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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2004; or
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 0-12742
SPIRE CORPORATION
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(Name of small business issuer as specified in its charter)
MASSACHUSETTS 04-2457335
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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)
Securities registered under Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE; REGISTERED ON THE NASDAQ STOCK 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 |_|
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. There were 6,839,909
outstanding shares of the issuer's only class of common equity, Common Stock,
$0.01 par value, on October 25, 2004.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
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TABLE OF CONTENTS
Page
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheet as of
September 30, 2004 .............................................. 1
Unaudited Condensed Consolidated Statements of Operations
for the Three and Nine Months Ended September 30, 2004 and 2003 .. 2
Unaudited Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2004 and 2003 ............ 3
Notes to Unaudited Condensed Consolidated Financial Statements ... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 11
Item 3. Controls and Procedures ......................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 22
Item 2. Changes in Securities .......................................... 22
Item 3. Defaults Upon Senior Securities ................................. 22
Item 4. Submission of Matters to a Vote of Security Holders ............. 22
Item 5. Other Information ............................................... 22
Item 6. Exhibits and Reports on Form 8-K ................................ 22
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SPIRE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30,
2004
------------
ASSETS
Current assets
Cash and cash equivalents $ 3,774,018
Restricted cash 619,697
------------
4,393,715
Net accounts receivable, trade 3,428,577
Inventories 2,306,265
Refundable income taxes 407,000
Prepaid expenses and other current assets 543,632
------------
Total current assets 11,079,189
------------
Property and equipment 23,943,520
Less: Accumulated depreciation and amortization (16,542,043)
------------
Net property and equipment 7,401,477
------------
Deposit - related party 168,750
Restricted cash - long-term 96,800
Intangible and other assets, net 752,165
------------
Total assets $ 19,498,381
------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of capital lease obligation $ 394,733
Current portion of capital lease obligation - related party 516,638
Accounts payable 1,313,663
Accrued liabilities 1,251,798
Current portion of accrued lease obligation - related party 510,611
Advances on contracts in progress 1,099,130
------------
Total current liabilities 5,086,573
------------
Long-term portion of capital lease obligation 549,742
Long-term portion of capital lease obligation - related party 2,398,139
Accrued lease obligation - related party 87,480
Unearned purchase discount 1,320,993
------------
Total long-term liabilities 4,356,354
------------
Total liabilities 9,442,927
------------
Commitments and Contingencies
Stockholders' equity
Common stock, $0.01 par value; shares authorized 20,000,000; issued 6,836,409 shares in 2004 68,364
Additional paid-in capital 9,414,696
Retained earnings 572,394
------------
Total stockholders' equity 10,055,454
------------
Total liabilities and stockholders' equity $ 19,498,381
============
See accompanying notes to condensed consolidated financial statements.
1
SPIRE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales and revenues
----------------------
Contract research and service revenues $ 2,290,456 $ 2,229,682 $ 7,621,518 $ 5,748,365
Sales of goods 1,437,047 1,843,631 5,394,116 5,038,962
------------ ------------ ------------ ------------
Total sales and revenues 3,727,503 4,073,313 13,015,634 10,787,327
------------ ------------ ------------ ------------
Costs and expenses
------------------
Cost of contract research and services 1,791,787 1,767,086 5,911,160 4,022,325
Cost of goods sold 1,353,809 1,548,622 4,662,413 4,558,418
Selling, general and administrative expenses 1,994,725 2,001,110 6,083,681 4,883,240
Internal research and development 308,531 388,197 1,039,156 767,542
------------ ------------ ------------ ------------
Total costs and expenses 5,448,852 5,705,015 17,696,410 14,231,525
------------ ------------ ------------ ------------
Gain on sale of license -- -- 3,000,000 4,989,150
------------ ------------ ------------ ------------
Earnings (loss) from operations (1,721,349) (1,631,702) (1,680,776) 1,544,952
------------
Interest expense, net (77,084) (68,065) (217,002) (82,148)
------------ ------------ ------------ ------------
------------
Earnings (loss) before income taxes (1,798,433) (1,699,767) (1,897,778) 1,462,804
Income tax benefit (expense) -- 450,000 -- (225,000)
------------ ------------ ------------ ------------
Net earnings (loss) $ (1,798,433) $ (1,249,767) $ (1,897,778) $ 1,237,804
------------------- ============ ============ ============ ============
Earnings (loss) per share of common stock - basic $ (0.26) $ (0.18) $ (0.28) $ 0.18
------------------------------------------------- ============ ============ ============ ============
Earnings (loss) per share of common stock - diluted $ (0.26) $ (0.18) $ (0.28) $ 0.18
--------------------------------------------------- ============ ============ ============ ============
Weighted average number of common and common
equivalent shares outstanding - basic 6,835,928 6,761,660 6,797,073 6,757,971
============ ============ ============ ============
Weighted average number of common and common
equivalent shares outstanding - diluted 6,835,928 6,761,660 6,797,073 6,834,731
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
2
SPIRE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
2004 2003
------------ ------------
Cash flows from operating activities:
-------------------------------------
Net income (loss) $ (1,897,778) $ 1,237,804
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 1,887,218 1,023,492
Gain on sale of license (3,000,000) (4,989,150)
Changes in assets and liabilities (excluding business acquisition):
Restricted cash 43,192 (520,690)
Accounts receivable, net 811,760 1,125,149
Inventories (875,276) 586,648
Prepaid expenses and other current assets (149,299) 146,077
Refundable income taxes 193,600 --
Accounts payable, accrued liabilities and other liabilities (642,509) (937,203)
Unearned purchase discount (108,889) (20,295)
Deposit - related party (168,750) --
Other assets -- (2,001)
Advances on contracts in progress (80,663) 222,713
------------ ------------
Net cash used in operating activities (3,987,394) (2,127,456)
------------ ------------
Cash flows provided by investing activities:
--------------------------------------------
Proceeds from sale of license 3,000,000 4,989,150
Additions to property and equipment (334,756) (831,217)
Acquisition, net of cash acquired -- (954,351)
Increase in intangible and other assets (493,439) (159,221)
------------ ------------
Net cash provided by investing activities 2,171,805 3,044,361
------------ ------------
Cash flows from financing activities:
-------------------------------------
Principal payments on capital lease obligation (278,492) (109,719)
Principal payments on capital lease obligation - related party (287,859) (117,107)
Exercise of stock options 156,867 12,215
------------ ------------
Net cash used in financing activities (409,484) (214,611)
------------ ------------
Net increase (decrease) in cash and cash equivalents (2,225,073) 702,294
Cash and cash equivalents, beginning of period 5,999,091 7,798,716
------------ ------------
Cash and cash equivalents, end of period $ 3,774,018 $ 8,501,010
------------ ------------
Supplemental disclosures of cash flow information:
--------------------------------------------------
Acquisition of Bandwidth Semiconductor:
Assets acquired $ -- $ 3,998,595
Liabilities assumed (including related party obligation of $1,247,241) -- (3,044,244)
------------ ------------
Cash paid $ -- $ 954,351
------------ ------------
Non cash financing activities:
Capital lease obligation for building - related party $ -- $ 3,390,397
------------ ------------
Cash paid (received) during the period for:
Interest $ 61,552 $ 34,769
------------ ------------
Interest - related party $ 162,137 $ 81,281
------------ ------------
Income taxes $ (193,600) $ 662,000
============ ============
See accompanying notes to condensed consolidated financial statements.
