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EX-32.2 - NEAH POWER SYSTEMS, INC.v171256_ex32-2.htm
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EX-31.1 - NEAH POWER SYSTEMS, INC.v171256_ex31-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2009

Commission File Number      000-49962
 
NEAH POWER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

 
88-0418806
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
 
98021
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (425) 424-3324

Securities registered pursuant to Section 12(b) of the Exchange Act:   None.

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common stock, $0.001 par value per share
(Title of Each Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes    ¨  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes    ¨  No x

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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 ¨            No x 

The aggregate market value of the Registrant’s common stock held by non-affiliates was approximately $1,279,000 as of March 31, 2009 based upon the closing price of common stock on March 31, 2009.

As of January 11, 2010, there were 36,592,730 million shares of the Registrant’s $0.001 par value common stock outstanding.

 
 

 

NEAH POWER SYSTEMS, INC.
TABLE OF CONTENTS

   
Page
 
Explanatory Note
1
 
Forward-Looking Statements
1
     
 
PART I.
 
     
Item 1.
Business
2
Item 1.B
Unresolved Staff Comments
8
Item 2.
Properties
8
Item 3.
Legal Proceedings
8
Item 4.
Submission of Matters to a Vote of Security Holders
9
     
 
PART II.
 
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
10
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
13
Item 8.
Financial Statements and Supplementary Data
20
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
39
Item 9A(T).
Controls and Procedures
39
Item 9B.
Other Information
40
 
PART III.
 
     
Item 10.
Directors, Executive Officers and Corporate Governance
41
Item 11.
Executive Compensation
44
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
47
Item 13.
Certain Relationships and Related Transactions and Director Independence
49
Item 14.
Principal Accountant Fees and Services
50
     
 
PART IV
 
     
Item 15.
Exhibits and Financial Statement Schedules
50
     
 
SIGNATURES
51

 
 

 

Explanatory Note

As used herein, (a) the terms “Neah Power,” “Company,” “we,” “our” and like references mean and include both Neah Power Systems, Inc., a Nevada corporation (formerly, Growth Mergers, Inc.), and our wholly-owned subsidiary, Neah Power Systems, Inc., a Washington corporation, on a combined basis, (b) the term, “Neah Power Washington” refers only to the Washington corporation. Except as otherwise expressly indicated, all references to shares of capital stock, notes, warrants, options and other outstanding securities mean securities only of the Nevada corporation.

Forward Looking Statements

This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Specifically, all statements other than statements of historical facts included in this annual report regarding our financial position, business strategy and plans and objectives of management for future operations are forward-looking statements. These forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. When used in this annual report, the words “anticipate,” “believe,” “estimate,” “expect,” “may,” “will,” “continue” and “intend,” and words or phrases of similar import, as they relate to our financial position, business strategy and plans, or objectives of management, are intended to identify forward-looking statements.

These statements reflect our current view with respect to future events and are inherently subject to risks and  uncertainties, many of which we cannot predict with accuracy and some of which we might not even anticipate.  Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions at the time made, we can give no assurance that such expectations will be achieved.  Future events and actual results, financial and otherwise, may differ materially from those expressed in the forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements.  We have no duty to update or revise any forward-looking statements after the date of this Annual Report on Form 10-K and the documents incorporated herein by reference or to conform them to actual results, new information, future events or otherwise.

The following factors, among others, could cause our or our industry’s future results to differ materially from historical results or those anticipated:

·
general economic conditions;

·
our future capital needs and our ability to obtain financing;

·
our ability to obtain governmental approvals, including product and patent approvals;

·
the success or failure of our research and development programs;

·
the acceptance and success of our fuel cell products;

·
our ability to develop and commercialize or products before our competitors; and

·
our limited operating history

These factors are the important factors of which we are currently aware that could cause actual results, performance or achievements to differ materially from those expressed in any of our forward looking statements.  We operate in a continually changing business environment and new risk factors emerge from time to time.  Other unknown or unpredictable factors could have material adverse effects on our future results, performance or achievements. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report may not occur.

 
1

 

PART I

ITEM 1: BUSINESS

Overview

We are engaged in the development and sale of renewable energy solutions. Our fuel cells are designed to replace existing rechargeable battery technology in mobile electronic devices and small-scale transportation vehicles. Our long-lasting, efficient and safe power solutions for these devices, such as notebook PCs, military radios, and other power-hungry computer, entertainment and communications products, use our patented, silicon-based design with higher power densities to enable lighter-weight, smaller form-factors and potentially lower costs.  Through our recent agreement to acquire SolCool One, LLC (“SolCool”), we also intend to expand our portfolio of renewable energy solutions. SolCool is a leading supplier of direct current (“DC”) air-conditioning systems for off-the-grid applications. We intend to utilize SolCool’s worldwide distribution network and developed market to facilitate the adoption of fuel cells and Remote Area Power Supplies (“RAPS”), or integrated power solutions, for similar applications of our fuel cell products.

Based on our research and testing, we believe our team of world-class engineers and scientists can continue to develop a commercially viable fuel cell that will outperform lithium ion batteries and other batteries in terms of run time, recharge time, portability and other measures of battery performance. Our fuel cell solution is particularly beneficial in applications currently requiring the use of more than one battery, since the user will only need to carry a single fuel cell with a supply of additional cartridges resulting in reduced burden.  We have developed what we believe is a potential breakthrough in the development of a direct methanol micro fuel cell, which may serve as a replacement for batteries in a variety of products.   Based on our seven issued patents and 4 additional U.S. patent filings, we believe our technology is proprietary and can be protected.

In 2009 we continued to advance the development of our technology. This included the completion of our fuel cell prototype and the subsequent completion of a system not requiring the availability of oxygen from the environment (“anaerobic” or “closed loop system”). We also demonstrated an air-breathing (“aerobic”) system.  We expect the prototype and the related technology to form the foundation for future fuel cell products that we plan to further develop and sell to customers over the next fiscal year.
 
During 2009, we received payments of approximately $1,147,000 from the Office of Naval Research (“ONR”) pursuant to the terms of a grant providing expense reimbursement for continuing research and development (“R&D”) having to do with certain technology. This system was successfully developed and demonstrated to the ONR in September 2009.

We have announced customer relationships with EKO Vehicles of Bangalore (“EKO”) and Hobie Cat Company (“Hobie Cat”) to develop early production devices that can be evaluated by original equipment manufacturers (“OEM’s”) for the eventual deployment of fuel cell products that we or potential licensees will use to manufacture products for sale to our partners, distributors or OEM customers. We also intend to design and distribute the fuel cartridge that our fuel cells require for refueling. We expect to generate future revenues from the sale and licensing of both fuel cartridges and the completed fuel cells. Our current business plan contemplates that we will subcontract to third parties substantially all of the production and assembly.   Prototype development continues and we expect to make our energy products commercially available in fiscal 2010.

Background
 
Neah Power Systems, Inc. was incorporated in the State of Nevada on February 1, 2001 under the name Growth Mergers, Inc. Effective March 9, 2006, Growth Mergers, Inc. entered into an Agreement and Plan of Merger, as amended on April 10, 2006, whereby Growth Acquisitions, Inc., a Washington corporation and wholly-owned subsidiary of Growth Mergers, Inc., merged with and into Neah Power Washington. Following the merger, Growth Mergers, Inc. changed its corporate name from Growth Mergers, Inc. to Neah Power Systems, Inc. By virtue of this merger, Growth Mergers, Inc. (as Neah Power Systems, Inc.) became the parent corporation of Neah Power Washington.

 
2

 

The purpose of the merger was to enable Neah Power Washington, as Growth Mergers, Inc.’s subsidiary, to access the capital markets via a public company. Our common stock currently trades on the OTC Bulletin Board under the symbol “NPWZ.” We intend to pursue a qualification on the American Exchange, but there is no assurance that we will qualify for quotation on a national securities association or exchange.
 
SolCool One, LLC Acquisition

On July 27, 2009, and amended September 19, 2009, we entered into a first amended and restated agreement and plan of merger (the “Amended Merger Agreement”) with SolCool, Neah Power Acquisition Corp. (“Merger Sub”), our wholly-owned subsidiary, and Mark Walsh, manager and founder of SolCool, pursuant to which the Merger Sub will be merged into SolCool (the “Merger”).

Under the terms of the Amended Merger Agreement, we will issue $500,000 of common stock, or 476,000 shares of common stock, at a price of $1.05 per share, such shares of common stock to vest as follows: (i) 50% upon execution and the remaining 50% 24 months from date of the Amended Merger Agreement, such vesting contingent upon Mark Walsh remaining as our employee and using his best efforts to achieve SolCool’s business plan, and (ii) pay $100,000 to fund SolCool’s operations and shipments. In August 2009, we paid $10,000 towards the cash payment obligation. In October 2009, we issued the initial payment of 238,000 shares. 238,000 additional common shares were issued in October 2009 and will be held in escrow to ensure best-effort execution of SolCool’s obligations under the Amended Merger Agreement. The closing of the merger is subject to other customary closing conditions including the filing of the articles of merger with the applicable states. For accounting purposes the acquisition was not completed before September and thus has not been reflected in the consolidated financial statements.

