UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES


EXCHANGE ACT OF 1934





FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011





 ̈  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES


EXCHANGE ACT OF 1934





COMMISSION FILE NUMBER 0-10999





COMPOSITE TECHNOLOGY CORPORATION


(Exact Name of Registrant as Specified in Its Charter)





NEVADA

59-2025386State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer Identification No.)2026 McGaw Avenue, Irvine, CA

92614(Address of Principal Executive Offices)

(Zip Code)





(949) 428-8500


(Registrant's Telephone Number, Including Area Code)





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





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES   ̈ NO   ̈





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)





Large accelerated filer   ̈
Accelerated filer  xNon-accelerated filer   ̈  (Do not check if a smaller reporting company)
Smaller reporting company   ̈





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  ̈ NO x





APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY


PROCEEDING DURING THE PRECEDING FIVE YEARS:





Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. YES  x NO  ̈





APPLICABLE ONLY TO CORPORATE ISSUERS:





Indicate the number of shares outstanding of each of the issuer's classes of common stock as of: June 15, 2011





CLASS

NUMBER OF SHARES OUTSTANDINGCommon Stock, par value $0.001 per share

288,519,660 shares





COMPOSITE TECHNOLOGY CORPORATION


Form 10-Q for the Quarter ended March 31, 2011


Table of Contents





PagePART I – FINANCIAL INFORMATIONItem 1    Financial Statements

3Item 2    Management's Discussion and Analysis of Financial Condition and Results of Operations

30Item 3    Quantitative and Qualitative Disclosures About Market Risk

43Item 4    Controls and Procedures

43PART II – OTHER INFORMATIONItem 1    Legal Proceedings

45Item 1A Risk Factors

47Item 2    Unregistered Sales of Equity Securities and the Use of Proceeds

49Item 3    Defaults Upon Senior Securities

49Item 4    (Removed and Reserved)

50Item 5    Other Information

50Item 6    Exhibits

51SIGNATURES

53EXHIBITS


2


PART 1 – FINANCIAL INFORMATION





Item 1. Financial Statements





COMPOSITE TECHNOLOGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED BALANCE SHEETS


(IN THOUSANDS, EXCEPT PAR VALUE AND SHARE AMOUNTS)





March 31,

2011


September 30,

2010(unaudited)ASSETSCURRENT ASSETSCash and Cash Equivalents

$
4,720


$
2,998Restricted Cash, Current Portion


1,818



11,689Accounts Receivable, net of reserve of $87 and $217, respectively


1,572



2,339Inventory


3,232



3,557Prepaid Expenses and Other Current Assets


1,002



1,111Current Assets of Discontinued Operations


268



2,220Total Current Assets


12,612



23,914Property and Equipment, net of accumulated depreciation of $2,906 and $2,721, respectively


2,802



2,936Restricted Cash, Non-Current


3,000



4,667Other Assets


579



778TOTAL ASSETS

$
18,993


$
32,295LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)CURRENT LIABILITIESAccounts Payable and Other Accrued Liabilities

$
8,776


$
6,012Deferred Revenue and Customer Advances


303



1,386Warranty Provision


251



306Derivative Liabilities – Current


—



2Loans Payable – Current, net of discount of $636 and $919, respectively


9,464



9,081Current Liabilities of Discontinued Operations


33,753



38,507Total Current Liabilities


52,547



55,294LONG-TERM LIABILITIESLong-Term Portion of Deferred Revenue


436



514Long-Term Portion of Warranty Provision


130



218Derivative Liabilities – Long-Term


1,281



1,295Total Long-Term Liabilities


1,847



2,027Total Liabilities


54,394



57,321COMMITMENTS AND CONTINGENCIESSHAREHOLDERS' EQUITY (DEFICIT)Common Stock, $.001 par value; 600,000,000 shares authorized; 288,519,660 and 288,269,660 issued and outstanding, respectively


289



288Additional Paid in Capital


253,635



252,215Accumulated Deficit


(289,327
)


(277,530
)Accumulated Other Comprehensive Income


2



1Total Shareholders’ (Deficit)


(35,401
)


(25,026
)TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)

$
18,993


$
32,295





The accompanying notes are an integral part of these financial statements.


3


COMPOSITE TECHNOLOGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS


(IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)


(UNAUDITED)





Three Months Ended

March 31,


Six Months Ended

March 31,2011


2010


2011


2010Revenue

$
1,393


$
4,252


$
6,587


$
6,953Cost of Revenue


1,179



3,241



4,962



5,724Gross Profit


214



1,011



1,625



1,229OPERATING EXPENSESOfficer Compensation


622



816



1,229



1,385General and Administrative


1,835



3,126



3,909



6,991Research and Development


591



490



1,153



1,146Sales and Marketing


1,791



1,847



3,498



2,984Depreciation & Amortization


57



163



120



259Total Operating Expenses


4,896



6,442



9,909



12,765LOSS FROM OPERATIONS


(4,682
)


(5,431
)


(8,284
)


(11,536
)OTHER INCOME / (EXPENSE)Interest Expense


(949
)


(175
)


(1,619
)


(1,068
)Interest Income


—



5



1



21Other Income / (Expense)


39



—



59



(264
)Change in Fair Value of Derivative Liabilities (Note 1)


491



66



151



840Total Other Expense


(419
)


(104
)


(1,408
)


(471
)Loss from Continuing Operations before Income Taxes


(5,101
)


(5,535
)


(9,692
)


(12,007
)Income Tax Expense


—



—



—



14NET LOSS FROM CONTINUING OPERATIONS


(5,101
)


(5,535
)


(9,692
)


(12,021
)Income (Loss) from Discontinued Operations, net of tax of $0, $0, $0 and $1, respectively (Note 2)


(3,498
)


2,307



(2,104
)


1,085NET LOSS


(8,599
)


(3,228
)


(11,796
)


(10,936
)OTHER COMPREHENSIVE INCOMEForeign Currency Translation Adjustment, net of tax of $0


—



—



1



—COMPREHENSIVE LOSS

$
(8,599
)

$
(3,228
)

$
(11,795
)

$
(10,936
)BASIC AND DILUTED LOSS PER SHARELoss per share from continuing operations

$
(0.02
)

$
(0.02
)

$
(0.03
)

$
(0.04
)Income (loss) per share from discontinued operations

$
(0.01
)

$
0.01


$
(0.01
)

$
—TOTAL BASIC AND DILUTED LOSS PER SHARE

$
(0.03
)

$
(0.01
)

$
(0.04
)

$
(0.04
)WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING


288,508,549



288,233,818



288,387,792



288,167,108





The accompanying notes are an integral part of these financial statements.


4


COMPOSITE TECHNOLOGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS


(IN THOUSANDS)


(UNAUDITED)





Six Months Ended March 31,2011


2010CASH FLOWS FROM OPERATING ACTIVITIESNet loss

$
(11,796
)

$
(10,936
)Adjustments to reconcile net loss to net cash used in operating activities:(Income) loss from discontinued operations


2,104



(1,085
)Interest and deferred finance charge amortization related to detachable warrants and fixed conversion features


924



542Depreciation and amortization


185



318Share-based compensation


987



1,489Amortization of prepaid expenses paid in stock/warrants


34



180Issuance of warrants for services


254



57Issuance of stock for services


50



45Change in fair value of derivative liabilities


(151
)


(840
)Bad debt expense (recovery)


29



31Loss on disposal of fixed assets


—



90Changes in Assets / Liabilities:Accounts receivable


738



(75
)Inventory


325



1,549Prepaids and other current assets


(108
)


(324
)Other assets


167



9Accounts payable and other accruals


2,641



(688
)Deferred revenue


(1,162
)


40Accrued warranty liability


(143
)


33Net assets/liabilities of discontinued operations


(4,907
)


(2,535
)Net cash used in operating activities

$
(9,829
)

$
(12,100
)CASH FLOW FROM INVESTING ACTIVITIESPurchase of property and equipment

$
(50
)

$
(124
)Restricted cash


11,538



(8
)Net cash provided by (used in) investing activities

$
11,488


$
(132
)CASH FLOW FROM FINANCING ACTIVITIESProceeds from exercise of options

$
—


$
7Proceeds from loans payable


899



—Repayments of loans payable


(836
)


(9,037
)Net cash provided by (used in) financing activities

$
63


$
(9,030
)Total net increase (decrease) in cash and cash equivalents

$
1,722


$
(21,262
)Cash and cash equivalents at beginning of period


2,998



23,968Cash and cash equivalents at end of period

$
4,720


$
2,706SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:INTEREST PAID

$
695


$
430INCOME TAX PAID

$
—


$
14





The accompanying notes are an integral part of these financial statements.


5


SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:





During the six months ended March 31, 2011, the Company:





Issued 1,400,000 warrants at an exercise price of $0.25 per share to six accredited investors, none of whom are affiliates of the Company, in conjunction with $700,000 Bridge Notes financing totaling $700,000.  The Company recorded $180,000 as debt discount for the warrants issued, and recorded $169,000 to interest expense during the six months ended March 31, 2011.  See Note 9.





Issued 472,548 warrants at an exercise price of $0.25 per share to Domonic Carney, the Company’s Chief Financial Officer, Stewart Ramsay, CTC Cable President, and two of the Company’s Directors, Michael Lee and Dennis Carey, in conjunction with Bridge Notes financing totaling $236,274.  The Company recorded $55,000 as debt discount for the warrants issued, and recorded the same amount to general and administrative expenses after full payment of the notes during the six months ended March 31, 2011.  See Note 9.





Issued 2,500,000 warrants at an exercise price of $0.30 per share valued at $225,000 in connection with performance-based service agreements.




Issued 300,000 warrants at an exercise price of $0.35 per share valued at $29,000 for consulting services rendered.




Issued 250,000 shares of common stock to Stewart Ramsay, CTC Cable President, valued at $50,000 in partial payment of an employment acceptance bonus.




Re-priced 10,000,000 warrants in connection with the April 2010 debt financing transaction, which resulted in $135,000 recorded to debt discount and derivative liabilities.  Additionally, the Company accrued a fee of $160,000, and recorded as debt discount.  These costs relate to a December 2010 waiver and modification agreement as discussed in Note 9.




During the six months ended March 31, 2010, the Company:




Issued 300,000 warrants at an exercise price of $0.45 per share valued at $57,000 in settlement of a legal dispute.




Issued 161,290 shares of common stock to John Brewster, CTC Cable President, valued at $45,000 in partial payment of an employment acceptance bonus.




Issued 600,000 warrants at an exercise price of $0.35 per share valued at $95,000 in connection with an ongoing service agreement. The Company recorded $16,000 to general and administrative expense related to services rendered during the six months ended March 31, 2010.


6


COMPOSITE TECHNOLOGY CORPORATION AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE THREE MONTHS ENDED MARCH 31, 2011





NOTE 1 – ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES





Composite Technology Corporation (the “Company”), originally incorporated in Florida and reincorporated in Nevada, is an Irvine, CA based company that has operated in two segments, CTC Cable (“Cable”) and DeWind (“Wind”).  As discussed below, in September 2009, the Company sold substantially all of its Wind segment, which sold wind turbines under the brand name DeWind. The Cable segment sells high efficiency patented composite core electricity conductors known as "ACCC® conductor" for use in electric transmission and distribution lines.  CTC Cable has sales operations in Irvine, California, China, Europe, the Middle East, and Brazil. ACCC® conductor is sold in North America directly by CTC Cable to utilities and by Alcan Cable.  ACCC® conductor is sold elsewhere in the world directly to utilities as well as through license and distribution agreements with Lamifil in Belgium, Midal Cable in Bahrain, Far East Composite Cable Co. in China, through two Indonesian companies, PT KMI Wire and Cable and PT Tranka Kabel, IMSA in Argentina, Centelsa in Colombia and now through Sterlite in India.  ACCC® conductor has been sold commercially since 2005 and is currently marketed worldwide to electrical utilities, transmission companies and transmission design/engineering firms.





BASIS OF PRESENTATION AND PRINCIPALS OF CONSOLIDATION





The accompanying Consolidated Financial Statements have been prepared on a going concern basis as discussed below.





The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete financial statements. Interim information is unaudited, however, in the opinion of the Company's management, the accompanying unaudited, consolidated financial statements reflect all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation of the Company's interim financial information. These financial statements and notes should be read in conjunction with the audited consolidated financial statements of the Company included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2010, filed with the Securities and Exchange Commission (SEC) on December 14, 2010.





The financial statements include the accounts of Composite Technology Corporation and its wholly-owned subsidiaries, the most significant of which is CTC Cable Corporation.





The Company consolidates the financial statements of all entities in which the Company has a controlling financial interest, as defined in US GAAP. All significant inter-company accounts and transactions are eliminated during consolidation.




Subsequent to March 31, 2011, the Company and its wholly owned primary operating subsidiary, CTC Cable Corporation, filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code (see Note 14 “Subsequent Events” for additional information).





GOING CONCERN





The Company received a report from its independent auditors for the year ended September 30, 2010 that includes an explanatory paragraph describing the uncertainty as to the Company's ability to continue as a going concern.  Such uncertainty has continued through the six months ended March 31, 2011.  These consolidated financial statements contemplate the ability to continue as such and do not include any adjustments that might result from this uncertainty.





During the year ended September 30, 2010, the Company incurred a net loss of $19,767,000 and had negative cash flows from operating activities – continuing operations of $17,358,000. In addition, the Company had an accumulated deficit of $277,530,000 at September 30, 2010.  During the six months ended March 31, 2011, the Company incurred a net loss of $11,796,000 and had negative cash flows from operating activities – continuing operations of $4,922,000. In addition, the Company had an accumulated deficit of $289,327,000 at March 31, 2011.  Subsequent to March 31, 2011, the Company and its wholly owned primary operating subsidiary, CTC Cable Corporation, filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code (see Note 14 “Subsequent Events” for additional information).  The filings, made voluntarily in the U.S. Bankruptcy Court for the Central District of California, are designed to enable CTC and its subsidiary, CTC Cable, to continue to develop, produce and market its ACCC® conductor to the utility industry.  The Company's ability to continue as a going concern is dependent upon its ability to generate profitable operations in the future and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due, including our ability to exit the Chapter 11 filing. The outcome of these matters cannot be predicted with any certainty at this time.





Our principal sources of working capital have been private debt issuances and historically, the Company has issued registered stock and unregistered, restricted stock, stock options, and warrants in settlement of both operational and non-operational related liabilities and as a source of funds.


7


Since inception through March 31, 2011, our Cable products business has generated revenue of approximately $90 million in ACCC® conductor products. We will require a significant increase in customer orders at sufficient profit margin levels to cover our expenses and generate sufficient cash flows from operations.  Currently, for fiscal 2011 we have $5.3 million in firm backlog for delivery through the end of the September 2011 quarter.




There is no guarantee that our products will be accepted or provide a marketable advantage and therefore no guarantee that our products will ever be profitable. In addition, management plans to ensure that sufficient capital will be available to provide for its capital needs with minimal borrowings and may issue equity securities to ensure that this is the case. However, there is no guarantee that the Company will be successful in obtaining sufficient capital through borrowings or selling equity securities. These financial statements do not include any adjustments to the amounts and classification of assets and liabilities that may be necessary should the Company be unable to continue as a going concern.




We believe our cash position as of March 31, 2011 of $4.7 million, current restricted cash held in escrow of $1.8 million, cash flows generated from our net accounts receivable balance of $1.6 million and expected cash flows from revenue orders may not be sufficient to fund operations for the next four quarters ending March 31, 2012.  We anticipate that additional cash will be needed to fund operations beyond December 2011, absent a large cash deposit for a future order, and to the extent required whether under Chapter 11 provisions or otherwise, the Company intends to continue the practice of issuing stock, debt or other financial instruments for cash or for payment of services until our cash flows from the sales of our primary products are sufficient to provide cash from operations or if we believe such a financing event would be a sound business strategy.





DISCONTINUED OPERATIONS





On September 4, 2009, our DeWind subsidiary, subsequently renamed Stribog, sold substantially all of its existing operating assets including all inventories, receivables, fixed assets, wind farm project assets and intangible assets including all intellectual property and transferred substantially all operating liabilities including supply chain and operating expense accounts payables and accrued liabilities, warranty related liabilities for U.S. turbine installations, and deferred revenues.  All of the remaining assets and liabilities of DeWind have been classified as net assets/liabilities of discontinued operations.  All operations of our former DeWind segment have been reported as discontinued operations. See discussion at Note 2.





REVENUE RECOGNITION





Revenues are recognized based on guidance provided by the SEC. Accordingly, our general revenue recognition policy is to recognize revenue when there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured, and delivery has occurred or services have been rendered.  Revenues recorded are shown net of any sales discounts or similar sales incentives provided to our customers.





The Company derives, or seeks to derive revenues from product revenue sales of composite core, stranded composite core, core and stranded core hardware, and other electric utility related products.





In addition to the above general revenue recognition principles prescribed by the SEC, our specific revenue recognition policies for each revenue source are as follows:





PRODUCT REVENUES. Product revenues are recognized when product shipment has been made and title has passed to the end user customer. Product revenues consist primarily of revenue from the sale of: (i) stranded composite core and related hardware to utilities either sold directly by the Company or through a distribution agreement, and (ii) composite core and related hardware sold to a cable stranding entity. Revenues are deferred for product contracts where the Company is required to perform installation services until after the installation is complete. Our distribution agreements are structured so that our revenue cycle is complete upon shipment and title transfer of products to the distributor with no right of return.





CTC Cable sales in the three and six months ended March 31, 2011 and 2010 consisted of stranded ACCC® conductor and ACCC® hardware sold to end-user utilities and sales of ACCC® core and ACCC® hardware to our stranding manufacturers.  All ACCC® product related sales were recognized upon delivery of product and transfer of title.  For ACCC® conductor product sales made directly by us and not through a manufacturer or distributor, through a third-party insurance company, we provide the option to purchase an extended warranty for periods up to five, seven or ten years. We allocate a portion of sales proceeds to the estimated fair value of the cost to provide such a warranty.  To date, most of our ACCC® related product sales have been without extended warranty coverage.  Additionally, all ACCC® conductor is sold to our end-user customers with a standard three-year product warranty. The Company purchases a three-year term product warranty liability insurance policy for all ACCC® conductor sold directly by the Company to mitigate any product warranty liability risk.  Revenues from ACCC® conductor sold directly to end-user customers are recorded net of the cost of the three-year term insurance policy.





CONSULTING REVENUE. Consulting revenues are generally recognized as the consulting services are provided. We have entered into service contract agreements with electric utility and utility services companies that generally require us to provide engineering or design services, often in conjunction with current or future product sales. In return, we receive engineering service fees payable in cash.  In the three and six months ended March 31, 2011 and 2010, we recognized no consulting revenues.


8


Multiple-element revenue arrangements are recognized with the overall arrangement fee being allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by vendor specific objective evidence or third-party evidence, or are based on the Company's estimated selling price.  Historically, except for the product warranty element discussed above, we have not had any multiple-element revenue arrangements.





WARRANTY PROVISIONS





Warranty provisions consist of the insured costs and liabilities associated with any post-sales associated with our ACCC® conductor and related hardware parts.  Warranties related to our ACCC® products relate to conductor and hardware sold directly by us to the end-user customer.  We mitigate our loss exposure through the use of third-party warranty insurance.  Warranty related liabilities for time periods in excess of one year are classified as non-current liabilities.





Our ACCC® conductor is sold to our end-user customers with a standard three-year product warranty. The Company purchases a three-year term product warranty liability insurance policy for all ACCC® conductor sold directly by the Company to mitigate any product warranty liability risk.  All customers have the option to extend this warranty for to up to ten years upon customer payment of additional insurance premiums.  The insurance policy covers materials costs and labor costs to replace the ACCC® conductor in the event of a product warranty claim caused by a product defect.  As such, the purchase of the initial three-year insurance policy covers significantly all product warranty liability for which the Company may be exposed under its standard three-year product warranty.  To date, the Company has had no product warranty claims.





USE OF ESTIMATES





The preparation of our financial statements conform with US GAAP, which requires management to make estimates and judgments in applying our accounting policies that have an important impact on our reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of our financial statements. On an on-going basis, management evaluates its estimates including those related to accounts receivable, inventories, share-based compensation, warranty provisions and derivative liabilities, as applicable. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from management’s estimates. We believe that the application of our accounting policies requires significant judgments and estimates on the part of management. We believe that the estimates, judgments and assumption upon which we rely are reasonable, and based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the period presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by US GAAP and does not require management's judgment in its application. There are also many areas in which management's judgment in selecting among available alternatives would produce a materially different result.





Our key estimates we use that rely upon management judgment include:





-
the estimates pertaining to the likelihood of our accounts receivable collectability. These estimates primarily rely upon past payment history for each customer and management’s judgment on the likelihood of future payments based on the current business condition of each customer and the general business environment.


-
the estimates pertaining to the valuation of our inventories. These estimates primarily rely upon the current order book for each product in inventory along with management’s expectations and visibility into future sales of each product in inventory.


-
the assumptions used to calculate fair value of our share-based compensation and derivative liabilities, primarily the volatility component of the Black-Scholes-Merton (Black-Scholes) option-pricing model used to value our warrants and our employee and non-employee options. This estimate relies upon the past volatility of our share price over time as well as the estimate of the option life.


-
the estimates and assumptions used to determine the settlement of certain accounts related to the sale of the DeWind assets for which a final accounting has not been completed and which may result in the increase or decrease of asset reserves or increase or decrease of accrued liabilities, principally penalty payments, interest, and other costs associated with the turbine parts suppliers for DeWind turbine parts. See related discussion at Note 2.


