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Soluna Holdings, Inc - Quarter Report: 2004 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

/X/ Quarterly report pursuant to Section 13 or 15 (d) of the Securities

Exchange Act of 1934

For the quarterly period ended September 30, 2004

or

/ / Transition report pursuant to Section 13 or 15 (d) of the Securities

Exchange Act of 1934

For the transition period from to

Commission File Number 0-6890

MECHANICAL TECHNOLOGY INCORPORATED

(Exact name of registrant as specified in its charter)

New York

14-1462255

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

431 New Karner Road, Albany, New York 12205

(Address of principal executive offices) (Zip Code)

(518) 533-2200

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class

Outstanding at November 3, 2004

Common Stock, $1.00 Par Value

29,246,916 Shares

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

INDEX

 

 

 

Part I. FINANCIAL INFORMATION

Page No.

   

Item 1. Financial Statements

Financial Statements of Mechanical Technology Incorporated and Subsidiaries

 
   

Condensed Consolidated Balance Sheets - September 30, 2004 (Unaudited) and December 31, 2003

3-4

   

Condensed Consolidated Statements of Operations - Three and nine months ended September 30, 2004 and 2003 (Unaudited)

5

   

Condensed Consolidated Statements of Shareholders' Equity and Comprehensive Income - Nine months ended September 30, 2004 and 2003 (Unaudited)

6

   

Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2004 and 2003 (Unaudited)

7

   

Notes to Condensed Consolidated Financial Statements (Unaudited)

8-27

   

Item 2. Management's Discussion and Analysis of Financial Condition

and Results of Operations

28-37

   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

38

   

Item 4. Controls and Procedures

38-39

   

Part II. OTHER INFORMATION

 
   

Item 1. Legal Proceedings

40

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

40

Item 3. Defaults Upon Senior Securities

40

Item 4. Submission of Matters to a Vote of Security Holders

40

Item 5. Other Information

40

Item 6. Exhibits

40

   

Signatures

41

 

 

 

 

 

 

 

 

 

 

 

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 30, 2004 (Unaudited) and December 31, 2003

(Dollars in thousands)

 

 

Sept. 30,

Dec. 31,

 

2004

2003

Assets

   

Current Assets:

   

Cash and cash equivalents

$17,159

$12,380

Securities available for sale

19,186

44,031

Accounts receivable

1,192

962

Inventories, net

1,099

1,300

Prepaid expenses and other current assets

619

514

Total Current Assets

39,255

59,187

     

Long Term Assets:

   

Securities available for sale - restricted

17,307

-

Property, plant and equipment, net

2,556

1,999

Deferred income taxes

3,426

4,652

Notes receivable-noncurrent, less allowance of $660 as of December 31, 2003

-

-

Total Assets

$62,544

$65,838

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

3

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 30, 2004 (Unaudited) and December 31, 2003

(Dollars in thousands, except share data)

 

Sept. 30,

Dec. 31,

 

2004

2003

Liabilities and Shareholders' Equity

   
     

Current Liabilities:

   

Accounts payable

$ 579

$ 692

Accrued liabilities

2,398

1,528

Accrued liabilities - related parties

53

48

Income taxes payable

12

12

Deferred income taxes

5,865

14,481

Total Current Liabilities

8,907

16,761

Long-Term Liabilities:

   

Derivative liability

4,163

-

Other credits

24

24

Total Liabilities

13,094

16,785

     

Commitments and Contingencies

   

Minority interests

1,706

787

     

Shareholders' Equity:

   

Common stock, par value $1 per share, authorized 75,000,000; issued
37,282,652 at September 30, 2004 and 35,776,510 at December 31, 2003

37,283

35,776

Paid-in-capital

75,819

68,708

Accumulated deficit

(67,431)

(62,433)

45,671

42,051

Accumulated Other Comprehensive Income:

   

Unrealized gain on securities available for sale, net of taxes

15,827

19,944

Common stock in treasury, at cost, 8,040,736 shares at September 30, 2004

and 8,035,974 shares at December 31, 2003

(13,754)

(13,729)

Total Shareholders' Equity

47,744

48,266

Total Liabilities and Shareholders' Equity

$ 62,544

$ 65,838

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

4

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(Dollars in thousands, except per share data)

Three months ended

Nine months ended

 

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

 

2004

2003

2004

2003

Revenues:

       

Product revenue

$ 1,642

$ 1,598

$ 4,452

$ 4,304

Funded research and development revenue

175

310

754

1,422

Total revenues

1,817

1,908

5,206

5,726

Operating costs and expenses:

Cost of product revenue

686

755

1,956

1,868

Research and product development expenses:

Funded research and product development

881

879

2,576

2,502

Unfunded research and product development

2,352

1,317

6,331

3,548

Total research and product development expenses

3,233

2,196

8,907

6,050

Selling, general and administrative expenses

1,526

1,854

4,890

4,559

Operating loss

(3,628)

(2,897)

(10,547)

(6,751)

Interest expense

-

-

-

(7)

(Loss) gain on derivatives

(2,635)

2

(2,424)

(4)

Gain on sale of securities available for sale, net

-

4,123

3,129

7,483

Impairment losses

-

-

-

(418)

Other income (expenses), net

41

(75)

60

(114)

(Loss) income from continuing operations before

income taxes and minority interests

(6,222)

1,153

(9,782)

189

Income tax benefit (expense)

2,473

(425)

3,854

(74)

Minority interests in losses of consolidated subsidiary

356

195

930

346

(Loss) income from continuing operations

(3,393)

923

(4,998)

461

Income from discontinued operations, net of tax

-

-

-

13

Net (loss) income

$ (3,393)

$ 923

$ (4,998)

$ 474

(Loss) Income per Share (Basic and Diluted):

(Loss) income per share from continuing operations

$ (0.12)

$ 0.03

$ (0.17)

$ 0.02

Income per share from discontinued operations

-

-

-

-

(Loss) income per share

$ (0.12)

$ 0.03

$ (0.17)

$ 0.02

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

5

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

AND COMPREHENSIVE INCOME (Unaudited)

(Dollars in thousands)

Nine months ended

Sept. 30,

Sept. 30,

 

2004

2003

COMMON STOCK

   

Balance, beginning

$ 35,776

$ 35,648

Issuance of shares - options

88

11

Issuance of shares - private placement

1,419

-

Balance, ending

$ 37,283

$ 35,659

PAID-IN-CAPITAL

   

Balance, beginning

$ 68,708

$ 67,479

Issuance of shares - options

115

9

MTI MicroFuel Cell investment

344

191

Private placement, net of expenses

5,827

-

Compensatory options

-

32

Derivative tax asset

695

-

Stock option exercises recognized differently for financial

   

reporting and tax purposes

130

1

Balance, ending

$ 75,819

$ 67,712

ACCUMULATED DEFICIT

   

Balance, beginning

$(62,433)

$(61,874)

Net (loss) income

(4,998)

474

Balance, ending

$(67,431)

$(61,400)

ACCUMULATED OTHER COMPREHENSIVE INCOME:

UNREALIZED GAIN ON SECURITIES AVAILABLE FOR SALE,

   

NET OF TAXES

   

Balance, beginning

$ 19,944

$ 13,170

Less reclassification adjustment for gains included in net income

(1,248)

(3,262)

Change in unrealized (loss) gain on securities available for sale, net of taxes

(2,869)

2,311

Balance, ending

$ 15,827

$ 12,219

RESTRICTED STOCK GRANT

   

Balance, beginning

$ -

$ (40)

Grants vested

-

37

Balance, ending

$ -

$ (3)

TREASURY STOCK

   

Balance, beginning

$(13,729)

$(13,635)

Stock acquisition

(25)

-

Balance, ending

$(13,754)

$(13,635)

SHAREHOLDERS' EQUITY

   

Balance, ending

$ 47,744

$ 40,552

TOTAL COMPREHENSIVE LOSS:

   

Net (loss) income

$ (4,998)

$ 474

Other comprehensive loss:

   

Change in unrealized loss on securities available for sale, net of taxes

(4,117)

(951)

Total comprehensive loss

$ (9,115)

$ (477)

The accompanying notes are an integral part of the condensed consolidated financial statements.

6

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

 

Nine months ended

 

Sept. 30,

2004

Sept. 30,

2003

Operating Activities

   

Net (loss) income excluding discontinued operations

$ (4,998)

$ 461

Adjustments to reconcile net (loss) income to net cash used by operations:

   

Loss on derivatives

2,424

4

Impairment losses

-

418

Minority interests in losses of consolidated subsidiary

(930)

(346)

Loss on retirement of subsidiary treasury stock

-

5

Depreciation and amortization

657

430

Gain on sale of securities available for sale, net

(3,129)

(7,483)

Loss on disposal of fixed assets

34

3

Deferred income taxes and other credits

(3,820)

104

Stock based compensation

-

69

Changes in operating assets and liabilities net of effects from discontinued operations:

Accounts receivable

(230)

306

Inventories, net

201

99

Prepaid expenses and other current assets

(105)

(912)

Accounts payable

(112)

(84)

Income taxes payable

-

(82)

Accrued liabilities - related parties

5

(86)

Accrued liabilities

870

245

Net cash used by operating activities excluding discontinued operations

(9,133)

(6,849)

Discontinued operations:

   

Income from discontinued operations

-

13

Deferred income taxes

-

8

Net cash provided by discontinued operations

-

21

Net cash used by operating activities

(9,133)

(6,828)

Investing Activities

   

Purchases of property, plant and equipment

(1,248)

(843)

Proceeds from sale of securities available for sale

3,804

11,654

Net cash provided by investing activities

2,556

10,811

Financing Activities

   

Gross proceeds from private placement

10,000

-

Costs of private placement

(1,015)

-

Purchase of common stock for treasury

(25)

-

Proceeds from stock option exercises

203

20

Proceeds from subsidiary stock issuances

2,193

1,001

Net cash provided by financing activities

11,356

1,021

Increase in cash and cash equivalents

4,779

5,004

Cash and cash equivalents - beginning of period

12,380

7,320

Cash and cash equivalents - end of period

$ 17,159

$ 12,324

 

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

 

7

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and contain all adjustments, consisting of only normal, recurring adjustments, necessary for a fair presentation of results for such periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year.

Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K and 10-K/A filed for the fiscal year ended December 31, 2003.

The information presented in the accompanying condensed consolidated balance sheet as of December 31, 2003 has been derived from the Company's December 31, 2003 audited consolidated financial statements. All other information has been derived from the Company's unaudited condensed consolidated financial statements for the periods as of and ending September 30, 2004 and 2003.

 

  1. Significant Accounting Policies

Revenue Recognition

Mechanical Technology Incorporated ("the Company" or "MTI") applies the guidance within SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements ("SAB 104") in the evaluation of its contracts to determine when to properly recognize revenue. Under SAB 104 revenue is recognized when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery has occurred or services have been rendered, the sales price is determinable, and collectibility is reasonably assured.

Product Revenue. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer or distributor has occurred, at which time title generally is passed to the customer or distributor, all of which generally occur upon shipment of the product. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied.

Funded Research and Development Revenue. The Company performs funded research and development for government agencies and commercial companies under both cost reimbursement and fixed-price contracts.  Cost reimbursement contracts provide for the reimbursement of allowable costs.  On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as the services are performed. In each type of contract, the Company generally receives periodic progress payments or payments upon reaching interim milestones. When the current estimates of total contract revenue for commercial development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in performing funded research and development projects are recognized as research and development expense as incurred. As of September 30, 2004, the Company has accrued approximately $114 thousand for anticipated contract losses on commercial contracts. When government agencies are providing funding they do not expect the government to be the only significant end user of the resulting products.  These contracts do not require delivery of products that meet defined performance specifications, but are best efforts arrangements to achieve overall research and development objectives. Included in accounts receivable are billed and unbilled work-in-progress on contracts. While the Company's accounting for government contract costs is subject to audit by the sponsoring entity, in the opinion of management, no material adjustments are expected as a result of such audits. Adjustments are recognized in the period made.

