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
three months ended September 30, 2009
OR
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from _______________ to __________________
Commission
File No. 001-31332
nCoat,
Inc.
(Exact
name of Registrant as specified in its charter)
Delaware
|
98-0375406
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
incorporation
or organization)
|
Identification
No.)
|
7237
Pace Dr.
PO
Box 38
Whitsett,
NC 27377-9118
(Address
of principal executive office, zip code)
Registrant’s
telephone number, including area code: (336) 447-2000
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
at least the past 90 days.
Yes o No x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting
company. See the 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 [ ]
|
Non-accelerated
filer [ ]
|
Smaller
reporting company [X]
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b
2 of the Exchange Act).
Yes o No x
As of
November 14, 2009, there were 117,441,939 shares of the registrant’s common
stock, $0.0001 par value, outstanding.
nCoat,
Inc.
FORM
10-Q
FOR
THE QUARTER ENDED SEPTEMBER 30, 2009
FORWARD-LOOKING
INFORMATION
Statements
in this report concerning the future sales, expenses, profitability, financial
resources, product mix, market demand, product development and other statements
concerning the future results of operations, financial condition and business of
nCoat, Inc., are “forward-looking” statements as defined in the Securities Act
of 1933 and Securities Exchange Act of 1934. Investors are cautioned that the
Company’s actual results in the future may differ materially from those
projected in the forward-looking statements due to risks and uncertainties that
exist in the Company’s operations and business environment, including
competition, need for increased acceptance of products, ability to continue to
develop and extend our brand identity, ability to anticipate and adapt to a
competitive market, ability to effectively manage rapidly expanding operations,
amount and timing of operating costs and capital expenditures relating to
expansion of our business, operations and infrastructure, ability to provide
superior customer service thereon , dependence upon key personnel and the like.
Additionally, words such as “anticipates,” “expect,” “intend,” “estimates,”
“seeks,” “may,” “could,” “plan,” “believes,” and similar words and phrases may
indicate forward-looking statements. The Company’s most recent
filings with the Securities and Exchange Commission, including reports on Form
8-K, contain additional information concerning many of these risk factors, and
copies of these filings are available from the Company upon request and without
charge. The Company disclaims any obligation or intention to update any forward
looking statement in this report.
1
TABLE
OF CONTENTS
Part
I – FINANCIAL INFORMATON
|
||
Item
1.
|
Financial
Statements
|
|
Condensed
Consolidated Balance Sheets as of September 30, 2009, and December 31,
2008 (Unaudited)
|
3
|
|
Condensed
Consolidated Statements of Operations for Nine Months Ended September 30,
2009 and 2008 (Unaudited)
|
4
|
|
Condensed
Consolidated Statement of Shareholders’ Deficit for the Nine Months
Ended September 30, 2009 (Unaudited)
|
5
|
|
Condensed
Consolidated Statements of Cash Flows for the Nine Months Ended September
30, 2009, and 2008 (Unaudited)
|
6
|
|
Notes
to Condensed Consolidated Financial Statements (Unaudited)
|
7
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
13
|
Item
3.
|
Quantitative and Qualitative Disclosures About Market Risk |
23
|
Item 4T. |
Controls
and Procedures
|
23 |
Part
II – OTHER INFORMATION
|
||
Item
1.
|
Legal
Proceedings
|
32
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
32
|
Item
3.
|
Defaults
Upon Senior Securities
|
33
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
33
|
Item
5.
|
Other
Information
|
33
|
Item
6.
|
Exhibits
|
33
|
Signature
Page
|
35
|
2
THE
FINANCIAL STATEMENTS INCLUDED HEREIN ARE NOT AUDITED OR REVIEWED. NCOAT HAS NOT
ACCUMULATED ENOUGH CASH TO PAY THE AUDIT FEE TO COMPLETE THE AUDIT OF ITS 2008
FINANCIALS PRIOR TO SUBMISSION OF THIS REPORT. IN ADDITION, LEGAL COUNSEL HAS
NOT REVIEWED THIS REPORT. FOLLOWING PAYMENT OF THE AUDIT FEE, NCOAT AUDITORS
WILL COMPLETE THE AUDIT, LEGAL COUNSEL WILL REVIEW THE COMPLETED AND AUDITED
REPORT, AND NCOAT WILL FILE AN AMENDED FORM 10K AND 10Q.
NCOAT,
INC. AND SUBSIDIARIES
(Unaudited)
September
30
|
December
31
|
|||||||
2009
|
2008
|
|||||||
ASSETS
|
(Unaudited)
|
(Unaudited)
|
||||||
Current
Assets
|
||||||||
Cash
|
$ | 127,789 | $ | 42,134 | ||||
Trade
receivables, net
|
540,438 | 767,160 | ||||||
Inventory
|
116,130 | 88,778 | ||||||
Other
current assets
|
53,668 | 99,281 | ||||||
Deferred
income tax assets
|
- | - | ||||||
Total
Current Assets
|
838,025 | 997,353 | ||||||
Property and Equipment,
net
|
1,250,473 | 1,677,037 | ||||||
Intangible Assets,
net
|
1,895,196 | 2,375,091 | ||||||
Total
Assets
|
$ | 3,983,694 | $ | 5,049,481 | ||||
LIABILITIES
AND STOCKHOLDERS' EQUITY (DEFICIT)
|
||||||||
Current
Liabilities
|
||||||||
Accounts
payable
|
$ | 3,640,211 | $ | 3,476,203 | ||||
Accrued
liabilities
|
1,035,593 | 794,571 | ||||||
Accrued
Interest
|
73,429,634 | 17,872,582 | ||||||
Accrued
Registration Liability
|
111,932,549 | 23,358,690 | ||||||
Deferred
revenue
|
509,174 | 759,176 | ||||||
Current
portion of notes payable
|
700,800,372 | 298,734,128 | ||||||
Derivative
Premium Payable
|
120,348 | 120,348 | ||||||
Accrued
consulting obligation
|
- | 500,000 | ||||||
Current
portion of obligations under capital leases
|
140,287 | 121,988 | ||||||
Total
Current Liabilities
|
891,608,168 | 345,737,686 | ||||||
Long-Term
Liabilities
|
||||||||
Notes
payable, net of current portion
|
204,953 | 150,322 | ||||||
Obligations
under capital leases , net of current portion
|
63,298 | 206,112 | ||||||
Deferred
income taxes
|
97,262 | 97,262 | ||||||
Total
Long-Term Liabilities
|
365,513 | 453,696 | ||||||
Stockholders'
Equity (Deficit)
|
||||||||
Common
stock - $0.0001 par value; 500,000,000 shares authorized;
112,108,606 shares outstanding
|
11,211 | 10,211 | ||||||
Additional
paid-in capital
|
22,309,667 | 22,295,667 | ||||||
Accumulated
deficit
|
(910,310,865 | ) | (363,447,779 | ) | ||||
Total
Stockholders' Equity (Deficit)
|
(887,989,987 | ) | (341,141,901 | ) | ||||
Total
Liabilities and Stockholders' Equity (Deficit)
|
$ | 3,983,694 | $ | 5,049,481 |
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
3
NCOAT,
INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For
the Three Months Ended
|
For
the Nine Months Ended
|
|||||||||||||||
September
30,
|
September
30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
|||||||||||||
Net
Sales
|
$ | 1,772,758 | $ | 2,563,447 | $ | 5,922,597 | $ | 8,206,374 | ||||||||
Cost
of Goods Sold
|
924,598 | 1,378,613 | 3,226,120 | 5,088,583 | ||||||||||||
Gross
Profit
|
848,160 | 1,184,834 | 2,696,477 | 3,117,791 | ||||||||||||
Operating
Expenses
|
||||||||||||||||
General
and Administrative Expense
|
$ | 532,029 | 1,309,340 | 2,714,067 | 4,107,659 | |||||||||||
Research
and Development Costs
|
$ | 80,209 | 80,710 | 240,627 | 296,456 | |||||||||||
Sales
and Marketing Expenses
|
$ | 153,160 | 162,525 | 457,680 | 491,350 | |||||||||||
Total
Operating Expenses
|
765,398 | 1,552,575 | 3,412,374 | 4,895,465 | ||||||||||||
(Loss)
from Operations
|
$ | 82,762 | (367,741 | ) | (715,897 | ) | (1,777,674 | ) | ||||||||
Redemption
premium interest expense
|
$ | (30,422,790 | ) | (45,503,225 | ) | (545,995,002 | ) | (95,347,496 | ) | |||||||
Other
Interest expense
|
$ | (5,235 | ) | (68,845 | ) | (87,672 | ) | (536,261 | ) | |||||||
Gain
on derivative liability valuation
|
$ | - | 19,703 | - | 492,044 | |||||||||||
Net
Loss
|
$ | (30,345,263 | ) | $ | (45,920,108 | ) | $ | (546,798,571 | ) | $ | (97,169,387 | ) | ||||
- | - | |||||||||||||||
Basic
and Diluted Loss per Share
|
$ | (0.27 | ) | $ | (0.46 | ) | $ | (4.88 | ) | $ | (0.98 | ) | ||||
Basic
and Diluted Weighted-Average Shares Outstanding
|
112,108,606 | 99,076,650 | 112,108,606 | 99,076,650 |
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
4
NCOAT,
INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ DEFICIT
For
the Nine Months Ended September 30, 2009
(Unaudited)
Additional
|
Total
|
|||||||||||||||||||
Common
Stock
|
Paid-In
|
Accumulated
|
Stockholders'
|
|||||||||||||||||
Shares
|
Amount
|
Capital
|
Deficit
|
Deficit
|
||||||||||||||||
Balance
- December 31, 2008(Unaudited)
|
102,108,606 | $ | 10,211 | $ | 22,295,667 | $ | (363,512,294 | ) | $ | (341,206,416 | ) | |||||||||
Shares
issued upon conversion of
|
||||||||||||||||||||
accrued
interest
|
- | |||||||||||||||||||
Compensation
related to vested and
|
||||||||||||||||||||
nonvested shares issued to employees,
|
||||||||||||||||||||
net of forfeitures
|
- | |||||||||||||||||||
Reclassification
of fair value of warrants
|
||||||||||||||||||||
to derivative liability.