SolCool’s existing worldwide distribution infrastructure could provide us with a distribution channel to distribute our products worldwide. We also anticipate using some of the energy generation, storage, and regulation expertise from SolCool to create new product offerings for energy generation and storage.

RESEARCH AND DEVELOPMENT

We conduct our research and development activities at our headquarters in Bothell, Washington.  We plan to invest in research and development and anticipate that our R&D costs will increase in 2010 compared to prior years due to the anticipated increase in product development related to technology improvements and specific customer products.

Our Unique Patented Technology

Rather than joining numerous other companies attempting to create Proton Exchange Membrane (“PEM”)-based direct methanol fuel cells (“DMFC”s), we felt an entirely new design approach was necessary to achieve the power capacity and reliability required by portable electronic devices. Our unique fuel cell design utilizes a patented porous silicon electrode structure and circulating liquid streams of fuel, oxidant and electrolyte that produce the chemical reactions needed to generate power. We believe our use of porous silicon and liquid oxidant is unique in the fuel cell industry. In final form, our products can be packaged in plastic casings to create self-contained systems that retain the excess water produced during operation and prevent contamination to the cathode as occurs in traditional PEM-based DMFCs. Furthermore, since our design is based largely on standard silicon wafer processing, we believe that it should have significant manufacturing advantages over traditional fuel cells.  Compared to competing DMFC technologies that use carbon-based electrodes and solid PEM’s, we believe that our approach will deliver higher power output and lower cost for the equivalent size of fuel cell. We also believe that our fuel cells will be more reliable and operate in a broader range of environments. We believe that our ability to use silicon electrodes, leverage the cost benefits of semiconductor manufacturing, and contain all chemical reactants within the fuel cell will give us distinct competitive advantages.

 
3

 

Porous Silicon Electrodes
 
Our electrode architecture uses conductive porous silicon as the catalyst support structure rather than carbon typically used in fuel cells. Using a silicon wafer commonly used in the semiconductor industry, we etch a pattern of millions of microscopic pores into the silicon. A conductive film is then applied to the surface of the pore walls followed by a catalyst coating over the conductive film. The process can be used to produce either anode or cathode electrodes depending on the type of catalyst used. The final result is a porous electrode that enables a larger reactive surface area to generate more power.

While our focus has been on the closed loop non–air (“anaerobic”) systems, in 2009, we also demonstrated an aerobic system which could be used where the quality of the air is high and predictable. This would reduce the complexity of the system, as well as increase the energy density of the system.

Comparison Between Porous Silicon Fuel Cells and PEM-Based Designs
 
We believe that the principal advantages of our approach over PEM-based designs include:

• 
Our use of porous silicon electrodes and the liquid electrolyte, eliminate a range of possible failure modes that have hampered introduction of PEM based systems. These include degradation of the PEM membrane, crossover of methanol fuel and degradation of the cathode catalyst, damage to the cathode catalyst by exposure to airborne contaminants such as sulfur; and flooding or alternatively drying out of the cathode catalyst. We believe that these advantages will allow our fuel cells to operate in a broader range of environmental conditions, in all orientations, with high reliability.

• 
The use of silicon technology allows us to make use of existing silicon production infrastructure, with reduced need to create specialized production facilities. We can also use standard silicon technology to optimize the dimension of the pores for high power, while reducing the thickness to reduce cost and overall dimensions of the fuel cell.

• 
The larger reaction area, coupled with the use of oxidizer at the cathode, leads to greater available power density, which reduces the size and cost of the fuel cell system.

• 
Our technology allows us to create alternative product designs that do not require interactions with the environment for operation. This allows us to extend our fuel cell products to applications like sensor networks that require operation without breathing air or expelling gases.

• 
The design of the fuel cell avoids conflicts with numerous patents and is itself patented by us.

• 
Water created in the fuel cell reaction is retained in the fuel cartridge, not vented where it can damage the host device.
 
We believe that the principal disadvantages of our approach consist of the following factors:

• 
Our approach requires both the fuel cell and the cartridge to contain acids at corrosive concentrations. It is therefore important to ensure that users of the technology are not brought into contact with these acids and that additional steps be taken to ensure that the lifetime of the system is adequate.

• 
The need to select materials compatible with the chemistry.
 
As an ongoing effort to increase the competitiveness of our product, we must focus on the following areas:
 
• 
Increase the volumetric power density over the power density currently available in our fuel cells - this will enable us to build more compact solutions

 
4

 

• 
Complete development of manufacturing techniques for fuel cell and fuel cartridge assembly, allowing the unit to meet relevant specifications (such as those of the Underwriters’ Laboratories) that are required by many customers;

• 
Further develop manufacturing techniques for key components of the fuel cells and locate suitable manufacturing partners or subcontractors; and

• 
Reduce the gold and platinum precious metal content of the fuel cells from present levels according to a staged program in order to meet our production cost objectives.

• 
Improve the aerobic solution that will provide higher energy density for aerobic applications, while leveraging other capabilities from our anaerobic system
 
COMMERCIALIZATION STRATEGY
 
We are focusing our initial strategy on the market for fuel cells for use in anaerobic or low oxygen content environments, such as under water, aerospace and military applications. Both EKO and Hobie Cat currently have electric drive consumer products where power capacity is limited by the need for extensive battery re-charging. Implementation of a fuel cell could enable continuous operation of these electric drive vehicles by the use of fuels cells with supplies of fuel cartridges. Also, competing PEM-based fuel cells could have significant operational limitations when environments contain diesel fumes or high humidity. We expect that partnerships with EKO, Hobie Cat and other potential customers will enable us to validate our product, supply chain and overall product strategy.

Beyond these initial markets, we intend to pursue the military, industrial and consumer markets, since we believe our product can also provide significant benefits within these business segments.

The Fuel Cell Market

Fuel cells can be categorized by the market applications they potentially serve and by their power output. We are focused on providing an alternative to conventional batteries for portable electronic devices that typically operate in the 5-1000+ Watt range. Specifically, we are targeting military, industrial and consumer markets with potential applications for computer, electronic media as well as products for military and homeland security electronic equipment.
 
These segments of the fuel cell market include low power systems (less than 10 Watts) for low power devices and trickle chargers, and higher power systems (greater than 100 Watt) typically aimed at stationary power generation or vehicle power plants. In particular, our technology may provide some unique advantages over batteries and other types of fuel cells in harsh environments or where access is limited or unavailable.
 
Our target market segment has a number of specific requirements and unique challenges. To succeed in this segment, fuel cells must have a high power density (high wattage for their size and weight), be relatively insensitive to the quality of the surrounding air and be cost effective. They must also be safe, easily portable, and efficient. The fuel cells must be transportable and operate reliably in a wide range of environmental conditions.
 
Within the 10-100 watt battery replacement space, the dominant technology direction over the last 30 years has been the ongoing development of fuel cells based on PEM. A PEM is usually a polymeric structure resembling a thin sheet of plastic that conducts protons, acting as a solid state electrolyte for electrochemical reactions. Typical PEM based fuel cells use this material as a basic building block of the electrochemical power generation unit. PEM -based solutions may use either the oxidation of hydrogen gas as the fuel source or the direct oxidation of liquid methanol in the DMFC configuration.

 
5

 
 
The commercial development of PEM-based solutions has been hampered by a number of technical issues. Performance of these PEM membranes is highly dependent on maintaining tight environmental control of the operating conditions which has been difficult to achieve in product based designs. Longevity of the PEM based systems has also been a challenge with membrane and catalyst degradation issues limiting the operating life of the systems. Finally, PEMs are expensive to manufacture because they use costly proprietary materials and because the industry has not been able to develop the scalable low-cost manufacturing processes that are needed for the unique PEM fuel cell requirements.

Remote Area Power Supplies (“RAPS”) Market

After the completion of the SolCool acquisition, we anticipate building on SolCool’s expertise to create RAPS which can provide 1kW to 10+ kW power systems that can operate off-the-grid. These systems would include a renewable, DC-based generation system (solar, wind, etc.), a power modulation system (DC-DC converter, DC-AC inverter) and storage systems. We expect increasing demand based on the current focus on renewable energy, and the need to reduce dependence on a depleting resource (fossil fuels) and, based our internal marketing estimates and reports published by the marketing research firm of Frost and Sullivan, this market is estimated to be in the range of $15 billion to $20 per year. In addition, RAPS products could provide backup power for critical infrastructure like cell phone towers, communication infrastructure and other command and control systems in developed countries.

