UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

 

 

	☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2014

or

 

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

 

Commission File Number: 000-54449

 

Cyclone Power Technologies, Inc.

(Exact name of registrant as specified in its charter)

 

 

Florida		26-0519058
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
601 NE 26th Ct
Pompano Beach, Florida		33064
(Address of principal executive offices)		(Zip Code)

(954) 943-8721

(Registrant’s telephone number, including area code)

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 ☑
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

As of December 15, 2014, there were 861,315,561 shares of the registrant’s common stock issued and outstanding.

   

 

CYCLONE POWER TECHNOLOGIES, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX

 

 

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013 (audited)	2
Condensed Consolidated Statements of Operations for the nine and three months ended September 30, 2014 and 2013 (unaudited)	3
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited)	4
Notes to Condensed Consolidated Financial Statements (unaudited)	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3. Quantitative and Qualitative Disclosures about Market Risk	22
Item 4. Controls and Procedures	22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	23
Item 1A. Risk Factors	23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 3. Defaults upon Senior Securities	23
Item 4. Mine Safety Disclosures	23
Item 5. Other Information	23
Item 6. Exhibits	24

  

 

CYCLONE POWER TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2014 AND DECEMBER 31, 2013

 

		September 30, 2014				December 31, 2013
		(Unaudited)				(Audited)
ASSETS
CURRENT ASSETS
Cash		$	306,320			$	17,363
Accounts receivable			150,000				-
Other receviables			150,000				-
Inventory, net			439,941				489,420
Other current assets			64,251				55,020
Total current assets			1,110,512				561,803
PROPERTY AND EQUIPMENT, NET
Furniture, fixtures, and equipment			531,048				502,562
Accumulated depreciation			(151,278	)			(125,799	)
Net property and equipment			379,770				376,763
OTHER ASSETS
Patents, trademarks and copyrights			590,643				571,178
Accumulated amortization			(225,795	)			(196,410	)
Net patents, trademarks and copyrights			364,848				374,768
Other assets			559,518				2,762
Total other assets			924,366				377,530
Total Assets		$	2,414,648			$	1,316,096
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable and accrued expenses		$	897,014			$	682,692
Accounts payable and accrued expenses-related parties			524,061				1,965,596
Notes and other loans payable, net-current portion			155,634				729,905
Derivative liabilities			483,892				484,796
Notes and other loans payable-related parties			799,319				775,120
Value of shares loaned by stockholder			-				1,496,217
Capitalized lease obligations-current portion			5,612				6,161
Deferred revenue and license deposits			122,627				416,186
Total current liabilities			2,988,159				6,556,673
NON CURRENT LIABILITIES
Capitalized lease obligations-non-current portion			16,320				20,550
Notes and other loans payable, -net- current portion			158,286				30,997
Total non-current liabilities			174,606				51,547
Total Liabilities			3,162,765				6,608,220
Commitments and contingencies
STOCKHOLDERS' DEFICIT
Series B preferred stock, $.0001 par value, 1,000 shares authorized, 1,000 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively.			-				-
Common stock, $.0001 par value, 2,000,000,000 shares authorized, 735,320,540 and 272,679,942 shares issued and outstanding at September 30, 2014 and December 31, 2013 respectively.			73,532				27,268
Additional paid-in capital			52,421,213				48,644,132
Treasury Stock, 0 and 40,405,420 shares, at September 30, 2014 and December 31, 2013 respectively, at cost.			-				(1,706,217	)
Prepaid expenses with common stock			(15,422	)			(595,980	)
Stock subscription receivable			(6,000	)			(6,000	)
Accumulated deficit (inclusive of non-cash derivative losses of $31,997,896 and other losses of $21,252,591 at September 30, 2014 and non-cash derivative losses of $31,033,299 and other losses of $21,440,971 at December 31, 2013)			(53,250,487	)			(52,474,270	)
Total stockholders' deficit-Cyclone Power Technologies Inc.			(777,164	)			(6,111,067	)
Non controlling interest in consolidated subsidiaries			29,047				818,943
Total Stockholders' Deficit			(748,117	)			(5,292,124	)
Total Liabilities and Stockholders' Deficit		$	2,414,648			$	1,316,096

 

See accompanying notes to the condensed consolidated financial statements

 

 

CYCLONE POWER TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED) 

 

		Nine Months Ended September 30,								Three Months Ended September 30,
		2014				2013				2014				2013
REVENUES		$	315,527			$	715,382			$	175,000			$	212,500
COST OF GOODS SOLD			85,877				428,556				-				133,134
Gross profit			229,650				286,826				175,000				79,366
OPERATING EXPENSES
Advertising and promotion			19,390				3,502				6,220				2,495
General and administrative			1,606,575				1,447,886				626,059				572,235
Research and development			713,237				573,600				396,420				202,829
Total operating expenses			2,339,202				2,024,988				1,028,699				777,559
Operating loss			(2,109,552	)			(1,738,162	)			(853,699	)			(698,193	)
OTHER INCOME (EXPENSE)
Other income (expense)			2,443,506				(11,518	)			2,443,506				(33,518	)
Derivative income (expense) -notes payable			(148,289	)			595				31,220				595
Interest (expense)			(1,133,133	)			(371,902	)			(281,158	)			(140,778	)
Total other income (expense)			1,162,084				(382,825	)			2,193,568				(173,701	)
Income (loss) before income taxes			(947,468	)			(2,120,987	)			1,339,869				(871,894	)
Income taxes			-				-				-				-
Net ( loss ) income		$	(947,468	)		$	(2,120,987	)		$	1,339,869			$	(871,894	)
Net ( loss ) income per common share, basic and diluted		$	0.00			$	(0.01	)		$	0.00			$	0.00
Weighted average number of common shares outstanding			335,841,941				242,791,040				525,746,233				246,939,524

 

See accompanying notes to the condensed consolidated financial statements 

 

 