8

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Significant Accounting Policies (Continued)

Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development arrangements are included in funded research and product development expenses.

Deferred revenue consists of payments received and amounts due from customers in advance of services performed, products shipped, customer acceptance or installation completed.

Warranty

The Company records a warranty reserve at the time product revenue is recorded based on a historical rate. The reserve is reviewed during the year and is adjusted, if appropriate, to reflect new product offerings or changes in experience. Actual warranty claims are tracked by product.

Stock Based Compensation

The Company has two stock-based employee compensation plans, which are described more fully in Note 13 of the consolidated financial statements for the year ended December 31, 2003. Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, requires the measurement of the fair value of stock options or warrants granted to employees to be included in the consolidated financial statements of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company accounts for stock-based compensation of employees under the intrinsic value method of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations and has elected the disclosure-only alternative under SFAS No. 123. The Company records the fair market value of stock options and warrants granted to non-employees in exchange for services in accordance with Emerging Issues Task Force ("EITF") Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, in the condensed consolidated statements of operations. The Company has adopted the disclosure provisions but does not intend to adopt the transition provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure.

The following table illustrates the effect on net (loss) income and (loss) income per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

(Dollars in thousands, except per share data)

Three months ended

Nine months ended

 

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

 

2004

2003

2004

2003

Net (loss) income, as reported

$(3,393)

$ 923

$(4,998)

$ 474

Add: Total stock-based employee

       

compensation expense already recorded in

       

financial statements, net of related tax effects

-

14

-

42

         

Deduct: Total stock-based employee

       

compensation expense determined under fair

       

value based method for all awards, net of

       

related tax effects

(936)

(262)

(1,109)

(916)

Pro forma net (loss) income

$(4,329)

$ 675

$(6,107)

$ (400)

         

(Loss) income per share:

       

Basic and diluted - as reported

$ (0.12)

$ 0.03

$ (0.17)

$ 0.02

Basic and diluted - pro forma

$ (0.15)

$ 0.02

$ (0.21)

$ (0.01)

9

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Significant Accounting Policies (Continued)
  2. Accounting for Derivative Instruments

    On October 1, 2000, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, which establishes a new model for accounting for derivatives and hedging activities. These standards required the Company to recognize all derivative instruments as either assets or liabilities in the statement of financial position and measure these instruments at fair value. Fair value is estimated using the Black Scholes Option-Pricing Model.

    In September 2000, the EITF issued EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company's Own Stock, which requires freestanding contracts that are settled in a company's own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under the provisions of EITF Issue No. 00-19, a contract designated as an asset or a liability must be carried at fair value, with any changes in fair value recorded in the results of operations. A contract designated as an equity instrument must be included within equity, and no fair value adjustments are required.

    The Company held or has outstanding the following derivative financial instruments:

     

    Sept. 30,

    Sept. 30,

    Dec. 31,

     
     

    2004

    2003

    2003

    Expiration

    Derivatives issued:

           

    Warrants, exercisable beginning February 5, 2005, to purchase the

           

    Company's common stock issued to Chicago Investment Group, L.L.C.

           

    at a purchase price of $10.572 per share

    28,377

    -

    -

    February 5, 2006

             

    First Investment Right, exercisable beginning April 25, 2004, to

           

    purchase the Company's common stock issued to Fletcher

           

    International, Ltd. at a purchase price of $6.34 per share (1)

    1,261,830

    -

    -

    December 31, 2004

             

    Second Investment Right, exercisable beginning immediately after

           

    the full exercise of the First Investment Right, to purchase the

           

    Company's common stock issued to Fletcher International, Ltd. at

           

    a purchase price of $6.34 per share through December 31, 2006 (1)

    3,154,575

    -

    -

    December 31, 2006

             

    Plug Power Investment Right, exercisable at any time from June 1, 2005

           

    through December 31, 2006 after the full exercise of the First

           

    Investment Right, to purchase a number of the Company's shares of

           

    Plug Power common stock (to the extent of the number of shares

           

    remaining in escrow pursuant to the agreement) equal to

           

    $10,000,000 divided by the prevailing price per share of Plug Power

           

    common stock (1)

    (2)

    -

    -

    December 31, 2006

             

    Warrants, immediately exercisable, to purchase the Company's

           

    common stock issued to SatCon at a purchase price of $12.56 per share

    -

    108,000

    -

    October 21, 2003

             

    Warrants, immediately exercisable, to purchase the Company's

           

    common stock issued to SatCon at a purchase price of $12.56 per share

    -

    192,000

    192,000

    January 31, 2004

             

    Derivatives held:

           

    Warrants, immediately exercisable, to purchase SatCon common

    stock at a purchase price of $7.84 per share

    -

    36,000

    -

    October 21, 2003

             

    Warrants, immediately exercisable, to purchase SatCon common

           

    stock at a purchase price of $7.84 per share

    -

    64,000

    64,000

    January 31, 2004

             

    (1) - The Company and Fletcher International, Ltd. entered into an amended private placement agreement on May 4, 2004 (see Note 8 - Shareholders' Equity).

    (2) - The exercise price for the Plug Power Investment Right is $10,000,000 less the positive difference between $18,000,000 and the product of the sum of 1,418,842 and the quantity of shares purchased in the exercise of the first $8 million additional investment right (1,261,830 shares) multiplied by the prevailing price per share of our common stock on the date Fletcher elects to exercise such right, all divided by the quotient obtained by dividing 10,000,000 by the prevailing price of Plug Power common stock on the date Fletcher elects to exercise such right (see Note 8- Shareholders' Equity).

    10

    MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

    NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  3. Significant Accounting Policies (Continued)

Income Taxes

The Company accounts for taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which requires the use of the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable for future years to differences between financial statement and tax bases of existing assets and liabilities. Under SFAS No. 109, the effect of tax rate changes on deferred taxes is

recognized in the income tax provision in the period that includes the enactment date. The provision for taxes is reduced by investment and other tax credits in the years such credits become available. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.

Reclassification

Certain 2003 amounts have been reclassified to conform to the 2004 presentation. The reclassifications have no effect on total revenues, total expenses, net (loss) income or shareholders' equity as previously reported.

The reclassifications impact our condensed consolidated statements of operations in the following way:

  • Selling, general and administrative expenses now include amortization of restricted stock compensation previously included in other expenses, net.

The reclassifications impact our condensed consolidated statements of shareholders' equity in the following way:

  • Accumulated Other Comprehensive Income now includes an allocation of tax to both realized and unrealized gains (losses) previously allocated to unrealized gains (losses).
  1. Accounts Receivable

Included in accounts receivable are the following at:

 

Sept. 30,

Dec. 31,

(Dollars in thousands)

2004

2003

U.S. and State Government:

   

Amount billed

$ 255

$ 280

Amount billable

242

272

Retainage

70

65

Total U.S. and State Government

$ 567

$ 617

Commercial:

$ 625

$ 345

Total

$1,192

$ 962

The balances billed but not paid by customers pursuant to retainage provisions in contracts are due upon completion of the contracts and acceptance by the customer. Based on the Company's experience, most retainage amounts are expected to be collected within the ensuing year.

 

 

 

 

 

 

 

 

 

11

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Inventories

Inventories consist of the following at:

 

Sept. 30,

Dec. 31,

(Dollars in thousands)

2004

2003

Finished goods

$ 345

$ 300

Work in process

88

316

Raw materials, components and assemblies, net

666

684

 

$1,099

$1,300

  1. Notes Receivable
  2. Notes receivable consist of the following at:

     

    Sept. 30,

    Dec. 31,

    (Dollars in thousands)

    2004

    2003

    Notes receivable(A)

    $ -

    $ 660

    Less: Current portion

    -

    -

    Less: Allowance for bad debt

    -

    (660)

     

    $ -

    $ -


    (A) On August 13, 2003, the Company converted its existing note receivable to a redeemable subordinated debenture. The debenture accrues interest at the rate of 12% per annum. Repayments are scheduled to begin December 1, 2004 in accordance with the debenture agreement.

    During the quarter ended September 30, 2004, the Company wrote this note receivable off against its allowance for bad debts.

  3. Securities Available for Sale

Securities available for sale are classified as both current assets and long-term restricted assets and accumulated net unrealized gains are reported in Other Comprehensive Income. In connection with the Company's private

placement consummated on January 29, 2004 and the amendment of the private placement agreement on May 4, 2004, the Company has escrowed 2.7 million shares of Plug Power common stock (see Note 8 - Shareholders' Equity).

The principal components of the Company's securities available for sale consist of the following at:

(Dollars in thousands, except stock price and share data)

       

Quoted

   
       

Market

   
 

Book

Unrealized

Recorded

Price

   

Security

Basis

Gain

Fair Value

Per NASDAQ

Ownership

Shares

September 30, 2004

           

Plug Power:

Current

$ 5,319

$13,867

$19,186

$ 6.41

4.09%

2,993,227

Restricted (1)

4,797

12,510

17,307

$ 6.41

3.69%

2,700,000

Total

$10,116

$26,377

$36,493

7.78%

5,693,227

December 31, 2003

           

Plug Power

$10,791

$33,240

$44,031

$ 7.25

8.36%

6,073,227

(1) In connection with the amended private placement agreement, the Company has deposited 2.7 million shares of Plug Power common stock into escrow.

12

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Securities Available for Sale (Continued)

The book basis roll forward of Plug Power securities is as follows:

Plug Power - Current

(Dollars in thousands)

Sept. 30,

Dec. 31,

2004

2003

Securities available for sale, beginning of period

$10,791

$14,344

Sale of shares

(675)

(3,553)

Transfer 3,000,000 shares to restricted on 1/29/04

(5,330)

-

Transfer 300,000 shares from restricted on 5/6/04

533

-

Securities book basis

5,319

10,791

Unrealized gain on securities available for sale

13,867

33,240

Securities available for sale, end of period

$19,186

$44,031

Plug Power - Restricted

(Dollars in thousands)

Sept. 30,

Dec. 31,

 

2004

2003

Securities available for sale, beginning of period

$ -

$ -

Transfer 3,000,000 shares from current on 1/29/04

5,330

-

Transfer 300,000 shares to current on 5/6/04

(533)

-

Securities book basis

4,797

-

Unrealized gain on securities available for sale

12,510

-

Securities available for sale - restricted, end of period

$17,307

$ -

Accumulated unrealized gains related to securities available for sale are as follows:

Sept. 30,

Dec. 31,

(Dollars in thousands)

2004

2003

Accumulated unrealized gains

$ 26,377

$ 33,240

Accumulated deferred tax expense

on unrealized gains

(10,550)

(13,296)

Accumulated net unrealized gains

$ 15,827

$ 19,944

  1. Income Taxes

The Company's effective income tax benefit (expense) rate from operations differed from the Federal statutory rate as follows:

Three months ended

Nine months ended

 

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

 

2004

2003

2004

2003

Federal statutory tax rate

34.00%

(34.00)%

34.00%

(34.00)%

State taxes, net of federal tax effect

6.00

(1.76)

5.58

3.43

Other expense, net

(.25)

( 1.10)

(.18)

( 8.48)

Tax rate

39.75%

(36.86)%

39.40%

(39.05)%

 

 

 

 

 

13

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Income Taxes (Continued)

Income tax benefit (expense) consists of the following:

Three months ended

Nine months ended

(Dollars in thousands)

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

 

