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

Exchange Act of 1934

For the quarterly period ended June 30, 2001

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

Exchange Act of 1934

For the period from to

Commission File Number 0-6890

(Exact name of registrant as specified in its charter)

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___

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

(Dollars in thousands)

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

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

1. Basis of Presentation

In the opinion of management the accompanying unaudited consolidated financial statements contain all adjustments, consisting of only normal, recurring adjustments, necessary for a fair presentation of results for such periods. The results for any interim period are not necessarily indicative of results for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto for the fiscal year ended September 30, 2000.

During 2001, the Company formed MTI MicroFuel Cells Inc. ("MTI MFCI"), a Delaware corporation. During 2001, the Company acquired substantially all of the outstanding stock of MTI MFCI in exchange for the contribution of the assets of its micro-fuel cell operations.

The financial statements as of June 30, 2001 and for the three and nine months ended June 30, 2001 have been restated. The Company has determined that effective June 30, 2001, the Company should have adopted the Emerging Issues Task Force Issue EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock." See Note 7 for additional disclosure.

The financial statements reflect the following changes:

As of June 30, 2001, the Company has recorded the fair value of warrants to purchase its stock of $1.210 million, recorded a $1.468 million gain, net of tax, as a cumulative effect of a change in accounting and reduced equity related to the warrants by $2.207 million, net of tax.

The as restated and as reported consolidated statements of operations data and consolidated balance sheet data follows:

Consolidated Statements of Operations Data:

6. Basis of Presentation (Continued)

Consolidated Balance Sheet Data:

2. Reclassification

Certain 2000 amounts have been reclassified to conform with the 2001 presentation.

At June 30, 2001, the principal components of the Company's holdings accounted for under the equity method of accounting are the following:

4. Holdings, at equity (Continued)

The following is a roll forward of the Company's accounting for holdings in Plug Power:

There is no difference between the carrying value of the Company's holdings in Plug Power and its interest in the underlying equity at June 30, 2001 or September 30, 2000.

The following is a roll forward of the Company's accounting for holdings in SatCon:

4. Holdings, at equity (Continued)

The difference between the carrying value of the Company's holdings in SatCon and its interest in the underlying equity consists of the following:

5. Securities available for sale

Securities available for sale are classified as current assets. Accumulated net unrealized gains (losses) are charged to Other Comprehensive Income.

As of June 30, 2001, securities available for sale consist of Beacon Power common stock and includes the following:

On November 17, 2000, the date of the Beacon Power IPO, Beacon Power converted Beacon Preferred Stock to common stock and completed a 2-for-1 stock split immediately prior to the IPO. Immediately after Beacon Power's IPO, the Company owned 2,881,142 shares, approximately 7.5%, of Beacon Power common stock.

In connection with the Company's May 23, 2000 purchase of Beacon Power Class F Preferred Stock, the Company received warrants to purchase shares of common stock, the exercise date, number of shares and exercise price of which would be determined upon either the sale of Beacon Power or the consummation of an underwritten public offering of Beacon Power common stock. When Beacon Power completed its IPO, the warrant terms were set for the purchase of 1,333,333 shares of common stock at an exercise price of $2.25 per share exercisable as of November 17, 2000. The warrants expire on May 23, 2005.

The Company exercised the 1,333,333 warrants on a cash-less basis, on December 20, 2000, and received 985,507 shares of Beacon Power common stock.

As of June 30, 2001, the Company owns 3,866,649 shares, approximately 9.1%, of Beacon Power common stock.

6. Debt

At June 30, 2001, the Company had a $30 million Credit Agreement, as amended, with an outstanding balance of $15.2 million at the Prime Rate (6.75% at June 30, 2001). Additional borrowings are available when the Plug Power stock price is above $20 per share. This liability is classified as short-term.