Market for Military Applications
 
Our R&D efforts to date have demonstrated the potential use of our fuel cells in a variety of military applications. The technology has the potential to provide longer power duration at significantly reduced size and weight. In addition, we believe our fuel cells may provide an environmentally friendly solution compared to rechargeable or non-rechargeable batteries.  Our products particularly address anaerobic needs such as underwater, underground, close quarters and high altitude and no atmosphere applications specific to military needs.

We believe that the market for military applications will be greater than $2 billion per year, as reflected in market research by Frost and Sullivan, as well as our internal marketing estimates.  This market includes fuel cell replacements for batteries, fuel cell power sources for specialized applications like underwater and/or unmanned vehicles and backup power supplies.

  Office of Naval Research - During the year ended September 30, 2009, we received payments of approximately $1,147,000 from the Office of Naval Research (“ONR”) pursuant to the terms of a grant providing expense reimbursement for continuing research and development having to do with certain technology. This contract included various technical developments, and the demonstration of a closed loop, self contained, anaerobic system. This system was successfully developed and demonstrated to the ONR in September 2009.

Other - We were party to a development agreement with a customer to develop proof-of-concept fuel cell power source prototypes (Phase I) and, if successful and elected by the customer, the development of fuel cell power sources (Phase II). We received $344,000 for certain services in Phase I and recognized revenue of $154,500 for the completion of the initial Phase I requirement in 2004 and deferred the balance of $189,500 until the related services were rendered and the final Phase I milestone was reached. We believe the final Phase I milestone was reached in 2009. However, customer acceptance has not yet occurred and the balance of $189,500 has not yet been recognized as revenue.

 Market for Industrial Applications, RAPS, and Transportation

We are currently developing RAPS that are renewable energy, fuel cell-based power generation and storage systems that can be used for distributed power applications where the quality of the electrical grid is non-existent or sub–par, or where back up power is needed.
 
In July 2009 we signed a Letter of Intent (“LOI”) with EKO, one of India’s larger manufacturers of electric two wheel vehicles, to develop fuel cell battery charging units for integration into their electric scooters, as well as  RAPS to act as charging stations for the scooters and off -grid power sources. With sufficient funding, we expect to deliver several beta prototype units in 2010 and after successful evaluation we expect to ship several hundred units.

 
6

 

In July 2009 we signed a technology license agreement with Hobie Cat to explore the use of our proprietary fuel cells to power various recreational water craft products. Additionally, we signed a LOI with Hobie Cat to produce on-board fuel cell battery chargers for their line of electric kayaks. With sufficient funding, we anticipate delivery of several beta prototype systems in 2010, and several hundred systems after successful completion of the beta evaluations.

Market for Consumer Mobile Electronics

Recent trends continue to demonstrate a clear need for better and longer-lasting power solutions to close the “power gap,” which is defined as the difference between the power capacity and the power need, thus enhancing mobility and productivity. Based on user demand, mobile electronic companies continue to add features for richer experiences. Notebook PC makers, for example, in recent years have enhanced their products with larger, more vivid color displays, faster processors, larger hard drives, DVD and/or CD drives, as well as multimedia and wireless networking capabilities. Each of these additions requires more power and, taken together, can be a significant drain on the PCs limited battery capacity.  Users are also more dependent on these mobile devices and using them longer without access to A/C power compounds the power gap.  Sales of notebook PCs continue to grow faster than those of the overall PC market, and now represent more than half of all PCs sold. The size of the consumer market is estimated to be between $6 billion and $8 billion per year, as reflected in market research by Frost and Sullivan and our internal marketing estimates, with no clear incumbent solution. Moreover, with the growth and widespread availability of high-speed wireless connections (Wi-Fi) in corporate offices and public locations, “persistent” computing - constant connectivity to the Internet, e-mail and corporate files - is becoming commonplace, creating additional demands for longer-lasting power.
 
 We believe that our fuel cells, when fully developed, will be capable of bridging the power gap by having more power, a longer life and instant recharge capability using replacement fuel cartridges. In addition, we believe that they will be smaller and lighter-weight than the batteries currently in use.

PROPRIETARY RIGHTS AND INTELLECTUAL PROPERTY
 
We rely primarily on patents and contractual obligations with employees and third parties to protect our proprietary rights.  We intend to seek appropriate patent protection for our proprietary technologies by filing patent applications in the U.S. and in certain foreign countries.  As of December 31, 2009, we owned or controlled seven issued or allowed U.S. patents and four pending U.S. patent applications, including provisional patent applications.

Our patents and patent applications are directed to the components and systems involved in our fuel cell design and  the use of porous substrates coated with catalyst as fuel cell electrodes and electrode structures, cell bonding techniques, and cartridges   Our financial success will depend in large part on our ability to:
 
·
obtain patent and other proprietary protection for our intellectual property;
 
·
enforce and defend patents and intellectual property once obtained;
 
·
operate without infringing on the patents and proprietary rights of third parties; and
 
·
preserve our trade secrets;
 
In addition, we believe our fuel cell design and technology are not in conflict with the U.S. patents covering PEM-based DMFCs held by several organizations.

 
7

 

EMPLOYEES
 
As of December 31, 2009, we had thirteen employees, including two executive officers, eight persons in research and development and two clerical and administrative personnel. 
 
COMPETITION
 
The development and marketing of fuel cells and fuel cell systems is extremely competitive. In many cases, we compete directly with alternative energy and entrenched power-generation and power-storage technologies. In addition, a number of firms throughout the world have established fuel cell development programs, albeit most of them PEM-based. Competitors range from development stage companies to major domestic and international companies, many of which have:

• 
substantially greater financial, technical, marketing and human resource capabilities;

• 
established relationships with original equipment manufacturers;

• 
name-brand recognition; and

• 
established positions in the markets that we have targeted for penetration.
 
These or other companies may succeed in developing and bringing to market products or technologies that are more cost-effective than those being developed by us or that would render our products and technology obsolete or non-competitive in the marketplace.

AVAILABLE INFORMATION

We are a reporting company and file annual, quarterly and special reports, and other information with the SEC. You may read and copy these reports at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 or email the SEC at publicinfo@SEC.gov for more information on the operation of the public reference room. Our SEC filings are also available at the SEC’s website at http://www.sec.gov.

ITEM 1B.  Unresolved Staff Comments.

None.

ITEM 2: Properties.
 
The following is a summary of our property and related lease obligation.  We do not own any real property.  We believe that these facilities are sufficient to support our research and development, operational and administrative needs under our current operating plan.

We currently lease both our corporate headquarters and laboratory facilities under a lease agreement which expired March 31, 2009 and was extended through September 30, 2009. We currently lease on a month-to-month basis, and intend to negotiate with the landlord for a lease extension.

ITEM 3: Legal Proceedings.
 
Our landlord has filed a claim for unpaid rent in the amount of $76,069 in a case styled Teachers Insurance & Annuity v. Neah Power Systems, Inc. in the Superior Court of the State of Washington, County of King, and was granted a default judgment in December 2009 in the amount of $81,866. Pursuant to that judgment, in January 2010 we received a notice of eviction from our landlord for the unpaid rent. We hope to avoid eviction by payment of the past-due rent prior to the notice response date of January 21, 2010.

 
8

 

A consultant of the Company obtained a default judgment in December 2009 in the amount of $62,524 in a case styled Novellus Systems, Inc. v. Neah Power Systems, Inc. in the Superior Court of California, County of Santa Clara.
 
ITEM 4: Submission of Matters to a Vote of Security Holders.
 
None. 

 
9

 

PART II

ITEM 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
Market Information
 
Our common stock trades on the Over-the-Counter Bulletin Board under the symbol "NPWZ." Set forth below are the range of high and low bid quotations for the periods indicated as reported by the OTCBB. The market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.
 