3
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER 30, 2004
1. DESCRIPTION OF THE BUSINESS
The Company develops, manufactures and markets highly-engineered
products and services in four principal business areas: solar equipment, solar
systems, biomedical and optoelectronics, generally bringing to bear expertise in
materials technologies, surface science and thin films across all four business
areas.
In the solar equipment area, the Company develops, custom manufactures
and markets specialized equipment for the production of terrestrial photovoltaic
modules from solar cells. The Company's equipment has been installed in more
than 150 factories in 42 countries.
In the solar systems area, the Company provides both stand alone
emergency power backup and electric power grid-connected distributed power
generation systems employing photovoltaic technology.
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 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.
2. INTERIM FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to fairly
present the Company's financial position as of September 30, 2004 and the
results of operations and cash flows for the three and nine months ended
September 30, 2004 and 2003. The results of operations for the three and nine
months ended September 30, 2004 are not necessarily indicative of the results to
be expected for the fiscal year ending December 31, 2004. The unaudited
condensed consolidated statements of cash flows for the nine months ended
September 30, 2003 have been updated to reflect the final allocation of purchase
price related to the Bandwidth Semiconductor, LLC ("Bandwidth") acquisition.
The accounting policies followed by the Company are set forth in Note 2
to the Company's consolidated financial statements in its annual report on Form
10-KSB for the year ended December 31, 2003.
3. NEW ACCOUNTING STANDARD
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46") which requires the
consolidation of variable interest entities by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. In December 2003, the FASB issued FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"). FIN 46R superseded FIN 46 and defers the effective date for small
business filers until the first reporting period that ends after December 15,
2004 (fourth quarter of 2004). The Company adopted of FIN 46R on January 1, 2004
and adoption did not have a material impact on the Company's financial position
or results of operations.
4
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
4. ACCOUNTS RECEIVABLE/ADVANCES ON CONTRACTS IN PROGRESS
Net accounts receivable, trade consists of the following:
September 30,
2004
------------
Amounts billed $ 3,036,585
Retainage 40,671
Accrued revenue 497,050
------------
3,574,306
Less: Allowance for sales returns and doubtful accounts (145,729)
------------
Net accounts receivable $ 3,428,577
============
Advances on contracts in progress $ 1,099,130
============
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. 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 $41,000 at September 30, 2004. All other accounts receivable are
expected to be collected within one year.
All contracts with United States government agencies have been audited
by the government through December 2002. The Company has not incurred
significant losses or adjustments as a result of government audits.
The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to pay amounts due. Bad
debts are written off against the allowance when identified. 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 but revenue has not been recognized.
5. INVENTORIES
Inventories consist of the following:
September 30,
2004
------------
Raw materials $ 1,162,174
Work in process 846,456
Finished goods 297,635
------------
$ 2,306,265
------------
5
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
6. 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 periods ended:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Weighted average number of common and
common equivalent shares outstanding - basic 6,835,928 6,761,660 6,797,073 6,757,971
Add: Net additional common shares upon
assumed exercise of common stock options -- -- -- 76,760
------------ ------------ ------------ ------------
Adjusted weighted average common and
common equivalents shares outstanding - diluted 6,835,928 6,761,660 6,797,073 6,834,731
============ ============ ============ ============
For the three and nine months ended September 30, 2004, 155,793 and
227,026 shares of common stock issuable relative to stock options were excluded
from the calculation of dilutive shares since the inclusion of such shares would
be anti-dilutive due to the Company's net loss position in the periods. In
addition, for the three and nine months ended September 30, 2004, 120,777 and
96,433 shares, respectively, 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 three months ended September 30, 2003, 173,147 shares of common
stock issuable relative to stock options were excluded from the calculation of
dilutive shares since the inclusion of such shares would be anti-dilutive due to
the Company's net loss position in the period. In addition, for the three and
nine months ended September 30, 2003, 55,000 and 418,014 shares, respectively,
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.
7. 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", which was adopted in 1998.
The results for Bandwidth Semiconductor have been combined with the
Company's Biophotonics Lifesciences segment which has been renamed the
Optoelectronics segment. The acquisition of Bandwidth took place on May 23,
2003.