The Company has pledged 8 million shares of Plug Power common stock as collateral. In addition, the Company entered into a Put and Call with First Albany Companies Inc. ("FAC") to provide independent credit support for repayment of its then $25.2 million indebtedness to KeyBank, N.A. ("FAC Credit Enhancement"). The FAC Credit Enhancement provides FAC with the option, if the price of Plug Power stock falls to $4 per share, to either purchase 6.3 million Plug Power shares pledged as collateral on the loan or take an assignment of KeyBank, N.A.'s rights under the Credit Agreement, as amended. The FAC Credit Enhancement may be triggered in the event of a default and was amended on April 27, 2001 (the original expiration date) to extend its expiration date to August 27, 2001. The FAC Credit Enhancement may be renewed by the Company and FAC on a monthly basis upon mutually agreeable terms. If the FAC Credit Enhancement expires, and is not replaced, prior to November 3, 2001, the loan is immediately due and payable. After November 3, 2001, upon expiration of the FAC Credit Enhancement, if Plug Power stock is trading below $20 per share, the loan is immediately due and payable. Mandatory repayments on any outstanding balance in excess of $25.2 million will be required if the Plug Power stock price declines below $16 per share while the FAC Credit Enhancement is in place. After the FAC Credit Enhancement expires, mandatory repayments on any outstanding balance will be required if the Plug Power stock price is below $20 per share. If the FAC Credit Enhancement, which expires on August 27, 2001, is not renewed, the Company may need to sell assets to fund the repayment of the outstanding balance on the credit line. The Company is obligated to make interest-only payments through March 15, 2002, and upon exercise of a term loan option at the end of the line of credit term, to repay the principal in 8 equal quarterly installments beginning March 31, 2002. Interest is payable monthly at either the Prime Rate or if certain performance standards are achieved, based on both the trading volume and market price of Plug Power common stock, at LIBOR based rates.

As of June 30, 2001, the $30 million Credit Agreement, as amended, required the Company to meet certain covenants, including maintenance of a debt service reserve account (equal to 6 months of interest payments on outstanding debt, the debt service account balance was $867 thousand at June 30, 2001), a collateral coverage ratio, the FAC Credit Enhancement and a minimum Plug Power share price. The Company was in compliance with these covenants as of June 30, 2001.

If the market price of Plug Power common stock falls below $10 per share, the line of credit will be reduced and the Company may need to sell assets, or otherwise raise cash to fund its obligations pursuant to the line of credit.

 

 

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. Debt (Continued)

On December 27, 2000, the Company entered into two bridge loan agreements with FAC. The first loan was for $945 thousand and was used to pay the purchase price of the original FAC Credit

Enhancement. The Company has pledged 200,000 shares of Plug Power common stock as collateral. The second loan is for $5 million, $3 million of which was used to make a December 27, 2000 principal loan repayment to KeyBank, N.A. and the remaining $2 million was available for working capital. The Company pledged 1 million shares of Plug Power common stock as collateral. Both loans bear interest at the Prime Rate (6.75% at June 30, 2001) and both interest and principal are due on January 3, 2002. Upon mutual agreement of FAC and the Company, the loans may be converted to equity prior to maturity. On April 30, 2001, the Company made principal and interest payments to FAC totaling $1,445 thousand and $117 thousand, respectively, which reduced the Company's obligations on the FAC Bridge Loans to zero.

On April 27, 2001, the Company amended the FAC Credit Enhancement to extend its expiration date from April 27, 2001 to August 27, 2001. The Company paid FAC a fee of $200,000 for this amendment.

As of June 30, 2001, the Company paid off both loans and has $5 million available under the $5 million FAC Bridge loan.

Outstanding debt is as follows:

As of August 10, 2001, the Company amended and restated its Credit Agreement with KeyBank, N.A. The $30 million Credit Agreement, as amended, was reduced to $10 million ("the $10 million Credit Agreement, as amended"). Concurrent with this amendment, the Company made a principal reduction of $5.2 million, bringing the loan balance to $10 million as of the amendment date. The Company made an additional principal reduction of $2.5 million bringing the loan balance to $7.5 million as of August 14, 2001.

The Company has pledged two million shares of Plug Power common stock as collateral for the KeyBank loan. The Agreement expires July 31, 2003. In the event the market value of Plug Power common stock falls below $10 per share, the facility will be reduced to $7.5 million and additional collateral will be required. In the event the market value of Plug Power common stock falls below $8 per share, the facility will be reduced to $5.0 million. In the event the market value of Plug Power common stock falls below $7 per share, the facility will be reduced to zero.