9


DERIVATIVE FINANCIAL INSTRUMENTS





The Company issues financial instruments in the form of stock options and stock warrants, and debt conversion features as part of its debt issuances. The Company has not issued any derivative instruments for hedging purposes since its inception. The Company uses the specific guidance and disclosure requirements provided in US GAAP. Generally, freestanding derivative contracts where settlement is required by physical share settlement or where the Company has a choice of share or net cash settlement are accounted for as equity. Contracts where settlement is in cash or in net share settlement; or where the counterparty may choose cash settlement are accounted for as a liability. Under current US GAAP, certain of our warrants are subject to liability accounting treatment (see discussion below under “Derivative Liabilities”), while our stock options are considered indexed to the Company’s stock and are accounted for as equity.





The values of the financial instruments are estimated using the Black-Scholes option-pricing model. Key assumptions used to value options and warrants granted, issued or repriced are as follows:





Six Months Ended

March 31,2011


2010Risk Free Rate of Return


0.30-1.91
%


0.82-2.43
%Volatility


78.9-100.2
%


95.6-108
%Dividend yield


0
%


0
%Expected life

1-5 yrs


2-5 yrs





Derivative Liabilities





Currently, our derivative liabilities include fair value based warrant liabilities pursuant to US GAAP applied to the terms of the underlying agreements. The Company has issued certain warrants to purchase common shares of the Company as additional incentive for investors who purchase unregistered, restricted common stock, certain debt obligations or convertible debentures. The fair value of certain warrants issued and debt conversion features in conjunction with financing events are recorded as a discount for debt issuances. Certain warrant agreements and debt conversion arrangements include provisions that require us to record them as a liability, at fair value, pursuant to Financial Accounting Standards Board (FASB) accounting rules, including certain provisions designed to protect a holder’s position from being diluted. The derivative liabilities are marked-to-market each reporting period and changes in fair value are recorded as a non-operating gain or loss in our consolidated statements of operations, until they are completely settled or they expire. The fair value of the warrants and debt conversion features are determined each reporting period using the Black-Scholes valuation model, using inputs and assumptions consistent with those used in our estimate of fair value of employee stock options, except that the remaining contractual life is used.  Such fair value is affected by changes in inputs to that model including our stock price, expected stock price volatility, interest rates and expected term.





Refer to “Fair Value Measurements” in Note 1 for additional derivative liabilities disclosures.





For the three and six months ended March 31, 2011, we recognized gains of $727,000 and $386,000, respectively, related to the revaluation of our derivative liabilities.  The 2011 revaluation gain resulted from a decrease in our stock price from the prior quarter, net of the increase from the re-pricing of certain warrants in the prior quarter, as further discussed in Note 10.





In connection with the warrants issued to investors as discussed above, the Company has issued warrants to compensate for financing fees and other service fees incurred.  Such compensatory warrants are recorded at fair value in the same manner as non-compensatory warrants, however, the recognized expense is offset to additional paid-in-capital.  Such warrants are considered equity transactions in accordance with US GAAP.  Additionally, warrants issued without anti-dilution provisions are generally considered equity transactions in accordance with US GAAP. All of our outstanding warrants including those subject to liability accounting treatment are further discussed in Note 10.





Share-Based Compensation





US GAAP requires that compensation cost relating to share-based payment arrangements be recognized in the financial statements. US GAAP requires measurement of compensation cost for employee share-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such fair value is recognized as expense over the service period, net of estimated forfeitures.





US GAAP requires that equity instruments issued to non-employees in exchange for services be valued at the more accurate of the fair value of the services provided, or the fair value of the equity instruments issued. For equity instruments issued that are subject to a required service period, the expense associated with the equity instruments is recorded as the instruments vest or the services are provided. The Company has granted options and warrants to non-employees and recorded the fair value of these equity instruments on the date of issuance using the Black-Scholes valuation model, for options and warrants not subject to vesting terms. For non-employee option and warrant grants subject to vesting terms, vested shares are recorded at fair value using the Black-Scholes valuation model and the associated expense is recorded simultaneously or as the services are provided. The Company has granted stock to non-employees for services and values the stock at the more reliable of the market value on the date of issuance or the value of the services provided. For issued grants subject to vesting or service requirements, expenses are deferred and recognized over the more appropriate of the vesting period, or as services are provided.


10


SEC guidance requires share-based compensation to be classified in the same expense line items as cash compensation. Additionally, the SEC issued guidance regarding the use of a "simplified" method in developing an estimate of expected term of "plain vanilla" share options in accordance with US GAAP rules. The Staff indicated that it will accept a company's election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. The Staff believed that more detailed external information about employee exercise behavior (e.g., employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies; however, the Staff continues to accept, under certain circumstances, the use of the simplified method. The Company currently uses the simplified method for the expected term in “plain vanilla” share options and warrants.





Additional information about share-based compensation is disclosed in Note 11.





Convertible Debt





Convertible debt is accounted for under specific guidelines established in US GAAP. The Company records a beneficial conversion feature (BCF) related to the issuance of convertible debt that have conversion features at fixed or adjustable rates that are in-the-money when issued and records the fair value of warrants issued with those instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion features, both of which are credited to paid-in-capital or liabilities as appropriate. The Company calculates the fair value of warrants issued with the convertible instruments using the Black-Scholes valuation method, using the same assumptions used for valuing employee options, except that the contractual life of the warrant is used. Upon each issuance, the Company evaluates the variable conversion features and determines the appropriate accounting treatment as either equity or liability, in accordance with US GAAP. The Company first allocates the value of the proceeds received to the convertible instrument and any other detachable instruments (such as detachable warrants) on a relative fair value basis and then determines the amount of any BCF based on effective conversion price to measure the intrinsic value, if any, of the embedded conversion option. Using the effective yield method, the allocated fair value is recorded as a debt discount or premium and is amortized over the expected term of the convertible debt to interest expense. For a conversion price change of a convertible debt issue, the additional intrinsic value of the debt conversion feature, calculated as the number of additional shares issuable due to a conversion price change multiplied by the previous conversion price, is recorded as additional debt discount and amortized over the remaining life of the debt.  As of March 31, 2011, we had no convertible debt outstanding.





US GAAP rules specify that a contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with US GAAP contingency rules. The contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured in accordance with said rules, pursuant to which a contingent obligation must be accrued only if it is more likely than not to occur. Historically, the Company has not been required to accrue any contingent liabilities in this regard.





CASH AND CASH EQUIVALENTS





For the purpose of the statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.





RESTRICTED CASH





The Company considers cash to be restricted cash if it is cash on deposit under control of the Company that secures standby letters of credit and other payment guarantees for certain vendors, as well as cash held in jointly controlled escrow accounts. As of March 31, 2011 and September 30, 2010, restricted cash consisted of cash held in escrow in connection with the sale of DeWind as discussed in Note 2, amounting to $4,818,000 and $16,356,000, respectively.  During the six months ended March 31, 2011, we reported an additional $8,000 from interest income, in accordance with the escrow agreement.





ACCOUNTS RECEIVABLE





The Company has trade accounts receivable from cable customers. Cable customer receivables are typically on net 30 day terms. Balances due greater than one year from the balance sheet date are reclassified to long term assets, as applicable. Collateral is generally not required for credit extended to customers. Credit losses are provided for in the financial statements based on management's evaluation of historical and current industry trends as well as history with individual customers. Additions to the provision for bad debts are included in General and Administrative expense on our Consolidated Statements of Operations; charge-offs of uncollectible accounts are made against existing provisions or direct to expense as appropriate. Although the Company expects to collect amounts due, actual collections may differ from estimated amounts.


11


CONCENTRATIONS OF CREDIT RISK





Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents. The Company places its cash and cash equivalents with high credit, quality financial institutions. At times, such cash and cash equivalents may be in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit (currently at $250,000 per depositor, per insured bank, for each account ownership category). All cash and cash equivalents are FDIC insured, with the exception of the foreign bank accounts. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.





INVENTORIES





Inventories consist of our wrapped and unwrapped manufactured composite core and related hardware products and raw materials used in the production of those products. Inventories are valued at the lower of cost or market under the FIFO method. Cable products manufactured internally are valued at standard cost which approximates replacement cost.  Payments made to third party vendors in advance of material deliveries are reported as a separate balance sheet line item, as applicable.  Costs for product sold are recorded to cost of goods sold as the expenses are incurred.





PROPERTY AND EQUIPMENT





Property is stated at the lower of cost or realizable value, net of accumulated depreciation. Additions and improvements to property and equipment are capitalized at cost. Designated project costs are capitalized to construction-in-progress as incurred. Depreciation of production equipment is computed using the units-of-production method based on estimated useful lives of specific production machinery and equipment and the related units estimated to be produced over a period of ten years. Depreciation for all other assets is computed using the straight-line method based on estimated useful lives of the assets which range from three to ten years. Leasehold improvements and leased assets are amortized or depreciated over the lesser of estimated useful lives or lease terms, as appropriate. Property is periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Expenditures for maintenance and repairs are charged to operations as incurred while renewals and betterments are capitalized. Gains or losses on the sale of property and equipment are reflected in the statements of operations.





IMPAIRMENT OF LONG-LIVED ASSETS





Management evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated future cash flow (undiscounted and without interest charges) from the use of an asset are less than the carrying value, an impairment would be recorded to reduce the related asset to its estimated fair value.





We did not recognize any impairment charges in the three and six months ended March 31, 2011, respectively.





FAIR VALUE MEASUREMENTS





Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described as follows:





Level 1 - Quoted prices in active markets for identical assets or liabilities, and identical liabilities when traded as an asset in an active market when no adjustments to the quoted price of the asset are required.


Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Inputs are based on management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.


12





The Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis. The fair value of these assets and liabilities was determined using the following inputs:




(Unaudited, In Thousands)At March 31, 2011

Total


Level 1


Level 2


Level 3Cash deposits (1)

$
61


$
61


$
—


$
—Restricted cash (Note 2)


4,818



4,818



—



—Prepaid services paid in warrants


128



—



—



128Total assets

$
5,007


$
4,879


$
—


$
128Derivative liabilities

$
1,281


$
—


$
—


$
1,281At September 30, 2010Cash deposits (1)

$
66


$
66


$
—


$
—Restricted cash (Note 2)


16,356



16,356



—



—Prepaid services paid in warrants


43



—



—



43Total assets

$
16,465


$
16,422


$
—


$
43Derivative liabilities

$
1,297


$
—


$
—


$
1,297





(1)
Short-term certificates of deposit and money market accounts included in cash and cash equivalents in our consolidated balance sheets.





During the six months ended March 31, 2011, there were no transfers into or out of Levels 1 and 2.  Financial instruments classified as Level 3 in the fair value hierarchy as of March 31, 2011 include derivative liabilities resulting from recent financing transactions.  In accordance with current accounting rules, the derivative liabilities are being marked-to-market each quarter-end until they are completely settled or expire. The derivative liabilities are valued using the Black-Scholes valuation model, using both observable and unobservable inputs and assumptions consistent with those used in our estimate of fair value of employee stock options. See “Derivative Liabilities” in Note 1.





The following table summarizes our fair value measurements using significant Level 3 inputs, and changes therein, as of March 31, 2011:





(Unaudited, In Thousands)

Level 3

Derivative LiabilitiesBalance as of October 31, 2009

$
1,570Transfers into/(out of) Level 3


—Initial valuation of derivative liabilities (1)


1,494Change in fair value of derivative liabilities - expired


(221
)Change in fair value of derivative liabilities - held


(1,546
)Balance as of September 30, 2010

$
1,297Transfers into/(out of) Level 3 (2)


235Modification of derivative liabilities (3)


135Change in fair value of derivative liabilities - held


(386
)Balance as of March 31, 2011

$
1,281





(1)
During the year ended September 30, 2010, we issued warrants in connection with the April 2010 debt financing transaction, which are subject to derivative liability accounting (see Note 10 “Warrants” for additional information).


(2)
During the six months ended March 31, 2011, we issued warrants in connection with February 2011 and March 2011 Bridge Note financing transactions (see Note 10 “Warrants” for additional information).


(3)
During the six months ended March 31, 2011, we re-valued the warrants in connection with the April 2010 debt financing transaction (see Note 10 “Warrants” for additional information).





At March 31, 2011 and September 30, 2010, the Company held no assets or liabilities that are measured at fair value on a non-recurring basis.





FAIR VALUE INFORMATION ABOUT FINANCIAL INSTRUMENTS





US GAAP regarding fair value disclosures of financial instruments requires disclosure of fair value information about certain financial instruments for which it is practical to estimate that value. The carrying amounts reported in our balance sheet for cash, cash equivalents, restricted cash, accounts receivable and accounts payable approximate fair value due to the short maturity of these financial instruments. The carrying amounts reported for debt obligations approximate fair value due to the effective interest rate of these obligations reflecting the Company’s current borrowing rate. Derivative liabilities are reported at fair value as discussed above. Considerable judgment is required to develop such estimates of fair value. Accordingly, such estimates would not necessarily be indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value.


13


FOREIGN CURRENCY TRANSLATION





The Company’s primary functional currency is the U.S. dollar. Assets and liabilities of the Company denominated in foreign currencies are translated at the rate of exchange on the balance sheet date. Revenues and expenses are translated using the average exchange rate for the period.





COMPREHENSIVE LOSS





Comprehensive loss includes all changes in shareholders’ equity (deficit) except those resulting from investments by, and distributions to, shareholders. Accordingly, the Company’s Consolidated Statements of Comprehensive Loss include net loss and foreign currency translation adjustments that arise from the translation of foreign currency financial statements into U.S. dollars.  For the three and six months ended March 31, 2011, we reported Other Comprehensive Income (Loss) from continuing operations of zero and $1,000, respectively.





In connection with the sale of DeWind and resulting discontinued operations (see Note 2), our Consolidated Statement of Operations and Comprehensive Loss for the year ended September 30, 2009 included a reclassification adjustment of the accumulated foreign currency translation adjustment losses for DeWind through September 4, 2009 (date of sale), in the amount of $361,000, to recognize the accumulated adjustments as a component of the loss from discontinued operations within net loss. Since inception, other comprehensive income (loss) had been derived from DeWind foreign currency translation adjustments.  For the six months ended March 31, 2011, other comprehensive loss in the amount of $1,276,000, derived from DeWind foreign currency translation adjustments, has been recognized and included as a component of the Income (Loss) from Discontinued Operations within Net Loss.





RESEARCH AND DEVELOPMENT EXPENSES





Research and development expenses are charged to operations as incurred.





START-UP COSTS





US GAAP defines start-up activities as one-time activities an entity undertakes when it opens a new facility, introduces a new product or service, conducts business in a new territory, or with a new class of customer or beneficiary, initiates a new process in an existing facility or commences some new operation.  Start-up activities include activities related to organizing a new entity (i.e. organization costs), which include initial incorporation and professional fees in connection with establishing the new entity.  In accordance with US GAAP, we expense all start-up activities as incurred.





Our start-up activities relate to professional fees for organization costs incurred.  During the three and six months ended March 31, 2011, no start-up expenses were incurred.  During the three and six months ended March 31, 2010, we recorded start-up expenses in the amounts of $16,000 and $158,000, respectively, which is included in general and administrative expenses.





DEFINED CONTRIBUTION PLAN





The Company maintains a 401(k) plan covering substantially all of its employees who are at least 21 years old with 1,000 hours of service.  Such employees are eligible to contribute a percentage of their annual eligible compensation and receive discretionary Company matching contributions.  Discretionary Company matching contributions are determined by the Board of Directors and may be in the form of cash or Company stock.  To date, the Company has not made any matching contributions in either cash or Company stock. There were no changes to the 401(k) plan during the three and six months ended March 31, 2011.





INCOME TAXES





The Company accounts for income taxes under the liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.


14


As of March 31, 2011 and September 30, 2010, the deferred tax assets related primarily to the Company's net operating loss carry-forwards are fully reserved. Due to the provisions of Internal Revenue Code Section 382, the Company may not have any net operating loss carry-forwards available to offset financial statement or tax return taxable income in future periods as a result of a change in control involving 50 percentage points or more of the issued and outstanding securities of the Company.





The Company will recognize the impact of uncertain tax positions in the consolidated financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position.  To date, we have not recorded any uncertain tax positions.





The Company recognizes potential accrued interest and penalties related to uncertain tax positions in income tax expense, as appropriate. During the three and six months ended March 31, 2011 and 2010, the Company did not recognize any amount of income tax expense from potential interest and penalties associated with uncertain tax positions.





The Company files consolidated tax returns in the United States Federal jurisdiction, in California and Texas, as well as foreign jurisdictions including Germany, the United Kingdom and China. The Company is no longer subject to U.S. Federal income tax examinations for fiscal years before 2007, is no longer subject to state and local income tax examinations by tax authorities for fiscal years before 2006, and is no longer subject to foreign examinations before 2001.





During fiscal 2008, the Company’s federal returns were selected for examination by the Internal Revenue Service (IRS) for prior fiscals years ended September 30, 2001 through 2005, all years in which net losses were reported and filed.  The examination has been completed.  During the quarter ended December 31, 2009, the IRS proposed certain preliminary adjustments related to payroll tax returns filed during the period under audit. No adjustments were proposed in connection with our previously filed federal income tax returns.  Based on the preliminary IRS findings, the Company recorded a payroll tax liability in the amount of $1,008,000, which was allocated to General and Administrative Expense ($560,000), Interest Expense ($277,000) and Other Expense from penalties ($171,000), during the six months ended December 31, 2009.  During the quarter ended June 30, 2010, the Company received a final determination of adjustment from the IRS. Accordingly, the Company has begun making payments relating to the assessment arising from the 2001 through 2005 payroll tax audits, which have totaled $494,000 to date.  During the fourth quarter ended September 30, 2010, the IRS provided final adjustments to interest and penalties and a final payment schedule, which resulted in a reduction of our payroll tax liability of $253,000. Penalties and interest will continue to accrue on outstanding balances until paid in full.  At March 31, 2011, the remaining payroll tax liability was $216,000, included as a component of Accounts Payable and Accrued Liabilities (see Note 6).





LOSS PER SHARE





Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.





The following common stock equivalents were excluded from the calculation of diluted loss per share for the three and six months ended March 31, 2011 and 2010 since their effect would have been anti-dilutive (assumes all outstanding options and warrants are in-the-money):





(Unaudited)

March 31,2011


2010Options for common stock


29,495,629



28,391,172Warrants for common stock


22,272,548



14,955,00151,768,177



43,346,173





RECLASSIFICATIONS





Certain prior year balances have been reclassified to conform to the current year presentation.





RECENT ACCOUNTING PROUNOUNCEMENTS





In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and International Financial Reporting Standards (IFRSs) to provide a consistent definition of fair value and ensure that fair value measurements and disclosure requirements are similar between US GAAP and IFRSs. This guidance changes certain fair value measurement principles and enhances the disclosure requirements for fair value measurements. The amendments in this ASU are effective for interim and annual periods beginning after December 15, 2011 and are applied prospectively. Early application by public entities is not permitted. The Company does not expect adoption of ASU 2011-04 will have a material impact on the Company’s financial position, results of operations or cash flows.


15


In January 2010, FASB issued Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures About Fair Value Measurements. The ASU requires new disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation of disclosed assets and liabilities, and about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3.  The new disclosures and clarifications of existing disclosures were effective, and adopted, during the Company’s second quarter ended March 31, 2010, however the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 measurements, will be effective for the Company’s first quarter ending December 31, 2011.  Other than requiring additional disclosures, the full adoption of this new guidance will not have an impact on our consolidated financial statements.





In December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (“ASU 2010-29”), which addresses diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in ASU 2010-29 also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in ASU 2010-29 are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The new rules become effective for the Company on October 1, 2011.  The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.





Significant recent accounting policies adopted or implemented during the six months ended March 31, 2011





On October 1, 2010, we adopted new FASB rules related to accounting for transfers of financial assets. These new rules were incorporated into the Accounting Standards Codification in December 2009 as discussed in FASB ASU No. 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets. The new rules amended various provisions related to accounting for transfers and servicing of financial assets and extinguishments of liabilities, by removing the concept of a qualifying special-purpose entity and removes the exception from applying FASB rules related to variable interest entities that are qualifying special-purpose entities; limits the circumstances in which a transferor derecognizes a portion or component of a financial asset; defines a participating interest; requires a transferor to recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of a transfer accounted for as a sale; and requires enhanced disclosure; among others. The adoption of this standard did not have an impact on our consolidated financial statements.





On October 1, 2010, we adopted new FASB rules which amended certain accounting for variable interest entities (VIE). These new rules were incorporated into the Accounting Standards Codification in December 2009 as discussed in FASB ASU No. 2009-17, Consolidation (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. The new rules require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; to eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a VIE. The adoption of this standard did not have an impact on our consolidated financial statements.





On October 1, 2010, we adopted new FASB rules which amended the Accounting Standards Codification, Revenue Recognition (Topic 605): Multiple-Element Arrangements.  The new rules amended accounting for revenue arrangements with multiple deliverables, to eliminate the requirement that all undelivered elements have Vendor-Specific Objective Evidence (VSOE) or Third-Party Evidence (TPE) before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity's estimated selling price. Application of the "residual method" of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption. Additionally, the new guidance will require entities to disclose more information about their multiple-element revenue arrangements.  Except for the product warranty element discussed above, the adoption of this standard did not have an impact on our consolidated financial statements.





NOTE 2 – DISCONTINUED OPERATIONS





On September 4, 2009, our DeWind subsidiary, subsequently renamed Stribog, sold substantially all of its existing operating assets including all inventories, receivables, fixed assets, wind farm project assets and intangible assets including all intellectual property and transferred substantially all operating liabilities including supply chain and operating expense accounts payables and accrued liabilities, warranty related liabilities for U.S. turbine installations and deferred revenues.  All of the remaining assets and liabilities of DeWind have been classified as net assets or liabilities of discontinued operations.  All operations of our former DeWind segment have been reported as discontinued operations.