Solar Solar Total
Equipment Systems Biomedical Optoelectronics Company
------------ ------------ ------------ ------------ ------------
For the three months ended September 30, 2004
---------------------------------------------
Net sales and revenues $ 317,808 $ 748,418 $ 2,221,709 $ 439,568 $ 3,727,503
Loss from operations (511,096) (166,696) (524,861) (518,696) (1,721,349)
For the three months ended September 30, 2003
---------------------------------------------
Net sales and revenues $ 1,350,568 $ 384,941 $ 1,602,605 $ 735,199 $ 4,073,313
Loss from operations (242,167) (365,679) (666,049) (357,807) (1,631,702)
For the nine months ended September 30, 2004
--------------------------------------------
Net sales and revenues $ 2,292,499 $ 2,536,289 $ 6,402,408 $ 1,784,438 $ 13,015,634
Earnings (loss) from operations (1,180,299) (228,755) 1,243,145 (1,514,867) (1,680,776)
For the nine months ended September 30, 2003
--------------------------------------------
Net sales and revenues $ 3,545,152 $ 1,195,138 $ 4,908,928 $ 1,138,109 $ 10,787,327
Earnings (loss) from operations (797,813) (911,741) 3,754,826 (500,320) 1,544,952
6
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
The following table shows net sales and revenues by geographic area
(based on customer location):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------------------- --------------------------------------------------
2004 % 2003 % 2004 % 2003 %
----------- ----- ----------- ----- ----------- ----- ----------- -----
Foreign $ 359,000 10% $ 617,000 15% $ 1,510,000 12% $ 2,728,000 25%
United States 3,369,000 90% 3,456,000 85% 11,506,000 88% 8,059,000 75%
----------- ----- ----------- ----- ----------- ----- ----------- -----
$ 3,728,000 100% $ 4,073,000 100% $13,016,000 100% $10,787,000 100%
=========== ===== =========== ===== =========== ===== ===========
Revenues from contracts with United States government agencies for the
three months ended September 30, 2004 and 2003 were $588,000 and $606,000 or 16%
and 15% of consolidated net sales and revenues, respectively.
Revenues from contracts with United States government agencies for the
nine months ended September 30, 2004 and 2003 were $2,053,000 and $1,919,000 or
16% and 18% of consolidated net sales and revenues, respectively.
Two customers accounted for approximately 34% and 27% of the Company's
gross sales during the three months ended September 30, 2004 and 2003,
respectively. One customer accounted for approximately 15% and three customers
accounted for approximately 39% of the Company's gross sales during the nine
months ended September 30, 2004 and 2003, respectively. No customer represented
more than 10% of trade account receivables at September 30, 2004.
8. OTHER INTANGIBLE ASSETS
Patents amounted to $495,506 net of accumulated amortization of $555,553
at September 30, 2004. Licenses amounted to $240,833 net of accumulated
amortization of $59,167 at September 30, 2004. 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. 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. For disclosure
purposes, the table below includes future amortization expense for patents owned
by the Company as well as $382,714 of estimated amortization expense related to
patents that remain pending. Estimated amortization expense for the periods
ending December 31, is as follows:
Year Amortization Expense
-------------------------- --------------------
2004 (fourth quarter only) $ 55,528
2005 199,853
2006 154,025
2007 146,873
2008 121,521
2009 61,539
--------------------
$736,339
====================
9. NOTES PAYABLE AND CREDIT ARRANGEMENTS
On June 23, 2003, the Company entered into a $2,000,000 Loan Agreement
(the "Agreement") with Citizens Bank of Massachusetts. The Agreement provides
Standby Letter of Credit Guarantees for foreign customers and is 100% secured
with cash. The Agreement had an original expiration date of June 30, 2004 and
was amended in June 2004 to extend the expiration date to June 28, 2005. The
amendment also suspended the Agreement's revolving line of credit conversion
feature for one year. At September 30, 2004, the Company had $716,000 of
restricted cash associated with outstanding Letters of Credit. Standby Letters
of Credit under this Agreement bear interest at 1%. 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 September 30,
2004, the Company was in compliance with its financial reporting requirements
and cash balance covenants. Letters of Credit issued with an expiration beyond
June 28, 2005 are required to be 100% secured by cash.
7
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
10. STOCK-BASED COMPENSATION
The Company has adopted the disclosure provisions of Statement of
Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation
- Transition and Disclosure" ("SFAS 148") which is an amendment of SFAS No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123"), and continues to apply
Accounting Principles Board Opinion No. 25 and related interpretations in
accounting for its stock plans. If the Company had elected to recognize
compensation cost for all of the plans based upon the fair value at the grant
dates for awards under those plans, consistent with the method prescribed by
SFAS 123, net earnings (loss) and earnings (loss) per share would have been
changed to the pro forma amounts indicated below.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net earnings (loss), as reported $ (1,798,433) $ (1,249,767) $ (1,897,778) $ 1,237,804
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (86,411) (85,021) (245,299) (254,585)
------------ ------------ ------------ ------------
Pro forma net earnings (loss) $ (1,884,844) $ (1,334,788) $ (2,143,077) $ 983,219
============ ============ ============ ============
Earnings (loss) per share:
Basic - as reported $ (0.26) $ (0.18) $ (0.28) $ 0.18
============ ============ ============ ============
Basic - pro forma $ (0.28) $ (0.20) $ (0.32) $ 0.15
============ ============ ============ ============
Diluted - as reported $ (0.26) $ (0.18) $ (0.28) $ 0.18
============ ============ ============ ============
Diluted - pro forma $ (0.28) $ (0.20) $ (0.32) $ 0.14
============ ============ ============ ============
The per-share weighted-average fair value of stock options granted during the
quarters ended September 30, 2004 and 2003 was $3.94 and $2.25, 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
---- -------------- ------------- ----------- -----------------
2004 -- 4.13% 5 years 77.1%
2003 -- 3.33% 5 years 81.7%
For the quarter ended September 30, 2004, 6,250 stock options were
granted.
11. SALE OF A LICENSE
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 has the right to
cancel the agreement at any time subsequent to the second payment. There can be
no assurances that these milestones will be attained and attainment is beyond
the control of the Company. During the year ended December 31, 2002, the Company
recorded the initial payment under the agreement, resulting in a gain of
$4,464,929, 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
8
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
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
$4,989,150, net of direct costs. During June 2004, the Company received the
first contingent milestone payment and recorded a gain of $3,000,000. There were
no direct costs associated with this payment. These gains have been recorded in
the accompanying unaudited condensed consolidated statements of operations for
the nine months ended September 30, 2004 and 2003, respectively. The Company
believes that the sale of the license does not reflect the day-to-day operations
of the Company. Therefore, the net proceeds received has been classified under
proceeds from a license in the unaudited condensed consolidated statements of
cash flows for the nine months ended September 30, 2004 and September 30, 2003,
respectively.
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 catheter
business.