|
- | |||||||||||||||||||
Partial
conversion of convertible note
|
- | |||||||||||||||||||
Conversion
of convertible note 5/22/2009
|
5,000,000 | 500 | 7,000 | 7,500 | ||||||||||||||||
Conversion
of convertible note 8/04/2009
|
5,000,000 | 500 | 7,000 | 7,500 | ||||||||||||||||
Net
Loss
|
(546,798,571 | ) | (546,798,571 | ) | ||||||||||||||||
Balance
- September 30, 2009 (Unaudited)
|
112,108,606 | $ | 11,211 | $ | 22,309,667 | $ | (910,310,865 | ) | $ | (887,989,987 | ) |
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
5
NCOAT,
INC. AND SUBSIDIARIES
(Unaudited)
For
the Nine Months Ended
|
||||||||
September
30,
|
||||||||
2009
|
2008
|
|||||||
(Unaudited)
|
(Unaudited)
|
|||||||
Cash
Flows From Operating Activities
|
||||||||
Net
loss
|
$ | (546,798,571 | ) | $ | (97,169,387 | ) | ||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Depreciation
|
451,576 | 451,298 | ||||||
Amortization
of intangible assets
|
479,895 | 539,394 | ||||||
Compensation
expense paid by issuance of common stock
|
- | 247,696 | ||||||
Redemption
premium on notes payable recognized as interest
expense
|
545,995,002 | 95,347,516 | ||||||
Gain
on derivitave warrant liability
|
(492,044 | ) | ||||||
Changes
in assets and liabilities:
|
||||||||
Accounts
receivable
|
226,722 | (203,582 | ) | |||||
Inventory
|
(27,352 | ) | 20,055 | |||||
Other
current assets
|
45,613 | (36,832 | ) | |||||
Accounts
payable
|
164,008 | 771,779 | ||||||
Deferred
revenue
|
(250,002 | ) | 629,333 | |||||
Accrued
liabilities
|
241,022 | 112,151 | ||||||
Net
Cash Provided by Operating Activities
|
527,913 | 217,377 | ||||||
Cash
Flows From Investing Activities
|
||||||||
Purchase
of property and equipment
|
(25,000 | ) | (53,325 | ) | ||||
Net
Cash Used in Investing Activities
|
(25,000 | ) | (53,325 | ) | ||||
Cash
Flows From Financing Activities
|
||||||||
Proceeds
from issuance of notes payable
|
250,000 | 500,000 | ||||||
Proceeds
from issuance of stock
|
7,500 | |||||||
Principal
payments on notes payable
|
(550,243 | ) | (811,276 | ) | ||||
Principal
payments under capital lease obligations
|
(124,515 | ) | (113,147 | ) | ||||
Net
Cash Used in Financing Activities
|
(417,258 | ) | (424,423 | ) | ||||
Net
Increase (Decrease) in Cash
|
85,655 | (260,371 | ) | |||||
Cash
At Beginning of Period
|
42,134 | 295,961 | ||||||
Cash
At End of Period
|
$ | 127,789 | $ | 35,590 | ||||
Supplemental
Disclosures of Cash Flow Information
|
||||||||
Cash
paid for interest
|
$ | 489,910 | $ | 489,910 |
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
6
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
THE
FINANCIAL STATEMENTS INCLUDED HEREIN ARE NOT AUDITED OR REVIEWED. NCOAT HAS NOT
ACCUMULATED ENOUGH CASH TO PAY THE AUDIT FEE TO COMPLETE THE AUDIT OF ITS 2008
FINANCIALS PRIOR TO SUBMISSION OF THIS REPORT. IN ADDITION, LEGAL COUNSEL HAS
NOT REVIEWED THIS REPORT. FOLLOWING PAYMENT OF THE AUDIT FEE, NCOAT AUDITORS
WILL COMPLETE THE AUDIT, LEGAL COUNSEL WILL REVIEW THE COMPLETED, AUDITED REPORT
AND NCOAT WILL FILE AN AMENDED FORM 10K AND 10Q.
Note
1. Basis of Presentation
Interim Financial
Statements – The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America (“generally accepted accounting
principles”) for interim financial information and with the instructions to Form
10-Q. Accordingly, they do not include all of the information and notes
required by generally accepted accounting principles for complete financial
statements. The accompanying unaudited condensed consolidated financial
statements should be read in conjunction with the Company’s annual consolidated
financial statements included in the Company’s amended annual report on Form
10-K/A filed with the Securities and Exchange Commission on April 15, 2009,
which also remains unaudited at the date of this filing. In the opinion of
management, all adjustments (consisting only of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine months ended September 30, 2009, are not necessarily
indicative of the results that may be expected for any future periods or for the
year ending December 31, 2009.
Nature of
Operations – nCoat, Inc., and its subsidiaries specialize in materials
science research and licensing, and the commercialization, distribution and
application of nano-scale as well as multiple non-nano surface coatings. The
Company’s specialized coatings are used by the automotive, diesel engine,
trucking, recreational vehicle, motorcycle, aerospace and oil and gas industries
for heat management, corrosion resistance, friction reduction, porosity
management, bond strength and appearance. Corporate offices and
operations headquarters are located in Whitsett, North Carolina, and application
operations are conducted at facilities located in Oklahoma City, Oklahoma;
Quakertown, Pennsylvania; Tempe, Arizona; and Whitsett, North
Carolina.
Principles of
Consolidation – The accompanying unaudited consolidated financial
statements include the operations, accounts and transactions of nCoat Automotive
Group, Inc., High Performance Coatings, Inc., nTech, Inc., and Metallic Ceramic
Coatings, Inc. (“MCCI”) for all periods presented. These entities are
collectively referred to herein as the “Company” or “nCoat.” All intercompany
transactions and balances have been eliminated in consolidation.
Business
Condition – The accompanying unaudited condensed consolidated financial
statements have been prepared on a going-concern basis, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has incurred losses of $ 546,798,571 and $97,169,387
and provided $527,913 and $217,377 of cash in operating activities during the
nine months ended September 30, 2009 and 2008, respectively. At
September 30, 2009, the Company has a working capital deficiency of
$890,770,143, an accumulated deficit of $910,310,865 and a stockholders’ deficit
of $887,989,865. Based on current operations, cash flows from
operations have become positive and should remain positive for the remainder of
the year; however, the Company will likely face negative income for the first
three quarters of the year ending December 31, 2009. As of September
30, 2009, the Company’s principal sources of liquidity were $127,789 of cash and
$540,438 of trade accounts receivable, while current liabilities totaled
$891,608,168 at that date, of which $700,800,372 relates to notes payable that
are due currently. These factors, among others, raise substantial doubt about
the Company’s ability to continue as a going concern for a reasonable period of
time. It is necessary for the company to raise additional capital to restructure
current debenture debt and to pay aged payables. This may be dilutive
to existing shareholders, and could suppress stock values if the number of
shares outstanding were to be increased. This will be difficult to
achieve during the current capital market environment and may be difficult to
achieve in a more robust capital markets environment. The
accompanying condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amount and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
7
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
Licensing Revenue
Recognition – Fees received from licensing the Company’s technology to
customers is recognized over the term of the license agreements. Licensing fees
received prior to recognition are accounted for as deferred revenue. Sales
revenue excludes lease payments made by customers on facilities used by the
Company.
Loss Per Common
Share – Basic loss per share is computed by dividing net loss for the
period by the weighted-average number of common shares outstanding. The
nonvested common shares issued as employee compensation are excluded from the
calculation of basic loss per share. Diluted loss per share reflects dilutive
potential common shares outstanding during the period. During the twelve months
ended December 31 2008, the following anti-dilutive potential common shares were
excluded from the calculation of diluted loss per share: 1,837,800 nonvested
shares of common stock; 6,601,388,889 shares of common stock issuable upon
conversion of notes payable; 32,418,750 shares of common stock issuable upon the
exercise of warrants.
Note
2. Acquisition of MCC, Inc.
On June
29, 2007, nCoat, Inc., completed the acquisition of all the capital stock of
Metallic Ceramic Coatings, Inc. ("MCCI"), doing business in the marketplace
under the brand of JET-HOT® Coatings. MCCI provides high performance coatings of
metal parts for industrial and personal use. In connection with the
acquisition of MCCI, the Company entered into a consulting agreement with the
former majority shareholder of MCCI whereby the Company is obligated to pay the
former majority shareholder consulting fees of $120,000 annually, performance
bonuses equal to 2.5% of net sales from new customers, and to purchase, for up
to $70,000, an automobile for the consultant. The term of the obligation for the
consulting fees and the performance bonuses is through December 31, 2009, and
will continue for successive one-year periods unless terminated by either party.
Due to low cash flow, nCoat has not paid consulting fees for 11 months accruing
a total liability of $110,000. In addition, a bank note with First Tennessee
Bank was obtained and personally guaranteed by Consultant prior to nCoat
purchase of MCCI in the amount of $226,869. In June, 2009, First Tennessee Bank
called the note due and payable in full from nCoat due to slow payments to the
bank. Consultant satisfied the personal guarantee for the bank note by
purchasing the note from First Tennessee Bank. nCoat will execute an agreement
shortly with Consultant to pay the Consultant $200,000 for the remaining balance
of the note at twelve percent (12%) interest over thirty six (36) months
beginning December 1, 2009. In addition, nCoat will pay the Consultant $90,000
over twenty four (24) months with no interest to complete the obligation of
consulting fees.
Note
3. Notes Payable
Series A and B 6%
Convertible Promissory Notes– From May 25, 2007 through June 18, 2007
(primarily on May 31, 2007), the Company issued $9,000,000 of Series A 6%
convertible promissory notes (the “Series A Notes”) and warrants to purchase
22,500,000 shares of common stock exercisable at $1.00 per share through May 31,
2012. The Series A Notes were originally convertible into common stock at $0.40
per share through May 31, 2010, when the Series A Notes were due. Accrued
interest is payable quarterly. From May 31, 2007 through July 10,
2007, the Company also issued $3,250,000 of Series B 6% convertible promissory
notes (the “Series B Notes”) and warrants to purchase 8,125,000 shares of common
stock exercisable at $0.80 per share through May 31, 2010. The Series B Notes
were originally convertible into common stock at $0.40 per share through May 31,
2010, when the Series B Notes were due. Accrued interest is payable quarterly.
Conversion of the promissory notes is limited such that at any time a note
holder cannot own more than 4.99% of the Company’s outstanding common stock. The
conversion price is adjustable to match any additional issuances of common stock
at prices lower than the current conversion price.
8
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
The
common stock into which the Series A Notes are convertible and the related
warrants are subject to certain registration rights. Per the registration rights
agreement, the Company is obligated to obtain the effectiveness of a
registration statement within six months of the execution of Series A and B
Notes, and to keep the registration statement effective until all the registered
shares of common stock are sold by the note holders. nCoat did not file the
registration statement within six months, however, under amendments to SEC Rule
144 in 2007, all stock converted by debentures holders of the Series A and B
Notes were eligible to be issued without restrictive legend six months from the
date of the SEC Ruling. As of February 1, 2008, stock eligible for conversion
under the Series A and B Notes were eligible to be issued without restrictive
legend. However, under the original agreement, if the company fails
to obtain effectiveness of the registration statement, the Company is required
to pay partial liquidated damages of 1% per month of the aggregate purchase
price paid by the Series A note holders, or $90,000 per month. Interest is
charged on unpaid damages at the rate of 18% per annum. The Company
recognized a registration payment liability at the date of the issuance of the
Series A notes and has adjusted the liability to $111,932,549 at September 30,
2009, for estimated payments to be made under the registration rights agreement.
The carrying value of the registration payment liability is adjusted to reflect
the fair value of the registration payment liability at each balance sheet
date.
Upon the
occurrence of certain default or triggering events, the notes holders may
demand redemption of the Series A and Series B notes. The triggering events
include failure to provide notice and pay the related partial liquidated damages
to the note holders within one day of the following events: failure to file the
registration statement or obtain its effectiveness by the required dates;
failure to respond to comments by the U.S. Securities and Exchange Commission
within 15 days of receipt of those comments; suspension from trading or listing
on a market; failure to convert shares upon request; failure to qualify new debt
as permitted debt under the terms of the Series A and Series B Notes; and
failure to make payments under the terms of the promissory notes. Upon the
occurrence of a triggering event, the holders have the right to require the
Company to redeem their notes at an amount equal to the total of unpaid accrued
interest, unpaid liquidated damages and the face amount of the notes multiplied
by the greater of (i)
125% during the first 12 months of the term of the note or 115% thereafter or
(ii) upon the
occurrence of certain of the listed triggering events, the closing market price
of the Company’s common stock on the date of the triggering event divided by the
closing market price on the first day of each month following the triggering
event. The conversion price also decreases to the closing market price on the
first day of each month following the triggering event.