16


In August, 2009 the Company completed negotiations with Daewoo Shipbuilding and Marine Engineering (DSME), and signed an Asset Purchase Agreement valued at $49.5 million in cash.  The transaction closed on September 4, 2009 and the Company received approximately $32.3 million in cash paid immediately with $17.175 million in cash escrowed for the benefit of DSME to provide for potential reimbursements of net asset value adjustments, breaches of representations and warranties, and intellectual property claims. The Company paid legal and transaction fees of $3.3 million out of cash proceeds.  Escrow claims presented by DSME are subject to an evaluation process, which requires that DSME submit a written claim against the escrowed funds and which thereby triggering processes for review and dispute by the Company.  Escrowed funds are only released by the escrow agent to the Company or DSME under either i) mutual written instruction by DSME and the Company or ii) scheduled escrowed cash releases to the Company at certain points in time, outlined below, and so long as DSME has not submitted an escrow claim in excess of the scheduled release amount.





In June 2010, DSME and the Company mutually agreed to release $836,000 to a third party vendor in full settlement of vendor’s supply chain related claim.





In March 2011, DSME, the Company, and a third party vendor reached a mutual agreement for settlement of the remaining supply chain dispute and DSME and the Company agreed to settle all claims between DSME and the Company made against the escrowed funds, through an Amended Escrow Agreement.  Under the terms of the Amended Escrow Agreement, the parties agreed that of the remaining $16.3 million of the original $17.2 million placed into escrow, $4.5 million would be disbursed to DeWind Co. (DWC), a wholly owned subsidiary of DSME; €1.1 million ($1.6 million at current exchange rates) would be disbursed to Zollern Dorstener Antriebstechnik Gesellschaft mbH & Co. KG (Zollern); and $7.2 million would be disbursed to the Company.  $4.5 million and $7.0 million of the $7.2 million were paid as of March 31, 2011 to DWC and the Company, respectively.  The remaining €1.1 million ($1.6 million at current exchange rates) and $0.2 million of the $7.2 million were paid in April 2011 to Zollernand the Company, respectively, and as such were reflected as current restricted cash as of March 31, 2011.





The remaining $3.0 million, reflected as non-current restricted cash as of March 31, 2011, was placed in escrow until September 4, 2012 at which time a portion or all of the funds may be released to DWC if it is necessary to satisfy any as yet currently unfiled but subsequently resolved additional claims.  If there are any unresolved claims made against the escrow fund at such time, then that portion or all of the fund for such claims shall not be released; provided however, that any unclaimed balance would be paid to the Company.





The consolidated assets and liabilities of our former DeWind segment have been classified on the balance sheet as Net Liabilities of Discontinued Operations.  The asset and liabilities comprising the balances, as classified in our balance sheets, consist of:





(In Thousands)

March 31, 2011


September 30, 2010(unaudited)ASSETSAccounts Receivable, net

$
268


$
2,199Prepaid Expenses and Other Current Assets


—



21TOTAL ASSETS

$
268


$
2,220LIABILITIESAccounts Payable and Other Accrued Liabilities

$
30,832


$
35,358Deferred Revenues and Customer Advances


2,192



2,248Warranty Provision


729



901TOTAL LIABILITIES


33,753



38,507Net Liabilities of Discontinued Operations

$
(33,485
)

$
(36,287
)





Significantly all of the assets and liabilities of the discontinued operations pertain to activities outside of the United States. The remaining operations of DeWind, consist of receipt of license fees from Chinese licensees of older DeWind technology and satisfaction of the remaining contracts that were not assumed by DSME, primarily the servicing of warranties related to wind turbines installed in Europe from 2006 through 2009, most of which are now expired, and one contract for 10 turbines sold to South America that as yet have not been installed. At March 31, 2011 and September 30, 2010, included above in Accounts Payable and Other Accrued Liabilities are net payables related to formerly consolidated, now insolvent European subsidiaries of approximately $20 million and $20 million, respectively, substantially all of which has been assigned by the insolvency receiver to FKI, a former owner of DeWind, currently engaged in legal actions against Stribog Ltd. (see Note 12). At March 31, 2011, the net payables from insolvent subsidiaries are comprised of assets in the amount of $7 million and liabilities in the amount of $27 million. We did not receive any update from the insolvency receiver related to the assets and liabilities for the insolvent subsidiaries during the three and six months ended March 31, 2011.


17


The consolidated results of our former DeWind segment have been classified on the Statements of Operations and Comprehensive Loss, as Income (Loss) from Discontinued Operations.  Summarized results of discontinued operations are as follows:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Revenues

$
—


$
1,131


$
—


$
1,440Cost (Gain) of Revenues


(105
)


847



(1,004
)


1,637Operating Expenses


635



136



793



1,419Other (Income) Expense


2,968



(2,159
)


2,315



(2,702
)Income Tax Expense


—



—



—



1Income (Loss) from Discontinued Operations

$
(3,498
)

$
2,307


$
(2,104
)

$
1,085




For the six months ended March 31, 2011, Cost of Revenues is substantially comprised of a gain from a settlement with a former DeWind customer in the amount of $807,000, and Other Expense is substantially comprised of foreign currency translation adjustments in the amount of $1,276,000 (refer to additional discussion at Note 1 “Comprehensive Loss”) and a loss from the amended and restated escrow and security agreement settlement with DSME discussed above in the amount of $1,047,000.





Since September 4, 2009, the Company has had no significant continuing involvement with our former DeWind segment; any subsequent cash flows are directly related to the liquidation of the remaining assets and liabilities.  No corporate overhead has been allocated to discontinued operations.





NOTE 3 – ACCOUNTS RECEIVABLE





Accounts receivable, net consists of the following:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Cable Receivables

$
1,659


$
2,556Reserves


(87
)


(217
)Net Accounts Receivable

$
1,572


$
2,339





NOTE 4 – INVENTORY





Inventories consist of the following:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Raw Materials

$
858


$
959Work-in-Progress


368



398Finished Goods


2,006



2,200Inventory

$
3,232


$
3,557





NOTE 5 – PROPERTY AND EQUIPMENT





Property and equipment consisted of the following:





(In Thousands)

Estimated Useful Lives

March 31,

2011


September 30,

2010(unaudited)Office Furniture and Equipment

3-10 yrs

$
837


$
832Production Equipment

10 yrs


4,056



4,047Leasehold Improvements

Lesser of lease term or 7 yrs


815



778Total Property




5,708



5,657Accumulated Depreciation




(2,906
)


(2,721
)Property and Equipment, net



$
2,802


$
2,936


18


Total depreciation expense was $95,000 and $185,000, for the three and six months ended March 31, 2011, respectively.  Depreciation expense was $192,000 and $318,000, for the three and six months ended March 31, 2010, respectively.





NOTE 6 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES





Accounts payable and accrued liabilities consisted of the following:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Trade Payables

$
6,566


$
3,949Accrued Commissions


311



155Accrued Insurance


285



3Accrued Payroll and Payroll Related


810



829Accrued Payroll Tax Liability (A)


216



427Accrued Interest


208



2Deferred Rent


252



296Accrued Sales Tax


128



186Accrued Other


—



165Total Accounts Payable and Accrued Liabilities

$
8,776


$
6,012





(A)
The Company accrued a payroll tax liability as a result of an IRS audit (see Note 1 “Income Taxes” for additional information).





NOTE 7 – DEFERRED REVENUE AND CUSTOMER ADVANCES





Deferred Revenue includes (i) extended warranties, as opted by the customer (see Note 1 “Revenue Recognition – Product Revenues” for additional information), and (ii) temporary timing-based revenue deferrals from shipments in transit prior to title passing to the customer. Customer Advances include all advance cash payments received from customers.  The recorded amounts will remain on our balance sheet until such time as the revenue cycle is completed and the amounts are recognized as revenue.  Deferred revenue and customer advances consist of the following:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Deferred Revenue

$
721


$
1,370Customer Advances


18



530Total Deferred Revenue and Customer Advances


739



1,900Less amount classified in current liabilities


303



1,386Long-term Deferred Revenue

$
436


$
514





Long-term deferred revenue is comprised of long-term customer purchased extended warranties.





NOTE 8 – WARRANTY PROVISION





Warranties relate to our ACCC® products for conductor and hardware sold directly by us to the end-user customer. We mitigate our loss exposure through the use of third-party warranty insurance (see Note 1 “Warranty Provisions”).  We have classified all warranty provisions considered to be payable within one year as current liabilities and all warranty provisions considered to be payable greater than one year as long-term liabilities.


19


Warranty provision consisted of:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Warranty Provision

$
381


$
524Less amount classified in current liabilities


251



306Long-Term Warranty Provision

$
130


$
218





The following table sets forth an analysis of warranty provision activity:





Six Months

Ended


Year Ended(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Beginning balance

$
524


$
564Additional reserves recorded to expense


295



265Provision utilized


(438
)


(305
)Ending balance

$
381


$
524





NOTE 9 – DEBT





The following table summarizes the Company’s debt:





(In Thousands)

March 31,

2011


September 30,

2010(unaudited)Senior Secured Loan due April 2012, net of discount of $625 and $919

$
9,375


$
9,081Bridge Loan due April 2011, net of discount of $11 and $0


89


$
—Total Loans Payable


9,464


$
9,081Less amount classified in current liabilities


9,464



9,081Long-Term Debt

$
—


$
—





Debt outstanding or issued during the three months ended March 31, 2011 consists of:





Loan and Note Agreements:





In March 2011, the Company entered into individual Loan and Promissory Note Agreements with six accredited investors, none of whom are affiliates of the Company, with an aggregate principal value of $700,000.  Pursuant to the bridge loan agreements, interest in the amount of 12% per annum, calculated on a 360 day year, will be paid as well as payment in kind interest of 5% due upon maturity. The loans are due the earlier of 30 days from the date of issuance or upon the closing a financing in excess of $2,000,000. No cash fees were paid to any party to the transaction in exchange for lending the money.





In connection with the March 2011 bridge loan agreements, the Company granted and issued warrants to purchase 1,400,000 shares of the Company’s common stock at $0.25 per share, exercisable until March 2014. The warrants may be exercised in a cashless manner unless registered for resale under an effective registration statement. The warrants have full ratchet antidilution protection while the corresponding notes are outstanding and weighted average price antidilution protection after the corresponding notes are repaid in full. The Company valued the warrants ranging between $0.1155 and $0.1310 per warrant for a total aggregate value of $180,000 using the Black-Scholes Merton option pricing model (see Note 10 “Warrants”) to value the fair value of the warrants issued using the following assumptions. The market price ranged between $0.20 and $0.22 on the respective closing dates in March 2011. The volatility estimates ranged between 99.9% and 100.2%, the life of the warrants was 3 years, the risk free rates ranged between 1.08% and 1.20% and the dividend yield was 0%. The value assigned to the warrants issued was recorded as a debt discount and will be amortized over the 30-day life of the loan.





In March 2011, the Company repaid an aggregate principal value of $600,000 of the $700,000 above, plus accrued interest, to four of the six accredited investors, and amortized $169,000 of debt discount related to the corresponding repaid notes to interest expense.  As of March 31, 2011, $100,000 in principal plus accrued interest remained outstanding to two of the remaining investors, with a corresponding $11,000 of unamortized debt discount.  The remaining principal was repaid in April 2011.


20


In February 2011, the Company entered into individual Loan and Promissory Note Agreements with Domonic Carney, the Company’s Chief Financial Officer, Stewart Ramsay, CTC Cable President, and two of the Company’s Directors, Michael Lee and Dennis Carey, with an aggregate principal value of $236,274. Pursuant to the bridge loan agreements, interest in the amount of 12% per annum, calculated on a 360 day year, will be paid as well as payment in kind interest of 5% due upon maturity. The Loan is due the earlier of 30 days from the date of issuance or upon the closing a financing in excess of $2,000,000. No fees were paid to any party for these bridge loans.





In connection with the February 2011 bridge loan agreements, the Company entered granted and issued warrants to purchase 472,548 shares of the Company’s common stock at $0.25 per share, exercisable until February 22, 2013. The warrants may be exercised in a cashless manner unless registered for resale under an effective registration statement. The warrants have full ratchet antidilution protection while the corresponding notes are outstanding and weighted average price antidilution protection after the corresponding notes are repaid in full.  The Company valued the warrants at $0.1155 per warrant for a total value of $55,000 using the Black-Scholes Merton option pricing model (see Note 10 “Warrants”) to value the fair value of the warrants issued using the following assumptions. The market price was $0.23, the closing price on the date of issuance. The volatility was estimated at 99.6%, the life of the warrants was 2 years, the risk free rate was 0.74% a dividend yield of 0%.  The value assigned to the warrants issued was recorded as a debt discount and amortized over the 30-day life of the loan.





In March 2011, the Company fully repaid the $236,274 in principal plus accrued interest, and fully amortized the $55,000 debt discount to interest expense.





Senior Secured Loan Payable:





In April 2010, the Company issued a $10.0 million Senior Secured Loan due in April 2012 and received $9.7 million in cash net of fees and costs of $0.3 million.  The loan bears interest at 7.5% payable monthly on balances secured by qualified accounts receivable of the Company and interest at 12.5% payable monthly on balances not secured by qualified accounts receivable. Qualified accounts receivable consist of 80% of current trade accounts receivable, which amounted to $1.0 million at March 31, 2011.  The loan is collateralized by substantially all of the Company’s assets. The loan package included an issuance of a total of 10 million warrants to purchase a like number of the Company’s common stock in two tranches.  The first tranche is for 5 million warrants with a three year life and an exercise price of $0.29 per warrant.  The second tranche is for 5 million warrants with a five year life and an exercise price of $1.00 per warrant.  Both warrant tranches may be exercised at any time prior to expiration on a cashless basis and are automatically exercised at expiration on a cashless basis for shares of the Company.  We valued the 10 million warrants at $1,494,000 using the Black-Scholes option-pricing model (see Note 10 “Warrants”). The value assigned to the warrants issued (net of $6,000 in cash consideration) was recorded as a debt discount and will be amortized to interest expense over the two-year life of the loan.





The issuance of the warrants triggered anti-dilution protection in one series of previously issued warrants.  Previously outstanding warrants with exercise prices of $0.95 and $0.98 and which expire in May, 2011 were reset by $0.01 per warrant.  We determined this modification, calculated as the difference in fair value of the warrants immediately before and after the change in exercise prices, had no significant impact on our results.





The loan has two financial covenants, measured monthly consisting of (i) a liquidity covenant and (ii) a profitability covenant.  The liquidity covenant requires the maintenance of a minimum of $7.5 million of combined cash and accounts receivable balances, measured at month-end.  The profitability covenant consists of a maximum accumulated adjusted operating loss of $5.0 million, measured beginning April 1, 2010.  The adjusted operating loss consists of operating loss, less depreciation, amortization, and certain other non-cash charges including stock related compensation and is increased or decreased by the corresponding increase or decrease in deferred revenues as compared to the March 31, 2010 deferred revenue balance.  At September 30, 2010 and March 31, 2011, the Company was not in compliance with its covenant.





In the event of a covenant breach, the lender could declare the loan in default and thereby pursue remedies included in the loan agreement which may include any or all of the following: immediate collection of the loan, assignment of cash receipts, control of the Company’s bank accounts, liquidation of the Company’s assets in part or in full, or apply the default rate of interest of 18% to the obligation.





In December 2010, the Company and lender agreed to amend its debt covenants.  The amendments allow for a temporary waiver of its covenants until January 15, 2011.  The amendments included:  i) a cash waiver fee of $160,000 payable by January 15, 2011; ii)  a reduction in the exercise price from $0.29 to $0.24 for 5 million warrants issued to lender expiring in April 2013; and iii) a reduction in the exercise price from $1.00 to $0.69 for 5 million warrants issued to lender expiring in April 2015.  We determined the value of these modifications, calculated as the difference in fair value of the warrants immediately before and after the change in exercise prices, to be $135,000. Warrant modifications are further discussed in Note 10 “Warrants”.   In accordance with US GAAP, the debt modification costs have been accounted for as an addition to the debt discount in the amount of $295,000.





Due to these amendments and the Company’s liquidity position, at March 31, 2011 and September 30, 2010, the loan has been reported as a current obligation.  As of March 31, 2011, the Company was in violation of its covenants. On April 6, 2011, the lender notified the Company that the loan was in default and accelerated payment of the loan through exercise of its account control agreements.  The lender received $144,000 applied against principal of the loan in April 2011. On April 6, 2011 lender filed suit in the Superior Court of California, County of Orange, (Case No. 30-2011 00464300) against the CTC Parties claiming Breach of Written Contract; Money Due under Written Guaranty; Conversion; and Injunctive Relief. On April 8, 2011 the Hon. David R. Chaffee approved a Temporary Restraining Order (TRO), which required the Company to remit all remaining cash balances on April 11, 2011, absent further action. The TRO and the suit were stayed upon the Company filing Title 11 Bankruptcy as described below.  On April 11, 2011 the Company filed for Chapter 11 Bankruptcy protection primarily to prevent the Company from having to comply with the TRO which would have required the Company to remit all remaining cash on hand to the lender.


21


NOTE 10 – SHAREHOLDERS' EQUITY (DEFICIT)





Preferred Stock





We have 5,000,000 shares of preferred stock authorized.  As of the six months ended March 31, 2011 there was no preferred stock outstanding.





Common Stock





The Company has 600,000,000 shares of Common Stock authorized.  We have never paid cash dividends on our common stock.





The following issuances of common stock were made during the six months ended March 31, 2011:





SERVICES





During the six months ended March 31, 2011 the Company issued 250,000 shares of common stock to Stewart Ramsay, CTC Cable President, valued at $50,000 at the date of issuance in partial payment of an employee acceptance bonus.





Warrants





The Company issues warrants to purchase common shares of the Company either as compensation for services or as additional incentive for investors who purchase unregistered, restricted common stock, certain debt obligations or convertible debentures. The value of warrants issued for compensation is accounted for as a non-cash expense to the Company at the fair value of the warrants issued. The value of warrants issued in conjunction with financing events is either a reduction in paid-in-capital for common stock issuances or as a discount for debt issuances. The Company values the warrants at fair value as calculated by using the Black-Scholes option-pricing model.  See Note 1 “Derivative Liabilities” for additional warrant liability accounting and disclosure.





The following table summarizes the warrant activity during the six months ended March 31, 2011:





(Unaudited)

Number of

Shares


Weighted Average

Exercise PriceOutstanding, September 30, 2010


18,200,000


$
0.58Granted


4,672,548


$
0.28Exercised


—


$
—Cancelled


(600,000
)

$
0.75OUTSTANDING, March 31, 2011


22,272,548


$
0.44EXERCISABLE, March 31, 2011


19,422,548


$
0.45





Warrant issuances and modifications during the six months ended March 31, 2011:





On February 9, 2011 we entered into two separate warrant agreements with two different third parties in connection with service agreements subject to vesting upon successful execution of certain events related to a conductor supply contract in the country of Paraguay issued by Administracion Nacional de Electricidad (“ANDE”). We issued 1,000,000 and 1,500,000 warrants, respectively, both with a strike price of $0.30 per warrant, and a one-year and two-year life, respectively.  We valued the warrants at an aggregate value of $56,000 and $169,000, respectively, using the Black-Scholes option pricing model and the following assumptions:


Dividend rate = 0%


Risk free return of 0.30% and 0.81%


Volatility of 78.9% and 99.7%


Market price of $0.24 per share


Maturity of 1 and 2 years


22





On February 21, 2011 we issued 300,000 warrants with a strike price of $0.35 per warrant and a two-year life in connection with consulting services rendered.  The warrants vest immediately upon issuance.  We valued the warrants at $29,000 using the Black-Scholes option pricing model and the following assumptions:


Dividend rate = 0%


Risk free return of 0.74%


Volatility of 99.6%


Market price of $0.23 per share


Maturity of 2 years





On February 22, 2011 we issued 472,548 warrants with a strike price of $0.25 per warrant and a two-year life as part of the bridge loan financings (see Note 9 above). The warrants may be exercised in a cashless manner unless registered for resale under an effective registration statement. The warrants have full ratchet antidilution protection while the corresponding notes are outstanding and weighted average price antidilution protection after the corresponding notes are repaid in full. We have determined these warrants are subject to derivative liability accounting treatment as discussed in Note 1 “Derivative Liabilities”. We valued the warrants issued in conjunction with the bridge loan using the Black-Scholes option pricing model at $55,000, which was recorded as debt discount and amortized over the 30-day life of the loan that was fully repaid in March 2011. The following assumptions were used to value the warrants:


Dividend rate = 0%


Risk free return of 0.74%


Volatility of 99.6%


Market price of $0.23 per share


Maturity of 2 years





On March 4, 2011 we issued 1,200,000 warrants with a strike price of $0.25 per warrant and a three-year life as part of the bridge loan financings (see Note 9 above).  The warrants may be exercised in a cashless manner unless registered for resale under an effective registration statement.  The warrants have full ratchet antidilution protection while the corresponding notes are outstanding and weighted average price antidilution protection after the corresponding notes are repaid in full.  We have determined these warrants are subject to derivative liability accounting treatment as discussed in Note 1 “Derivative Liabilities”.  We valued the warrants issued in conjunction with the bridge loan using the Black-Scholes option pricing model at $157,000, which was recorded as debt discount and fully amortized in March 2011 when the loan was fully repaid.  The following assumptions were used to value the warrants:


Dividend rate = 0%


Risk free return of 1.20%


Volatility of 99.9%


Market price of $0.22 per share


Maturity of 3 years





On March 15, 2011 we issued 200,000 warrants with a strike price of $0.25 per warrant and a three-year life as part of the bridge loan financings (see Note 9 above).  The warrants may be exercised in a cashless manner unless registered for resale under an effective registration statement.  The warrants have full ratchet antidilution protection while the corresponding notes are outstanding and weighted average price antidilution protection after the corresponding notes are repaid in full.  We have determined these warrants are subject to derivative liability accounting treatment as discussed in Note 1 “Derivative Liabilities”.  We valued the warrants issued in conjunction with the bridge loan using the Black-Scholes option pricing model at $23,000, which was recorded as debt discount and will be amortized over the 30-day life of the loan.  The following assumptions were used to value the warrants:


Dividend rate = 0%


Risk free return of 1.08%


Volatility of 100.2%


Market price of $0.20 per share


Maturity of 3 years





On April 12, 2010 we issued 10,000,000 warrants in two tranches in connection with a debt financing transaction.  The first tranche is for 5 million warrants with a three-year life and an exercise price of $0.29 per warrant.  The second tranche is for 5 million warrants with a five-year life and an exercise price of $1.00 per warrant.  Both warrant tranches may be exercised at any time prior to expiration on a cashless basis and are automatically exercised at expiration on a cashless basis for shares of the Company.  We have determined these warrants are subject to derivative liability accounting treatment as discussed in Note 1 “Derivative Liabilities”.  The issuance of the warrants triggered anti-dilution protection in one series of previously issued warrants.  Previously outstanding warrants with exercise prices of $0.95 and $0.98 and which expire in May, 2011 were reset by $0.01 per warrant.  We determined this modification, calculated as the difference in fair value of the warrants immediately before and after the change in exercise prices, had no significant impact on our results.  We valued the 10 million warrants at $1,494,000 using the Black-Scholes option-pricing model and the following assumptions:


23


Dividend rate = 0%


Risk free return of 1.65% and 2.60%


Volatility of 95%


Market price of $0.27 per share


Maturity of 3 and 5 years





In December 2010, we modified certain terms of our April 12, 2010 debt financing arrangement (see Note 9), including reducing the exercise price from $0.29 to $0.24 for the first tranche of 5 million warrants and reducing the exercise price from $1.00 to $0.69 for the second tranche of 5 million warrants.  The modification triggered anti-dilution protection in one series of previously issued warrants.  Previously outstanding warrants with exercise prices of $0.94 and $0.97 and which expire in May, 2011 were reset by $0.01 per warrant.  We determined this modification, calculated as the difference in fair value of the warrants immediately before and after the change in exercise prices, had no significant impact on our results.  We determined the modifications of the 10 million warrants derived an incremental cost of $135,000 using the Black-Scholes option-pricing model and the following assumptions:


Dividend rate = 0%


Risk free return of 0.98% and 1.91%


Volatility of 100% and 91%


Market price of $0.24 per share


Maturity of 2 and 4 years





Management has reviewed and assessed the warrants issued or modified during the six months ended March 31, 2011 and determined there are no changes to warrants that qualify for treatment as derivatives under applicable US GAAP rules, as discussed in Note 1 “Derivative Liabilities”.





