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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended December 31, 2006 or
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from _______ to _______
Commission file number: 0-12742
SPIRE CORPORATION
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(Name of small business issuer as specified in its charter)
MASSACHUSETTS 04-2 57335
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
ONE PATRIOTS PARK
BEDFORD, MASSACHUSETTS 01730-2396
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(Address of principal executive offices)
(781) 275-6000
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(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Act:
COMMON STOCK, $0.01 PAR VALUE; REGISTERED ON THE NASDAQ GLOBAL MARKET
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(Title of class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the issuer was required to file such
reports); and (2) has been subject to such filing requirements for the past 90
days. Yes |X| No |_|
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The issuer's revenues for its most recent fiscal year: $20,125,000.
The aggregate market value of the voting stock held by non-affiliates of
the issuer based on the last sale price of such stock as reported by The Nasdaq
Global Market on March 1, 2007, was approximately $60,184,000.
The number of shares outstanding of the issuer's common stock, as of March
1, 2007, was 8,260,137.
Transitional Small Business Disclosure Format (Check One): Yes |_| No |X|
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the Special Meeting in Lieu
of 2007 Annual Meeting of Stockholders to be held on May 17, 2007, are
incorporated by reference in Part III of this Report.
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SPIRE CORPORATION
FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 2006
TABLE OF CONTENTS
PART I
Item 1. Description of Business ........................................................................................... 1
Item 2. Description of Property ........................................................................................... 12
Item 3. Legal Proceedings ................................................................................................. 13
Item 4. Submission of Matters to a Vote of Security Holders ............................................................... 13
PART II
Item 5. Market for Common Equity and Related Stockholder Matters .......................................................... 14
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................. 14
Item 7. Financial Statements .............................................................................................. 26
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............................... 50
Item 8A. Controls and Procedures ........................................................................................... 50
Item 8B. Other Information ................................................................................................. 51
PART III
Item 9. Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance with
Section 16(a) of the Exchange Act ................................................................................. 51
Item 10. Executive Compensation ............................................................................................ 51
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .................... 51
Item 12. Certain Relationships and Related Transactions, and Director Independence ......................................... 52
Item 13. Exhibits .......................................................................................................... 52
Item 14. Principal Accountant Fees and Services ............................................................................ 53
FORWARD-LOOKING STATEMENTS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"),
AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE
"EXCHANGE ACT"), WHICH STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. THESE
STATEMENTS RELATE TO OUR FUTURE PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS.
THESE STATEMENTS MAY BE IDENTIFIED BY THE USE OF WORDS SUCH AS "MAY", "COULD",
"WOULD", "SHOULD", "WILL", "EXPECTS", "ANTICIPATES", "INTENDS", "PLANS",
"BELIEVES", "ESTIMATES" AND SIMILAR EXPRESSIONS. OUR ACTUAL RESULTS AND TIMING
OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN THESE
STATEMENTS. FACTORS THAT COULD CONTRIBUTE TO THESE DIFFERENCES INCLUDE BUT ARE
NOT LIMITED TO, THOSE DISCUSSED UNDER "RISK FACTORS", "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS", AND ELSEWHERE IN
THIS REPORT. THE CAUTIONARY STATEMENTS MADE IN THIS REPORT SHOULD BE READ AS
BEING APPLICABLE TO ALL FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS
REPORT.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Spire Corporation ("Spire" or the "Company") is a Massachusetts corporation
incorporated in 1969. Our principal offices are located at One Patriots Park,
Bedford, Massachusetts, and our phone number is (781) 275-6000. Our SEC filings
are available through our website, www.spirecorp.com. Our common stock trades on
the Nasdaq Global Market under the symbol "SPIR".
PRINCIPAL PRODUCTS AND SERVICES
Overview
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The Company develops, manufactures and markets highly-engineered products
and services in three principal business areas: (i) solar, (ii) biomedical and
(iii) optoelectronics, generally bringing to bear expertise in materials
technologies, surface science and thin films across all three business areas. In
some cases, such as IONGUARD(R) processing of orthopedic devices, commercial
services are well established, while in other cases, commercialization is just
beginning.
In the solar area, the Company develops, manufactures and markets
specialized equipment for the production of terrestrial photovoltaic modules
from solar cells. The Company's equipment has been installed in approximately
190 factories in 46 countries. The Company also provides custom and building
integrated photovoltaic (BIPV) modules, stand-alone emergency power back up and
photovoltaic systems integration services using technology developed by the
Company.
In the biomedical area, the Company provides value-added surface treatments
to manufacturers of orthopedic and other medical devices that enhance the
durability, antimicrobial characteristics or other material characteristics of
their products; develops and markets coated hemodialysis catheters and related
devices for the treatment of chronic kidney disease; and performs sponsored
research programs into practical applications of advanced biomedical and
biophotonic technologies.
In the optoelectronics area, the Company provides custom compound
semiconductor foundry and fabrication services on a merchant basis to customers
involved in biomedical/biophotonics instruments, telecommunications and defense
applications. Services include compound semiconductor wafer growth, other thin
film processes and related device processing and fabrication services. The
Company also provides materials testing services and performs services in
support of sponsored research into practical applications of optoelectronic
technologies.
Solar Equipment and Solar Systems
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Solar photovoltaics, the direct conversion of sunlight into electricity, is
an important source of distributed power that can be employed locally or
connected to a power grid. Spire believes that it is one of the world's leading
suppliers of the manufacturing equipment and technology needed to manufacture
solar photovoltaic power systems. Spire's individual items of manufacturing
equipment and its SPI-LINETM integrated turnkey wafer, cell, and module
production lines are designed to
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meet the needs of a broad range of customers ranging from small manufacturers
relying on mostly manual processes to the largest photovoltaic manufacturing
companies in the world.
Spire's equipment spans the full process for fabricating photovoltaic
modules including:
o Sorting solar cells into performance groups;
o Assembling and soldering strings of cells interconnected with metal
ribbons or "tabs";
o Completing the module circuit by soldering bus ribbons to connect the
strings together;
o Cutting polymer, fiberglass, and back cover to length and assembling
them with the glass and module circuit in preparation for
encapsulation;
o Laminating the module assembly and curing the encapsulating polymer;
o Final assembly, including edge trimming, installing an edge gasket and
frame, and attaching a junction box;
o Performing a high voltage isolation test to guarantee voltage
isolation between the cell circuit and the module frame; and
o Electrically testing the module performance by measuring a
current-voltage curve under simulated sunlight.
The fabrication of photovoltaic modules uses solar cells and module
materials as input and produces functional PV modules, ready for use. The
Company provides the necessary equipment and training for implementing these
process steps as individual equipment items and as fully integrated production
lines. The Company also provides materials to support the manufacturing
activities of our customers on an ongoing basis.
Spire solar systems provide clients with grid-connected distributed
photovoltaic ("PV") systems and custom modules to meet their demand for solar
electricity. The business is primarily a system design and engineering service
whose team of experienced professionals offers complete project design,
management, installation coordination, and customer service.
Spire solar systems was originally founded in collaboration with BP Solarex
to address the renewable energy needs of the City of Chicago, State of Illinois,
and the local utility, and was based in Chicago. The Company has since moved all
production operations to its Bedford, MA location. The Company continues to
pursue the PV system product line through its Bedford operations primarily
focused on providing photovoltaic systems integration services.
Spire Biomedical
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Spire Biomedical is both a manufacturer of medical devices and a provider
of advanced medical device surface treatment processes. Spire Biomedical's
medical device business develops, manufactures, and sells premium products for
vascular access in chronic kidney disease patients. Spire Biomedical's surface
treatment business modifies the surfaces of medical devices to improve their
performance.
Spire Biomedical's line of long-term hemodialysis catheters is defined to
combine high level performance with increased catheter placement options. The
Company's proprietary catheter products provide higher flow at lower pressures
and superior kink-resistance. Its patented separated distal tip design minimizes
recirculation and provides a wider margin of functionality compared to
conventional staggered tip designs. The Company believes that these key features
present the renal care community with attractive value and performance for
patient care. The Company added a heparin-coated catheter to its catheter
product line in the second half of 2006. This catheter has been demonstrated in
invitro and animal studies to reduce catheter clotting, a significant
complication in hemodialysis vascular access. The Company has also announced it
would sell a silver coated catheter in 2007.
The Company offers its medical customers a family of process services
utilizing ion beam technologies to enhance both the surface characteristics and
the performance of medical devices. The Company's advanced surface modification
technology services employ proprietary Ion Implantation and Ion Beam Assisted
Deposition ("IBAD") techniques to improve the performance of medical components.
Spire's customized surface treatments meet a variety of needs, including reduced
friction, wear and abrasion, infection resistance, enhanced tissue and bone
growth, increased thromboresistance, conductivity, improved radiopacity and the
improvement of other performance characteristics. Spire-treated products
currently include orthopedic prostheses (such as replacement hips, knees,
elbows), catheters, guidewires, ear-nose-throat devices, vascular grafts, and
other specialty medical devices.
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Bandwidth Semiconductor
-----------------------
Bandwidth Semiconductor ("Bandwidth"), the principal business unit of the
Company's optoelectronics business segment, operates in a state-of-the-art
semiconductor foundry and fabrication facility in Hudson, New Hampshire equipped
with advanced and sophisticated metal-organic chemical vapor deposition
("MOCVD") reactors and fabrication equipment. Our fabrication facility has been
designed to have the flexibility to engage in quick-turn research and
prototyping as well as for economical full-rate volume production services in
three primary areas: MOCVD epitaxial wafers, device foundry services, and thin
film circuits.
Our MOCVD epitaxial wafer services include a wide range of compound
semiconductor (chiefly gallium arsenide and indium phosphide-based compounds)
epitaxial structures fabricated to our customers' designs or in some cases to
our own designs. We recognize that time-to-market is critical to our customers'
success, so we strive to provide the fastest turnaround times possible.
Bandwidth Semiconductor has a number of standard structures available to meet
many device needs and speed prototype development. Our epitaxial engineers work
closely with customers to develop and improve proprietary structures for
specific applications. Typical applications include: Vertical Cavity Surface
Emitting Lasers ("VCSEL"), optical waveguides, high power edge emitting lasers,
photocathodes, high electron mobility transistors ("HEMT"), field effect
transistors ("FET"), "PIN" photodetectors, avalanche photo-detectors ("APD") and
other gallium arsenide-on-silicon, lattice mismatched indium gallium arsenide
photodetectors, strained quantum well and other compound semiconductor material
structures.
Our foundry services can take compound semiconductor wafers up to 4 inches
in diameter through processing, on-wafer test, and die separation. We can use
customer-supplied photomasks or develop a new set of masks for an entire process
sequence. We design the process steps and conditions to meet the desired device
characteristics and implement the process in our fabrication facility, saving
our customers development time and providing a source of proprietary devices
without the expense of a dedicated internal fabrication. Typical OEM devices we
have fabricated include single-element photodetectors, photodetector arrays,
VCSELs, edge-emitting lasers, thermo-photovoltaic ("TPV") cells and
communications-quality light emitting diodes ("LED").
Our thin film circuit services include the fabrication of custom
structures, chip resistors and resistor arrays to customer orders using thin
film technology on alumina ceramic, aluminum nitride, ferrite, glass, quartz,
sapphire and silicon substrates using a variety of metals and alloys.
On August 29, 2006, Bandwidth entered into a five-year manufacturing
agreement in which it will be the exclusive supplier to Principia Lightworks,
Inc. ("Principia"), of semiconductor wafers, enabling Principia, a Woodland
Hills, California firm, to begin high volume production of its patented device,
an electron beam pumped vertical cavity surface emitting laser ("eVCSEL") as a
light source for production display applications, including rear-projection
consumer televisions. Bandwidth will manufacture epitaxial wafers which will be
further processed by Principia to produce red, blue, and green colored lasers
PRINCIPAL DISTRIBUTION METHODS
The Company's products and services are sold primarily by its direct,
internal sales staff with four notable exceptions: in certain offshore markets,
the Company's solar equipment is sold via independent sales representatives, the
Company's hemodialysis catheter products are sold via independent distributors,
proposals for sponsored research and development work are prepared by the
Company's scientists and researchers, and, in certain locations, the Company has
granted licenses to third parties to sell their products.
PHYSICIAN RELATIONSHIPS
We have engaged certain physicians to serve as consultants to the Company.
These physicians enter into written contracts that specify their duties and fix
their compensation for periods of one or more years. The compensation for these
consultants is the result of arm's length negotiations and generally depends
upon competitive factors in the local market, the physician's professional
qualifications and the specific duties and responsibilities of the physician.
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COMPETITIVE CONDITIONS
The markets in which the Company operates are highly competitive and
characterized by changes due to technological improvements and developments. The
Company competes with many other manufacturers and service providers in each of
its product and service areas; many of these competitors have greater resources
and sales. Additionally, the Company's products and services compete with
products and services utilizing alternative technologies. For example, the
Company's solar photovoltaic systems compete with other forms of renewable
energy such as wind, solar thermal, and geo-thermal. Price, service and product
performance are significant elements of competition in the sale of each of the
Company's products. The Company believes that there are considerable barriers to
entry into the markets it serves, including a significant investment in
specialized capital equipment and product design and development, and the need
for a staff with sophisticated scientific and technological knowledge.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Principal raw materials purchased by the Company include polymer
extrusions, molded plastic parts, silicon photovoltaic cells, compound
semiconductor wafer substrates, high purity industrial gases, custom metal
welded structures, fasteners, position sensors, electrical motors, electrical
power conditioning inverters, and electrical controls. All of these items are
available from several suppliers and the Company generally relies on more than
one supplier for each item. There has been increased demand for semiconductor
grade silicon during the past year leading to shortages. The shortage in
semiconductor grade silicon had an adverse effect on the ordering patterns of
our solar equipment customers in the early part of 2006 and could have an
adverse effect on solar ordering patterns in the future.
SOURCES AND AVAILABILITY OF MANUFACTURING SERVICES
The Company employs an outsourcing-model supply chain in its biomedical
products business by which certain manufacturing services, such as polymer
extrusion, assembly, packaging and sterilization, are obtained from third party
contractors. The Company has identified multiple potential sources for the
services it requires; however, certain elements of the supply chain currently
involve only one qualified contractor. As sales volume expands, the Company
plans to reassess its supply chain to eliminate potential "bottlenecks" and
reduce dependence on sole-source, single site contract services.
DEPENDENCE ON MAJOR CUSTOMERS
One customer accounted for more than 10% of consolidated net sales and
revenues during the year ended December 31, 2006, and no customers accounted for
more than 10% of net sales and revenues in 2005.
KEY LICENSES AND PATENTS, GOVERNMENT RIGHTS TO INTELLECTUAL PROPERTY
In October 2002, the Company sold an exclusive patent license for its
hemodialysis split-tip catheter to Bard Access Systems, Inc. ("Bard"), a wholly
owned subsidiary of C.R. Bard, Inc., in exchange for $5 million upon the
execution of the agreement, with another $5 million due upon the attainment of
certain milestones no later than 18 months after signing, and a total of $6
million upon achievement of certain milestones by Bard through 2005. In June
2005, the Company received the final contingent payment of $3 million. In
connection with the sale, the Company also received a sublicense that permits
the Company to continue to manufacture and market hemodialysis catheters for the
treatment of chronic kidney disease.
On May 26, 2005, the Company entered into a global consortium agreement
(the "Agreement") with Nisshinbo Industries, Inc. ("Nisshinbo") for the
development, manufacturing, and sales of solar photovoltaic module manufacturing
equipment. Nisshinbo's prior relationship with Spire was as a sub-licensee of
Marubeni Corporation with whom the Company had a license arrangement that was
originally signed in 1997, extended in 2003, and terminated in May 2005.
Nisshinbo's role as sub-licensee was to manufacture equipment for Marubeni to
sell to the Japanese market based upon the Company's proprietary technology.
Under the terms of the Agreement, Nisshinbo purchased a license to manufacture
and sell the Company's module manufacturing equipment on a semi-exclusive basis
for an upfront fee plus additional royalties based on ongoing equipment sales
over a ten-year period. In addition, the Company and Nisshinbo agreed, but are
not obligated, to pursue joint research and development, product improvement
activities and sales and marketing efforts. The companies may share market costs
such as product collateral and trade show expenses. It may also collaborate on
sales leads and have the other company manufacture and service its equipment in
the field. Both companies have reciprocal rights to participate in the other
company's R&D efforts on a going-forward basis. Nisshinbo can request the
Company to further develop a technology but Nisshinbo must (a) share in the
costs of these development efforts equally with the Company (and thereafter have
joint ownership) otherwise the Company will own the technology under a partial
contribute or no
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participation by Nisshinbo with the Company receiving a royalty from Nisshinbo
if it utilizes the technology. At the end of the license all non-jointly owned
technology developed under the Agreement will revert back to the owner, with the
other party being required to purchase a new license based upon the fair market
value of that technology in order to continue to utilize the technology.
On June 27, 2005, the Company received JPY 400,000,000 from the sale of
this permanent license. The Company determined that the Nisshinbo Agreement
contains multiple elements consisting of (1) the granting of a license to
utilize the Company's technology and (2) the semi-exclusive right to utilize the
technology for a period of 10 years. The Company believes the granting of the
license meets the criteria of Emerging Issues Task Force ("EITF") 00-21,
"Accounting for Revenue Arrangements with Multiple Elements", paragraph 9(a), as
the license to utilize the technology has value to Nisshinbo on a stand-alone
basis. Further, Question 1 to Securities and Exchange Commission ("SEC") Staff
Accounting Bulletin Topic 13A-3f "Nonrefundable Up-Front Fees", was directly
considered as guidance for determining if the upfront fee under the Nisshinbo
Agreement should be recognized upon the signing of contract or recognized over
the term of the license. It is the Company's belief that a separate earnings
process was complete as Nisshinbo was purchasing access to utilize technology it
already had in its possession; therefore, recognition of the gain on the sale
was appropriate. The Company has determined the fair value of the license and
royalty based on an appraisal. As a result, a $3,319,600 gain was recognized as
a gain on sale of license in the accompanying consolidated statements of
operations for the year ended December 31, 2005. The balance of $350,000 was
determined to represent an advanced royalty payment and was recorded as an
advance on contracts in progress. This amount is being credited as royalty
income over the ten-year license period on a straight-line basis.
Through over 30 years of research and development, the Company has
accumulated extensive scientific and technological expertise. The Company
protects its technological advances as trade secrets, in part through
confidentiality agreements with employees, consultants and third parties. The
Company also seeks and enforces patents as appropriate. The Company currently
has 35 issued United States patents, one of which is jointly owned, eleven
patents pending in the United States, and five foreign patents pending, all of
which cover elements of its materials and processing technologies.
The United States government retains the right to obtain a patent on any
invention developed under government contracts as to which the Company does not
seek and obtain a patent, and may require the Company to grant a third party
license of such invention if steps to achieving practical application of the
invention have not been taken. The United States government also retains a
non-exclusive, royalty-free, non-transferable license to all technology
developed under government contracts, whether or not patented, for government
use, including use by other parties to United States government contracts.
Furthermore, the Company's United States government contracts prohibit the
Company from granting exclusive rights to use or sell any inventions unless the
grantee agrees that any product using the invention will be manufactured
substantially in the United States.
GOVERNMENT REGULATION OF MEDICAL PRODUCTS
The Company's hemodialysis catheters and accessory products require the
approval of the United States Food & Drug Administration ("FDA") prior to sale
within the United States. Sales within the European Union ("EU") require the CE
Mark certification and sales within Canada require a medical device license
issued by Health Canada.
Within the United States, the process requires that a pre-market
notification (the "510(k) Submission") be made to the FDA to demonstrate that
the device is as safe and effective, substantially equivalent to a legally
marketed device that is not subject to pre-market approval. FDA guidance
documents are used to prepare the 510(k) Submission. Applicants must compare
this device to one or more similar devices commercially available in the United
States, known as the "predicate" device(s), and make and support their
substantial equivalency claims. Applicants must submit descriptive data and
performance data to establish that the device is substantially equivalent to a
predicate device. In some instances, data from human clinical trials must also
be submitted in support of a 510(k) Submission. If so, the data must be
collected in a manner that conforms to specific requirements in accordance with
federal regulations. The FDA must issue a 510(k) letter order finding
substantial equivalence before commercial distribution can occur. Upon receipt
of the 510(k) application by the FDA, up to a 90-day response period is allowed
before the FDA must respond.
The Company currently holds all required approvals and certifications to
market its hemodialysis catheters and accessory products in the USA, EU, Canada,
Australia and Hong Kong. The Company is committed to maintaining these critical
approvals and certifications and the stringent quality requirements applicable
to the development, testing, manufacturing, labeling, marketing and distribution
of these products.
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GOVERNMENT REGULATION OF CONTRACTS
The Company's United States government contracts are subject to a large
number of federal regulations and oversight requirements. Compliance with the
array of government regulations requires extensive record keeping and the
maintenance of complex policies and procedures relating to all aspects of the
Company's business, as well as to work performed for the Company by any
subcontractors. The Company believes that it has put in place systems and
personnel to ensure compliance with all such federal regulations and oversight
requirements. All contracts with United States government agencies have been
audited by the government through December 2004. The Company has not incurred
substantial losses as a result of these incurred cost audits.
RESEARCH AND DEVELOPMENT
The Company's policy is to support as much of its research and development
as possible through government contract funding, which it recognizes as revenue.
Revenues from the Company's research and development contracts funded by the
United States government, and their percent of consolidated net sales and
revenues were $2,261,000, or 11%, and $3,233,000, or 14%, for the years ended
December 31, 2006 and 2005, respectively.