CYCLONE POWER TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Nine Months Ended September 30,
		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(947,468	)		$	(2,120,987	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization			54,864				48,773
Gain on deconsolidation of Whe Gen subsidiary			(2,443,506	)			-
Provision for inventory reserve			80,000				-
Issuance of restricted common stock, options and warrants for services			109,579				723,001
Issuance of restricted common stock in settlement of common stock warrants			49,500				-
Warrants issued pursuant to repayment of debt in common stock			-				119,782
Loss (gain) from derivative liability-notes payable			148,289				(595	)
Amortization of derivative debt discount			816,308				47,717
Loss on debt conversion via common stock-net			-				11,518
Original issue discount paid with stock			10,714				-
Amortization of prepaid expenses via common stock and warrants			434,724				65,957
Amortization of original issue discount			47,652				-
Changes in operating assets and liabilities:
(Increase) decrease in inventory			(30,521	)			190,683
(Increase) decrease in other current assets			(36,731	)			14,320
(Increase) in other assets			-				(1,200	)
Increase in accounts payable and accrued expenses			567,266				159,490
Increase in accounts payable and accrued expenses-related parties			183,539				260,136
Increase (decrease) in deferred revenue and deposits			6,505				(210,400	)
Net cash used by operating activities			(949,286	)			(691,805	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures incurred for patents, trademarks and copyrights			(19,465	)			(2,469	)
Expenditures for property and equipment			(34,913	)			(12,592	)
Cash transferred in sale of Whe Gen subsidiary			(887,544	)			-
Net cash used by investing activities			(941,922	)			(15,061	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of capitalized lease obligations			(4,779	)			(3,467	)
Proceeds from notes and loans payable			515,000				870,000
Repayment of notes and loans payable			(38,615	)			(161,922	)
Proceeds from sale of common stock			110,000				100,000
Proceeds from Whe Gen debt financing			350,000				-
Proceeds from Whe Gen equity financing, net of offering costs			1,224,360				-
Increase in related party notes and loans payable-net			24,199				38,422
Net cash provided by financing activities			2,180,165				843,033
Net increase in cash			288,957				136,167
Cash at beginning of year			17,363				14,888
Cash at end of period		$	306,320			$	151,055
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Payment of interest in cash		$	46,055			$	25,855
NON CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of 20,313,416 shares of Common stock for repayment of related party payables		$	668,312			$	-
Issuance of 2,050,000 shares of Common stock for accrued expenses		$	93,000			$	-
Issuance of 399,038,505 shares of Common stock for debt repayment		$	1,048,232			$	-
Issuance of 9,989,8721 shares of Common stock for debt interest		$	32,322			$	-
Value of shares repaid to stockholder		$	1,496,217			$	-
Forgiveness of deferred officers' salaries		$	956,762			$	-
Reclassification of derivative liabilities to additional paid in capital at conversion of convertible debt		$	954,641			$	-
Cancellation of treasury stock		$	210,000			$	-
Issuance of 675,000 shares of Common stock for repayment of related party payables		$	-			$	54,000
Issuance of 612,500 shares of Common stock for accrued expenses		$	-			$	45,875
Issuance of 4,920,833 shares of Common stock for debt repayment		$	-			$	343,672
Issuance of 342,996 shares of Common stock for payment of debt interest		$	-			$	20,994

 

See accompanying notes to the condensed consolidated financial statements  

 

 

CYCLONE POWER TECHNOLOGIES, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

NOTE 1 – ORGANIZATIONAL AND SIGNIFICANT ACCOUNTING POLICIES

 

A. ORGANIZATION AND OPERATIONS

 

Cyclone Power Technologies, Inc. (the “Company”, “our,” “Cyclone”) is the successor entity to the business of Cyclone Technologies LLLP (the “LLLP”), a limited liability limited partnership formed in Florida in September 2004. The LLLP was the original developer and intellectual property holder of the Cyclone engine technology. The Company is primarily a research and development engineering company whose main purpose is to develop, commercialize, market and license its Cyclone engine technology.

 

In 2010, the Company established a subsidiary WHE Generation Corp. f/k/a, Cyclone-WHE LLC (the “WHE Subsidiary”, “WheGen”), to market the waste heat recovery systems for all Cyclone engine models. As of September 30, 2014 the Company has sold most of its ownership and retained a 15.13 % non controlling interest in the WHE Subsidiary (see Note 15). In 2012, the Company established Cyclone Performance LLC (“Cyclone Performance”) f/k/a Cyclone-TeamSteam USA, LLC. The purpose of Cyclone Performance is to build, test and run a vehicle utilizing the Company’s engine. As of September 30, 2014, the company had a 95% controlling interest in Cyclone Performance.

 

B. PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

 

The unaudited consolidated financial statements include the accounts of the Company and its 95% owned subsidiary Cyclone Performance. All material inter-company transactions and balances have been eliminated in the condensed consolidated financial statements. The condensed consolidated balance sheet at December 31, 2013 and the condensed consolidated statements of operations and cash flows for the nine and three months ended September 30, 2014 include the accounts of the WHE subsidiary. Effective September 30, 2014, Cyclone sold most of its investment in the WHE Subsidiary and currently retains a non controlling 15.13% investment. This investment was deconsolidated on September 30, 2014 and is currently recorded on the cost basis (see Note 15).

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the SEC. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements. Interim results are not necessarily indicative of results for a full year. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.

 

The accounting principles utilized by the Company require the Company to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures during the periods. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited to, those that relate to the realizable value of inventory, identifiable intangible assets and other long-lived assets, contracts, income taxes, derivative liabilities, and contingencies. Actual results could differ from these estimates. 

  

C. CASH

 

Cash includes cash on hand and cash in banks. The Company maintains cash balances at several financial institutions.

  

 

D. COMPUTATION OF INCOME (LOSS) PER SHARE

 

Net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is not presented as the conversion of the preferred stock and exercise of outstanding stock options and warrants would have an anti-dilutive effect. As of September 30, 2014 and 2013, total anti-dilutive shares amounted to approximately 14.9 million and 19.3 million shares, respectively.

 

E. INCOME TAXES

 

Income taxes are accounted for under the asset and liability method as stipulated by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.

 

In the unlikely event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of September 30, 2014, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability to the taxing authorities. Interest related to the unrecognized tax benefits is recognized in the consolidated financial statements as a component of income taxes. The Company’s tax returns are subject to examination by the federal and state tax authorities for the years ended 2011 through 2013.