Stock Options





On May 15, 2001, TTC, a predecessor to the Company, established the 2001 Incentive Compensation Stock Option Plan (the "TTC Plan"). The TTC Plan was administered by the Company's Board of Directors. Under the TTC Plan, the Board had reserved 4,764,000 shares of common stock to support the underlying options which may be granted. As part of TTC's acquisition by the Company on November 3, 2001, the TTC Plan was terminated, and the options were converted into options to purchase shares of the Company’s common stock pursuant to the 2002 Non-Qualified Stock Compensation Plan (the "2002 Stock Plan"). The number of shares reserved initially under the 2002 Stock Plan was 9,000,000. This number was increased to 14,000,000 on October 24, 2002 and increased to 24,000,000 on April 27, 2006. The 2002 Stock Plan automatically terminates on May 15, 2021 and no options under the 2002 Stock Plan may be granted after May 15, 2011.





On January 11, 2008 the Company’s Board of Directors established the 2008 Non-Qualified Stock Compensation Plan (the “2008 Stock Plan”) which was ratified by the Shareholders of the Company on March 4, 2008. The number of shares reserved under the 2008 Stock Plan was established at 25,000,000.  The 2008 Stock Plan allows for Incentive Stock Options to be issued to the Company’s employees or officers and Non-Statutory or Non-Qualifying Stock Options to be issued to the Company’s employees, officers, consultants, and directors for a period of 10 years from January 11, 2008.  To date, only Non-Qualifying Stock Options have been issued.





The exercise price of the underlying shares for both the 2002 Stock Plan and 2008 Stock Plan will be determined by the Board of Directors; however, the exercise price may not be lower than 100% of the mean of the last reported bid and asked price of the Company's common stock on the grant date as quoted on the NASDAQ Bulletin Board or any other exchange or organization. The term of each option will be established by the Board of Directors at the date of issue and may not exceed 10 years.  Option grants to employees, directors, and officers typically have a vesting schedule of between 3 and 5 years and are based upon length of service.





Certain options granted under the 2008 Stock Plan may be exercised at any time for restricted stock of the Company if not otherwise prohibited by the Company’s Board of Directors.  Shares issued under the 2008 Stock Plan may be subject to a right of first refusal, one or more repurchase options, or other conditions and restrictions as determined by the Company’s Board of Directors in its discretion at the time the option is granted.  As of March 31, 2011 all of the 2008 Stock Plan option grants were exercisable. To date, no restricted stock has been issued under the 2008 Stock Plan.  Of the 2008 Stock Plan options exercisable, 7,586,065 options were vested and exercisable into unrestricted stock as of March 31, 2011.


24


The following table summarizes the 2002 Stock Plan and 2008 Stock Plan stock option activity during the six months ended March 31, 2011:





(Unaudited)

2002 Plan

Number of

Options


2008 Plan

Number of

Options


Total Number of

Options


Weighted

Average

Exercise

PriceOutstanding, September 30, 2010


15,812,268



14,104,332



29,916,600


$
0.35Granted


—



150,000



150,000


$
0.35Exercised


—



—



—


$
—Cancelled


(399,304
)


(171,667
)


(570,971
)

$
0.38Outstanding, March 31, 2011


15,412,964



14,082,665



29,495,629


$
0.35Exercisable , March 31, 2011


15,088,463



14,082,665



29,171,128


$
0.35





The weighted-average remaining contractual life of the options outstanding at March 31, 2011 was 6.1 years. The exercise prices of the options outstanding at March 31, 2011 ranged from $0.25 to $0.35, and information relating to these options is as follows (unaudited):





Range of Exercise

Prices


Stock Options

Outstanding


Stock Options

Exercisable


Weighted

Average

Remaining

Contractual

Life in years


Weighted

Average

Exercise Price

of Options

Outstanding


Weighted

Average

Exercise Price of

Options

Exercisable$
0.25-0.34



728,000



728,000



5.76


$
0.25


$
0.25$
0.35-$0.49



28,767,629



28,443,128



6.05


$
0.35


$
0.35Total



29,495,629



29,171,128





During the six months ended March 31, 2011, the Company granted 150,000 options, respectively, with a weighted-average grant-date fair value of $0.17 per option, determined using the Black-Scholes option-pricing model. Additionally, during the six months ended March 31, 2011, the Company’s vested and cancelled options had a weighted-average grant-date fair value of $0.37 and $0.78 per option, respectively; and the Company’s non-vested options at the beginning and ending of the six month period ended March 31, 2011, had a weighted-average grant-date fair value of $0.32 and $0.31 per option, respectively.





During the six months ended March 31, 2011, approximately 1,073,000 options vested with an aggregate grant-date fair value of $395,000.





At March 31, 2011, the Company had 29,171,128 options exercisable with an aggregate intrinsic value of $0, an aggregate exercise value of $10,137,000, and a weighted-average remaining contractual life of 6.1 years.





NOTE 11 – SHARE-BASED COMPENSATION





US GAAP requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award. US GAAP also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. The fair value of stock options is determined using the Black-Scholes valuation model.





US GAAP requires that equity instruments issued to non-employees in exchange for services be valued at the more accurate of the fair value of the services provided, or the fair value of the equity instruments issued. For equity instruments issued that are subject to a required service period, the expense associated with the equity instruments is recorded as the instruments vest or the services are provided. For granted options and warrants to non-employees, the fair value of these equity instruments is recorded on the date of issuance using the Black-Scholes valuation model, for options and warrants not subject to vesting terms. For non-employee option and warrant grants subject to vesting terms, vested shares are recorded at fair value using the Black-Scholes valuation model and the associated expense is recorded simultaneously or as the services are provided. Common stock grants to non-employees for services are valued at the stock market value on the date of issuance. For issued grants subject to vesting or service requirements, expenses are deferred and recognized over the more appropriate of the vesting period, or as services are provided.





Key assumptions used in valuing options granted during the six months ended March 31, 2011 and 2010 are as follows:





Six Months EndedMarch 31,2011


2010Risk Free Rate of Return


1.18
%


2.18-2.43
%Volatility


95.6
%


95.6
%Dividend yield


0
%


0
%Expected life

5 years


5 years


25


The fair value of the Company’s share-based compensation was estimated at the date of grant using the Black-Scholes option-pricing model, assuming no dividends and using the valuation assumptions noted in the table above. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the guidance provided by the FASB and SEC, including historical exercise behavior of employees and the option expiration date. The estimated volatility for option grants is the historical volatility for the equivalent look back period for the expected life of the grant. All volatility calculations were made on a daily basis.





Share-based compensation included in the results from continuing operations for the three and six months ended March 31, 2011 and 2010 was as follows:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Cost of Product Sold

$
22


$
37


$
44


$
55Officer Compensation


235



360



476



687General and administrative


88



311



246



493Research and development


15



14



34



66Selling and marketing


89



103



187



188Totals

$
449


$
825


$
987


$
1,489





As of March 31, 2011, there was $1.4 million of total unrecognized compensation cost related to unamortized accrued share-based compensation arrangements related to stock options consisting of $1.0 million related to employee grants and $0.4 million related to consultant and director grants. The costs are expected to be recognized over a weighted-average period of 1.9 years.  Such amounts may change as a result of additional grants, forfeitures, modifications in assumptions and other factors.





All of our existing options are subject to time of service vesting or vesting on the achievement of specific performance objectives.  Our stock options vest either on an annual or a quarterly basis for options subject to time of service vesting, or on specific performance measurements for option vesting tied to performance criteria.  Compensation cost is generally calculated on a daily basis over the requisite service period incorporating actual vesting period dates, and includes expected forfeiture rates between 0% and 1.2%.  Compensation cost is subsequently adjusted upon a termination and actual forfeiture event, as appropriate.





For the six months ended March 31, 2011 and 2010, DeWind employee share-based compensation expense was reported in the Income (Loss) from Discontinued Operations in the amounts of $0 and $89,000, respectively (see further discussion at Note 2).





NOTE 12 – LITIGATION





Below we describe the legal proceedings we are currently involved in or which were resolved during the six months ended March 31, 2011 through the date we prepared this report:





(i) The FKI related matters:





FKI PLC and FKI Engineering Ltd v. Stribog Ltd and De Wind GmbH





On or about January 21, 2010, FKI Engineering Ltd. and FKI Engineering, formerly FKI Plc., filed an action against Stribog Ltd., formerly DeWind Ltd., in the Commercial Court, Queen’s Bench Division, United Kingdom (Case No. 2010 Folio 61). FKI’s claim is brought pursuant to an assignment agreement executed by the insolvency administrator assigning FKI the right to pursue claims on behalf of DeWind GmbH for amounts allegedly owed to DeWind GmbH from Stribog Ltd. In particular, the claim alleges that Stribog Ltd. is in breach of an August 1, 2005 business transfer agreement where DeWind GmbH agreed to sell and DeWind Ltd. agreed to purchase the assets of DeWind GmbH. FKI Engineering Ltd. and FKI Ltd. claim that DeWind GmbH is owed approximately 46,681,543 Euros (US $69,201,000 at May 3, 2011 exchange rates), which sum is comprised by a claim for principal in the sum of Euros 28,346,590 plus Value Added Tax of Euros 4,542,181, together with either interest of Euros 13,792,772 as at January 21, 2010 (continuing at a daily rate of Euros 7,316.63) or, in the alternative, statutory interest. Stribog Ltd. disputes that it owes any funds to DeWind GmbH and is vigorously contesting the validity of this allegation. Amongst other issues in dispute, the validity of the Assignment is currently subject to proceedings in both the Luebeck court in Germany (commenced by the company against FKI in September 2009) and the English courts (commenced by FKI in January 2010). The Luebeck court is expected to hear the dispute in the second half of 2011. Stribog also applied to stay the English proceedings on the basis that the issue was first filed in the German courts. This stay was initially denied,  but the Court of Appeals granted  leave to appeal that decision in October 2010.  The appeal was heard in February 2011.  On May 26, 2011 the Court of Appeals over-ruled the lower court decision and granted Stribog, Ltd. a stay and further ordered FKI to pay court costs and fees of 250,000 Pounds Sterling  and that Stribog Ltd could recover an additional 75,000 Pounds Sterling in court costs totaling 325,000 Pounds Sterling in recovery (approximately $535,000 at June 3, 2011 exchange rates).


26


Stribog Ltd. (formerly DeWind Ltd.) v. FKI Plc. and FKI Engineering Ltd.





On September 18, 2009 the Company’s wholly owned subsidiary, Stribog Ltd. (formerly DeWind Ltd.), filed an action for negative declaration in the Court of Lubeck, Germany against FKI Engineering Ltd. and FKI Ltd., formerly FKI Plc (“FKI”) (Case No. 17 O256/09) to obtain a court’s declaration that FKI is not entitled to any rights to rescission and claims against Stribog Ltd. pursuant to an assignment agreement executed by the German Insolvency administrator of DeWind GmbH assigning such rights to FKI. In its defense, FKI states (i) that the license agreement dated August 1, 2005 and the following transfer of those licenses for a purchase price of 500,000 Euros (US $741,000 at May 3, 2011 exchange rates) from DeWind GmbH to Stribog Ltd. in August 2008 could be challenged, in particular as the transferred licenses would have a significant higher value and (ii) that claims for damages could arise from a sale and transfer agreement dated August 1, 2005. Any particular amount in this respect was not provided by FKI. The Company believes that fair market value was paid for this intellectual property and that  any rights to rescission do not exist and (ii) that the assignment agreement was invalid. Stribog Ltd. has not recorded a liability as it is uncertain (i) whether such rights to challenge the transfer exist and whether the assignment of such rights to FKI is valid and (ii) if the court decides that such rights can be claimed by FKI, whether FKI will challenge the transfer accordingly.





Insolvency of DeWind GmbH





On August 29, 2008 in Lubeck Local Court – Bankruptcy Court, Lubeck Germany, DeWind GmbH, an indirect subsidiary of the Company, filed for voluntary insolvency in lieu of a required recapitalization under German law of approximately 5,000,000 Euros (US $7,412,000 at May 3, 2011 exchange rates) (Case No. 53a1E 8/08 ). The DeWind GmbH subsidiary had limited operational function for the DeWind segment, functioning solely to provide services on wind turbines that remained under warranty and which warranties were entered into prior to June, 2005.





On September 18, 2008 an insolvency receiver was appointed and set an initial reporting date in December, 2008 and which was primarily procedural in nature. No formal reporting has been received since December, 2008. On September 8, 2009, the insolvency receiver for DeWind GmbH entered into an Agreement in regard to a Settlement of Claims in which the insolvency receiver assigned any potential claim DeWind GmbH held against the Company, DeWind, Inc. and related Company entities to FKI for undisclosed consideration. All liabilities associated with these potential claims are recorded in liabilities from discontinued operations. This assignment is being disputed as discussed above.





(ii) The Mercury related matters :





Composite Technology Corporation and CTC Cable Corporation v. Mercury Cable & Energy, LLC, Ronald Morris, Edward Skonezny, Wang Chen, and “Doe” Defendants 1-100 (“Mercury”)





On August 15, 2008 the Company filed suit in the Superior Court of the State of California, County of Orange, Central Justice Center (Case No. 30-2008 00110633) against the Mercury parties including multiple unknown “Doe” defendants, claiming Breach of Contract, Unfair Competition, Fraud, Intentional Interference with Contract, and Injunctive Relief. Various Defendants filed counter claims for damages based on a Settlement Agreement of Claims filed under the Company’s 2005 Chapter 11 bankruptcy proceedings. In April 2011 all parties agreed to settle all claims and counterclaims made between the parties. No damages or legal costs are expected to be paid to or from either party. The settlement agreement is effective upon approval from the Bankruptcy Court.





CTC Cable Corporation v. Mercury Cable & Energy, LLC, Energy Technology International, General Cable Corporation, Diversified Composites, Ronald Morris, Edward Skonezny, Wang Chen, and Todd Harris





On March 3, 2009, CTC Cable filed action against Mercury Cable for patent infringement in the U.S. District Court, Central District of California, Southern Division (Case No. SACV 09-261 DOC (MLGx)). CTC Cable believes upon information that the Defendants have infringed, contributed to infringement of, and/or actively induced infringement by itself and/or through its agents, unlawfully and wrongfully making, using, offering to sell, and/or selling products and materials embodying the patented invention within and outside the United States without permission or license from CTC Cable. On October 18, 2010 the Court approved the expansion of the Complaint to include additional defendants including additional Mercury subsidiaries, Mercury’s strander, General Cable Corporation, Mercury’s core producer Diversified Composites, and Individuals Morris, Harris, Chen, and Skonezny. The Company is asking for actual damages, treble damages, attorney’s fees, interest, costs and injunctive relief. No estimate of such damages can be made at this time and no accrual for the Company’s future fees and costs is included in the Company's financial statements at September 30, 2010 or March 31, 2011. In early April the parties agreed to temporarily stay the proceedings through June 3, 2011. A stay during the pendency of the Company’s Title 11 Bankruptcy is now being sought. During the first and second quarters of 2011 the suit was amicably settled only with respect to defendants General Cable Corporation and Diversified Composites.


27


In Re Composite Technology Corporation Derivative Litigation (Brad Thomas v. Benton Wilcoxon, Michael Porter, Domonic J. Carney, Michael McIntosh, Stephen Bircher, Rayna Limited, Keeley Services Limited, Ellsford Management Limited, Laikadog Holdings Limited, James Carkulis, and Does 1 through 1000 (including D. Dean McCormick, III, CPA as Doe 1, John P. Mitola, as Doe 2, and Michael K. Lee, as Doe 3) and Nominal Defendant Composite Technology Corporation)





On June 26, 2009 Mr. Brad Thomas, alleged to be a shareholder of the Company, filed a shareholder derivative complaint in the Superior Court of the State of California, County of Orange (Case No. 30-2009-00125211) for damages and equitable relief. Certain of the defendants are current directors and/or officers or past officers of the Company. Under the Company’s articles of incorporation and bylaws, the Company is obligated to provide for indemnification for director and officer liability.  On October 28, 2010 the Honorable David R. Chaffee dismissed the complaint with prejudice and noted Mercury’s involvement in the matter.





In Re Partners for Growth II, L.P. vs. Composite Technology Corporation, CTC Cable Corporation, CTC Renewables Corporation, Stribog, In.c, and DOES 1 through 20





On April 6, 2011 Partners for Growth II, L.P. (PFG), the Company’s senior secured lender filed suit in the Superior Court of California, County of Orange, (Case No. 30-2011 00464300) against the CTC Parties claiming Breach of Written Contract; Money Due under Written Guaranty; Conversion; and Injunctive Relief.  This action followed a notice of default and acceleration of the Company’s Senior Secured Notes on April 6, 2011.  On April 8, 2011 the Hon. David R. Chaffee approved a Temporary Restraining Order, which required the Company to remit all remaining cash balances on April 11, 2011, absent further action. The TRO and the suit were stayed upon the Company filing Title 11 Bankruptcy as described below.





Title 11 Bankruptcy Filing:


On April 11, 2011, (“Petition Date”) Composite Technology Corporation filed for protection under Title 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Central District of California under Case No. 8:11-bk-15058 TA. Its subsidiaries CTC Cable Corporation, Stribog, Inc., and CTC Renewables, Inc. also filed for such protection.  All cases are jointly administered under the Composite Technology Corporation filing.  As of the Petition Date, the Company’s primary lender had obtained an injunction and Temporary Restraining Order that would have required the Company to remit all remaining cash balances to the lender.  As a result of the Title 11 filing, attempts to collect, secure or enforce remedies with respect to most pre-petition claims against the Company are subject to the automatic stay provisions of Section 362(a) of Title 11.  On April 14, 2011 a “First Day” Hearing was conducted and approved the use of up to $500,000 of cash to pay payroll and certain operating expenses and continued the hearing until April 27, 2011.  On April 27, 2011 the Lender and the Company agreed to continue the hearing until June 2, 2011 and allow the Company to conduct business in the ordinary course, subject to the Company’s cash forecast.  On May 26, 2011 the Company, the Lender, and the Unsecured Creditors committee agreed to allow the Company to continue to operate, under a monitoring process under a cash budget through August 2011.  To date, neither the Company nor its subsidiaries have filed a Plan of Reorganization.





NOTE 13 – SEGMENT INFORMATION





As of March 31, 2011, we manage and report our operations through one business segment: CTC Cable. When applicable, segment data is organized on the basis of products. Historically, the Company evaluates the performance of its operating segments primarily based on revenues and operating income, any transactions between reportable segments are eliminated in the consolidation of reportable segment data.





Located in Irvine, California with sales operations in Irvine, California, China, Europe, the Middle East, and Brazil, CTC Cable produces and sells ACCC® conductor products and related ACCC® hardware products. ACCC® conductor production is a two-step process. The Irvine operations produce the high capacity, energy efficient, light weight, patented composite ACCC® core, which is then shipped to one of nine conductor stranding licensees in the U.S., Canada, Belgium, China, Indonesia, India, Argentina, Columbia or Bahrain where the core is stranded with conductive aluminum to become ACCC® conductor.  ACCC® conductor is sold in North America directly by CTC Cable to utilities and by Alcan Cable.  ACCC® conductor is sold elsewhere in the world directly to utilities as well as through license and distribution agreements with Lamifil in Belgium, Midal Cable in Bahrain, Far East Composite Cable Co. in China, through two Indonesian companies, PT KMI Wire and Cable and PT Tranka Kabel, IMSA in Argentina, Centelsa in Colombia and now through Sterlite in India.  ACCC® conductor has been sold commercially since 2005 and is currently marketed worldwide to electrical utilities, transmission companies and transmission design/engineering firms.