In
December 2007, the Company entered into an agreement with the Series A and
Series B note holders whereby the Series A and Series B note holders agreed
to waive certain triggering events in exchange for the modification of the
conversion price to $0.25 per share and for the Company agreeing to pay partial
liquidated damages to the note holders for triggering events occurring on or
after February 29, 2008. However, on February 29, 2008, the Company failed
to obtain effectiveness of the required registration statement. On April 1,
2008, July 1, 2008, October 1, 2008, January 1, 2009, April 1, 2009, July 1,
2009 and October 1, 2009 the Company failed to pay accrued interest to the
Series A and B note holders. As a result, the Series A and B notes
became due on demand at a redemption premium as described above. At September
30, 2009, the carrying value of the Series A and B notes has been adjusted to
$698,935,588 for the increase in the redemption price. As of the date
of this report there has been only one note holder that has given demand for the
redemption of its Series A note. The note was originally issued May
31, 2007, with the face amount of $1,500,000. The note holder has to
date issued four conversion demands on the following dates and for the following
amounts: December 1, 2008 for $10,000, May 22, 2009 for $7,500,
August 21, 2009 for $7,500, and October 8, 2009 for $8,000, as reflected in the
financial statements set forth herein. The demand is for the
remaining balance of the note of $1,457,000 plus interest of $232,183 multiplied
by a 115% premium factor for a total demand of $1,963,209. As of the
date of this report, no other demand had been made by the remaining note holders
for redemption of the Series A and B Notes. At the October 1, 2009, conversion
price of $0.015 per share, the Series A and B Notes are convertible into
7,473,907,067 shares of common stock. However, there are only 400,923,350
authorized, unissued shares of common stock available and, therefore, the notes
payable cannot all be converted.
Unpaid
accrued interest bears interest at 18% per annum. Under the terms of the Series
A and B Notes, the unpaid accrued interest and the unpaid registration payment
liability have also been increased by the redemption premium formula described
above, which resulted in accrued interest on the Series A and B Notes of $
73,420,637 and a registration payment liability $ 111,932,549 at September 30,
2009.
9
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
Notes
payable at September 30, 2009, and December 31, 2008, are summarized as
follows:
September
30
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
6%
$9,000,000 Series A convertible promissory notes; due on
demand
|
$ | 513,479,412 | $ | 218,215,000 | ||||
6%
$3,250,000 Series B convertible promissory notes; due on
demand
|
185,441,176 | 78,812,500 | ||||||
Note
payable, bearing interest at prime plus 1.0% (8.25% at December 31, 2007);
due March 2011
|
141,192 | 146,264 | ||||||
Note
payable, bearing interest at prime plus 1.0% (8.25% at December 31,
2007); payable on demand
|
280,364 | 280,364 | ||||||
Note
payable to bank; secured by equipment; bearing interest at 8.75%:
payments due through 2010
|
- | 14,670 | ||||||
Notes
payable to a bank; secured by equipment; bearing interest at 6.75% to
7.75%; payments due through 2010
|
6,312 | |||||||
Note
payable to a bank; secured by equipment; bearing interest at 6.98%;
payable in monthly installments of $4,841 through February
2014
|
226,869 | 235,652 | ||||||
Note
Payable, bridge loan, on demand
|
250,000 | |||||||
Notes
payable; bearing interest at 10%; unsecured; due on demand
|
1,180,000 | 1,180,000 | ||||||
Total
Notes Payable
|
701,005,325 | 298,884,450 | ||||||
Less:
Current portion
|
700,800,372 | 298,734,128 | ||||||
Long-Term
Notes Payable
|
$ | 204,953 | $ | 150,322 |
The fair
value of notes payable was determined based upon their short-term redemption
requirements and based upon current market interest rates and totaled
$701,005,325 at September 30, 2009. Future annual maturities of notes payable as
of September 30, 2009, were as follows:
Years
Ending December 31:
|
||||
2009
|
1,295,932 | |||
2010
|
699,504,740 | |||
2011
|
72,919 | |||
2012
|
57,459 | |||
Thereafter
|
74,275 | |||
Total
|
701,005,325 |
Note
4. Derivative Warrant Liability
On
September 30, 2009 the carrying value of the Series A and B promissory notes
increased and their conversion prices decreased to a point that the Company does
not have sufficient authorized, unissued shares of common stock to enable the
conversion of the promissory notes and the exercise of outstanding warrants.
Because the Company may be required to settle the outstanding warrants for cash,
they became a derivative liability on March 31, 2008, and their fair value of
$612,392 was reclassified from additional paid-in capital to a derivative
liability.
10
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
Due to
decreases in the market value of the Company’s common stock, the fair value of
the derivative warrant liability decreased to $120,348 at September 30, 2008,
which resulted in the recognition of a gain on the derivative liability
valuation of $19,703 during the three months ended September 30, 2008. The fair
value of the warrants at September 30, 2008, was determined using the
Black-Scholes option pricing model with the following weighted-average
assumptions: expected future volatility of 125%, risk-free interest rate of
2.8%, expected dividend yield of 0% and an expected life of 3.17 years. At
September 30, 2008, there were 32,418,750 warrants outstanding that were
exercisable at a weighted-average price of $0.92 per share. The weighted-average
remaining contractual term was 2.42 years.
Note
5. Stock Compensation Plan
On
February 2, 2007, the Company adopted a stock award plan (the “Plan”) and began
awarding shares of common stock and shares of non-vested common stock to
employees and consultants as compensation. The non-vested shares vest over
periods ranging from immediately upon being issued to four years. If an employee
terminates employment with the Company prior to the shares vesting, the
non-vested portion of the shares are be forfeited and returned to the Company.
As of September 30, 2009, employees holding 235,000 non-vested shares have
terminated their employment with the Company but have not forfeited and returned
those shares to the Company. The Company is at risk that it may not obtain back
the forfeited shares. Accordingly, the Company has not accounted for those
shares as forfeited.
Compensation
related to the shares awarded is based upon the fair value of the awards on the
dates awarded or modified as determined by the Black-Scholes option-pricing
model applied to awards expected to vest and recognized by the graded-vesting
method applied to awards expected to vest. Compensation expense related to
non-vested shares held by terminated employees will be reversed when and if
those shares are returned to the Company.
A summary
of the status of the Company’s nonvested shares of common stock as of September
30, 2009:
Weighted-Average
|
||||||||
Award-Date
|
||||||||
Nonvested
Shares of Common Stock
|
Shares
|
Fair
Value
|
||||||
Award
|
13,309,090
|
$
|
0.144
|
|||||
Vested
|
(10,902,190
|
)
|
$
|
0.129
|
||||
Forfeited
|
(402,000
|
)
|
$
|
0.129
|
||||
Nonvested
at December 31, 2008
|
2,004,900
|
$
|
0.139
|
As of
December 31, 2008, there was $100,471 of total unrecognized compensation expense
related to nonvested share-based compensation arrangements granted under the
Plan. That cost is expected to be recognized over a weighted-average period of
1.4 years from December 31, 2008. There were no additional vestitures in the
third quarter of 2009.
Note
6. Common Stock
In
August, 2008, the Company received a Notice of Conversion from one of the
Holders of Notes, seeking to convert $25,000 into common shares at $.02 per
share. The Company issued 1,250,000 to satisfy this
conversion.
In May,
2009, the Company received a Notice of Conversion from one of the Holders of
Notes, seeking to convert $7,500 into common shares at $.0015 per share. The
Company issued 5,000,000 to satisfy this conversion.
In
August, 2009, the Company received a Notice of Conversion from one of the
Holders of Notes, seeking to convert $7,500 into common shares at $.0015 per
share. The Company issued 5,000,000 to satisfy this conversion.
In
October, 2009, the Company received a Notice of Conversion from one of the
Holders of Notes, seeking to convert $8,000 into common shares at $.0015 per
share. The Company issued 5,333,333 to satisfy this conversion.
11
NCOAT,
INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2009
(Unaudited)
Note
7. Deferred Income Taxes
Deferred
income taxes consisted of the following:
September 30
|
December
31
|
|||||||
2009
|
2008
|
|||||||
Deferred
Tax Liabilities
|
||||||||
Property
and equipment
|
$ | 451,576 | $ | 293,344 | ||||
Intangible
assets
|
479,895 | 1,146,574 | ||||||
Total
Deferred Tax Liabilities
|
931,471 | 1,439,918 | ||||||
Deferred
Tax Assets
|
||||||||
Allowance
for doubtful accounts
|
109,906 | 120,008 | ||||||
Accrued
PTO
|
210,477 | 210,477 | ||||||
Operating
loss carryforwards
|
7,374,202 | 6,640,543 | ||||||
Total
Deferred Tax Assets
|
7,694,585 | 6,971,028 | ||||||
Valuation
Allowance
|
(6,763,114 | ) | (5,531,110 | ) | ||||
Net
Deferred Tax Liability
|
$ | - | $ | - |
12
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
This
management’s discussion and analysis should be read in conjunction with the
condensed consolidated financial statements and notes included elsewhere in this
report on Form10-Q.
This
management’s discussion and analysis, as well as other sections of this report
on Form10-Q, may contain “forward-looking statements” that involve risks and
uncertainties, including statements regarding our plans, future events,
objectives, expectations, forecasts, or assumptions. Any statement that is not a
statement of historical fact is a forward-looking statement, and in some cases,
words such as “believe,” “estimate,” “ project,” “expect,” “intend,” “may,”
“anticipate,” “plans,” “seeks,” and similar expressions identify forward-looking
statements. These statements involve risks and uncertainties that could cause
actual outcomes and results to differ materially from the anticipated outcomes
or results, and undue reliance should not be placed on these statements. These
risks and uncertainties include, but are not limited to uncertainties discussed
in filings made with the Securities and Exchange Commission. The Company
disclaims any intention or obligation to update or revise any forward-looking
statements, whether as a result of new information, future events, or
otherwise.
The
following Management’s discussion and Analysis of financial Condition and
Results of Operations (“MD&A”) is intended to help the reader understand
nCoat, Inc., our operations and our present business
environment. MD&A is provided as a supplement to, and should be
read in conjunction with, our consolidated financial statements and the
accompanying notes thereto contained in Item 1 of this report. This
overview summarizes MD&A, which includes the following
sections:
·
|
Overview – a general
description of our business and the markets in which we operate; our
objective; our areas of focus; and challenges and risks of our
business.
|
·
|
Significant Accounting
Policies – a discussion of accounting policies that require
critical judgments and estimates.
|
·
|
Results of Operations –
an analysis of our Company’s consolidated results of operations for the
three years presented in our consolidated financial
statements. Except to the extent that differences among our
operating segments are material to an understanding of our business as a
whole, we present the discussion in the MD&A on a consolidated
basis.
|
·
|
Liquidity and Capital
Resources – an analysis of cash flows; off-balance sheet
arrangements and aggregate contractual obligations; the impact of
foregoing exchange; an overview of financial position; and the impact of
inflation and changing prices.
|
We intend
for this discussion to provide the reader with information that will assist in
understanding our financial statements, the changes in certain key items in
those financial statements from year to year, and the primary factors that
accounted for those changes, as well as how certain accounting principles affect
our financial statements. The discussion also provides information
about the financial results of the various segments of our business to provide a
better understanding of how those segments and their results affect the
financial condition and results of operations of the Company as a
whole. This discussion should be read in conjunction with our
financial statements as of September 30, 2009, and the year then ended and the
notes accompanying those financial statements.
13
Overview
nCoat
continues to focus on its core business of providing high quality, nano-scale
and micronized particle surface treatment materials (coatings) that provide heat
management, corrosion management, abrasion reduction, and porosity reduction to
multiple mature industries. We focus on creating a competitive company with
scalable processes, equipment and facilities to meet customer demand and to
provide newly innovated nano-formulated materials with novel
properties.