The $10 million Credit Agreement, as amended, requires the Company to meet certain covenants, including maintenance of a debt service

7. Debt (Continued)

reserve account (equal to three months interest payments on outstanding debt), minimum Plug Power share price and pledge additional collateral and maintain an additional collateral value, if required, based on the Plug Power share price falling below $10 per share.

The Company is required to make interest only payments through July 31, 2003 and to pay any outstanding principal balance on July 31, 2003. Interest is payable monthly at either the Prime Rate or, after November 3, 2001, if certain performance standards are achieved, based on both the trading volume and market price of Plug Power common stock, at LIBOR based rates.

6. Changes in Accounting

Effective October 1, 2000, the Company adopted SFAS No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 established a new model for accounting for derivatives and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure these instruments at fair value

regardless of purpose or intent for holding them. Changes in the fair value of derivative financial instruments are either recognized

periodically in income or shareholders' equity (as a component of comprehensive income), depending on whether the derivative is being used to hedge changes in fair value or cash flows. Upon adoption of SFAS No. 133, the Company recorded an unrealized gain of $9.986 million. The deferred tax expense on this unrealized gain was $3.876 million, resulting in a net unrealized gain of $6.110 million, reported in the Company's results of operations as a cumulative effect of a change in accounting.

Effective June 30, 2001, the Company adopted the Emerging Issues Task Force Issue EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock," which requires freestanding contracts that are settled in a company's own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value, with any changes in fair value recorded in the results of operations. A contract designated as an equity instrument must be included within equity, and no fair value adjustments are required. In accordance with EITF 00-19, the Company has determined that outstanding warrants as of June 30, 2001 to purchase 300,000 shares of the Company's Common Stock issued to SatCon Technology Corporation should be designated as a liability. Effective June 30, 2001, all warrants designated as a liability must be recorded as a liability and therefore, the Company reclassified the warrants designated as a liability from equity to liabilities, which had a fair value on the issuance date of $3.678 million, using the Black-Scholes option-pricing model.  Additionally, on June 30, 2001, the Company recorded the warrants at the current fair value of $1.210 million, using the Black-Scholes option-pricing model, and recorded a $1.468 million gain, net of tax, in its results of

MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

7. Changes in Accounting (Continued)

operations as a cumulative effect of a change in accounting principle.  After June 30, 2001, the outstanding warrants designated as a liability will continue to be recorded at fair value with any changes in the fair value included in the results of operations.

Derivative financial instruments do not have quoted market prices; therefore fair value is based on estimates using valuation techniques.

The Company held the following derivative financial instruments:

8. Income Taxes

The Company's effective tax rates for the three and nine months ended June 30, 2001 and 2000 were as follows:

7. Income Taxes (Continued)

Income tax expense (benefit) consists of the following:

8. Earnings per Share

The amounts used in computing earnings per share ("EPS") and the effect on income and the weighted average number of shares of potentially dilutive securities are as follows:

At June 30, 2000, options to purchase 2,646,075 shares of common stock at prices ranging from $.542 to $21.917 per share and warrants to purchase 300,000 shares of common stock at $12.56 per share were

outstanding but were not included in the computation of Earnings per share-assuming dilution because the Company incurred a loss during this period and inclusion would be anti-dilutive.

The Company operates in two business segments, New Energy and Test and Measurement Instrumentation. The New Energy segment develops new

7. Segment Information (Continued)

energy technologies and companies and is currently focused on commercializing direct methanol micro fuel cells. The Test and Measurement Instrumentation segment develops, manufactures, markets

and services sensing instruments and computer-based balancing systems for aircraft engines.

The Company evaluates performance based on profit or loss from operations before income taxes, accounting changes, non-recurring items and interest income and expense. Inter-segment sales are not significant. Summarized financial information concerning the

Company's reportable segments are shown in the following table. The "Other" column includes corporate related items and items like income taxes or unusual items, which are not allocated to reportable

segments. In addition, segments noncash items include any depreciation and amortization in reported profit or loss. The New Energy segment figures include the Company's activities related to evaluating new energy technologies, companies and growth opportunities, micro fuel cell operations, the Company's holdings in Plug Power, SatCon and Beacon Power and the results of the Company's equity method accounting for certain holdings. SatCon results are accounted for on a one-quarter lag. The results for Plug Power and SatCon are derived from their unaudited quarterly and audited annual financial statements.