The Company operates and markets its services and products on a worldwide basis. Revenues by geographical region are as follows:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Europe

$
120


$
16


$
462


$
105China


—



181



706



181Middle East


11



—



213



—Other Asia


981



1,615



1,005



1,622North America


198



2,430



4,119



3,607South America


83



10



82



1,438Total Revenue

$
1,393


$
4,252


$
6,587


$
6,953


28


All long-lived assets, comprised of property and equipment, are located in the United States.





For the three months ended March 31, 2011, five customers represented 97% of revenue (one in the U.S. at 14%, one in Chile at 6%, two in Indonesia at 68% and one in Belgium at 9%).  For the six months ended March 31, 2011, five customers represented 90% of revenue (one in the U.S. at 27%, one in Canada at 33%, one in China at 11%, one in Indonesia at 13% and one in Belgium at 7%).   No other customer represented greater than 5% of consolidated revenue.





For the three months ended March 31, 2010, three customers represented 94% of revenue (two in the U.S. at 56% and one in Indonesia at 38%).  For the six months ended March 31, 2010, four customers represented 91% of revenue (two in the U.S. at 47%, one in Chile at 21% and one in Indonesia at 23%).  No other customer represented greater than 5% of consolidated revenue.





NOTE 14 – SUBSEQUENT EVENTS (Unaudited)





Subsequent to March 31, 2011, the Company filed to reorganize under Chapter 11 of the U.S. Bankruptcy Code.  Its wholly owned subsidiary, CTC Cable Corporation, the leading producer of high-capacity energy efficient composite core conductors for electric transmission and distribution lines, also has filed for Chapter 11 protection.





The filings, made voluntarily in the U.S. Bankruptcy Court for the Central District of California, are designed to enable CTC and its subsidiary, CTC Cable, to continue to develop, produce and market its ACCC® conductor to the utility industry.





The Company’s decision to seek bankruptcy protection to protect the viability of the company has been necessitated due to actions taken by its lender.  On Tuesday, April 5, 2011, our lender served notice of default and accelerated its loan for $10,000,000.  On Thursday April 7, 2011, the lender filed an application for an emergency protective legal order which was granted without a hearing on Friday afternoon, April 8, 2011. The court order provides for the companies to immediately send all remaining cash recently released from the escrow containing proceeds from the sale of the wind division in 2009.  The Company’s attorneys believe that the court had not cited a basis to do so and that the Company’s dispute the lenders right to free the funds.  The lender also has attempted to freeze funds in operating accounts using account control provisions from the loan agreement. Unfortunately, Chapter 11 offers the only alternative to continue to operate the Company given these events.





As discussed in Note 1, for financial reporting purposes, the consolidated financial statements have been prepared on a going concern basis. Although the Company was not in Bankruptcy as of the Balance Sheet Date, the debtor has applied the provisions using specific guidance and disclosure requirements provided in US GAAP below on a pro forma basis beginning on the petition date of April 11, 2011.





All unsecured pre-petition liabilities expected to be classified on the balance sheet as Liabilities Subject to Compromise on a pro forma basis beginning on the petition date of April 11, 2011 consist of the following amounts:





(Unaudited, In Thousands)

April 2011Accounts Payable

$
6,843Accrued Compensation and Employee Benefits


285Accrued Disputed Balances


44Accrued Payroll Tax Liability


216Total

$
7,388





We expect certain other adjustments related to the financial statements.


29


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





You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing at the beginning of this report. The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended September 30, 2010 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on December 14, 2010.




The following discussion and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” and similar terms. Our actual results could differ materially from any future performance suggested in this report as a result of factors, including those discussed elsewhere in this report and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010. All forward-looking statements are based on information currently available to Composite Technology Corporation and we assume no obligation to update such forward-looking statements, except as required by law. Service marks, trademarks and trade names referred to in this Form 10-Q are the property of their respective owners.





OVERVIEW





We develop, produce, market and sell innovative energy efficient transmission products for the electrical utility industry.  We have conducted our operations in the following two business segments: the CTC Cable division and the DeWind division.  In September, 2009 we sold substantially all of the assets and liabilities of the DeWind segment.  Accordingly, all operations of our former DeWind segment have been reported as discontinued operations in the accompanying unaudited consolidated financial statements and notes thereto.




The financial results for the six months ended March 31, 2011 as compared to the six months ended March 31, 2010 reflected $0.4 million in revenue decreases from $6.9 million to $6.5 million primarily due to lower sales price ACCC® core sales and timing of deliveries. For the six months ended March 31, 2011 we shipped 668 kilometers of ACCC® products an increase from 545 kilometers in the six months ended March 31. 2010.  CTC Cable’s March 2011 quarter was weaker than expected as orders from the U.S. were delayed due to the North American Electric Reliability Corporation  (NERC) Order 810 regulation, orders from India under the new Sterlite agreement have not been realized, and further delays in reenergizing the China market.  We continue to see business prospects improving and expect the prospects to continue to improve as the worldwide economic recovery continues.  We continue to achieve project conductor design wins that we believe will eventually result in contract awards and revenues for several line projects that specify ACCC® conductor in both new international markets and the United States. Gross profit margins for the six months ended March 31, 2011 improved by $0.4 million to $1.6 million, or 25% of revenues from the $1.2 million figure for the six months ended March 31, 2010 and are reflective of higher margin sales of ACCC® core. However, with the low production levels seen in the first half of fiscal 2011, we continue to have production inefficiencies for our manufacturing plant in Irvine.  While our individual sales at historical standard costs were in line with historical margins, the historically low utilization of our plant resulted in a much less efficient allocation of our fixed overhead and trained production labor force.  If order levels and production levels increase, we expect to see gross margins in line with historical levels.




Our actions to reduce our operating expenses continue and are beginning to be reflected in our financial results. For the six months ending March 31, 2011, our operating expenses were reduced to $9.9 million, (including approximately $1.5 million in non-cash expenses) down $2.9 million from $12.8 million (including approximately $2.1 million in non-cash expenses) for the six months ending March 31, 2010. Excluding non-cash expenses, our non-GAAP cash basis expenses decreased by $2.3 million from $10.7 million to $8.4 million from 2011 to 2010.




Our efforts to expand our customer base and consequently our revenue base continue.  In November 2010 we signed a manufacturing agreement with Sterlite Technologies Limited located in India. The initial term for the agreement is six years with options to extend for additional terms.  The agreement allows for Sterlite to be the sole manufacturer of ACCC® conductor in India as long as Sterlite satisfies certain milestone conditions including sales and marketing targets, type registration, and minimum purchase quantities.  The agreement does not prevent other stranders from selling ACCC® conductor in India.  Other than losing their exclusivity within India, Sterlite is under no obligation to purchase ACCC® core from the Company currently or in the future and therefore the Company does not consider this to be a binding purchase obligation.  However, if Sterlite achieves the milestones listed in the contract, we could begin to see revenues from this agreement by the fourth fiscal quarter of 2011 with potentially significant and material revenues thereafter.  Future revenues from this transaction cannot be projected with any reasonable accuracy at this time and none of our current backlog results from this agreement.




In December 2010 we signed a manufacturing agreement with Taihan Electric Wire, LTD located in South Korea. The initial term for the agreement is one year with provisions for annual renewal. The agreement allows for Taihan to be the sole manufacturer of ACCC® conductor in Korea for sales to the Korean market as long as Taihan satisfies certain milestone conditions including sales and marketing targets, type registration, and minimum purchase quantities. The agreement does not prevent other stranders from selling ACCC® conductor in Korea. Other than termination of the agreement, Taihan is under no obligation to purchase ACCC® core from the Company currently or in the future and therefore the Company does not consider this to be a binding purchase obligation. However, if Taihan achieves the milestones listed in the contract, we could begin to see revenues from this agreement by the fourth fiscal quarter of 2011 with additional revenues thereafter. Future revenues from this transaction cannot be projected with any reasonable accuracy at this time and none of our current backlog results from this agreement.


30





In December, 2010 we were awarded a contract worth approximately $13.9 million for ACCC® conductor and hardware with Adminstracion Nacional de Electricidad (“ANDE”) for the Licitación Pública Internacional ANDE project in Paraguay. This contract bid award was conditional on the issuance of a performance bond and negotiation of the payment terms under letters of credit. Since notification of the contract bid award, we negotiated with entities for the issuance of the specific performance bond required by ANDE. The performance bond was withheld pending an administrative review of the contract by the government in Paraguay due to a request by a losing bidder. This administrative review resulted in an emergency re-bid in late March 2011. The award of the rebid contract remains uncertain as of the date of this filing. We had previously included this contract amount in our backlog for the quarter ended December 31, 2010. However, given the uncertainty of the rebid award and our Chapter 11 filing, we have removed this contract from our backlog. The contract calls for delivery of the entire contracted amount within 150 days from the finalization of the contract, the issuance of a performance bond, and the delivery of an acceptable letter of credit to CTC Cable.





In March 2011, the Company settled all current and outstanding claims related to its escrow agreement with Daewoo Shipbuilding and Marine Engineering (DSME) related to the September 2009 sale of the assets of its wind segment, DeWind.  The remaining escrow prior to the settlement consisted of $16.3 million.  DSME and the Company agreed to the following revised escrow arrangement:





·
$7.2 million in cash released to the Company of which $7 million was paid prior to March 31, 2011 and the $0.2 million remainder paid in April, 2011,


·
$3.0 million in cash retained in escrow to satisfy any additional claims.  This cash is scheduled to be released in September 2012 to the Company,


·
$4.5 million paid to DSME to satisfy all existing net asset value and other claims of DSME, and


·
$1.6 million paid to a third party vendor in April, 2011 in full satisfaction of all claims.





Senior Secured Debt Acceleration, Default, and Chapter 11Bankruptcy  filing:





On December 13, 2010, we entered into loan modifications with our senior secured lender for certain debt covenants resulting in a temporary waiver through January 14, 2011.  No additional waivers were received subsequent to January 4, 2011.  On April 6, 2011 the lender issued a notice of default and acceleration and requested immediate repayment of the $10 million notes plus interest, fees, and penalties.  On April 6, 2011 the lender filed suit in Superior Court, County of Orange, case number 30-2011-00464300 along with an Ex Parte Application for a Temporary Restraining Order (TRO).  On April 8, 2011 a hearing was conducted without arguments and the Hon. David R. Chaffee approved the Temporary Restraining Order, which commanded, among other issues, that the Company and its primary operating subsidiaries remit all remaining cash balances to the lender by April 11, 2011.  Between April 11, 2011 and April 12, 2011, the Company filed for Chapter 11 Reorganization for Composite Technology Corporation and its wholly owned subsidiaries CTC Cable, Stribog, Inc., and CTC Renewables.  With the filing for Chapter 11, an immediate stay was placed on the TRO for the PFG v. CTC case.





On April 14, 2011 the United States Bankruptcy Court, Central District of California, Santa Ana Division conducted a “First Day” hearing regarding use of cash and payment of pre-petition payroll.  The Hon. Mark Wallace approved a temporary motion to allow the Company, now debtor-in-possession, to operate until a hearing on April 27, 2011.  On April 27, 2011, the Company and the lender mutually agreed to allow the Company to operate under a 90-day cash-spending plan until a hearing scheduled for June 2, 2011. On May 25, 2011, the Company, the lender, and the unsecured creditors committee agreed to a further extension of the use of cash collateral and in the engagement of key professional advisors.




The Company’s bankruptcy proceedings may have a material negative impact on operations and finance.  After the filing, the Company’s market price per share was reduced from $0.19/share on April 8, 2011 to $0.05/share on April 13, 2011. The Company’s management was required to devote time for the first three weeks of the filing of the bankruptcy case on bankruptcy paperwork and expects to require additional time and resources to cover the costs of compliance.  The Company’s management will also be involved with ongoing compliance requirements for the United States Trustee’s office and with ongoing negotiations regarding formulating and implementing a reorganization and recapitalization plan.  Nonetheless, we do not expect these activities to impair the ability of management to focus on marketing and operational issues.




The bankruptcy filing has not altered the Company’s plans with respect to marketing, processing orders and shipments, product development, or any other aspect of the business.  To date, the filing has had limited revenue impact as the Company has had only one order cancelled by a customer as a direct result of the bankruptcy filing for $171,000 of ACCC® products. However, the impact of the bankruptcy filing on the Company’s relationships with its customers is difficult to assess and the bankruptcy filing may result in future order losses.




To date, the Company believes that the bankruptcy has enabled the Company to maintain its ongoing and continuing operations and preserve its key assets, including its intellectual property.  The Company’s relationships with its primary vendors and strategic partners have not been significantly impacted or interrupted by the bankruptcy filing and all of the key vendors have agreed to continue selling to the company.  The Company’s filing has had a limited impact on its employees.  Between April 11 and June 9, three non-production employees have resigned, citing the filing as a reason, although none of the Company’s senior management team has resigned and this level of turnover is not significantly higher than normal non-production employee turnover.  The filing of the bankruptcy has also stayed substantially all of the Company’s costly litigation and reduced legal expenses for those cases.




31




CTC Cable Division





Located in Irvine, California with sales operations in Irvine, California; Beijing, China, Europe, the Middle East, India and Brazil, CTC Cable produces and sells ACCC® conductor products and related ACCC® hardware products. ACCC® conductor production is a two-step process, in which our Irvine operations produce the high capacity, energy efficient, light weight, patented composite ACCC® composite core, that is then shipped to one of nine conductor stranding licensees in the U.S., Canada, Belgium, China, Indonesia (2), India, Argentina or Bahrain where the core is stranded with conductive aluminum to become ACCC® conductor.  ACCC® conductor is sold in North America directly by CTC Cable to utilities and by Alcan Cable.  ACCC® conductor is sold elsewhere in the world directly to utilities as well as through license and distribution agreements with Lamifil in Belgium, Midal Cable in Bahrain, Far East Composite Cable Co. in China, PT KMI Wire and Cable and PT Tranka Kabel in Indonesia, IMSA in Argentina and now through Sterlite in India and Taihan in Korea.  ACCC® conductor has been sold commercially since 2005 and is currently marketed worldwide to electrical utilities, transmission companies and transmission design/engineering firms.





RECENT DEVELOPMENTS





The Cable division’s focus during the quarter ended March 31, 2011 was sales, marketing, and operations with a goal to position CTC Cable for rapid revenue growth and expansion. The combination of a tentative but recovering worldwide economy, recent regulatory changes, and the focused efforts of our new CTC Cable President, Stewart Ramsay, who joined the Company in August 2010 coupled with the sales efforts of CTC Cable’s sales, marketing, and business development teams are beginning to drive an improved order flow and increased revenues.





Looking forward into the remainder of fiscal 2011, we expect to focus on penetrating new markets, monetize existing markets through follow-on orders, leverage our new and existing distributors, and restart sales in the Chinese market.  Our goal for 2011 is to land or monetize several long-term contracts for recurring ACCC® core sales in strategic locations including India, China, and North America.  In addition to this base of business, we will continue to open new markets elsewhere in the world and to conclude sales to new and repeat customers in our existing markets.





Our revenues for fiscal 2010 and fiscal 2011 to date have been driven by individual contracts, as opposed to recurring repeat orders.  Therefore our revenues from quarter to quarter have varied considerably as the number of sizable contracts changes. Our revenues for the quarter ended March 31, 2011 of $1.4 million consisted of sales of $1.0 million to two customers in Indonesia, $0.1 million to a customer in Belgium and $0.1 million to a customer in South America, all of which were repeat customers.  The remaining $0.2 million was from three customers around the world.  By comparison, our revenues for the March 31, 2010 quarter included $2.4 million in North America from two customers, $1.6 million in Indonesia from one customer, and sales to three other customers totaling $0.3 million.




To provide additional insight into our current and future revenues, we provide additional information below about our sales pipeline and opportunities.





Sales Pipeline, Opportunities, and Backlog





We define our sales pipeline in terms of sales opportunities, sales commitments, sales orders (backlog), and revenues.  Our sales efforts over the past year have increased with our increased sales and marketing efforts and as of May 31, 2011 we have over $1 billion in worked sales opportunities.  Such opportunities consist of separate, unique transmission conductor projects that have been identified by our sales and marketing team as opportunities specified to sell ACCC® conductor, which have the potential to be designed or installed using ACCC® conductor within the next 24 months and for which contact points with those potential customers have been established.  Sales opportunities are listed at the estimated value of potential revenues to CTC Cable and tracked over time to closure. Opportunities that are being worked by CTC employees and consultants, which are currently expected to have a likelihood of award to CTC Cable within the next twelve months, include over 100 separate transmission projects with a total value of over $400 million.  Additional projects are worked in markets served by engineering consulting companies and stranding licensees.  We expect to close a fraction of the projects listed as sales opportunities, but to date, our sales volatility, the volatility of the economic environment and our limited history does not allow for a meaningful analysis of a reasonable estimate of our closure rate for our sales opportunities.





Purchase commitments consist of contracts with customers or stranding licensees that represent agreements to purchase ACCC® conductor or ACCC® core over periods of time.  The commitments may be binding (take-or-pay) which would require delivery, or non-binding commitments which do not require delivery but which may carry other penalties such as those described below.  We currently have no binding purchase commitments from any of our customers or stranders.  The current non-binding commitments represent written agreements to purchase minimum quantities of ACCC® products in exchange for any or all of the following:  i) predetermined prices which may be pegged and adjustable to a certain raw material cost such as aluminum, ii) for exclusive rights to sales to certain customers, or iii) for exclusive rights to sales in certain geographic territories.  The extent of the commitment is that these licensees stand to lose any or all of the commitment benefits described in i) through iii) above if they fail to meet their minimum quantity orders.  The range of potential revenue if all of our non-binding commitments under our existing manufacturing and distribution agreements met their minimum quantity orders is between $35 million and $65 million of additional potential ACCC® core revenue over the next 12 to 18 months depending on core sizes and delivery schedules.  A considerable amount of time and effort has, and is expected to continue to be, expended to assist our network of stranders to meet or exceed their minimum commitments.


32





We define “firm backlog” as orders from customers or stranding licensees that are evidenced by a signed contract, purchase order or equivalent purchase document, or a signed sales order for stranding licensees under purchase commitment with agreed prices and delivery schedules.  We expect our entire firm backlog to eventually convert to delivered product and therefore revenues.  As of June 15, 2011 for delivery in the remainder of fiscal 2011 we have $5.3 million in firm backlog for delivery to customers in North America, South America, Europe, and Indonesia through the end of the September 2011 quarter.





In addition to the recovering economy, the adoption of ACCC® conductor has been positively impacted by a recent regulatory order in North America.  On October 7, 2010 the North American Electric Reliability Corporation (NERC) issued Order 810, which created a requirement for utilities with certain transmission and distribution lines to conduct review and remediation efforts and established substantial penalties for non-compliance.  Unless substantially modified, this edict will result in substantial expenditures on North American transmission lines over the next one to two years.  We believe that NERC 810 remediation using ACCC® conductors provides utilities with a cost-effective solution that is superior to other more costly and less effective solutions.  We have already begun to market ACCC® conductor as an alternative with positive initial results including several utilities who have begun line design work on critical projects and we have received tentative design wins which are included in our sales opportunities that are actively being worked by our sales and marketing team.  We expect orders from these opportunities to begin later in 2011 and which we expect will continue to drive ACCC® conductor adoption in North America to new and existing customers.





In another development, the recent unveiling of the 12th Five-Year Plan in China, the national operating blueprint for the country, revealed that composite core transmission conductor, of which ACCC® conductor, we believe, is the only commercially proven product in widespread use in China, has been identified as a high priority technology to be used widely to help meet the energy efficiency goals of the country.  This is a very positive endorsement of the technology and is complementary to the focused strategy and tactics that the Company has for the region.





Production





We currently have sufficient production capacity in our Irvine, CA ACCC® core facility to handle our expected revenues for the remainder of fiscal year 2011.  To the extent required, we have the ability to quickly add production capacity both through additional equipment into the Irvine facility or to open new production facilities.





We will continue to work to expand our ACCC® conductor production capacity through stranding and manufacturing agreements with targeted manufacturers worldwide.  Discussions with additional new stranding partners are underway at multiple locations worldwide in particular with several additional stranding manufacturers and distributors in China, Korea, and South America.  Additional sales efforts are also underway in the Middle East, Europe, and Africa.





Revenue





CTC Cable revenues were as follows for the three months and six months ended March 31, 2011 and 2010:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Europe

$
120


$
16


$
462


$
105China


—



181



706



181Other Asia


981



1,615



1,005



1,622North America


198



2,430



4,119



3,607South America


83



10



82



1,438Middle East


11



—



213



—Total Revenue

$
1,393


$
4,252


$
6,587


$
6,953Kilometers shipped


245



390



668



545ACCC® Core/Conductor Revenue per km

$
4,750


$
9,732


$
8,606


$
11,010





The decrease in revenues per kilometer was due to a higher proportion of sales of ACCC® core for the current year as compared to the prior year.  Our firm order backlog as of June 15, 2011 was $5.3 million.


Our gross margins decreased by $0.8 million  from $1.0 million in 2010 to $0.2 million for the three months ended March 31, 2011 with our reduced order and recognized revenue levels.  As a percentage of sales, gross margins declined to 15% of revenues as compared to 24% of revenues for the 2010 quarter, but increased to 25% of revenues as compared to 18% for the six months ended March 31, 2011.  Although we had lower charges to inventory reserves and sold a higher proportion of ACCC® core, which carries higher margins per revenue dollar than ACCC® conductor, in the March 2011 quarter, our plant utilization was inefficient due to the low production levels.  Our plant carries fixed costs for rent and labor which is based on plant utilization in excess of 20% to build our ACCC® core including our production teams, quality assurance, and infrastructure groups.




33




CTC Cable operating expenses decreased by $1.0 million from $4.2 million during the March 2010 quarter to $3.2 million during the March 2011 quarter primarily related to lower legal expenses, commissions, overall headcount reductions, lower overhead costs and other G&A cost reduction efforts partially offset by higher research and development expenses due to increased headcount related costs.