12. COMMITMENTS
Letters of Credit
-----------------
During the second quarter of 2004, the Company entered into a Purchase
and Sale Agreement (the "Agreement") to supply certain solar systems units and
equipment to a third party. Performance under the Agreement is subject to
several precedent conditions including the issuance of a Standby Letter of
Credit by the Company in favor of the third party and the advance funding of the
total purchase price by the third party to Spire. On July 1, 2004, Spire issued
a $5,860,249 Standby Letter of Credit, as amended, in accordance with the terms
of this Agreement. The Standby Letter of Credit is subject to the terms of the
Company's Loan Agreement as discussed in Note 9 and is only available for
drawing to the extent that payments are received by the Company from the third
party. The Standby Letter of Credit expired on October 31, 2004 as no payment
was received from the third party.
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 (Bandwidth's 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 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 ($168,750 as of
September 30, 2004). The lease agreement does not provide for a transfer of
ownership at any point. Interest costs were assumed at 7%. For the nine months
ended September 30, 2004, interest expense was approximately $162,000. 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 September 30, 2004, $517,000 and $2,398,000 are reflected as the
current and long-term portions of capital lease obligation - related party,
respectively, in the September 30, 2004 unaudited condensed consolidated balance
sheet.
9
SPIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEPTEMBER 30, 2004
Unrelated Party Capital Lease
-----------------------------
In September 2001, Bandwidth Semiconductor, LLC ("Bandwidth") entered
into an agreement with GE Capital Leasing Corp, for the lease of a reactor for
its wafer production line. The lease is accounted for as a capital lease. Under
the lease agreement, the Company is making monthly payments of $36,000. After
the initial three-year period ending in September 2004, the lease allows for an
additional two-year extension. In September 2004, the Company extended the lease
term for the additional two years to September 2006. The lease includes a
residual value guarantee of $204,000 at the end of extended period. Interest
costs were assumed at 7%. For the nine months ended September 30, 2004, interest
expense was approximately $48,000.
10
ITEM 2. 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 THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER SIGNIFICANTLY FROM
THE RESULTS AND TIMING DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED OR REFERRED TO IN THIS REPORT AND IN ITEM 6 OF THE ANNUAL REPORT
ON FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 2003. MANAGEMENT'S DISCUSSION AND
ANALYSIS INCLUDES THE FOLLOWING SECTIONS:
o OVERVIEW;
o RESULTS OF OPERATIONS;
o THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 2003;
o LIQUIDITY AND CAPITAL RESOURCES;
o RECENT ACCOUNTING PRONOUNCEMENTS;
o IMPACT OF INFLATION AND CHANGING PRICES;
o FOREIGN CURRENCY FLUCTUATION;
o RELATED PARTY TRANSACTIONS;
o CRITICAL ACCOUNTING POLICIES; AND
o CONTRACTUAL OBLIGATIONS, COMMERCIAL COMMITMENTS AND OFF-BALANCE SHEET
ARRANGEMENTS.
Overview
--------
The Company develops, manufactures and markets highly-engineered
products and services in four principal business areas: biomedical, solar
equipment, solar systems and optoelectronics, generally bringing to bear
expertise in materials technologies, surface science and thin films across all
four business areas.
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 solar equipment area, the Company develops, custom manufactures
and markets specialized equipment for the production of terrestrial photovoltaic
modules from solar cells. The Company's equipment has been installed in more
than 150 factories in 42 countries.
In the solar systems area, the Company provides both stand alone
emergency power backup and electric power grid-connected distributed power
generation systems employing photovoltaic technology.
In the optoelectronics area, the Company provides 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.
Results of Operations
---------------------
The following table sets forth certain items as a percentage of net
sales and revenues for the periods presented:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------- -----------------
2004 2003 2004 2003
------ ------ ------ ------
Net sales and revenues 100% 100% 100% 100%
Cost of sales and revenues 84 81 81 79
------ ------ ------ ------
Gross profit 16 19 19 21
Selling, general and administrative expenses (54) (49) (47) (45)
Internal research and development (8) (10) (8) (7)
Gain on sale of license -- -- 23 46
------ ------ ------ ------
Earnings (loss) from operations (46) (40) (13) 15
Interest expense, net (2) (2) (2) (1)
------ ------ ------ ------
Earnings (loss) before income taxes (48) (42) (15) 14
Income tax (expense) benefit -- 11 -- (2)
------ ------ ------ ------
Net earnings (loss) (48%) (31%) (15%) 12%
------ ------ ------ ------
11
OVERALL
The Company's total net sales and revenues for the nine months ended
September 30, 2004 ("2004") increased 21% compared to the nine months ended
September 30, 2003 ("2003"). The increase was attributable to an increase in
solar systems in 2004 (12%), the acquisition of Bandwidth Semiconductor, LLC
("Bandwidth") in May 2003 (7%), and to a lesser extent, increases in biomedical
processing services (6%), medical devices (6%), and government funded research
and development activities (4%). These increases were partially offset by a
decrease in solar equipment sales (14%).
SOLAR BUSINESS UNIT
Sales in the Company's solar business unit increased 2% during 2004 as
compared to 2003 primarily due to a 113% increase in solar systems sales
resulting from the temporary permitting challenges experienced in 2003 in the
metro Chicago area that Spire did not encounter in 2004. The increase can also
be attributed to a 113% increase in revenue from government-funded research and
development activities associated with Spire's cost sharing agreement with the
Department of Energy National Renewable Energy Laboratory ("NREL"). These
increases were substantially offset by a 51% decrease in equipment sales in 2004
of the Company's solar energy manufacturing equipment as compared to 2003
primarily due to the sale of a 5 megawatt SPI-LINETM turnkey photovoltaic module
production line.
BIOMEDICAL BUSINESS UNIT
Revenues of the Company's biomedical business unit increased 27% during
2004 as compared to 2003 as a result of a 25% increase in revenue from Spire's
IONGUARD(R) implant process services and an 84% increase in revenue from Spire's
line of hemodialysis catheters and, to a lesser extent, a 6% increase in revenue
from Spire's government-funded research and development activities.
OPTOELECTRONICS
Sales in the Company's optoelectronics business unit increased 76%
during 2004 as compared to 2003, due to the May 23, 2003 acquisition of
Bandwidth Semiconductor, LLC ("Bandwidth").
Operating results will depend upon 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 were 10% of net sales and revenues in
2004 and are expected to continue to constitute a significant portion of the
Company's net sales and revenues.