  

F. REVENUE RECOGNITION

 

The Company’s revenue recognition policies are in compliance with ASC 605, “Revenue Recognition – Multiple Element Arrangements”, and Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition. Revenue is recognized at the date of shipment of engines and systems, engine prototypes, engine designs or other deliverables to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Revenue from contracts for multiple deliverables and milestone method recognition are evaluated and allocated as appropriate. The Company has determined that the milestone method of revenue recognition (ASC 605-28) was appropriate for two of the Company’s contracts which specifically enumerate approved work effort milestones required for remuneration – the Company’s contract with the U.S. Army / TARDEC and the Amended and Restated Technology Application License Agreement with Phoenix Power Group LLC. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as deferred revenue on the consolidated balance sheets. Final delivery of the U.S. Army contract was completed in the second quarter of 2014 and the Phoenix Power Group contract was transferred to the WHE subsidiary as part of the separation agreement (see Note 15). The Company does not allow its customers to return prototype products. Current contracts do not require the Company to provide any warranty assistance after the “deliverable” has been accepted.

 

It is the Company’s intention when it has royalty revenue from its contracts to record royalty revenue periodically when earned, as reported in sales statements from customers. The Company does not have any royalty revenue to date.

 

G. WARRANTY PROVISIONS

 

Current contracts do not require warranty assistance subsequent to acceptance of the “deliverable R&D prototype” by the customer. For products that the Company will sell in the future, warranty costs are anticipated to be borne by the manufacturing vendor.

  

 

H. INVENTORY

 

Inventory is recorded at the lower of cost or market. Costs include material, labor and allocated overhead to manufacture a completed engine. These costs are periodically evaluated to determine if they have a net realizable value. If the net realizable value is lower than the carrying amount, a reserve is provided.

 

I. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

ASC 820, “Fair Value Measurements and Disclosures” requires disclosures of information about the fair value of certain financial instruments for which it is practicable to estimate the value. The carrying amounts reported in the balance sheet for cash, accounts payable and accrued expenses, and loans payable approximate their fair market value based on the short-term maturity of these instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s own assumptions based on the best information available in the circumstances. The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels. The three levels of the fair value hierarchy are defined as follows:

 

Level 1	—	Inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date.
Level 2	—	Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, as of the reporting date.
Level 3	—	Unobservable inputs for the asset or liability that reflect management’s own assumptions about the assumptions that market participants would use in pricing the asset or liability as of the reporting  date.

  

The summary of fair values and changing values of financial instruments as of January 1, 2014 (beginning of period) and September 30, 2014 (end of period) is as follows:

 

Instrument		Beginning of Period				Change				End of Period				Level			Valuation Methodology
Derivative liabilities		$	484,796			$	(904	)		$	483,892				3		Stochastic Process Forecasting Model

 

Please refer to Note 17 for disclosure and assumptions used to calculate the fair value of the derivative liabilities.

  

J. RESEARCH AND DEVELOPMENT

 

Research and development activities for product development are expensed as incurred. Costs for the nine months ended September 30, 2014 and 2013 were $713,237 and $573,600, respectively.

 

K. STOCK BASED COMPENSATION

 

The Company applies the fair value method of ASC 718, “Share Based Payment”, in accounting for its stock based compensation. This standard states that compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. The Company values stock based compensation at the market price for the Company’s common stock as of the date in which the obligation for payment of services is incurred.

   

L. COMMON STOCK OPTIONS AND PURCHASE WARRANTS

 

The Company accounts for common stock options and purchase warrants at fair value in accordance with ASC 815-40, “Derivatives and Hedging”. The Black-Scholes option pricing valuation method (“BSM option pricing model”) is used to determine fair value of these warrants consistent with ASC 718, “Share Based Payment”. Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields, expected term of the warrants and risk-free interest rates.

    

 

The Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “Equity Based payments to Non-employees”.

 

M. ORIGINAL ISSUE DEBT DISCOUNT

 

The original issue discount (OID) related to notes payable is amortized by the effective interest method over the repayment period of the notes. The unamortized OID is represented as a reduction of the amount of the notes payable.

 

N. PROPERTY AND EQUIPMENT

 

Property and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives of the assets as follows:

          

		Years
Display equipment for trade shows			3
Leasehold improvements and furniture and fixtures			10 - 15
Shop equipment			7
Computers			3

 

Expenditures for maintenance and repairs are charged to operations as incurred.

 

O. IMPAIRMENT OF LONG LIVED ASSETS

 

The Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company has not recognized any impairment charges.

  

P. RECENT ACCOUNTING PRONOUNCEMENTS

 

In 2014, the FASB issued an Accounting Standard Update (“ASU”) 2014-16 “Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or to Equity”, ASU 2014-15 “Presentation of Financial Statements-Going Concern (Subtopic 205-40) , ASU 2014-12 “Compensation-Stock Compensation” (Topic 718) , ASU 2014-09 “ Revenue from Contracts with Customers” (Topic 606), ASU 2014-03 Derivatives and Hedging (Topic 815) Accounting for Certain Receive-Variable, Pay Fixed Interest Rate Swaps-Simplified Hedge Account Approach, and ASU 2014-02 Intangibles-Goodwill and Other (Topic 350). Management believes that these standards will not materially impact our financial statements.

 

Q. CONCENTRATION OF RISK

 

The Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to be the two assets most likely to subject the Company to concentrations of credit risk. The Company’s policy is to maintain its cash with high credit quality financial institutions to limit its risk of loss exposure.

 

As of September 30, 2014, the Company maintained its cash in two quality financial institutions. The Company has not experienced any losses in its bank accounts through September 30, 2014. The Company purchases raw material and components from multiple sources, none of which may be considered a principal or material supplier. If necessary, the Company could replace these suppliers with minimal effect on its business operations.

  

 

R. DERIVATIVE FINANCIAL INSTRUMENTS

 

Accounting and reporting standards for derivative instruments and for hedging activities were codified by ASC Topic 815, Derivatives and Hedging (“ASC Topic 815”). It requires that all derivatives be recognized in the balance sheet and measured at fair value. Gains or losses resulting from changes in the fair value of derivatives are recognized in earnings or recorded in other comprehensive income (loss) depending on the purpose of the derivatives and whether they qualify and have been designated for hedge accounting treatment. The Company has derivative liabilities pursuant to convertible debt and common stock warrants, and has recognized net expenses on the condensed consolidated statements of operations. The Company does not have any derivative instruments for which it has applied hedge accounting treatment.