Discontinued Operations – Stribog (formerly DeWind)





In March 2011, Daewoo Shipbuilding and Marine Engineering (DSME), the Company, and a third party vendor reached a mutual agreement for settlement of the remaining supply chain dispute and DSME and the Company agreed to settle all claims between DSME and the Company, made against the escrowed funds ,through an Amended Escrow Agreement.  Under the terms of the Amended Escrow Agreement, the parties agreed that of the remaining $16.3 million of the original $17.2 million placed into escrow, $4.5 million would be disbursed to DeWind Co. (DWC), a wholly owned subsidiary of DSME; €1.1 million ($1.6 million at current exchange rates) would be disbursed to Zollern Dorstener Antriebstechnik Gesellschaft mbH & Co. KG (Zollern); and $7.2 million would be disbursed to the Company.  $4.5 million and $7.0 million of the $7.2 million were paid as of March 31, 2011 to DWC and the Company, respectively.  The remaining €1.1 million ($1.6 million at current exchange rates) and $0.2 million of the $7.2 million were paid in April 2011 to Zollernand the Company, respectively, and as such were reflected as current restricted cash as of March 31, 2011.





The remaining $3.0 million, reflected as non-current restricted cash as of March 31, 2011, was placed in escrow until September 4, 2012 at which time a portion of the funds would be released to DWC to satisfy any as yet unfiled additional claims.  If there are any unresolved claims made against the escrow fund at such time, then that portion of the fund for such claims shall not be released; provided however, that any unclaimed balance would be paid to the Company.  Refer to Note 2 to the consolidated financial statements.





The remaining assets and liabilities of the discontinued operations consist of the following:





(Unaudited, In Thousands)

March 31, 2011ASSETSAccounts Receivable, net

$
268LIABILITIESAccounts Payable and Other Accrued Liabilities

$
30,832Deferred Revenues and Customer Advances


2,192Warranty Provision


729Total Liabilities


33,753Net Liabilities of Discontinued Operations

$
33,485





All of the assets and liabilities of the discontinued operations pertain to activities outside of the United States. The remaining operations of DeWind, consist of receipt of license fees from Chinese licensees of older DeWind technology and satisfaction of the remaining contracts that were not assumed by DSME, primarily the servicing of warranties related to wind turbines installed in Europe from 2006 through 2009, most of which are now expired, and one contract for 10 turbines sold to South America that as yet have not been installed. At March 31, 2011, included above in Accounts Payable and Other Accrued Liabilities are net payables related to formerly consolidated, now insolvent European subsidiaries of approximately $20 million, substantially all of which has been assigned by the insolvency receiver to FKI, a former owner of DeWind, currently engaged in legal activities with the Company (see Note 12 to the consolidated financial statements). At March 31, 2011, the net payables from insolvent subsidiaries are comprised of assets in the amount of $7 million and liabilities in the amount of $27 million. We did not receive any update from the insolvency receiver related to the assets and liabilities for the insolvent subsidiaries during the six months ended March 31, 2011.





RESULTS OF OPERATIONS





The following table presents a comparative analysis of Revenue, Cost of Revenues, and Gross Margins for continuing operations, our CTC Cable division:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Product Revenue

$
1,393


$
4,252


$
6,587


$
6,953Cost of Revenue

$
1,179


$
3,241


$
4,962


$
5,724Gross Margin

$
214


$
1,011


$
1,625


$
1,229Gross Margin %


15.4
%


23.8
%


24.7
%


17.7
%


34





PRODUCT REVENUE:  Product revenues decreased $2.9 million, or 67%, from $4.3 million in 2010 to $1.4 million for the three months ended March 31, 2011, and decreased $0.4 million, or 5%, from $7.0 million in 2010 to $6.6 million for the six months ended March 31, 2011.





The decrease for the three months ended March 31, 2011 was primarily related to a significant decline in shipments of 141 km of ACCC® products to Indonesia and North America.  The decrease for the six months ended March 31, 2011 was primarily related to a shift in product mix of ACCC® products to a higher concentration of lower revenue yielding ACCC® core versus higher revenue yielding ACCC® conductor.





COST OF REVENUE: Cost of revenue represent materials, labor, freight, product cost depreciation and allocated overhead costs to produce ACCC® conductor, ACCC® core, and related hardware.  Cost of revenue decreased $2.1 million, or 64%, from $3.2 million in 2010 to $1.2 million for the three months ended March 31, 2011, and decreased $0.7 million, or 13%, from $5.7 million in 2010 to $5.0 million for the six months ended March 31, 2011.





Cost of revenue and resultant gross margin: Gross margin percentage of sales decreased 8% for the three months ended March 31, 2011, but increased 7% for the year.  For the three months ended March 31, 2011, gross margin percentage decreased primarily due to production inefficiencies as a result of significant idle production capacity, and inventory reserves recorded in the period.   For the six months ended March 31, 2011, gross margin percentage increased primarily due to a change in product mix to higher margin ACCC® core products and lower charges to inventory reserves.





The following table presents a comparative analysis of operating expenses for continuing operations:





Three Months Ended March 31,2011


2010(Unaudited, In Thousands)

Corporate


Cable


Total


Corporate


Cable


TotalOfficer Compensation

$
499


$
123


$
622


$
656


$
160


$
816General and Administrative


1,189



646



1,835



1,588



1,538



3,126Research and Development


—



591



591



—



490



490Sales and Marketing


—



1,791



1,791



—



1,847



1,847Depreciation and Amortization


2



55



57



—



163



163Total Operating Expenses

$
1,690


$
3,206


$
4,896


$
2,244


$
4,198


$
6,442





Six Months Ended March 31,2011


2010(Unaudited, In Thousands)

Corporate


Cable


Total


Corporate


Cable


TotalOfficer Compensation

$
985


$
244


$
1,229


$
1,225


$
160


$
1,385General and Administrative


2,297



1,612



3,909



4,195



2,796



6,991Research and Development


—



1,153



1,153



—



1,146



1,146Sales and Marketing


—



3,498



3,498



—



2,984



2,984Depreciation and Amortization


4



116



120



—



259



259Total Operating Expenses

$
3,286


$
6,623


$
9,909


$
5,420


$
7,345


$
12,765





OFFICER COMPENSATION: Officer Compensation represents CTC Corporate expenses and consists primarily of salaries, and the fair value of stock grants issued to officers of the Company. Officer compensation decreased $0.2 million, or 24%, from $0.8 million in 2010 to $0.6 million for the three months ended March 31, 2011, and decreased $0.2 million, or 11%, from $1.4 million in 2010 to $1.2 million for the six months ended March 31, 2011.  The decreases for the three and six months ended March 31, 2011 were primarily due to lower fair value share-based compensation expense for vested stock options.





GENERAL AND ADMINISTRATIVE: General and administrative expense consists primarily of salaries and employee benefits for administrative personnel, professional fees, facilities costs, insurance, travel, share-based compensation charges and any expenses related to reserves for uncollectible receivables. G&A expense decreased $1.3 million, or 42%, from $3.1 million in 2010 to $1.8 million for the three months ended March 31, 2011, and decreased $3.1 million, or 44%, from $7.0 million in 2010 to $3.9 million for the six months ended March 31, 2011.


35





The decrease of $1.3 million for the three months ended March 31, 2011 was due to a decrease in non-recurring expenses from 2010, including a $0.4 million decrease from corporate and a $0.9 million decrease from Cable.  The corporate related general and administrative decrease is derived substantially from reduced headcount related costs and reduced share-based compensation charges for vested stock options.  The Cable general and administrative decrease is related primarily to reduced headcount and legal costs.





The decrease of $3.1 million for the six months ended March 31, 2011 was due to a $1.9 million decrease in corporate and a $1.2 million decrease in Cable.  The corporate related general and administrative decrease is derived primarily from decreases in legal and other professional service fees and payroll taxes accrued in 2009 in connection with an IRS payroll tax audit, as discussed in Note 1 (“Income Taxes”) to the consolidated financial statements.  The decrease in Cable related general and administrative expenses is derived primarily from reduced headcount and legal costs.





RESEARCH AND DEVELOPMENT:  Research and development expenses consist primarily of salaries, consulting fees, materials, tools, and related expenses for work performed in designing and developing of manufacturing processes for the Company's products. Research and Development expenses increased $101,000, or 21%, from $0.5 million in 2010 to $0.6 million for the three months ended March 31, 2011, and remained flat at $1.1 million for the six months ended March 31, 2011.





The increase of $101,000 for the three months ended March 31, 2011 was due to increased headcount and headcount related costs for Cable partially offset by professional service fees.





SALES AND MARKETING: Sales and marketing expenses consist primarily of salaries, consulting fees, materials, travel, and other expenses performed in marketing, sales, and business development efforts for the Company. Sales and marketing expenses remained flat at $1.8 million for the three months ended March 31, 2011, but increased $0.5 million, or 17.2%, from $3.0 million in 2010 to $3.5 million for the six months ended March 31, 2011.





The increase of $0.5 million for the six months ended March 31, 2011 was related primarily to increases in headcount costs and professional service fees partially offset by reduced commissions on the lower revenue volume.





DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense consists of the depreciation and amortization of the Company's capitalized assets used in operations, excluding product cost depreciation (refer to cost of revenue discussion above). Depreciation expense decreased $108,000, or 65%, from $163,000 in 2010 to $57,000 for the three months ended March 31, 2011, and decreased $139,000, or 54%, from $259,000 in 2010 to $120,000 for the six months ended March 31, 2011.  The decrease was due to decreases in the fixed asset base.





INTEREST EXPENSE: Interest expense consists of the cash interest payable on the Company’s debt and amortization of the related debt discount on the Company’s debt.  For the prior year six months ended March 31, 2010, interest expense consisted of the cash interest on $9.0 million of Convertible Notes with an 8% coupon rate as well as the non-cash expense for amortization of the Convertible Note discount recorded for the value of the warrants and conversion features issued in conjunction with the Convertible Notes.  For the current year six months ended March 31, 2011, interest expense consisted of the cash interest on $10.0 million of 2 year Senior secured loan entered into in April 2010, and the remaining outstanding $100,000 30-day bridge loans entered into in March 2011, as well as the non-cash expense for amortization of the debt discount recorded for the value of the warrants issued in conjunction with the loans.





The net increases for the three and six months ended March 31, 2011, of $0.8 million and $0.6 million, respectively, is due to the prior year maturity and resultant payment of our convertible note in January 2010, in addition to the higher net financing costs related to the outstanding April 2010 Senior secured loan and March 2011 bridge loans.





INTEREST INCOME: The interest income changes from period to period are due to changes in the underlying cash balances.  Interest income decreased by $20,000 in the six months ended March 31, 2011 compared to the same period in the prior year.





OTHER INCOME/EXPENSE:  For the three and six months ended March 31, 2011, other income of $39,000 and $59,000, respectively, was primarily comprised of foreign exchange gains of $2,000 and $18,000, respectively, and a recovery from the reduction of penalties accrued of $38,000 associated with the findings from the examination by the Internal Revenue Service (“IRS”) for prior fiscals years ended September 30, 2001 through 2005 (refer to “Income Taxes” in Note 1 to the consolidated financial statements).  For the three and six months ended March 31, 2010, other expense of $0 and $264,000, respectively, was primarily comprised of a $90,000 loss on disposal of fixed assets and $171,000 in penalties associated with the IRS examination mentioned above.





CHANGE IN FAIR VALUE OF DERIVATIVE LIABILITIES: Refer to discussion at Note 1 (“Derivative Liabilities”) to the consolidated financial statements.




INCOME TAXES:  No provisions for income taxes were made for the three months ended March 31, 2011 and 2010.  We made provisions for income taxes of $0 and $14,000 for the six months ended March 31, 2011 and 2010, respectively. We have determined that due to our continuing operating losses as well as the uncertainty of the timing of profitability in future periods, we should fully reserve our deferred tax assets. As of March 31, 2011, our deferred tax assets continued to be fully reserved. We will continue to evaluate, on a quarterly basis, the positive and negative evidence affecting our ability to realize our deferred tax assets.


36




EFFECTS OF INFLATION: We are subject to inflation and other price risks arising from price fluctuations in the market prices of the various raw materials that we use to produce our products. Price risks are managed through cost-containment measures. Except as noted below, we do not believe that inflation risk or other price risks with respect to raw materials used to produce our products are material to our business, financial position, results of operations or cash flows. Due to a decrease in demand for composite quality carbon materials worldwide in particular in the aerospace and defense industries and despite a restricted supply of high quality carbon due to a limited number of suppliers, the Company experienced a price decline in unit costs of such carbon.  However, the Company may be exposed to raw material price increases or carbon material shortfalls should demand increase with the worldwide economic recovery and if additional suppliers or supplies do not become available. We cannot quantify any such price or material impacts at this time.





EFFECTS OF EXCHANGE RATE CHANGES: We are subject to price risks arising from exchange rate fluctuations in the functional currency of our European subsidiaries, primarily the Euro, the UK Sterling and the Chinese Yuan.  We currently do not hedge the exchange rate risk related to our assets and liabilities and do not hedge the exchange rate risk related to expected future operating expenses.





RECONCILIATION OF NON-GAAP MEASURES





The following tables present a reconciliation of consolidated non-GAAP EBITDAS or Earnings before Interest, Taxes, Depreciation & Amortization, and Share-based Compensation charges for continuing operations for the three months and six months ended March 31, 2011 and 2010:





The Company has provided non-GAAP measures such as EBITDAS in the following management discussion and analysis. The Company uses the non-GAAP information internally as one of several measures used to evaluate its operating performance and believes these non-GAAP measures are useful to, and have been requested by, investors as they provide additional insight into the underlying operating results viewed in conjunction with United States generally accepted accounting principles (US GAAP) operating results.  For the non-GAAP EBITDAS measure, a significant portion of non-cash expenses is excluded, primarily for interest, depreciation and for share-based compensation charges that are valued based on the share price and volatility at the date of grant and then expensed as earned, typically upon vesting of service over time.  The material limitation of non-GAAP EBITDAS compared with Net Income/Loss is that significant non-cash expenses are excluded.  Management compensates for such limitation by utilizing EBITDAS only for particular purposes and that it evaluates EBITDAS in the context of other metrics such as Net Income/Loss when evaluating the Company’s performance and financial condition. Non-GAAP measures are not stated in accordance with, should not be considered in isolation from, and are not a substitute for, US GAAP measures. A reconciliation of US GAAP to non-GAAP results has been provided in the financial tables below.  We will include the change in fair value of derivative liabilities, asset impairments and warrant modification expense in our reconciliation as well.





Three Months Ended March 31,2011


2010(Unaudited, In Thousands)

Corporate


Cable


Total


Corporate


Cable


TotalEBITDAS:Net loss from continuing operations

$
(2,107
)

$
(2,994
)

$
(5,101
)

$
(2,350
)

$
(3,185
)

$
(5,535
)Depreciation & Amortization


2



93



95



—



192



192Share-based compensation


301



148



449



625



200



825Change in fair value of derivative liabilities


(491
)


—



(491
)


(66
)


—



(66
)Interest expense, net


947



2



949



173



(3
)


170Income tax expense


—



—



—



—



—



—EBITDAS Income (Loss)

$
(1,348
)

$
(2,751
)

$
(4,099
)

$
(1,618
)

$
(2,796
)

$
(4,414
)





Six Months Ended March 31,2011


2010(Unaudited, In Thousands)

Corporate


Cable


Total


Corporate


Cable


TotalEBITDAS:Net loss from continuing operations

$
(4,695
)

$
(4,997
)

$
(9,692
)

$
(5,824
)

$
(6,197
)

$
(12,021
)Depreciation & Amortization


4



181



185



—



318



318Share-based compensation


509



478



987



1,126



363



1,489Change in fair value of derivative liabilities


(151
)


—



(151
)


(840
)


—



(840
)Interest expense, net


1,616



2



1,618



1,061



(14
)


1,047Income tax expense


—



—



—



14



—



14EBITDAS Loss

$
(2,717
)

$
(4,336
)

$
(7,053
)

$
(4,463
)

$
(5,530
)

$
(9,993
)


37





Consolidated EBITDAS Loss for the three months ended March 31, 2011 for continuing operations decreased by $0.3 million as compared to 2010 primarily due to a $0.3 million decrease from corporate. Consolidated EBITDAS Loss for the six months ended March 31, 2011 for continuing operations decreased by $2.9 million as compared to 2010 due to a $1.7 million decrease from corporate and a $1.2 million decrease from our Cable operations.  The total decrease was primarily due to reduced operating expenses.





NET LOSS





The following table presents the components of our total net loss:





Three Months Ended March 31,


Six Months Ended March 31,(Unaudited, In Thousands)

2011



2010



2011



2010Net Loss from Continuing Operations

$
(5,101
)

$
(5,535
)

$
(9,692
)

$
(12,021
)Income (Loss) from Discontinued Operations (Note 2)


(3,498
)


2,307



(2,104
)


1,085Net Loss

$
(8,599
)

$
(3,228
)

$
(11,796
)

$
(10,936
)





Net loss increased by $5.4 million to $8.6 million for the three months ended March 31, 2011 from $3.2 million in 2010, and increased by $0.9 million to $11.8 million for the six months ended March 31, 2011 from $10.9 million in 2010.  The increases in net loss are primarily due to the activity level of our discontinued operations through March 31, 2011 compared to the same period in 2010.  The $0.9 million net loss increase for the six months ended March 31, 2011was due to:





·
A partially offsetting increase in Gross Margin from continuing operations of $0.4 million from 2010 to 2011.





·
A partially offsetting decrease in Total Operating Expense from continuing operations of $2.9 million from 2010 to 2011.





·
An increase in Total Other Expense (including income taxes) from continuing operations of $1.0 million from 2010 to 2011.





·
An increase in Loss from Discontinued Operations of $3.2 million from a gain of $1.1 million in 2010 to a loss of $2.1 million in 2011.





Gross Margin: As discussed above, the gross margin increase of $0.4 million is primarily due to an improved product mix to higher margin ACCC® core and improved production efficiencies.





Total Operating Expense: As detailed above, the total decrease in operating expense is driven by significant decreases in general and administrative expenses totaling $3.1 million, a $0.2 million decrease for officer compensation, partially offset by an increase in sales and marketing expenses of $0.5 million for the six months ended March 31, 2011 compared to 2010.





Total Other Expense: As discussed above, the total other expense decrease is primarily due to a $0.7 million change in fair value of derivatives liabilities from a $0.8 million gain in 2010 to a $0.1 million gain in 2011, a $0.5 million increase in interest expenses, partially offset by reduced other expenses of $0.3 million in the six months ended March 31, 2011 compared to 2010 (refer to discussion above).





Loss from Discontinued Operations: As discussed above and detailed in Note 2 to the consolidated financial statements, the $5.8 million change from a $2.3 million gain for 2010 to a $3.5 loss for the three months ended March 31, 2011, and the $3.2 million change from a $1.1 million gain for 2010 to a $2.1 million loss for the six months ended March 31, 2011, is derived from the September, 2009 DeWind asset sale and related discontinuation of the DeWind business segment.





LIQUIDITY AND CAPITAL RESOURCES





Since inception, our principal sources of working capital have been private debt issuances and equity financings.


38





For the six months ended March 31, 2011, we had a net loss from continuing operations of $9.7 million. At March 31, 2011 we had $4.7 million of cash and cash equivalents, which represented a net increase of $1.7 million from September 30, 2010. The increase was due to cash used in operations of $9.8 million, cash provided by investing activities of $11.5 million and cash provided by financing activities of $63,000.





Cash used in operations during the six months ended March 31, 2011 of $9.8 million was primarily the result of a net loss of $11.8 million, offset by a loss from discontinued operations of $2.1 million and net non-cash reconciling items of $2.5 million (comprised of depreciation and amortization of $1.1 million, common stock related charges of $1.3 million and net inventory charges of $0.2 million, offset by a gain from the change in fair value of derivative liabilities of $0.1 million) and net cash provided from working capital of $2.3 million (comprised of positive changes in accounts payable of $2.6 million, accounts receivable of $0.8 million, inventory of $0.1 million and other assets of $0.2 million, offset by negative changes in deferred revenue of $1.2 million, prepaid expenses of $0.1 million and warranty provisions of $0.1). Additionally, cash used in operations was increased by a negative change in net assets/liabilities from discontinued operations of $4.9 million.





Cash provided by investing activities during the six months ended March 31, 2011 of $11.5 million was primarily from the release of restricted cash of $11.5 million related to the amended and restated escrow and security agreement settlement with DSME (refer to Note 2 to the consolidated financial statements.





Cash provided by financing activities during the six months ended March 31, 2011 of $63,000 was primarily from the proceeds received of $0.9 million from bridge loan financings, offset by repayments of some of the bridge loans of $0.8 million (refer to Note 9 to the consolidated financial statements).





Our cash position as of March 31, 2011 was $4.7 million.  In April 2010, we raised $10.0 million in senior secured debt, net of $0.3 million in fees (refer to Note 9 to the consolidated financial statements).  Our senior secured debt agreement includes certain restrictive financial covenants that the Company was not in compliance with during the months of September 2010 and January 2011; thereafter the Company had received conditional waivers and was in compliance with its amended covenants until January 15, 2011.  As of March 31, 2011, the Company was in violation of its covenants (see discussion in Note 9 to the consolidated financial statements).





In July 2010, in connection with the DeWind asset sale to DSME (refer to Note 2 to the consolidated financial statements), the Company received $836,000 of the escrowed cash, which was used to pay a vendor claim, leaving $16.3 million remaining in escrow.  In March 2011, under an Amended Escrow Agreement in connection with the DeWind asset sale, the Company received $7.2 million of the $13.3 million disbursed under the agreement (see discussion in Note 2 to the consolidated financial statements), leaving $3.0 million held in escrow as of March 31, 2011.