Three and Nine Months Ended September 30, 2004 Compared to Three and Nine Months
--------------------------------------------------------------------------------
Ended September 30, 2003
------------------------
NET SALES AND REVENUES
The following table categorizes the Company's net sales and revenues for
the periods presented:
Three Months Ended September 30,
-------------------------
Increase/(Decrease)
----------------------
2004 2003 $ %
---------- ---------- ---------- -----
Contract research and service revenues $2,291,000 $2,230,000 $ 61,000 3%
Sales of goods 1,437,000 1,843,000 (406,000) (22%)
---------- ---------- ---------
Net sales and revenues $3,728,000 $4,073,000 $ (345,000) (8%)
========== ========== ==========
The 3% increase in contract research and service revenues for the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003 is primarily attributable to an increase in biomedical processing
services (12%) and an increase in research and development activities (3%) both
offset by a decrease in Bandwidth foundry services (12%). Revenue from Spire's
biomedical processing services increased 28% in 2004 compared to 2003 as a
result of continued strong demand for Spire's IONGUARD implant services.
Revenues from Spire's research and development activities increased 18% in 2004
as compared to 2003 primarily due to an increase in the number of contracts
associated with funded research and development and an increase in revenue from
activities associated with our cost sharing agreement with NREL. Revenues from
Bandwidth foundry services declined 40% in 2004 compared to 2003 due to the
timing and delivery of customer orders.
12
The 22% decrease in sales of goods for the three months ended September
30, 2004 as compared to the three months ended September 30, 2003 was primarily
due to a decrease in solar equipment revenues (58%) offset by increases in
biomedical product sales (16%) and solar systems (20%). Solar equipment sales
decreased 89% in 2004 as compared to 2003 primarily due to the timing and
delivery of customer orders. Biomedical product sales increased 120% in 2004 as
compared to 2003 as a result of increased demand for Spire's line of
hemodialysis catheters and initial sales of Spire's Decathlon product line which
was introduced in December 2003.
The following table categorizes the Company's net sales and revenues for
the periods presented:
Nine Months Ended September 30,
-------------------------
Increase/(Decrease)
----------------------
2004 2003 $ %
---------- ---------- ---------- -----
Contract research and service revenues $7,622,000 $5,748,000 $1,874,000 33%
Sales of goods 5,394,000 5,039,000 355,000 7%
---------- ---------- ---------
Net sales and revenues $13,016,000 $10,787,000 $2,229,000 21%
========== ========== ==========
The 33% increase in contract research and service revenues for the nine
months ended September 30, 2004 is primarily attributable to the acquisition of
Bandwidth (13%) on May 23, 2003, and an increase in biomedical processing
services (12%) and, to a lesser extent, an increase in government-funded
research and development activities associated with Spire's cost sharing
agreement with NREL (8%). Revenue from Spire's biomedical processing services
increased 25% in 2004 compared to 2003 as a result of continued strong demand
for Spire's IONGUARD implant process services.
The 7% increase in sales of goods for the nine months ended September
30, 2004 was primarily due to an increase in solar systems revenues (26%) and,
to a lesser extent, an increase in biomedical product sales (12%), both offset
by a decrease in solar equipment sales (31%). The increase in solar systems
revenues was primarily due to a 113% increase in solar systems revenue in 2004
as compared to 2003 resulting from the temporary permitting challenges
experienced in 2003 in the metro Chicago area that Spire did not encounter in
2004. Biomedical product sales increased 84% in 2004 as compared to 2003 as a
result of increased demand for Spire's line of hemodialysis catheters and
initial sales of Spire's Decathlon product line which was introduced in December
2003. Solar equipment sales decreased 51% in 2004 as compared to 2003 primarily
due to the sale of a 5 megawatt SPI-LINE turnkey photovoltaic module production
line in 2003.
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:
Three Months Ended September 30,
-----------------------------------------------
Increase/(Decrease)
----------------------
2004 % 2003 % $ %
---------- ----- ---------- ----- ---------- -----
Cost of contract research and services $1,792,000 78% $1,767,000 79% $ 25,000 1%
Cost of goods sold 1,354,000 94% 1,549,000 84% (195,000) (13%)
---------- ---------- ----------
Net cost of sales and revenues $3,146,000 84% $3,316,000 81% $ (170,000) (5%)
========== ========== ==========
The $25,000 (1%) increase in cost of contract research and service
revenues in 2004 is primarily due to a 32% increase in the Company's biomedical
processing services direct costs associated with its 28% increase in revenues.
The decline in profit margins associated with the biomedical processing services
is primarily attributable to product mix. This increase was substantially offset
by a 24% decrease in factory overhead and direct costs associated with the
Company's semiconductor foundry. This decrease was attributable to a cost
adjustment associated with a one-time business interruption insurance payment
recovered during the quarter. The decrease in cost of contract research and
services as a percentage of revenues is due to a greater mix of biomedical
processing services margin in 2004 as compared to 2003.
The $195,000 (13%) decrease in cost of goods sold is primarily due to a
76% decrease in Spire's solar equipment direct costs resulting from its 89%
decrease in revenues discussed above. This decrease was substantially offset by
increases in Spire's solar systems and biomedical products units due to
increased sales levels in both units. The increase in cost of goods sold as a
percentage of revenue is the result of the decrease in solar equipment sales
discussed above and a decrease in margin in our biomedical products units both
offset by improved contribution margins at our Chicago facility due to the
increase in revenues discussed above.
13
COST OF SALES AND REVENUES
Nine Months Ended September 30,
------------------------------------
Increase/(Decrease)
----------------------
2004 % 2003 % $ %
----------- ----- ---------- ----- ---------- -----
Cost of contract research and services $ 5,911,000 78% $4,022,000 70% $1,889,000 47%
Cost of goods sold 4,662,000 86% 4,559,000 90% 103,000 2%
----------- ---------- ----------
Net cost of sales and revenues $10,573,000 81% $8,581,000 80% $1,992,000 23%
=========== ========== ==========
The $1,889,000 (47%) increase in cost of contract research and service
revenues in 2004 is primarily due to increased factory overhead and direct costs
of $1,247,000 associated with the Company's semiconductor foundry and a $667,000
increase in biomedical processing services costs associated with its 25%
increase in revenues. The increase was partially offset by a decrease in cost of
sales associated with Spire's research and development activities. The increase
in cost of contract research and service revenues as a percentage of revenues is
the direct result of the Bandwidth acquisition, which recorded a -30% gross
margin in 2004.