   
High
   
Low
 
Fiscal Year Ended September 30 2007:
           
First Quarter (October 1, 2006 – December 31, 2006)
 
$
68.33
   
$
25.00
 
Second Quarter (January 1, 2007 – March 31, 2007)
   
61.33
 
   
28.67
 
Third Quarter (April 1, 2007 – June 30, 2007)
   
34.00
     
14.00
 
Fourth Quarter (July 1, 2007 – September 30, 2007)
   
22.00
     
6.67
 
Fiscal Year Ended September 30, 2008:
               
First Quarter (October 1, 2007 – December 31, 2007)
 
$
12.33
   
$
5.50
 
Second Quarter (January 1, 2008 – March 31, 2008)
   
7.00
     
0.83
 
Third Quarter (April 1, 2008 – June 30, 2008)
   
3.08
     
0.77
 
Fourth Quarter (July 1, 2008 – September 30, 2008)
   
1.00
     
0.08
 
Fiscal Year Ended September 30, 2009:
               
First Quarter (October 1, 2008 – December 31, 2008)
 
$
0.33
   
$
0.08
 
Second Quarter (January 1, 2009 – March 31, 2009)
   
0.27
     
0.12
 
Third Quarter (April 1, 2009 – June 30, 2009)
   
8.93
     
0.12
 
Fourth Quarter (July 1, 2009 –September 30, 2009)
   
5.27
     
0.93
 

On July 27, 2009, we effected a 200:1 reverse stock split of all issued and outstanding shares of our common stock. On August 14, 2009, we effected a 6:1 forward split of all issued and outstanding shares of our common stock. This schedule reflects those changes to the historical prices.

The last sale price of our common stock on December 31, 2009, was $0.60.
 
Holders
 
As of December 31, 2009, there were approximately 350 holders of record of our common stock. This number does not include beneficial owners of common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries.

Dividends
 
 
Unregistered Sales of Equity Securities

The following sets forth certain information for all securities we sold during the fiscal year ended September 30, 2009 without registration under the Securities Act of 1933, as amended, other than those sales previously reported in a Current Report on Form 8-K or a Quarterly Report on Form 10-Q:

 
10

 

In September 2009, we issued 24,000 warrants to purchase shares of our common stock at $1.05 per share to DNA Global for business development services provided. The warrants are exercisable until September 2010. In August 2009, we issued 120,000 warrants to purchase shares of our common stock at $2.08 per share to Aaron Grunfeld for legal services provided. The warrants are exercisable until August 2014. In July 2009, we issued 26,000 warrants to purchase shares of our common stock at $0.29 per share to Biomed Capital for fees paid to investment bank for assistance in raising capital. These warrants were exercised in November 2009. In July 2009, we issued 3,000 warrants to purchase shares of our common stock at $0.29 per share to Moody Capital for fees paid to investment bank for assistance in raising capital. The warrants are exercisable until July 2010.

In February 2009, we entered into a Securities Purchase Agreement with each of Agile Opportunity Fund, LLC (“Agile”) and Capitoline Advisors, Inc. (“Capitoline”) under which we were to receive funding through the issuance of convertible promissory notes (“the Notes) in the aggregate amount of $1,050,000 and an aggregate purchase price of $900,000, with a maturity date of August 12, 2009 and prepaid interest at the rate of 18% per annum. The Notes are convertible into shares of our common stock at a conversion price of $3.33 per share, at the discretion of the creditor, subject to adjustment to conversion price if subsequent sales of our common stock are issued at a price lower than the conversion price. The Notes are subject to mandatory redemption in the event we enter into a going private transaction or we are sold. The Notes are secured by all our assets and, upon conversion, have certain piggyback registration rights. In February, March and June 2009, we received funds from Agile pursuant to these agreements in the aggregate face amount of $635,000, and aggregate purchase price amount of $550,000. In consideration for the Notes, approximately 3,372,000 common shares are issuable under the terms of the agreement.  As of September 30, 2009, the Notes were unpaid and past-due. We are negotiating with Agile on forbearance. However, there is no assurance that Agile will grant forbearance or refrain from taking actions against us available to them under the agreement.
 
In July, August and September 2009, we received funds from Capitoline in the aggregate face amount of $321,000 and aggregate purchase price amount of $275,000. In consideration for the Notes, approximately 117,164 common shares are issuable under the terms of the agreement.  As of the date of this report, the principal balances of the Notes remain unpaid and past-due. We are negotiating with Capitoline on forbearance. However, there is no assurance that Capitoline will grant forbearance or refrain from taking actions against us available to them under the agreement.

Description of Equity Incentive Compensation Plans

The table below sets forth certain information as of September 30, 2009 regarding the shares of common stock available for grant or granted under our long-term incentive plans that were (i) approved by our stockholders, and (ii) were not approved by our stockholders:

Equity Incentive Compensation Plan Information

   
Number of
Common shares
to be Issued
Upon Exercise
of Outstanding
Options
   
Weighted-
Average
Exercise Price
of Outstanding
Options
   
Number of Common
Shares Remaining for
Future Issuance Under
Long-Term Incentive
Equity Compensation Plan
(Excluding Outstanding
Options)
 
Equity compensation plans approved by stockholders
    2,862,745     $ 1.31       3,137,255  
Equity compensation plans not approved by stockholders
                     
Total
    2,862,745     $ 1.31       3,137,255  
 
 
11

 

Long Term Incentive Compensation Plan - In August of 2008, we amended our Long Term Incentive Compensation Plan (“the Plan”) first adopted in March 2006. Under the amended Plan, the maximum number of shares issuable is 6,000,000. The Plan is to continue for a term of ten years from the date of its adoption. The Plan is administered by our board of directors. We have outstanding stock options for 2,862,745 shares to employees, the board of directors, and advisors and consultants, and none of these options have as of yet been exercised. Options are exercisable for ten years from date of grant. Options granted in excess of 6,000,000 will require shareholder approval. For the years ended September 30, 2009 and 2008, there were 2,841,700 and nil stock options issued, respectively, under the amended Plan.

Employee Stock Purchase Plan - In August 2008, we adopted an Employee Stock Purchase Plan (the “Stock Purchase Plan”). The number of shares of common stock that may be sold pursuant to the Stock Purchase Plan shall not exceed, in the aggregate, 900,000 shares of our common stock. As of September 30, 2009, no shares have been purchased under the Stock Purchase Plan.
 
12

ITEM 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation.
 
Overview

Statements contained herein that are not historical fact may be forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Exchange Act, that are subject to a variety of risks and uncertainties.  There are a number of important factors that could cause actual results to differ materially from those projected or suggested in any forward-looking statement made by us.  These factors include, but are not limited to: (i) general economic conditions; (ii) our future capital needs and our ability to obtain additional funding; (ii) our ability to obtain required governmental approvals, including product and patent approvals; (iii) our ability to successfully complete product research and development and commercialization; and (iv) our ability to develop and commercialize products that can compete favorably with those of competitors.  In addition, significant fluctuations in annual or quarterly results may occur as a result of the timing of milestone payments, the recognition of revenue from milestone payments and other sources not related to product sales to third parties, and the timing of costs and expense related to our research and development programs.  Additional factors that would cause actual results to differ materially from those projected or suggested in any forward-looking statements are contained in our filings with the SEC, including those factors discussed under the caption “Forward-Looking Statements” in this Report, which we urge investors to consider.  We undertake no obligation to publicly release revisions in such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events or circumstances, except as otherwise required by securities and other applicable laws.

The following management’s discussion and analysis is intended to provide information necessary to understand our audited  consolidated financial statements and highlight certain other financial information, which in the opinion of management, will enhance a reader’s understanding of our financial condition, changes in financial condition, and results of operations.  In particular, the discussion is intended to provide an analysis of significant trends and material changes in our financial condition and operating results during the fiscal year ended September 30, 2009 as compared to the fiscal year ended September 30, 2008. This Item is organized as follows:

 
·
The section entitled “Background” describes our principal operational activities and summarizes significant trends and developments in our business and in our industry.
 
·
“Critical Accounting Policies and Estimates” discusses our most critical accounting policies and estimates.
 
·
“Recently Issued Accounting Pronouncements” discusses new accounting standards.
 
·
“Liquidity, Capital Resources and Going Concern” discusses our cash requirements, sources and uses of cash and liquidity, including going concern qualifications.
 
·
“Comparison of Annual Results of Operations” discusses the primary factors that are likely to contribute to significant variability of our results of operations for the fiscal year ended September 30, 2009 as compared to September 30, 2008.
 
·
“Off-Balance Sheet Arrangements” indicate that we did not have any off-balance sheet arrangements as of September 30, 2009.
 
 Background
 
We are engaged in the development and sale of renewable energy solutions. Our fuel cells are designed to replace existing rechargeable battery technology in mobile electronic devices and small-scale transportation. Our long-lasting, efficient and safe power solutions for these devices, such as notebook PCs, military radios, and other power-hungry computer, entertainment and communications products, use our patented, silicon-based design with higher power densities to enable lighter-weight, smaller form-factors and potentially lower costs.  Through our recent agreement to acquire SolCool, we also intend to expand our portfolio of renewable energy solutions. SolCool is a leading supplier of direct current (“DC”) air-conditioning systems for off-the-grid applications. We intend to utilize SolCool’s worldwide distribution network and developed market to facilitate the adoption of fuel cells and RAPS, or integrated power solutions, for similar applications of our fuel cell products.