We believe our current cash position, expected cash flows from revenue orders, and potential recovery of additional escrowed cash may not be sufficient to fund our operations for the next twelve months ending March 31, 2012 on a consolidated basis and to exit our Title 11 bankruptcy filing and to the extent required, the Company intends to raise capital.  Such capital may result in significant additional dilution to the Company’s existing shareholders.Due to the sale of substantially all of the DeWind business, recorded as discontinued operations, the cash requirements of the Company have decreased as a result of significantly lower cash operating expenses and the elimination of inventory purchases for costly wind turbine parts.  As CTC Cable has sufficient production capacity in its existing plant to achieve profitability, it is not expected that significant capital expenditures will be required to expand production, as seen in prior years.  CTC Cable has also significantly reduced its reliance on one customer as compared to prior fiscal years, which has lowered its customer concentration risk.  Additionally, as needed, we intend to continue the practice of issuing stock, debt, or other financial instruments for cash or for payment of services or debt extinguishment until our cash flows from the sales of our primary products is sufficient to fully provide for cash used in operations or if we believe such a financing event would be a sound business strategy. The Company received a report from its independent auditors for the year ended September 30, 2010 that included an explanatory paragraph describing the uncertainty as to the Company's ability to continue as a going concern. As of March 31, 2011, our consolidated financial statements contemplate the ability to continue as such and do not include any adjustments that might result from this uncertainty.  Therefore, the Company has conservatively estimated, assuming no additional net cash receipts are generated from the escrowed cash and, if needed, we do not close a financing transaction that provides adequate cash flow, that our ability to continue operations after September 30, 2011 is uncertain (refer to “Going Concern” in Note 1 to the consolidated financial statements).





CAPITAL EXPENDITURES





The Company does not have any material commitments for capital expenditures.





OFF BALANCE SHEET ARRANGEMENTS





As of March 31, 2011, we have no off balance sheet arrangements.





CONTRACTUAL OBLIGATIONS





The following table summarizes our contractual obligations (including interest expense) and commitments as of March 31, 2011:





39




Due in





In excess of(Unaudited, In Thousands)

Total


Year 1


In Years 2-3


3 YearsWarranty Provisions (A)

$
381


$
251


$
130


$
—Debt Obligations (B)

$
11,938


$
11,860


$
78


$
—Operating Lease Obligations

$
1,965


$
997


$
968


$
—





(A) Warranty provisions are discussed in Note 8 to the consolidated financial statements.





(B) Bridge loans due April 2011 and the related estimated monthly interest payments, and the Senior secured loan due April 2012 and the related estimated monthly interest-only payments (see Note 9 to the consolidated financial statements).





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





Our discussion and analysis of our financial condition and results of operations is based on our Consolidated Financial Statements, which have been prepared in accordance with US GAAP.  Critical accounting policies and estimates, included in Note 1 to the consolidated financial statements, are as follows:





Revenue Recognition





Revenues are recognized based on guidance provided by the Securities and Exchange Commission (SEC). Accordingly, our general revenue recognition policy is to recognize revenue when there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the related receivable is reasonably assured, and delivery has occurred or services have been rendered.  Revenues recorded are shown net of any sales discounts or similar sales incentives provided to our customers.





The Company derives, or seeks to derive, revenues from product revenue sales of composite core, stranded composite core, core and stranded core hardware, and other electric utility related products.





In addition to the above general revenue recognition principles prescribed by the SEC, our specific revenue recognition policies for each revenue source are as follows:





PRODUCT REVENUES. Product revenues are recognized when product shipment has been made and title has passed to the end user customer. Product revenues consist primarily of revenue from the sale of: (i) stranded composite core and related hardware to utilities either sold directly by the Company or through a distribution agreement, and (ii) composite core and related hardware sold to a cable stranding entity. Revenues are deferred for product contracts where the Company is required to perform installation services until after the installation is complete. Our distribution agreements are structured so that our revenue cycle is complete upon shipment and title transfer of products to the distributor with no right of return.





CTC Cable sales in the three months ended March 31, 2011 and 2010 consisted of stranded ACCC® conductor and ACCC® hardware sold to end-user utilities and sales of ACCC® core and ACCC® hardware to our stranding manufacturers. All ACCC® product related sales were recognized upon delivery of product and transfer of title. For ACCC® conductor product sales made directly by us and not through a manufacturer or distributor, through a third-party insurance company, we provide the option to purchase an extended warranty for periods up to five, seven or ten years. We allocate a portion of sales proceeds to the estimated fair value of the cost to provide such a warranty. To date, most of our ACCC® related product sales have been without extended warranty coverage. Additionally, all ACCC® conductor is sold to our end-user customers with a standard three-year product warranty. The Company purchases a three-year term product warranty liability insurance policy for all ACCC® conductor sold directly by the Company to mitigate any product warranty liability risk. Revenues from ACCC® conductor sold directly to end-user customers are recorded net of the cost of the three-year term insurance policy.





CONSULTING REVENUE. Consulting revenues are generally recognized as the consulting services are provided. We have entered into service contract agreements with electric utility and utility services companies that generally require us to provide engineering or design services, often in conjunction with current or future product sales. In return, we receive engineering service fees payable in cash.  In the three months ended March 31, 2011 and 2010, we recognized no consulting revenues.





Multiple-element revenue arrangements are recognized with the overall arrangement fee being allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by vendor specific objective evidence or third-party evidence, or are based on the Company's estimated selling price.  Historically, except for the product warranty element discussed above, we have not had any multiple-element revenue arrangements.


40


Warranty Provisions





Warranty provisions consist of the insured costs and liabilities associated with any post-sales associated with our ACCC® conductor and related hardware parts.  Warranties related to our ACCC® products relate to conductor and hardware sold directly by us to the end-user customer.  We mitigate our loss exposure through the use of third-party warranty insurance.  Warranty related liabilities for time periods in excess of one year are classified as non-current liabilities.





Our ACCC® conductor is sold to our end-user customers with a standard three-year product warranty. The Company purchases a three-year term product warranty liability insurance policy for all ACCC® conductor sold directly by the Company to mitigate any product warranty liability risk.  All customers have the option to extend this warranty for to up to ten years upon customer payment of additional insurance premiums.  The insurance policy covers materials costs and labor costs to replace the ACCC® conductor in the event of a product warranty claim caused by a product defect.  As such, the purchase of the initial three-year insurance policy covers significantly all product warranty liability for which the Company may be exposed under its standard three-year product warranty.  To date, the Company has had no product warranty claims.





Use of Estimates





The preparation of our financial statements conform with US GAAP, which requires management to make estimates and judgments in applying our accounting policies that have an important impact on our reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of our financial statements. On an on-going basis, management evaluates its estimates including those related to accounts receivable, inventories, share-based compensation, warranty provisions and goodwill and intangibles, as applicable. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from management’s estimates. We believe that the application of our accounting policies requires significant judgments and estimates on the part of management. We believe that the estimates, judgments and assumption upon which we rely are reasonable, and based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the period presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by US GAAP and does not require management's judgment in its application. There are also many areas in which management's judgment in selecting among available alternatives would produce a materially different result.





The key estimates we use that rely upon management judgment include:





-
the estimates pertaining to the likelihood of our accounts receivable collectability. These estimates primarily rely upon past payment history for each customer and management’s judgment on the likelihood of future payments based on the current business condition of each customer and the general business environment.


-
the estimates pertaining to the valuation of our inventories. These estimates primarily rely upon the current order book for each product in inventory along with management’s expectations and visibility into future sales of each product in inventory.


-
the assumptions used to calculate fair value of our share-based compensation and derivative liabilities, primarily the volatility component of the Black-Scholes-Merton (Black-Scholes) option-pricing model used to value our warrants and our employee and non-employee options. This estimate relies upon the past volatility of our share price over time as well as the estimate of the option life.


-
the estimates and assumptions used to determine the settlement of certain accounts related to the sale of the DeWind assets for which a final accounting has not been completed and which may result in the increase or decrease of asset reserves or increase or decrease of accrued liabilities, principally penalty payments, interest, and other costs associated with the turbine parts suppliers for DeWind turbine parts. See related discussion at Note 2 to the consolidated financial statements.





Derivative Financial Instruments





The Company issues financial instruments in the form of stock options and stock warrants, and debt conversion features as part of its debt issuances. The Company has not issued any derivative instruments for hedging purposes since its inception. The Company uses the specific guidance and disclosure requirements provided in US GAAP. Generally, freestanding derivative contracts where settlement is required by physical share settlement or where the Company has a choice of share or net cash settlement are accounted for as equity. Contracts where settlement is in cash or in net share settlement; or where the counterparty may choose cash settlement are accounted for as a liability. Under current US GAAP, certain of our warrants are subject to liability accounting treatment (see discussion below under “Derivative Liabilities”), while our stock options are considered indexed to the Company’s stock and are accounted for as equity.





The values of the financial instruments are estimated using the Black-Scholes option-pricing model. Key assumptions used to value options and warrants granted, issued or repriced are as follows:


41





Six Months Ended

March 31,2011


2010Risk Free Rate of Return


0.30-1.91
%


0.82-2.43
%Volatility


78.9-100.2
%


95.6-108
%Dividend yield


0
%


0
%Expected life

1-5 yrs


2-5 yrs





Derivative Liabilities





Currently, our derivative liabilities include fair value based warrant liabilities pursuant to US GAAP applied to the terms of the underlying agreements. The Company has issued warrants to purchase common shares of the Company as additional incentive for investors who purchase unregistered, restricted common stock, certain debt obligations or convertible debentures. The fair value of certain warrants issued and debt conversion features in conjunction with financing events are recorded as a discount for debt issuances. Certain warrant agreements and debt conversion arrangements include provisions that require us to record them as a liability, at fair value, pursuant to Financial Accounting Standards Board (FASB) accounting rules, including certain provisions designed to protect a holder’s position from being diluted. The derivative liabilities are marked-to-market each reporting period and changes in fair value are recorded as a non-operating gain or loss in our consolidated statements of operations, until they are completely settled or expire. The fair value of the warrants and debt conversion features are determined each reporting period using the Black-Scholes valuation model, using inputs and assumptions consistent with those used in our estimate of fair value of employee stock options, except that the remaining contractual life is used.  Such fair value is affected by changes in inputs to that model including our stock price, expected stock price volatility, interest rates and expected term.





Refer to “Fair Value Measurements” in Note 1 to the consolidated financial statements for additional derivative liabilities disclosures.





For the three and six months ended March 31, 2011, we recognized gains of $727,000 and $386,000, respectively, related to the revaluation of our derivative liabilities.  The 2011 revaluation gain resulted from a decrease in our stock price from the prior quarter, net of the increase from the re-pricing of certain warrants in the prior quarter, as further discussed in Note 10.





In connection with the warrants issued to investors as discussed above, the Company has issued warrants to compensate for financing fees and other service fees incurred.  Such compensatory warrants are recorded at fair value in the same manner as non-compensatory warrants, however, the recognized expense is offset to additional paid-in-capital.  Such warrants are considered equity transactions in accordance with US GAAP.  Additionally, warrants issued without anti-dilution provisions are generally considered equity transactions in accordance with US GAAP. All of our outstanding warrants including those subject to liability accounting treatment are further discussed in Note 10 to the consolidated financial statements.





Share-Based Compensation





US GAAP requires that compensation cost relating to share-based payment arrangements be recognized in the financial statements. US GAAP requires measurement of compensation cost for all share-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such fair value is recognized as expense over the service period, net of estimated forfeitures.




US GAAP requires that equity instruments issued to non-employees in exchange for services be valued at the more accurate of the fair value of the services provided, or the fair value of the equity instruments issued. For equity instruments issued that are subject to a required service period, the expense associated with the equity instruments is recorded as the instruments vest or the services are provided. The Company has granted options and warrants to non-employees and recorded the fair value of these equity instruments on the date of issuance using the Black-Scholes valuation model, for options and warrants not subject to vesting terms. For non-employee option and warrant grants subject to vesting terms, vested shares are recorded at fair value using the Black-Scholes valuation model and the associated expense is recorded simultaneously or as the services are provided. The Company has granted stock to non-employees for services and values the stock at the more reliable of the market value on the date of issuance or the value of the services provided. For issued grants subject to vesting or service requirements, expenses are deferred and recognized over the more appropriate of the vesting period, or as services are provided.





SEC guidance requires share-based compensation to be classified in the same expense line items as cash compensation. Additionally, the SEC issued guidance regarding the use of a "simplified" method in developing an estimate of expected term of "plain vanilla" share options in accordance with US GAAP rules. The Staff indicated that it will accept a company's election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. The Staff believed that more detailed external information about employee exercise behavior (e.g., employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies; however, the Staff continues to accept, under certain circumstances, the use of the simplified method. The Company currently uses the simplified method for the expected term in “plain vanilla” share options and warrants.


42


Additional information about share-based compensation is disclosed in Note 11 to the consolidated financial statements.





Convertible Debt





Convertible debt is accounted for under specific guidelines established in US GAAP. The Company records a beneficial conversion feature (BCF) related to the issuance of convertible debt that have conversion features at fixed or adjustable rates that are in-the-money when issued and records the fair value of warrants issued with those instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion features, both of which are credited to paid-in-capital or liabilities as appropriate. The Company calculates the fair value of warrants issued with the convertible instruments using the Black-Scholes valuation method, using the same assumptions used for valuing employee options, except that the contractual life of the warrant is used. Upon each issuance, the Company evaluates the variable conversion features and determines the appropriate accounting treatment as either equity or liability, in accordance with US GAAP. The Company first allocates the value of the proceeds received to the convertible instrument and any other detachable instruments (such as detachable warrants) on a relative fair value basis and then determines the amount of any BCF based on effective conversion price to measure the intrinsic value, if any, of the embedded conversion option. Using the effective yield method, the allocated fair value is recorded as a debt discount or premium and is amortized over the expected term of the convertible debt to interest expense. For a conversion price change of a convertible debt issue, the additional intrinsic value of the debt conversion feature, calculated as the number of additional shares issuable due to a conversion price change multiplied by the previous conversion price, is recorded as additional debt discount and amortized over the remaining life of the debt.  As of March 31, 2011, we had no convertible debt outstanding.





US GAAP rules specify that a contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with US GAAP contingency rules. The contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured in accordance with said rules, pursuant to which a contingent obligation must be accrued only if it is more likely than not to occur. Historically, the Company has not been required to accrue any contingent liabilities in this regard.





RECENT ACCOUNTING PROUNOUNCEMENTS





Refer to Note 1 to the consolidated financial statements.





Item 3. Quantitative and Qualitative Disclosures About Market Risk





Our exposure to market risk relates primarily to our cash balances and the effect that changes in interest rates have on the interest earned on that portfolio.  Our current debt obligations bear a fixed rate of interest.





As of March 31, 2011 we did not hold any derivative financial instruments for speculative or trading purposes. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk. As of March 31, 2011, we had $4.7 million in cash and cash equivalents including short-term investments purchased with original maturities of three months or less. Due to the short duration of these financial instruments, we do not expect that a change in interest rates would result in any material loss to our investment portfolio.





Item 4. Controls and Procedures





Evaluation of Disclosure Controls and Procedures





Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934. Disclosure controls and procedures are controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as of March 31, 2011 because of the material weaknesses identified during management’s annual assessment of internal control over financial reporting for the year ended September 30, 2010.


43





Internal Control over Financial Reporting





Refer to “Item 9A – Controls and Procedures” in our Form 10-K filed with the Securities and Exchange Commission on December 14, 2010 for management’s annual report on internal control over financial reporting.   The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2010.  In making this assessment, the Company’s management used the criteria set forth in the framework established by the Committee of Sponsoring Organizations of the Treadway Commission entitled “Internal Control – Integrated Framework”.  Based on their assessment, management concluded that, as of September 30, 2010, the Company’s internal control over financial reporting is not effective based on those criteria, because of the material weaknesses identified.





Changes in Internal Control over Financial Reporting





There was no change in our internal control over financial reporting during the six months ended March 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.





The Company's management has identified the steps necessary to address the material weaknesses identified as of September 30, 2010, as follows:





(1) Hiring additional accounting and operations personnel and engaging outside contractors with technical accounting expertise, as needed, and reorganizing the accounting and finance department to ensure that accounting personnel with adequate experience, skills and knowledge relating to complex, non-routine transactions are directly involved in the review and accounting evaluation of our complex, non-routine transactions;





(2) Involving both internal accounting and operations personnel and outside contractors with technical accounting expertise, as needed, early in the evaluation of a complex, non-routine transaction to obtain additional guidance as to the application of generally accepted accounting principles to such a proposed transaction;





(3) Documenting to standards established by senior accounting personnel and the principal accounting officer the review, analysis and related conclusions with respect to complex, non-routine transactions;





(4) Evaluating an internal audit function in relation to the Company's financial resources and requirements;





(5) Investing in additional enhancements to our IT systems including enhancements to processing manufacturing and inventory transactions, and security over user access and administration;





(6) Creating policy and procedures manuals for the accounting, finance and IT functions; and





(7) Improving our purchasing and accounts payable cycle controls.





The Company began to execute the remediation plans identified above in the first fiscal quarter of 2011. These remediation efforts are expected to continue through fiscal 2011.


44


PART II – OTHER INFORMATION





Item 1. Legal Proceedings





The following are the material pending legal proceedings to which the Company or its subsidiaries is a party or of which any of our property is the subject material developments during the three months ended March 31, 2011.





(i) The FKI related matters:





FKI PLC and FKI Engineering Ltd v. Stribog Ltd and De Wind GmbH





On or about January 21, 2010, FKI Engineering Ltd. and FKI Engineering, formerly FKI Plc., filed an action against Stribog Ltd., formerly DeWind Ltd., in the Commercial Court, Queen’s Bench Division, United Kingdom (Case No. 2010 Folio 61). FKI’s claim is brought pursuant to an assignment agreement executed by the insolvency administrator assigning FKI the right to pursue claims on behalf of DeWind GmbH for amounts allegedly owed to DeWind GmbH from Stribog Ltd. In particular, the claim alleges that Stribog Ltd. is in breach of an August 1, 2005 business transfer agreement where DeWind GmbH agreed to sell and DeWind Ltd. agreed to purchase the assets of DeWind GmbH. FKI Engineering Ltd. and FKI Ltd. claim that DeWind GmbH is owed approximately 46,681,543 Euros (US $69,201,000 at May 3, 2011 exchange rates), which sum is comprised by a claim for principal in the sum of Euros 28,346,590 plus Value Added Tax of Euros 4,542,181, together with either interest of Euros 13,792,772 as at January 21, 2010 (continuing at a daily rate of Euros 7,316.63) or, in the alternative, statutory interest. Stribog Ltd. disputes that it owes any funds to DeWind GmbH and is vigorously contesting the validity of this allegation. Amongst other issues in dispute, the validity of the Assignment is currently subject to proceedings in both the Luebeck court in Germany (commenced by the company against FKI in September 2009) and the English courts (commenced by FKI in January 2010). The Luebeck court is expected to hear the dispute in the second half of 2011. Stribog also applied to stay the English proceedings on the basis that the issue was first filed in the German courts. This stay was initially denied, but the Court of Appeals granted  leave to appeal that decision in October 2010.  The appeal was heard in February 2011.  On May 26, 2011 the Court of Appeals over-ruled the lower court decision and granted Stribog, Ltd. a stay and further ordered FKI to pay court costs and fees of 250,000 Pounds Sterling  and that Stribog Ltd could recover an additional 75,000 Pounds Sterling in court costs totaling 325,000 Pounds Sterling in recovery (approximately $535,000 at June 3, 2011 exchange rates).





Stribog Ltd. (formerly DeWind Ltd.) v. FKI Plc. and FKI Engineering Ltd.





On September 18, 2009 the Company’s wholly owned subsidiary, Stribog Ltd. (formerly DeWind Ltd.), filed an action for negative declaration in the Court of Lubeck, Germany against FKI Engineering Ltd. and FKI Ltd., formerly FKI Plc (“FKI”) (Case No. 17 O256/09) to obtain a court’s declaration that FKI is not entitled to any rights to rescission and claims against Stribog Ltd. pursuant to an assignment agreement executed by the German Insolvency administrator of DeWind GmbH assigning such rights to FKI. In its defense, FKI states (i) that the license agreement dated August 1, 2005 and the following transfer of those licenses for a purchase price of 500,000 Euros (US $741,000 at May 3, 2011 exchange rates) from DeWind GmbH to Stribog Ltd. in August 2008 could be challenged, in particular as the transferred licenses would have a significant higher value and (ii) that claims for damages could arise from a sale and transfer agreement dated August 1, 2005. Any particular amount in this respect was not provided by FKI. The Company believes that fair market value was paid for this intellectual property and that  any rights to rescission do not exist and (ii) that the assignment agreement was invalid. Stribog Ltd. has not recorded a liability as it is uncertain (i) whether such rights to challenge the transfer exist and whether the assignment of such rights to FKI is valid and (ii) if the court decides that such rights can be claimed by FKI, whether FKI will challenge the transfer accordingly.





Insolvency of DeWind GmbH





On August 29, 2008 in Lubeck Local Court – Bankruptcy Court, Lubeck Germany, DeWind GmbH, an indirect subsidiary of the Company, filed for voluntary insolvency in lieu of a required recapitalization under German law of approximately 5,000,000 Euros (US $7,412,000 at May 3, 2011 exchange rates) (Case No. 53a1E 8/08 ). The DeWind GmbH subsidiary had limited operational function for the DeWind segment, functioning solely to provide services on wind turbines that remained under warranty and which warranties were entered into prior to June, 2005.





On September 18, 2008 an insolvency receiver was appointed and set an initial reporting date in December, 2008 and which was primarily procedural in nature. No formal reporting has been received since December, 2008.  On September 8, 2009, the insolvency receiver for DeWind GmbH entered into an Agreement in regard to a Settlement of Claims in which the insolvency receiver assigned any potential claim DeWind GmbH held against the Company, DeWind, Inc. and related Company entities to FKI for undisclosed consideration.  All liabilities associated with these potential claims are recorded in liabilities from discontinued operations.  This assignment is being disputed as discussed above.