 

NOTE 2 - GOING CONCERN

 

As shown in the accompanying condensed consolidated financial statements, the Company incurred substantial operating and other losses and expenses of approximately $1.0 million for the nine months ended September 30, 2014, which included a $ 2.4 million gain on a sale of a subsidiary, and a net $3.8 million loss for the year ended December 31, 2013. The cumulative deficit since inception is approximately $ 53.3 million, which is comprised of $21.3 million attributable to actual operating losses (which were paid in cash, stock for services and other equity instruments) and net other expenses, and $32.0 million in non-cash derivative liability accounting which was a result of the conversion of the Company’s Series A Convertible Preferred Stock in 2011, the retirement of a common stock purchase warrant in 2012, and the change in fair value of derivatives associated with notes payable for the year ended December 31, 2013 and the nine months ended September 30, 2014. The Company has a working capital deficit at September 30, 2014 of approximately $1.9 million. There is no guarantee whether the Company will be able to generate enough revenue and/or raise capital to support its operations. This raises substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on management’s plans which include implementation of its business model to generate revenue from development contracts, licenses and product sales, and continuing to raise funds through debt or equity raises. The Company will also likely continue to rely upon related-party debt or equity financing. 

 

The condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. The Company is currently raising working capital to fund its operations via private placements of common stock and debt, advance contract payments (deferred revenue), and advances from and deferred payments to related parties.

 

NOTE 3 – INVENTORY, NET

 

Inventory, net consists of:

		September 30, 2014				December 31, 2013
Engine material and parts		$	311,210			$	316,513
Labor			280,712				237,311
Applied overhead			28,019				35,596
Total			619,941				589,420
Inventory valuation reserve			(180,000	)			(100,000	)
Inventory, net		$	439,941			$	489,420

 

 

NOTE 4 – PROPERTY AND EQUIPMENT, NET

 

Property and equipment consists of the following:

		September 30, 2014				December 31, 2013
Display equipment for trade shows		$	9,648			$	9,648
Leasehold improvements and furniture and fixtures			93,922				94,572
Equipment and computers			427,478				398,342
Total			531,048				502,562
Accumulated depreciation			(151,278	)			(125,799	)
Net property and equipment		$	379,770			$	376,763

  

 

Depreciation expense for the nine months ended September 30, 2014 and 2013 was $25,479 and $19,686, respectively.

 

NOTE 5 – PATENTS, TRADEMARKS AND COPYRIGHTS

 

Patents, trademarks and copyrights consist of legal fees paid to file and perfect these claims. The net balances as of September 30, 2014 and December 31, 2013 were $364,848 and $374,768, respectively. For the nine months ended September 30, 2014 and for the year ended December 31, 2013, the Company capitalized $19,465 and $6,920, respectively, of expenditures related to these assets. As of September 30, 2014, the Company had 33 patents issued on its technology both in the U.S. and internationally, and six trademarks in the U.S.

 

Patents, trademarks and copyrights are amortized over the life of the intellectual property which is 15 years. Amortization expense for the nine months ended September 30, 2014 and 2013 was $29,385 and $29,087, respectively.

 

NOTE 6 – NOTES AND OTHER LOANS PAYABLE

 

A.	NON-RELATED PARTIES

 

A summary of non-related party notes and other loans payable is as follows:

 

		September 30, 2014				December 31, 2013
12% senior secured note payable, plus 6% redemption premium, collateralized by all assets of the Company, monthly payments commencing December 2013 through September 2014.		$	-			$	361,767
6-12% uncollateralized demand notes payable.			45,000				127,500
12% convertible notes payable, net of discounts of $63,285 and $48,851 at September 30, 2014 and December 31, 2013, respectively, maturing at various dates from November 2013 through September 2016 (A)			67,433				139,769
10% convertible note payable, net of discount of $0 and $115,585 at September 30, 2014 and December 31, 2013, respectively, monthly payments commencing in December 2013 through July 2014 (B)			31,562				74,344
10% convertible notes payable, net of discount of $54,987 and $58,279 at September 30, 2014 and December 31, 2013, respectively, maturing at various dates from May 2015 through February 2016 (C)			45,013				15,634
10% convertible notes payable, net of discount of $25,765 and $55,109 at September 30, 2014 and December 31, 2013, respectively, maturing at various dates from December 2015 through January 2016 (D)			35,235				10,891
6% convertible notes payable, net of discount of $47,395 and $89,003 at September 30, 2014 and December 31, 2013, respectively, maturing at various dates from December 2016 through February 2017 ( E )			10,605				30,997
10% convertible note payable, net of discount of $103,311 at September 30, 2014, maturing at various dates from February 2015 through August 2015 ( F )			38,689				-
12% convertible notes payable, net of discount of $44,617 at September 30, 2014, maturing at various dates from April 2015 through May 2015 ( G )			40,383				-
Total non related party notes –net of discount			313,920				760,902
Less-Current Portion			155,634				729,905
Total non-current non related party notes –net of discount (accrued interest is included in accrued expenses)		$	158,286			$	30,997

  

 

	(A)	Notes issued net of 10% original discount ($18,054 unamortized at September 30, 2014) along with additional discount from derivative liabilities ($45,231 unamortized at September 30, 2014). At September 30, 2014, the Company held 54,987,344 shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants.
	(B)	Note issued net of original discount of $26,250 (fully amortized at September 30, 2014) along with stock purchase warrants whose value at issuance of $34,680 has been carried as a discount against the note (fully amortized at September 30, 2014) and an additional discount from derivative liabilities of $89,370 (fully amortized at September 30, 2014).
	(C)	Notes issued net of discount from derivative liabilities ($54,987 unamortized at September 30, 2014). At September 30, 2014, the Company held 11,261,887 shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants.
	(D)	Notes issued net of discount from derivative liabilities ($25,765 unamortized at September 30, 2014). At September 30, 2014, the Company held 12,106,895 shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants.
	(E)	Notes issued net of 10% original discount ($16,765 unamortized at September 30, 2014) along with additional discount from derivative liabilities ($30,630 unamortized at September 30, 2014). At September 30, 2014, the Company held 92,691,111 shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants.
	(F)	Notes issued net of discount from derivative liabilities ($103,311 unamortized at September 30, 2014). At September 30, 2014, the Company held 3,752,156 shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants.
	(G)	Notes issued net of discount from derivative liabilities ($44,617 unamortized at September 30, 2014).