The $103,000 (2%) increase in cost of goods sold in 2004 is due to
increased direct costs of $630,000 in solar systems costs and $579,000 in
biomedical product costs both offset by a $1,106,000 decrease in solar equipment
costs. The decrease in cost of goods sold as a percentage of revenue is the
result of improved contribution margins at the Chicago facility and increased
contribution from Spire's hemodialysis catheter product line both partially
offset by reduced absorption of fixed costs within Spire's solar equipment line
resulting from its decrease in revenue.
INTERNAL RESEARCH AND DEVELOPMENT
Internal research and development for the three months ended September
30, 2004 decreased $79,000 or 21% to $309,000, compared to $388,000 for the
three months ended September 30, 2003. The decrease was primarily a result of
reduced internal research projects within the biomedical segment. As a
percentage of sales and revenues, internal research and development decreased 1%
primarily due to reduced efforts with the biomedical segment noted above
partially offset by the decrease in sales and revenues.
Internal research and development for the nine months ended September
30, 2004 increased $271,000 or 35% to $1,039,000, compared to $768,000 for the
nine months ended September 30, 2003. The increase was primarily a result of the
Company's continued investment in its semiconductor foundry and the "next
generation" solar energy module manufacturing equipment under a cost-sharing
contract with NREL. These increases were partially offset by decreased research
and development efforts within the biomedical products group. As a percentage of
sales and revenues, internal research and development increased 1% primarily due
to the continued investments discussed above partially offset by the increase in
sales and revenue.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months ended
September 30, 2004 decreased $6,000 to $1,995,000, or 54% of sales and revenues,
compared to $2,001,000 or 49% of sales and revenues for the three months ended
September 30, 2003. The decrease was due primarily to decreased cost associated
with legal and audit expenses in connection with increased compliance
requirements partially offset by increased cost associated with sales and
marketing efforts of the Company's biomedical products and solar business units.
The increase in selling, general and administrative expenses as a percentage of
sales and revenues was primarily due to the decrease in sales and revenue.
Selling, general and administrative expenses for the nine months ended
September 30, 2004 increased $1,201,000 to $6,084,000, or 47% of sales and
revenues, compared to $4,883,000 or 45% of sales and revenues for the nine
months ended September 30, 2003. The increase was due primarily to increased
costs associated with sales and marketing efforts of the Company's biomedical
products and solar business units, the addition of Bandwidth and increased costs
associated with legal and auditing expenses in connection with increased
compliance requirements. The increase in selling, general and administrative
expenses as a percentage of sales and revenues was primarily due to the dollar
increases described above partially offset by the increase in sales and revenue.
14
INTEREST
The Company earned $13,000 and $24,000 of interest income for the
quarters ended September 30, 2004 and 2003, respectively. The Company incurred
interest expense of $90,000 and $92,000 for the quarters ended September 30,
2004 and 2003, respectively. The interest expense is primarily associated with
interest incurred on capital leases associated with the semiconductor foundry.
The Company earned $48,000 and $64,000 of interest income for the nine
months ended September 30, 2004 and 2003, respectively. The Company incurred
interest expense of $265,000 and $146,000 for the nine months ended September
30, 2004 and 2003, respectively. The interest expense is primarily associated
with interest incurred on capital leases associated with the semiconductor
foundry.
INCOME TAXES
The Company incurred zero income tax expense for the quarter and the
nine months ended September 30, 2004, compared to income tax benefit of $450,000
for the quarter September 30, 2003 and a tax expense of $225,000 the nine months
ended September 30, 2003. The effective tax rate was a benefit of 26% for the
three months ended September 30, 2003 and 15% for the nine months ended
September 30, 2003. A valuation allowance has been provided against the current
year income tax benefit due to uncertainty regarding the realization of the net
operating loss in the future.
NET EARNINGS (LOSS)
The Company reported a net loss for the three months ended September 30,
2004 of $1,798,000, compared to a net loss of $1,250,000 in 2003. The net loss
increased $548,000 primarily due to the $450,000 income tax benefit recognized
in the third quarter of 2003.
The Company reported a net loss for the nine months ended September 30,
2004 of $1,898,000, compared to net earnings of $1,238,000 in 2003. The loss for
the nine months ended September 30, 2004 is attributable to the Company's
operations as outlined above offset by the Company's income associated with the
$3,000,000 gain on the sale of license. The Net earnings (loss) decreased
$3,136,000 primarily due to the $1,989,000 decrease in the gain on sale of
license and, to a lesser extent, the increased fixed costs associated with the
Company's semiconductor foundry.
Liquidity and Capital Resources
-------------------------------
Cash and cash equivalents decreased $2,225,000 to $3,774,000 as of
September 30, 2004 primarily due to $3,987,000 of cash used in operations and,
to a lesser extent, investments in patents and licenses and payments on capital
leases. These decreases were substantially offset by the $3,000,000 proceeds
from the sale of a license.
The Company has historically funded its operating cash requirements
using operating cash flow and proceeds from the sale and licensing of
technology. The Company's liquidity position benefited as a result of cash
receipts of $5,000,000 in each of the years ended December 31, 2003 and 2002,
and $3,000,000 in the nine months ended September 30, 2004 arising from the sale
of a hemodialysis patent license to Bard Access Systems. The license sale
agreement provides for the Company to receive one additional contingent cash
payment of $3,000,000 upon the completion of certain milestones by Bard Access
Systems during 2005. There can be no assurance that these milestones will be
attained and attainment is beyond the control of the Company.
On June 23, 2003, the Company entered into a $2,000,000 Loan Agreement
(the "Agreement") with Citizens Bank of Massachusetts. The Agreement provides
Standby Letter of Credit Guarantees for foreign customers and is 100% secured
with cash. The Agreement had an original expiration date of June 30, 2004 and
was amended in June 2004 to extend the expiration date to June 28, 2005. The
amendment also suspended the Agreement's revolving line of credit conversion
feature for one year. At September 30, 2004, the Company had $716,000 of
restricted cash associated with outstanding letters of credit. Standby Letters
of Credit under this Agreement bear interest at 1%. 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 September 30,
2004, the Company was in compliance with its financial reporting requirements
and cash balance covenants. Letters of Credit issued with an expiration beyond
June 28, 2005 are required to be 100% secured by cash.