 
13

 

Based on our research and testing, we believe our team of world-class engineers and scientists can continue to develop a commercially viable fuel cell that will outperform lithium ion batteries and other batteries in terms of run time, recharge time, portability and other measures of battery performance. Our fuel cell solution is particularly beneficial in applications currently requiring the use of more than one battery, since the user will only need to carry a single fuel cell with a supply of additional cartridges resulting in reduced burden.  We have developed what we believe is a potential breakthrough in the development of a direct methanol micro fuel cell, which may serve as a replacement for batteries in a variety of products. Based on our seven issued patents and four additional U.S. patent filings, we believe our technology is proprietary and can be protected.

In 2009 we continued to advance the development of our technology. This included the completion of our fuel cell prototype and the subsequent completion of a system not requiring the availability of oxygen from the environment (“closed loop system”). We also demonstrated an air-breathing (“aerobic”) system.  We expect the prototype and the related technology to form the foundation for future fuel cell products that we plan to further develop and sell to customers over the next fiscal year.
 
During 2009, we received payments of approximately $1,147,000 from ONR pursuant to the terms of a grant providing expense reimbursement for continuing R&D having to do with certain technology. This system was successfully developed and demonstrated to ONR in September 2009.

We have announced customer relationships with EKO and Hobie Cat to develop early production devices that can be evaluated by original equipment manufacturers (“OEM’s”) for the eventual deployment of fuel cell products that we or potential licensees will use to manufacture products for sale to our partners, distributors or OEM customers. We also intend to design and distribute the fuel cartridge that our fuel cells require for refueling. We expect to generate future revenues from the sale and licensing of both fuel cartridges and the completed fuel cells. Our current business plan contemplates that we will subcontract to third parties substantially all of the production and assembly. Prototype development continues and we expect to make our energy products commercially available in fiscal 2010.

SolCool One, LLC Acquisition

On July 27, 2009, and amended September 19, 2009, we entered into the Amended Merger Agreement with SolCool, Merger Sub, our wholly-owned subsidiary, and Mark Walsh, manager and founder of SolCool, pursuant to which the Merger Sub will be merged into SolCool (the “Merger”).

Under the terms of the Amended Merger Agreement, we will issue $500,000 of common stock, or 476,190 shares of common stock, at a price of $1.05 per share, such shares of common stock to vest as follows: (i) 50% upon execution and the remaining 50% 24 months from date of the Amended Merger Agreement, such vesting contingent upon Mark Walsh remaining our employee and using his best efforts to achieve SolCool’s business plan, and (ii) pay $100,000 to fund SolCool’s operations and shipments. In August 2009, we paid $10,000 towards the cash payment obligation. In October 2009, we issued the initial payment of 238,000 shares. 238,000 additional common shares were issued in October 2009 and will be held in escrow to ensure best-effort execution of SolCool’s obligations under the Amended Merger Agreement. The closing of the merger is subject to other customary closing conditions including the filing of the articles of merger with the applicable states. For accounting purposes the acquisition was not completed before September and thus has not been reflected in the consolidated financial statements.

SolCool’s existing worldwide distribution infrastructure could provide us with a distribution channel to distribute our products worldwide. We also anticipate using some of the energy generation, storage, and regulation expertise from SolCool to create new product offerings for energy generation and storage.

Critical Accounting Policies and Estimates
 
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates that affect the reported amounts of assets, liabilities and expenses. Our critical accounting policies include revenue recognition, accounting for research and development costs, accounting for contingencies, accounting for income taxes, and accounting for share-based compensation. Other key estimates and assumptions that affect reported amounts and disclosures include depreciation and amortization and expense accruals. We base our estimates on historical experience and on actual information and assumptions that are believed to be reasonable under the circumstances at that time. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies affect our more significant estimates used in the preparation of our financial statements.

 
14

 

Revenue Recognition
 
Revenue normally consists of grant and contract revenues. We recognize revenue when we have persuasive evidence of an arrangement, the services have been provided to the customer, the price for services is fixed and determinable, no significant unfulfilled obligations exist, and collectability is reasonably assured.

Grant revenues are recognized as the related research is conducted. Contract revenues consist of amounts recorded from services provided to a single customer. Revenues earned under such arrangements are recorded as earned either as milestones are achieved or as the services are provided. Upfront payments received under contractual arrangements are deferred and recognized as revenue over the service period.

Share Based Payments

We use the Black-Scholes option pricing model as our method of valuation for share-based awards.  Share-based compensation expense is recorded over the requisite service period typically and based on the value of the portion of the stock-based award that will vest during the period, adjusted for expected forfeitures.  Our determination of the fair value of share-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected life of the award, expected stock price volatility over the term of the award and historical and projected exercise behaviors.   The estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual or updated results differ from our current estimates, such amounts will be recorded in the period estimates are revised. Although the fair value of share-based awards is determined in accordance with authoritative guidance, the Black-Scholes option pricing model requires the input of highly subjective assumptions and other reasonable assumptions could provide differing results.  Non-cash compensation expense is recognized on a straight-line basis over the applicable vesting periods of one to ten years, based on the fair value of such share-based awards on the grant date.

Income Taxes

We follow the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and on the expected future tax benefits to be derived from net operating loss carryforwards measured using current tax rates. A valuation allowance is established if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Due to the nature of the reverse merger that occurred in 2006 and the resulting greater than 50% change in control, our ability of to utilize NOL carryforwards from NPSWA may be limited.

Recently Issued Accounting Pronouncements
 
In October 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance (which does not have impact on our accounting).  Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of a selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method.  The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition.  We believe adoption of this new guidance will not have a material effect on our consolidated financial statements.

 
15

 
 
In June 2008, the Emerging Issues Task Force of the FASB issued authoritative guidance on accounting for convertible instruments and warrants with provisions that protect holders from declines in the stock price (“down-round” provisions), which is effective for us beginning October 1, 2009. Instruments with such provisions will no longer be recorded in equity. The guidance is to be applied to outstanding instruments as of the beginning of the fiscal year in which the guidance is applied. The cumulative effect of the change in accounting principle shall be recognized as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) for that fiscal year, presented separately. The cumulative-effect adjustment is the difference between the amounts recognized in the statement of financial position before initial application of authoritative guidance and the amounts recognized in the statement of financial position upon its initial application. The amounts recognized in the statement of financial position as a result of the initial application are determined based on the amounts that would have been recognized if the guidance had been applied from the issuance date of the instrument. In connection with the warrants issued in connection with the Agile and Capitoline agreements, which have such down-round protection provisions, we are assessing the impact of adoption of this guidance on our consolidated financial position and results of operations.
 
In December 2007, the FASB issued authoritative guidance on business combinations to be applied prospectively for fiscal years beginning on or after December 15, 2008. The statement also applies to the treatment of taxes from prior business combinations. The statement requires more assets acquired and liabilities assumed in future business combinations to be measured at fair value as of the acquisition date. In addition, expenses incurred for all acquisition-related costs are to be expensed and liabilities related to contingent consideration are to be re-measured to fair value each subsequent reporting period. We adopted the new authoritative guidance with respect to business combinations at the beginning of our 2010 fiscal year, or October 1, 2009, and believe the impact will be material as it applies to the accounting treatment of our merger with SolCool.

In December 2007, the FASB issued authoritative guidance on accounting for collaborative arrangements which is effective for us beginning October 1, 2009 and will be applied retrospectively to all prior periods presented for all collaborative arrangements existing as of the effective date. The authoritative guidance defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. The adoption of this authoritative guidance will not have a material impact on our financial position and results of operations.

Liquidity, Going Concern and Capital Resources

We have prepared our consolidated financial statements assuming that we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. We had $20,000 in unrestricted cash on hand as of September 30, 2009. We had an accumulated deficit as of September 30, 2009 in the amount of $48,274,000 and negative working capital of $4,240,000. For the fiscal year ended September 30, 2009, we had negative cash flow from operating activities of amount of $1,019,000.

We have limited capital resources and have sustained substantial losses, which raise substantial doubt about our ability to continue as a going concern. In addition, we now have multiple instances of actual and threatened litigation for past-due vendor balances and other obligations. Some of these may result in additional loss, expense, and management burden. We must, therefore, raise sufficient capital to remedy these claims, fund our overhead burden, and continue our R&D and product development efforts going forward. Without this funding, our current cash balance is estimated to not support our operations through January 2010. Although we have entered into and are negotiating agreements for the sales of equity securities to meet our requirements, no assurance can be given that we will be successful in obtaining adequate capital on acceptable conditions or at all.

In February 2009, we entered into a Securities Purchase Agreement with Agile and Capitoline under which we issued Notes secured by all of our assets. The Notes are convertible at $3.33 per share, subject to down-round adjustment based on future common stock sales. As of September 30, 2009, we had received net proceeds of $732,000 from eight tranches in aggregate note amounts totaling $956,000. Subsequent to September 30, 2009, we have received $125,000 in additional net proceeds in aggregate note amounts totaling $164,000.
 