Our
principal business strategy includes the following components:
Internal Organic Growth. We
have integrated the existing “book of business” of our two acquired
subsidiaries, which creates additional product offerings for both entities as
cross sales opportunities from the sister company’s product
lines. Operationally we have created common core formulations that
represent the best-of-breed from all sources acquired or owned. Our emphasis on
the after-market retail customer continues to be one of the two major segments
of our business. In addition to the aftermarket sector, we continue
to develop customers in the OEM market segment. HPC has now been focused on
Original Equipment Manufacturing (OEM) application and development accounts and
the JET-HOT (MCCI) brand has been focused on aftermarket applications. nCoat
products are becoming more recognized as a standard product for reducing
corrosion and heat in diesel engines. The initial market for these products has
been heavy duty over-the-road diesel engine trucks. nCoat is now beginning to
expand into other sub-segments of the diesel engine markets including marine,
locomotives, military vehicles and sea-going vessels, recreational vehicles,
stationary generators, pumps and other fixed applications, agriculture, heavy
duty equipment, aftermarket re-manufactured engines and other areas. In
addition, we are expanding our customer base in gasoline powered engines as well
including into increased activity in motorcycle and racing venues. A strong
source for internal organic growth in the next three years is the continued
emphasis by the manufacturers of diesel, gasoline and hybrid fueled engines to
meet demanding environmental requirements imposed on their respective industries
as we seek to improve air quality of exhaust emissions, fuel economy and safety.
nCoat also continues to innovate new nano-products that meet the needs of our
customers. nCoat continues to beta test a new anti-oxidation nano-coating to
eliminate discoloration of chrome on vehicle exhaust systems. nCoat expects
these kinds of new products to create cross selling opportunities with existing
customers and opportunities to expand the market base with product offerings to
existing and new market segments. nCoat expects these product opportunities to
add to the internal growth of our customer base and revenues. Because of our
initial focus on automotive, trucking, motorcycles and recreational vehicles, we
expect that our revenues will remain subject to (1) seasonal build schedules of
our OE and aftermarket customers, (2) volume adjustments dictated by
macro-economic conditions, and (3) changing consumer and corporate spending
trends. Year to date, Company revenues are down approximately twenty percent
(20%) as our customers have adjusted to lower consumer demand consumer
confidence in current and future economic conditions. We have not lost any major
accounts during this period of reductions in manufacturing output, however,
total same period unit volumes for the first and second quarters of 2009 in our
largest market segment were significantly reduced year-over-year from 2008
levels. All 2008 unit volumes were significantly reduced from 2007 levels. In
the middle of the third quarter, 2009, we began to receive significant unit
volume increases from diesel engine manufactures for 2009 model year engines to
meet increasing demand for 2009 model year trucks prior to the universal
introduction of new 2010 engine platforms mandated by the EPA. From mid-third
quarter to the present, we continue to receive unit volumes approximately two
times higher than comparable period unit volumes from 2008. We expect this
production level to continue through year end 2009 at which time we will likely
experience a significant reduction in unit volumes upon introduction of new 2010
model year engines. We expect weaker volumes to continue from January through
June 2010 at which time customers are projecting sharp volume increase from July
through year end 2010.
14
Licensed Application and Joint
Venture Development. We continue to work to develop technology licensing
and/or joint venture business agreements to establish on-site coatings
application as part of the assembly-line process within the manufacturing and/or
assembly process of a large customer. This business model will become
increasing viable as nCoat products continue to gain acceptance in our targeted
markets and as we increase volume production to levels that make on-site
licensing financially viable for our customers. nCoat currently has two OEM
customers employing a licensing model and we continue to have discussions with
other prospects. The savings on handling, shipping, inventory,
logistics management and other similar expenses that comes from having the
on-site process is the principle benefit for our larger customers. Prime targets
for licensed applications include engine builders, vehicles manufactures, engine
re-manufacturers, automotive parts manufacturers, and other major industry
applications.
Licensing Intellectual
Property. We continue to enter into protected “field of use”
licensing with manufacturers that are tier-one suppliers of large OEM companies
or who deploy a licensed application or joint venture model as described above.
However, unlike the licensed application and/or joint venture model where
application expertise and management control are inherent elements of the model,
our “field of use” license agreements supply proprietary coatings to third
parties already applying coating at their plants. The license agreements
will be limited to targeted applications and industries where nCoat is not
likely to engage in application services in the future and are structured as
joint ventures to avoid creating competition in our own current market
space.
Acquisitions. We
completed the acquisition, transition and integration of HPC and MCCI which have
given us a base of operations and market presence. We have minimized work
on merger and acquisition activity during the current global economic downturn
and to reduce expenses in our current condition of low available cash. As
capital, the economy and opportunities allow, we may identify new specific
target companies in target markets for acquisition. There may be selective
opportunities to acquire or merge with companies significantly affected by
recent economic turbulence wherein valuations or ability to operate without
adequate cash flow or access to credit or capital render businesses unable to
continue without strategic options. Where prudent and within guidelines and
restrictions of current Company investment contracts, we many consider strategic
opportunities to increase revenue, gross margins, profitability
marketshare.
Strengthen nTech's research and
development efforts. On January 15, 2008, nCoat announced that North
Carolina Agricultural and Technical State University (NC A&T) in Greensboro,
North Carolina, and nCoat Inc. had established a technical collaboration
agreement for characterization and development of nanotechnology based materials
and industrial coatings. The Memorandum of Understanding (“MOU”) was signed
December 20th, 2007 with the Division of Research and Economic Development at
the university’s campus in Greensboro, North Carolina. Under the MOU, nCoat
collaborates with NC A&T’s Center for Advanced Materials and Smart
Structures (CAMSS) in areas of advanced composites, carbon nanotubes, nano
enhanced slurry coatings and metallic degradation from extreme thermal and
chemical environments. CAMSS has a track record in nano-science based advanced
materials as applied to thin film research, nano-composites, tribological and
environmental coatings.
15
CAMSS is
an extensively equipped and staffed materials research facility located on the
campus of NC A&T in Greensboro a few miles from nCoat’s location in
Whitsett. CAMSS is a NC A&T-wide umbrella center receiving support from the
National Science Foundation (Center for Research Excellence in Science and
Technology), Department of Energy, Department of Defense (Center for Nanoscience
and Nanomaterials), Air Force, and many industries. The center has extensive
nano characterization equipment including recent multiple innovations in atomic
and electron scanning microscopy and optical technologies. NC A&T has been
recognized as one of the leading nano materials research and development centers
in the United States.
The
agreement outlines joint efforts between nCoat and NC A&T to identify,
characterize, develop and commercialize new nano technology enhancements for
functional coatings and materials with applications in aerospace, medical,
energy, automotive, industrial, textile, advance composites, diesel engine
applications and other industries.
Among
other activities, the MOU is intended to establish a framework for
conceptualization and implementation of R&D projects with subsequent
commercialization. The agreement outlines governance of jointly and separately
developed intellectual property and potential patent alliances for inventions.
The agreement is also designed to establish joint revenues through technology
licensing for commercial applications.
Some of
the initial collaborative commercialization activities will be in the
nano-structured surface engineered systems to improve thermal barrier,
corrosion, tribological properties, biocompatibility and creating surface
technologies that create a cleaner environment. The
MOU also allows nCoat to collaborate with CAMSS on testing, prototyping and
development of materials specific to enhancing nCoat industry
needs.
This
agreement and others under discussion with outside research and development
groups, including technology transfer offices of universities, private
laboratories and other small start-up technology companies are designed to
continue to strengthen and exploit our research and development capacities while
reducing R&D costs. All of nTech’s research activities are
focused on projects that can show commercialization within three to six months,
rather than long term R&D projects. Many research projects are driven by
direct requests from customers seeking immediate solutions to immediate critical
problems.
Currently,
nCoat executives either chair or are members of technology commercialization
committees for both NC A&T university as a whole and for the Engineering
Resource Center principally located at CAMSS. In the third quarter, 2009, nCoat
continued identifying additional research and development opportunities with NC
A&T and continued to develop technology prospects toward
commercialization.
16
Completed
Acquisitions
The
acquisitions of HPC and JET-HOT have created certain market strengths for the
combined company. As a whole, the combination of the companies gives nCoat the
opportunity to scale our operations to meet larger OE customer
demands.
Acquisition
of MCCI/JET-HOT
With
respect to the acquisition of JET-HOT in June, 2007, we have realized key
synergies which include:
1.
JET-HOT had a plant in Arizona as did HPC. The plants were about 10 miles apart.
These were consolidated into a single location.
2.
JET-HOT plants are built for high through-put and packaging of individual
aftermarket production. HPC plants are built for high volume of OEM parts
production. Key strengths of each company have been used to create
best-of-breed know-how at all operating plants.
3.
Two corporate headquarters existed. The JET-HOT accounting, human resources,
legal, purchasing, sales and marketing, R&D and company management were
consolidated into our North Carolina headquarter.
4.
HPC and JET-HOT sales and marketing groups were consolidated for maximum
production and efficiency, including advertising budgets.
5. JET-HOT
R&D and technical services were consolidated to nTech, for efficiency
and intellectual property synergies.
6.
HPC and JET-HOT sales prospects include many of the same names, including
several where the two companies are the only two competitors for the account.
This list was sorted into HPC and MCCI responsibilities, creating a
non-competing sales effort.
7.
We have acquired sufficient market and operational experience to realize that a
single coating entity has a competitive disadvantage in attempting to create
high volume productions of both aftermarket parts and OEM parts. The
addition of MCCI allows us to create focused operations for each of our major
market sectors.
8.
Competition between MCCI and HPC for stand-alone coatings sales (no applications
services) has been eliminated and we are offering “best of breed” coating from
each company to customers.
9. JET-HOT
had more thermal barrier customers than HPC. HPC had more corrosion resistance
and lubritic coatings customers than JET-HOT. Cross selling now occurs in each
company’s customer base to attempt to raise same-customer revenue. In addition,
JET-HOT did not sell internal engine coatings. Their product line was for
coatings on external parts only. HPC internal engine coatings are now offered to
all of JET-HOT’s approximate 9000 annual individual aftermarket
customers.
10. Beginning
October 15, 2009, nCoat closed the Pennsylvania operating plant of JET-HOT and
consolidated equipment and application services principally to North Carolina.
We expect to complete the disassembly and transport of all assets
from the Pennsylvania to North Carolina vacate the premise by December 31, 2009.
The Pennsylvania lease expires January 31, 2010.
Since the
acquisition of JET-HOT, we have gradually transition most aftermarket product
sales and services across all companies into JET-HOT to leverage the JET-HOT
brand in the marketplace for consumer products and we have gradually
transitioned most OE product sales and services to HPC to leverage the HPC brand
for engineered products for industry applications.
17
Company contact
information
Our
headquarters’ address is 7237 Pace Drive, P.O. Box 38, Whitsett, NC 27377, and
our phone number is (336) 447-2000.
Results
of Operations
Performance
in First Nine Months of 2009 Compared to First Nine Months of 2008
Performance
Overview
The
comparative revenue for the nine months ending September 30, 2008, to September
30, 2009, shows a decrease of $2,283,777 or 27.8%. Aftermarket
sales began to experience declines in June, 2008 as consumer confidence
plummeted and uncertain and negative economic conditions began to impact
consumer spending. Quarter over quarter aftermarket sales experienced 60%
reduction in the fourth quarter of 2008 as economic conditions and consumer
uncertainty worsened. In the first, second and third quarters of 2009,
aftermarket sales were down 30.9% compared to the first nine months of
2008. Additionally, OEM sales have been negatively impacted by
reductions in demand with diesel engine manufacturers.
In 2007,
our diesel engine manufacturing customers were required to introduce new engine
platforms to meet new Environmental Protection Agency (EPA) requirements to
lower harmful particulates in engine emissions in order to comply with Federal
clean air standards. nCoat sells and applies corrosion resistant coatings
created to protect engines from corrosive agents in the emissions re-circulated
during use of new technology that aides diesel emissions systems to meet these
new standards. The new standards affected those engine platforms commencing in
2007 and the complete 2007 year was a period of “wait and see” as the new
engineering was road-proven prior to the acceptance by the
market. The same cycle is repeating in 2009 in anticipation of
introduction of new 2010 model year engines. The downturn of active new unit
purchases was further affected by the dramatic increase in fuel prices, rapid
and broad tightening of available credit in response to global financial
turbulence, followed by the economic recession. Additionally, the national
economic downturn and severe limitations on corporate credit resources beginning
in the fall of 2008 continued the limitations of unit sales. Until economic
activity shows signs of rebounding, and liquidity returns to the financial
markets, transportation companies will defer capital expenditures on rolling
stock.