   

  

B.	RELATED PARTIES

 

A summary of related party notes and other loans payable is as follows: 

 

		September 30, 2014				December 31, 2013
6% demand loans per Operations Agreement with Schoell Marine Inc., a company owned by Cyclone’s Chairman and controlling shareholder (A)		$	416,182			$	424,285
6% non-collateralized loans from officer and shareholder, payable on demand. The original principal balances were $157,101.			79,721				85,364
12% non-collateralized loans from officer and shareholder, payable on demand			13,558				11,000
Accrued Interest			289,858				254,471
Total current related party notes, inclusive of accrued interest		$	799,319			$	775,120

 

(A)

This note arose from services and salaries incurred by Schoell Marine on behalf of the Company. Schoell Marine also owns the building that is leased to the Company. The Schoell Marine note bears an interest rate of 6% and repayments occur as cash flow of the Company permits. The note was secured by a UCC-1 filing on the Company’s patents and patent applications, which expired and has not been renewed. For the nine months ended September 30, 2014 and for the year ended December 31, 2013, $8,100 and $500 of principal was paid on the note balance.

 

During the last quarter of 2013, the Company’s Chairman and co-founder loaned approximately 37.4 million shares of Company common stock, valued at approximately $1.5 million, as reserve treasury shares pursuant to various debt covenants. These shares have been presented as value of shares loaned by stockholder in the accompanying consolidated balance sheets. These shares were returned to the Chairman in March 2014.

 

NOTE 7 – RELATED PARTY TRANSACTIONS

 

A. LEASE ON FACILITIES

 

The Company leases a 6,000 square foot warehouse and office facility located at 601 NE 26th Court in Pompano Beach, Florida. The lease, which is part of the Company’s Operations Agreement with Schoell Marine, provides for the Company to pay rent equal to the monthly mortgage payment on the building plus property taxes, utilities and sales tax due on rent. Occupancy costs for the nine months ended September 30, 2014 and 2013 were $47,223 in both periods. The Operations Agreement runs year-to-year, however, the lease portion of this agreement is month-to-month, but can only be cancelled on 180 day notice by Schoell Marine.

 

B. DEFERRED COMPENSATION

 

Included in accounts payable and accrued expenses - related parties as of September 30, 2014 and December 31, 2013 are $462,839 and $1,910,073, respectively, of accrued and deferred officers’ salaries compensation which may be paid as funds are available. These are non-interest bearing and due on demand. In January 2014, four of the Company’s executive management converted $668,312 in deferred salary into 20,313,416 shares of restricted common stock, and forgave $956,762 in deferred salary as contributed capital. This forgiveness of deferred salary was recorded as additional paid in capital in the accompanying condensed consolidated balance sheet at September 30, 2014.

  

NOTE 8 – PREFERRED STOCK

 

The Series B Preferred Stock is majority voting stock and is held by the two co-founders of the Company. Ownership of the Series B Preferred Stock shares assures the holders thereof a 51% voting control over the common stock of the Company. The 1,000 Series B Preferred Stock shares are convertible on a one-for-one basis with the common stock in the instance the Company is merged, sold or otherwise dissolved.

 

NOTE 9 – STOCK TRANSACTIONS

 

During the nine months ended September 30, 2014, the Company:

 

a-

Issued 2,050,000 shares of restricted common stock valued at $ 93,000 for payment of liabilities, 5,950,000 shares of restricted common stock valued at $98,175 for services, and 4,722,365 shares of common stock pursuant to a cashless warrants conversion.

  

 

b-

Amortized (based on vesting) $9,755 of common stock options for employee services and issued 357,142 shares of restricted common stock valued at $10,714 in advance payment of debt interest.

 

c-

Sold 5,500,000 shares of restricted common stock for $110,000 and issued 2,719,298 shares of restricted common stock pursuant to a price guarantee for common stock sold in the prior year.

 

d-

Issued 409,028,377 shares of common stock valued at $1,080,554 as repayment of debt and related interest expense.

 

e-

Issued 20,313,416 shares of restricted common stock to four of the Company’s executive management as a conversion of $668,312 in deferred salary and forgave $956,762 of deferred salary as contributed capital.

  

f-

Issued 15,000,000 shares of restricted common stock valued at $49,500 in settlement and cancellation of a common stock warrant agreement.

.

g-

Cancelled 3,000,000 shares of treasury stock, valued at $210,000 pursuant to the separation agreement of WHE GEN (see Note 15).

 

 

NOTE 10 – STOCK OPTIONS AND WARRANTS

 

A. COMMON STOCK OPTIONS

 

Per the employment contracts with certain officers, the company issued 900,000 common stock options, valued at $2,577 (pursuant to the Black Scholes valuation model) ) that are exercisable into shares of common stock at an average exercise price of $0.003 and with a maturity life of 10 years. For the nine months ended September 30, 2014, the amortization of stock options was $9,755 and the unamortized balance was $2,067.

 

To improve the common stock position of the Company and help limit dilution, effective with the second quarter of 2013, the four corporate officers unanimously agreed to waive their rights to 2.4 million common stock options (600,000 per quarter collectively) contractually due them through April 2014. In lieu of issuing additional options to these officers and all other employees through the end of the year, the Company re-priced 4,185,000 million vested options held by the officers and employees that were priced at a minimum of $0.15 per share ($0.20 average) to $0.10 per share. The result was a non-cash charge of approximately $52,000. The remaining contractual life of the options was not changed. 