The Company's contracts with the United States government grant to the
Company proprietary rights in any technology developed pursuant to such
contracts and grant to the United States government a non-exclusive license to
utilize the technology for its benefit. The United States government retains the
right to obtain the patent on any inventions made under these contracts as to
which patent protection is not sought and obtained by the Company. The Company's
rights to technology developed under contracts with private companies vary,
depending upon negotiated terms.
The Company's internally funded research and development expenditures were
$734,000 and $1,346,000 for the years ended December 31, 2006 and 2005,
respectively.
ENVIRONMENTAL QUALITY
Compliance with federal, state and local provisions regulating the
discharge of materials into the environment has not materially affected the
Company's capital expenditures, earnings or its competitive position. Currently
there are no lawsuits related to the environment or material administrative
proceedings pending against the Company.
EMPLOYEES
At December 31, 2006, the Company had approximately 126 employees, of whom
113 worked full time. The Company also from time to time employs part-time
employees and hires independent contractors. The Company's employees are not
represented by any collective bargaining agreement, and the Company has never
experienced a work stoppage. The Company believes that its employee relations
are good.
RISK FACTORS
In addition to the other information in this Form 10-KSB, the following
risk factors inherent in and affecting the business of the Company should be
considered. The descriptions in this Form 10-KSB contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
and the timing of certain events may differ materially from the results and
timing described in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those described
below and in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and above in "Business."
RISKS RELATING TO OUR BUSINESS
------------------------------
OUR SUCCESS WILL DEPEND UPON OUR ABILITY TO EFFECTIVELY IMPLEMENT OUR BUSINESS
MODEL OF CREATING OR ACQUIRING SCIENTIFICALLY ADVANCED TECHNOLOGY, DEVELOPING
AND MANUFACTURING COMMERCIALLY VIABLE PRODUCTS FROM SUCH TECHNOLOGY AND
SUCCESSFULLY MARKETING AND DISTRIBUTING SUCH PRODUCTS. THE FAILURE TO
SUCCESSFULLY EXECUTE ANY STAGE OF THIS PROCESS COULD HAVE A MATERIALLY NEGATIVE
IMPACT ON OUR BUSINESS AND RESULTS OF OPERATIONS.
We believe that our continued success will depend upon our ability to
create or acquire scientifically advanced technology, apply our technology
cost-effectively across product lines and markets, develop or acquire
proprietary products, attract and retain skilled development personnel, obtain
patent or other protection for our products, obtain required
6
regulatory approvals, manufacture and successfully market our products either
directly or through outside distributors and sales representatives and supply
sufficient inventory to meet customer demand. There can be no assurance that we
will realize financial benefit from our technology development and application
efforts, that we will continue to be successful in identifying, developing and
marketing new products or enhancing our existing products, or that products or
technologies developed by others will not render our products or technologies
non-competitive or obsolete.
WE HAVE EXPERIENCED LOSSES FROM OPERATIONS, BEFORE THE SALE OF CERTAIN
TECHNOLOGY LICENSES, AND WE EXPECT THAT OUR OPERATING RESULTS WILL FLUCTUATE IN
THE FUTURE.
We have experienced losses from operations, before the sale of certain
technology licenses, in each of the past two fiscal years. These losses have
resulted in an accumulated deficit of approximately $9.8 million as of December
31, 2006. Our revenues have not been sufficient to cover our operating expenses,
and we anticipate that we may sustain future losses from operations if revenues
do not increase significantly. Future fluctuations in operating results may also
be caused by a number of factors, many of which are outside our control.
Additional factors that could affect our future operating results include the
following:
o Availability of raw materials required to perform the manufacturing or
services we provide, particularly in the silicon wafer and solar cell
markets;
o Availability of raw materials processed by the capital equipment we
provide to our buyers, particularly the polysilicon used in the
manufacture of the silicon wafers and solar cells;
o Delays, postponements or cancellations of orders and shipments of our
products, particularly in our solar equipment and solar systems
businesses where individual order sizes may be large and thus may
represent a significant portion of annual revenue;
o Changes in our receipt of license fees, milestone payments, and
royalty payments relating to our intellectual property;
o Loss of major customers, particularly as a result of customers
changing their own product designs in such ways as reduce or eliminate
the need for the manufacturing services we provide;
o Reductions in the selling prices of our products and services as a
result of competitive pressures;
o Delays in introducing and gaining physician acceptance for new
products and product improvements, particularly in our biomedical
products business;
o Disruption in the distributor sales channels by which we bring our
biomedical products to market;
o Variation in capacity, capacity utilization and manufacturing yields
within the third party medical contract manufacturing service
providers that constitute the supply chain for our biomedical products
that, in turn, cause variation in our ability to timely ship our
products;
o Increased competition from current and future competitors, including
competition resulting from services and products utilizing competing
technologies;
o Variation in the timing of customer orders and inventory levels at our
customers, particularly within our biomedical manufacturing services
business; and
o Termination of existing grants with government agencies or delays in
funding of grants awarded.
If we are unable to reach and sustain profitability from our operations, we
risk depleting our working capital balances and our business may not continue as
a going concern. Although future sales of technology licenses may be pursued,
such sales cannot be assured. In addition, we may need to raise additional
capital, or arrange other sources of funds, in order to sustain our operations.
There can be no assurance that we will be able to raise such funds if they are
required. Even if new financing were available, it may not be on commercially
reasonable terms or terms that are acceptable to us.
OUR ABILITY TO EXPAND REVENUE AND SUSTAIN PROFITABILITY DEPENDS SUBSTANTIALLY ON
THE STABILITY AND GROWTH OF THE VARIOUS MARKETS FOR OUR PRODUCTS AND SERVICES.
SHOULD WE BE UNABLE TO EXPAND OUR REVENUE, OUR ABILITY TO REACH AND SUSTAIN
PROFITABILITY WOULD BE IMPAIRED.
o The world demand for photovoltaic manufacturing equipment depends on
sustained expansion in the demand for decentralized power sources,
especially in developing countries, and on domestic and foreign
government funding of initiatives to invest in solar energy as an
alternative to the burning of fossil fuels and other energy production
methods. There can be no assurance that government funding for such
initiatives will be available, or that solar energy will prove to be a
cost-effective alternative to other energy sources and thus gain
acceptance where traditional energy sources continue to be available.
Should demand for solar photovoltaic power sources not increase,
demand for new photovoltaic manufacturing equipment would not
materialize and our business would be adversely affected.
7
o Most of our research and development revenues are generated by
contracts with the United States government. There can be no assurance
that the United States government will fund our research and
development projects at the same level as it has in the past. Should
federal research funding priorities change, and should we be unable to
adjust our research focus to reflect the shift, our business could be
adversely affected.
o Our solar systems business is dependent on continued and increased
order activity from the development of other industrial and
residential sales opportunities. Should we be unable to capture a
significant stream of new solar system installation projects from a
more diverse group of project sponsors, our solar systems business
could be adversely affected.
o The growth of our biomedical products business depends on increased
physician acceptance of our hemodialysis catheter products, our
ability to manage the production of higher unit volumes of catheter
products and our ability to effectively distribute those products.
Should our hemodialysis catheters not gain market acceptance or should
we not be able to meet demand for our products, our biomedical
products business could be adversely affected.
o The growth of our biomedical services business depends upon our
customers' ability to serve demand for the end-use items, such as
orthopedic prostheses, on which our services are performed and thus is
substantially beyond our control.
o Our ability to expand our biomedical business depends upon our ability
to introduce new products and services. The marketing of new
biomedical products requires pre-approval of government regulatory
authorities, the completion of which can be lengthy and more costly
than originally planned.
o The growth of our optoelectronics business depends upon growth in
demand for compound semiconductor wafers from manufacturers of
microwave and optoelectronic circuits and sensors that, in turn, are
used in diverse biomedical, telecommunications and aerospace products.
Should these end-use markets not experience anticipated levels of
growth and, in the case of telecommunications uses, experience a
recovery from currently depressed business levels, our optoelectronics
business could be adversely affected.
o The Company has made a substantial investment in equipment at
Bandwidth in anticipation of future revenues under its agreement with
Principia Lightworks. If these anticipated revenues are not achieved
the Company will have significant unutilized capacity and may not
recover its investment in the equipment.
WE HAVE NOT CONSISTENTLY COMPLIED WITH NASDAQ'S MARKETPLACE RULES FOR CONTINUED
LISTING, WHICH EXPOSES US TO THE RISK OF DELISTING FROM THE NASDAQ GLOBAL
MARKET.
Our stock is currently listed on the Nasdaq Global Market. In August 2003,
we received notice from Nasdaq that the Company was not in compliance with
Nasdaq's Marketplace Rules as a result of filing its second quarter Form 10-QSB
prior to the completion of the review by the Company's independent auditors and,
accordingly, was subject to possible delisting. The Company subsequently filed
all reports and was able to maintain its continued listing on the Nasdaq Global
Market.
In April 2005, the Company received notice from Nasdaq that it was not in
compliance with the minimum stockholders' equity level of $10,000,000 required
for continued listing on the Nasdaq Global Market. Following the submission of a
plan of compliance and making later filings showing this deficiency no longer
existed, Nasdaq subsequently notified the Company that it had achieved
compliance with the $10,000,000 stockholders' equity threshold during 2005 and
the matter was closed. However, as of December 31, 2006 and 2005, the Company
was not in compliance with the minimum stockholders' equity threshold. As a
result, the Company did not meet Standard No. 1 for continued listing on the
Nasdaq Global Market. However, the Company believes that it does meet Standard
No. 2 for continued listing on the Nasdaq Global Market as the market value of
its listed securities currently exceeds $50,000,000 and it meets all of the
other requirements of Standard No. 2. In order to remain in compliance with
Standard No. 2, the Company's market value of listed securities cannot fall
below $50,000,000 for ten consecutive trading days at any point. If the Company
fails to maintain compliance with these rules and its common stock is delisted
from the Nasdaq Global Market, there could be a number of negative implications,
including reduced liquidity in the common stock as a result of the loss of
market efficiencies associated with the Nasdaq Global Market, the loss of
federal preemption of state securities laws, the potential
8
loss of confidence by suppliers, customers and employees, as well as the loss of
analyst coverage and institutional investor interest, fewer business development
opportunities and greater difficulty in obtaining financing.
OUR BUSINESS RELIES IN PART ON A LIMITED NUMBER OF CUSTOMERS, AND UNFAVORABLE
DEVELOPMENTS IN RELATION TO A MAJOR CUSTOMER MAY ADVERSELY AFFECT OUR REVENUES,
OPERATING RESULTS AND CASH FLOWS.
The Company had one customer that accounted for more than 10% of
consolidated net sales and revenues in fiscal 2006. In addition, we have had
such customers in other years and may have them again in the future. If an
unfavorable development were to occur with respect to any significant customer
it would likely have a material adverse affect on our business, financial
condition, operating results, cash flows and future prospects.
WE SELL OUR PRODUCTS AND SERVICES AGAINST ESTABLISHED COMPETITORS, AND ENTITIES
NOW OPERATING IN RELATED MARKETS MAY ENTER OUR MARKETS. SOME OF OUR CURRENT AND
POTENTIAL COMPETITORS HAVE GREATER FINANCIAL AND TECHNICAL RESOURCES THAN WE DO.
SHOULD WE BE UNABLE TO OFFER OUR CUSTOMERS PRODUCTS AND SERVICES THAT REPRESENT
ATTRACTIVE PRICE VERSUS VALUE, OUR BUSINESS WOULD SUFFER.
Although we believe that there are considerable barriers to entry into the
markets we serve, including a significant investment in specialized capital
equipment, product design and development, and the need for a staff with
sophisticated scientific and technological knowledge, there can be no assurance
that new or existing entities would not seek to enter our markets or that we
would be able to compete effectively against such entities.
o In our biomedical products business, our hemodialysis catheter
products directly compete against the already established product
offerings of larger competitors. Although we believe that our catheter
products offer significant advantages, widespread physician acceptance
of these products in preference to the more established products of
competitors cannot be assured.
o In our optoelectronics business, our manufacturing services may
compete against the internal manufacturing capabilities of our
customers. Although we believe that we offer significant advantages in
terms of timely response, reduced total cost and reduced capital
investment over the captive fabrication facilities of our customers,
customers may elect to maintain their internal capabilities despite
economic incentives to outsource these services from us.
IF WE ARE UNABLE TO DEVELOP AND INTRODUCE NEW PRODUCTS SUCCESSFULLY OR TO
ACHIEVE MARKET ACCEPTANCE OF OUR NEW PRODUCTS, OUR OPERATING RESULTS WOULD BE
ADVERSELY AFFECTED.
We compete in markets characterized by technological advances and
improvements in manufacturing efficiencies. Our ability to operate profitably
depends in large part on our timely access to, or development of, technological
advances, and on our ability to use those advances to improve existing products,
develop new products and manufacture those products efficiently. There can be no
assurance that we will realize financial benefit from our development programs,
will continue to be successful in identifying, developing and marketing new
products or enhancing our existing products, or that products or technologies
developed by others will not render our products or technologies non-competitive
or obsolete. The failure to introduce new or enhanced products on a timely and
cost competitive basis, or to attain market acceptance for commercial products,
could have a material adverse effect on our business, results of operations or
financial condition.
IF WE ARE NOT SUCCESSFUL IN PROTECTING OUR INTELLECTUAL PROPERTY RIGHTS, OUR
ABILITY TO COMPETE MAY BE HARMED.
We rely on a combination of patent, copyright, trademark and trade secret
protections as well as confidentiality agreements and other methods, to protect
our proprietary technologies and processes. For example, we enter into
confidentiality agreements with our employees, consultants and business
partners, and control access to and distribution of our proprietary information.
We have been issued 35 United States patents, one of which is jointly owned, and
have a number of pending patent applications. However, despite our efforts to
protect our intellectual property, we cannot assure that:
o The steps we take to prevent misappropriation or infringement of our
intellectual property will be successful;
o Any existing or future patents will not be challenged, invalidated or
circumvented;
o Any pending patent applications or future applications will be
approved;
o Others will not independently develop similar products or processes to
ours or design around our patents; or
o Any of the measures described above would provide meaningful
protection.
9
A failure by us to meaningfully protect our intellectual property could
have a material adverse effect on our business, financial condition, operating
results and ability to compete. In addition, effective patent, copyright,
trademark and trade secret protection may be unavailable or limited in certain
countries.
From time to time the Company may be subject to lawsuits by other parties
seeking to enforce their intellectual property rights. WE DEPEND ON OTHERS,
PARTICULARLY ON AGENCIES OF THE UNITED STATES GOVERNMENT, FOR FUNDING OUR
RESEARCH AND DEVELOPMENT EFFORT.
Substantially all of our research and development work is funded by
agencies of the United States government either directly or via their
contractors. Loss of outside funding may materially adversely affect our ability
to further develop our proprietary technologies and to apply these technologies
to our current products and products under development. If we are unable to
maintain our current level of such funding for any reason, we would need to
generate funds for such research from other sources, reduce our research and
development effort or increase our internal funding for research and
development. An increase in internally funded research and development would
have a negative impact on our profitability.
Additionally, the process of bidding for, obtaining, retaining and
performing United States government contracts is subject to a large number of
United States government regulations and oversight requirements. Compliance with
these government regulations requires extensive record keeping and the
maintenance of complex policies and procedures relating to all aspects of our
business, as well as to work performed for us by any subcontractors. Any failure
to comply with applicable regulations, or to require our subcontractors so to
comply, could result in a variety of adverse consequences, ranging from remedial
requirements to termination of contracts, reimbursement of fees, reduction of
fees on a going forward basis and prohibition from obtaining future United
States government contracts. While we believe that we have in place systems and
personnel to ensure compliance with all United States government regulations
relating to contracting, we cannot assure that we will at all times be in
compliance or that any failure to comply will not have a material adverse effect
on our business, results of operations or financial condition.
THE U.S. GOVERNMENT HAS CERTAIN RIGHTS RELATING TO OUR INTELLECTUAL PROPERTY.
The United States government retains the right to obtain a patent on any
invention developed under government contracts as to which the Company does not
seek and obtain a patent, and may require the Company to grant a third party
license of such invention if steps to achieving practical application of the
invention have not been taken. The United States government also retains a
non-exclusive, royalty-free, non-transferable license to all technology
developed under government contracts, whether or not patented, for government
use, including use by other parties to United States government contracts.
Furthermore, the Company's United States government contracts prohibit the
Company from granting exclusive rights to use or sell any inventions unless the
grantee agrees that any product using the invention will be manufactured
substantially in the United States.
WE DEPEND ON THIRD-PARTY CONTRACTORS TO MANUFACTURE SUBSTANTIALLY ALL OF OUR
CURRENT BIOMEDICAL PRODUCTS.
We depend on third-party subcontractors in the U.S. for the manufacturing,
assembly and packaging of our biomedical products. Any difficulty in obtaining
parts or services from these subcontractors could affect our ability to meet
scheduled product deliveries to customers, which could in turn have a material
adverse effect on our customer relationships, business and financial results.
Several significant risks are associated with reliance on third-party
subcontractors, including:
o The lack of assured product supply and the potential for product
shortages;
o Reduced control over inventory located at contractors' premises;
o Limited control over delivery schedules, manufacturing yields and
production costs;
o Direct control over product quality;
o The temporary or permanent unavailability of, or delays in obtaining,
access to key process technologies; and
o Dependence on single source contractors to provide critical services.
OUR SUCCESS DEPENDS ON OUR ABILITY TO HIRE AND RETAIN QUALIFIED TECHNICAL
PERSONNEL, AND IF WE ARE UNABLE TO DO SO, OUR PRODUCT DEVELOPMENT EFFORTS AND
CUSTOMER RELATIONS WILL SUFFER.
Our products require sophisticated manufacturing, research and development,
marketing and sales, and technical support. Our success depends on our ability
to attract, train and retain qualified technical personnel in each of these
areas.
10
Competition for personnel in all of these areas is intense and we may not be
able to hire or retain sufficient personnel to achieve our goals or support the
anticipated growth in our business. The market for the highly trained personnel
we require is very competitive, due to the limited number of people available
with the necessary technical skills and understanding of our products and
technology. If we fail to hire and retain qualified personnel, our product
development efforts and customer relations will suffer.
WE ARE SUBJECT TO ENVIRONMENTAL LAWS AND OTHER LEGAL REQUIREMENTS THAT HAVE THE
POTENTIAL TO SUBJECT US TO SUBSTANTIAL LIABILITY AND INCREASE OUR COSTS OF DOING
BUSINESS.
Our properties and business operations are subject to a wide variety of
federal, state, and local environmental, health and safety laws and other legal
requirements, including those relating to the storage, use, discharge and
disposal of toxic, volatile or otherwise hazardous substances used in our
manufacturing processes. We cannot assure that these legal requirements will not
impose on us the need for additional capital expenditures or other requirements.
If we fail to obtain required permits or otherwise fail to operate within these
or future legal requirements, we may be required to pay substantial penalties,
suspend our operations or make costly changes to our manufacturing processes or
facilities. Although we believe that we are in compliance and have complied with
all applicable legal requirements, we may also be required to incur additional
costs to comply with current or future legal requirements.
OUR INTERNATIONAL SALES SUBJECT US TO RISKS THAT COULD ADVERSELY AFFECT OUR
REVENUE AND OPERATING RESULTS.
Sales to customers located outside the U.S. have historically accounted for
a significant percentage of our revenue (approximately 33% in 2006) and we
anticipate that such sales will continue to be a significant percentage of our
revenue. International sales involve a variety of risks and uncertainties,
including risks related to:
o Reliance on strategic alliance partners such as representatives and
licensees;
o Compliance with changing foreign regulatory requirements and tax laws;
o Reduced protection for intellectual property rights in some countries;
o Longer payment cycles to collect accounts receivable in some
countries;
o Political instability;
o Economic downturns in international markets; and
o Changing restrictions imposed by United States export laws.
Failure to successfully address these risks and uncertainties could
adversely affect our international sales, which could in turn have a material
and adverse effect on our results of operations and financial condition.
THE USE OF OUR CATHETER AND OTHER MEDICAL RELATED PRODUCTS ENTAILS A RISK OF
PHYSICAL INJURY; THE DEFENSE OF CLAIMS ARISING FROM SUCH RISK MAY EXCEED OUR
INSURANCE COVERAGE AND DISTRACT OUR MANAGEMENT.
The use of orthopedic and other medical devices may entail a risk of
physical injury to patients. To the extent we have been involved in the design
and manufacturing of these products, we may be exposed to potential product
liability and other damage claims. Furthermore, the use of our photovoltaic
module manufacturing equipment could result in operator injury. We have had
cases brought against us in which it was alleged that we have been a party to
the manufacture and sale of defective heart valves with other defendants. A case
has recently been filed alleging that our catheter was the cause of a patient's
death in Ohio. No other claims of product liability or other damages have been
initiated against us. We maintain product liability and umbrella insurance
coverage; however, there can be no assurance that any product liability claim
assessed against us would not exceed our insurance coverage, or that insurance
coverage would continue to be available. While we typically obtain agreements of
indemnity from manufacturers of biomedical products for which we provide
manufacturing services, there can be no assurance that any such indemnity
agreements will be enforceable or that such manufacturers will have adequate
funds to meet their obligations under such agreements. The cost of defending a
product liability, negligence or other action, and/or assessment of damages in
excess of insurance coverage, could have a material adverse effect on our
business, results of operations, or financial condition.
RISKS RELATED TO OUR COMPANY
OUR COMPANY IS SUBJECT TO CONTROL BY PRINCIPAL STOCKHOLDER.