Many
diesel manufacturers ceased production of new 2009 model trucks in April 2009
choosing to sell out existing inventories and prepare for new 2010 model year
vehicles which are required to meet new EPA emissions standards. However,
currently, the average age of the heavy duty (Class 8) truck fleet across
America is currently at the oldest level in fifteen years. The new EPA
restrictions forcing multiple engine platform changes in recent years, economic
conditions, and lack of available credit and capital have all forestalled sales
of new trucks. Media sources continue to report year-over-year engine build
rates the past two years as being down over 60% from pre-2007 levels. Because
the final new EPA mandated engine platform change for over-the-road Class 8
trucks occurs beginning January 2010 and because credit and capital deficiencies
began to ease in the third quarter, many fleet truck buyers placed orders for
new 2009 trucks prior to the January 2010 platform change. The significant unit
volume increases from diesel engine manufactures for 2009 model year engines to
meet increasing demand for 2009 model year trucks has placed our capacity
utilization of our North Carolina plant at 100% and our Oklahoma plant at 75%.
Ramp up of labor, materials and equipment to meet demand has strained cash flows
throughout the third quarter, however we have carefully managed cash to capture
new opportunities. Diesel engines customers expect demand for 2010 engines to be
weak as the fleet buyers test new model year engines and vehicles through an
adaption cycle lasting approximately through the first and second quarters of
2010. Our customers are projecting third and fourth quarters in 2010 to
experience vigorous sales as truck fleets continue to age and as buyers now can
purchase new trucks without concern of future forced engine platform
changes.
18
Cost
of Sales
Cost of
sales was $3,226,120 for the first nine months of 2009, a reduction of
36.6% from the same period last year. Cost of Sales as a percentage
of sales for the nine months ending September 30, 2009 and 2008 were 54% and 62%
respectively. The company continues to realize efficiencies stemming from
closing Mississippi, Utah and now Pennsylvania plant
locations. Additionally we continue to improve processes and reduce
variable cost and waste through our lean manufacturing program and Six-Sigma
management training. In the third quarter, seven members of our management and
supervisory team achieved Six Sigma black-belt designations after completing
training provided to the company by North Carolina State University as a free
service from the North Carolina Department of Commerce as an economic incentive
to the our company.
General
and Administrative Expenses
General
and administrative expenses for the nine months ended September 30,
2009, decreased by approximately $1,393,592 or 33.9% over same period 2008
expenses. General and administrative expenses as a percentage of sales for the
nine months ending September 30, 2009 and 2008 were 46% and 50% respectively.
Management has instituted a number of steps designed to reduce these expenses
including:
1)
Closing Mississippi, Utah and Pennsylvania plant locations, relocating their
capacity to other existing facilities and consolidating the JET-HOT and HPC
plants in Arizona.
2) Increasing
the effectiveness of communications and reducing unnecessary
travel.
3) Realigning
upper management positions to more closely track the size and present revenues
of the Company.
Sales
and Marketing Expense
Sales and
marketing expense for the three months ended September 30, 2009, decreased by
approximately $33,670 or 6% compared to the same period in 2008. Sales and
marketing expenses as a percentage of sales for the nine months ending September
30, 2009 and 2008 were 8% and 6% respectively. Management has
restructured the marketing and sales group, revamped commission structure and
reduced print advertising expense. However, management believes some expense
reductions have impacted aftermarket sales and OE sales and that further
reductions to advertising and direct marketing and sales efforts will adversely
impact both aftermarket and OE sales efforts and thereby revenues and the
overall financial condition of the Company. Management believes that some
increase in marketing and sales expenditures will be necessary to sustain sales
and customer services.
19
Interest
Expense
Management’s
greatest concern remains that all of the significant positive changes that have
been made to reach operating profitability have been overshadowed by the great
impact seen in our financial reports of the interest, premiums, penalties,
carrying charges and warrant expenses attributed to the contractual redemption
premium computations. We are in technical default under the terms of the
Series A and Series B Promissory Notes and hence are subject to the premium
computed on a redemption right granted to the holders of the Notes. As of
the date of this report management has received demand from one note holder for
the redemption of its Series A note. The note was originally issued
May 31, 2007 with the face amount of $1,500,000. The note holder has
previously converted a portion of its note ($50,000) as reflected in the
financial statements set forth herein. The demand was later
withdrawn, and the same investor converted $7,500 at a share price of $.0015 for
5,000,000 shares in May of this year, another $7,500 at a share price of $.0015
for 5,000,000 shares in August of this year and another $8,000 at a share price
of $.0015 for 5,333,333 shares in October of this year. No other demand has been
made by the remaining note holders for redemption of the Series A and B Notes.
We have had no indication from the other Note holders of demand, or other
negative impacts and continue to work to complete further negotiations with them
in order to restructure the debenture agreements to satisfy the triggering
events which have lead to the accounting entries. We expect that to restructure
the Notes, we will need to raise additional capital which may lead to debt or
equity obligation of the Company that will cause dilution to shareholders and/or
indebtedness to the Company in exchange for concessions by current Note
holders.
Earnings
per Share
As a
result of the share exchange transaction discussed in the overview section
above, exercise of warrants and conversion of debt, the number of outstanding
shares increased to 112,108,606 as of September 30, 2009. For the
nine month period ended September 30, 2009 there was a loss per share of
4.88.
Financial
Statements, One-Time Charges and Capital Expenditures
Cost
reduction activities have been underway since our anticipated funding was only
partially completed in 2007. We continue to realize reductions in
personnel, consolidation of facilities and emphasis on lean and efficient
manufacturing practices. Our resulting operational savings have been
encouraging.
1. Facilities
– Since the first quarter of 2007, facilities have been shut down in
Mississippi, Utah and Pennsylvania and two facilities in Arizona consolidated to
one. The capacity was shifted to other existing facilities, reducing
our overhead and improving our labor productivity.
Our plans
call for a second OEM production line in North Carolina in 2010 at an
installation cost of approximately $400,000. Installation of this line in 2009
was postponed due to cash flow. Most of this cost will be for
installation of increased electrical capacity at our North Carolina plant and
existing equipment which has already been relocated due to the consolidation of
the Mississippi, Utah, Arizona and Pennsylvania plants.
20
2. Personnel
- The Company reduced the workforce from over 200 employees in July, 2007 to
approximately 107 employees as of June 30, 2009. This decrease came
from operating plants more efficiently, reducing the number of plant locations,
and revenue decreases from economic conditions. From June 30, 2009 to October
30, 2009, our total workforce increased to 132 to meet customer demand. Many of
these jobs are part-time positions as we expect some production weakness in the
first and second quarters of 2010. Labor increases have been in production
operations only as we continue to decrease general and administrative labor as
prudent. Current management staff level is in line with existing
business levels. We continue to focus on updating our Standard
Operating Procedure documentation, preparation of information systems,
accounting, human resource, production, communications, mixing and blending,
strategic finance and other systems to accommodate potential rapid growth from
internal and acquisition growth.
3. Research
and Development – Our expenditures for research and development were $240,627
for the nine months ended September 30, 2009. Expenditures for the
first nine months of 2008 totaled $296,456.
4. Financing
- Expenses in the first nine months of 2009 show Redemption premium interest
expense of $545,995,002. This is the current calculation for the
penalty associated with the default on the A and B notes discussed at length
elsewhere in this report.
Liquidity
and Capital Resources
nCoat is
a company with limited operating history and experience upon which to base an
evaluation of its performance. In September of 2005, we acquired High
Performance Coatings, Inc. (“HPC”), an operational coatings company, which was
responsible for the majority of our consolidated revenues. In 2006, we formed an
intellectual property and development entity, nTech, Inc. (“nTech”), and in June
2007, we acquired all of the common stock of Metallic Ceramic Coatings, Inc.
(“MCCI”), a primary competitor of HPC with 26 years of coatings experience and
historical revenues similar to HPC.
On April
13, 2007, we converted $2,000,000 of convertible debentures and $67,752 of
accrued interest into 4,135,503 shares of our common stock at $0.50 per share.
The remaining $500,000 of convertible debentures, along with accrued interest of
$18,107, was converted to 1,036,215 shares of common stock at $0.50 per share on
August 24, 2007.
From May
25, 2007, through July 9, 2007, we issued $9,000,000 of Series A 6% convertible
promissory notes (the “Series A Notes”) and warrants to purchase 22,500,000
shares of common stock, exercisable at $1.00 per share through May 31, 2012. The
Series A Notes are convertible into common stock at $0.40 per share through May
31, 2010 when the Series A Notes are due. On May 31, 2007, the Company issued
$3,250,000 of Series B 6% convertible promissory notes (the “Series B Notes”)
and warrants to purchase 8,125,000 shares of common stock at $0.80 per share
through May 31, 2010. The Series B Notes are convertible into common stock at
$0.40 per share through May 31, 2010 when the Series B Notes are due. The Series
A and B private placement offerings included the conversion of $800,000 of
advances from investors of which $700,000 had been received prior to March 31,
2007. The Company received $10,618,916 of proceeds from the issuance of the
Series A and Series B convertible notes, net of the $700,000 of advances
previously recognized and net of cash offering costs of
$931,064.
21
In the
final stages of the offering, after we had closed on the purchase of MCCI, a
subscribed investor did not fund its portion of offering. Our intended use
of proceeds included retirement of debt and related accrued interest of
$3,677,286, $5,000,000 for the acquisition of MCCI, payment of significant
pre-offering liabilities and establishing a working capital reserve. The
retirement of pre-offering liabilities and the working capital portion of the
offering did not get raised prior to our contractual obligation to close the
offering. This deficiency of the expected $6,500,000 in funding, combined
with the seasonal lull in aftermarket and OEM revenues, caused us to experience
a significant liquidity crisis. A number of our vendors turned our account
over to collection agencies and at December 31, 2008, we had accounts payable in
excess of $2.0 million over 120 days past due.
At
December 31, 2008 we are in technical breech of the Securities Purchase
Agreement and the related Series A and B Convertible Notes and Registration
Agreement (collectively the “Note Agreement”). This technical breech is due to
our failure to pay partial liquidating damages and failure to pay interest nCoat
is attempting to negotiate a restructure of these debenture notes to provide a
work out arrangement favorable to both current debenture holders and
shareholders. To accomplish this restructure, nCoat must raise in the next
twelve (12) months, additional capital to satisfy negotiated demands of the
current debenture holders and to pay aged accounts payables current owed by
nCoat to its vendors. Capital raised to this end may (1) be accomplished in a
debt instrument which will incur debt to the Company, and/or (2) be raised in an
equity offering which may create significant dilution to current shareholders,
(3) a combination of numbers 1 and 2 above, or (4) not be completed at all.
nCoat is seeking through negotiations to restructure all outstanding penalties,
interest, carrying charges and principal accrued under the current debenture
notes. Any changes to the agreement or to accounting treatment
described herein will be reflected in subsequent periods.
Although
no demand has been made (other than the one mentioned above that was made and
then withdrawn), the Note Agreement provides that in the event of a breech,
within the first 12 months following closing, the holders are entitled to demand
immediate redemption of all, or any portion of, the face value of the Series A
Notes and Series B Notes, along with a redemption premium. This
premium is the greater of 25% or the product of a multiplicand whose numerator
is the stock price on the day of the default trigger event divided by the
weighted market price at the beginning of each month thereafter. As a
result, the full face value of the Notes and redemption premium are shown on our
Balance Sheet as current liabilities in our annual report at December 31, 2008
and in the financials of this report.