2004

2003

2004

2003

Operations before minority interest

       

Federal

$ -

$ -

$ 96

$ -

State

-

74

(62)

30

Deferred

2,473

(499)

3,820

(104)

Total continuing operations

$2,473

$ (425)

$3,854

$ (74)

Discontinued operations

       

Federal

-

-

-

-

State

-

-

-

-

Deferred

-

-

-

( 8)

Total discontinued operations

-

-

-

( 8)

Total

$2,473

$ (425)

$3,854

$ (82)

Items credited

directly to shareholders' equity:

       

Increase in unrealized gain on securities available for

sale - Deferred

$2,437

$ 40

$2,745

$ 634

Expenses for employee stock options recognized

differently for financial reporting/tax purposes -

Federal

 

2

 

-

 

130

 

1

Derivative tax asset - Deferred

-

-

695

-

 

$ 2,439

$ 40

$ 3,570

$ 635

Deferred tax assets and (liabilities) consist of the following tax effects relating to temporary differences and carryforwards:

(Dollars in thousands)

Sept. 30,

Dec. 31,

 

2004

2003

Current deferred tax assets (liabilities):

   

Bad debt reserve

$ -

$ 264

Inventory valuation

14

3

Inventory capitalization

20

20

Securities available for sale

(6,431)

(15,289)

Vacation pay

170

181

Warranty and other sale obligations

17

11

Stock options

269

269

Other reserves and accruals

76

60

Net current deferred tax liabilities

$(5,865)

$(14,481)

Non-current deferred tax assets (liabilities):

   

Net operating loss

$ 8,979

$ 5,785

Property, plant and equipment

(145)

(145)

Securities available for sale - restricted

(5,989)

-

Derivatives

1,665

-

Other

239

239

Research and development tax credit

459

459

Alternative minimum tax credit

54

150

 

5,262

6,488

Valuation allowance

(1,836)

(1,836)

Net non-current deferred tax assets

$ 3,426

$ 4,652

Other Credits

$ (24)

$ (24)

14

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Income Taxes (Continued)

The valuation allowance at September 30, 2004 and December 31, 2003 was $1.836 million. The valuation allowance reflects the estimate that it was more likely than not that certain net operating losses may be unavailable to offset future taxable income.

  1. Shareholders' Equity

Common Shares

Changes in common shares issued are as follows:

Nine

Months Ended

Year Ended

 

Sept. 30,

Dec. 31,

 

2004

2003

Balance, beginning

35,776,510

35,648,135

Issuance of shares for stock option exercises

87,300

128,375

Issuance of shares for private placement

1,418,842

-

Balance, ending

37,282,652

35,776,510

Treasury Stock

Changes in treasury stock shares are as follows:

Nine

Months Ended

Year Ended

 

Sept. 30,

Dec. 31,

 

2004

2003

Balance, beginning

8,035,974

8,020,250

Shares acquired for cash

4,762

15,724

Balance, ending

8,040,736

8,035,974

Warrants Issued

On February 5, 2004, the Company issued to Chicago Investment Group, L.L.C. a warrant to purchase 28,377 shares of the Company's common stock at an exercise price of $10.572 per share. The estimated fair value of this warrant at the date issued was $1.39 per share, using a Black Scholes Option-Pricing Model and assumptions similar to those used for valuing the Company's stock options. The warrant may not be exercised until February 5, 2005 and expires on February 5, 2006.

Reservation of Shares

The Company has reserved common shares for future issuance as of September 30, 2004 as follows:

Stock options outstanding

3,793,531

Stock options available for issuance

2,697,901

Additional Investment Rights as required by amended private placement agreement

5,520,505

Warrants outstanding

28,377

Number of common shares reserved

12,040,314

 

15

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Shareholders' Equity (Continued)

Completion of Option Exchange

On December 22, 2003, the Company announced the completion of the first phase of its stock option exchange offer. A total of 757,000 options with an average exercise price of approximately $19 were tendered by

employees and then cancelled by the Company in exchange for the future issuance of options at a one-for-two ratio. New options totaling 341,000 were issued in the final phase of the exchange offer on June 23, 2004 at an exercise price of $6.17 per share to employees and directors who were employed by the Company or served as directors of the Company from December 22, 2003, the acceptance date, through June 23, 2004.

Private Placement

On January 29, 2004, the Company issued to Fletcher International, Ltd., or Fletcher, in a private placement (1) 1,418,842 shares of our common stock for an aggregate purchase price of $10 million, or $7.048 per share, and (2) rights to purchase up to an additional $26 million of our common stock and in certain instances up to 3,000,000 shares of Plug Power Inc. (NASDAQ:PLUG) common stock owned by us, which rights are referred to herein as the additional investment rights.

On May 4, 2004, the Company amended its agreement with Fletcher. This agreement, as amended, ("the 2004 Private Placement") includes a change in the exercise price for the rights to purchase additional shares of MTI common stock to a fixed price $6.34 per share from, in the original agreement, $7.048 per share until December 31, 2005 and the lesser of $7.048 per share or a variable price in 2006. The change to a fixed price substantially reduces the potential for shareholder dilution if shares had been purchased at a variable price in 2006. The price remains subject to adjustment upon the occurrence of certain limited events. The 2004 Private Placement, also includes: (1) an increase in the rights to purchase additional shares of MTI common stock to $28 million from $26 million, (2) a reduction in Fletcher's right to purchase Plug Power common stock escrowed by the Company to a maximum of 2,700,000 shares from a maximum of 3,000,000 shares, (3) an extension of the exercise period for the right to purchase Plug Power common stock to one or more purchases between June 1, 2005 and December 31, 2006 from a one-time purchase in June of 2005, (4) an extension of MTI's ability to withdraw Plug Power common stock from escrow through December 31, 2006 instead of through June 30, 2005, and (5) an extension of the exercise period for the right to invest the first $8 million in MTI's common stock to any time prior to December 31, 2004 from any time prior to ninety business days after the effective date of MTI's registration statement.

On May 20, 2004, the Company's registration statement with the SEC became effective for 1,418,842 shares. The registration statement permits Fletcher to re-sell the shares of our common stock issued to them.

Additional Investment Rights

The additional investment rights provide Fletcher with the right, but not the obligation, to purchase up to an additional $8 million of our common stock at any time prior to December 31, 2004, at a price per share equal to $6.34. In addition, in the event Fletcher exercises in full such $8 million investment right, Fletcher shall have

the right, but not the obligation, to purchase, in a single purchase or multiple purchases, up to an additional $20 million of our common stock at any time prior to December 31, 2006 at a price per share equal to $6.34, which date may be extended in the event that we have not satisfied our contractual obligations with respect to the registration for resale of common stock issued or issuable to Fletcher.

The table below illustrates the number of shares Fletcher would receive upon exercise of its $20 million additional investment right at a price per share equal to $6.34 (such exercise price is subject to adjustment as described below under "Adjustment Provisions"). Note that the Company's 2004 Private Placement

 

 

16

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Shareholders' Equity (Continued)

agreement with Fletcher provides that the maximum number of shares we could potentially issue to Fletcher is 8,330,411 shares.

Shares Issuable in

Purchase Price

Exchange for $20

MTI Stock

Million Investment

$6.34

3,154,575

Plug Power Shares

In connection with the 2004 Private Placement agreement, the Company has reduced the number of shares of Plug Power it has deposited into escrow to 2,700,000 shares, a reduction of 300,000 shares. Commencing immediately after the SEC declares effective the registration statement relating to shares of our common stock that Fletcher owns (or may acquire), we continue to have the right to have 250,000 of such shares released from escrow to us, on a monthly basis, in the event that on any day during such month, the prevailing price of our common stock exceeds $6.343 (which price may have been adjusted to reflect stock splits, recombinations, stock

dividends or the like). If Fletcher does not exercise its right to purchase the first additional $8 million of our common stock, all of such Plug Power shares will be released from escrow to us. If, however, Fletcher does exercise such right, then at any time, on one or multiple occasions, from June 1, 2005 to December 31, 2006, Fletcher may exercise its right to purchase from us a number of shares of Plug Power common stock totaling $10,000,000 divided by the prevailing price per share of Plug Power common stock, but only to the extent of the number of shares remaining in escrow.

The exercise price for the Plug Power investment right is $10,000,000 less the positive difference between $18,000,000 and the product of the sum of 1,418,842 and the quantity of shares purchased in the exercise of the first $8 million of additional investment rights multiplied by the prevailing price per share of our common stock on the date Fletcher elects to exercise such right, all divided by the quotient obtained by dividing 10,000,000 by the prevailing price of Plug Power common stock on the date Fletcher elects to exercise such right. As used herein, a prevailing price is the average of the daily volume-weighted average price per share of common stock during the sixty-business-day period ending three days prior to the date Fletcher elects to exercise such right, provided however that the price may not exceed the average of the daily volume-weighted average prices for any ten business days within such sixty-business-day period. Each of the above referenced per share exercise prices for the additional investment rights was subject to adjustment as described below under "Adjustment Provisions."

As a result of this exercise price calculation, we may be required to sell shares of Plug Power at a discount to prices we would otherwise obtain in sales at market prices. The table below illustrates such potential discounts based on assumed decreases in our stock price from $6.00 (which, for the purposes of this illustration, serves as an approximation of the price of our common stock as of March 11, 2004, the date we filed Amendment No. 1 to our Registration Statement on Form S-3 (SEC File No. 333-112464)), and an assumed price of Plug Power common stock at the time of exercise. Note that Fletcher's right to purchase Plug Power shares is conditioned on the exercising of Fletcher's first $8 million of additional investment rights.

Assumed

Effective

Percentage

MTI

Plug

Exercise

Discount

Plug Shares

Proceeds to

Price

Price

Price

to Market

Purchased

MTI

$6.00

$7.00

$5.66

19%

1,428,571

$8,084,031

$4.50

$7.00

$2.84

59%

1,428,571

$4,063,023

$3.00

$7.00

$0.03

99%

1,428,571

$ 42,016

$1.50

$7.00

$ -

100%

1,428,571

$ -

17

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Shareholders' Equity (Continued)

Adjustment Provisions

The 2004 Private Placement agreement with Fletcher also provides that the Company may be required to issue additional shares to Fletcher, reduce the exercise prices described above for the additional investment rights and/or extend the investment term upon the occurrence of certain events (each as more fully described below) including:

  • a restatement of our financial results,
  • a change in control of our company,
  • a future issuance of our capital stock at a price less than $7.048 as it relates to the initial $10 million investment and $6.34 as it relates to all additional investments, or
  • our failure to maintain the effectiveness of the registration statement relating to shares of our common stock that Fletcher owns or may acquire, as well as our failure to satisfy the other requirements relating to registration.

Restatement

In the event we restate any portion of our financial statements prior to January 29, 2005, or prior to the first anniversary of the closing of any additional investment, as the case may be, the exercise price for the additional investment rights will be adjusted to equal the prevailing price of our common stock sixty days after we restate our financial statements. In addition, with respect to any investments made prior to the time of the restatement, Fletcher will receive additional shares of common stock such that all such investments will have been effectively made at such adjusted exercise price.

Change in Control

In the event of a change of control of our company prior to sixty days after the expiration of the additional investment term, we may have to issue additional shares of our common stock to Fletcher and the additional investment rights (including the right to purchase the Plug Power shares) may be accelerated. If the consideration per share paid to our shareholders in the change of control transaction is less than twice the amount of the price per share paid by Fletcher for any of its investments pursuant to the agreement with Fletcher or the certificate of additional investment rights, then we must issue to Fletcher a number of shares of our common stock such that all of its investments will have been effectively made at a price per share equal to such per share change of control consideration multiplied by 0.5. In addition, if our shareholders have not approved the transaction with Fletcher prior to a change of control of our company, Fletcher may make a net basis settlement with respect to its additional investment rights. The mechanics of a net basis settlement are described below under "Net Basis Settlement and Shareholder Approval."