(Dollars in thousands)

12. Segment Information (Continued)

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

On August 7, 2001, the Company and Dupont announced that they signed definitive agreements forming a strategic partnership to accelerate the development and commercialization of direct methanol micro fuel cells for portable electronics.

Terms of the partnership include an agreement to develop selected fuel cell components based on DuPontä Nafionâ membrane technology. The components would be customized for the Company's micro fuel cells, which are being developed for portable electronic applications including cellular telephones, personal digital assistants and portable computers.

The partnership also includes a supply agreement for DuPont to provide the Company with membranes and related fuel cell components. DuPont also has obtained a minority equity interest in MTI MicroFuel Cells Inc., a subsidiary of the Company established to commercialize micro fuel cells.

During July 2001, Plug Power completed a public equity financing of 4,575,000 shares of its common stock at $12 per share raising $51.3 million in net proceeds after fees and expenses. Simultaneous with the closing of the public financing, another 416,666 shares were sold to both GE Power Systems Equities and DTE Energy in a private equity financing raising an additional $9.6 million in net proceeds.

In July 2001, the Financial Accounting Standards Board issued Statement No. 141, ACCOUNTING FOR BUSINESS COMBINATIONS, and Statement No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. These Statements modify accounting for business combinations after June 30, 2001 and will affect the Company's treatment of goodwill and other intangible assets at the start of fiscal year 2002. The Statements require that goodwill existing at the date of adoption be reviewed for possible impairment and that impairment tests be periodically repeated, with impaired assets written-down to fair value. Additionally, existing goodwill and intangible assets must be assessed and classified consistent with the Statements' criteria. Intangible assets with estimated useful lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indeterminate lives will cease. The Company is currently analyzing the impact of these Statements.

The following is management's discussion and analysis of certain significant factors, which have affected the Company's earnings during the periods included in the accompanying, consolidated statements of income.

Sales for the quarter ended June 30, 2001 totaled $2.260 million compared to $1.146 million for the same period in the prior year, an increase of $1.114 million, a 97.2% increase. This increase in sales is primarily the result of MTI Instruments' change in sales mix reflecting a reduction in PBS balancing system and capacitance sales offset by increases in semiconductor and OEM instrument sales. Sales for the first nine months of fiscal 2001 versus the same period in fiscal 2000 have increased by $1.313 million to $5.555 million in 2001 from $4.242 million in 2000, a 31.0% increase. The nine-month change is also the result of MTI Instruments' increased sales of its new wafer thickness and instruments product lines.

Gross profit decreased to 54.7% of sales in the third quarter of fiscal 2001 from 55.8% of sales for the same period in the prior year. Gross profits decreased in the fiscal 2001 third quarter due to the shift in product mix to OEM instrument sales from PBS balancing systems. Gross profit as a percentage of sales for the first nine months of fiscal 2001 versus the same period in fiscal 2000 has increased by 3.7% to 55.2% from 51.5%. The first nine months' change is also the result of the sale of Ling in October 1999 (Ling had lower margin sales) and sales of higher margin products in fiscal 2001.

Selling, general and administrative expenses increased $.231 million to $1.412 million for the three months ended June 30, 2001 as compared to $1.181 million for the three months ended June 30, 2000, a 19.6% increase. Selling, general and administrative expenses during the first nine months of fiscal 2001 of $4.558 million represents a $1.16 million or 34.1% increase from $3.399 million incurred during the same period in fiscal 2000. These increases are primarily the result of increased personnel costs related to the operations of the new energy technology segment.

Product development and research costs for the three months ended June 30, 2001 were 39.7% of sales, compared to 54.6% for the same period in the prior year. Development costs increased $.271 million from the three months ended June 30, 2000 to the same period in 2001. Product development and research costs during the first nine months of fiscal 2001 of $2.56 million represents a $1.351 million or 111.7% increase from $1.209 million incurred during the same period in fiscal 2000. These increases reflect the Company's commitment to developing its micro fuel cell business and new products at MTI Instruments.