 

A summary of the common stock options for the period from December 31, 2013 through September 30, 2014 follows:

 

		Number Outstanding				Weighted Avg. Exercise Price				Weighted Avg. Remaining Contractual Life (Years)
Balance, December 31, 2013			9,740,000			$	0.129				6.5
Options issued			900,000				0.003				9.9
Options exercised			-				-				-
Options cancelled			-				-				-
Balance, September 30, 2014			10,640,000			$	0.128				6.1

  

 

The vested and exercisable options at period end follows:

 

		Exercisable/ Vested Options Outstanding				Weighted Avg. Exercise Price				Weighted Avg. Remaining Contractual Life (Years)
Balance September 30, 2014			9,740,000			$	.129				6.5
Additional vesting by December 31, 2014			-				-				-

  

 

The fair value of new stock options, re-priced stock options, new purchase warrants and re-priced purchase warrants granted using the Black-Scholes option pricing model was calculated using the following assumptions:

 

		Nine Months Ended September 30, 2014				Year Ended December 31, 2013
Risk free interest rate			.67 % -1.32%				.51% - 1.41%
Expected volatility			63% - 83%				34% -107%
Expected term			2-4				1-5
Expected dividend yield			0%				0%
Average value per options and warrants		$	.001 - $ .017			$	.01 - $.06

 

Expected volatility is based on historical volatility of the Company’s common stock price. Short Term U.S. Treasury rates were utilized at the risk free interest rate. The expected term of the options and warrants was calculated using the alternative simplified method newly codified as ASC 718 “Accounting for Stock Based Compensation,” which defined the expected life as the average of the contractual term of the options and warrants and the weighted average vesting period for all issuances.

 

B. COMMON STOCK WARRANTS

 

 During the nine months ended September 30, 2014, the Company: 

 

	a-	Re-priced 625,000 common stock warrants to $0.011 (valued at $10,821) pursuant to a price guarantee from the 2013 sale of common stock to unaffiliated third parties.
	b-	Issued 2,838,048 common stock warrants and re-priced 565,625 common stock warrants, both to $0.011 (valued at $43,280) pursuant to a price guarantee from a 2013 debt agreement. No other terms of these common stock warrants were revised.
	c-	Issued 4,722,365 aggregate shares of common stock in a cashless exercise of 9,037,230 warrants.
	d-	Cancelled 2,261,251 common stock warrants with an average exercise price of $0.18 per share that expired.

   

e-

Cancelled 3,403,673 common stock warrants with an average exercise price of $0.011 per share for a payment of $49,500.  This warrant, issued pursuant to a debt issuance had a significant downward reprising provision.

    

 

 

A summary of outstanding vested warrant activity for the period from December 31, 2013 to September 30, 2014 follows:

 

		Number Outstanding				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (Years)
Common Stock Warrants
Balance, December 31, 2013			16,097,798			$	0.057				2.85
Warrants exercised-cashless			(9,037,230	)			(0.017	)
Warrants issued			2,838,048				0.011				3.92
Warrants expired			(2,261,251	)			(.178	)
Warrants cancelled			(3,403,673	)			(.011	)
Warrants re-priced:
Cancelled – old			(1,190,625	)			(0.020	)
Re-Priced			1,190,625				0.011
Balance, September 30, 2014			4,233,692			$	0.08				1.00

 

All warrants were vested and exercisable as of the date issued.

  

 

NOTE 11 – INCOME TAXES

 

A reconciliation of the differences between the effective income tax rates and the statutory federal tax rates for the nine months ended September 30, 2014 and 2013 are as follows:

 

		Nine months ended September 30, 2014				Amount				Nine months ended September 30, 2013				Amount
Tax benefit at U.S. statutory rate			34	%		$	129,717				34	%		$	377,941
State taxes, net of federal benefit			4				15,261				4				44,464
Change in valuation allowance			(38	)			(144,978	)			(38	)			(422,405	)
			-	%		$	-				-	%		$	-

 

The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at September 30, 2014 and December 31, 2013 consisted of the following:

  

Deferred Tax Assets		September 30, 2014				December 31, 2013
Net Operating Loss Carry-forward		$	7,938,465			$	7,946,959
Deferred Tax Liabilities – Accrued Officers’ Salaries			(286,663	)			(440,135	)
Net Deferred Tax Assets			7,651,802				7,506,824
Valuation Allowance			(7,651,802	)			(7,506,824	)
Total Net Deferred Tax Assets		$	-			$	-

  

As of September 30, 2014, the Company had a net operating loss carry forward for income tax reporting purposes of approximately $17.1 million that may be offset against future taxable income through 2029. Current tax laws limit the amount of loss available to be offset against future taxable income when a substantial change in ownership occurs. Therefore, the amount available to offset future taxable income may be limited. No tax asset has been reported in the financial statements because the Company believes there is a 50% or greater chance the carry forwards will expire unused. Accordingly, the potential tax benefits of the loss carry forwards are offset by a valuation allowance of the same amount.

  

 

NOTE 12 –LEASE OBLIGATIONS

 

A. CAPITALIZED LEASE OBLIGATIONS

 

In September 2012, the Company acquired $21,310 of equipment via capitalized lease obligations at an interest rate of 12.5%. In December 2013, the Company acquired $8,408 of equipment via capitalized lease obligations at an interest rate of 15.5%. Total lease payments made for the nine months ended September 30, 2014 were $4,779. The balance of capitalized lease obligations payable at September 30, 2014 and December 31, 2013 was $21,932 and $26,711, respectively. Future lease payments are:

  

2014		$	1, 335
2015			5,801
2016			6,620
2017			6,079
2018			2,097
		$	21,932

 

B. LEASE ON ADDITIONAL FACILITIES

 

In July 2011, the Company signed a one-year lease (with extensions) for an additional 2,000 square feet. Effective July 2013, the Company renewed this lease for one year, at an annual rate of $ 17,304 or $8.65/s.f, terminating in September 2014, and was again extended to December 31, 2014. The lease expense for the nine months ended September 30, 2014 and 2013 was $13,314 and $ 14,761, respectively.

 

Commencing January 2014, the WHE Generation Corp. accrued $1,000 in monthly rent (inclusive of utilities, taxes and shared office assistance) to Precision CNC as part of the joint facility / manufacturing arrangement, and effective July 2014 rent increased to $2,500 per month. The rent expense for the nine months ended September 30. 2014 recorded by WHE-Gen was $ 13,957.  