 

 

 

 

 

 

 

 

 

 

 

 

 

18

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Shareholders' Equity (Continued)

Dilutive Issuances

If on or prior to December 31, 2004 we issue any equity securities at a price below $7.048 as it relates to the initial $10 million investment and $6.34 as it relates to all additional investments, then we must issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was such lower price and adjust the exercise price for the additional investment rights to such lower price. In addition, if after December 31, 2004 and ending December 31, 2006 we issue any equity securities at a price below $7.048 as it relates to the initial $10 million investment and $6.34 as it relates to any additional investments which have been made, the exercise price for the additional investment rights shall be adjusted to provide Fletcher "weighted average" anti-dilution protection and we must issue to Fletcher a number of additional shares such that all prior investments will have been effectively made at such adjusted exercise price.

Registration Obligations

In the event we fail to satisfy our contractual obligations to register for resale shares of common stock issued or issuable to Fletcher, then we must issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was based on the actual exercise price reduced by five percent for each month in which we fail to satisfy our obligations and adjust the exercise price for the additional investment rights to such lower price. In addition, such failure will result in an extension of the investment term for each day we fail to satisfy our registration obligations. These registration obligations include, among other things, maintaining the effectiveness of registration statements.

Other

The 2004 Private Placement agreement also provides Fletcher certain other rights including, but not limited to, indemnification rights with respect to (1) breaches of representations, warranties and covenants contained in the agreements with Fletcher, and (2) misstatements in or omissions from the prospectus and the registration statement relating to shares of our common stock that Fletcher owns or may acquire.

Placement and Amendment Fees

In connection with the 2004 Private Placement, in February 2004 the Company paid placement fees, recorded in equity against the proceeds of the private placement, of $600 thousand to Chicago Investment Group, L.L.C. and issued a warrant to purchase 28,377 shares of the Company's common stock at an exercise price of $10.572 per share. The warrant may not be exercised until February 5, 2005 and expires on February 5, 2006. In connection with the amendment of the private placement, the Company paid advisory fees of $300 thousand to Citigroup Global Markets Inc.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

19

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. (Loss) Income Per Share

The following is the reconciliation of the numerators and denominators of the basic and diluted (loss) income per share computations:

 

Three months ended

Nine months ended

 

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

(Dollars in thousands, except per share data)

2004

2003

2004

2003

(Loss) income from continuing operations

$ (3,393)

$ 923

$(4,998)

$ 461

Basic (Loss) Income per Share:

       

Common shares outstanding, beginning of period

29,240,791

27,639,260

27,740,536

27,627,885

Unvested restricted common shares

-

(50,000)

-

(50,000)

Weighted average common shares issued during the period

1,125

-

1,335,297

10,646

Weighted average common shares reacquired during the period

-

-

(3,233)

-

Weighted average shares outstanding, end of period

29,241,916

27,589,260

29,072,600

27,588,531

(Loss) income per weighted average share

$(0.12)

$ 0.03

$(0.17)

$ 0.02

Diluted (Loss) Income per Share:

Common shares outstanding, beginning of period

29,240,791

27,639,260

27,740,536

27,627,885

Weighted average common shares issued during the period

1,125

-

1,335,297

10,646

Weighted average number of shares reacquired during the period

-

-

(3,233)

-

Weighted average number of options

-

1,039,181

-

739,579

Weighted average number of warrants

-

-

-

-

Weighted average shares outstanding

29,241,916

28,678,441

29,072,600

28,378,110

(Loss) income per weighted average share

$ (0.12)

$ 0.03

$(0.17)

$ 0.02

For the three and nine months ended September 30, 2004, options to purchase 3,793,531 shares of common stock at exercise prices ranging from $0.54 to $20.92 per share, additional investment rights to purchase approximately 4,416,405 shares ($28,000,000 divided by $6.34 per share) of common stock with an exercise price of $6.34 per share and warrants to purchase 28,377 shares of common stock with an exercise price of $10.572 per share were outstanding but were not included in the computations of Loss per Share-assuming dilution because the Company incurred losses during this period and inclusion would be anti-dilutive.

For the three and nine months ended September 30, 2003, warrants to purchase 300,000 shares of common stock with an exercise price of $12.56 per share were outstanding but were not included in the computations of EPS-assuming dilution because inclusion would be anti-dilutive. Additionally, under SFAS No. 128, Earnings per Share, 50,000 shares of non-vested restricted common stock, which vest solely upon continued service, were excluded from the computation of basic earnings per share.

  1. Sale of Securities Available for Sale

The Company sold shares of the following securities and recognized gains and proceeds as follows:

 

Three months ended

Nine months ended

 

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

(Dollars in thousands, except shares)

2004

2003

2004

2003

Plug Power

       

Shares sold

-

1,000,000

380,000

2,000,000

Proceeds

$ -

$ 5,024

$ 3,804

$10,251

Gain on sales

$ -

$ 3,247

$ 3,129

$ 6,698

SatCon

Shares sold

-

581,100

-

773,600

Proceeds

$ -

$ 1,237

$ -

$ 1,403

Gain on sales

$ -

$ 876

$ -

$ 785

Total net gain on sales

$ -

$ 4,123

$ 3,129

$ 7,483

20

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Cash Flows - Supplemental Information

Nine months ended

 

Sept. 30,

Sept. 30,

(Dollars in thousands)

2004

2003

Non-cash Operating, Investing and Financing Activities:

   

Additional paid-in-capital resulting from stock option exercises treated differently for financial reporting and tax purposes

$ 130

$ 1

Change in investment and paid-in-capital resulting from other investors' activity in MTI MicroFuel Cells Inc. stock

344

191

Derivative tax asset

695

-

Prepaid material in exchange for investment in subsidiary

-

3

  1. Segment Information

The Company operates in two business segments, New Energy and Test and Measurement Instrumentation. The New Energy segment is focused on commercializing direct methanol micro fuel cells ("DMFCs"). The Test and Measurement Instrumentation segment designs, manufactures, markets and services computer-based balancing systems for aircraft engines, high-performance test and measurement instruments and systems, and wafer characterization tools for the semiconductor industry. The Company's principal operations are located in North America.

The accounting policies of the New Energy and Test and Measurement Instrumentation segments are the same as those described in the summary of significant accounting policies in the Company's consolidated financial statements for the year ended December 31, 2003. The Company evaluates performance based on profit or loss from operations before income taxes, accounting changes, items management does not deem relevant to segment performance, and interest income and expense. Inter-segment sales are not significant.

Summarized financial information concerning the Company's reportable segments is shown in the following table. The "Other" column includes corporate related items and items like income taxes or unusual

items, which are not allocated to reportable segments. The "Reconciling Items" column includes minority interests in a consolidated subsidiary. In addition, segments' noncash items include any depreciation and amortization in reported profit or loss. The New Energy segment figures include the Company's micro fuel cell operations, equity securities of Plug Power and SatCon, gains (losses) on the sale of these securities, (losses) gains related to the embedded derivative for the purchase of Plug Power common stock and warrants to purchase SatCon common stock.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

  1. Segment Information (Continued)

(Dollars in thousands)

 

Test and

 

Condensed

Measurement

Reconciling

Consolidated

Three months ended September 30, 2004

New Energy

Instrumentation

Other

Items

Totals

Product revenue

$ -

$1,642

$ -

$ -

$ 1,642

Funded research and

development revenue

175

-

-

-

175

Research and product

development expenses

2,970

263

-

-

3,233

Selling, general and

administrative expenses

312

433

781

-

1,526

Loss on derivatives

(2,635)

-

-

-

(2,635)

Segment (loss) profit from

continuing operations before

income taxes and minority interests

 

(5,994)

 

187

 

(415)

 

-

 

(6,222)

Segment (loss) profit

(5,994)

187

2,058

356

(3,393)

Total assets

53,843

1,870

6,831

-

62,544

Securities available for sale

19,186

-

-

-

19,186

Securities available for sale - restricted

17,307

-

-

-

17,307

Derivative liability

4,163

-

-

-

4,163

Capital expenditures

154

23

240

-

417

Depreciation and amortization

116

17

110

-

243

Three months ended September 30, 2003

         

Product revenue

$ -

$ 1,598

$ -

$ -

$ 1,598

Funded research and

development revenue

310

-

-

-

310

Research and product

development expenses

1,910

286

-

-

2,196

Selling, general and

administrative expenses

806

423

625

-

1,854

Gain on derivatives

2

-

-

-

2

Gain on sale of securities available for

sale, net

4,123

-

-

-

4,123

Segment profit (loss) from continuing

operations before income

taxes and minority interests

 

1,647

 

90

 

(584)

 

-

 

1,153

Segment profit (loss)

1,647

90

(1,009)

195

923

Total assets

40,584

2,211

10,280

-

53,075

Securities available for sale

31,156

-

-

-

31,156

Capital expenditures

210

24

102

-

336

Depreciation and amortization

73

25

60

-

158

 

 

 

 

 

 

 

 

 

 

 

 

 

22

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

  1. Segment Information (Continued)

(Dollars in thousands)

 

Test and

 

Condensed

Measurement

Reconciling

Consolidated

Nine months ended September 30, 2004

New Energy

Instrumentation

Other

Items

Totals

Product revenue

$ -

$4,452

$ -

$ -

$ 4,452

Funded research and

development revenue

754

-

-

-

754

Research and product

development expenses

8,049

858

-

-

8,907

Selling, general and

administrative expenses

1,048

1,265

2,577

-

4,890

Loss on derivatives

(2,424)

-

-

-

(2,424)

Gain on sale of securities available

for sale, net

3,129

-

-

-

3,129

Segment (loss) profit from continuing

operations before income taxes and minority

interests

 

(8,441)

 

149

 

(1,490)

 

-

 

(9,782)

Segment (loss) profit

(8,441)

149

2,364

930

(4,998)

Total assets

53,843

1,870

6,831

-

62,544

Securities available for sale

19,186

-

-

-

19,186

Securities available for sale - restricted

17,307

-

-

-

17,307

Derivative liability

4,163

-

-

-

4,163

Capital expenditures

662

59

527

-

1,248

Depreciation and amortization

318

50

289

-

657

Nine months ended September 30, 2003

         

Product revenue

$ -

$ 4,304

$ -

$ -

$ 4,304

Funded research and

development revenue

1,422

-

-

-

1,422

Research and product

development expenses

5,218

832

-

-

6,050

Selling, general and

administrative expenses

1,817

1,219

1,523

-

4,559

Loss on derivatives

(4)

-

-

-

(4)

Gain on sale of securities available

for sale, net

7,483

-

-

-

7,483

Impairment losses

(418)

-

-

-

(418)

Segment profit (loss) from continuing

operations before income

taxes and minority interests

 

1,281

 

250

 

(1,342)

 

-

 

189

Segment profit (loss)

1,281

250

(1,403)

346

474

Total assets

40,584

2,211

10,280

-

53,075

Securities available for sale

31,156

-

-

-

31,156

Capital expenditures

371

32

440

-

843

Depreciation and amortization

205

82

143

-

430

The following table presents the details of "Other" segment profit (loss):

Three months ended

Nine months ended

(Dollars in thousands)

Sept. 30,

Sept. 30,

Sept. 30,

Sept. 30,

2004

2003

2004

2003

Corporate and Other Income (Expense):

Depreciation and amortization

$ (110)

$ (60)

$ (289)

$ (143)

Interest expense

-

-

-

(7)

Interest income

4

50

27

96

Income tax benefit (expense)

2,473

(425)

3,854

(74)

Income from discontinued operations, net

-

-

-

13

Other expense, net

(309)

(574)

(1,228)

(1,288)

Total corporate and other income (expense)

$2,058

$(1,009)

$ 2,364

$(1,403)

23

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Related Party Transactions

In connection with the National Institute of Standards and Technology ("NIST") contract billings and supplier accounts payable, as of September 30, 2004 and December 31, 2003, the Company has a liability to E.I. du Pont de Nemours and Company ("Dupont") (a minority shareholder in MTI Micro) for approximately $53 and $48 thousand, respectively. This liability is included in the financial statement line "Accrued liabilities - related parties."