15
To date, there are no material commitments by the Company for capital
expenditures. At September 30, 2004, the Company's retained earnings were
$572,000, compared to retained earnings of $2,470,000 as of December 31, 2003.
Working capital as of September 30, 2004 decreased to $5,993,000, compared to
$8,182,000 as of December 31, 2003.
During the second quarter of 2004, the Company entered into a Purchase
and Sale Agreement (the "Agreement") to supply certain solar systems units and
equipment to a third party. Performance under the Agreement is subject to
several precedent conditions including the issuance of a Standby Letter of
Credit by the Company in favor of the third party and the advance funding of the
total purchase price by the third party to Spire. On July 1, 2004, Spire issued
a $5,860,249 Standby Letter of Credit, as amended, in accordance with the terms
of this Agreement. The Standby Letter of Credit is subject to the terms of the
Company's Loan Agreement as discussed in Note 9 and is only available for
drawing to the extent that payments are received by the Company from the third
party. The Standby Letter of Credit expired on October 31, 2004 as no payment
was received from the third party.
The Company believes it has sufficient resources to finance its current
operations for the foreseeable future through working capital.
Recent Accounting Pronouncements
--------------------------------
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46") which requires the
consolidation of variable interest entities by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. In December 2003, the FASB issued FASB
Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN
46R"). FIN 46R superseded FIN 46 and defers the effective date for small
business filers until the first reporting period that ends after December 15,
2004 (fourth quarter of 2004). The Company adopted of FIN 46R on January 1, 2004
and adoption did not have a material impact on the Company's financial position
or results of operations.
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.
Related Party Transactions
--------------------------
The Company subleases 74,000 square feet in a building leased by
Mykrolis Corporation, who in turn leases the building from 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. The Company believes
that the terms of the third-party sublease are commercially reasonable. 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 agreement provides for minimum rental
payments plus annual increases linked to the consumer price index. Rent expense
under this sublease for the nine months ended September 30, 2004 was $809,000.
In connection with this sublease, the Company is invoiced and pays certain Trust
related expenses, including building maintenance and insurance. The Company
invoices the Trust on a monthly basis and the Trust reimburses the Company for
all such costs.
In conjunction with the acquisition of Bandwidth by the Company, the
Company released Bandwidth from the lease agreement that had existed between
Bandwidth and the Company. In November 2001, Bandwidth, under its previous
16
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
continues 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. As of September 30, 2004, the
remaining lease obligation is $598,091, which is reflected as "accrued lease
obligation - related party" in the June 30, 2004 unaudited condensed
consolidated balance sheet. The amount due beyond one year has been reflected in
long-term liabilities. The difference between the actual rent payment and the
discounted rent payment will be accreted to the consolidated statements of
operations as interest expense. Interest of 4.75% has been assumed on this
obligation. For the nine months ended September 30, 2004, interest expense was
approximately $29,000.
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 (Bandwidth's 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 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 ($168,750 as of
September 30, 2004). The lease agreement does not provide for a transfer of
ownership at any point. Interest costs were assumed at 7%. For the nine months
ended September 30, 2004, interest expense was approximately $162,000. 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 September 30, 2004, $516,638 and $2,398,139 are reflected as the
current and long-term portions of capital lease obligation - related party,
respectively, in the accompanying unaudited condensed 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 unaudited
condensed consolidated financial statements are those relating to revenue
recognition, impairment of long-lived assets, acquisition accounting, income
taxes, and warranties. 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 unaudited condensed
consolidated financial statements. Refer to Footnote 2 of our notes to
consolidated financial statements in our annual report on Form 10-KSB for the
year ended December 31, 2003 for a description of our accounting policies for
income taxes and warranties.
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.
17
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.
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. 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 EXW 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 a percentage- of-completion method of accounting using a
cost-to-cost methodology. 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 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.
ACQUISITION ACCOUNTING
Through its acquisition, the Company has accumulated assets, the
valuation of which involves estimates based on fair value assumptions. Estimated
lives assigned to the assets acquired in a business purchase also involve the
use of estimates. These matters that are subject to judgments and estimates are
inherently uncertain, and different amounts could be reported using different
methodologies. Management uses its best estimate in determining the appropriate
values and estimated lives to reflect in the consolidated financial statements,
using historical experience, market data, and all other available information.
18
Contractual Obligations, Commercial Commitments and Off-Balance Sheet
---------------------------------------------------------------------
Arrangements
------------
The following table summarizes the Company's gross contractual
obligations at September 30, 2004 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 $2,248,000 $2,135,000 $ 113,000 $ -- --
CAPITAL LEASES:
Unrelated party capital lease $1,042,000 $ 437,000 $ 605,000 $ -- --
Related party capital lease 3,364,000 705,000 1,860,000 799,000 --
OPERATING LEASES:
Unrelated party operating leases $ 236,000 $ 160,000 $ 64,000 $ 12,000 --
Related party operating lease 1,244,000 1,066,000 178,000 -- --
Purchase obligations include all open purchase orders outstanding
regardless of whether they are cancelable or not.
Capital lease obligations outlined above include both the principal and
interest components of these contractual obligations. Included in the related
party operating lease is the accrued lease obligation in the amount of $598,091.
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 has the right to reclaim the equipment should the
Company not meet its obligations in the Purchase Commitment. The proceeds from
the sale of the production equipment purchased by BPS have been classified as an
unearned purchase discount in the accompanying unaudited condensed consolidated
balance sheet. The Company will amortize this discount as a reduction to cost of
sales as it purchases solar cells from BPS. During the quarter ended September
30, 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 $108,889 for the
nine months ended September 30, 2004.
In addition, the agreement contains 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 allows 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. As of September 30, 2004, the Company has no intention of terminating
the agreement.