Roger G. Little, the founder, Chairman of the Board, Chief Executive
Officer and President of the Company, controls approximately 27% of the
Company's outstanding Common Stock. As a result, Mr. Little is in a position to
exert significant
11
influence over actions of the Company which require stockholder approval and
generally to direct the affairs of the Company, including the election of
directors, potential acquisitions and sales or otherwise preventing or delaying
changes in control of the Company that may be otherwise viewed as beneficial by
shareholders other than Mr. Little.
WE DO NOT PAY DIVIDENDS AND WE MAY NOT PAY DIVIDENDS IN THE FUTURE.
We have paid no cash dividends since the Company's inception. We anticipate
retaining any future earnings for reinvestment in operations and do not
anticipate that dividends will be paid in the foreseeable future. Thus, the
return on investment should be expected to depend on changes in the market price
of our common stock.
THE MARKET PRICE FOR OUR COMMON STOCK HAS BEEN VOLATILE AND FUTURE VOLATILITY
COULD CAUSE THE VALUE OF INVESTMENTS IN THE COMPANY TO FLUCTUATE.
Our stock price has experienced significant volatility. While our revenues
have increased since 2000, we expect that uncertainty regarding demand for our
products will cause our stock price to continue to be volatile. In addition, the
value of your investment could decline due to the impact of any of the following
factors, among others, upon the market price of our common stock:
o Additional changes in investment analysts' estimates of our revenues
and operating results;
o Our failure to meet investment analysts' performance expectations; and
o Changes in market valuations of other companies in the biomedical,
alternative energy or semiconductor industries.
In addition, many of the risks described elsewhere in this section could
materially and adversely affect our stock price, as discussed in those risk
factors. U.S. financial markets have recently experienced substantial price and
volume volatility. Fluctuations such as these have affected and are likely to
continue to affect the market price of our common stock.
SOME OF THE REQUIREMENTS OF SARBANES-OXLEY AFFECT US AS A SMALL COMPANY
DISPROPORTIONATELY, AND WE MAY NOT BE ABLE TO COMPLY IN A TIMELY MANNER DESPITE
SUBSTANTIAL EFFORT AND EXPENSE.
The Sarbanes-Oxley Act of 2002 imposed many new requirements on public
companies, the most significant of which involves the documentation, testing and
reporting of the effectiveness of our internal control over financial reporting.
Although we are not required to be in compliance with Section 404 of
Sarbanes-Oxley relating to internal control over financial reporting until our
annual report for the year ended December 2007, we will begin documenting and
testing our internal controls in a way that we have never before been required
to do. We expect this effort will involve substantial time and expense. Because
we have limited resources we can devote to this effort we cannot be sure that we
will be able to complete the task in a timely manner or that our internal
controls will meet the standards that are currently required. We have various
material weakness and significant control deficiencies identified by our
registered public accounting firm. These deficiencies include, among other
things, inadequate staffing in our finance area and the need to improve and
update the documentation of our policies, procedures, and related internal
controls surrounding our accounting and financial reporting functions. Although
we are not yet required to report on our assessment of the effectiveness of our
internal control over financial reporting until at least the end of the next
fiscal year (or provide auditor attestation until the end of fiscal 2008), there
is a reasonable likelihood that our registered public accounting firm will
inform us of one or more material weaknesses before we complete our compliance
and remediation efforts. We are working to address the issues raised by these
control deficiencies, but we may not be successful in remediating them within
the required time frame.
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate headquarters are located at One Patriots Park, Bedford,
Massachusetts. This 92,000 square foot facility is leased and contains our
administrative offices, sales and marketing offices, research and development
facilities and the manufacturing facilities of the Company's biomedical and
solar equipment and systems businesses. The lease expires in November 2007. We
lease an approximately 90,000 square foot facility located at 25 Sagamore Park
Road, Hudson, New Hampshire that contains a semiconductor wafer growth and
fabrication facility and administrative offices used primarily by our
Optoelectronics business unit including Bandwidth Semiconductor. The lease
expires in May 2008. The Company believes that its facilities are suitable for
their present intended purposes and adequate for the Company's current level of
operations.
12
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is subject to legal proceedings and claims
arising from the conduct of its business operations. The Company does not expect
the outcome of these proceedings, either individually or in the aggregate, to
have a material adverse effect on its financial position, results of operations,
or cash flows.
The Company was named a defendant in 58 cases filed from August 2001 to
July 2003 in various state courts in Texas by persons claiming damages from the
use of allegedly defective mechanical heart valves coated by a process licensed
by the Company to St. Jude Medical, Inc., the heart valve manufacturer, which
has also been named as a defendant in these cases. In June 2003, a motion for
summary judgment was granted to the Company and most of these cases were
dismissed, based on the principle of federal preemption. The Texas Court of
Appeals upheld the lower court's decision, and, because these cases were not
submitted for review to the Texas Supreme Court, the judgments rendered are now
final.
As of January 2007, four cases remain pending in various district courts in
Harris County, Texas. One of these cases appears to remain pending despite its
inclusion in the original summary judgment which was subsequently upheld by the
first court of appeals. This may be the result of an administrative omission;
counsel for the Company intends to confirm with the court that this case should
in fact no longer be pending. Two of the remaining cases where filed after the
motion for summary judgment, but since the appeals court has subsequently ruled
in the Company's favor, counsel for the Company is asking the plaintiffs in
these cases to consider voluntary dismissal, or alternatively, because the cases
are not actively prosecuted, to ask the court to dismiss them. The remaining
case was not subject to the preemption argument advanced by the Company's
counsel and either may be settled or may go to trial.
During the second quarter of 2005 a suit was filed by Arrow International,
Inc. against Spire Biomedical, Inc., a wholly owned subsidiary of the Company,
alleging patent infringement by the Company. The complaint claims one of the
Company's catheter products induces and contributes to infringement when medical
professionals insert it. The Company has responded to the complaint denying all
allegations and has filed certain counterclaims. The discovery process in this
case has continued and is nearly complete. The Company filed a motion for
summary judgment, asserting patent invalidity resulting from plaintiff's failure
to follow the administrative procedures of the U.S. Patent and Trademark Office
("USPTO") which failure has remained uncorrected. On August 4, 2006, the Court
granted the Company's motion and dismissed this lawsuit without prejudice.
Plaintiffs applied to revive the applicable patent, which application was
granted by the USPTO in August 2006. Plaintiffs refiled their lawsuit against
the Company in September 2006. The Company has filed its answer and resumed its
defense. The parties have been working to conclude discovery. At this time,
however, in response to a joint request, the court has temporarily stayed the
proceedings to allow the parties to discuss possible alternative methods toward
resolution of the subject matter of the litigation. Based on information
presently available to the Company, the Company believes that it does not
infringe any valid claim of the plaintiff's patent and that, consequently, it
has meritorious legal defenses with respect to this action in the event it were
to be reinstated.
In an amended complaint filed on December 28, 2006, in the Eastern Division
of the U.S. District Court for the Southern District of Ohio, the wife and
executor of the estate of Darrell Adams, deceased, alleges that the failure of a
hemodialysis catheter manufactured by the Company was a cause of his death.
Counsel retained by its insurance underwriters, on behalf of the Company, have
filed an answer denying all such allegations and asserting various defenses.
Based on the knowledge available to it at this time, the Company determined the
likelihood of an unfavorable outcome to be remote and accordingly has not
recorded an accrued expense.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders in
the fourth quarter of 2006.
13
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock, $0.01 par value ("Common Stock"), is traded on
the Nasdaq Global Market under the symbol "SPIR." The following chart sets forth
the high and low bid prices for the Common Stock for the periods shown:
High Bid Low Bid
-------- -------
2006
First Quarter $10.61 $ 7.49
Second Quarter 10.25 6.98
Third Quarter 7.45 6.67
Fourth Quarter 8.69 6.50
2005
First Quarter $ 6.18 $ 4.32
Second Quarter 8.99 3.68
Third Quarter 11.95 6.28
Fourth Quarter 11.24 6.56
These prices do not reflect retail mark-ups, markdowns or commissions and
may not reflect actual transactions. The closing price of the Common Stock on
March 1, 2007 was $10.32, and on that date, there were 193 stockholders of
record. The number of holders does not include individuals or entities who
beneficially own shares but whose shares are held of record by a broker or
clearing agency, but does include each such broker or clearing agency as one
record holder.
DIVIDENDS
The Company did not pay any cash dividends during 2006 or 2005 and
currently does not intend to pay dividends in the foreseeable future so that we
may reinvest our earnings in the development of our business. The payment of
dividends in the future will be at the discretion of the Board of Directors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SECTION AND OTHER PARTS OF THIS REPORT CONTAIN
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"), WHICH
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. THESE STATEMENTS RELATE TO OUR
FUTURE PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THESE STATEMENTS MAY BE
IDENTIFIED BY THE USE OF WORDS SUCH AS "MAY", "COULD", "WOULD", "SHOULD",
"WILL", "EXPECTS", "ANTICIPATES", "INTENDS", "PLANS", "BELIEVES", "ESTIMATES",
AND SIMILAR EXPRESSIONS. THE COMPANY'S ACTUAL RESULTS AND THE TIMING OF CERTAIN
EVENTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS AND TIMING DESCRIBED IN THE
FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE FACTORS DESCRIBED BELOW AND
ABOVE IN "RISK FACTORS" AND "BUSINESS." THE FOLLOWING DISCUSSION AND ANALYSIS OF
THE COMPANY'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN
LIGHT OF THOSE FACTORS AND IN CONJUNCTION WITH, THE COMPANY'S ACCOMPANYING
CONSOLIDATED FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO.
OVERVIEW
Spire Corporation ("Spire" or the "Company") develops, manufactures and
markets highly-engineered products and services in three principal business
areas: (i) solar equipment and systems, (ii) biomedical and (iii)
optoelectronics, generally bringing to bear expertise in materials technologies,
surface science and thin films across all three business areas, discussed below.
In the solar area, the Company develops, manufactures and markets
specialized equipment for the production of terrestrial photovoltaic modules
from solar cells. The Company's equipment has been installed in approximately
190
14
factories in 46 countries. The Company also provides stand alone emergency power
backup and electric power grid-connected distributed power generation systems,
employing photovoltaic technology developed by the Company and others.
In the biomedical area, the Company provides value-added surface treatments
to manufacturers of orthopedic and other medical devices that enhance the
durability, antimicrobial characteristics or other material characteristics of
their products; develops and markets coated and uncoated hemodialysis catheters
and related devices for the treatment of chronic kidney disease; and performs
sponsored research programs into practical applications of advanced biomedical
and biophotonic technologies.
In the optoelectronics area, the Company provides custom compound
semiconductor foundry and fabrication services on a merchant basis to customers
involved in biomedical/biophotonic instruments, telecommunications and defense
applications. Services include compound semiconductor wafer growth, other thin
film processes and related device processing and fabrication services. The
Company also provides materials testing services and performs services in
support of sponsored research into practical applications of optoelectronic
technologies.
Operating results will depend upon revenue growth and product mix, as well
as the timing of shipments of higher priced products from the Company's solar
equipment line and delivery of solar systems. Export sales, which amounted to
33% of net sales and revenues for 2006, continue to constitute a significant
portion of the Company's net sales and revenues.
RESULTS OF OPERATIONS
The following table sets forth certain items as a percentage of net sales
and revenues for the periods presented:
Year Ended December 31,
-----------------------
2006 2005
------ ------
Net sales and revenues 100% 100%
Cost of sales and revenues (89) (85)
------ ------
Gross profit 11 15
Selling, general and administrative expenses (48) (38)
Internal research and development expenses (4) (6)
Gain on extinguishment of purchase commitment -- 3
Gain on sales of licenses -- 28
------ ------
Earnings (loss) from operations (41)
2
Other expense, net -- (2)
------ ------
Earnings (loss) before income taxes (41) --
Income tax expense (benefit) -- --
------ ------
Net earnings (loss) (41)% -%
====== ======
OVERALL
The Company's total net sales and revenues for the year ended December 31,
2006 ("2006") decreased 10% to $20,125,000 as compared to $22,422,000 for the
year ended December 31, 2005 ("2005"). The decrease was attributable to our
solar and biomedical business units, while our optoelectronics business unit
achieved a small increase.
SOLAR BUSINESS UNIT
Sales in the Company's solar business unit decreased 26% to $6,992,000 in
2006 as compared to $9,393,000 in 2005, primarily due to a 30% decrease in solar
equipment sales resulting from lower volume and timing of the delivery of
equipment and by a 11% decrease in solar systems sales.
BIOMEDICAL BUSINESS UNIT
Revenues of the Company's biomedical business unit decreased less than 1%
during 2006 to $10,517,000 as compared to $10,578,000 in 2005, as a result of a
28% decrease in revenue from Spire's research and development activities offset
by a 16% increase in revenue from Spire's line of hemodialysis catheters and a
7% increase in biomedical services.
15
OPTOELECTRONICS BUSINESS UNIT
Sales in the Company's optoelectronics business unit increased 7% in 2006
to $2,616,000 as compared to $2,451,000 in 2005.
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
---------------------------------------------------------------------
Net Sales and Revenues
The following table categorizes the Company's net sales and revenues for
the periods presented:
Year Ended December 31, (Decrease)
------------------------- -------------------
2006 2005 $ %
----------- ----------- -----------
Contract research, service
and license revenues $10,563,000 $11,151,000 $ (588,000) 5%
Sales of goods 9,562,000 11,271,000 (1,709,000) 15%
----------- ----------- -----------
Net sales and revenues $20,125,000 $22,422,000 $(2,297,000) 10%
=========== =========== ===========
The 5% decrease in contract research, service and license revenues in 2006
is primarily attributable to a decrease in our contract research activities.
Revenues from the Company's research activities decreased 30% in 2006 as
compared to 2005 primarily due to a decrease in the number and dollar value of
contracts associated with government and third party funded research. The
decrease was partially offset by a 7% increase in biomedical and optoelectronic
service revenue.
The 15% decrease in sales of goods for the year ended December 31, 2006 as
compared to the year ended December 31, 2005 was primarily due to a 26% decrease
in solar equipment and solar systems revenues. Contributing to the solar
equipment decrease was the timing of the delivery of equipment that was ordered
but did not get shipped prior to our year-end. Our ability to deliver equipment
is, at times, dependent upon our customer's ability to have their facilities
ready to receive the equipment as scheduled, as well as the Company's ability to
produce the equipment. Solar sales were also impacted by a tight supply of solar
wafers available to our customers. The tight wafer market had eased somewhat by
year-end 2006. Biomedical product sales increased 16% in 2006 as compared to
2005 as a result of increased demand for the Company's expanded line of
hemodialysis catheters. The Company introduced a new heparin coated catheter
late in the fourth quarter of 2006.
Cost of Sales and Revenues
--------------------------
The following table categorizes the Company's cost of sales and revenues
for the periods presented, stated in dollars and as a percentage of related
sales and revenues:
Years Ended December 31, Increase (Decrease)
------------------------------------- ------------------
2006 % 2005 % $ %
----------- --- ----------- --- ----------- ----
Cost of contract research,
service and license revenues $ 8,819,000 83% $ 8,779,000 79% $ 40,000 --
Cost of goods sold 9,029,000 94% 10,322,000 92% (1,293,000) (13%)
----------- ----------- -----------
Net cost of sales and revenues $17,848,000 89% $19,101,000 85% $(1,253,000) (7%)
=========== =========== ===========
The overall cost of contract research, services and licenses in 2006 is up
slightly as increased costs at our optoelectronics facility (Bandwidth) were
somewhat offset by a decrease in costs of our contract research activities due
to lower volumes. Bandwidth's costs increased primarily due to an allocation of
costs that were charged to internal research and development in 2005. This
allocation of costs reflects the increase in optoelectronics service revenues in
2006. Cost of contract research, services and licenses as a percentage of
revenue increased to 83% of revenues in 2006 from 79% in 2005, primarily due to
the increase in Bandwidth costs.
Cost of goods sold decreased 13% in 2006 as compared to 2005, primarily as
a result of the 15% decrease in related revenues. As a percentage of sales, cost
of goods sold was 94% of sales of goods in 2006 as compared to 92% of sales in
2005. This change is due to increased costs in 2006 associated with certain
equipment contracts, partially offset by a reduction in solar systems
manufacturing overhead costs. The solar systems savings were realized with the
move of solar systems operations from Chicago to Bedford.
16
Cost of goods sold also includes approximately $47,000 of stock based
compensation in 2006, due to the adoption of SFAS 123(R), as compared to zero
stock based compensation in 2005.
OPERATING EXPENSES
The following table categorizes the Company's operating expenses for the
periods presented, stated in dollars and as a percentage of net sales and
revenues:
Years Ended December 31, Increase (Decrease)
------------------------------------- ------------------
2006 % 2005 % $ %
----------- --- ----------- --- ----------- ----
Selling, general and administrative $ 9,794,000 48% $ 8,539,000 38% $ 1,255,000 15%
Internal research and development 734,000 4% 1,346,000 6% (612,000) (45%)
----------- ----------- -----------
Operating expenses $10,528,000 52% $ 9,885,000 44% $ 643,000 7%
=========== =========== ===========
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The 15% increase in selling, general and administrative expenses was
primarily due to increased costs associated with sales and marketing efforts
throughout all of our product lines, ongoing litigation matters, loss from a
buy-out of a capital lease, increased facility related costs, and stock-based
compensation costs. The increase in selling, general and administrative expenses
as a percentage of sales and revenues were due to the overall increase in costs
while sales and revenues decreased. Selling, general and administrative expense
includes approximately $209,000 of stock based compensation in 2006, due to the
adoption of SFAS 123(R), as compared to zero stock based compensation in 2005.
INTERNAL RESEARCH AND DEVELOPMENT EXPENSES
The 45% decrease in internal research and development expense in 2006
versus 2005 was primarily due to decreased development efforts within the solar
equipment and biomedical services group and an allocation of certain internal
research and development costs at Bandwidth to cost of sales in 2006. The
decrease in internal research and development expenses as a percentage of sales
and revenues was due to the decrease in costs.
OTHER INCOME (EXPENSE), NET
The Company earned $268,000 and $74,000 of interest income for the years
ended December 31, 2006 and 2005, respectively. The Company incurred interest
expense of $154,000 and $274,000 for the years ended December 31, 2006 and 2005,
respectively. The increased interest income is due to interest earned on
short-term investments made with the net proceeds of approximately $7.7 million
received from a private placement of common equity in April 2006. The decrease
in interest expense is primarily associated with interest incurred on capital
leases associated with the semiconductor foundry.
The Company recorded $14,000 and $104,000 of currency transaction loss
related to the conversion of a Japanese Yen account into U.S. dollars for the
years ended December 31, 2006 and 2005, respectively.
INCOME TAXES
The Company did not record an income tax provision for years ended December
31, 2006 and 2005 as earnings (loss) before income taxes is expected to be
substantially offset by net operating loss carryforwards of approximately
$10,200,000. A valuation allowance was provided against the deferred tax assets
generated in 2006 and 2005 due to uncertainty regarding the realization of the
net operating loss in the future. At December 31, 2006, the Company had gross
deferred tax assets of $6,450,000, against which a valuation allowance of
$6,400,000 had been applied. Gross deferred tax liabilities of $50,000 were
applied against the net deferred tax asset.
NET EARNINGS (LOSS)
The Company reported a net loss for the year ended December 31, 2006 of
$8,151,000, compared to net income of $44,000 in 2005. In 2006 the Company did
not record any gains from the sale of technology licenses compared to a
$6,320,000 gain on the sale of licenses to the Company's solar and biomedical
technology and the $593,000 gain on extinguishment of purchase commitment
realized in 2005. The Company is likely to continue to report losses unless it
can increase revenues significantly or sell additional technology licenses. If
additional sources of revenue are not identified the
17
Company can take measures to reduce costs but it is unclear whether cost
reductions alone can eliminate all of the potential future losses.
LIQUIDITY AND CAPITAL RESOURCES
(Decrease)
December 31, December 31, -------------------
2006 2005 $ %
----------- ----------- ----------- -----
Cash and cash equivalents $1,536,000 $3,630,000 $(2,094,000) (58%)
Working capital $3,938,000 $5,270,000 $(1,332,000) (25%)
Included in working capital at December 31, 2006, is $5,000,000 of
certificates of deposit with a bank, classified on the balance sheet as
short-term investments. $1,969,000 of this short-term investment is restricted
as security for a letter of credit.
On April 26, 2006, the Company entered into Stock Purchase Agreements with
two accredited institutional investors in connection with the private placement
of 941,176 shares of the Company's common stock at a purchase price of $8.50 per
share. On April 28, 2006, the Company completed the private placement. The net
proceeds of the sale were approximately $7.7 million after deducting placement
fees and other closing costs. The proceeds were used to fund additions to
property plant and equipment, short-term investments and operating losses.
Under the terms of the Stock Purchase Agreements, the Company was obligated
to file a registration statement on Form S-3 with the Securities and Exchange
Commission (the "SEC") registering the resale of the shares of common stock
sold. The Company filed the Form S-3 on May 3, 2006 and the SEC declared it
effective on May 12, 2006. In the event that this registration statement ceases
to be effective and available to the investors for an aggregate period of 30
days in any 12 month period, the Company must pay liquidated damages starting on
the 61st day (in the aggregate) of any suspensions in any 12 month period, and
each 30th day thereafter until the suspension is terminated an amount equal to
1% of the aggregate purchase price paid by the investors. However, the Company
is not obligated to pay liquidation damages on shares not owned by the investors
at the time of the suspension or shares that are tradable under Rule 144(k). The
Company reviewed Emerging Issues Task Force ("EITF") 00-19: ACCOUNTING FOR
DERIVATIVE FINANCIAL INSTRUMENTS INDEXED TO, AND POTENTIALLY SETTLED IN, A
COMPANY'S OWN STOCK, and EITF 05-04: THE EFFECT OF A LIQUIDATED DAMAGES CLAUSE
ON A FREESTANDING FINANCIAL INSTRUMENT SUBJECT TO EITF ISSUE NO. 00-19, to
determine if these liquidation damages provisions require a portion of the
equity raised needs to be accounted under Financial Accounting Standards ("FAS")
No. 133: ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. It
determined that the liquidated damages provisions did not require treatment
under FAS No. 133 and therefore will treat all of the funds raised under these
agreements as additions to permanent equity.