In July 2009, we entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Optimus Capital Partners, LLC (“Optimus”), under which Optimus, subject to certain conditions, committed to purchase up to $10,000,000 of our Series B preferred stock. As of the date of this report, we have not issued any tranche notices for funding under the Purchase Agreement.

 
16

 

Discussion of Cash Flows

We used cash of approximately $1.0 million in our operating activities in 2009, compared to $2.4 million in 2008.  Cash used in operating activities relates primarily to funding net losses offset partially by non-cash expenses such as stock-based compensation. We expect to use cash for operating activities in the foreseeable future as we continue our operating activities.

Our investing activities used cash of approximately $16,000 in 2009 compared to nil in 2008. The cash used was from notes receivable issued to SolCool and were to be used for operating expenses as we continued our efforts toward completion of a merger agreement.

Our financing activities provided cash of approximately $996,000 in 2009 compared to $1.8 million in 2008.  Changes in cash from financing activities are primarily due to proceeds from sale of common stock and preferred stock, and net proceeds from notes payable, less principal payments.

Recent Financing Activities

In July 2009, we entered into the Purchase Agreement with Optimus under which Optimus, subject to certain conditions, committed to purchase up to $10 million of our Series B Preferred Stock. As of the date of this report, we have not issued any tranche notices for funding.

Summary

We are dependent on existing cash resources and external sources of financing to meet our working capital needs.  The current cash balance, which includes proceeds from our bridge funding, is estimated to support our budgeted and anticipated working capital requirements through approximately January 2010. To satisfy our working capital requirements from that point forward, we are currently seeking financing from the sale of debt or equity instruments to current investors and potential strategic investors. There is no assurance that we will be successful in raising this capital on a timely basis, if at all. The failure to obtain the necessary working capital would have a material adverse effect on the development program and business prospects and, depending upon the shortfall, we may have to curtail or cease our operations.

To attain profitable operations and generate cash flow, management’s plan is to execute its strategy of:
 
(i)
completing production prototypes for EKO vehicles, Hobie Cat, and other customers, and qualifying the product for high volume market acceptance,
 
(ii)
funding the market growth of SolCool DC-air conditioning products, and enabling shipment to existing and future customers, and
 
(iii)
Developing and deploying RAPS systems, and other energy generation and storage solutions.

We will continue to be dependent on outside capital to fund our operations for the near future. We have relied primarily on sales of securities and proceeds from borrowings for operating capital. During 2009, we raised capital by selling nine promissory notes for a total of $1,056,000 with net proceeds of $832,000 received upon closing.  During the year ended September 30, 2009, we also received payments of $1,147,000 from the ONR pursuant to the terms of a grant providing expense reimbursement for continuing research and development having to do with certain technology. As of September 2009, all of the work under this contract was completed and we had received all related payments due. In addition, during the year ended September 30, 2009, we received $191,000 from a private placement of our Series A preferred stock. Any future financing we obtain may further dilute or otherwise impair the ownership interest of our current stockholders. If we fail to generate positive cash flows or obtain additional capital when required, we could modify, delay or abandon some or all of our plans. These factors, among others, raise substantial doubt about our ability to continue as a going concern.

 
17

 

Comparison of Annual Results of Operations

   
For the years ended September 30,
   
$
    %  
   
2009
   
2008
   
Change
   
Change
 
Contract Revenues
  $ 1,106,976     $ 1,395,729       (288,753 )     -21 %
                                 
Operating expenses
                               
Research and development expense
    1,452,714       2,990,406       (1,537,692 )     -51 %
General and administrative expense
    4,308,627       2,709,973       1,598,654       59 %
                                 
Total operating expenses
    5,761,341       5,700,379       60,962       1 %
Loss from operations
    (4,654,365 )     (4,304,650 )     (349,715 )     -8 %
Other income (expense), net
                               
Amortization of deferred financing costs
    (426,582 )     (575,000 )     148,418       26 %
Interest expense, net
    (1,433,367 )     (1,481,073 )     47,706       3 %
Gain on extinguishment of debt
            206,252       (206,252 )     -100 %
                                 
Net Loss
  $ (6,514,314 )   $ (6,154,471 )     (359,843 )     6 %

Revenue.  Revenue decreased in the year ended September 30, 2009 due to the winding up of activity under the September 2008 ONR contract. As of September 2009, all of the work under this contract was completed and we have received all related payments.

Research and Development. Research and Development (“R&D”) expenses consist primarily of salaries and other personnel-related expenses, consulting and other outside services, laboratory supplies facilities costs and other costs.  We expense all R&D costs as incurred.  R&D expense for the year ended September 30, 2009 decreased as compared to the 2008 period, due to the following:

 
·
Personnel-related expenses decreased by approximately 50%, to $837,000 in 2009 compared to $1,668,000 in 2008 due to streamlining of operations and reductions in head count.

 
·
Project and laboratory expenses, including direct expenditures relating to the ONR contract, decreased by 51% to $280,000 in 2009 compared to $573,000 in 2008, due to reduced headcount and reduced ONR related expenditures.

 
·
Stock-based compensation included in R&D expense decreased from $260,000 in 2008 to $74,000 in 2009.

 
·
Facilities expenses decreased by 36% to $234,000 in 2009 compared to $365,000 in 2008, primarily due to a decrease in leased office space and reduced IT and computer related expenditures allocated on a headcount related basis.

 
·
Depreciation expense included in R&D expense was $28,000 in 2009 as compared to $125,000 in 2008, due to laboratory assets reaching the end of their accounting useful lives.

We expect our R&D expenses to increase in 2010 due to the anticipated increase in product development activities related to technology improvements and specific customer products

General and Administrative.  General and administrative expense (“G&A”) consist primarily of salaries and other personnel-related expenses to support our R&D activities, non-cash stock-based compensation for general and administrative personnel and non-employee members of our Board of Directors, professional fees, such as accounting and legal, corporate insurance and facilities costs.  The 59% increase in general and administrative expense in 2009 compared to 2008 resulted primarily from the increase in stock-based compensation in the current year.  Non-director Stock compensation expense increased to $2,685,000 in 2009 from $491,000 in 2008. The increase in stock compensation expense was due to stock options issued to management and employees in September 2009. These stock options were issued to encourage retention and compensate for furloughs and salary reductions in 2009 and the board of director’s compensation was recorded based on the implementation of the compensation plan approved in February 2009 and effective as of June 2008 and the issuance of stock options to directors in September 2009. We recorded to expense $485,000 and nil for director stock based compensation for the year’s ended September 30, 2009 and 2008, respectively. We recorded total board compensation of $635,000 in board of director’s in 2009 as compared to nil in 2008. The increase in stock-based compensation in the current year was partially offset by the following:

 
18

 

 
·
G&A salaries decreased by 58% to $413,000 in 2009 from $985,000 in 2008 primarily due to the decreased headcount of administrative staff.

 
·
Professional services expenses decreased by approximately 54% to $442,000 in 2009 from $971,000 in 2008 primarily due to reductions in technical consulting, legal and accounting services.
 
·
Marketing and other administrative expenses decreased by $115,000 to $92,000 in 2009 from $207,000 in 2008 primarily due to decreases in marketing, public relations, and employee travel and moving expenses.

We expect general and administrative expenses to increase in fiscal 2010 in support of our expected increased R&D and product development activities.

Amortization of deferred financing costs.  We incurred financing costs and fees related to our outstanding loans.  The decrease in amortization of deferred financing costs in 2009 compared to 2008 is due to the differing loan terms, fees and resulting amortization of our loans with Agile and Capitoline in 2009 and loans with EPD Investment Co. LLC (“EPD”) and CAMHZN Master LDC (“CAMHZN “) in 2008.

Interest expense, net. We incurred interest expense on our outstanding loans.  The 3% decrease in interest expense, net, in 2009 is primarily due to the differing loan terms and resulting interest on our loans with Agile and Capitoline as compared with those of the loans with EPD and CAMHZN for the same period in 2008.  We expect interest expense to decrease in 2010 as a result of the lower loan balances and interest resulting from payment of loan and accounts payable balances from funds received from anticipated long term funding efforts.
 
Gain on extinguishment of Debt. A gain on extinguishment of debt in the amount of $206,000 was recorded in the year ended September 30, 2008. There was no comparable extinguishment in the year ended September 30, 2009.

Off-Balance Sheet Arrangements

As of September 30, 2009, we did not have any off-balance sheet arrangements.

 
19

 

Item 8: Financial Statements and Supplementary Data.