We have
been active in our attempt to reduce our losses and conserve cash. We
have had a reduction in work force and reduced the number of employees to levels
appropriate for our production demands. We consolidated operations
and eliminated three facilities in 2008 and one in 2009. During the
first nine months of 2009 the two senior executives of the Company have deferred
all their salaries and certain other employees elected to defer portions of
their salaries totaling $506,426.
At
September 30, 2009, we had assets of $3,983,694 and current liabilities of
$891,608,168 of which the redemption premium set forth above comprises 98% of
that total. Any amounts owed to related parties have no specific
terms of repayment and bear no interest.
22
Off
Balance Sheet Arrangements
The
Company’s off-balance sheet arrangements include operating leases for it
production facilities and office space.
Item
3 – Quantitative and Qualitative Disclosures About Market Risk
Information
in this section will be added once an audit has been completed.
Item
4T – Controls and Procedures
Management’s
Report On Internal Control Over Financial Reporting
Evaluation of disclosure
controls and procedures.
All financial information
contained in this report is unaudited and un-reviewed. The last
accounting firm review of any of our quarterly filings was as of September 30,
2008. nCoat has not produced enough cash flow to pay the auditors to complete
the audit by the publication date any report since that time including this
September 30, 2009 report. Upon payment of the audit fees, the auditors will
complete the audit and an amended Form 10K and 10Q will be filed. All figures
are presented in accordance with Generally Accepted Accounting Principles
(GAAP), but have not been tested or validated by an outside firm as of
yet. As of the end of the period covered by this report, an
evaluation was carried out under the supervision and with the participation of
the company’s management, including its Chief Executive Officer and Chief
Financial Officer, and its Vice President of Finance of its disclosure controls
and procedures (as defined by Rules13a — 15(e)and 15d-15(e)under the Securities
Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer and the Vice President of Finance concluded that the
design and operation of these disclosure controls and procedures were effective
as of the end of the period covered by this report.
Changes
in internal Controls over Financial Reporting
There have been no changes in the
registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect our internal control over financial
reporting.
RISKS
RELATED TO NCOAT BUSINESS
nCoat
has not completed an audit of its financial statements as of the date of the
filing of the Annual Report for the year ended December 31, 2008, and as such,
the financial statements filed with the Annual Report are not audited, and the
interim quarterly financial statements in the Quarterly Reports for the first,
second or third quarters of 2009, were not reviewed.
As of the
date of filing of the Company’s Annual Report for the year ended December 31,
2008 with the SEC, nCoat had not been able to accumulate enough cash reserves to
pay its public auditor to complete the audit of nCoat’s financial statements for
the year ended December 31, 2008. Accordingly, the Annual Report on
Form 10-K for the year ended December 31, 2008 and filed on April 15, 2009 with
the SEC, does not include audited financial statements. Additionally,
the Company’s auditors did not review the financial statements included in the
Quarterly Report for the quarters ending March 31, June 30 or September 30,
2009. Moreover, neither the Company’s auditors nor its outside legal
counsel reviewed either the Annual Report for the year ended December 31, 2008,
or the Quarterly Reports for the first nine months ending September 30,
2009. As such, such reports may contain material misstatements or
omissions.
The
Company intends to use some of the proceeds of a future capital acquisition to
obtain an audit of the December 31, 2008, financial statements and a review of
the March 31, June 30, and September 30, 2009, quarterly interim financial
statements, and to update and amend the Annual and Quarterly Reports which will
be reviewed by the Company’s auditors and outside legal
counsel. However, there may be material changes to both the Annual
and Quarterly Reports as a result of these amendments.
23
nCoat
has been in technical default on its debenture notes for over eighteen (18)
months and owes substantial amounts of interest, penalties, liquidated damages
and default fees to its debenture holders.
Because
of cash shortfalls beginning in September, 2007, nCoat has not paid cash
interest payments to its debenture holders since October, 2007. nCoat paid
interest in stock for the third quarter of 2007, but has not paid interest in
any form since that time. Subject to provisions of the documentation governing
technical and/or actual default of the debenture financings, nCoat is subject to
significant increases in interest rates, increases in principal owed, compounded
penalties for non-payment of interest and principal, liquidated damages, and
other penalties, many of which are tied to changes in nCoat’s public stock
prices. With nCoat’s current stock price under $.01/share, penalties create
exorbitant cash and stock penalties currently owed by nCoat to its debenture
holders. While nCoat has been in continual contact with its debenture holders
and is attempting to reached a verbal agreement to restructure terms favorable
to nCoat, there can be no assurance that such and agreement will ever be
completed and nCoat could be subject to a declaration of actual default and
thereby be subject to partial or complete liquidation of its assets by debenture
holders.
nCoat
is seeking a restructure of its current debenture debt and agreements and must
raise additional capital to accomplish this restructure.
As
mentioned above herein, nCoat is in technical default on its current debenture
financing. nCoat is seeking and attempting to negotiate a restructure of these
debenture notes to provide a work out arrangement favorable to both current
debenture holders and shareholders. To accomplish this restructure, nCoat may
need to raise additional capital to satisfy negotiated demands of the current
debenture holders and to pay aged accounts payables currently owed by nCoat to
its vendors. No assurance can be made the terms of the capital raise will
provide enough capital to repay all Company debt or satisfy all current demands
on the Company. There can be no assurance that nCoat will raise needed capital
in time to forestall actual default of its debentures and subsequent possible
liquidation of its assets.
Current
global, national and local economic conditions have affected nCoat revenues in
both aftermarket and OEM market sectors and these revenue decreases may continue
for the foreseeable future.
The
current global economic crisis world-wide in general has had a dramatic negative
impact on key industries from which nCoat derives a significant portion of its
revenue and most of its profitability. Automotive revenues decreased in the
fourth quarter of 2008 by 55% over same period revenues in 2007. Heavy duty
truck sales have decreased 65% over 2007 and 2008 when compared with sales the
two years previous and largely remain at significant lows to previous years.
Consumer confidence and spending decreased to levels not seen for the last 40
years. These factors have had a negative impact on nCoat revenues in both OEM
and aftermarket market segments. nCoat total revenues in the fourth quarter of
2008 decreased 20% year over year with aftermarket sales decreasing over 40% in
the same period. With the limited exception of OE diesel engine sales in the
third and fourth quarters of 2009, nCoat expects revenues in these sectors to
remain low or experience additional decreases in OEM and aftermarket sales until
automotive, trucking, motorcycle and aircraft sales begin to increase
consistently.
24
nCoat,
HPC, MCCI and nTech have a limited operating history.
nCoat is
a company with limited operating history and experience. nCoat, Inc.
was also limited in its operating history prior to the merger with Tylerstone.
It had acquired HPC, a company with a 23-year operating history with all but the
last seven years in performance automotive markets. While HPC’s operating
history in its historical primary market is strong, commercial success in the
new OEM markets is limited. MCCI historical operating history is
similar to that of HPC. nTech was formed three years ago and
therefore has less operating history than nCoat or any of its other
subsidiaries. Therefore both the Company and all its operating
subsidiaries have a limited number of current customers in the new target
markets. Further, both the Company and its operating subsidiaries have
experienced the need to refocus manufacturing to handle increased volume of OEM
orders, which has required significant corporate cash resources and required
significant management attention to accomplish. This change led to reduced cash
reserves for operations and management disruption to the core after-market
business. In addition, activities necessary to transition and integrate acquired
companies and to consolidate operating facilities, management, employees and
systems have required significant capital and management and employee time and
attention. Recent negative impacts of the global financial crisis and subsequent
decreased nCoat revenues have also required management time and
attention. To meet its business plan, the Company will need to remain
focused on business prospects, develop structured management and personnel
responsibilities, and develop expansion plans for product development,
production and customer services that can remain ahead of the prospective growth
or shrinkage based on market conditions and financial status.
We
will require substantial working capital to implement our business
plan.
Projected
success and growth are dependent on sufficient working capital to fund
operations and product development. Management originally engaged investment
bankers to assist in raising substantial capital via the sale of the Series A
and Series B Notes and Warrants. Included a possible capital raise
would be additional capital to sufficiently fund operations, fund expansion of
sales efforts, fund expansion of production capacity and operations, fund the
development and growth of our product mix. There is no assurance that
any future capital will be available or available on terms and conditions
acceptable to the Company. Further, if we are successful in raising
such funds, there can be no assurance that such funds will be sufficient or that
such operational activities will be successful within the anticipated timeframe.
In such case, we could be required to seek additional investment on terms
available in the marketplace, which could materially increase corporate
indebtedness, subject us to high interest rates and/or dilute shareholders’
ownership positions. Furthermore, the failure to obtain additional working
capital, if needed, could prevent us from achieving our business
objectives.
We
have incurred continuing losses, and we may not be able to operate profitably in
the future
Through
September 30, 2009, nCoat incurred losses totaling $(546,798,571) and had
negative shareholders’ equity of $(887,989,987). While nCoat achieved positive
operating income for the same reporting period, penalties, premiums and other
charges relating to non-payment of the Company’s Series A and B Convertible
Debentures created substantial losses. If we are unable to complete a
restructure of the debt represented by the Company’s Series A and B Notes and
continue to generate positive operating income and attain consistent
profitability we may need to cease operations or seek protection under the
bankruptcy laws.
25
We
are experiencing a significant liquidity crisis and we may not obtain sufficient
funding to continue operations.
We
continue to experience a significant liquidity crisis. A number of our vendors
have turned our accounts over to collection agencies, and at September 30, 2009,
we had accounts payable in excess of $3.6 million over 120 days past due. At
September 30, 2009, we had cash on hand of $127,789, and net trade receivables
of $540,438. We do not generate sufficient cash from our operations in any given
month to meet our financing expenses and fund our operations. We have an
immediate need for financing to pay such overdue accounts and restructure our
Series A and B Convertible Debenture debt. Because we generate only enough
income to support our current operations, we need immediate financing to pay
aged payables and notes on current terms. There can be no assurance
such financing will be available, or available on terms acceptable to the
Company. If we are unable to obtain such financing, we will be unable to pay our
liabilities, and we may need to cease operations or file for bankruptcy
protection.
Our
independent registered public accounting firm has included an explanatory
paragraph relating to our ability to continue as a going concern in its report
on our financial statements for the year ended December 31, 2007.
Because
our Annual Report for 2008 did not contain audited financial statements for
2008, we included in that report a note from our 2007 Annual Report on Form
10-K. Because we generated significant losses and required additional
working capital to continue operations, our independent registered accounting
firm included in its report for the year ended December 31, 2007 an explanatory
paragraph to the effect that these conditions raised substantial doubt about our
ability to continue as a going concern. We expect that given current financial
conditions of the Company, the independent auditors would include a similar or
identical statement in our current financial statements upon completion of the
audit of those statements.
Our
business strategy includes dependence on strategic partnerships with
well-established corporations for business growth and development.
Our
business strategy includes, among other elements, the development of long-term
strategic partnerships with well-established corporations. These
companies include large original equipment manufacturers (OEMs) that build
parts, engines, pistons, or other components in the automotive, trucking,
motorcycle and gas and oil industries with which we could leverage our business
using their book of business, or brand identification in the
industry. We cannot dictate to those companies their business
activities regarding our partnership, however, we expect to enter into
agreements that will allow us to influence the partnership for mutual
success. Our growth in this area of our business plan may be
limited if we are either unable to identify and partner with these larger
companies, or in the course of the partnership we are unable to execute our
business plans.
Our
products and technologies are subject to technological change and
obsolescence.
Our
products are subject to competitive technological advances and new competitive
product introductions. Current competitors or new market entrants could
introduce products with features that render products sold by the Company less
marketable or obsolete. In addition, some of our services to large accounts
provide products enabling customers’ technology to efficiently operate. There
can be no assurances that our customers will continue to utilize their current
technology innovations that require our products and services. New technology
innovations that do not require our products and services may be used. Our
future success will depend, to a certain extent, on the ability to adapt to
technological change and to address market needs. There can be no assurance that
we will be able to keep pace with technological change or the demands of the
marketplace.