The Company has a $2,000,000 Loan Agreement (the "Agreement") with Citizens
Bank of Massachusetts (the "Bank"), which expires on June 26, 2007. The
Agreement provides Standby Letter of Credit guarantees, for certain foreign and
domestic customers, which are 100% secured with cash. In December 2006 the
Company temporarily expanded its line of credit to $3,000,000 in order to
facilitate its purchase of production equipment for Bandwidth. On March 31, 2007
the credit line will revert back to the original $2,000,000. At December 31,
2006, the Company had approximately $390,000 of restricted cash and $1,969,000
of restricted short-term investments associated with outstanding letters of
credit. Standby letters of credit under this Agreement bear interest at 1%,
however, the Company retains all interest earned on the restricted investments.
The Agreement also provides the Company with the ability to convert to a
$2,000,000 revolving line of credit, based upon eligible accounts receivable and
certain conversion covenants. Loans under this revolving line of credit bear
interest at the Bank's prime rate as determined plus 1/2% (8.75% at December 31,
2006). At December 31, 2006, the Company had not exercised its conversion option
and no amounts were outstanding under the revolving line of credit. A commitment
fee of .25% is charged on the unused portion of the borrowing base. The
Agreement contains covenants including certain financial reporting requirements.
At December 31, 2006, the Company was in compliance with its financial reporting
requirements and cash balance covenants.
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to pay amounts due. The Company
actively pursues collection of past due receivables as the circumstances
warrant. Customers are contacted to determine the status of payment and senior
accounting and operations management are included in these efforts as is deemed
necessary. A specific reserve will be established for past due accounts over 60
days and over a specified amount, when it is probable that a loss has been
incurred and the Company can reasonably estimate the amount of the loss. The
Company does not record an allowance for government receivables and invoices
backed by letters of credit as realizeability is reasonably assured. Bad debts
are written off against the allowance when identified. There is no dollar
threshold for account balance write-offs. While rare, a write-off is only
recorded when all efforts to collect the
18
receivable have been exhausted and only in consultation with the appropriate
business line manager.
At December 31, 2006, the Company's accumulated deficit was approximately
$9,756,000, compared to accumulated deficit of approximately $1,605,000 as of
December 31, 2005.
The Company has incurred significant operating losses in 2006 and 2005.
Loss from operations, before gain on sales of licenses and extinguishment of
purchase commitment, were $8.3 million and $6.6 million in 2006 and 2005,
respectively. These losses from operations have resulted in a cash loss from
operations of approximately $5.4 million and $4.2 million in 2006 and 2005,
respectively. The Company has funded these cash losses from cash receipts of
$7.7 million from the sale of equity in 2006 and $6.7 million related to the
sale of certain licenses to its medical products and solar technologies in 2005.
As of December 31, 2006, the Company had unrestricted cash and cash equivalents
of $1.5 million and unrestricted short-term investments of $3.0 million. While
the Company believes it has inherent assets and technology that it could sell or
license in the near term, there is no guarantee that the Company would be able
to sell or license those assets on a timely basis and at appropriate values that
would allow the Company to continue to fund its operating losses. The Company
has developed several plans to mitigate cash losses primarily from increased
revenues and, if required, potential cost reduction efforts and outside
financing. As a result, the Company believes it has sufficient resources to
continue as a going concern for the foreseeable future. The table below details
the Company's cash loss from operations.
Years Ended December 31,
2006 2005
----------- -----------
Earnings (loss) from operations $(8,251,000) $ 348,000
Gain on licenses -- (6,320,000)
Gain on purchase commitment -- (593,000)
----------- -----------
Adjusted earnings (loss) from operations (8,251,000) (6,565,000)
Depreciation and amortization 2,027,000 2,451,000
Loss on lease buyout 105,000 --
Deferred comp 35,000 --
Unearned purchase discount -- (65,000)
Stock-based compensation 256,000 --
Additions to reserves 467,000 (30,000)
----------- -----------
Cash loss from operations $(5,361,000) $(4,209,000)
=========== ===========
CONTRACTUAL OBLIGATIONS, COMMERCIAL COMMITMENTS AND OFF-BALANCE SHEET
ARRANGEMENTS.
The following table summarizes the Company's gross contractual obligations
at December 31, 2006 and the maturity periods and the effect that such
obligations are expected to have on its liquidity and cash flows in future
periods:
Payments Due by Period
-------------------------------------------------------------------
Less than 2 - 3 4 - 5 More Than
Contractual Obligations Total 1 Year Years Years 5 Years
------------------------------------------------------------------------------------------------------------
PURCHASE OBLIGATIONS $6,415,000 $6,358,000 $ 57,000 -- --
CAPITAL LEASES:
Related party capital lease $1,598,000 $1,103,000 $495,000 -- --
OPERATING LEASES:
Unrelated party operating leases $ 226,000 $ 110,000 $116,000 -- --
Related party operating lease $1,247,000 $1,247,000 -- -- --
Purchase obligations include all open purchase orders outstanding
regardless of whether they are cancelable or not. Included in purchase
obligations are raw material and equipment needed to fulfill customer orders.
Capital lease obligations outlined above include both the principal and
interest components of these contractual obligations.
19
On October 8, 1999, the Company entered into an agreement with BP Solarex
("BPS") in which BPS agreed to purchase certain production equipment built by
the Company, for use in the Company's Chicago factory ("Spire Solar Chicago")
and in return the Company agreed to purchase solar cells of a minimum of two
megawatts per year over a five-year term for a fixed fee from BPS (the "Purchase
Commitment"). BPS had the right to reclaim the equipment if the Company failed
to meet its obligations in the Purchase Commitment. The proceeds from the sale
of the production equipment purchased by BPS were classified as an unearned
purchase discount in the Company's consolidated balance sheets in prior periods.
The Company had amortized this discount as a reduction to cost of sales as it
purchased materials from BPS. In 2003 the Company and BPS retroactively amended
the agreement to include all purchases of solar modules, solar systems, inverter
systems and other system equipment purchased by the Company from BPS in the
purchase commitment calculation. Amortization of the purchase discount amounted
to approximately $65,000 for the year ended December 31, 2005. The production
equipment had been classified as a component of fixed assets. Depreciation
amounted to approximately $211,000 for the year ended December 31, 2005.
In addition, the agreement contained a put option for BPS to have the
Company create a separate legal entity for Spire Solar Chicago and for BPS to
convert the value of the equipment and additional costs, as defined, into equity
of the new legal entity. The percentage ownership in the joint venture would be
determined based on the cumulative investments by BPS and the Company. The
amended agreement also allowed the Company to terminate the agreement on 30 days
notice in consideration for a termination payment based on the aggregate amount
of Spire purchases of BPS products and the fair market value of the production
equipment purchased by BPS at the time of the termination election.
On August 16, 2005, the Company entered into a Settlement and Contract
Termination Agreement (the "Termination Agreement") with BPS effective September
30, 2005. Under the terms of the Termination Agreement, the Company and BPS
agreed to terminate the amended agreement including the Purchase Commitment. In
exchange for release of the purchase commitment, the Company paid BPS $275,000
and retained ownership of the production equipment. The unamortized unearned
purchase discount as of the effective date was approximately $1,205,000 and the
net book value of the production equipment was approximately $287,000. As result
of this action, Spire reevaluated the recoverability of the long-lived assets
associated with this segment as part of its third quarter review. Based on cash
flow projections for the Solar System segment, the Company determined that the
production equipment was impaired and should be written-off.
The Company has recorded an approximate $593,000 gain from these actions,
which is reflected as a gain on extinguishment of purchase commitment in the
accompanying consolidated statement of operations for the year ended December
31, 2005. The components of this gain are outlined below:
Unearned purchase discount $1,205,000
Net book value of production equipment (287,000)
Payment to extinguish purchase commitment (275,000)
Accrued relocation costs (50,000)
----------
Gain on extinguishment of purchase commitment $ 593,000
==========
In October 2002, the Company sold an exclusive patent license for a
hemodialysis split-tip catheter to Bard Access Systems, Inc. ("Bard"), a wholly
owned subsidiary of C. R. Bard, Inc., in exchange for $5,000,000 upon the
execution of the agreement, with another $5,000,000 due upon the earlier to
occur of: (a) the date of the first commercial sale of a licensed product by
Bard; or (b) no more than 18 months after signing. The agreement further
provided for two additional contingent cash payments of $3,000,000 each upon the
completion of certain milestones by Bard in 2004 and 2005. Bard had the right to
cancel the agreement at any time subsequent to the second payment. During the
year ended December 31, 2002, the Company recorded the initial payment under the
agreement, resulting in a gain of $4,465,000, net of direct costs. Due to the
potential length of time between the first and second payments and the
cancellation provisions within the agreement, the Company did not record the
potential remaining payments at that time. During June 2003, in accordance with
the agreement, the Company received notification from Bard of the first
commercial sale, collected the $5,000,000 payment due and recorded a gain of
$4,989,000, net of direct costs. In June 2004, the Company received the first
contingent milestone payment and recorded a gain of $3,000,000. In June 2005,
the Company received the second and final contingent milestone payment and
recorded a gain of $3,000,000. There were no direct costs associated with these
payments. The June 2005 payment has been recorded as a gain in the accompanying
consolidated statements of operations for the year ended December 31, 2005.
20
In conjunction with the sale, the Company received a sublicense, which
permits the Company to continue to manufacture and market hemodialysis catheters
for the treatment of chronic kidney disease. In addition, the Company granted
Bard a right of first refusal should the Company seek to sell the product lines
associated with the licensed intellectual property.
On May 26, 2005, the Company entered into a global consortium agreement
(the "Agreement") with Nisshinbo Industries, Inc. ("Nisshinbo") for the
development, manufacturing, and sales of solar photovoltaic module manufacturing
equipment. Nisshinbo's prior relationship with Spire was as a sub-licensee of
Marubeni Corporation with whom the Company had a license arrangement that was
originally signed in 1997, extended in 2003, and terminated in May 2005.
Nisshinbo's role as sub-licensee was to manufacture equipment for Marubeni to
sell to the Japanese market based upon the Company's proprietary technology.
Under the terms of the Agreement, Nisshinbo purchased a license to manufacture
and sell the Company's module manufacturing equipment on a semi-exclusive basis
for an upfront fee plus additional royalties based on ongoing equipment sales
over a ten-year period. In addition, the Company and Nisshinbo agreed, but are
not obligated, to pursue joint research and development, product improvement
activities and sales and marketing efforts. The companies may share market costs
such as product collateral and trade show expenses. It may also collaborate on
sales leads and have the other company manufacture and service its equipment in
the field. Both companies have reciprocal rights to participate in the other
company's R&D efforts on a going-forward basis. Nisshinbo can request the
Company to further develop a technology but Nisshinbo must (a) share in the
costs of these development efforts equally with the Company (and thereafter have
joint ownership) otherwise the Company will own the technology under a partial
contribute or no participation by Nisshinbo with the Company receiving a royalty
from Nisshinbo if it utilizes the technology. At the end of the license all
non-jointly owned technology developed under the Agreement will revert back to
the owner, with the other party being required to purchase a new license based
upon the fair market value of that technology in order to continue to utilize
the technology.
On June 27, 2005, the Company received JPY 400,000,000 from the sale of
this permanent license. The Company determined that the Nisshinbo Agreement
contains multiple elements consisting of (1) the granting of a license to
utilize the Company's technology and (2) the semi-exclusive right to utilize the
technology for a period of 10 years. The Company believes the granting of the
license meets the criteria of Emerging Issues Task Force ("EITF") 00-21,
"Accounting for Revenue Arrangements with Multiple Elements", paragraph 9(a), as
the license to utilize the technology has value to Nisshinbo on a stand-alone
basis. Further, Question 1 to Securities and Exchange Commission ("SEC") Staff
Accounting Bulletin Topic 13A-3f "Nonrefundable Up-Front Fees", was directly
considered as guidance for determining if the upfront fee under the Nisshinbo
Agreement should be recognized upon the signing of contract or recognized over
the term of the license. It is the Company's belief that a separate earnings
process was complete as Nisshinbo was purchasing access to utilize technology it
already had in its possession; therefore, recognition of the gain on the sale
was appropriate. The Company has determined the fair value of the license and
royalty based on an appraisal. As a result, a $3,320,000 gain was recognized as
a gain on sale of license in the accompanying consolidated statements of
operations for the year ended December 31, 2005. The balance of $350,000 was
determined to represent an advanced royalty payment and was recorded as an
advance on contracts in progress. This amount is being credited as royalty
income over the ten year license period on a straight-line basis.
The Company maintains a Japanese yen account (approximately JPY 44,680,000
as of December 31, 2006.) As of December 31, 2006, approximately $375,000 has
been reflected in cash and cash equivalents in the accompanying consolidated
balance sheet utilizing the closing yen/dollar exchange rate as of December 31,
2006. Total currency translation loss of $14,000 and $104,000 for the years
ended December 31, 2006 and 2005, respectively, is reflected in other expense,
net in the accompanying consolidated statement of operations.
Outstanding letters of credit totaled $2,359,000 at December 31, 2006. The
letters of credit secure performance obligations and purchase commitments, and
allow holders to draw funds up to the face amount of the letter of credit if the
Company does not perform as contractually required. These letters of credit
expire through 2007 and are 100% secured by cash and short term-investments.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Earlier application is
encouraged if the enterprise has not yet issued financial statements, including
interim financial statements, in the period the Interpretation is adopted. This
interpretation of FAS 109 is not expected to have a material impact on the
Company's financial position or results of operations.
21
In September 2006, the FASB issued FAS No. 157, Fair Value Measurement
("FAS 157"). FAS 157 defines fair value, establishes a framework for measuring
fair value and expands disclosures about fair value measurements. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years. The Company is
evaluating the impact of adopting FAS 157 on the Company's financial position,
results of operations and cash flow.
In September 2006, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among
registrants, SAB 108 expresses SEC staff views regarding the process by which
misstatements in financial statements are evaluated for purposes of determining
whether financial statement restatement is necessary. SAB 108 is effective for
fiscal years ending after November 15, 2006, and early application is
encouraged. We do not believe SAB 108 will have a material impact on our results
from operations or financial position.
IMPACT OF INFLATION AND CHANGING PRICES
Historically, the Company's business has not been materially impacted by
inflation. Manufacturing equipment and solar systems are generally quoted,
manufactured and shipped within a cycle of approximately nine months, allowing
for orderly pricing adjustments to the cost of labor and purchased parts. The
Company has not experienced any negative effects from the impact of inflation on
long-term contracts. The Company's service business is not expected to be
seriously affected by inflation because its procurement-production cycle
typically ranges from two weeks to several months, and prices generally are not
fixed for more than one year. Research and development contracts usually include
cost escalation provisions.
FOREIGN CURRENCY FLUCTUATION
The Company sells only in U.S. dollars, generally against an irrevocable
confirmed letter of credit through a major United States bank. Therefore the
Company is not directly affected by foreign exchange fluctuations on its current
orders. However, fluctuations in foreign exchange rates do have an effect on the
Company's customers' access to U.S. dollars and on the pricing competition on
certain pieces of equipment that the Company sells in selected markets. The
Company received Japanese yen in exchange for the sale of a license to its solar
technology. In addition, purchases made and royalties received under the
Company's Consortium Agreement with its Japanese partner will be in Japanese
yen. The Company has committed to purchase certain pieces of equipment from
European vendors; these commitments are denominated in Euros. The Company bears
the risk of any currency fluctuations that may be associated with these
commitments. The Company does not believe that foreign exchange fluctuations
will materially affect its operations.
RELATED PARTY TRANSACTIONS
The Company subleased 77,000 square-feet in a building leased by Mykrolis
Corporation, who in turn leased the building from SPI-Trust, a Trust of which
Roger Little, Chairman of the Board, Chief Executive Officer and President of
the Company, is the sole trustee and principal beneficiary. The 1985 sublease,
originally for a period of ten years, was extended for a five-year period
expiring on November 30, 2000 and was further extended for a five-year period
expiring on November 30, 2005. The sublease agreement provided for minimum
rental payments plus annual increases linked to the consumer price index.
Effective December 1, 2005, the Company entered into a two-year Extension of
Lease Agreement (the "Lease Extension") directly with SPI-Trust.
The Company assumed certain responsibilities of Mykrolis, the tenant under
the former lease, as a result of the Lease Extension including payment of all
building and real estate related expenses associated with the ongoing operations
of the property. The Company will allocate a portion of these expenses to
SPI-Trust based on pre-established formulas utilizing square footage and actual
usage where applicable. These allocated expenses will be invoiced monthly and be
paid utilizing a SPI-Trust escrow account of which the Company has sole
withdrawal authority. SPI-Trust is required to maintain three (3) months of its
anticipated operating costs within this escrow account. On December 1, 2006, the
Company and SPI-Trust amended the Lease Extension to include the lease of an
additional 15,000 square feet from SPI-Trust for a one-year term. The additional
space is being leased at a rate of $8.06 per square foot on annual basis. The
additional space will be used to expand the Company's solar operations. Rent
expense under this sublease as extended and amended, for the year ended December
31, 2006 and 2005 was $1,262,000 and $1,093,000, respectively. In connection
with this lease, the Company was invoiced and paid certain SPI-Trust related
expenses, including building maintenance and insurance. The Company invoiced
SPI-Trust on a monthly basis and SPI-Trust reimbursed the Company for all such
costs. Approximately $14,000 was due from SPI-Trust as of December 31, 2006 for
building related costs. The Company believes that the terms of the Lease
Extension, as amended, are commercially reasonable.
22
In conjunction with the acquisition of Bandwidth by the Company, the
Company released Bandwidth from a lease agreement that had existed between
Bandwidth and the Company. In November 2001, Bandwidth, under its previous
owner, abandoned the space being subleased from the Company in Bedford,
Massachusetts, to move to a new building and wafer fabrication lab in Hudson,
New Hampshire. At that time, there were 48 months left on the lease. Subsequent
to the move to Hudson, New Hampshire, Bandwidth was unable to sublease the
Bedford, Massachusetts space, and was paying the Company for the unused space.
In conjunction with the acquisition of Bandwidth in May 2003, the Company
released Bandwidth from the remaining lease payments. However, the Company
continued to be obligated to Mykrolis Corporation for the entire amount of the
remaining lease agreement. As a result, the present value of the remaining lease
obligation associated with the unused space was recorded as an assumed liability
of $1,247,000 in the purchase accounting. This lease obligation terminated in
November 2005. The difference between the actual rent payment and the discounted
rent payment was accreted to the consolidated statements of operations as
interest expense. Interest of 4.75% had been assumed on this obligation. For the
year ended December 31, 2005, interest expense was approximately $11,000.
Also in conjunction with the acquisition of Bandwidth by the Company,
SPI-Trust, a Trust of which Roger G. Little, Chairman of the Board, Chief
Executive Officer and President of the Company, is sole trustee and principal
beneficiary, purchased from Stratos Lightwave, Inc. (Bandwidth's former owner)
the building that Bandwidth occupies in Hudson, New Hampshire for $3.7 million.
Subsequently, the Company entered into a lease for the building (90,000 square
feet) with SPI-Trust whereby the Company will pay $4.1 million to the SPI-Trust
over an initial five-year term expiring in 2008 with a Company option to extend
for five years. In addition to the rent payments, the lease obligates the
Company to keep on deposit with SPI-Trust the equivalent of three months rent
($236,000 as of December 31, 2006.) The lease agreement does not provide for a
transfer of ownership at any point. Interest costs were assumed at 7%. Interest
expense was approximately $136,000 and $179,000 for the years ended December 31,
2006 and 2005, respectively. This lease has been classified as a related party
capital lease and a summary of payments (including interest) follows:
Rate Per Security
Year Square Foot Annual Rent Monthly Rent Deposit
--------------------------- ----------- ----------- ------------ --------
June 1, 2003 - May 31, 2004 $6.00 $ 540,000 $45,000 $135,000
June 1, 2004 - May 31, 2005 7.50 675,000 56,250 168,750
June 1, 2005 - May 31, 2006 8.50 765,000 63,750 191,250
June 1, 2006 - May 31, 2007 10.50 945,000 78,750 236,250
June 1, 2007 - May 31, 2008 13.50 1,215,000 101,250 303,750
----------
$4,140,000
==========
At December 31, 2006, $1,027,000 and $486,000 are reflected as the current
and long-term portions of capital lease obligation - related party,
respectively, in the consolidated balance sheet.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Among the significant estimates affecting our consolidated
financial statements are those relating to revenue recognition, reserves for
doubtful accounts and sales returns and allowances, reserve for excess and
obsolete inventory, impairment of long-lived assets, income taxes, and warranty
reserves. We regularly evaluate our estimates and assumptions based upon
historical experience and various other factors that we believe 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. To the extent actual results differ from
those estimates, our future results of operations may be affected. We believe
the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements.
Refer to Footnote 2 of our notes to consolidated financial statements for a
description of our significant accounting policies.
REVENUE RECOGNITION
The Company derives its revenues from three primary sources: (1) commercial
products including, but not limited to, solar energy manufacturing equipment,
solar energy systems and hemodialysis catheters; (2) biomedical and
semiconductor processing services; and (3) United States government funded
research and development contracts.