   
PAGE
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
    21  
         
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
       
         
Consolidated Balance Sheets at September 30, 2009 and 2008
    22  
         
Consolidated Statements of Operations for the years ended September 30, 2009 and 2008
    23  
         
Consolidated Statements of Cash Flows for the years ended September 30, 2009 and 2008
    24  
         
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended September 30, 2009 and 2008
    25  
         
Notes to Consolidated Financial Statements
    26  

 
20

 
 
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors
Neah Power Systems, Inc.
Bothell, Washington


We have audited the accompanying consolidated balance sheets of Neah Power Systems, Inc. and Subsidiary ("the Company") as of September 30, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the years then ended.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Neah Power Systems, Inc., and Subsidiary as of September 30, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.
 
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.  As discussed in Note 2 to the consolidated financial statements, the Company had an accumulated deficit of approximately $48,274,000 and negative working capital of approximately $4,240,000 at September 30, 2009.  Additionally, the Company had negative cash flows from operating activities of approximately $1,019,000 for the year ended September 30, 2009, and has experienced recurring losses from operations.  This raises substantial doubt about the Company's ability to continue as a going concern.  Management's plans regarding this matter are also described in Note 2.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.


/S/ PETERSON SULLIVAN LLP


Seattle, Washington
January 13, 2010

 
21

 

NEAH POWER SYSTEMS, INC.
 
CONSOLIDATED BALANCE SHEETS
September 30, 2009 and 2008
   
September 30,
   
September 30,
 
   
2009
   
2008
 
ASSETS
           
             
Current assets
           
Cash and cash equivalents
  $ 20,223     $ 59,661  
Contract receivable
    0       39,718  
Deferred financing costs, net
    28,594        
Prepaid expenses and other current assets
    63,956       43,847  
Total current assets
    112,773       143,226  
                 
Property and equipment, net
    43,919       71,870  
                 
Total assets
  $ 156,692     $ 215,096  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
               
                 
Current liabilities
               
Accounts payable
  $ 1,763,581     $ 1,669,068  
Accrued expenses
    521,439       218,138  
Notes payable - related parties
    102,416       45,000  
Notes payable, net of debt discount of $8,745 and $0, respectively
    1,776,299       589,201  
Deferred revenue
    189,500       189,500  
Total current liabilities
    4,353,235       2,710,907  
                 
Total liabilities
    4,353,235       2,710,907  
                 
Commitments and contingencies
               
                 
Stockholders' equity (deficit)
               
Series A preferred stock and additional-paid-in capital, convertible $0.001 par value, $0.04 stated value, 4,996,500 and 25,000,000 shares authorized, respectively, 0 and 20,217,100 shares issued and outstanding, respectively
    0       669,007  
Common stock and additional paid-in-capital $0.001 par value, 80,000,000 shares authorized, 34,833,598 and 8,646,318 shares issued and 34,377,890 and 6,617,478 outstanding, respectively
    44,077,472       38,594,883  
Treasury stock, 112,590 common shares, at no cost
               
Accumulated deficit
    (48,274,015 )     (41,759,701 )
Total stockholders' equity (deficit)
    (4,196,543 )     (2,495,811 )
                 
Total liabilities and stockholders' equity (deficit)
  $ 156,692     $ 215,096  

See Notes to Consolidated Financial Statements

 
22

 

NEAH POWER SYSTEMS, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 2009 and 2008
 
   
For the
   
For the
 
   
Year Ended
   
Year Ended
 
   
September 30, 2009
   
September 30, 2008
 
Contract Revenues
  $ 1,106,976     $ 1,395,729  
                 
Operating expenses
               
Research and development expense
    1,452,714       2,990,406  
General and administrative expense
    4,308,627       2,709,973  
                 
Total operating expenses
    5,761,341       5,700,379  
                 
Loss from operations
    (4,654,365 )     (4,304,650 )
                 
Other income (expense), net
               
Amortization of deferred financing costs
    (426,582 )     (575,000 )
Interest expense, net
    (1,433,367 )     (1,481,073 )
Gain on extinguishment of debt
          206,252  
                 
Net Loss
  $ (6,514,314 )   $ (6,154,471 )
                 
Basic and diluted loss per common share
  $ (0.45 )   $ (1.39 )
                 
Basic and diluted weighted average common shares outstanding
    14,569,968       4,425,335  
 
See Notes to Consolidated Financial Statements

 
23

 

NEAH POWER SYSTEMS, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 2009 and 2008
 
   
For the Years ended September 30,
 
   
2009
   
2008
 
             
Cash flows from operating activities:
           
Net loss
  $ (6,514,314 )   $ (6,154,471 )
Adjustments to reconcile net loss to net cash used by operating activities:
               
Depreciation
    27,688       125,220  
Amortization of deferred financing costs
    426,582       575,000  
Share-based payments included in operating expenses
    3,332,707       804,011  
Non-cash forbearance fees on note payable
    567,000       -  
Amortization of debt discount and beneficial conversion feature on convertible debt
    122,098       216,299  
Gain on extinguishment of debt
    -       (206,252 )
Interest paid with common stock or warrants
    563,727       1,097,657  
Loss on disposal of assets
    263       -  
Other
    1,861       -  
                 
Changes in operating assets and liabilities
               
Contract receivable
    39,718       13,594  
Prepaid expenses and other current assets
    (4,108 )     (4,335 )
Accounts payable
    114,513       939,728  
Accrued expenses
    303,300       192,101  
Net cash used by operating activities
    (1,018,965 )     (2,401,448 )
                 
Cash flows from investing activities:
               
Issuance of notes receivable
    (16,000 )     -  
Net cash used by investing activities
    (16,000 )     -  
                 
Cash flows from financing activities:
               
Proceeds from sale of common stock
    -       100,000  
Net proceeds from notes payable
    832,091       1,095,000  
Proceeds from warrant exercises
    -       126,181  
Proceeds from sale of Series A convertible preferred stock
    191,020       707,586  
Principal payments on notes payable
    (27,584 )     (280,000 )
Other
    -       1,900  
Net cash provided by financing activities
    995,527       1,750,667  
                 
Net change in cash and cash equivalents
    (39,438 )     (650,780 )
                 
Cash and cash equivalents, beginning of period
    59,661       710,441  
                 
Cash and cash equivalents, end of period
  $ 20,223     $ 59,661  
                 
Supplemental cash flow information
               
                 
Cash paid for interest
  $ -     $ 331  
Cash paid for income taxes
  $ -     $ -  
                 
Noncash investing and financing activities
               
Increase in note payable due to forbearance fee
  $ 567,000     $ -  
Shares issued in partial payment of forebearance fee on note payable
  $ 327,000     $ -  
Deferred financing costs paid with issuance of common stock
  $ 364,128     $ 575,000  
Settlement of accounts payable with issuance of stock
  $ 20,000     $ 105,000  
Settlement of note payable with issuance of stock
  $ 15,000     $ -  
Original issue discount on notes payable
  $ 130,843     $ -  
Partial conversion of EPD Note Payable to common stock
  $ -     $ 62,576  
Accounts payable financed with Note Payable
  $ -     $ 89,201  
Conversion of note payable to Series A Preferred Stock
  $ -     $ 50,000  
Issuance of common stock to Series A placement agent
  $ -     $ 63,338  
Debt discount from issuance of warrants
  $ -     $ 135,667  
 
See Notes to Consolidated Financial Statements

 
24

 

NEAH POWER SYSTEMS, INC.
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT )
For the Years Ended September 30, 2009 and 2008
 
   
Preferred Stock
   
Common Stock and APIC
   
Treasury Stock
         
Total
 
   
Number
         
Number of shares
         
Number
         
Accumulated
   
Stockholders'
 
   
of Shares
   
Amount
   
Outstanding
   
Amount
   
of Shares
   
Amount
   
Deficit
   
Equity (Deficit)
 
                                                                 
Balances at September 30, 2007
    -     $ -       3,485,391     $ 35,442,920       (112,590 )   $ -     $ (35,605,230 )   $ (162,310 )
                                                                 
Sale of Series A Preferred Stock for cash
    18,967,100       619,007                                               619,007  
                                                                 
Conversion of debt to Series A Preferred Stock
    1,250,000       50,000                                               50,000  
                                                                 
Issuance of common stock to Series A placement agent
                    263,910       63,338                               63,338  
                                                                 
Sale of common stock for cash
                    300,000       100,000                               100,000  
                                                                 
Issuance of common stock pursuant to antidilution provisions of common stock purchase agreement
                    1,700,000       -                               -  
                                                                 
Issuance of common stock with respect to debt financing fees
                    85,008       575,000                               575,000  
                                                                 
Issuance of common stock for note payable penalty consideration recorded as interest expense
                    705,277       1,091,724                               1,091,724  
                                                                 