On March 29, 2004, the Company acquired 4,762 shares of its common stock from its CEO, Dale Church, in connection with a revised tax liability of Mr. Church resulting from the vesting of restricted stock in October 2003. The Company had previously acquired 15,724 shares in connection with the payment of Mr. Church's original tax liability as reported on October 28, 2003.

 

  1. Effect of Recent Accounting Pronouncements

None.

  1. Commitments and Contingencies

Lawrence

On September 9, 1998, Barbara Lawrence, the Lawrence Group, Inc. ("Lawrence"), and certain other Lawrence-related entities ("Plaintiffs") initially filed suit in the Bankruptcy Court and the United States District Court for the Northern District of New York which were subsequently consolidated in the District Court, against First Albany Corporation ("FAC"), Mechanical Technology Incorporated, Dale Church, Edward Dohring, Beno Sternlicht, Alan Goldberg and George McNamee (former Directors of the Company), Marty Mastroianni (former President and Chief Operating Officer of the Company), and 33 other individuals ("Defendants") who purchased a total of 820,909 (2,462,727 shares post split) shares of the Company's common stock from the Plaintiffs. The case concerns the Defendants' 1997 purchase of Mechanical Technology shares from the Plaintiffs at the price of $2.25 per share ($0.75 per share post split). FAC acted as Placement Agent for the Defendants in the negotiation and sale of the shares and in proceedings before the Bankruptcy Court for the Northern District of New York, which approved the sale in September 1997.

Plaintiffs claim that the Defendants failed to disclose material inside information concerning Plug Power, LLC to the Plaintiffs and therefore the $2.25 per share ($0.75 per share post split) purchase price was unfair. Plaintiffs are seeking damages of $5 million plus punitive damages and costs. In April 1999, Defendants filed a motion to dismiss the amended complaint, which was denied by the Bankruptcy Court. On appeal in October 2000, Plaintiffs' cause of action was dismissed by the United States District Court for the Northern District of New York. In November 2000, Plaintiffs filed an appeal of that dismissal with the United States Court of Appeals for the Second Circuit. In June 2002, the Second Circuit Court of Appeals reversed the District Court decision and remanded the case for further consideration of the Plaintiff's claims as motions to modify the Bankruptcy Court sale order. The Plaintiff's claims have now been referred back to Bankruptcy Court for such consideration. In September 2003, the Bankruptcy Court issued an order permitting Plaintiffs to conduct limited discovery concerning how First Albany formed an opinion about the Company's stock up until the date the Stock Purchase Agreement was executed.

The Company believes the claims have no merit and intends to defend them vigorously. The Company cannot predict the outcome of the claims nor reasonably estimate a range of possible loss given the current status of the litigation. Accordingly, no amounts have been reserved for this matter.

Ling Electronics, Inc.

On July 8, 2003, Donald R. Gililland, Sharon Gililland, Vernon Dunham and Jean Dunham, owners of 4890 E. La

Palma Avenue, Anaheim, CA 92870 ("Plaintiffs"), the former location of Ling Electronics, Inc. ("Ling"), filed

24

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Commitments and Contingencies (Continued)

suit in the Superior Court of California for Orange County against SatCon Power Systems, Inc., a subsidiary of SatCon Technology Corporation ("SatCon"), and Mechanical Technology. In September 2003, SatCon and the Company filed a joint answer to the complaint. In September 2004, the Company and SatCon each retained independent counsel. The matter is scheduled for trial in January 2005.

The complaint alleges breach of the lease and, among other things, Ling's failure to maintain and repair the premises. Ling was a subsidiary of the Company until it was sold to SatCon Technology Corporation in 1999. The Plaintiffs allege that the correction and repair of the various breaches by SatCon and the Company of their obligations under the lease will exceed $400,000. The building was leased from 1983 through lease expiration in 2003. The Company remained as a guarantor on the lease after the sale of Ling to SatCon.

The Company believes the claims have no merit and intends to defend them vigorously. The Company cannot predict the outcome of the claims nor reasonably estimate a range of possible loss given the current status of the litigation. Accordingly, no amounts have been reserved for this matter.

Leases

The Company and its subsidiaries lease four manufacturing, laboratory and office facilities. The leases generally provide for the Company to pay either an increase over a base year level for taxes, maintenance, insurance and other costs of the leased properties or the Company's allocated share of insurance, taxes, maintenance and other costs of leased properties. The leases contain renewal provisions.

Future minimum rental payments required under non-cancelable operating leases are (dollars in thousands): $139 remaining in 2004; $566 in 2005, $446 in 2006, $318 in 2007, $316 in 2008, and $289 thereafter.

Warranties

A reconciliation of changes in product warranty liabilities is as follows:

 

Nine months ended

Year ended

 

Sept. 30,

Dec. 31,

(Dollars in thousands)

2004

2003

Balance, January 1

$28

$ 54

Accruals for warranties issued

22

55

Accruals related to pre-existing warranties (including changes in estimates)

-

(66)

Settlements made (in cash or in kind)

(9)

(15)

Balance, end of period

$41

$ 28

Licenses

The Company licenses, on a non-exclusive basis, certain DMFC technology from Los Alamos National Laboratory ("LANL"). Under this agreement, the Company is required to pay future minimum annual license fees of (dollars in thousands): $200 in 2004 and $250 yearly through 2019. Once products are being sold, royalties will be based on 2% of the first $50 million of net sales, 1% on net sales in excess of $50 million but less than $100 million and .5% on net sales in excess of $100 million. License payments made in any year can be applied against royalties due and total annual fees in any year shall not exceed $1 million.

Employment Agreements

The Company has employment agreements with certain employees that provide severance payments and accelerated vesting of certain options upon termination of employment under certain circumstances, as defined in the applicable agreements. As of September 30, 2004, the Company's potential minimum obligation to these employees was approximately $1.061 million.

25

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Commitments and Contingencies (Continued)

Guaranty of Subsidiary Funding

In connection with the Strategic Alliance Agreement between MTI MicroFuel Cells Inc. ("MTI Micro") and The Gillette Company ("Gillette"), the Company guaranteed additional investments in its subsidiary, MTI Micro, of up to $20 million before September 19, 2005, if other sources of funding are not available. Immediately prior to the Gillette transaction closing in September 2003, the Company invested $11 million ($7.4 million in cash and $3.6 million through the conversion of a loan receivable to equity) of its $20 million commitment in MTI Micro common stock. In October 2003, Jeong Kim, an MTI Micro board member, invested $1 million in MTI Micro common stock and on April 7, 2004, the Company invested $15 million into MTI Micro fulfilling its guaranty obligation.

Investment Company Act

The Company's securities available for sale constitute investment securities under the Investment Company Act of 1940 (the "Investment Company Act"). In general, a company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of its total assets, subject to certain exclusions and exemptions. Investment companies are subject to registration under, and compliance with, the Investment Company Act unless a particular exemption or safe harbor provision applies. If the Company were to be deemed an investment company, the Company would become subject to the requirements of the Investment Company Act. As a consequence, the Company would be prohibited from engaging in certain businesses or issuing certain securities, certain of the Company's contracts might be voidable, and the Company might be subject to civil and criminal penalties for noncompliance.

Until fiscal 2001, the Company qualified for a safe harbor exemption under the Investment Company Act based upon the level of ownership of shares of Plug Power and influence over its management or policies. However, since the Company sold some of its shares of Plug Power during fiscal 2001, this safe harbor exemption may not be available.

On December 3, 2001, the Company made an application to the SEC requesting that it either declare that the Company is not an investment company because it is primarily engaged in another business or exempt it from the provisions of the Investment Company Act for a period of time. The Company amended this application on October 20, 2003. This application is pending. If the Company's application is not granted, the Company will have to find another safe harbor or exemption that it can qualify for, which may include a one-year safe harbor granted by the Investment Company Act, or become an investment company subject to the regulations of the Investment Company Act.

If the Company was deemed to be an investment company and could not find another safe harbor or exemption and failed to register as an investment company, the SEC could require the Company to sell its interest in Plug Power until the value of its securities available for sale are reduced below 40% of total assets. This could result in sales of securities in quantities of shares at depressed prices and the Company may never realize anticipated benefits from, or may incur losses on, these sales. Also, in connection with the Strategic Alliance Agreement with Gillette, the Company has agreed to indemnify Gillette against any losses arising out of or related to the

Company's noncompliance with the Investment Company Act or any regulations thereunder.

Further, the Company may be unable to sell some securities due to contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, the Company may incur tax liabilities when selling assets.

  1. Issuance of Stock by Subsidiary

MTI Micro was formed on March 26, 2001. The Company owns approximately 89% of the outstanding capital stock of MTI Micro as of September 30, 2004.

 

26

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

  1. Issuance of Stock by Subsidiary (Continued)

On April 7, 2004, MTI Micro sold 3,218,885 and 215,000 shares of MTI Micro common stock to the Company and a group of private investors, respectively, at a price of $4.66 per share for approximately $15 million and $1 million

respectively. As a result of the Company's investment, it has fully satisfied its remaining investment guaranty under the Gillette Agreement. Further, on May 20, 2004, MTI Micro sold 215,000 shares of MTI Micro common stock to a private investor at a price of $4.66 per share for approximately $1 million.

One component of the Company's paid-in-capital increase in 2004 represents a $344 thousand increase for changes in the Company's equity investment in MTI Micro, which resulted from third-party stock transactions in MTI Micro.

 

  1. Subsequent Events
  2. Sale of Securities Available for Sale

    From October 1 through November 5, 2004, the Company sold available for sale securities as follows:

    (Dollars in thousands)

    Company

    Number of

    Shares Sold

    Proceeds

    from Sales

    Plug Power

    100,000

    $675

    Contracts

    On October 20, 2004, the Company announced that its subsidiary, MTI Micro, received two contracts to demonstrate energy density advantages and to quantify potential logistical advantages of its direct methanol micro fuel cells ("DMFCs") and fuel refill systems for the United States Armed Forces. The first award, which will be administered by the Army Research, Development and Engineering Command ("RDECOM") as part of its evaluation of new technologies for field-readiness, will total approximately $250,000 over the next ten months.

    The second award, a Phase I Small Business Innovative Research ("SBIR") contract from Marine Corp System Command, will provide $70,000 over the next six months to support efforts to analyze and report on current regulations and requirements necessary to field DMFCs and fuel refill systems. An optional three month period could raise the total value of the contract to $100,000.

  3. Amendment to the Gillette Agreement

On August 18, 2004, MTI Micro, entered into an amendment to the multi-year strategic alliance agreement with The Gillette Company ("Gillette") whereby MTI Micro, Gillette and Gillette's Duracell business unit will exclusively develop and commercialize a low-power direct methanol micro fuel cell power system and a compatible fuel refill system to power future mass market, high volume, portable consumer devices. The amendment to the agreement clarified the allocation of deliverables in milestones 3 and 4; added an additional milestone; and changed the due dates for MTI Micro's and Gillette's deliverables. MTI Micro also granted a non-exclusive license to Gillette to any improvements by MTI Micro to intellectual property developed by Gillette.