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 has the right to
cancel the agreement at any time subsequent to the second payment. There can be
no assurances that these milestones will be attained and attainment is beyond
the control of the Company. During the year ended December 31, 2002, the Company
recorded the initial payment under the agreement, resulting in a gain of
$4,464,929, 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
19
payment due and recorded a gain of $4,989,150, net of direct costs. During June
2004, the Company received the first contingent milestone payment and recorded a
gain of $3,000,000. There were no direct costs associated with this payment.
Outstanding letters of credit totaled $716,000 at September 30, 2004.
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 February 3, 2006 and are 100% secured by cash.
During the second quarter of 2004, the Company entered into a Purchase
and Sale Agreement (the "Agreement") to supply certain solar systems units and
equipment to a third party. Performance under the Agreement is subject to
several precedent conditions including the issuance of a Standby Letter of
Credit by the Company in favor of the third party and the advance funding of the
total purchase price by the third party to Spire. On July 1, 2004, Spire issued
a $5,860,249 Standby Letter of Credit, as amended, in accordance with the terms
of this Agreement. The Standby Letter of Credit is subject to the terms of the
Company's Loan Agreement as discussed in Note 9 and is only available for
drawing to the extent that payments are received by the Company from the third
party. The Standby Letter of Credit expired on October 31, 2004 as no payment
was received from the third party.
ITEM 3. 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
September 30, 2004. 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, in the course of this
evaluation, management considered certain internal control areas, including
those discussed below, in which we have made and are continuing to make changes
to improve and enhance controls. Based upon the required evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that as of September
30, 2004 the Company's disclosure controls and procedures were effective (at the
"reasonable assurance" level mentioned above) 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.
From time to time, the Company and its management have conducted and
will continue to conduct further reviews and, from time to time put in place
additional documentation, of the Company's disclosure controls and procedures,
as well as its internal control over financial reporting. The Company may from
time to time make changes aimed at enhancing their effectiveness, as well as
changes aimed at ensuring that the Company's systems evolve with, and meet the
needs of, the Company's business. These changes may include changes necessary or
desirable to address recommendations of the Company's management, its counsel
and/or its independent auditors, including any recommendations of its
independent auditors arising out of their audits and reviews of the Company's
financial statements. These changes may include changes to the Company's own
systems, as well as to the systems of businesses that the Company has acquired
or that the Company may acquire in the future and will, if made, be intended to
enhance the effectiveness of the Company's controls and procedures. The Company
is also continually striving to improve its management and operational
efficiency and the Company expects that its efforts in that regard will from
time to time directly or indirectly affect the Company's disclosure controls and
procedures, as well as the Company's internal control over financial reporting.
As disclosed in our annual report on Form 10-KSB for the year ended
December 31, 2003, the Company's independent auditor, Vitale, Caturano and
Company, Ltd. ("VCC") advised management and the Audit Committee by a letter
dated March 18, 2004 that, in connection with its audit of the Company's
consolidated financial statements for the year ended December 31, 2003, it noted
certain matters involving internal control and its operation that it considered
to be a material weakness under standards established by the American Institute
of Certified Public Accountants. Reportable conditions are matters coming to an
independent auditors' attention that, in their judgment, relate to significant
deficiencies
20
in the design or operation of internal control and could adversely affect the
organization's ability to record, process, summarize, and report financial data
consistent with the assertions of management in the financial statements.
Further, a material weakness is a reportable condition in which the design or
operation of one or more internal control components does not reduce to a
relatively low level the risk that errors or fraud in amounts that would be
material in relation to the financial statements being audited may occur and not
be detected within a timely period by employees in the normal course of
performing their assigned functions. VCC advised management and the Audit
Committee that it considered the following to constitute material weaknesses in
internal control and operations: (i) the Company's failure to adequately staff
its finance group with the appropriate level of experience to effectively
control the increased level of transaction activity, address the complex
accounting matters and manage the increased financial reporting complexities
resulting from, among other things, the acquisition of Bandwidth, the
implementation of a new financial reporting system and the investigation
surrounding the filing and eventual restatement of the Company's Form 10-QSB, as
amended, for the quarter ended June 30, 2003 and (ii) the Company's current
monthly close process does not mitigate the risk that material errors could
occur in the books, records and financial statements, and does not ensure that
those errors would be detected in a timely manner by the Company's employees in
the normal course of performing their assigned functions. The matter noted in
clause (i) above was similar to the material weakness noted by our former
independent auditor (as disclosed in prior SEC filings). VCC noted that these
matters were considered by it during its audit and did not modify the opinion
expressed in its independent auditor's report dated March 18, 2004.
The Company is still in the process of assessing the findings of its
independent auditors. The Company has implemented several of the specific
recommendations noted by the independent auditors letter including: instituting
a disciplined and timely monthly close process, detailed reviews of the monthly
closing packages by the appropriate levels of management and monthly
reconciliations of all account balances. These efforts have been supplemented by
detailed, substantive reviews by Company management to ensure that the
information 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. As noted above, however, the Company has made and is
continuing to make changes in its controls and procedures, including its
internal control over financial reporting, aimed at enhancing their
effectiveness and ensuring that the Company's systems evolve with, and meet the
needs of, the Company's business. As further noted above, the Company is also
continually striving to improve its management and operational efficiency and
the Company expects that its efforts in that regard will from time to time
directly or indirectly affect the Company's controls and procedures, including
its internal control over financial reporting. For example, the Company has
recently added to its accounting staff and expects to hire additional
professionals and the Company has recently completed compliance training and
will continue to arrange for additional training for its staff. On April 1,
2004, the Company hired a permanent chief financial officer with the appropriate
experience and background to manage the diverse and complex financial issues
which may arise in the Company's business. The Company is also continuing its
efforts to upgrade its information technology capabilities and has completed the
implementation of a common accounting system at all of its business units.
Changes in Internal Control Over Financial Reporting
----------------------------------------------------
There was no change in the Company's internal control over financial
reporting that occurred during the third fiscal quarter of 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
21
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
--------
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.
b. Reports on Form 8-K
-------------------
None.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Spire Corporation
Dated: November 12, 2004 By: /s/ Roger G. Little
----------------------------------------
Roger G. Little
Chairman of the Board, Chief Executive
Officer and President
Dated: November 12, 2004 By: /s/ James F. Parslow
----------------------------------------
James F. Parslow
Chief Financial Officer
23