Operating loss decreased $.096 million to an operating loss of $1.072 million for the three months ended June 30, 2001 as compared to $1.168 million for the three months ended June 30, 2000, an 8.2%

Continuing Operations (Continued)

decrease. This decrease results from increased expenses for administration and product development at the Company's micro fuel cell operation offsetting increased gross profits at the precision instrumentation operation. The first nine months of fiscal 2001 resulted in an operating loss of $4.050 million, an increase of $1.627 million or 67.1% from the $2.423 million operating loss recorded during the same period in fiscal 2000. This increase is the result of increased expenditures for research and product development by the Company's micro fuel cell operation.

As of October 1, 2000, the Company recorded a $6.110 million unrealized gain, net of tax, from the adoption of SFAS No.133 "Accounting for Derivative Instruments and Hedging Activities," as of October 1, 2000. On June 30, 2001, the Company began accounting for warrants to purchase the Company's common stock designated as a liability in accordance with EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock," and, therefore, recorded a cumulative unrealized gain, net of tax, of $1.468 million as of June 30, 2001.

The Company also recorded a net $.807 million loss on derivative accounting for the nine months ended June 30, 2001. Changes in derivative fair values are recorded on a quarterly basis.

Results during the three and nine months ended June 30, 2001 were affected by interest expense of $.463 million and $1.778 million, respectively, compared to $.521 and $1.336 million, respectively, for the same periods last year. The decrease in expense for the three month period results from decreases in the prime interest since last year. The nine month increase reflects higher average debt outstanding during 2001 as compared to 2000.

Fiscal 2001 first nine months' results include a $31.009 million gain on the sale of holdings and the prior year results included a $1.262 million gain from the sale of Ling.

In the three and nine months ended June 30, 2001, the Company recorded a $3.832 million and $12.866 million loss, net of tax, respectively, from the recognition of the Company's proportionate share of losses in equity holdings compared to $3.868 million and $9.666 million loss, net of tax, respectively, for the comparable periods in fiscal 2000.

Equity in holdings losses result from the Company's minority ownership in certain companies, which are accounted for under the equity method of accounting. Under the equity method of accounting, the Company's proportionate share of each company's operating losses and amortization of the Company's net excess investment over its equity in each company's net assets is included in equity in holdings losses. Equity in holdings losses for the nine months ended June 30, 2001 includes the results from the Company's minority ownership in Plug Power and SatCon. The Company expects these

Continuing Operations (Continued)

companies to continue to invest in development of their products and services, and to recognize operating losses, which will result in future charges recorded by the Company to reflect its proportionate share of such losses.

Equity in holdings losses includes a loss, before taxes, from Plug Power of $4.930 million and $17.624 million, respectively, for the three and nine months ended June 30, 2001 compared to $5.679 million and $14.154 million, respectively, for the three and nine months ended June 30, 2000. The three month decrease is primarily the result of the Company's decrease in ownership of Plug Power since 2000. The nine month increase in losses is primarily the result of Plug Power expanding its operations including costs to develop and prototype residential fuel cell units. Equity in holdings losses, before taxes, for the three and nine months ended June 30, 2001 also includes our proportionate share of losses from SatCon of $.825 million and $1.638 million, respectively, compared to $.250 and $.445, respectively, for the three and nine months ended June 30, 2000; and embedded difference (the difference between the carrying value of the Company's holdings and its interest in the underlying equity) amortization of $.688 million and $2.066 million, respectively, for the three and nine months ended June 30, 2001 compared to $.649 and $1.299, respectively, for the three and nine months ended June 30, 2000. SatCon is accounted for on a one-quarter lag and includes results of SatCon through March 31, 2001. The Company acquired its stock holdings in SatCon during fiscal 2000.

The tax rates for the three and nine months ended June 30, 2001 are 40.53% and 40.80%, respectively, compared to the rates for the three and nine months ended June 30, 2000 of (42.04%) and (42.04%), respectively. These tax rates are primarily due to losses generated by operations, gains generated through the sale of holdings, use of net operating losses, calculation of alternative minimum tax and changes in deferred tax liabilities associated with the accounting for holdings in and recognition of the Company's proportionate share of losses from Plug Power and SatCon and its investment in derivatives and marketable securities. Further, as a result of ownership changes in 1996, the availability of net operating loss carryforwards to offset future taxable income will be limited pursuant to the Internal Revenue Code.

Inventory and accounts receivable turnover ratios and their changes for the nine months ended June 30 are as follows: