not issue any common stock or common stock equivalents at a price per share less $1.65. In the event of a breach of this provision, the holders may elect to require the Company to purchase the Warrant Cs for a purchase price equal to the Black-Scholes value of the remaining unexercised portion of each Warrant C. As a result of the November 8, 2007 and December 20, 2007 preferred stock financing, as described in Note L below, the holders were entitled for a limited period of time (45 days after each issuance) to exercise this right. During 2007, the Company paid approximately $0.7 million to redeem Warrant Cs representing 621,215 shares of common stock. During 2008, the Company paid approximately $0.2 million to redeem Warrant Cs representing 151,516 shares of common stock. (See table below for assumptions used in valuing the warrants redeemed). During the six month period ended June 30, 2011, warrants to purchase 265,152 shares of common stock were exercised. As of June 30, 2011 and December 31, 2010, Warrant Cs to purchase 348,485 and 613,637 shares of common stock were outstanding, respectively.
If the volume weighted average price per share of the Companys common stock for any 20 consecutive trading days exceeded 200% of the exercise price, then, if certain conditions were satisfied, the Company had the right to require the holders of the Warrant Cs to exercise up to 50% of the unexercised portions of such warrants. If the volume weighted average price per share of the Companys common stock for any 20 consecutive trading days exceeds 300% of the exercise price, then, if certain equity conditions are satisfied, the Company may require the holders of the Warrant Cs to exercise all or any part of the unexercised portions of such warrants.
During 2010, the Company notified the holders of the outstanding Warrant As and Warrant Cs that the holders were required to exercise 50% of their un-exercised warrants. As a result of this notification by the Company holders of Warrant As exercised warrants to purchase 469,699 shares of common stock and holders of Warrant Cs exercised warrants to purchase 234,849 shares of common stock. During the six month period ended June 30, 2011, an additional 580,303 Warrant As and 265,152 Warrant Cs were exercised, as noted above, as a result of notification sent out to the remaining holders of the Warrant As and Warrant Cs.
The table below summarizes Black-Scholes option pricing model range of assumptions that were used in valuing the warrants redeemed for both the Warrant As and Warrant Cs.