45





(ii) The Mercury related matters :





Composite Technology Corporation and CTC Cable Corporation v. Mercury Cable & Energy, LLC, Ronald Morris, Edward Skonezny, Wang Chen, and “Doe” Defendants 1-100 (“Mercury”)





On August 15, 2008 the Company filed suit in the Superior Court of the State of California, County of Orange, Central Justice Center (Case No. 30-2008 00110633) against the Mercury parties including multiple unknown “Doe” defendants,  claiming Breach of Contract, Unfair Competition, Fraud, Intentional Interference with Contract, and Injunctive Relief. Various Defendants  filed counter claims for damages based on a Settlement Agreement of Claims filed under the Company’s 2005 Chapter 11 bankruptcy proceedings.  In April 2011 all parties agreed to settle all claims and counterclaims made between the parties.  No damages or legal costs are expected to be paid to or from either party.  The settlement agreement is effective upon approval from the Bankruptcy Court.





CTC Cable Corporation v. Mercury Cable & Energy, LLC, Energy Technology International, General Cable Corporation, Diversified Composites, Ronald Morris, Edward Skonezny, Wang Chen, and Todd Harris





On March 3, 2009, CTC Cable filed action against Mercury Cable for patent infringement in the U.S. District Court, Central District of California, Southern Division (Case No. SACV 09-261 DOC (MLGx)). CTC Cable believes upon information that the Defendants have infringed, contributed to infringement of, and/or actively induced infringement by itself and/or through its agents, unlawfully and wrongfully making, using, offering to sell, and/or selling products and materials embodying the patented invention within and outside the United States without permission or license from CTC Cable.  On October 18, 2010 the Court approved the expansion of the Complaint to include additional defendants including additional Mercury subsidiaries, Mercury’s strander, General Cable Corporation, Mercury’s core producer Diversified Composites, and Individuals Morris, Harris, Chen, and Skonezny. The Company is asking for actual damages, treble damages, attorney’s fees, interest, costs and injunctive relief. No estimate of such damages can be made at this time and no accrual for the Company’s future fees and costs is included in the Company's financial statements at September 30, 2010 or March 31, 2011.  In early April the parties agreed to temporarily stay the proceedings through June 3, 2011.  A stay during the pendency of the Company’s Title 11 Bankruptcy is now being sought.  During the first and second quarters of 2011 the suit was amicably settled only with respect to defendants General Cable Corporation and Diversified Composites.





In Re Composite Technology Corporation Derivative Litigation (Brad Thomas v. Benton Wilcoxon, Michael Porter, Domonic J. Carney, Michael McIntosh, Stephen Bircher, Rayna Limited, Keeley Services Limited, Ellsford Management Limited, Laikadog Holdings Limited, James Carkulis, and Does 1 through 1000 (including D. Dean McCormick, III, CPA as Doe 1, John P. Mitola, as Doe 2, and Michael K. Lee, as Doe 3) and Nominal Defendant Composite Technology Corporation)





On June 26, 2009 Mr. Brad Thomas, alleged to be a shareholder of the Company, filed a shareholder derivative complaint in the Superior Court of the State of California, County of Orange (Case No. 30-2009-00125211) for damages and equitable relief. Certain of the defendants are current directors and/or officers or past officers of the Company. Under the Company’s articles of incorporation and bylaws, the Company is obligated to provide for indemnification for director and officer liability.  On October 28, 2010 the Honorable David R. Chaffee dismissed the complaint with prejudice and noted Mercury’s involvement in the matter.





In Re Partners for Growth II, L.P. vs. Composite Technology Corporation, CTC Cable Corporation, CTC Renewables Corporation, Stribog, In.c, and DOES 1 through 20





On April 6, 2011 Partners for Growth II, L.P. (PFG), the Company’s senior secured lender filed suit in the Superior Court of California, County of Orange, (Case No. 30-2011 00464300) against the CTC Parties claiming Breach of Written Contract; Money Due under Written Guaranty; Conversion; and Injunctive Relief.  This action followed a notice of default and acceleration of the Company’s Senior Secured Notes on April 6, 2011.  On April 8, 2011 the Hon. David R. Chaffee approved a Temporary Restraining Order, which required the Company to remit all remaining cash balances on April 11, 2011, absent further action. The TRO and the suit were stayed upon the Company filing Title 11 Bankruptcy as described below.





Title 11 Bankruptcy Filing:


On April 11, 2011, (“Petition Date”) Composite Technology Corporation filed for protection under Title 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Central District of California under Case No. 8:11-bk-15058 TA. Its subsidiaries CTC Cable Corporation, Stribog, Inc., and CTC Renewables, Inc. also filed for such protection.  All cases are jointly administered under the Composite Technology Corporation filing.  As of the Petition Date, the Company’s primary lender had obtained an injunction and Temporary Restraining Order that would have required the Company to remit all remaining cash balances to the lender.  As a result of the Title 11 filing, attempts to collect, secure or enforce remedies with respect to most pre-petition claims against the Company are subject to the automatic stay provisions of Section 362(a) of Title 11.  On April 14, 2011 a “First Day” Hearing was conducted and approved the use of up to $500,000 of cash to pay payroll and certain operating expenses and continued the hearing until April 27, 2011.  On April 27, 2011 the Lender and the Company agreed to continue the hearing until June 2, 2011 and allow the Company to conduct business in the ordinary course, subject to the Company’s cash forecast.  On May 26, 2011 the Company, the Lender, and the Unsecured Creditors committee agreed to allow the Company to continue to operate, under a monitoring process under a cash budget through August 2011.  To date, neither the Company nor its subsidiaries have filed a Plan of Reorganization.


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Item 1A. Risk Factors





The following risk factors have changed or have been added or updated for recent information as compared to the Risk Factors listed in Form 10-K filed with the Securities and Exchange Commission on December 14, 2010. Such risk factors should be read in conjunction with the risk factors listed in such Form 10-K.





Bankruptcy Related





WE MAY BE UNABLE TO DEVELOP A PLAN OF REORGANIZATION THAT IS ULTIMATELY SUCCESSFULLY CONSUMMATED.





Our future results are dependent upon successfully implementing our plan of reorganization. We have the exclusive right to file a Plan of Reorganization until August 9, 2011, unless extensions are requested by the Company and granted by the Bankruptcy Court.There can be no assurance that any plan we submit will be ultimately approved and even if approved by the court will be consummated. If a plan is not timely consummated, the value of our enterprise could erode to the detriment of all stockholders.





OUR TITLE 11 PROCEEDINGS MAY RESULT IN A NEGATIVE PUBLIC PERCEPTION OF US THAT MAY ADVERSELY AFFECT OUR RELATIONSHIPS WITH CUSTOMERS, BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.





Our Title 11 filing may hinder our ongoing business activities and our ability to operate, fund and execute our business plan by (i) impairing relations with existing and potential customers; (ii) negatively impacting our ability to attract, retain and compensate key executives and associates and to retain employees generally; (iii) limiting our ability to obtain additional funding; (iv) impairing present and future relationships with strategic partners; and (v) cause our stock price to be negatively impacted.





OUR TITLE 11 FILINGS OSTENSIBLY TRIGGERED DEFAULTS OR TERMINATION EVENTS ON SUBSTANTIALLY ALL OF OUR DEBT AND LEASE OBLIGATIONS, AND CONTRACTUAL OBLIGATIONS.





Before our Title 11 filing, many of our contracts and debt obligations contained provisions that state that the contracts terminated or that we were in default if we filed for bankruptcy.  We are in the process of addressing the issues arising from the bankruptcy termination and default provisions in our material agreements and obligations through the bankruptcy process itself, by obtaining waivers from affected parties and by negotiating amendments. However, parties with which we have business relationships may seek financial premiums from us when doing business with us in the future.  In addition, if we are unable to obtain such waivers and amendments, our business will suffer.





WE EXPECT FUTURE LOSSES AND OUR FUTURE PROFITABILITY IS UNCERTAIN.





Prior to acquiring Transmission Technology Corporation, or TTC, in November 2001, we were a shell corporation having no operating history, revenues from operations, or assets since December 31, 1989. We have recorded approximately $90 million in ACCC® product sales since inception. Historically, we have incurred substantial losses and we may experience significant quarterly and annual losses for the foreseeable future. We may never become profitable. If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. We expect the need to significantly increase our general administrative and product prototype and equipment prototype production expenses, as necessary. As a result, we will need to generate significant revenues and earnings to achieve and maintain profitability.





IF WE CANNOT RAISE CAPITAL WHEN IT IS NEEDED, WE MAY BE REQUIRED TO REDUCE OR SUSPEND OPERATIONS OR GO OUT OF BUSINESS ALTOGETHER FOR ONE OR MORE OF OUR OPERATING SEGMENTS.





We anticipate that for the foreseeable future, the sales of our ACCC® cable may not be sufficient enough to sustain our current level of operations and that we will continue to incur net losses.   On April 12, 2010 we raised $10.0 million of debt that has restrictive debt covenant requirements and which places limits on our losses and limits our cash spending to minimum cash levels. For these reasons, we believe that we will need to either raise additional capital, until such time, if ever, as we become cash flow positive. It is highly likely that we will continue to seek to raise money through public or private sales of our securities, debt financing or short-term loans, corporate collaborations, asset sales, or a combination of the foregoing. Our ability to raise additional funds in the public or private markets may be adversely affected if the results of our business operations are not favorable, if any products developed are not well received or if our stock price or trading volume is low. Additional funding may not be available on favorable terms to us, or at all. To the extent that money is raised through the sale of our securities, the issuance of those securities could result in dilution to our existing stockholders. If we raise money through debt financing, we may be required to secure the financing with all of our business assets, which could be sold or retained by the creditor should we default in our payment obligations. If we cannot sustain our working capital needs with financings or if available financing is prohibitively expensive, we may not be able to complete the commercialization of our products. As a result, we may be required to discontinue our operations without obtaining any value for our products, which could eliminate stockholder equity, or we could be forced to relinquish rights to some or all of our products in return for an amount substantially less than we expended.


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WE HAVE EXCEEDED THE FINANCIAL THRESHOLDS OF OUR DEBT COVENANTS UNDER OUR SENIOR SECURED DEBT. THE SENIOR SECURED DEBT ISSUED BY THE COMPANY IN APRIL 2010 INCLUDES RESTRICTIVE DEBT COVENANTS WHICH MAY LIMIT OUR ABILITY TO OPERATE, OBTAIN FINANCING, OR WHICH MAY ALLOW THE LENDERS TO SEIZE MOST IF NOT ALL OF OUR ASSETS AND CAUSE OUR COMMON STOCK TO BECOME WORTHLESS.





We entered into a loan agreement in April 2010 which includes restrictive debt covenants that include both a liquidity covenant, which requires a minimum combined cash and accounts receivable balance in excess of $7.5 million, and a profitability covenant which allows for a maximum level of accumulated non-GAAP losses after March 31, 2010 of $5 million, adjusted for non-cash items and timing of revenue recognition.  The debt is secured by substantially all assets of the Company.  We are currently in violation of our debt covenants and may therefore be placed into default by our lenders.  If we cannot cure or renegotiate the debt covenants, or refinance the debt in total or in part, the lenders could pursue remedies included in the loan agreement which may include any or all of the following: immediate collection of the loan, assignment of cash receipts, control of the Company’s bank accounts, or liquidation of the Company’s assets in part or in full.   During the three months ended March 31, 2011, the Company’s conditional waiver expired and the Company was in violation of its covenants.   If we are unable to cure these covenants or have such covenants waived or resolved through Chapter 11, the lenders may seize most if not all our assets and cause us to terminate our operations and the value of our common stock may become worthless.





OUR INDEPENDENT AUDITORS ISSUED AN UNQUALIFIED REPORT AND INCLUDED AN EMPHASIS PARAGRAPH AS OF AND FOR THE YEAR ENDED SEPTEMBER 30, 2010 WITH RESPECT TO OUR ABILITY TO CONTINUE AS A GOING CONCERN, AND WE MAY NEVER ACHIEVE PROFITABILITY.





For the year ended September 30, 2010, our accountants issued a report relating to our audited financial statements which contains a qualification with respect to our ability to continue as a going concern because, among other things, our ability to continue as a going concern is dependent upon our ability to generate profitable operations in the future or to obtain the necessary financing to meet our obligations and repay our liabilities from normal business operations when they come due. There is no guarantee that the products will be accepted or provide a marketable advantage, and therefore, no guarantee that the commercialization will ever be profitable. For the fiscal year ended September 30, 2010, we had a net loss of $19,767,000 and negative cash flows from operating activities – continuing operations of $17,358,000. During the six months ended March 31, 2011, the Company incurred a net loss of $11,796,000 and had negative cash flows from operating activities – continuing operations of $4,922,000. In addition, the Company had an accumulated deficit of $289,327,000 at March 31, 2011. As of March 31, 2011, our consolidated financial statements contemplate the ability to continue as such and do not include any adjustments that might result from this uncertainty (refer to “Going Concern” in Note 1 to the consolidated financial statements).





OUR BUSINESS MAY BE SUBJECT TO INTERNATIONAL RISKS.





We are pursuing international business opportunities, including in South America, Europe, Russia, India, China, Mexico, the Middle East, Indonesia, certain far eastern countries and Africa. As to international business in South America, we recently received a large order in Paraguay and we expect a significant portion of our revenue may be derived from that country for the next two quarters.  Our Cable business model has been implemented in the United States, Canada, Europe, Bahrain, Indonesia, and China.  We produce ACCC® core in the United States for delivery to our stranding licensees under manufacturing and distribution agreements for ACCC® conductor deliveries made to date in the United States and China. Expansion internationally will depend on our adaptation of this model to other international markets and may be costly and time consuming. Risks inherent in international operations in general include:





(i) unexpected changes in regulatory requirements, export restrictions, tariffs and other trade barriers;





(ii) challenges in staffing and managing foreign operations;





(iii) differences in technology standards, employment laws and business practices;





(iv) longer payment cycles and problems in collecting accounts receivable;





(v) political instability;





(vi) changes in currency exchange rates;





(vii) currency exchange controls; and





(viii) potentially adverse tax consequences.





In particular, certain of our target markets in the Middle East include Iraq and Afghanistan in which there is considerable violent instability that may affect our ability to operate in those markets.


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Risks Related to our Securities





THE PRICE OF OUR COMMON STOCK IS VOLATILE. VOLATILITY MAY INCREASE IN THE FUTURE, WHICH COULD AFFECT OUR ABILITY TO RAISE CAPITAL IN THE FUTURE OR MAKE IT DIFFICULT FOR INVESTORS TO SELL THEIR SHARES.





The market price of our common stock may be subject to significant fluctuations in response to our operating results, announcements of new products or market expansions by us or our competitors, changes in general conditions in the economy, the financial markets, the electrical power transmission and distribution industry, or other developments and activities affecting us, our customers, or our competitors, some of which may be unrelated to our performance. The sale or attempted sale of a large amount of common stock into the market may also have a significant impact on the trading price of our common stock. During the last 12 fiscal months ending March 31, 2011, the closing bid prices for our common stock have fluctuated from a high of $0.31 to a low of $0.17.  As of June 13, 2011, the closing bid price of our common stock was $0.05.  Fluctuations in the trading price or liquidity of our common stock may adversely affect our ability to raise capital through future equity financings.





OUR FUTURE REVENUE IS UNPREDICTABLE AND COULD CAUSE OUR OPERATING RESULTS TO FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER.





Our quarterly revenue and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. Our business consists of a small number of relatively large dollar transactions and the timing of revenue recognition is heavily dependent on customer defined delivery dates and shipping schedules which may impact the timing of revenue recognition. Historically, our CTC Cable business has had a significant portion of its revenue sourced from one customer in China and revenue recognition is determined by shipment of products to this customer subject to their delivery schedules. Our revenues for much of fiscal 2011 is expected to be sourced from one customer in Paraguay. Since our revenues may fluctuate and are difficult to predict, and our expenses are largely independent of revenues in any particular period, it is difficult for us to accurately forecast revenues and profitability.





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





As of December 13, 2010, the Company repriced (i) amended and restated warrants in favor of PFG to purchase 5,000,000 shares of the Company’s common stock at $0.24 per share and (ii) amended and restated warrants favor of PFG to purchase 5,000,000 shares of the Company’s common stock at $0.69 per share.  The Company relied upon the exemption from registration as set forth in Section 4(2) of the Securities Act for the issuance of these securities. The recipient represented that it took its securities for investment purposes without a view to distribution and had access to information concerning the Company and its business prospects, as required by the Securities Act. In addition, there was no general solicitation or advertising for the acquisition of these securities.





On February 22, 2011, the Company issued (i) warrants in favor of certain existing lenders to purchase 472,548 shares of the Company’s common stock at $0.25 per share. The Company relied upon the exemption from registration as set forth in Section 4(2) of the Securities Act for the issuance of these securities. The recipient represented that it took its securities for investment purposes without a view to distribution and had access to information concerning the Company and its business prospects, as required by the Securities Act. In addition, there was no general solicitation or advertising for the acquisition of these securities. These securities have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.





Between March 4, 2011 and March 8, 2011, the Company issued (i) warrants in favor of certain existing lenders to purchase 1,200,000 shares of the Company’s common stock at $0.25 per share. The Company relied upon the exemption from registration as set forth in Section 4(2) of the Securities Act for the issuance of these securities. The recipients represented that they took the securities for investment purposes without a view to distribution and had access to information concerning the Company and its business prospects, as required by the Securities Act. In addition, there was no general solicitation or advertising for the acquisition of these securities. These securities have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.





On March 18, 2011, the Company issued (i) warrants in favor of the Lenders to purchase 200,000 shares of the Company’s common stock at $0.25 per share. The Company relied upon the exemption from registration as set forth in Section 4(2) of the Securities Act for the issuance of these securities. The recipients represented that they took the securities for investment purposes without a view to distribution and had access to information concerning the Company and its business prospects, as required by the Securities Act. In addition, there was no general solicitation or advertising for the acquisition of these securities. These securities have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.





Item 3. Defaults Upon Senior Securities





None.


49





Item 4. (Removed and Reserved)





Item 5. Other Information





None.


50


Item 6. Exhibits





EXHIBIT INDEX





Number

Description2.1 (4)

Asset Purchase Agreement by and between Daewoo Shipbuilding & Marine Engineering Co. Ltd. and DeWind, Inc. and the Registrant dated as of August 10, 2009.2.2 (4)

Asset Purchase Agreement by and between Daewoo Shipbuilding & Marine Engineering Co. Ltd. and DeWind, Ltd. dated as of August 10, 2009.2.3 (5)

Amendment No. 1 dated as of September 4, 2009 to the Asset Purchase Agreement by and between Daewoo Shipbuilding & Marine Engineering Co. Ltd. and DeWind, Inc. and the Registrant dated as of August 10, 2009.2.4 (5)

Amendment No. 1 dated as of September 4, 2009 by and between Daewoo Shipbuilding & Marine Engineering Co. Ltd. and DeWind, Ltd. dated as of August 10, 2009.2.4 (10)

Amended and Restated Escrow Agreement, dated as of March 24, 2011, by and between DeWind Co., Stribog, Inc., and U.S. Bank National Association.3.1 (1)

Articles of Incorporation of the Company.3.2 (2)

Certificate of Amendment to Articles of Incorporation.3.3 (3)

Bylaws of Composite Technology Corporation, as modified January 6, 2006.10.1 (6)

Conditional Waiver and Modification to Loan and Security Agreement by and between Partners for Growth II, L.P., Composite Technology Corporation, CTC Cable Corporation and CTC Renewables Corporation, dated December 13, 2010.10.2 (6)

Conditional Waiver and Modification No. 2 to Loan and Security Agreement by and between Partners for Growth II, L.P., Composite Technology Corporation, CTC Cable Corporation and CTC Renewables Corporation, dated December 13, 2010.10.3 (6)

Amended and Restated Warrant.10.4 (6)

Amended and Restated Warrant.10.5 (7)

Loan Agreement dated as of February 22, 2011.10.6 (7)

Promissory Note dated as of February 22, 2011.10.7 (7)

Form of Warrant to purchase common stock dated as of February 22, 2011.10.8 (8)

Loan Agreements dated March, 2011.10.9 (8)

Promissory Notes dated March, 2011.10.10 (8)

Form of Warrants to purchase common stock dated March, 2011.10.11 (9)

Loan Agreement dated as of March 15, 2011.10.12 (9)

Promissory Note dated as of March 15, 2011.10.13 (9)

Form of Warrant to purchase common stock dated as of March 15, 2011.10.14 (11)

Press release of Composite Technology Corporation dated April 11, 2011.31.1 (12)

Rule 13a-14(a) / 15d-14(a)(4) Certification of Chief Executive Officer.31.2 (12)

Rule 13a-14(a) / 15d-14(a)(4) Certification of Chief Financial Officer.


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32.1 (12)

Section 1350 Certification of Chief Executive Officer.32.2 (12)

Section 1350 Certification of Chief Financial Officer.





(1) Incorporated herein by reference to Form 10-KSB filed as a Form 10-KT with the U. S. Securities and Exchange Commission on February 14, 2002.





(2) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on December 18, 2007.





(3) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on January 12, 2006.





(4) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on August 14, 2009; and to Form 8-K/A filed with the U.S. Securities and Exchange Commission on December 8, 2010.





(5) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on September 11, 2009; and to Form 8-K/A filed with the U.S. Securities and Exchange Commission on December 8, 2010.





(6) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on December 17, 2010.





(7) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on February 28, 2011.





(8) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on March 10, 2011.





(9) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on March 24, 2011.





(10) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on April 1, 2011.





(11) Incorporated herein by reference to Form 8-K filed with the U.S. Securities and Exchange Commission on April 11, 2011.





(12) Filed herewith.


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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.





COMPOSITE TECHNOLOGY CORPORATION


(Registrant)





Date: June 15, 2011
By:/s/ Benton H WilcoxonBenton H WilcoxonChief Executive Officer(Principal Executive Officer)Date: June 15, 2011
By: /s/ Domonic J. CarneyDomonic J. CarneyChief Financial Officer(Principal Financial and Accounting  Officer)


53