Common stock issued upon exercise of warrants
                    18,927       126,181                               126,181  
                                                                 
Common stock issued upon partial conversion of note payable
                    23,466       62,576                               62,576  
                                                                 
Common stock issued for legal settlement
                    10,500       105,000                               105,000  
                                                                 
Issuance of restricted common stock to employees
                    25,000       33,332                               33,332  
                                                                 
Share based compensation on options and warrants
                            770,679                               770,679  
                                                                 
Issuance of warrants in lieu of interest on note payable
                            5,933                               5,933  
                                                                 
Allocation of proceeds from debt to warrants and beneficial conversion feature
                            216,299                               216,299  
                                                                 
Other
                            1,901                               1,901  
                                                                 
Net loss for the year ended September 30, 2008
                                                    (6,154,471 )     (6,154,471 )
                                                                 
Balances at September 30, 2008
    20,217,100       669,007       6,617,478       38,594,883       (112,590 )     -       (41,759,701 )     (2,495,811 )
                                                                 
Sale of Series A preferred stock
    4,775,500       191,020                                               191,020  
                                                                 
Conversion of Series A preferred stock to common stock
    (24,992,600 )     (860,027 )     19,994,394       860,027                               -  
                                                                 
Shares issued in partial payment of forebearance fee on note payable
                    1,635,000       327,000                               327,000  
                                                                 
Shares issued in connection with settlement of accounts payable
                    199,998       20,000                               20,000  
                                                                 
Common stock and warrants issued for services
                    405,500       127,252                               127,252  
                                                                 
Share-based compensation related to stock options
                            3,205,455                               3,205,455  
                                                                 
Shares issued for financing costs related to notes payable
                    1,620,470       364,128                               364,128  
                                                                 
Shares issued in payment of interest on notes payable
                    1,955,050       563,727                               563,727  
                                                                 
Issuance of common stock pursuant to antidilution provisions of common stock purchase agreement and settlement of note payable
                    1,950,000       15,000                               15,000  
                                                                 
Net loss for the year ended September 30, 2009
                                                    (6,514,314 )     (6,514,314 )
                                                                 
Balances at September 30, 2009
    -     $ 0       34,377,890     $ 44,077,472       (112,590 )   $ -     $ (48,274,015 )   $ (4,196,543 )
 
See Notes to Consolidated Financial Statements

 
25

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Business

We are engaged in the development and sale of renewable energy solutions. Our fuel cells are designed to replace existing rechargeable battery technology in mobile electronic devices and small-scale transportation vehicles. Our long-lasting, efficient and safe power solutions for these devices, such as notebook PCs, military radios, and other power-hungry computer, entertainment and communications products, use our patented, silicon-based design with higher power densities to enable lighter-weight, smaller form-factors and potentially lower costs.  Through our recent agreement to acquire SolCool One, LLC (“SolCool”), we also intend to expand our portfolio of renewable energy solutions that we intend to offer the market. SolCool is a leading supplier of direct current (“DC”) solar air-conditioning systems for off-the-grid applications. We intend to utilize SolCool’s worldwide distribution network and developed market to facilitate the adoption of fuel cells and Remote Area Power Supplies (“RAPS”), or integrated power solutions for similar applications of our fuel cell products.

On July 27, 2009 and amended September 19, 2009, we entered into a first amended and restated agreement and plan of merger (the “Amended Merger Agreement”) with SolCool, Neah Power Acquisition Corp. (“Merger Sub”), our wholly-owned subsidiary, and Mark Walsh, manager and founder of SolCool, pursuant to which the Merger Sub will be merged into SolCool (the “Merger”).
 
Under the terms of the Amended Merger Agreement, we will issue $500,000 of common stock, or 476,000 shares of common stock, at a price of $1.05 per share, such shares of common stock to vest as follows: (i) 50% upon execution and the remaining 50% 24 months from the date of the Amended Merger Agreement, such vesting contingent upon Mark Walsh remaining our employee and using his best efforts to achieve SolCool’s business plan, and (ii) pay $100,000 to fund SolCool’s operations and shipments. In August 2009, we paid $10,000 towards the cash payment obligation. In October 2009, we issued the initial payment of 238,000 shares. 238,000 additional common shares were issued in October 2009 and will be held in escrow to ensure best-effort execution of SolCool’s obligations under the Amended Merger Agreement. The closing of the merger is subject to other customary closing conditions including the filing of the articles of merger with the applicable states and was not completed for accounting purposes prior to September 30, 2009 and thus the merger is not reflected in these consolidated financial statements.
 
Note 2. Going Concern

We have prepared our consolidated financial statements assuming that we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.  We had $20,000 in unrestricted cash on hand as of September 30, 2009. We had an accumulated deficit as of September 30, 2009 of $48,274,000 and negative working capital of $4,240,000. For the fiscal year ended September 30, 2009, we had negative cash flow from operating activities of $1,019,000.

We have limited capital resources and have sustained substantial losses, which raise substantial doubt about our ability to continue as a going concern. In addition, we now have multiple instances of actual and threatened litigation complaints for claims of past-due vendor balances and other obligations. Some of these may result in additional loss, expense, and management burden. We must, therefore, raise sufficient capital to remedy these claims, fund our overhead burden, and continue our R&D and product development efforts going forward. Without this funding, our current cash balance is estimated to not support our operations through January 2010. Although we have entered into and are negotiating agreements for the sales of equity securities to meet our requirements, no assurance can be given that we will be successful in obtaining adequate capital on acceptable conditions or at all.

We have relied primarily on sales of securities and proceeds from borrowings for operating capital. During the fiscal year ended September 30, 2009, we raised capital by selling nine promissory notes for a total of $1,056,000 with net proceeds of $832,000 received upon closing.

During the year ended September 30, 2009, we also received payments of $1,147,000 from the Office of Naval Research (“ONR”) pursuant to the terms of a grant providing expense reimbursement for continuing research and development having to do with certain technology. As of September 2009, all of the work under this contract was completed and we had received all related payments due.

 
26

 

Additionally, we have received approximately $191,000 in our fiscal year 2009 of proceeds from a private placement (see Note 7).

In July 2009, we entered into a Preferred Stock Purchase Agreement (the “Purchase Agreement”) with Optimus Capital Partners, LLC (“Optimus”), under which Optimus, subject to certain conditions, has committed to purchase up to $10 million of our Series B Preferred Stock (see Note 7). As of the date of this report, we have not issued any tranche notices for funding
 
In February 2009, we entered into a Securities Purchase Agreement with Agile Opportunity Fund, LLC (“Agile”) and Capitoline Advisors Inc. (“Capitoline”) under which we issued Original Issue Discount Term Convertible Notes (the “Notes”) secured by all of our assets. The Notes are convertible into shares of our common stock at $3.33 per share. As of September 30, 2009, we had received proceeds net of Original Issue Discount (“OID”), prepaid interest, and financing costs paid in cash of $676,000 from eight tranches in aggregate note amounts totaling $732,000. Subsequent to September 30, 2009, we have received $125,000 in additional net proceeds in aggregate note amounts totaling $164,000.
 
The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should we have to curtail operations or be unable to continue in existence.

Note 3. Summary of Significant Accounting Policies

Principles of Consolidation

Neah Power Systems, Inc. was incorporated in Nevada on February 1, 2001, under the name Growth Mergers, Inc. (“GMI”). In March 2006, GMI, at the time a public shell company, acquired all of the outstanding capital stock of an operating Washington corporation, Neah Power Systems, Inc. (“NPSWA”). Neah Power Systems, Inc. of Nevada (“NPSNV”) is the legal parent of NPSWA, but these financial statements, other than capital stock accounts, are those of NPSWA. The consolidated financial statements include the accounts of NPSNV and its wholly-owned subsidiary, NPSWA. Intercompany balances and transactions have been eliminated.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation. There has been no impact on previously reported net loss or stockholders’ equity (deficit).

Use of Estimates
 
In preparing financial statements conforming with accounting principles generally accepted in the United States, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
 
Cash and Cash Equivalents
 
Cash and cash equivalents consist of cash and short-term investments that are readily convertible to cash and have original maturities of three months or less at the time of acquisition. On occasion, we maintain cash balances in excess of federal insurance limits.  We have not experienced any losses related to these balances, and believe our credit risk is minimal.

 
27

 

Fair Value of Financial Instruments

We consider the fair value of cash and cash equivalents, contract receivable, accounts payable, notes payable and accrued expenses to not be materially different from their carrying value due to their short-term maturities.  Effective October 1, 2008, we adopted the authoritative guidance for financial assets and liabilities which defines fair value, provides guidance for measuring fair value and requires certain disclosures. At September 30, 2009, we had no financial assets or liabilities subject to f