 

 

 

 

 

 

 

27

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Item 2 contains forward-looking statements that involve risks and uncertainties, which may cause the Company's actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. See "Statement Concerning Forward-Looking Statements" on page 36.

Overview

The Company is primarily engaged in the development and commercialization of DMFCs through its majority-owned subsidiary MTI Micro and the design, manufacture and sale of high-performance test and measurement instruments and systems through its wholly-owned subsidiary MTI Instruments. The Company also co-founded and retains an interest in Plug Power (NASDAQ: PLUG), a designer and developer of on-site energy systems based on proton exchange membrane fuel cells.

MTI Micro designs and develops DMFCs for portable power applications. A micro fuel cell is a portable power source that converts chemical energy into useable electrical energy. MTI Micro is developing a micro fuel cell

that uses methanol, a common alcohol, as its fuel. The Company believes DMFC systems could potentially have an energy density of five to ten times that of Lithium-Ion "(Li-Ion") batteries. The advantage of DMFC systems is that, when commercialized, they should be able to power a wireless electronic device for longer periods of time than Li-Ion batteries between recharging/refueling. In addition, DMFCs may be instantly refueled without the need for a power outlet or a lengthy recharge.

MTI Micro's fuel cell technology platform can be customized to provide portable power for a number of applications depending on the power level, required run time and size requirements. MTI Micro plans to launch its initial product, a power source for Intermec Technologies Corporation ("Intermec") RFID tag readers, by the end of 2004. MTI Micro has also developed prototype DMFC systems for military customers, including the RF Communications Division of Harris Corporation ("Harris"), a supplier of military communication devices.

MTI Instruments has three product groups: aviation, general gaging and semiconductor. These product groups provide: portable balancing systems for aircraft engines; electronic, computerized general gaging instruments for position, displacement and vibration applications; and semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers. MTI Instruments' strategy is to continue to enhance and expand its product offerings with the goal of increasing market share and profitability. MTI Instruments' largest customers include the U.S. Air Force and industry leaders in the computer, electronic, semiconductor, automotive, aerospace, aircraft and bioengineering fields.

MTI Instruments' Engine Balancing and Vibration Analysis system primarily serves the aviation industry, both in the commercial and military sectors.  These systems perform a number of vibration analysis and engine balancing functions typically for large turbofan engines on the flight-line and in test cells.  In addition, our Engine Balancing and Vibration Analysis system has recently been used for the first time in an industrial turbo machinery application.

The General Instruments product line employs three sensing technologies - capacitance, fiber optics and laser triangulation - to measure displacement, position, thickness, vibration and other dimensional measurement applications.  The advantages of each technology are generally related to the requirements of specific applications, which typically transcend the capabilities of conventional measuring techniques.  The most successful applications have been in data storage, OEMs, semiconductors and the automotive industry.  End-users cover a broad range of industrial markets, as well as research labs, universities and the government agencies.

MTI Instruments' semiconductor tools compete in the wafer metrology segment of the semiconductor equipment market. Product models include manual units, semi-automated units and fully automated systems which measure thickness, total thickness variation, bow, warp, site and global flatness. These metrology and inspection tools cover a broad range of applications both on the front-end and back-end of the manufacturing process. End-users of these tools include both wafer manufacturers (foundries) and device (chip) manufacturers.

 

 

 

28

From inception through September 30, 2004, the Company has incurred net losses of $67.4 million and expects to incur losses as it continues micro fuel cell product development and commercialization programs. The Company expects that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, gains on sales of securities available for sale and the operating results of MTI Instruments and MTI Micro.

Critical Accounting Policies and Estimates

The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 1 to the condensed consolidated financial statements includes a summary of the Company's most significant accounting policies. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, inventories, securities available for sale, derivative instruments and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The following critical accounting policies have been newly identified or modified since December 31, 2003:

Derivative Instruments

The Company has held or issued certain derivative instruments and embedded derivative instruments and records these derivatives and embedded derivative instruments separated from the host contract in accordance with Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and

Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities. These standards require the Company to recognize all derivative instruments as either assets or liabilities on the statement of financial position and measure these instruments at fair value. Fair value is estimated using the Black Scholes Option-Pricing Model.

Revenue Recognition

The Company applies the guidance within SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements ("SAB 104") in the evaluation of its contracts to determine when to properly recognize revenue. Under SAB 104 revenue is recognized when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery has occurred or services have been rendered, the sales price is determinable, and collectibility is reasonably assured.

Product Revenue. Product revenue is recognized when there is persuasive evidence of an arrangement, the fee is fixed or determinable, delivery of the product to the customer or distributor has occurred, at which time title generally is passed to the customer or distributor, all of which generally occur upon shipment of the product. If the product requires installation to be performed by the Company, all revenue related to the product is deferred and recognized upon the completion of the installation. If the product requires specific customer acceptance, revenue is deferred until customer acceptance occurs or the acceptance provisions lapse, unless the Company can objectively and reliably demonstrate that the criteria specified in the acceptance provisions are satisfied.

Funded Research and Development Revenue. The Company performs funded research and development for government agencies and commercial companies under both cost reimbursement and fixed-price contracts.  Cost reimbursement contracts provide for the reimbursement of allowable costs.  On fixed-price contracts, revenue is generally recognized on the percentage of completion method based upon the proportion of costs incurred to the total estimated costs for the contract. Revenue from reimbursement contracts is recognized as the services are performed. In each type of contract, the Company receives periodic progress payments or payments upon reaching interim milestones. When the current estimates of total contract revenue for commercial development contracts indicate a loss, a provision for the entire loss on the contract is recorded. Any losses incurred in

 

29

performing funded research and development projects are recognized as research and development expense as incurred. As of September 30, 2004, the Company has accrued approximately $114 thousand for anticipated contract losses on commercial contracts. When government agencies are providing funding they do not expect the government to be the only significant end user of the resulting products.  These contracts do not require delivery of products that meet defined performance specifications, but are best efforts arrangements to achieve overall research and development objectives. Included in accounts receivable are billed and unbilled work-in-progress on cost contracts. While the Company's accounting for government contract costs is subject to audit by the sponsoring entity, in the opinion of management, no material adjustments are expected as a result of such audits. Adjustments are recognized in the period made.

Cost of product revenue includes material, labor and overhead. Costs incurred in connection with funded research and development arrangements are included in funded research and product development expenses.

Deferred revenue consists of payments received and amounts due from customers in advance of services performed, products shipped, customer acceptance or installation completed.

Results of Operations

Three and Nine Months Ended September 30, 2004 Compared to the Three and Nine Months Ended September 30, 2003

The following is management's discussion and analysis of certain significant factors, which have affected the Company's results of operations for the three and nine months ended September 30, 2004 compared to the three and nine months ended September 30, 2003.

Product Revenue. Product revenue in the Test and Measurement Instrumentation segment for the three months ended September 30, 2004 increased in comparison to the same period last year by $.044 million or 2.8% to $1.642 million. The three-month increase is primarily the result of increases in semiconductor product sales of $.354 million, which includes the shipment of an AutoScan and a 300 SA wafer metrology tool. This increase has been partially offset by decreases in sales to aviation customers of $.266 million, reflecting a decline in shipments under the existing Air Force retrofit and maintenance contract and other decreases of $.044 million in general gaging product sales.

Product revenue for the first nine months of 2004 increased in comparison to the same period last year by $.148 million or 3.4% to $4.452 million. The nine-month increase is primarily the result of a $.706 million increase in semiconductor product sales, which includes shipments of the first two AutoScans and two 300 SA wafer metrology tools. This increase has been partially offset by decreases in sales to aviation customers of $.465 million, reflecting a decline in shipments under two existing Air Force contracts and other decreases in sales to general gaging customers of $.093 million due to decreased activity from original equipment manufacturer customers.

Information regarding government contracts included in product revenue is as follows:

(Dollars in thousands, except contract values)

   

Revenues

Revenues

Contract Life to

Total Contract

 

Nine months ended

Nine months ended

Date Revenues as of

Orders

Contract

Expiration

Sept. 30, 2004

Sept. 30, 2003

Sept. 30, 2004

Received to Date

           

$8.8 million

         

Retrofit and

         

Maintenance

of PBS 4100's

06/20/2008

$ 1,363

$ 1,530

$ 3,104

$ 3,310

           

$3.1 million

         

PBS units and

         

Accessory Kits

09/30/2004*

$ 111

$ 211

$ 1,132

$ 2,469

* Although this contract expired, all open delivery orders under the contract are active.

30

Funded Research and Development Revenue. Funded research and development revenue in the New Energy segment for the three months ended September 30, 2004 decreased in comparison to the same period last year by $.135 million to $.175 million, a 43.5% decrease. The three-month decrease is primarily the result of the National Institute of Standards and Technology ("NIST") and New York State Energy Research and Development Authority ("NYSERDA") government contracts contributing $.273 million more revenues in 2003 compared to 2004 due to the completion of the NYSERDA contract in the fourth quarter of 2003 and the wind down of the NIST contract during the third quarter of 2004. This decrease was partially offset by $.138 million in revenues under new contracts with the US Army Research Laboratory ("ARL") for the delivery of micro fuel cell units and Cabot Superior Micropowders ("CSMP") and the U.S. Department of Energy ("DOE") for the advancement of the consumer DMFC platform.

Funded research and development revenue for the first nine months of 2004 decreased in comparison to the same period last year by $.668 million to $.754 million, a 47.0% decrease. The nine-month decrease is the result of the NIST and NYSERDA government contracts contributing $.805 million more revenues in 2003 compared to 2004 due to the completion of the NYSERDA contract in the fourth quarter of 2003 and the wind down of the NIST contract during the third quarter of 2004. Harris revenues of $.175 million were also recorded in 2003. These decreases were partially offset by $.312 million in revenues under new contracts with ARL, CSMP and DOE.

Information regarding government contracts included in funded research and development revenue is as follows:

(Dollars in thousands, except contract values)

   

Revenues

Revenues

Contract Life to

 

Nine months ended

Nine months ended

Date Revenues as of

Contract

Expiration

Sept. 30, 2004

Sept. 30, 2003

Sept. 30, 2004

$3.0 million DOE

07/31/07

$ 44

$ -

$ 44

$350 thousand NYSERDA

08/31/05

$ -

$ -

$ -

$200 thousand NIST **

06/30/05

$ 72

$ -

$ 72

$200 thousand ARL

12/31/04

$ 200

$ -

$ 200

$4.6 million NIST *

09/30/04

$ 438

$ 1,038

$ 3,334

$200 thousand NYSERDA

01/31/04

$ -

$ -

$ 200

$500 thousand NYSERDA

09/30/03

$ -

$ 204

$ 500

* This contract is a joint venture with Dupont. Dupont's share of the contract revenue is $1.3 million.

** This contract is a subcontract with CSMP under NIST.

Cost of Product Revenue. Cost of product revenue in the Test and Measurement Instrumentation segment for the three months ended September 30, 2004 decreased in comparison to the same period last year by $.069 million or 9.1% to $.686 million. The decrease was primarily due to the product mix, which during 2004 includes the shipment of an AutoScan which had a reduced carrying value due to the soft semiconductor market over the last two years.

Gross profit as a percentage of product revenue increased to 58.2% for the three months ended September 30, 2004 from 52.8% in the prior year. The gross profit percentage increased primarily as a result of the sales volume and product mix, which during 2004 includes a higher share of semiconductor product sales.

Cost of product revenue in the Test and Measurement Instrumentation segment for the nine months ended September 30, 2004 increased in comparison to the same period last year by $.088 million or 4.7% to $1.956 million. The increase was primarily due to a higher sales volume.