26
Many
of our competitors may have greater capitalization or be better positioned in
our markets.
The
coatings industry includes large commodity coating providers, including BASF,
DuPont, Dow Chemical, Pittsburg Paint & Glass, and Sherwin-Williams to name
some of the largest. Although we are in a much smaller niche segment
of the coatings industry which includes a large number of small and regional
providers, these larger companies may elect to develop or acquire operations and
marketing into our niche of high performance coatings. These
competitors possess greater capitalization, market presence and sales and
distribution channels than the company and could, if they elected to directly
compete, eliminate market advantages currently enjoyed by nCoat leading to
significant loss of revenue and consequently lead to our failure.
Certain
nCoat technologies are in the early stages of development.
While we
do have marketable formulations that include formulas and coatings that we
employ in generating revenues, we also have additional technologies that are not
yet incorporated in our market mix. Our business plan is based, in
part, on our ability to create additional nanoparticle formulations that exceed
the performance of a number of our current coatings, as well as developing
additional methods to improve the application process. We are
developing coatings with greater thermal, corrosion, abrasion, and porosity
protection capabilities, with methods that will allow us to create more plant
throughput for our OEM volume clients and direct development of new materials
that will provide higher levels of performance. Some of our
technologies are in an early stage of development while others are in late
stages of development but not yet launched in broad market applications. These
technologies have not been extensively marketed or laboratory tested. In order
to fully validate the commercial feasibility of the technologies, additional
product research and development and extensive testing must be
done. Any failures experienced by our technologies while in product
development could negatively impact our performance and ability to achieve our
business objectives.
We
may experience difficulty integrating future acquisitions.
While
cash constraints and significant debt overhang currently complicate acquiring
other companies, one of the elements of our business strategy which may be
executed in the future is to continue to acquire other coatings companies. With
each of the potential targets, we undertake extensive due diligence to
understand all aspects of the acquisition target, including its history,
management, markets, operations, marketing, sales, finance, personnel, assets,
intellectual property, risks, reputation, strengths, weaknesses, opportunities,
threats, and synergies, etc. of all domestic and international business
operations. Experience has shown that discovering all of the issues inherent in
an acquisition leading to total seamless operations between us and the acquired
company is impossible. We may, in the course of future acquisitions,
meet unexpected difficulties in transitioning and integrating a new
acquisition. Areas of potential difficulty may include inexperience
in certain markets, actions of previous owners, management or employees of the
acquired company, lack of anticipated synergy with our core business, and/or
missing historical information. Any of these issues may result in
increased expenses, decreased revenues, loss of key personnel, or other impacts
which could negatively affect the Company. In each acquisition nCoat
negotiates a holdback of a portion of the purchase consideration for a period of
time as we integrate the operations of the acquisition. There can be no
assurance that the amount held back will be sufficient to offset the losses or
expenses incurred should problems arise.
27
Our
processes and equipment are subject to the risk of unexpected
failures.
Our
manufacturing processes are extremely specialized and depend on critical pieces
of equipment, such as air compressors, ovens, application machinery, conveyor
systems, overhead cranes, vehicles, computer and communications systems and
other machinery that may have to be repaired or replaced. On occasion, equipment
may be out of service as a result of unanticipated failures which may result in
material plant shutdowns or periods of reduced production with significant
expense and time delay. Interruptions in production capabilities will inevitably
increase production costs and reduce nCoat sales and earnings. In addition to
equipment failures, our facilities are also subject to the risk of catastrophic
loss due to unanticipated natural or man-caused events such as fires,
explosions, floods, natural disasters, adverse weather conditions, or other
unforeseen conditions. Furthermore, any interruption in production capability
may require us to make large capital expenditures to remedy the situation, which
could have a negative effect on our profitability and cash flows. Although we
have business interruption insurance, management cannot provide any assurance
that the insurance will cover all losses that could occur as a result of the
equipment failures or that insurance payments will be received by the Company in
time to replace or repair damaged equipment and/or facilities. In addition,
longer-term business disruption could result in a loss of customers. If this
were to occur, future sales levels, and therefore profitability, could be
adversely affected.
There
is no guarantee that we will be able to protect our intellectual
property.
As part
of our business strategy, we intend to accelerate investment in new technologies
in an effort to strengthen and differentiate the product portfolio and make our
manufacturing processes more efficient. As a result, we believe that the
protection of proprietary intellectual property will become increasingly
important to the business. Currently, we have patent applications pending. We
expect to rely on a combination of patents, trade secrets, trademarks and
copyrights to provide protection in this regard, but this protection might be
inadequate. For example, pending or future patent applications might not be
approved or, if allowed, the patents might not be of sufficient strength or
scope. Conversely, third parties might assert that technologies infringe their
proprietary rights. In either case, litigation could result in substantial costs
and diversion of our resources, and whether or not we are ultimately successful,
the litigation could hurt our business and financial condition.
We
may incur significant costs to comply with the “controls and procedures”
requirements of the securities laws.
As
directed by Section 404 of the Sarbanes-Oxley Act of 2002 or “SOX 404,” the
Securities and Exchange Commission (“SEC”) adopted rules requiring public
companies to include a report of management on the company’s internal controls
over financial reporting in their annual reports, including Form 10-K. In
addition, the independent registered public accounting firm auditing a company’s
financial statements must also attest to and report on management’s assessment
of the effectiveness of the Company’s internal controls over financial reporting
as well as the operating effectiveness of the company’s internal controls. The
Company’s management has evaluated the Company’s internal control systems in
order to allow management to report thereon, and independent auditors to attest
to, the Company’s internal controls as required by these requirements of SOX
404. Under current law, the Company was subject to these requirements beginning
with the management report for the annual report for the fiscal year ending
December 2007 and auditor attestation for the Company’s 2008 annual report.
Management can provide no assurance that the Company will be able to comply with
all of the requirements imposed thereby. There can be no assurance that the
Company will receive a positive attestation from the independent auditors. In
the event nCoat identifies significant deficiencies or material weaknesses in
its internal controls that cannot be remediated in a timely manner or management
is unable to receive a positive attestation from the independent auditors with
respect to the Company’s internal controls, investors and others may lose
confidence in the reliability of the Company’s financial
statements.
28
RISKS
RELATED TO MANAGEMENT OF THE COMPANY
We
rely heavily on Company management.
Our
ability to execute our business plan relies to a considerable extent on the
efforts of Paul Clayson and Terry Holmes. In the event that the services of Mr.
Clayson and Mr. Holmes become unavailable, we may not be able to achieve our
business objectives.
Paul
Clayson, our Chief Executive Officer and Chairman of our Board and Terry R.
Holmes, our President and Chief Operating Officer are involved in other
businesses which may cause them to devote less time to our
business.
Paul
Clayson, our Chief Executive Officer and Chairman of our Board and Terry R.
Holmes, our President and Chief Operating Officer, serve as officers for other
companies. In addition to serving as our Chief Executive Officer and
Chairman of our Board, Mr. Clayson also serves as the President and Chief
Operating Officer and equity partner of Sequoia Pacific Research Company, Inc.
(“SPRC”), a nano-technology research, development and technology licensing
company that presently has no day-to-day operating activity. Mr.
Clayson devotes approximately 100% of his professional time, to the business of
nCoat. Mr. Holmes serves as Chief Executive Officer and Chairman of the Board of
TelNetz, Inc., an ASP telephony and web service company and as Chief Executive
Officer and Chairman of SPRC. In addition, he is involved with other business
interests, which collectively require little involvement on a day-to-day
business effort. Mr. Holmes devotes virtually 100% of his
professional time to the business of nCoat. Messrs. Clayson’s and
Holmes’ involvement with other businesses have been handled after hours, and at
times when there has been no conflict to date. One of the risks we
face, however, may be the point in time where outside business involvement may
cause them to allocate their time and services between nCoat and other entities.
Consequently, they may give priority to other matters over our needs which may
materially cause us to lose their services temporarily which could affect our
operations and profitability.
We
are dependent on the services of our technical personnel.
The loss
of any key personnel could have a material adverse impact on our business. Our
future success depends, to a significant extent, on its ability to attract,
train and retain technical personnel. Recruiting and retaining capable
personnel, particularly those with expertise in the industry, are vital to
success. There is substantial competition for qualified technical personnel, and
there can be no assurance that we will be able to attract or retain such
personnel. If it is unable to attract and retain qualified employees, the
Company may be materially and adversely affected.
29
RISKS
RELEATED TO OWNERSHIP OF OUR STOCK
The
market price of our common stock likely will be volatile and beyond our
control.
As we are
a new company in the public market, the market price for our shares is likely to
be highly volatile and subject to wide fluctuations in response to factors
including the following:
•
|
Announcements
of technological or competitive developments;
|
•
|
Regulatory
developments in target markets affecting the Company, customers or
competitors;
|
•
|
Announcements
regarding patent litigation or the issuance of patents to the Company or
its competitors;
|
•
|
Announcements
regarding new financings, acquisitions or other financial
transactions;
|
•
|
Announcements
of studies and reports relating to the conversion efficiencies of
anticipated products of the Company or those of its
competitors;
|
•
|
Actual
or anticipated fluctuations in nCoat quarterly operating
results;
|
•
|
Changes
in financial estimates by securities research analysts;
|
•
|
Changes
in the economic performance or market valuations of other high performance
coating industry companies;
|
•
|
Addition
or departure of the Company’s executive officers and key
personnel;
|
•
|
Release
or expiry of resale restrictions on other outstanding common
shares;
|
•
|
Sales
or perceived sales of additional shares to raise working
capital
|
•
|
Announcements
of changes in status of debenture debt including either triggering of any
actual default or elimination of debenture debt due to
restructuring
|
•
|
Global,
national, regional or local economic conditions; and/or
|
•
|
Multiple
additional unforeseen factors.
|
In
addition, the securities market has from time to time experienced significant
price and volume fluctuations that are not related to the operating performance
of particular companies in general or our Company in specific. These market
fluctuations may also have a material adverse effect on the market price of the
Company’s shares.
Our
ownership is highly concentrated in a few individuals.
There is
a large portion of our stock owned by few individuals. Approximately 45.5% of
our present outstanding voting securities are beneficially owned by a few
shareholders. As a result, they possess significant influence and can elect a
majority of our board of directors and authorize or prevent proposed significant
corporate transactions. This concentrated ownership and control may also have
the effect of delaying or preventing a future change in control, impeding a
merger, consolidation, takeover or other business combination or discourage a
potential acquirer from making a tender offer. In addition, we anticipate
additional financing efforts in order to complete our business strategy. Some or
all of such financing may be acquired by a single person or a relatively small
group of persons that could have the effect of further concentrating the
ownership. In addition, the Company has fewer than 150 total shareholders. This
limited number of shareholders could create limited liquidity in daily trading
activity and create wider price swings between buyers bids and sellers offers to
sell.
30
Trading
in our common stock is limited.
Our
common stock is quoted on the Pink Sheet OTC Electronic Markets (“Pink Sheets”).
The Pink Sheets is a significantly more limited liquidity market than the New
York Stock Exchange or NASDAQ system or the OTC Bulletin Board. The quotation of
our shares on the Pink Sheets may result in a less liquid market available for
existing and potential stockholders to trade shares of its common stock, could
depress the trading price of its common stock and could have a long-term adverse
impact on our ability to raise capital in the future.
We
previously traded on the OTC Bulletin Board, but became ineligible for continued
listing due to our untimely public filings. Although the Company’s
management intends to become and remain current in its public filing
obligations, there can be no guarantee that the Company will be able to remain
current or qualify for listing on the OTC Bulletin Board or other market or
trading facility in the near future or ever.
The
trading market for our common stock is limited, and investors who purchase
common stock in this offering may have difficulty selling their
shares.