23
We generally recognize product revenue upon shipment of products provided
there are no uncertainties regarding customer acceptance, persuasive evidence of
an arrangement exists, the sales price is fixed or determinable, and
collectibility is reasonably assured. These criteria are generally met at the
time of shipment when the risk of loss and title passes to the customer or
distributor, unless a consignment arrangement exists. Revenue from consignment
arrangements is recognized based on product usage indicating sales are complete.
The Company utilizes a distributor network to market and sell its
hemodialysis catheters domestically. The Company generally recognizes revenue
when the catheters are shipped to its distributors. Gross sales reflect
reductions attributable to customer returns and various customer incentive
programs including pricing discounts and rebates. Product returns are permitted
in certain sales contracts and an allowance is recorded for returns based on the
Company's history of actual returns. Certain customer incentive programs require
management to estimate the cost of those programs. The allowance for these
programs is determined through an analysis of programs offered, historical
trends, expectations regarding customer and consumer participation, sales and
payment trends, and experience with payment patterns associated with similar
programs that had been previously offered. An analysis of the sales return and
rebate activity for the years ended December 31, 2006 and 2005, is as follows:
Rebates Returns Total
-------- -------- --------
Balance - December 31, 2004 $ 56,000 $ 29,000 $ 85,000
Provision 362,000 96,000 458,000
Utilization (326,000) (106,000) (432,000)
-------- -------- --------
Balance - December 31, 2005 92,000 19,000 111,000
Provision 387,000 60,000 447,000
Utilization (341,000) (62,000) (403,000)
-------- -------- --------
Balance - December 31, 2006 $138,000 $ 17,000 $155,000
======== ======== ========
o Credits for rebates are recorded in the month of the actual sale.
o Credits for returns are processed when the actual merchandise is
received by Spire.
o Substantially all rebates and returns are processed no later than
three months after original shipment by Spire.
The reserve percentage has been approximately 13% to 15% of inventory held
by distributors over the last two years. Spire performs various sensitivity
analyses to determine the appropriate reserve percentage to use. To date, actual
quarterly reserve utilization has approximated the amount provided. The total
inventory held by distributors was approximately $1,210,000 at December 31,
2006.
If sufficient history to make reasonable and reliable estimates of returns
or rebates does not exist, revenue associated with such practices is deferred
until the return period lapses or a reasonable estimate can be made. This
deferred revenue will be recognized as revenue when the distributor reports to
us that it has either shipped or disposed of the units (indicating that the
possibility of return is remote).
The Company's OEM capital equipment solar energy business builds complex
customized machines to order for specific customers. Substantially all of these
orders are sold on a FOB Bedford, Massachusetts (or EX-Works Factory) basis. It
is the Company's policy to recognize revenues for this equipment as the product
is shipped to the customer, as customer acceptance is obtained prior to shipment
and the equipment is expected to operate the same in the customer's environment
as it does in the Company's environment. When an arrangement with the customer
includes future obligations or customer acceptance, revenue is recognized when
those obligations are met or customer acceptance has been achieved. The
Company's solar energy systems business installs solar energy systems on
customer-owned properties on a contractual basis. Generally, revenue is
recognized once the systems have been installed and the title is passed to the
customer. For arrangements with multiple elements, the Company allocates fair
value to each element in the contract and revenue is recognized upon delivery of
each element. If the Company is not able to establish fair value of undelivered
elements, all revenue is deferred.
The Company recognizes revenues and estimated profits on long-term
government contracts on the accrual basis where the circumstances are such that
total profit can be estimated with reasonable accuracy and ultimate realization
is reasonably assured. The Company accrues revenue and profit utilizing the
percentage of completion method using a cost-to-cost methodology. A percentage
of the contract revenues and estimated profits is determined utilizing the ratio
of costs incurred to date to total estimated cost to complete on a contract by
contract basis. Profit estimates are revised periodically based upon changes and
facts, and any losses on contracts are recognized immediately. Some of the
contracts include provisions to withhold a portion of the contract value as
retainage until such time as the United States government performs an audit of
the cost incurred under the contract. The Company's policy is to take into
revenue the full value of the
24
contract, including any retainage, as it performs against the contract since the
Company has not experienced any substantial losses as a result of audits
performed by the United States government.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, including fixed assets and intangible assets, are
continually monitored and are evaluated at least annually for impairment. The
determination of recoverability is based on an estimate of undiscounted cash
flows expected to result from the use of an asset and its eventual disposition.
The estimate of cash flows is based upon, among other things, certain
assumptions about expected future operating performance. Our estimates of
undiscounted cash flows may differ from actual cash flows due to, among other
things, technological changes, economic conditions, changes to our business
model or changes in our operating performance. If the sum of the undiscounted
cash flows (excluding interest) is less than the carrying value, we recognize an
impairment loss, measured as the amount by which the carrying value exceeds the
fair value of the asset.
STOCK-BASED COMPENSATION
On January 1, 2006, the Company adopted the fair value recognition
provisions of Financial Accounting Standards Board ("FASB") Statement No.
123(R), Share-Based Payment ("Statement 123(R)") using the modified prospective
method. In accordance with the modified prospective method, the Company has not
restated its consolidated financial statements for prior periods. Under this
transition method, stock-based compensation expense for 2006 includes
stock-based compensation expense for all of the Company's stock-based
compensation awards granted prior to, but not yet vested as of, January 1, 2006,
based on the grant-date fair value estimated in accordance with the provisions
of FASB Statement No. 123, Accounting for Stock-Based Compensation ("Statement
123"). Stock-based compensation expense for all stock-based compensation awards
granted on or after January 1, 2006 will be based on the grant-date fair value
estimated in accordance with the provisions of Statement 123(R). The impact of
Statement 123(R) on the Company's results of operations resulted in recognition
of stock-based compensation expense of approximately $256,000 for the year ended
December 31, 2006.
25
ITEM 7. FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm ........................................ 27
Consolidated Financial Statements:
Consolidated Balance Sheet as of December 31, 2006 ........................................ 28
Consolidated Statements of Operations for the Years Ended December 31, 2006 and 2005 ..... 29
Consolidated Statements of Stockholders' Equity and Comprehensive Income/(Loss) for
the Years Ended December 31, 2006 and 2005 ............................................ 30
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006 and 2005 ..... 31
Notes to Consolidated Financial Statements .............................................. 32
26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of Spire Corporation:
We have audited the consolidated balance sheet of Spire Corporation and
subsidiaries as of December 31, 2006 and the related consolidated statements of
operations, stockholders' equity and comprehensive income/(loss), and cash flows
for the years ended December 31, 2006 and 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. An audit includes consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Spire Corporation
and subsidiaries as of December 31, 2006, and the results of their operations
and their cash flows for the years ended December 31, 2006 and 2005, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 2 to the financial statements, effective January 1, 2006
the Company adopted the provisions of Statement of Financial Accounting Standard
No. 123R " Share-Based Payment".
/s/ Vitale, Caturano & Company, Ltd.
VITALE, CATURANO & COMPANY, LTD.
March 30, 2007
Boston, Massachusetts
27
SPIRE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31,
2006
------------
ASSETS
Current assets
Cash and cash equivalents $ 1,536,000
Restricted cash - current portion 269,000
------------
1,805,000
------------
Short-term investments 3,031,000
Restricted short-term investments 1,969,000
Accounts receivable - trade, net 4,010,000
Inventories, net 4,217,000
Deposits on equipment for inventory 2,580,000
Prepaid expenses and other current assets 737,000
------------
Total current assets 18,349,000
------------
Property and equipment, net 6,673,000
------------
Intangible and other assets (less accumulated
amortization of $790,000) 844,000
Available-for-sale investments, at quoted market value
(cost of $1,361,000) 1,461,000
Restricted cash - long-term 121,000
Deposit - related party 236,000
------------
Total other assets 2,662,000
------------
Total assets $ 27,684,000
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of capital lease obligation - related party $ 1,027,000
Accounts payable 1,982,000
Accrued liabilities 5,006,000
Advances on contracts in progress 6,396,000
------------
Total current liabilities 14,411,000
------------
Long-term portion of capital lease obligation - related party 486,000
Long-term portion of advances on contracts in progress 1,823,000
Deferred compensation 1,461,000
Deferred taxes 40,000
------------
Total long-term liabilities 3,810,000
------------
Total liabilities 18,221,000
------------
Commitments and Contingencies
Stockholders' equity
Common stock, $0.01 par value; shares authorized 20,000,000;
8,236,663 shares issued and outstanding 82,000
Additional paid-in capital 19,077,000
Accumulated deficit (9,756,000)
Accumulated other comprehensive income, net 60,000
------------
Total stockholders' equity 9,463,000
------------
Total liabilities and stockholders' equity $ 27,684,000
============
The accompanying notes are an integral part of these
consolidated financial statements.
28
SPIRE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
----------------------------
2006 2005
------------ ------------
Net sales and revenues
Contract research, service and license revenues $ 10,563,000 $ 11,151,000
Sales of goods 9,562,000 11,271,000
------------ ------------
Total net sales and revenues 20,125,000 22,422,000
------------ ------------
Costs and expenses
Cost of contract research, services and licenses 8,819,000 8,779,000
Cost of goods sold 9,029,000 10,322,000
Selling, general and administrative expenses 9,794,000 8,540,000
Internal research and development expenses 734,000 1,346,000
------------ ------------
Total costs and expenses 28,376,000 28,987,000
------------ ------------
Gain on extinguishment of purchase commitment -- 593,000
Gain on sales of licenses -- 6,320,000
------------ ------------
Earnings (loss) from operations (8,251,000) 348,000
------------
Other income (expense), net 100,000 (304,000)
------------ ------------
Earnings (loss) before income taxes (8,151,000) 44,000
Income tax benefit (expense) -- --
------------ ------------
Net income (loss) $ (8,151,000) $ 44,000
----------------- ============ ============
Earnings (loss) per share of common stock - basic $ (1.03) $ 0.01
------------------------------------------------- ============ ============
Earnings (loss) per share of common stock - diluted $ (1.03) $ 0.01
--------------------------------------------------- ============ ============
Weighted average number of common and common equivalent
shares outstanding - basic 7,898,320 6,975,347
============ ============
Weighted average number of common and common equivalent
shares outstanding - diluted 7,898,320 7,237,129
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
29
SPIRE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Accumulated
Common Stock Additional Other
------------------------- Paid-in Comprehensive (Accumulated
Shares Amount Capital Income Deficit) Total
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 2004 6,848,541 $ 68,000 $ 9,448,000 $ 25,000 $(1,649,000) $ 7,892,000
Exercise of stock options 374,446 4,000 1,315,000 -- -- 1,319,000
Net income -- -- -- -- 44,000 44,000
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 2005 7,222,987 72,000 10,763,000 25,000 (1,605,000) 9,255,000
Exercise of stock options 72,500 1,000 337,000 -- -- 338,000
Proceeds from issuance of
common stock, net of
offering costs 941,176 9,000 7,721,000 -- -- 7,730,000
Stock based compensation -- -- 256,000 -- -- 256,000
Net unrealized gain on
available for sale marketable
securities, net of tax -- -- -- 35,000 -- 35,000
Net loss -- -- -- -- (8,151,000) (8,151,000)
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 2006 8,236,663 $ 82,000 $19,077,000 $ 60,000 $(9,756,000) $ 9,463,000
=========== =========== =========== =========== =========== ===========
Years Ended December 31,
--------------------------
2006 2005
----------- -----------
Comprehensive income is calculated as follows:
Net income (loss) $(8,151,000) $ 44,000
Other comprehensive gain on available for sale marketable securities 35,000 --
----------- -----------
Comprehensive income (loss) $(8,116,000) $ 44,000
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
30
SPIRE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------
2006 2005
----------- -----------
Cash flows from operating activities:
Net income (loss) $(8,151,000) $ 44,000
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,027,000 2,451,000
Loss on buy-out of capital lease 105,000 --
Gain on sale of licenses -- (6,320,000)
Gain on extinguishment of purchase commitment -- (593,000)
Deferred compensation 35,000 --
Unearned purchase discount -- (65,000)
Stock-based compensation 256,000 --
Increase in accounts receivable reserves 86,000 31,000
Increase (decrease) in inventory reserves 381,000 (62,000)
Changes in assets and liabilities:
Restricted cash 536,000 (98,000)
Accounts receivable (400,000) 500,000
Interest receivable (158,000) --
Inventories (1,938,000) 126,000
Deposits, prepaid expenses and other current assets (2,552,000) (52,000)
Accounts payable, accrued liabilities and other liabilities 3,839,000 (770,000)
Deposit - related party (45,000) (23,000)
Advances on contracts in progress 6,461,000 (840,000)
----------- -----------
Net cash provided by (used in) operating activities 482,000 (5,671,000)
----------- -----------
Cash flows from investing activities:
Purchase of short-term investments (7,500,000) --
Sale of short-term investments 2,500,000 --
Proceeds from sale of licenses -- 6,320,000
Purchase of property and equipment (4,085,000) (428,000)
Payment to extinguish purchase commitment -- (275,000)
Increase in intangible and other assets (268,000) (22,000)
----------- -----------
Net cash provided by (used in) investing activities (9,353,000) 5,595,000
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs 7,730,000 --
Principal payments on capital lease obligations - related parties (734,000) (548,000)
Principal payments and buy-out of capital lease obligations (557,000) (402,000)
Proceeds from exercise of stock options 338,000 1,319,000
----------- -----------
Net cash provided by financing activities 6,777,000 369,000
----------- -----------
Net increase (decrease) in cash and cash equivalents (2,094,000) 293,000
Cash and cash equivalents, beginning of year 3,630,000 3,337,000
----------- -----------
Cash and cash equivalents, end of year $ 1,536,000 $ 3,630,000
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid $ 18,000 $ 83,000
=========== ===========
Interest received $ 110,000 $ 74,000
=========== ===========
Interest paid - related party $ 136,000 $ 190,000
=========== ===========
Income taxes paid (refunded) $ (155,000) $ 150,000
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
31
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
1. DESCRIPTION OF THE BUSINESS
Spire Corporation ("Spire" or the "Company") develops, manufactures and
markets highly-engineered products and services in three principal business
areas: (i) solar equipment and solar systems, (ii) biomedical and (iii)
optoelectronics, generally bringing to bear expertise in materials technologies,
surface science and thin films across all three business areas.
In the solar area, the Company develops, manufactures and markets
specialized equipment for the production of terrestrial photovoltaic modules
from solar cells. The Company's equipment has been installed in approximately
190 factories in 46 countries. The Company also provides custom and building
integrated photovoltaic modules, stand alone emergency power backup and electric
power grid-connected distributed power generation systems employing photovoltaic
technology developed by the Company and others.
In the biomedical area, the Company provides value-added surface treatments
to manufacturers of orthopedic and other medical devices that enhance the
durability, antimicrobial characteristics or other material characteristics of
their products; develops and markets hemodialysis catheters and related devices
for the treatment of chronic kidney disease; and performs sponsored research
programs into practical applications of advanced biomedical and biophotonic
technologies.
In the optoelectronics area, the Company provides custom compound
semiconductor foundry and fabrication services on a merchant basis to customers
involved in biomedical/biophotonic instruments, telecommunications and defense
applications. Services include compound semiconductor wafer growth, other thin
film processes and related device processing and fabrication services. The
Company also provides materials testing services and performs services in
support of sponsored research into practical applications of optoelectronic
technologies.
Operating results will depend upon revenue growth and product mix, as well
as the timing of shipments of higher priced products from the Company's solar
equipment line and delivery of solar systems. Export sales, which amounted to
33% of net sales and revenues for 2006, continue to constitute a significant
portion of the Company's net sales and revenues.
The Company has incurred significant operating losses in 2006 and 2005.
Loss from operations, before gain on sales of licenses and extinguishment of
purchase commitment, were $8.3 million and $6.6 million in 2006 and 2005,
respectively. These losses from operations have resulted in cash losses
(earnings (loss) from operations excluding gain on sales of licenses plus or
minus non-cash adjustments) of approximately $5.4 million and $4.2 million in
each of 2006 and 2005, respectively. The Company has funded these cash losses
from cash receipts of $7.7 million from proceeds of a common stock offering in
2006 and $6.7 million related to the sale of certain licenses to its medical
products and solar technologies in 2005. As of December 31, 2006, the Company
had cash and cash equivalents of $1.5 million and unrestricted short-term
investments of $3.0 million. While the Company believes it has inherent assets
and technology that it could sell or license in the near term, there is no
guarantee that the Company would be able to sell or license those assets on a
timely basis and at appropriate values that would allow the Company to continue
to fund its operating losses. The Company has developed several plans to
mitigate cash losses primarily from increased revenues and, if required,
potential cost reduction efforts and outside financing. As a result, the Company
believes it has sufficient resources to continue as a going concern at least
through December 31, 2007.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(B) REVENUE RECOGNITION
The Company derives its revenues from three primary sources: (1) commercial
products including, but not limited to, solar energy manufacturing equipment,
solar energy systems and hemodialysis catheters; (2) biomedical and
semiconductor processing services; and (3) United States government funded
research and development contracts.
32
We generally recognize product revenue upon shipment of products provided
there are no uncertainties regarding customer acceptance, persuasive evidence of
an arrangement exists, the sales price is fixed or determinable, and
collectibility is reasonably assured. These criteria are generally met at the
time of shipment when the risk of loss and title passes to the customer or
distributor, unless a consignment arrangement exists. Revenue from consignment
arrangements is recognized based on product usage indicating sales are complete.
The Company utilizes a distributor network to market and sell its
hemodialysis catheters domestically. The Company generally recognizes revenue
when the catheters are shipped to its distributors. Gross sales reflect
reductions attributable to customer returns and various customer incentive
programs including pricing discounts and rebates. Product returns are permitted
in certain sales contracts and an allowance is recorded for returns based on the
Company's history of actual returns. Certain customer incentive programs require
management to estimate the cost of those programs. The allowance for these
programs is determined through an analysis of programs offered, historical
trends, expectations regarding customer and consumer participation, sales and
payment trends, and experience with payment patterns associated with similar
programs that had been previously offered. An analysis of the sales return and
rebate activity for the years ended December 31, 2006 and 2005, is as follows:
Rebates Returns Total
-------- -------- --------
Balance - December 31, 2004 $ 56,000 $29,000 $ 85,000
Provision 362,000 96,000 458,000
Utilization (326,000) (106,000) (432,000)
-------- -------- --------
Balance - December 31, 2005 92,000 19,000 111,000
Provision 387,000 60,000 447,000
Utilization (341,000) (62,000) (403,000)
-------- -------- ---------
Balance - December 31, 2006 $138,000 $ 17,000 $ 155,000
======== ======== =========
o Credits for rebates are recorded in the month of the actual sale.
o Credits for returns are processed when the actual merchandise is
received by Spire.
o Substantially all rebates and returns are processed no later than
three months after original shipment by Spire.
The reserve percentage has been approximately 13% to 15% of inventory held
by distributors over the last two years. Spire performs various sensitivity
analyses to determine the appropriate reserve percentage to use. To date, actual
quarterly reserve utilization has approximated the amount provided. The total
inventory held by distributors was approximately $1,210,000 at December 31,
2006.
If sufficient history to make reasonable and reliable estimates of returns
or rebates does not exist, revenue associated with such practices is deferred
until the return period lapses or a reasonable estimate can be made. This
deferred revenue will be recognized as revenue when the distributor reports to
the Company that it has either shipped or disposed of the units (indicating that
the possibility of return is remote).
The Company's OEM capital equipment solar energy business builds complex
customized machines to order for specific customers. Substantially all of these
orders are sold on a FOB Bedford, Massachusetts (or EX-Works Factory) basis. It
is the Company's policy to recognize revenues for this equipment as the product
is shipped to the customer, as customer acceptance is obtained prior to shipment
and the equipment is expected to operate the same in the customer's environment
as it does in the Company's environment. When an arrangement with the customer
includes future obligations or customer acceptance, revenue is recognized when
those obligations are met or customer acceptance has been achieved. The
Company's solar energy systems business installs solar energy systems on
customer-owned properties on a contractual basis. Generally, revenue is
recognized once the systems have been installed and the title is passed to the
customer. For arrangements with multiple elements, the Company allocates total
fees under contract to each element using the residual method and revenue is
recognized upon delivery of each element. If the Company is not able to
establish fair value of undelivered elements, all revenue is deferred.
The Company recognizes revenues and estimated profits on long-term
government contracts on the accrual basis where the circumstances are such that
total profit can be estimated with reasonable accuracy and ultimate realization
is reasonably assured. The Company accrues revenue and profit utilizing the
percentage of completion method using a cost-to-cost methodology. A percentage
of the contract revenues and estimated profits is determined utilizing the ratio
of costs incurred to date to total estimated cost to complete on a contract by
contract basis. Profit estimates are revised periodically based upon changes and
facts, and any losses on contracts are recognized immediately. Some of the
contracts include provisions to withhold a portion of the contract value as
retainage until such time as the United States government
33
performs an audit of the cost incurred under the contract. The Company's policy
is to take into revenue the full value of the contract, including any retainage,
as it performs against the contract since the Company has not experienced any
substantial losses as a result of audits performed by the United States
government.
(C) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash, time deposits and all highly liquid
debt instruments with original maturities of three months or less. These
investments are carried at cost, which approximates market value. Cash and cash
equivalents are deposited at various area banks, and at times may exceed
federally insured limits.
(D) SHORT TERM INVESTMENTS
Short term investments include highly liquid debt instruments with original
maturities of more than three months and less than one year. These investments
are carried at cost, which approximates market value.
(E) AVAILABLE-FOR-SALE INVESTMENTS
Available-for-sale securities consist of the following assets held as part
of the Spire Corporation Non-Qualified Deferred Compensation Plan:
December 31, 2006
-----------------
Equity investments $1,160,000
Government bonds 262,000
Cash and money market funds 39,000
----------
$1,461,000
==========
These investments have been classified as long-term available-for-sale and
are reported at fair value, with unrealized gains and losses included in
accumulated other comprehensive income, net of related tax effect. As of
December 31, 2006, the pre-tax unrealized gain on these marketable securities
was approximately $99,000.
(F) INVENTORIES
Inventories are stated at the lower of cost or market, cost being
determined on a first-in, first-out (FIFO) basis. Judgments and estimates are
used in determining the likelihood that goods on hand can be sold to customers.
The Company expensed approximately $208,000 to cost of sales, for work in
process inventory that was determined to be valued in excess of market value.
Historical inventory usage and current revenue trends are considered in
estimating both excess and obsolete inventory. If actual product demand and
market conditions are less favorable than those projected by management,
additional inventory write-downs may be required. No general and administrative
expenses are included in inventory.
(G) PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization are
provided using the straight-line method over the estimated useful lives of the
respective assets, as follows:
Building and equipment under capital lease Lesser of 5 years or remaining life of lease term
Machinery and equipment 5 and 7 years
Furniture and fixtures 5 years
Leasehold improvements Lesser of 10 years or remaining life of facility lease term
Maintenance and repairs are charged to expense as incurred. Major renewals
and betterments are added to property and equipment accounts at cost.
(H) INTANGIBLE AND OTHER ASSETS
Patents amounted to $137,000, net of accumulated amortization of $637,000,
at December 31, 2006. Licenses amounted to $172,000 net of accumulated
amortization of $153,000, at December 31, 2006. Patent cost is primarily
composed of cost associated with securing and registering patents that the
Company has been awarded or that have been submitted to, and the Company
believes will be approved by, the government. License cost is composed of the
cost to
34
acquire rights to the underlying technology or know-how. These costs are
capitalized and amortized over their useful lives or terms, ordinarily five
years, using the straight-line method. There are no expected residual values
related to these patents. Amortization expense, relating to patents and
licenses, was approximately $94,000 and $84,000, for the years ended 2006 and
2005, respectively.
For disclosure purposes, the table below includes future amortization
expense for patents and licenses owned by the Company as well as estimated
amortization expense related to patents that remain pending at December 31, 2006
of $535,000. This estimated expense for patents pending assumes that the patents
are issued immediately, and therefore are being amortized over five years on a
straight-line basis. Estimated amortization expense for the periods ending
December 31, is as follows:
Year Amortization Expense
---------- --------------------
2007 $ 214,000
2008 187,000
2009 146,000
2010 141,000
2011 136,000
Thereafter 20,000
---------
$ 844,000
=========
(I) LONG-LIVED ASSETS
The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". SFAS No. 144 requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company measures recoverability of assets to be held and used
by a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceed the fair value of the assets. The Company
reports assets to be disposed of at the lower of the carrying amount or fair
value less costs to sell.
(J) INCOME TAXES
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
recognizes deferred income taxes based on the expected future tax consequences
of differences between the financial statement basis and the tax basis of assets
and liabilities, calculated using enacted tax rates in effect for the year in
which the differences are expected to be reflected in the tax return. Valuation
allowances are provided if, based on the weight of available evidence, it is
more likely than not that some or all of the deferred tax assets will not be
realized.
(K) WARRANTY
The Company provides warranties on certain of its products and services.
The Company's warranty programs are described below:
Spire Solar Equipment warrants solar energy module manufacturing equipment
sold for a total of 360 days, the first 90 days of which include the replacement
of defective component parts and the labor to correct the defect and the next
270 days of which include only the cost of defective component parts.
Spire Solar Systems warrants photovoltaic electric power systems sold
against defective components for 360 days to include the replacement of
defective component parts and the labor to correct the defect. Spire Solar
Systems also warrants that its photovoltaic electric power systems will achieve
a minimum of 80% of rated electrical power output for 20 years.
Spire Biomedical warrants that any of its catheter products found to be
defective will be replaced. No warranty is made that the failure of the product
will not occur, and Spire disclaims any responsibility for any medical
complications. Spire Biomedical warrants that its services only will meet the
agreed upon specifications.
Bandwidth Semiconductor, LLC ("Bandwidth") warrants that its products will
meet the agreed upon specifications.
35
The Company provides for the estimated cost of product warranties,
determined primarily from historical information, at the time product revenue is
recognized. Should actual product failure warranties differ from the Company's
estimates, revisions to the estimated warranty liability would be required. The
Company incurred a high level of warranty expense attributed to one customer in
2006 and does not expect the problem to have a significant impact on earnings in
future periods. The changes in the product warranties for the year ended
December 31, 2006, are as follows:
Balance at December 31, 2004 $ 50,000
Provision charged to income 30,000
Usage (30,000)
---------
Balance at December 31, 2005 50,000
Provision charged to income 250,000
Usage (185,000)
---------
Balance at December 31, 2006 $ 115,000
=========
(L) INTERNAL RESEARCH AND DEVELOPMENT COSTS
Internal research and development costs are charged to operations as
incurred. During the years ended December 31, 2006 and 2005, Company funded
research and development costs were approximately $734,000 and $1,346,000,
respectively.
(M) EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted earnings (loss) per share gives effect to all
potential dilutive common shares outstanding during the period. The computation
of diluted earnings (loss) per share does not assume conversion, exercise or
contingent exercise of securities that would have an anti-dilutive effect on
earnings (loss) per share. The Company did not pay any dividends in 2006 and
2005.
(N) COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income. Other comprehensive income includes certain changes in
equity that are excluded from net income (loss). At December 31, 2006,
accumulated other comprehensive income was comprised of unrealized gain of
available-for-sale investments of approximately $60,000, net of tax.
(o) STOCK-BASED COMPENSATION
On January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS No. 123(R) Share-Based Payment ("Statement 123(R)") using the
modified prospective method. In accordance with the modified prospective method,
the Company has not restated its consolidated financial statements for prior
periods. Under this transition method, stock-based compensation expense for the
year ended December 31, 2006 includes stock-based compensation expense for all
of the Company's stock-based compensation awards granted prior to, but not yet
vested as of January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation" ("Statement 123"). Stock-based compensation expense
for all stock-based compensation awards granted on or after January 1, 2006 will
be based on the grant-date fair value estimated in accordance with the
provisions of Statement 123(R). The impact of Statement 123(R) on the Company's
results of operations resulted in recognition of stock-based compensation
expense of approximately $256,000 for the year ended December 31, 2006.
(P) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Significant estimates include revenue
recognition, valuation of income tax assets, warranty reserves, inventory
reserves, and intangible assets. Actual results could differ from those
estimates.
(Q) FINANCIAL INSTRUMENTS
36
Financial instruments of the Company consist of cash and cash equivalents,
short-term investments, accounts receivable, available for sale marketable
securities, accounts payable and capital leases. The carrying amounts of these
financial instruments approximate their fair value.
(R) SHIPPING AND HANDLING COSTS
Shipping and handling costs are included in cost of goods sold.
(S) FOREIGN CURRENCY
The Company sells only in U.S. dollars, generally against an irrevocable
confirmed letter of credit through a major United States bank. Therefore the
Company is not directly affected by foreign exchange fluctuations on its current
orders. However, fluctuations in foreign exchange rates do have an effect on the
Company's customers' access to U.S. dollars and on the pricing competition on
certain pieces of equipment that the Company sells in selected markets. The
Company received Japanese yen in exchange for the sale of a license to its solar
technology. In addition, purchases made and royalties received under the
Company's Consortium Agreement with its Japanese partner will be in Japanese
yen. The Company has committed to purchase certain pieces of equipment from
European vendors; these commitments are denominated in Euros. The Company bears
the risk of any currency fluctuations that may be associated with these
commitments. The Company does not believe that foreign exchange fluctuations
will materially affect its operations.
(T) NEW ACCOUNTING STANDARDS
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109. FIN 48 is effective for
fiscal years beginning after December 15, 2006. Earlier application is
encouraged if the enterprise has not yet issued financial statements, including
interim financial statements, in the period the Interpretation is adopted. This
interpretation of FAS 109 is not expected to have a material impact on the
Company's financial position or results of operations.
In September 2006, the FASB issued FAS No. 157, Fair Value Measurement
("FAS 157"). FAS 157 defines fair value, establishes a framework for measuring
fair value and expands disclosures about fair value measurements. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years. The Company is
evaluating the impact of adopting FAS 157 on the Company's financial position,
results of operations and cash flow.
In September 2006, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 108 ("SAB 108"). Due to diversity in practice
among registrants, SAB 108 expresses SEC staff views regarding the process by
which misstatements in financial statements are evaluated for purposes of
determining whether financial statement restatement is necessary. SAB 108 is
effective for fiscal years ending after November 15, 2006, and early application
is encouraged. We do not believe SAB 108 will have a material impact on our
results from operations or financial position.
3. ACCOUNTS RECEIVABLE/ADVANCES ON CONTRACTS IN PROGRESS
Net accounts receivable, trade consists of the following:
December 31, 2006
-----------------
Amounts billed $3,876,000
Retainage 8,000
Accrued revenue 399,000
----------
4,283,000
Less: Allowance for sales returns and doubtful accounts (273,000)
----------
Net accounts receivable - trade $4,010,000
----------
Advances on contracts in progress $8,219,000
==========
Accrued revenue represents revenues recognized on contracts for which
billings have not been presented to customers as of the balance sheet date.
These amounts are billed and generally collected within one year.
Retainage represents revenues on certain United States government sponsored
research and development contracts.
37
These amounts, which usually represent 15% of the Company's research fee on each
applicable contract, are not collectible until a final cost review has been
performed by government auditors. Included in retainage are amounts expected to
be collected after one year, which totaled approximately $8,000 at December 31,
2006. The government's most recent audit was as of December 31, 2004, with no
adverse impact. All other accounts receivable are expected to be collected
within one year.
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to pay amounts due. The Company
actively pursues collection of past due receivables as the circumstances
warrant. Customers are contacted to determine the status of payment and senior
accounting and operations management are included in these efforts as is deemed
necessary. A specific reserve will be established for past due accounts over 60
days and over a specified amount, when it is probable that a loss has been
incurred and the Company can reasonably estimate the amount of the loss. The
Company does not record an allowance for government receivables and invoices
backed by letters of credit as realizeability is reasonably assured. Bad debts
are written off against the allowance when identified. There is no dollar
threshold for account balance write-offs. While rare, a write-off is only
recorded when all efforts to collect the receivable have been exhausted and only
in consultation with the appropriate business line manager.
In addition, the Company maintains an allowance for potential future
product returns and rebates related to current period revenues. The Company
analyzes the rate of historical returns when evaluating the adequacy of the
allowance for sales returns and allowances. Returns and rebates are charged
against the allowance when incurred.
Advances on contracts in progress represent contracts for which billings
have been presented to the customer, either as deposits or progress payments
against future shipments, but revenue has not been recognized.
4. SHORT-TERM INVESTMENTS
Short-term investments at December 31, 2006 consist of $5,000,000 of
certificates of deposit maturing March 31, 2007. Interest receivable on these
short-term investments amounted to approximately $158,000 at December 31, 2006,
and is classified with other current assets. Approximately $1,969,000 of the
short-term investment is restricted to back a letter of credit with a bank.
5. INVENTORIES
Inventories, net of $534,000 of reserves, consist of the following:
December 31, 2006
-----------------
Raw materials $1,519,000
Work in process 2,310,000
Finished goods 388,000
----------
$4,217,000
==========
6. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31, 2006
-----------------
Building under capital lease $3,390,000
Machinery and equipment 13,448,000
Furniture fixtures and computer equipment 3,760,000
Leasehold improvements 2,078,000
Construction in progress 3,889,000
----------
26,565,000
Accumulated depreciation and amortization (19,892,000)
----------
$6,673,000
==========
Depreciation and amortization expense relating to property and equipment
was approximately $1,933,000 and $2,366,000 for the years ended December 31,
2006 and 2005, respectively.
38
7. ACCRUED LIABILITIES
Accrued liabilities include the following:
December 31, 2006
-----------------
Accrued payroll and payroll taxes $ 689,000
Accrued legal and audit fees 214,000
Accrued liability for equipment purchases 2,506,000
Accrued accounts payable 812,000
Accrued other 785,000
----------
$5,006,000
==========
8. NOTES PAYABLE AND CREDIT ARRANGEMENTS
The Company has a $2,000,000 Loan Agreement (the "Agreement") with Citizens
Bank of Massachusetts (the "Bank"), which expires on June 26, 2007. The
Agreement provides Standby Letter of Credit guarantees, for certain foreign and
domestic customers, which are 100% secured with cash. In December 2006, the
Company temporarily expanded its line of credit to $3,000,000 in order to
facilitate its purchase of production equipment for Bandwidth. On March 31, 2007
the credit line will revert back to the original $2,000,000. At December 31,
2006, the Company had approximately $390,000 of restricted cash and $1,969,000
of restricted short-term investments associated with outstanding letters of
credit. Standby Letters of Credit under this Agreement bear interest at 1%;
however, the Company retains any interest earned on the restricted investments.
The Agreement also provides the Company with the ability to convert to a
$2,000,000 revolving line of credit, based upon eligible accounts receivable and
certain conversion covenants. Loans under this revolving line of credit bear
interest at the Bank's prime rate as determined plus 1/2% (8.75% at December 31,
2006). At December 31, 2006, the Company had not exercised its conversion option
and no amounts were outstanding under the revolving line of credit. A commitment
fee of .25% is charged on the unused portion of the borrowing base. The
Agreement contains covenants including certain financial reporting requirements.
At December 31, 2006, the Company was in compliance with its financial reporting
requirements and cash balance covenants.
9. STOCK-BASED COMPENSATION
The Company has one employee stock option plan: the 1996 Equity Incentive
Plan. This plan was approved by stockholders and provides that the Board of
Directors may grant options to purchase the Company's common stock to key
employees and directors of the Company. Incentive and non-qualified options must
be granted at least at the fair market value of the common stock or, in the case
of certain optionees, at 110% of such fair market value at the time of grant.
The options may be exercised, subject to certain vesting requirements, for
periods up to ten years from the date of issue.
At December 31, 2006, the Company has outstanding under its 1996 Equity
Incentive Plan, 72,187 non-qualified stock options held by the unaffiliated
directors of the Company for the purchase of common stock at an average price of
$6.08 per share. The options may be exercised, subject to certain vesting
requirements, for periods up to ten years from the date of issue.
A summary of the activity of this plan follows:
Weighted
Number of Average
Shares Exercise Price
--------- --------------
Options Outstanding at December 31, 2005 406,314 $4.38
Granted 103,250 $8.18
Exercised (72,500) $4.66
Forfeited (21,062) $5.67
-------- ------
Options Outstanding at December 31, 2006 416,002 $5.21
======== ======
Options Exercisable at December 31, 2006 208,387 $3.89
======== ======
Options Available for Future Grant at
December 31, 2006 --
========
39
The 1996 Equity Incentive Plan expired, for future option grants, on
December 10, 2006 with 419,849 available options not granted.
On January 1, 2006, the Company adopted the fair value recognition
provisions of Statement 123(R) using the modified prospective method. In
accordance with the modified prospective method, the Company has not restated
its consolidated financial statements for prior periods. Under this transition
method, stock-based compensation expense for the year ended December 31, 2006
includes stock-based compensation expense for all of the Company's stock-based
compensation awards granted prior to, but not yet vested as of, January 1, 2006,
based on the grant-date fair value estimated in accordance with the provisions
of Statement No. 123. Stock-based compensation expense for all stock-based
compensation awards granted on or after January 1, 2006 will be based on the
grant-date fair value estimated in accordance with the provisions of Statement
123(R). The impact of Statement 123(R) on the Company's results of operations
resulted in recognition of stock-based compensation expense of approximately
$256,000 for the year ended December 31, 2006. Approximately $209,000 of
stock-based compensation expense was charged to selling, general and
administrative expenses and approximately $47,000 was charged to cost of sales.
This represents an incremental charge of $.03 per basic and diluted share for
the year ended December 31, 2006. The adoption had no impact on cash used in
operating activities or cash provided by financing activities. No stock-based
compensation expense was capitalized during 2006 and no stock-based compensation
expense was recorded in 2005. Compensation expense related to stock options to
be charged in future periods amount to approximately $760,000 at December 31,
2006, which the Company expects to recognize as follows:
For the years ended Expected
December 31, Compensation Expense
------------------- --------------------
2007 $278,000
2008 243,000
2009 153,000
2010 86,000
--------
$760,000
========
Prior to January 1, 2006, the Company accounted for share-based payments
under the recognition and measurement provisions for Accounts Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related Interpretations, as permitted by Statement 123. In accordance with APB
25 no compensation cost was required to be recognized for options granted to
employees that had an exercise price equal to the market value of the underlying
common stock on the date of grant.
The following table illustrates the pro forma effect on net loss and net
loss per share if the Company had applied the fair value recognition provisions
of Statement 123 to stock-based employee compensation for the twelve month
period ended December 31, 2005. Since stock-based compensation expense for the
year ended December 31, 2006 was calculated and recorded under the provisions of
Statement 123(R), no pro forma disclosure for that period is presented.
Year Ended
December 31, 2005
-----------------
Net income, as reported $ 44,000
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards net of related tax effects (322,000)
----------
Pro forma net loss $ (278,000)
==========
Earnings per share:
Basic - as reported $ 0.01
==========
Basic - pro forma $ (0.04)
==========
Diluted - as reported $ 0.01
==========
Diluted - pro forma $ (0.04)
==========
The Company uses the Black-Scholes option pricing model as its method for
determining fair value of stock option grants, which was also used by the
Company for its pro forma information disclosures of stock-based compensation
expense prior to the adoption of Statement 123(R). The Company uses the
straight-line method of attributing the value of
40
stock-based compensation expense for all stock option grants. Stock compensation
expense for all stock-based grants and awards is recognized over the service or
vesting period of each grant or award.
Statement 123(R) requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures differ
from those estimates in order to derive the Company's best estimate of awards
ultimately expected to vest. Forfeitures represent only the unvested portion of
a surrendered option and are typically estimated based on historical experience.
Based on an analysis of the Company's historical data, the Company applied 14%
forfeiture rates to stock options outstanding in determining its Statement
123(R) stock-based compensation expense which it believes is a reasonable
forfeiture estimate for the period. In the Company's pro forma information
required under Statement 123 for the periods prior to 2006, the Company
accounted for forfeitures as they occurred.
The options outstanding and exercisable at December 31, 2006 were in the
following exercise price ranges:
Options Outstanding Options Exercisable
-------------------------------------------------------------------------- -------------------------------------------------
Weighted Weighted
Average Weighted- Average Weighted
Number Remaining Average Number Remaining Average
Range of of Shares Contractual Life Exercise Aggregate of Shares Contractual Exercise Aggregate
Exercise Price Outstanding (Years) Price Intrinsic Value Exercisable Life (Years) Price Intrinsic Value
------------------ ------------ ---------------- --------- --------------- ----------- ------------ -------- ---------------
$1.78 to$2.70 29,374 3.20 $2.23 $ 178,000 28,874 3.15 $ 2.22 $175,000
$2.71 to $3.90 115,496 4.85 $3.90 506,000 115,496 4.85 $ 3.90 506,000
$3.91 to $4.90 143,195 7.54 $4.33 565,000 56,510 6.63 $ 4.27 227,000
$4.91 to $6.36 12,187 8.01 $6.06 27,000 4,377 7.85 $ 5.96 10,000
$6.37 to $10.74 115,750 9.63 $8.28 24,000 3,130 8.87 $ 9.10 1,000
------- ---------- ------- --------
416,002 7.08 $5.21 $1,300,000 208,387 5.22 $ 3.89 $919,000
======= ========== ======= ========
The aggregate intrinsic value in the table above represents the total
intrinsic value, based on the Company's closing stock price of $8.28 as of
December 31, 2006, which would have been received by the option holders had all
option holders exercised their options as of that date. The total intrinsic
value of options exercised was approximately $289,000 and $2,382,000, for the
years ended December 31, 2006 and 2005, respectively.
The per-share weighted-average fair value of stock options granted was
$5.41 and $3.58 for the years ended December 31, 2006 and 2005, respectively, on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions:
Expected Risk-Free Expected Expected
Year Dividend Yield Interest Rate Option Life Volatility Factor
---- -------------- ------------- ----------- -----------------
2005 -- 3.97% 7.5 years 66.6%
2006 -- 4.71% 4.5 years 83.3%
The risk free interest rate reflects treasury yields rates over a term that
approximates the expected option life. The expected option life is calculated
based on historical lives of all options issued under the plan. The expected
volatility factor is determined by measuring the actual stock price volatility
over a term equal to the expected useful life of the options granted.
On November 10, 2005, the Financial Accounting Standards Board ("FASB")
issued FASB Staff Position SFAS 123R-3 "Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards." The Company has
elected to adopt the alternative transition method provided by the FASB Staff
Position for calculating the tax effects (if any) of stock-based compensation
expense pursuant to Statement 123(R). The alternative transition method includes
simplified methods to establish the beginning balance of the additional paid-in
capital pool related to the tax effects of employee stock-based compensation,
and to determine the subsequent impact to the additional paid-in capital pool
and the consolidated statements of operations and cash flows of the tax effects
of employee stock-based compensation awards that are outstanding upon adoption
of Statement 123(R).
41
10. NASDAQ LISTING
At December 31, 2006, the Company's stockholder's equity was $9.5 million.