Gross profit as a percentage of product revenue decreased to 56.1% for the nine months ended September 30, 2004 from 56.6% in the prior year. The gross profit percentage decreased as a result of a slight increase in overhead costs due to a decline in directly applied manufacturing labor stemming from the current year's product mix.

 

 

31

Funded Research and Product Development Expenses. Funded research and product development expenses in the New Energy segment increased by $.002 million or 0.2% to $.881 million for the three months ended September 30, 2004 in comparison to the same period last year.

Funded research and product development expenses in the New Energy segment increased by $.074 million or 3.0% to $2.576 million for the nine months ended September 30, 2004 in comparison to the same period last year. The

increased costs are attributable to the development of prototypes for Harris and costs incurred under new contracts with ARL for the delivery of micro fuel cell units and CSMP and DOE for the advancement of the consumer DMFC platform. These costs were partially offset by decreased development costs related to the completion of the second NYSERDA contract during 2003 and reduced costs related to the NIST contract as it was winding down during the third quarter of 2004.

Unfunded Research and Product Development Expenses. Unfunded research and product development expenses increased by $1.035 million or 78.6% to $2.352 million for the three months ended September 30, 2004 in comparison to the same period last year. This increase reflects a $1.058 million increase in the New Energy segment internal development costs directed at commercializing micro fuel cells, including costs for the development of our micro fuel cell system for Intermec and development costs in connection with Gillette and potential commercial products. This increase was offset by a $.023 million decrease in product development costs in the Test and Measurement Instrumentation segment related to a staff reduction.

Unfunded research and product development expenses increased by $2.783 million or 78.4% to $6.331 million for the nine months ended September 30, 2004 in comparison to the same period last year. This increase reflects a $2.757 million increase in the New Energy segment reflecting increased internal development costs directed at commercializing micro fuel cells, including costs for the development of our micro fuel cell system for Intermec and

development costs in connection with Gillette and potential commercial products. This increase also includes a $.026

million increase in product development costs in the Test and Measurement Instrumentation segment related to the continued development of the PBS-3300 and MTI-2100. The PBS-3300 is a smaller test cell system used for small turbines and props and the MTI-2100 is the newest version of the fiber-optic based vibration sensor.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $.328 million to $1.526 million for the three months ended September 30, 2004 in comparison to the same period last year, a 17.7% decrease. This decrease is primarily the result of decreased professional fees of approximately $.301 million related to business transactions that occurred during 2003 and other net expense decreases of $.027 million.

Selling, general and administrative expenses increased $.331 million to $4.890 million for the nine months ended September 30, 2004 in comparison to the same period last year, a 7.3% increase. This increase is primarily the result of a net increase of $.154 million in professional fees which includes $.300 million in advisory fees and approximately $.155 million in costs related to the amendment of the Company's private placement transaction in 2004 offset by $.301 million related to business transactions that occurred during 2003 and other net expense increases of $.177 million related to costs associated with commercializing micro fuel cells.

Operating Loss. Operating loss for the three months ended September 30, 2004 in comparison to the same period last year increased by $.731 million to $3.628 million, a 25.2% increase. This increase in operating loss results primarily from increases in research and product development costs and decreases in funded research and development revenue in the New Energy segment partially offset by increases in gross profits from product revenues in the Test and Measurement Instrumentation segment and decreases in selling, general and administrative expenses.

Operating loss for the nine months ended September 30, 2004 in comparison to the same period last year increased by $3.796 million to $10.547 million, a 56.2% increase. This increase in operating loss results primarily from increases in research and product development costs, selling, general and administration expenses and decreases in funded research and development revenue in the New Energy segment partially offset by increases in gross profits from product revenues in the Test and Measurement Instrumentation segment.

Gain on Sale of Securities Available for Sale, Net. Results for the three and nine months ended September 30, 2004 included a $0 and $3.129 million gain on the sale of securities available for sale, respectively, compared to a $4.123

32

and $7.483 million gain on the sale of securities available for sale, respectively, for the same period in 2003. The average selling price per share of Plug Power common stock was $9.93 for the nine months ended September 30, 2004. The average selling price per share of Plug Power and SatCon common stock was $4.96 and $2.07,

respectively, for the three months ended September 30, 2003, and $5.07 and $1.75, respectively, for the nine months ended September 30, 2003.

(Loss) Gain on Derivatives. The Company recorded a loss of $2.635 million and a gain of $.002 million on derivative accounting for the three months ended September 30, 2004 and 2003, respectively. Losses of $2.424 million and $.004 million were recorded for the nine months ended September 30, 2004 and 2003, respectively. The 2004 loss relates to the embedded derivative for the purchase of Plug Power common stock, which is part of the private placement transaction, while the gain (loss) in 2003 related to warrants for the purchase of SatCon common stock held by the Company. Changes in derivative fair values for the embedded derivative and the SatCon warrants are calculated using the Black Scholes Option-Pricing Model.

Impairment Losses. For the three and nine months ended September 30, 2003, the Company recorded a $0 and $.418 million charge for impairment losses for other than temporary declines in the value of certain securities available for sale.

Income Tax Benefit (Expense). The tax benefit rates for the three and nine months ended September 30, 2004 were 39.75% and 39.40% compared to the tax expense rates for the three and nine months ended September 30, 2003 of (36.86)% and (39.05)%. These tax benefit rates are primarily due to losses generated by operations. The valuation allowance at September 30, 2004 and December 31, 2003 was $1.836 million. The Company determined that it was more likely than not that the ultimate recognition of certain deferred tax assets would not be realized.

Further, as a result of ownership changes in 1996, the availability of $1.014 million of net operating loss carryforwards to offset future taxable income will be limited pursuant to the Internal Revenue Code.

Liquidity and Capital Resources

The Company has incurred significant losses as it continues to fund MTI Micro's DMFC product development

and commercialization programs. The Company expects that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, gains on sales of securities available for sale, the operating results of MTI Instruments and MTI Micro, the availability of equity financing including the

additional investment rights issued in connection with the 2004 Private Placement and the ability to attract

government funding resources to offset research development costs. As of September 30, 2004, the Company had an accumulated deficit of $67.431 million. During the nine months ended September 30, 2004, the Company recognized a loss of $4.998 million and used cash in operating activities totaling $9.133 million. This cash use in 2004 was funded primarily by proceeds from the sale of securities available for sale which totaled $3.804 million, net proceeds of $8.985 million from the 2004 Private Placement transaction and proceeds from subsidiary stock issuances of $2.193 million. The Company expects to continue to incur losses as it develops and commercializes DMFCs and it expects to continue funding its operations from current cash and cash equivalents, the sales of securities available for sale, proceeds, if any, from the exercise of additional investment rights issued in connection with the 2004 Private Placement and government program funding in each case unless other sources of funding can be found.

During the remainder of 2004, the Company expects to spend approximately $3.0 million on research and development of DMFCs and $.200 million in research and development on MTI Instruments' products.

The Company anticipates that it will be able to meet the liquidity needs of its operations for the next year from current cash resources, sale of securities available for sale and, to the extent available, equity financings. However, there can be no assurance that the Company will not require additional financing within this time frame or that any additional financing will be available to the Company on terms acceptable to the Company, if at all. Cash used in operations is expected to total approximately $14.3 million for 2004. Further, cash used for capital expenditures is expected to total approximately $3.2 million in 2004. Capital expenditures for 2004 will consist of expenditures for facility expansion, furniture, computer equipment, software and manufacturing and laboratory equipment. The Company believes it will have adequate resources to fund operations and capital expenditures for 2004 and 2005 based on current cash and cash equivalents, current cash flow and revenue projections and the potential sale of unrestricted securities available for sale at current market values. Proceeds from the sale of

33

securities available for sale are subject to fluctuations in the market value of Plug Power as well as limitations on the ability to sell shares arising from the escrow of 2,700,000 shares in connection with Fletcher's right to purchase Plug

Power common stock between June 1, 2005 and December 31, 2006, subject to the terms of the agreement with Fletcher. The Company may also seek to provide additional resources through an equity offering. Additional

government revenues and Fletcher's exercise of additional investment rights totaling up to an additional $28 million could also provide additional resources. The Company anticipates that it will have to raise additional equity capital to fund its long-term business plan, regardless of whether Fletcher exercises any or all of its additional investment rights.

Future sales of Plug Power securities will generate taxable income or loss which is different from book income or loss due to the tax basis in these assets being significantly different from their book basis. Book and tax basis as of September 30, 2004 are as follows:

   

Average

Average

Security

Shares Held

Book Cost Basis

Tax Basis

Plug Power - unrestricted

2,993,227

$1.78

$0.96

Plug Power - restricted

2,700,000

$1.78

$0.96

As of September 30, 2004, the Company owned 5,693,227 common shares of Plug Power. In connection with the May 4, 2004 amended private placement agreement with Fletcher, the Company has placed 2,700,000 of its Plug Power shares in escrow and Fletcher may have the right to purchase those shares, potentially at a discount. Plug Power stock is currently traded on the Nasdaq National Market and is therefore subject to stock market

conditions. When acquired, these securities were unregistered. Plug Power securities are considered "restricted

securities" as defined in Rule 144 and may be sold in the future without registration under the Securities Act of 1933 subject to compliance with the provisions of Rule 144.

Working capital was $30.348 million at September 30, 2004 a $12.078 million decrease from $42.426 million at December 31, 2003. This decrease is primarily the result of an increase to current assets for the proceeds from the private placement offset by decreases to current assets related to the restriction of 2,700,000 shares of Plug Power under the escrow agreement pursuant to the Company's amended private placement and the associated decrease to current deferred tax liabilities for the tax impact of the reclassification of these securities from current to long-term assets.

At September 30, 2004, the Company's order backlog was $2.098 million, compared to $.447 million at December 31, 2003.

Inventory and accounts receivable (from product revenues) turnover ratios and their changes for the nine months ended September 30 are as follows:

 

2004

2003

Change

Inventory

1.80

1.70

.10

Accounts receivable (for product revenues)

6.65

6.53

.12

The changes in the inventory and accounts receivable turnover ratios are the result of the volume and timing of sales. The Test and Measurement Instrumentation segment had higher year to date sales and higher cost of sales during 2004 as compared to 2003.

Cash flow used by operating activities for the nine months ended September 30, 2004 was $9.133 million compared with $6.828 million for the same period in the prior year. This cash use increase of $2.305 million primarily reflects increases in cash expenditures to fund New Energy segment research and development, offset by balance sheet changes which reflect the timing of cash payments and receipts.

Capital expenditures during the first nine months of 2004 were $1.248 million, an increase of $.405 million from the same period of the prior year. Capital expenditures in 2004 included furniture, computer equipment, facilities fit-up, software, and manufacturing and laboratory equipment. Remaining capital expenditures in 2004 are expected to approximate $1.9 million, consisting of expenditures for computer equipment, software, software implementation and

34

manufacturing and laboratory equipment. The Company expects to finance these expenditures with current cash and cash equivalents, the sale of securities available for sale, equity financing and other sources, as appropriate.

On January 29, 2004, the Company consummated a private placement to Fletcher International, Ltd. of $10 million of its common stock and certain additional investment rights. This private placement was amended on May 4, 2004, as more fully described in Note 8 - Shareholders' Equity.

As of September 30, 2004, the Company sold 380,000 shares of Plug Power common stock with proceeds totaling $3.804 million and net gains totaling $3.129 million. This gain related to the Company's previously announced strategy to raise additional capital through the sale of its assets and equity offerings in order to fund its micro fuel cell operations. Taxes on the net gains are expected to be offset by the Company's net operating losses. As of September 30, 2004, the Company estimates its remaining net operating loss carryforwards to be approximately $22.4 million.