The
public trading market for our common stock is limited. As of the date
of this Agreement, our common stock was listed on the Pink
Sheets. Nevertheless, an established, vibrant public trading market
for our common stock may be slow to develop or, if developed, it may not be able
to be sustained. The Pink Sheets is an unorganized, inter-dealer,
over-the-counter market that provides significantly less liquidity than other
markets. Purchasers of our common stock therefore may have difficulty
selling their shares should they desire to do so.
Our
common stock is considered a penny stock. Penny stocks are subject to
special regulations, which may make them more difficult to trade on the open
market.
Securities
in the OTC market are generally more difficult to trade than those on the NASDAQ
National Market, the NASDAQ SmallCap Market or the major stock exchanges. In
addition, accurate price quotations are also more difficult to
obtain. The trading market for our common stock is subject to special
regulations governing the sale of penny stock.
A "penny
stock," is defined by regulations of the Securities and Exchange Commission as
an equity security with a market price of less than $5.00 per share. However, an
equity security with a market price under $5.00 will not be considered a penny
stock if it fits within any of the following exceptions:
•
|
the
equity security is listed on NASDAQ or a national securities
exchange;
|
•
|
the
issuer of the equity security has been in continuous operation for less
than three years, and either has (a) net tangible assets of at least
$5,000,000, or (b) average annual revenue of at least $6,000,000;
or
|
•
|
the
issuer of the equity security has been in continuous operation for more
than three years, and has net tangible assets of at least
$2,000,000.
|
If you
buy or sell a penny stock, these regulations require that you receive, prior to
the transaction, a disclosure explaining the penny stock market and associated
risks. Furthermore, trading in our common stock would be subject to Rule 15g-9
of the Exchange Act, which relates to non-NASDAQ and non-exchange listed
securities. Under this rule, broker-dealers who recommend our securities to
persons other than established customers and accredited investors must make a
special written suitability determination for the Purchaser and receive the
Purchaser's written agreement to a transaction prior to sale. Securities are
exempt from this rule if their market price is at least $5.00 per
share.
Penny
stock regulations will tend to reduce market liquidity of our common stock,
because they limit the broker-dealers' ability to trade, and a purchaser's
ability to sell the stock in the secondary market. The low price of our common
stock will have a negative effect on the amount and percentage of transaction
costs paid by individual shareholders. The low price of our common stock may
also limit our ability to raise additional capital by issuing additional shares.
There are several reasons for these effects. First, the internal policies of
many institutional investors prohibit the purchase of low-priced stocks. Second,
many brokerage houses do not permit low-priced stocks to be used as collateral
for margin accounts or to be purchased on margin. Third, some brokerage house
policies and practices tend to discourage individual brokers from dealing in
low-priced stocks. Finally, broker's commissions on low-priced stocks usually
represent a higher percentage of the stock price than commissions on higher
priced stocks. As a result, our shareholders will pay transaction costs that are
a higher percentage of their total share value than if our share price were
substantially higher.
31
PART
II
OTHER
INFORMATION
Item
1 – Legal Proceedings
From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. Litigation is subject to inherent
uncertainties, and an adverse result in these or other matters may arise from
time to time that may harm our business. As of the date of this Report, with the
exception of the case cited below, we were not aware of any such legal
proceedings or claims against the Company or its subsidiaries that management
believes will have a material adverse affect on business development, financial
condition or operating results.
First
Tennessee Bank v. MCC Inc. and Michael Novakovic, Case No. CH-09-0558-1 Shelby
County Chancery Court for the Thirtieth Judicial District at Memphis,
TN. On April 17th,
2009 First Tennessee filed a complaint against MCC Inc. and Michael Novakovic
(collectively, the “Plaintiffs”) claiming breach of contract regarding a
promissory note. This note was originated February 15, 2007 by MCC Inc. Michael
Novakovic personally guaranteed this loan prior to nCoat purchasing MCCI. Mike
Novakovic subsequently purchased the note from First Tennessee to satisfy the
personal guarantee and the First Tennessee complaint was withdrawn and Mr.
Novakovic filed a complaint in Pennsylvania which brings claims for accelerated
balance due on the note for $240,384. . Negotiations have been completed by
the Company for settlement of the obligation with Mr.
Novakovic. nCoat will execute an agreement shortly with Mr. Novakovic
to pay $200,000 to satisfy in total the remaining balance of the note at twelve
percent (12%) interest over thirty six (36) months beginning December 1,
2009
On
January 19, 2008 and January 29, 2008, the Company issued 1,554,198 shares of
its common stock as payment of interest on the Series A Notes and Series B Notes
for interest due for the third quarter of 2007.
On August
18, 2008, the Company issued 1,250,000 shares of its common stock as the result
of a partial conversion of a Note holder’s principal, reducing that Note by
$25,000.
On
December 1, 2008, the Company issued 3,031,956 share of its common stock as the
result of a partial conversion of a Note holder’s interest, reducing the Note by
$10,000.
On May
22, 2009 the Company issued 5,000,000 shares of its common stock as the result
of a partial conversion of a Note holder’s interest, reducing the Note by
$7,500.
On August
21, 2009 the Company issued 5,000,000 shares of its common stock as the result
of a partial conversion of a Note holder’s interest, reducing the Note by
$7,500.
On
October 8, 2009 the Company issued 5,333,333 shares of its common stock as the
result of a partial conversion of a Note holder’s interest, reducing the Note by
$8,000.
There
have been no repurchases of equity securities by nCoat during the years ended
December 31, 2007 or 2006.
In each
case, the securities were issued in connection with private transactions with
accredited investors pursuant to Section 4(2) of the Securities Act and
regulations promulgated there under.
Proceeds
from the sale of the above securities were and will be used for retirement of
debt, acquisition of MCCI and working capital.
32
Item
3 – Defaults Upon Senior Securities
As set
forth above, the Company was in technical breach of the underlying financing
agreements until it obtained waivers as described in the 10-KA report filed by
the Company on August 1, 2008.
Item
4 – Submission of Matters to a Vote of Security Holders
None.
Item
5 – Other Information
None
The
following documents are filed as an exhibit to this Report:
Exhibit
Description
3.1
|
Certificate
of Incorporation (previously filed as an exhibit to a registration
statement on Form SB-2, filed with the Commission on December 27, 2004,
and incorporated herein by this
reference).
|
3.2
|
Certificate
of Amendment to Certificate of Incorporation (previously filed as an
exhibit to a Current Report on Form 8-K, filed with the Commission on
February 8, 2007, and incorporated herein by this
reference).
|
3.3
|
Bylaws
(previously filed as an exhibit to a registration statement on Form SB-2,
filed with the Commission on December 27, 2004, and incorporated herein by
this reference).
|
4.1
|
Convertible
Debenture, dated October 24, 2006 (previously filed as an exhibit to a
Current Report on Form 8-K, filed with the Commission on November 3, 2006,
and incorporated herein by this
reference).
|
4.2
|
Convertible
Debenture, dated November 9, 2006 (previously filed as an exhibit to a
Quarterly Report on Form 10-QSB, filed with the Commission on January 17,
2007, and incorporated herein by this
reference).
|
4.3
|
Convertible
Debenture, dated November 28, 2006 (previously filed as an exhibit to a
Quarterly Report on Form 10-QSB, filed with the Commission on January 17,
2007, and incorporated herein by this
reference).
|
4.4
|
Convertible
Debenture, dated February 6, 2007 (previously filed as an exhibit to a
Registration Statement on Form SB-2, filed with the Commission on July 12,
2007, and incorporated herein by this
reference).
|
4.5
|
Convertible
Debenture, dated May 14, 2007 (previously filed as an exhibit to a
Registration Statement on Form SB-2, filed with the Commission on July 12,
2007, and incorporated herein by this
reference).
|
10.1
|
Form
of Securities Purchase Agreement (previously filed as an exhibit to the
Company’s Current Report on Form 8-K, filed with the Commission on June 1,
2007, and incorporated herein by this
reference).
|
33
10.2
|
Form
of Series A Notes (previously filed as an exhibit to the Company’s Current
Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.3
|
Form
of Series A Warrants (previously filed as an exhibit to the Company’s
Current Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.4
|
Form
of Series B Notes (previously filed as an exhibit to the Company’s Current
Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.5
|
Form
of Series B Warrants (previously filed as an exhibit to the Company’s
Current Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.6
|
Form
of Registration Rights Agreement (previously filed as an exhibit to the
Company’s Current Report on Form 8-K, filed with the Commission on June 1,
2007, and incorporated herein by this
reference).
|
10.7
|
Form
of Escrow Agreement (previously filed as an exhibit to the Company’s
Current Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.8
|
Form
of Amendment to Escrow Agreement (previously filed as an exhibit to the
Company’s Current Report on Form 8-K, filed with the Commission on June 1,
2007, and incorporated herein by this
reference).
|
10.9
|
Form
of Lockup Agreement (previously filed as an exhibit to the Company’s
Current Report on Form 8-K, filed with the Commission on June 1, 2007, and
incorporated herein by this
reference).
|
10.10
|
Stock
Purchase Agreement by and among nCoat, Inc., MCC, Inc., and Michael
Novakovic and Phebe Novakovic, dated June 19, 2007 (previously filed as an
exhibit to the Company’s Current Report on Form 8-K, filed with the
Commission on June 22, 2007, and incorporated herein by this
reference).
|
10.11
|
Lease
Agreement, dated May 15, 2001, between Remco Management Company, LLC, and
HPC, (previously filed as an exhibit to a Registration Statement on Form
SB-2, filed with the Commission on October 12, 2007, and incorporated
herein by this reference).
|
10.12
|
Lease
Extension Agreement, dated June 1, 2006, between Remco Management Company,
LLC, and HPC (previously filed as an exhibit to a Registration Statement
on Form SB-2, filed with the Commission on October 12, 2007, and
incorporated herein by this
reference).
|
10.13
|
Industrial
Lease, dated October 15, 2005, between Ralf LLC, and HPC (previously filed
as an exhibit to a Registration Statement on Form SB-2, filed with the
Commission on October 12, 2007, and incorporated herein by this
reference).
|
10.14
|
Lease
Agreement, dated February 21, 2006, between Mebane Warehouse, LLC, and HPC
(previously filed as an exhibit to a Registration Statement on Form SB-2,
filed with the Commission on October 12, 2007, and incorporated herein by
this reference).
|
10.15
|
Memorandum
of Sublease, dated November 1, 2005, between Heritage One, L.L.C., Rocky
Mountain Seed and Grain, and HPC(previously filed as an exhibit to a
Registration Statement on Form SB-2, filed with the Commission on October
12, 2007, and incorporated herein by this
reference).
|
10.16
|
Commercial
Lease Agreement, dated October 13, 2005, between Philadelphia Suburban
Development Corporation and MCCI (previously filed as an exhibit to a
Registration Statement on Form SB-2, filed with the Commission on October
12, 2007, and incorporated herein by this
reference).
|
10.17
|
Lease
Agreement, dated January 22, 2007, between Milford Business Centre and
MCCI (previously filed as an exhibit to a Registration Statement on Form
SB-2, filed with the Commission on October 12, 2007, and incorporated
herein by this reference).
|
31.1
|
Certification
of the Chairman and Chief Executive Officer, Section 302 of Sarbanes-Oxley
Act of 2002
|
32.1
|
Certification
of the Chairman and Chief Executive Officer, Section
1350
|
34
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 hereunto
duly authorized.
nCoat,
Inc
|
|
(Registrant)
|
|
Date:
November 16, 2009
|
Paul
Clayson
|
Paul
Clayson
|
|
Chief
Executive Officer
|
|
(Principal
Executive Officer)
|
|
Date:
November 16, 2009
|
Paul
Clayson
|
Paul
Clayson
|
|
Acting
Chief Financial Officer
|
|
(Principal
Financial and Accounting Officer)
|
35