As a result, the Company did not meet the $10 million minimum stockholder's
equity requirement under Standard No. 1 for continued listing on the Nasdaq
Global Market. However, the Company believes that it does meet Standard No. 2
for continued listing on the Nasdaq Global Market as the market value of its
listed securities currently exceeds $50 million and it meets all other
requirements under Standard No. 2. In order to remain in compliance with
Standard No. 2, the Company's market value of listed securities cannot fall
below $50 million for ten consecutive trading days at any point.
11. INCOME TAXES
There was no income tax provision (benefit) required for 2006 and 2005.
The reconciliation between the amount computed by applying the United
States federal statutory tax rate of 34% to pretax income (loss) and the actual
provision for income taxes follows:
2006 2005
----------- ----------
Income tax expense (benefit) at statutory rate $(2,763,000) $ 15,000
State income taxes net of federal income tax
benefit -- 3,000
Increase (decrease) in valuation allowance
related to income tax expense 2,674,000 (21,000)
Permanent differences 89,000 18,000
Tax credits -- (14,000)
Foreign tax credits -- (1,000)
Other -- --
----------- ----------
Total $ -- $ --
=========== ==========
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities are as follows:
2006
----------
Deferred tax assets:
Accounts receivable $ 110,000
Accruals 1,159,000
Inventories 752,000
Net operating loss carryforwards 4,096,000
General business credit carryforwards 22,000
Alternative minimum tax credit carryforwards 268,000
Foreign tax credit 38,000
----------
Total gross deferred tax assets $6,445,000
----------
Depreciation (45,000)
----------
Total gross deferred tax liabilities (45,000)
----------
Valuation allowance 6,400,000
----------
Net deferred tax assets $ --
==========
The net change in the total valuation allowance for the period ended
December 31, 2006 was an increase of $3.2 million. Gross net operating loss
carryforwards were approximately $10.2 million as of December 31, 2006. Included
in this amount was approximately $2.5 million attributable to equity based
compensation transactions. Approximately $1 million of the valuation allowance
will be relieved through equity if these deductions for equity based
transactions are realized.
42
12. COMMITMENTS
Letters of Credit
-----------------
Outstanding letters of credit totaled $2,359,000 at December 31, 2006. The
letters of credit principally secure performance obligations, and allow holders
to draw funds up to the face amount of the letter of credit if the Company does
not perform as contractually required. These letters of credit expire through
2007 and are 100% secured by cash and short-term investments.
Property Under Capital Leases and Lease Commitments
---------------------------------------------------
At December 31, 2006, the Company had capital leases in effect for a
building. The Company also had operating leases for office space and other
miscellaneous items.
The components of capitalized costs and carrying value of the property
under capital leases were as follows:
December 31, 2006
-----------------
Related party capital lease:
Hudson, New Hampshire building $3,390,000
Less: accumulated depreciation (2,430,000)
----------
$ 960,000
==========
At December 31, 2006, future minimum lease payments for the period ended
are as follows:
Related Party Unrelated Party Related Party
Capital Lease Operating Leases Operating Lease
------------- ---------------- ----------------
2007 $ 1,103,000 $ 110,000 $ 1,247,000
2008 495,000 75,000 --
2009 -- 41,000 --
----------- --------- -----------
Total minimum lease payments 1,598,000 $ 226,000 $ 1,247,000
========= ===========
Less amount representing interest (85,000)
-----------
Present value of minimum lease payments 1,513,000
Less current portion (1,027,000)
-----------
Long-term portion of capital lease obligation $ 486,000
===========
Unrelated Party Capital Lease
-----------------------------
In September 2001, Bandwidth entered into an agreement with GE Capital
Leasing Corp, for the lease of a reactor for its wafer production line. The
lease was originally accounted for as a capital lease. Under the lease
agreement, the Company was making monthly payments of approximately $36,000.
After the initial three-year period ending in September 2004, the lease allowed
for an additional two-year extension. In September 2004, the Company extended
the lease term for the additional two years to September 2006. In September 2006
the Company purchased the equipment from the leasing company for $275,000
resulting in a loss on buyout of capital lease of $105,000. The expense is
included in selling, general and administrative expense for the optoelectronics
business unit.
Related Party Capital Lease
---------------------------
In conjunction with the acquisition of Bandwidth by the Company, SPI-Trust,
a Trust of which Roger G. Little, Chairman of the Board, Chief Executive Officer
and President of the Company, is sole trustee and principal beneficiary,
purchased from Stratos Lightwave, Inc. (Bandwidth's former owner) the building
that Bandwidth occupies in Hudson, New Hampshire for $3.7 million. Subsequently,
the Company entered into a lease for the building (90,000 square feet) with
SPI-Trust whereby the Company will pay $4.1 million to the SPI-Trust over an
initial five-year term expiring in 2008 with a Company option to extend for five
years. In addition to the rent payments, the lease obligates the Company to keep
on deposit with SPI-Trust the equivalent of three months rent ($236,000 as of
December 31, 2006.) The lease agreement does not provide for a transfer of
ownership at any point. Interest costs were assumed at 7%. For the years ended
December 31,
43
2006 and 2005, interest expense was approximately $136,000 and $179,000,
respectively. This lease has been classified as a related party capital lease
and a summary of payments (including interest) follows:
Rate Per Monthly Security
Year Square Foot Annual Rent Rent Deposit
--------------------------- ----------- ----------- ------- --------
June 1, 2003 - May 31, 2004 $6.00 $ 540,000 $45,000 $135,000
June 1, 2004 - May 31, 2005 7.50 675,000 56,250 168,750
June 1, 2005 - May 31, 2006 8.50 765,000 63,750 191,250
June 1, 2006 - May 31, 2007 10.50 945,000 78,750 236,250
June 1, 2007 - May 31, 2008 13.50 1,215,000 101,250 303,750
-----------
$ 4,140,000
===========
At December 31, 2006, $1,027,000 and $486,000 are reflected as the current and
long-term portions of capital lease obligation- related party, respectively, in
the consolidated balance sheet.
Unrelated Party Operating Leases
--------------------------------
Unrelated party operating leases primarily consist of leases for copiers
and the telephone system.
Related Party Operating Lease
-----------------------------
The Company subleased 77,000 square-feet in a building leased by Mykrolis
Corporation, who in turn leased the building from SPI-Trust, a Trust of which
Roger Little, Chairman of the Board, Chief Executive Officer and President of
the Company, is the sole trustee and principal beneficiary. The 1985 sublease,
originally was for a period of ten years, was extended for a five-year period
expiring on November 30, 2000 and was further extended for a five-year period
expiring on November 30, 2005. The sublease agreement provided for minimum
rental payments plus annual increases linked to the consumer price index.
Effective December 1, 2005, the Company entered into a two-year Extension of
Lease Agreement (the "Lease Extension") directly with SPI-Trust.
The Company assumed certain responsibilities of Mykrolis, the tenant under
the former lease, as a result of the Lease Extension including payment of all
building and real estate related expenses associated with the ongoing operations
of the property. The Company will allocate a portion of these expenses to
SPI-Trust based on pre-established formulas utilizing square footage and actual
usage where applicable. These allocated expenses will be invoiced monthly and be
paid utilizing a SPI-Trust escrow account of which the Company has sole
withdrawal authority. SPI-Trust is required to maintain three (3) months of its
anticipated operating costs within this escrow account. On December 1, 2006, the
Company and SPI-Trust amended the Lease Extension. The amendment increases the
leased area to 91,701 square feet. Rent expense under this sublease, lease
extension and amendment, for the years ended December 31, 2006 and 2005 was
approximately $1,262,000 and $1,093,000, respectively. In connection with this
lease, the Company was invoiced and paid certain SPI-Trust related expenses,
including building maintenance and insurance. The Company invoiced SPI-Trust on
a monthly basis and SPI-Trust reimbursed the Company for all such costs.
Approximately $14,000 was due from SPI-Trust as of December 31, 2006 for
building related costs. The Company believes that the terms of the Lease
Extension, as amended, are commercially reasonable.
In conjunction with the acquisition of Bandwidth by the Company, the
Company released Bandwidth from a lease agreement that had existed between
Bandwidth and the Company. In November 2001, Bandwidth, under its previous
owner, abandoned the space being subleased from the Company in Bedford,
Massachusetts, to move to a new building and wafer fabrication lab in Hudson,
New Hampshire. At that time, there were 48 months left on the lease. Subsequent
to the move to Hudson, New Hampshire, Bandwidth was unable to sublease the
Bedford, Massachusetts space, and was paying the Company for the unused space.
In conjunction with the acquisition of Bandwidth in May 2003, the Company
released Bandwidth from the remaining lease payments. However, the Company
continued to be obligated to Mykrolis Corporation for the entire amount of the
remaining lease agreement. As a result, the present value of the remaining lease
obligation associated with the unused space was recorded as an assumed liability
of $1,247,241 in the purchase accounting. This lease obligation terminated in
November 2005. The difference between the actual rent payment and the discounted
rent payment was accreted to the consolidated statements of operations as
interest expense. Interest of 4.75% had been assumed on this obligation. For the
year ended December 31, 2005, interest expense was approximately $11,000.
44
Agreement with BP Solarex
-------------------------
On October 8, 1999, the Company entered into an agreement with BP Solarex
("BPS") in which BPS agreed to purchase certain production equipment built by
the Company, for use in the Company's Chicago factory ("Spire Solar Chicago")
and in return the Company agreed to purchase solar cells of a minimum of two
megawatts per year over a five-year term for a fixed fee from BPS (the "Purchase
Commitment"). BPS had the right to reclaim the equipment if the Company failed
to meet its obligations in the Purchase Commitment. The proceeds from the sale
of the production equipment purchased by BPS were classified as an unearned
purchase discount in the Company's consolidated balance sheets in prior periods.
The Company had amortized this discount as a reduction to cost of sales as it
purchased materials from BPS. In 2003 the Company and BPS retroactively amended
the agreement to include all purchases of solar modules, solar systems, inverter
systems and other system equipment purchased by the Company from BPS in the
purchase commitment calculation. Amortization of the purchase discount amounted
to approximately $65,000 for the years ended December 31, 2005. The production
equipment had been classified as a component of fixed assets. Depreciation
amounted to approximately $211,000 for the year ended December 31, 2005.
In addition, the agreement contained a put option for BPS to have the
Company create a separate legal entity for Spire Solar Chicago and for BPS to
convert the value of the equipment and additional costs, as defined, into equity
of the new legal entity. The percentage ownership in the joint venture would be
determined based on the cumulative investments by BPS and the Company. The
amended agreement also allowed the Company to terminate the agreement on 30 days
notice in consideration for a termination payment based on the aggregate amount
of Spire purchases of BPS products and the fair market value of the production
equipment purchased by BPS at the time of the termination election.
On August 16, 2005, the Company entered into a Settlement and Contract
Termination Agreement (the "Termination Agreement") with BPS effective September
30, 2005. Under the terms of the Termination Agreement, the Company and BPS
agreed to terminate the amended agreement including the Purchase Commitment. In
exchange for release of the purchase commitment, the Company paid BPS $275,000
and retained ownership of the production equipment. The unamortized unearned
purchase discount as of the effective date was approximately $1,205,000 and the
net book value of the production equipment was approximately $287,000. As result
of this action, Spire reevaluated the recoverability of the long-lived assets
associated with this segment as part of its third quarter review. Based on cash
flow projections for the Solar System segment, the Company determined that the
production equipment was impaired and should be written-off.
The Company has recorded an approximate $593,000 gain from these actions,
which is reflected as a gain on extinguishment of purchase commitment in the
accompanying consolidated statement of operations for the year ended December
31, 2005. The components of this gain are outlined below:
Unearned purchase discount $1,205,000
Net book value of production equipment (287,000)
Payment to extinguish purchase commitment (275,000)
Accrued relocation costs (50,000)
----------
Gain on extinguishment of purchase commitment $ 593,000
==========
13. EMPLOYEE BENEFIT PLANS
Profit Sharing Plan
-------------------
In 1985, the Company adopted a profit sharing plan under Section 401(k) of
the Internal Revenue Code. This plan allows employees to defer up to 17.5% of
their income up to certain dollar limits on a pretax basis through contributions
to the plan. No matching contributions have been made to the plan for the years
ended December 31, 2006 and 2005, respectively.
Deferred Compensation Plan
--------------------------
Effective January 1, 2002, the Company adopted the Spire Corporation
Non-Qualified Deferred Compensation Plan (the "Plan") for Roger Little, Chairman
of the Board, Chief Executive Officer and President of the Company (the
"Participant"). Under this Plan, the Company makes equal monthly contributions
to the Spire Corporation Non-Qualified Deferred Compensation Trust (the "Trust")
up to the annually required amount of $250,000. The Company records these
contributions as selling, general and administrative expense when made. The
Trustee makes all investment decisions for the Trust on behalf of the
Participant. The Company has not guaranteed a return on investment for the
Participant, however, all
45
earnings and losses on the Plan assets are borne by the Participant. All
contributions and earnings are fully vested to the Participant when made but are
subject to the Company's creditors in the event of bankruptcy. As a result, the
assets held in the Plan have been recorded as available-for-sale investments in
the consolidated balance sheet with a corresponding liability being recorded as
deferred compensation. Unrealized gains and losses on the available-for-sale
investments are recorded as accumulated other comprehensive income within the
equity section of the consolidated balance sheet. A corresponding entry to
deferred compensation is made to increase (decrease) the amounts due the
Participant resulting from the changes in the asset value with an offsetting
charge or credit to selling, general and administrative expense. Compensation
expense was approximately $250,000 in each of the years ended December 31, 2006
and 2005.
14. EARNINGS (LOSS) PER SHARE
The following table provides a reconciliation of the denominators of the
Company's reported basic and diluted earnings (loss) per share computations for
the years ended December 31:
2006 2005
--------- ---------
Weighted average number of common and common
equivalent shares outstanding - basic 7,898,320 6,975,347
Add: Net additional common shares upon assumed
exercise of common stock options -- 261,782
--------- ---------
Weighted average number of common and common
equivalent shares - diluted 7,898,320 7,237,129
========= =========
For the year ended December 31, 2005, 32,500 shares of common stock
issuable relative to stock options had exercise prices per share that exceeded
the average market price of the Company's common stock and were excluded from
the calculation of diluted shares since their inclusion would be anti-dilutive.
For the year ended December 31, 2006 416,002 shares of common stock
issuable relative to stock options were excluded from the calculation of diluted
shares since their inclusion would have been anit-dilutive.
15. LEGAL MATTERS
From time to time, the Company is subject to legal proceedings and claims
arising from the conduct of its business operations. The Company does not expect
the outcome of these proceedings, either individually or in the aggregate, to
have a material adverse effect on its financial position, results of operations,
or cash flows.
The Company was named a defendant in 58 cases filed from August 2001 to
July 2003 in various state courts in Texas by persons claiming damages from the
use of allegedly defective mechanical heart valves coated by a process licensed
by the Company to St. Jude Medical, Inc., the heart valve manufacturer, which
has also been named as a defendant in these cases. In June 2003, a motion for
summary judgment was granted to the Company and most of these cases were
dismissed, based on the principle of federal preemption. The Texas Court of
Appeals upheld the lower court's decision, and, because these cases were not
submitted for review to the Texas Supreme Court, the judgments rendered are now
final.
As of January 2007, four cases remain pending in various district courts in
Harris County, Texas. One of these cases appears to remain pending despite its
inclusion in the original summary judgment which was subsequently upheld by the
first court of appeals. This may be the result of an administrative omission;
counsel for the Company intends to confirm with the court that this case should
in fact no longer be pending. Two of the remaining cases where filed after the
motion for summary judgment, but since the appeals court has subsequently ruled
in the Company's favor, counsel from the Company is asking the plaintiffs in
these cases to consider voluntary dismissal, or alternatively, because the cases
are not actively prosecuted, to ask the court to dismiss them. The remaining
case was not subject to the preemption argument advanced by the Company's
counsel and either may be settled or may go to trial.
During the second quarter of 2005 a suit was filed by Arrow International,
Inc. against Spire Biomedical, Inc., a wholly owned subsidiary of the Company,
alleging patent infringement by the Company. The complaint claims one of the
Company's catheter products induces and contributes to infringement when medical
professionals insert it. The Company has responded to the complaint denying all
allegations and has filed certain counterclaims. The discovery process in this
case has continued and is nearly complete. The Company filed a motion for
summary judgment, asserting patent invalidity resulting from plaintiff's failure
to follow the administrative procedures of the U.S. Patent and Trademark Office
("USPTO") which failure has remained uncorrected. On August 4, 2006, the Court
granted the Company's motion and
46
dismissed this lawsuit without prejudice. Plaintiffs applied to revive the
applicable patent, which application was granted by the USPTO in August 2006.
Plaintiffs refiled their lawsuit against the Company in September 2006. The
Company has filed its answer and resumed its defense. The Parties are concluding
discovery at this time. In January, 2007, a 60 day stay was granted to the
parties in order to mediate a settlement in the case. Based on information
presently available to the Company, the Company believes that it does not
infringe any valid claim of the plaintiff's patent and that, consequently, it
has meritorious legal defenses with respect to this action.
In an amended complaint filed December 28, 2006, in the Eastern Division of
the U.S. District Court for the Southern District of Ohio, the wife and executor
of the estate of Darrell Adams, deceased, alleges that the failure of a
hemodialysis catheter manufactured by the Company was a cause of his death.
Counsel retained by its insurance underwriters, on behalf of the Company, have
filed an answer denying all such allegations and asserting various defenses.
Based on the knowledge available to it at this time, the Company determined the
likelihood of an unfavorable outcome to be remote and accordingly has not
recorded an accrued expense.
16. OPERATING SEGMENTS AND RELATED INFORMATION
The following table presents certain operating division information in
accordance with the provisions of SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information".
Spire Spire Total
Solar Biomedical Optoelectronics Other Company
----------- ----------- --------------- ---------- -----------
December 31, 2006
Net sales and revenues $ 6,992,000 $10,517,000 $2,616,000 $ -- $20,125,000
Earnings (loss) from operations (4,011,000) (1,241,000) (2,999,000) -- (8,251,000)
Identifiable assets 7,516,000 4,819,000 6,615,000 8,734,000 27,684,000
Capital expenditures 14,000 309,000 3,618,000 144,000 4,085,000
Depreciation and amortization 88,000 374,000 1,421,000 144,000 2,027,000
Stock-based compensation 40,000 66,000 34,000 116,000 256,000
December 31, 2005
Net sales and revenues $9,393,000 $10,578,000 $2,451,000 $ -- $22,422,000
Earnings (loss) from operations 918,000 2,170,000 (2,740,000) -- 348,000
Identifiable assets 3,262,000 4,043,000 4,392,000 6,255,000 17,952,000
Capital expenditures 94,000 184,000 84,000 66,000 428,000
Depreciation and amortization 285,000 521,000 1,437,000 208,000 2,451,000
The following table shows net sales and revenues by geographic area (based
on customer location) for the years ended December 31:
2006 % 2005 %
----------- ----- ----------- -----
Foreign $6,671,000 33% $7,463,000 33%
United States 13,454,000 67% 14,959,000 67%
----------- ----- ----------- -----
$20,125,000 100% $22,422,000 100%
=========== ===== =========== =====
The Company's operations are focused on three primary business areas: Spire
Solar (comprised of solar equipment and solar systems), Spire Biomedical
(comprised of biomedical and biophotonics research) and optoelectronics
(comprised primarily of Bandwidth Semiconductor, LLC). In previous years, solar
equipment and solar systems had been reported as separate business segments.
During 2006 solar equipment and solar systems have been merged under common
management and are no longer reported separately. Spire Solar and Spire
Biomedical operate out of the Company's facility in Bedford, Massachusetts.
Bandwidth Semiconductor LLC operates out of the Company's facility in Hudson,
New Hampshire. Each business area is independently managed and has separate
financial results that are reviewed by the Board of Directors and Chief
Executive Officer and the chief executive officers of each operating division.
Earnings (loss) from operations is net sales less cost of sales, selling,
general and administrative expenses and gain on sales of licenses, but is not
affected either by non-operating income or by income taxes. The Spire Biomedical
segment benefited from a $3,000,000 gain on sale of license in 2005. The Solar
segment benefited from a $3,320,000 gain on sale of license in 2005. In
calculating earnings from operations for individual business units, substantial
administrative expenses incurred at the operating level that are common to more
than one segment are allocated on a net sales basis. Certain
47
corporate expenses of an operational nature are also allocated to the divisions
based on factors including occupancy, employment, and purchasing volume. All
intercompany transactions have been eliminated.
Revenues from contracts with United States government agencies for 2006 and
2005 were approximately $2,261,000 and $3,233,000, or 11% and 14% of
consolidated net sales and revenues, respectively.
One customer accounted for 10% of gross sales in 2006, and no customer
accounted for more than 10% of gross sales during 2005. Two customers
represented approximately 14% and 10% of net accounts receivable, trade at
December 31, 2006 and one customer represented approximately 19% of net account
receivables, trade at December 31, 2005.
Germany is the only foreign country that accounted for more than 10% of
sales in 2006 and no foreign countries accounted for more that 10% of sales in
2005. Net sales to customers in Germany accounted for $2,568,000 in 2006.
17. SALE OF LICENSES
On May 26, 2005, the Company entered into a global consortium agreement
(the "Agreement") with Nisshinbo Industries, Inc. ("Nisshinbo") for the
development, manufacturing, and sales of solar photovoltaic module manufacturing
equipment. Nisshinbo's prior relationship with Spire was as a sub-licensee of
Marubeni Corporation with whom the Company had a license arrangement that was
originally signed in 1997, extended in 2003, and terminated in May 2005.