From October 1 through November 5, 2004, the Company sold available for sale securities as follows:

(Dollars in thousands, except share data)

 

Number of

Net Proceeds

Company

Shares Sold

from Sales

Plug Power

100,000

$675

Cash and cash equivalents were $17.159 million at September 30, 2004 compared to $12.380 million at December 31, 2003.

The launch of MTI Micro's first product for Intermec scheduled for the end of 2004 will have negative gross margins and therefore will be shipped in low volumes. The shipment of the Intermec product will meet key objectives for MTI Micro, including: the development of a product platform which has potential applications in other vertical markets critical to MTI Micro's technology development- the military market; creation of codes and standards; valuable field experience and user feedback; and advancement of product development, design and manufacturing methods.

Contractual Obligations

Contractual obligations as of September 30, 2004, under agreements with non-cancelable terms are as follows:

 

Payments Due by Period

   

Less Than

1-3

3-5

More than

 

Total

1 Year

Years

Years

5 Years

Contractual obligations:

         

Operating leases

$2,193

$ 644

$ 865

$ 631

$ 53

Purchase obligations

2,316

2,259

56

1

-

License obligations (A), (B)

3,950

450

500

500

2,500

Other long-term liabilities recorded

         

on the balance sheet

24

-

24

-

-

Total

$8,483

$3,353

$1,445

$1,132

$2,553

(A) Once products are sold under the LANL license agreement, royalties will be based on 2% of the first $50 million of net sales, 1% on net sales in excess of $50 million but less than $100 million and .5% on net sales in excess of $100 million. License payments made in any year can be applied against royalties due and total annual fees in any year shall not exceed $1 million.

(B) Under the Strategic Alliance Agreement (the "Agreement"), as amended, with Gillette, if MTI Micro sells fuel refills in the target market after its exclusivity obligations have expired, then MTI Micro will be required to pay Gillette royalties as defined in the Agreement. Portions of the Agreement are subject to confidential treatment as filed with the SEC.

New Accounting Pronouncements

None.

 

35

Additional Information Concerning Risks

In connection with the 2004 Private Placement, as amended, we may have to (1) sell shares of our common stock at prices which result in substantial dilution to our shareholders, and (2) issue additional shares of our common stock to Fletcher without any payment required by Fletcher, which would cause our shareholders to suffer additional dilution.

The 2004 Private Placement provides Fletcher additional investment rights to purchase: (1) $8 million of our common stock at a price equal to $6.34 per share (subject to adjustment) and (2) in the event that Fletcher purchases the full $8 million, an additional $20 million of our common stock at a price equal to $6.34 per share (subject to adjustment). Any exercise of the additional investment rights could result in sales of our common stock at prices that are below the market price for our common stock at the time the investment right is exercised and could result in substantial dilution to our shareholders.

Our agreement with Fletcher also provides that Fletcher will receive additional shares of our common stock with respect to shares it already owns, and the exercise price and term relating to unexercised additional investment rights will be adjusted to the benefit of Fletcher, each upon the occurrence of certain events or circumstances, some of which are beyond our control, including:

- issuances of our equity securities at a price below $7.048 per share (which is the price Fletcher paid in connection with its initial $10 million investment) or issuances of our equity securities at a price below $6.34 per share (which is the exercise price Fletcher will pay in connection with its exercise of its investment rights totaling $28 million);

- our failure to satisfy certain requirements relating to registering the resale of shares issued or issuable to Fletcher pursuant to the securities laws;

- a change in control of our company; and

- a restatement of our financial results.

In addition, in any event, 8,330,411 shares is the maximum number of shares of our common stock we may be required to issue to Fletcher, which amount includes the 1,418,842 shares issued on January 29, 2004.

In connection with the 2004 Private Placement, as amended, we may have to sell shares of Plug Power common stock at a price below the market value of such shares, which sales would reduce the value of our assets.

Pursuant to our amended agreement with Fletcher, we have deposited 2,700,000 shares of Plug Power common stock in escrow to satisfy our potential obligation to sell such shares to Fletcher. The number of shares Fletcher may purchase and the exercise price for those shares is subject to fluctuation based on the market price of our common stock and the market price of Plug Power stock. Accordingly, Fletcher may, in certain instances, purchase shares of Plug Power common stock either at a price below the fair market value of such shares, thereby reducing the value of our assets, or even if based on the market price of Plug Power shares, at a price at which we would not desire to sell such shares.

Under new regulations required by the Sarbanes-Oxley Act of 2002, an adverse opinion on internal controls over financial reporting could be issued by our auditors, and this could have a negative impact on our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we establish and maintain an adequate internal control structure and procedures for financial reporting and assess on an on-going basis the design and operating effectiveness of our internal control structure and procedures for financial reporting. Our auditors are required to audit both the design and operating effectiveness of our internal controls over financial reporting, and management's assessment of the design and the effectiveness of those controls. Although we are not aware of any material weaknesses at this time, this is the first time that we have undergone a comprehensive internal assessment and external audit of our internal controls over financial reporting. Therefore, it is possible that material weaknesses could be found. If we are unable to remediate those weaknesses before the conclusion of the external audit, the auditors could be required to issue an adverse opinion on our internal controls over financial reporting.

36

 

Because opinions on internal controls over financial reporting have not been required in the past, it is uncertain what impact an adverse opinion would have upon our stock price.

Statement Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents we have filed with the Securities and Exchange Commission that are incorporated by reference into this Form 10-Q contain and incorporate forward-looking

statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Any statements contained, or incorporated by reference, in this Form 10-Q that are not statements of historical fact may be forward-looking statements. When we use the words "anticipates," "plans," "expects," "believes," "should," "could," "may," "will" and similar expressions, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include, among others:

  • our need to raise additional financing;
  • Fletcher's decision whether to exercise its additional investment rights and the price at which Fletcher purchases shares;

− risks related to developing direct methanol micro fuel cells, or DMFCs, and whether we will ever successfully develop commercially viable DMFCs;

  • market acceptance of DMFCs;
  • the potential for early termination of our agreement with Gillette and its Duracell division;
  • our inability, or Gillette's inability, to develop DMFCs or fuel refills on our planned schedule;
  • our dependence on OEMs integrating DMFCs into their devices;
  • the need for current regulations to change to permit methanol to be carried onto airplanes for DMFCs to achieve mass market commercialization;
  • risks related to the flammable nature of methanol as a fuel source;
  • intense competition in the DMFC and instrumentation businesses;
  • our dependence on the success of Plug Power Inc.;
  • risks related to protection and infringement of intellectual property;
  • our history of losses;
  • the historical volatility of our stock price;
  • the risk we may become an inadvertent investment company;
  • general market conditions; and
  • other factors referred to under the caption "Risk Factors," which are set forth in our Annual Report on Form 10-K and Form 10-K/A.

Readers should not rely on our forward-looking statements. These and other risks are set forth in greater detail in the "Risk Factors" section of our Annual Report on Form 10-K and Form 10-K/A, which are incorporated herein by reference and under the caption "Additional Information Concerning Risks Related to the 2004 Private Placement Transaction, as Amended" in this quarterly report on Form 10-Q. Except as may be required by applicable law, we do not undertake or intend to update any forward-looking statements after the date of our Annual Report on Form 10-K and Form 10-K/A, which are incorporated herein by reference.

 

 

37

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We develop products in the United States and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign exchange rates or weak economic conditions in foreign markets. Since our sales are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets. Interest income is sensitive to changes in the general level of U.S. interest rates, particularly since our investments are in cash equivalents. Based on the nature and current levels of our cash equivalents, however, we have concluded that there is no material market risk exposure.

As a result of holding securities available for sale, the Company is exposed to fluctuations in market value. The Company recognizes changes in market value through the balance sheet, however if an other than temporary market decline were to occur, it could have a material impact on the Company's operating results.

The Company's issued derivatives consist of warrants and rights to purchase shares of the Company's common stock and Plug Power common stock owned by the Company. The fair value of the embedded derivative for the right to purchase Plug Power common stock is recorded in the financial statement line titled "Derivative liability." This derivative is valued quarterly using the Black Scholes Option-Pricing Model. The Company's held derivatives consist of warrants to purchase SatCon common stock. The fair value of the warrants to purchase SatCon common stock is based on estimates using the Black Scholes Option-Pricing Model. The Company recognizes changes in fair value through the operating statement line titled "(Loss) gain on derivatives." The Company does not use derivative financial instruments for speculative or trading purposes.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

 

The Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e)). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective in ensuring that all material information required to be disclosed in the reports the Company files and submits under the Securities and Exchange Act of 1934 has been made known to them on a timely basis and that such information has been properly recorded, processed, summarized and reported, as required.

 

Changes in Internal Controls

 

There have been no significant changes in the Company's internal controls over financial reporting during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.

 

Sarbanes-Oxley Section 404 Compliance

 

Section 404 of the Sarbanes-Oxley Act of 2002 (the "Act") will require the Company to include an internal control report from management in its Annual Report on Form 10-K for the year ended December 31, 2004 and in subsequent Annual Reports thereafter. The internal control report must include the following: (1) a statement of management's responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of the Company's internal control over financial reporting, (3) management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, including a statement as to whether or not internal control over financial reporting is effective, and (4) a statement that the Company's independent auditors have issued an attestation report on management's assessment of internal control over financial reporting.

 

38

Management acknowledges its responsibility for establishing and maintaining internal controls over financial reporting and seeks to continually improve those controls. In addition, in order to achieve compliance with Section 404 of the Act within the required timeframe, the Company has been conducting a process to document and evaluate its internal controls over financial reporting since 2003.

In this regard, the Company has dedicated internal resources and adopted a detailed work plan to: (i) assess and document the adequacy of internal control over financial reporting; (ii) take steps to improve control processes where required; (iii) validate through testing that controls are functioning as documented; and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. The Company believes its process for documenting, evaluating and monitoring its internal control over financial reporting is consistent with the objectives of Section 404 of the Act. Furthermore, the Company expects that the assessment and validation process will be significantly complete before December 31, 2004, thereby enabling the Company to conclude on the adequacy of the design and function of its internal controls over financial reporting.

During the third quarter of 2004, the Company commenced testing and gap analysis of its internal controls over financial reporting. The Company's documentation and testing to date have identified certain gaps in the documentation, design and effectiveness of internal controls over financial reporting that the Company has taken action to remediate. Although the Company expects to have completed, before year-end 2004, remediation of all gaps of which it is currently aware, the testing and gap analysis is ongoing. Therefore, it is possible that additional conditions requiring remediation could be found before the testing and gap analysis is concluded. As a result, given the risks inherent in the design and operation of internal controls over financial reporting, the Company can provide no assurance as to its or its independent auditor's conclusions at December 31, 2004 with respect to the effectiveness of its internal controls over financial reporting.

 

It should be noted that any system of internal controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the internal control system are met. In addition, the design of any internal control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of internal control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

39

 

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

 

Item 6. Exhibits

Exhibit No.

Description

31.1

Rule 13a-14(a)/15d-14(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Steven N. Fischer

31.2

Rule 13a-14(a)/15d-14(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Cynthia A. Scheuer

32.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Steven N. Fischer

32.2

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Cynthia A. Scheuer

10.123

Amendment to the Strategic Alliance Agreement between The Gillette Company and MTI MicroFuel Cells Inc. dated August 18, 2004

 

 

 

 

 

 

 

 

 

 

40

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Mechanical Technology Incorporated

11/09/2004

(Date)

/s/Steven N. Fischer

Steven N. Fischer

Chief Executive Officer

   

11/09/2004

(Date)

/s/Cynthia A. Scheuer

Cynthia A. Scheuer

Vice President and Chief Financial Officer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

41