 

NOTE 13 – COMMITMENTS AND CONTINGENCIES

 

The Company has employment agreements with Harry Schoell, Chairman and CTO (previously, CEO), at $150,000 per year and Frankie Fruge, President, at $120,000 per year; (collectively, the “Executives”). These agreements provide for a term of three (3) years from their Effective Date (July 2007 with automatically renewing successive one year periods starting on the end of the second anniversary of the Effective Date. If the Executive is terminated “without cause” or pursuant to a “change in control” of the Company, as both defined in the respective agreements, the Executive shall be entitled to (i) any unpaid Base Salary accrued through the effective date of termination, (ii) the Executive’s Base Salary at the rate prevailing at such termination through 12 months from the date of termination or the end of his Term then in effect, whichever is longer, and (iii) any performance bonus that would otherwise be payable to the Executive were he/she not terminated, during the 12 months following his or her termination.

  

Christopher Nelson, former President and General Counsel, resigned his positions effective July 17, 2014 as President and General Counsel of the Company and elected to forgo any salary and benefits subsequent to May 31 2014 from Cyclone Power Technologies Inc. Effective July 31, 2014, Mr. Nelson signed an employment agreement with WHE-Generation Corp. as the Chief Executive Officer. For the period through September 30, 2014, $70,165 was recorded as officer compensation by WHE-Generation Corp.

  

NOTE 14 –CONSOLIDATED SUBSIDIARY

 

In 2012, the Company established a 100% owned subsidiary (renamed) Cyclone Performance LLC. The purpose of Cyclone Performance is to build, test and run a vehicle utilizing the Company’s engine. In the last quarter of 2012, the Company sold a 5% equity investment to an unrelated investor for $30,000. Prior to December 31, 2012, this 5% equity investment was acquired by a corporate officer of the Company.  Losses of the subsidiary are currently fully borne by the Company, as there is no guarantee of future profits or positive cash flow of the subsidiary. As of September 30, 2014, the cumulative unallocated losses to the non-controlling interests of this subsidiary of $953 are to be recovered by the parent from future subsidiary profits if they materialize.

  

 

NOTE 15 – DECONSOLIDATION OF WHE SUBSIDIARY

 

The Company sold most of its 73.72% investment in the WHE subsidiary to an unrelated buyer effective September 30, 2014 under separation and stock repurchase agreements dated July 17, 2014 and September 30, 2014, respectively. Under the agreements, the Company retained a non-controlling 15.13% investment, which has been deconsolidated due to the loss of control over the WHE subsidiary. The transaction was recorded in accordance with ASC 810-10-40, wherein the Company recognized a gain on the sale of its investment in the amount of $2,443,506, and its remaining investment in the WHE subsidiary was recorded at the fair value of the WHE common stock held by the Company, which was $556,756 as of September 30, 2014.

 

As part of the separation agreement Whe Gen paid to the company $350,000, and is to pay $150,000 for the remainder of the company’s investment sold. Whe Gen also paid to TCA Global Master Credit Fund LP, the Company’s senior secured creditor, approximately $78,000 to fully retire that debenture and release all of the Company’s assets from its security interest. Whe Gen also paid to the Company an additional $24,000 in reimbursements, and transferred back to Cyclone 3,000,000 shares of treasury stock in Cyclone (valued at $210,000). Whe Gen also assumed a $50,000 liability, deferred revenue of approximately $10,000 and accepted the responsibility to complete an engine delivery contract (previously recorded as $290,000 deferred revenue by the Company) . The Company forgave an intercompany receivable of approximately $85,000. Additionally, the Company satisfied a liability of $17,550 via transferring 65,000 shares of its Whe Gen shares.

 

To raise funds pursuant to the separation agreement, Whe Generation Corp. in the “Seed” Round of financing commencing in July 2014, issued $ 350,000 of 6% convertible debt, maturing in 12 months, which were subsequently converted into common stock at $.12 per share as of September 30, 2014. In the common stock “A” funding WHE Generation Corp. raised $1,314,360 of common stock sales at $.27 per share as of September 30, 2014.

 

In connection with the Agreement, the Company and Whe Gen also amended its 2010 License Agreement (the “License”) to provide the Company with an initial non refundable license fee of $175,000 and on-going 5% royalties from Whe Gens sale of engines utilizing the licensed technology. This License is 20 years with two 10-year extensions. It is worldwide in territory and exclusive for the specific applications of stationary waste heat recovery (WHR) and waste-to-power (WtP).

 

The total losses of the Whe Gen subsidiary for the nine months ended September 30, 2014, for the year ended December 31, 2013 and cumulatively since inception were $696,831 and $157,266, and $ 828,531 respectively. These losses were fully borne by the Company and are included in net (loss) income in the condensed consolidated statements of operations.

  

NOTE 16 – RECEIVABLES, DEFERRED REVENUE AND BACKLOG

 

As of September 30, 2014, total backlog for prototype engines to be delivered in the following three months was $400,000 from the Combilift agreement, of which $100,000 has been paid and has been recorded as deferred revenue.

 

NOTE 17 – DERIVATIVE FINANCIAL INSTRUMENTS

 

Pursuant to additional financing, in the nine months ended September 30, 2014 and in the year ended December 31, 2013 the Company entered into convertible note agreements in the aggregate face amount of $942,052 and $743,250, respectively. The conversion prices into common stock ranged from a discount of 30% to 45% of the lowest closing prices in the 10 to 20 trading days prior to the conversion. Under provisions of ASC Topic 815-40, this conversion feature triggered derivative accounting treatment because the convertible note was convertible into an indeterminable number of shares of common stock. The fair value of the embedded conversion option was required to be presented as a derivative liability and adjusted to fair value at each reporting date, with changes in fair value reported in the condensed consolidated statements of operation.

   

The Company recorded derivative liabilities of $800,225 and $456,681 with a discount offset against the underlying loan, during the nine months ended September 30, 2014 and for the year ended December 31, 2013, respectively.