Nisshinbo's role as sub-licensee was to manufacture equipment for Marubeni to
sell to the Japanese market based upon the Company's proprietary technology.
Under the terms of the Agreement, Nisshinbo purchased a license to manufacture
and sell the Company's module manufacturing equipment on a semi-exclusive basis
for an upfront fee plus additional royalties based on ongoing equipment sales
over a ten-year period. In addition, the Company and Nisshinbo agreed, but are
not obligated, to pursue joint research and development, product improvement
activities and sales and marketing efforts. The companies may share market costs
such as product collateral and trade show expenses. It may also collaborate on
sales leads and have the other company manufacture and service its equipment in
the field. Both companies have reciprocal rights to participate in the other
company's R&D efforts on a going-forward basis. Nisshinbo can request the
Company to further develop a technology but Nisshinbo must (a) share in the
costs of these development efforts equally with the Company (and thereafter have
joint ownership) otherwise the Company will own the technology under a partial
contribute or no participation by Nisshinbo with the Company receiving a royalty
from Nisshinbo if it utilizes the technology. At the end of the license all
non-jointly owned technology developed under the Agreement will revert back to
the owner, with the other party being required to purchase a new license based
upon the fair market value of that technology in order to continue to utilize
the technology.
On June 27, 2005, the Company received JPY 400,000,000 from the sale of
this permanent license. The Company determined that the Nisshinbo Agreement
contains multiple elements consisting of (1) the granting of a license to
utilize the Company's technology and (2) the semi-exclusive right to utilize the
technology for a period of 10 years. The Company believes the granting of the
license meets the criteria of Emerging Issues Task Force ("EITF") 00-21,
"Accounting for Revenue Arrangements with Multiple Elements", paragraph 9(a), as
the license to utilize the technology has value to Nisshinbo on a stand-alone
basis. Further, Question 1 to Securities and Exchange Commission ("SEC") Staff
Accounting Bulletin Topic 13A-3f "Nonrefundable Up-Front Fees", was directly
considered as guidance for determining if the upfront fee under the Nisshinbo
Agreement should be recognized upon the signing of contract or recognized over
the term of the license. It is the Company's belief that a separate earnings
process was complete as Nisshinbo was purchasing access to utilize technology it
already had in its possession; therefore, recognition of the gain on the sale
was appropriate. The Company has determined the fair value of the license and
royalty based on an appraisal. As a result, a $3,320,000 gain was recognized as
a gain on sale of license in the accompanying consolidated statements of
operations for the year ended December 31, 2005. The balance of $350,000 was
determined to represent an advanced royalty payment and was recorded as an
advance on contracts in progress. This amount is being credited as royalty
income over the ten year license period on a straight-line basis. The Company
recognized $35,000 and $17,500 of royalty income associated with this license in
2006 and 2005 respectively.
18. PRIVATE PLACEMENT OF EQUITY
On April 26, 2006, the Company entered into Stock Purchase Agreements with
two accredited institutional investors in connection with the private placement
of 941,176 shares of the Company's common stock at a purchase price of $8.50 per
share. On April 28, 2006, the Company completed the private placement. The net
proceeds of the sale were approximately $7.7 million after deducting placement
fees and other closing costs.
48
Under the terms of the Stock Purchase Agreements, the Company was obligated
to file a registration statement on Form S-3 with the SEC, registering the
resale of the shares of common stock sold. The Company filed the Form S-3 on May
3, 2006 and the SEC declared it effective on May 12, 2006. In the event that
this registration statement ceases to be effective and available to the
investors for an aggregate period of 30 days in any 12 month period, the Company
must pay liquidated damages starting on the 61st day (in the aggregate) of any
suspensions in any 12 month period, and each 30th day thereafter until the
suspension is terminated an amount equal to 1% of the aggregate purchase price
paid by the investors. However, the Company is not obligated to pay liquidation
damages on shares not owned by the investors at the time of the suspension or
shares that are tradable under Rule 144(k). The Company reviewed EITF 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock", and EITF 05-04, "The Effect of a Liquidated
Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No.
00-19", to determine if these liquidation damages provisions require a portion
of the equity raised needs to be accounted under FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("Statement
133"). It determined that the liquidated damages provisions did not require
separate treatment under Statement 133 and therefore will treat all of the funds
raised under these agreements as additions to permanent equity.
19. MANUFACTURING AGREEMENTS
On August 29, 2006, the Company's wholly owned subsidiary, Bandwidth
Semiconductor, LLC ("Bandwidth"), entered into a five-year manufacturing
agreement in which it will be the exclusive supplier to Principia Lightworks,
Inc. ("Principia"), of semiconductor wafers, enabling Principia, a Woodland
Hills, California firm, to begin high volume production of its patented device,
an electron beam pumped vertical cavity surface emitting laser ("eVCSEL") as a
light source for production display applications, including rear-projection
consumer televisions. Bandwidth will manufacture epitaxial wafers which will be
further processed by Principia to produce red, blue, and green colored lasers.
Under the terms of this agreement, Bandwidth will be producing III/V and
II/VI wafers for Principia with full production expected to start in mid 2007.
Bandwidth will begin the scale-up of its existing metalorganic chemical vapor
deposition ("MOCVD") and related processing facilities to satisfy Principia's
requirements. Principia made an up-front payment for nonrecurring engineering
and facility access costs and, in addition, will make monthly facility
availability payments throughout the term of the agreement. The first eighteen
months of the facility availability payments have been secured by a pledge of
Principia common equity which shall be returned after eighteen months upon
receipt of the monthly payments. The Company reviewed FASB Statement No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Debt", and determined that the Company shall not recognize the pledged shares
and only will recognize if Principia defaults under the terms of the agreement.
Principia has no right of repayment with respect to these payments. Bandwidth
has an obligation to purchase and qualify MOCVD equipment to manufacture the
wafers and make available the facility for Principia's manufacturing needs for a
period of 5 years. Upon qualification, Principia has an obligation to purchase a
minimum quantity of wafers for the first two years of the Agreement. A fixed
price has been established for each wafer produced with some discounting
contingent upon Principia committing to certain volume commitments. Until
Bandwidth qualifies the new equipment, it will defer the revenue recognition of
any advance payments related to the facility preparation and availability.
Bandwidth shall have full ownership of the equipment and may utilize any excess
capacity for other customers. In September 2006, the Company entered into a
purchase order with a manufacturer of MOCVD equipment. Although the Company will
be committing capital resources to complete the scale-up, it anticipates the
up-front payment plus the monthly payments will be sufficient to meet its
capital requirements under the agreement. Providing the parties meet their
respective obligations over the term of the Agreement, no net outlay of capital
will be needed. The new equipment has been received and installed at Bandwidth
and is currently being qualified for Principia.
On March 16, 2006, Company entered into a Turn-Key Project Agreement to
provide a privately owned solar firm located in Europe (the "Purchaser"), a
commercially sized multi-megawatt turn-key Photovoltaic Cell Manufacturing Line
(the "Cell Line") for $6.75 million (to be paid over the course of two years
upon the achievement of certain milestones). The agreement was subsequently
amended to include automation equipment bringing the total value of the contract
to $9 million. The Cell Line is scheduled to ship during the second quarter of
2007 and is subject to various design, manufacturing and performance
specifications. Actual shipment of the equipment will depend on the availability
of the customer's facility which is currently under construction. The Company is
subject to certain penalty provisions if the Cell Line does not meet agreed-upon
performance criteria within a set period of time. Under this agreement, the
Company also agreed to supply the Purchaser up to 1,500,000 mono-crystalline
wafers or multi-crystalline wafers (meeting certain electrical capacity and
efficiency standards) prior to the starting date of production of cells by the
Cell Line or within 60 days after shipment of the Cell Line. The actual amount
of wafers ordered and the price of such wafers is subject to the mutual
agreement of the parties, and the Purchaser may cancel this non-exclusive
arrangement at any time. The price for such wafer supply is in addition to the
purchase price for the Cell Line. At December 31, 2006, the criteria for revenue
49
recognition under Staff Accounting Bulletin No. 104, "Revenue Recognition in
Financial Statements", have not been met therefore no revenue has been
recognized.
In addition, concurrently with the execution of the Turn-Key Project
Agreement, the Company and the Purchaser entered into a Wafer Supply Agreement
under which the Company agreed to supply the Purchaser up to an additional
4,500,000 wafers (meeting certain electrical capacity and efficiency standards)
during the first three quarters of 2007. The actual amount of wafers ordered and
the price of such wafers is subject to the mutual agreement of the parties, and
the Purchaser may cancel this non-exclusive arrangement at any time.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
------------------------------------------------
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), the Company carried out an evaluation under the
supervision and with the participation of the Company's management, including
the Chief Executive Officer and President and the Chief Financial Officer, of
the effectiveness of the Company's disclosure controls and procedures as of
December 31, 2006. In designing and evaluating the Company's disclosure controls
and procedures, the Company and its management recognize that there are inherent
limitations to the effectiveness of any system of disclosure controls and
procedures, including the possibility of human error and the circumvention or
overriding of the controls and procedures. Accordingly, even effective
disclosure controls and procedures can only provide reasonable assurance of
achieving their desired control objectives. Additionally, in evaluating and
implementing possible controls and procedures, the Company's management was
required to apply its reasonable judgment. Furthermore, management considered
certain matters deemed by the Company's independent auditors to constitute a
material weakness in the Company's internal control over financial reporting, as
described below. Based upon the required evaluation, the Chief Executive Officer
and President and the Chief Financial Officer concluded that as of December 31,
2006, due to the material weakness in internal control over financial reporting
described below, the Company's disclosure controls and procedures were not
effective to ensure that information required to be disclosed by the Company in
the reports it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms.
On March 27, 2007, the Company's independent auditor, Vitale, Caturano &
Company, Ltd. ("VCC") issued a letter advising management and the Audit
Committee, that, in connection with its audit of the Company's consolidated
financial statements for the year ended December 31, 2006, it noted certain
matters involving internal control and its operation that it considered to be a
material weakness under standards of the Public Company Accounting Oversight
Board. VCC noted that, since its March 2006 letter, in which VCC noted material
weaknesses in the Company's internal controls in connection with its audit of
the Company's 2005 financial statements, the Company continues to improve its
internal control over financial reporting; however, account reconciliations
still contained errors that resulted in material audit adjustments and were not
always prepared, reviewed and approved in a timely manner.
In addition, the Company continued to suffer due to turnover in the Finance
department, but has worked diligently to fill these positions. During 2006, the
Company hired a Cost Accountant to assist in analyzing revenue transactions, but
still had to supplement its staff with outside assistance. The Company remained
significantly resource constrained and the established controls, policies and
procedures could not be properly performed with the then current staffing.
In January 2007, the Company hired a Corporate Controller and recently
appointed him to Chief Accounting Officer. Lastly, in March 2007 the Company has
hired a Director of Corporate Compliance and Controls, who will have the primary
responsibility of analyzing, improving, formalizing, documenting and testing the
internal control over financial reporting.
50
Changes in Internal Control Over Financial Reporting
----------------------------------------------------
There was no change in the Company's internal control over financial
reporting that occurred during the fourth fiscal quarter of 2006 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
The Sarbanes-Oxley Act of 2002 imposed many new requirements on public
companies, the most significant of which involves the documentation, testing and
reporting of the effectiveness of our internal control over financial reporting.
We expect this effort will involve substantial time and expense. Because we have
limited resources we can devote to this effort we cannot be sure that we will be
able to complete the task in a timely manner or that our internal controls will
meet the standards that are currently required. We have various significant
control deficiencies identified by our registered public accounting firm. These
deficiencies include, among other things, inadequate staffing in our finance
area and the need to improve and update the documentation of our policies,
procedures, and related internal controls surrounding our accounting and
financial reporting functions. Although we are not yet required to report on our
assessment of the effectiveness of our internal control over financial
reporting, until at least the end of the next fiscal year (or provide auditor
attestation until the end of fiscal 2008) there is a reasonable likelihood that
our registered public accounting firm will inform us of one or more material
weaknesses before we complete our compliance and remediation efforts. We are
working to address the issues raised by these control deficiencies, but we may
not be successful in remediating them within the required time frame.
ITEM 8B. OTHER INFORMATION
None
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Information concerning the directors, executive officers, promoters,
control persons and corporate governance of the Company is set forth in the
Proxy Statement for the Special Meeting in Lieu of 2006 Annual Meeting of
Stockholders ("Proxy Statement") and is incorporated herein by reference.
Information concerning compliance with Section 16(a) of the Exchange Act is set
forth under "Compliance with Section 16(a) of the Securities Exchange Act of
1934" in the Proxy Statement and is incorporated herein by reference.
The Company has adopted a Code of Business Conduct and Ethics (the "Code")
that applies to its principal executive officer, principal financial officer and
principal accounting officer or controller, as well as to directors, officers
and employees generally. The Code sets forth written standards that are
reasonably designed to deter wrongdoing and to promote (1) honest and ethical
conduct, (2) full, fair, accurate, timely and understandable disclosure in
reports and documents that the Company files with the SEC and in other public
communications made by the Company, (3) compliance with applicable governmental
laws, rules and regulations, (4) the prompt internal reporting of violations of
the Code to an appropriate person or persons identified in the Code and (5)
accountability for adherence to the Code. The Company will provide to any person
without charge, upon request, a copy of the Code. Any person wishing a copy
should write to Michael W. O'Dougherty, Clerk, Spire Corporation, One Patriots
Park, Bedford, Massachusetts 01730-2396.
A copy of the Code is incorporated by reference as Exhibit 21 to the 2003
Form 10-KSB.
ITEM 10. EXECUTIVE COMPENSATION
Information concerning executive compensation is set forth in the Proxy
Statement and is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and
management, and related stockholder matters, is set forth in the Proxy Statement
and is incorporated herein by reference.
51
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information concerning certain relationships and related transactions, and
director independence, is set forth in the Proxy Statement and is incorporated
herein by reference.
ITEM 13. EXHIBITS
The following Exhibits are either filed herewith or are incorporated by
reference as may be indicated.
3(a) Articles of Organization as amended, incorporated by reference to
Exhibit 3(a) to the Company's Form 10-QSB for the quarter ended June 30,
1997
3(b) By-Laws, as amended, incorporated by reference to Exhibit 3(b) to the
Company's Form 10-K for the year ended December 31, 1989
10(a) Sublease Agreement with Millipore Corporation as landlord for facility
at Bedford, Massachusetts dated November 25, 1985, incorporated by
reference to Exhibit 10(a) to the Company's Form 10-K for the year ended
December 31, 1985
10(b) Amendment to Sublease Agreement with Millipore Corporation as landlord
for facility at Bedford, Massachusetts dated December 30, 1999,
incorporated by reference to Exhibit 10(b) to the Company's Form 10-KSB
for the year ended December 31, 1999 ("1999 10-KSB")
10(c) Sublease Agreement with Methode Electronics, Inc. as tenant for a
portion of the facility at Bedford, Massachusetts dated December 29,
1999, incorporated by reference to Exhibit 10(c) to the 1999 10-KSB
10(d) Asset Purchase Agreement dated as of November 18, 1999 with Methode
Electronics, Inc. and Methode Massachusetts, Inc., incorporated by
reference to Exhibit 1 to the Company's Form 8-K dated December 29, 1999
10(e) Employment Agreement with Roger G. Little dated as of January 1, 2002,
incorporated by reference to Exhibit 10(e) to the Company's Form 10-KSB
for the year ended December 31, 2001 ("2001 10-KSB")
10(f) Deferred Compensation Plan with Roger G. Little dated as of January 1,
2002, incorporated by reference to Exhibit 10(f) to 2001 10-KSB
10(g) Spire Corporation 1985 Incentive Stock Option Plan, incorporated by
reference to Exhibit 10(d) to the Company's Form 10-K for the year ended
December 31, 1984
10(h) Spire Corporation 401(k) Profit Sharing Plan, incorporated by reference
to Exhibit 10(h) to the Company's Form 10-KSB for the year ended
December 31, 2003 ("2003 10-KSB")
10(i) Spire Corporation 1996 Equity Incentive Plan, incorporated by reference
to Appendix A to the Company's Proxy Statement dated April 15, 2004
10(j) Purchase Agreement dated May 23, 2003 with Stratos Lightwave and
Bandwidth Semiconductor, LLC, incorporated by reference to Exhibit 10(h)
to the Company's Form 10-QSB for the quarter ended June 30, 2003
10(k) Lease Agreement dated May 23, 2003 by and between Roger G. Little,
Trustee of SPI-Trust as Landlord and Spire Corporation as Tenant,
incorporated by reference to Exhibit 10(i) to the Company's Form 10-QSB
for the quarter ended June 30, 2003
10(l) Trust Agreement dated April 1, 2004 between the Company and Riggs Bank
N.A. as Trustee of the Company's 401(k) Profit Sharing Plan,
incorporated by reference to Exhibit 10(1) to the Company's Form 10-KSB
for the year ended December 31, 2004 ("2004 10-KSB")
52
10(m) Amendment No. One dated November 18, 2004 to Employment Agreement for
Roger G. Little, incorporated by reference to Exhibit 10(m) to the
Company's 2004 10-KSB
10(n) Development, Manufacturing, and Sales Consortium Agreement between
Nisshinbo Industries, Inc. and Spire Corporation, with an effective date
of 16 May 2005, incorporated by reference to Exhibit 10(n) to the
Company's For 10-QSB for the quarter ended June 30, 2005.*
10(o) Extension of Lease Agreement dated November 11, 2005 between Roger G.
Little, Trustee of SPI-Trust and Spire Corporation (lease of premises,
77,037 sq. ft.), incorporated by reference to Exhibit 10(o) to the
Company's 2005 10-KSB
10(p) Amendment Number Four to the Spire Corporation 401(k) Profit Sharing
Plan dated November 21, 2005, incorporated by reference to Exhibit 10(p)
to the Company's 2005 10-KSB
10(q) Turn-Key Project Agreement, dated March 16, 2006, incorporated by
reference to Exhibit 10(s) to the Company's 2006 10-QSB for the quarter
ended March 31, 2006 **
10(r) Wafer Supply Agreement, dated March 16, 2006, incorporated by reference
to Exhibit 10(r) to the Company's 2006 10-QSB for the quarter ended
March 31, 2006 **
10(s) Manufacturing Agreement, dated August 29, 2006, by and between Bandwidth
Semiconductor, LLC, a wholly owned subsidiary of Spire ("Bandwidth"),
and Principia Lightworks, Inc. ("Principia"), incorporated by reference
to Exhibit 10(s) to the Company's 2006 10-QSB for the quarter ended
September 30, 2006 **
10(t) First Amendment to Extension of Lease Agreement dated December 1, 2006
between Roger G. Little, Trustee of SPI-Trust and Spire Corporation
(lease of premises, approximately 91,701 sq. ft.) (filed herewith)
10(u) Amendment Number Five to the Spire Corporation 401(k) Profit Sharing
Plan dated December 22, 2006, (filed herewith)
14 Code of Business Conduct and Ethics incorporated by reference to Exhibit
14 to the 2003 10-KSB
21 Subsidiaries of the Registrant incorporated by reference to Exhibit 21
to the 2003 10-KSB
23 Consent of Independent Registered Public Accounting Firm (filed
herewith)
31.1 Certification of the Chairman of the Board, Chief Executive Officer and
President pursuant to ss.302 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
31.2 Certification of the Chief Financial Officer pursuant to ss.302 of the
Sarbanes-Oxley Act of 2002 (filed herewith)
32.1 Certification of the Chairman of the Board, Chief Executive Officer and
President pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906
of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002
(filed herewith)
* Portions of this Exhibit have been omitted pursuant to a grant of
confidential treatment.
** Portions of this Exhibit have been omitted pursuant to a request for
confidential treatment.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services is set forth
in the Proxy Statement and incorporated herein by reference.
53
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SPIRE CORPORATION
By: /s/ Roger G. Little March 30, 2007
------------------------
Roger G. Little
Chairman of the Board, Chief
Executive Officer, and President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Roger G. Little Chairman of the Board, Chief March 30, 2007
--------------------------- Executive Officer and President
Roger G. Little
/s/ Christian Dufresne Chief Financial Officer and March 28, 2007
--------------------------- Treasurer
Christian Dufresne
/s/ Richard P. Thomley Chief Accounting Officer March 28, 2007
---------------------------
Richard P. Thomley
/s/ Udo Henseler Director March 30, 2007
---------------------------
Udo Henseler
/s/ David R. Lipinski Director March 28, 2007
---------------------------
David R. Lipinski
/s/ Mark C. Little Chief Executive Officer, Spire March 28, 2007
--------------------------- Biomedical and Director
Mark C. Little
/s/ Michael J. Magliochetti Director March 30, 2007
---------------------------
Michael J. Magliochetti
/s/ Guy L. Mayer Director March 30, 2007
---------------------------
Guy L. Mayer
/s/ Roger W. Redmond Director March 30, 2007
---------------------------
Roger W. Redmond
54
EXHIBIT INDEX
Exhibit Description
------- -----------
10(t) First Amendment to Extension of Lease Agreement dated December 1, 2006
between Roger G. Little, Trustee of SPI-Trust and Spire Corporation
(lease of premises, approximately 91,701 sq. ft.) (filed herewith)
10(u) Amendment Number Five to the Spire Corporation 401(k) Profit Sharing
Plan dated December 22, 2006, (filed herewith)
23 Consent of Independent Registered Public Accounting Firm
31.1 Certification of the Chairman of the Board, Chief Executive Officer
and President pursuant to ss.302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to ss.302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of the Chairman of the Board, Chief Executive Officer
and President pursuant to 18 U.S.C. ss.1350, as adopted pursuant to
ss.906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of
2002
55