 

In the nine months ended September 30, 2014, the Company recorded a $816,308 non-cash charge to interest expense (reflective of debt discount amortization), an increase of $954,641 in additional paid in capital pursuant to conversion of convertible notes to common stock, and $148,289 of derivative loss related to adjusting the derivative liability to fair value. At September 30, 2014, the derivative related fair value of debt was $483,892.

  

 

The Company calculates the estimated fair values of the liabilities for derivative instruments at each quarter-end using the BSM option pricing model and Stochastic Process Forecasting models (Monte Carlo simulations). Volatility, expected term and risk free interest rates used to estimate the fair value of derivative liabilities are indicated in the table below. The volatility was based on historical volatility, the expected term is equal to the remaining term of the debt and the risk free rate is based upon rates for treasury securities with the same term.

 

		Nine Months Ended September 30, 2014				Year Ended Dec. 31, 2013
Volatility			114% - 234%				87% - 171%
Risk Free Rate			.03% - .99%				.1% - 1.75%
Expected Term (years)			0 - 4				0 - 3
Dividend Rate			0%				0%

 

NOTE 18 – SUBSEQUENT EVENTS

 

 In the fourth quarter of 2014, the Company engaged in the following transactions:

 

a-

The Company issued approximately 80 million shares of common stock in conversion of approximately $55,000 in convertible debt and interest.

 

	b-	In October 2014 , the Company borrowed 10 million shares of Company common stock from the Chairman and used the shares for settlement of a liability. The company is obligated to repay these shares as authorized common stock is available.

  

c-

The Company increased the authorized number of common shares to 2,000,000,000 shares. This has been retroactively reflected on these financial statements. Some of these shares will be used to increase the reserve allocation of common stock to the required 300% coverage pursuant to convertible debt agreements.

 

d-

The Company has placed purchase orders for the pre production manufacturing of 10 Mark 1 engines to test application and integration with customers’ systems.

  

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward Looking Statements 

 

This report contains forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including, among other things:

 

	●	the ability to successfully complete development and commercialization of our technology;
	●	changes in existing and potential relationships with collaborative partners;

	●	the ability to retain certain members of management;
	●	our expectations regarding general and administrative expenses;

	●	our expectations regarding cash availability and balances, capital requirements, anticipated revenue and expenses, including infrastructure and patent expenditures;
	●	other factors detailed from time to time in filings with the SEC.

  

 

In addition, in this registration, we use words such as “anticipate,” “believe,” “plan,” “expect,” “future,” “intend,” and similar expressions to identify forward-looking statements.

 

We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this registration. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this registration may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements.

 

Overview 

 

The Company is engaged in the research and development of all-fuel, eco-friendly engine and parts technologies for integration and use within customers systems. The company anticipates that it will concentrate on the following engine models (power ratings) : Mark 1 (2.7 KW- 6 HP), Mark 3 (12 KW-22 HP) and the Mark 5 ( 60 KW- 100 HP). Additionally, revenue is anticipated via sales of component parts and licensing fees.

 

 Our R&D team is moving towards completion of the Mark 5 project in Quarter 1 of 2015. These engines are to be delivered to Combilift for use as a clean-burning power supply in material lift equipment. We are forecasting the payment of $300,000 from completion of this initial contract. The Mark 5 engine will also be used in Cyclone’s land speed record (LSR) streamliner in an attempt a run for the fastest steam car on earth.

 

We have ordered from HyPex Inc. (our primary sourced manufacturer) 10 pre production Mark I engines. These engines are to be installed by customers within their systems to test performance and quality control before Cyclone orders engine production on a larger scale.

 

In early 2015, we anticipate to deliver company designed, customized atomizers and pumps, produced by our primary sourced manufacturer. This is a new system application for use in hydrocarbon extractor units that require high temperatures and pressures to extract residual recyclable products from the waste of oil fracking and contamination spills. Projected revenue from this order is $135,000.

 

Other anticipated revenue is being generated by the delivery of 2 heat exchangers to customers, which is another current application of Cyclones component parts. These heat exchangers generate high BTU ratings for turbine electrical combined heat and power units.

 

Cyclone also anticipates to receive initial royalty income from Whe Gen in early 2015 from the Mark 2 engine. This license is from sale of engines that produces power from static waste heat.

 

Management is also pursuing other major R&D contracts that both support and build-off of these engine and component parts programs. This includes marine and renewable power applications.

 

Corporate Structural Actions.   The Company’s focus is on revenue and funding derived from sales of engines and parts for integration into customers applications and systems. With delivery of our engines and material component parts, we are transitioning from the convertible notes used to finance the Company over the last 18 months.

 

 To better publicize the company and its products, we have hired inhouse managers for marketing and investor relations.

 

The Company recently increased its authorized common stock to 2,000,000,000 shares. Some of these shares will be used to increase the reserve allocation of common stock to the required 300% coverage pursuant to convertible debt agreements.

 

Management will seek to use these additional shares to build long term value for Cyclone, including getting products to market, generating strong and consistent revenue, reducing debt on our books, and possibly partnering with companies that can provide a diversified income stream and technology base. Along these lines, management is seeking strategic business relationships in the areas of manufacturing and clean energy technologies with vertical synergies.

  

 

Results of Operations

 

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013

 

Revenue. The Company had $175,000 of revenue in the quarter ended September 30, 2014 from the licensing agreement with its former subsidiary Whe Gen. The Company had recognized $212,500 in revenue in the quarter ended September 30, 2013 of which $150,000 was from the successful fulfillment of the first milestone under the revised Phoenix license and $62,500 of previously deferred revenue from the Great Wall (China) license upon contract termination.

 

Gross Margin. The gross profit for the quarter ended September 30, 2014 was $175,000, attributable to the Whe Gen license. Gross profit for the quarter ended September 30, 2013 was $79,366, the majority of which was from the Great Wall revenue.

 

Operating Expenses. Operating expenses incurred for the quarter ended September 30, 2014 were $1,028,699 as compared to $777,559 for the same period in the previous year, an increase of $251,140 or 32%. The increase was due to an increase in research and development expenses of $193,591 or 95 %, reflective of the commencement of enhanced development testing by the Ohio State University Center for Automotive Research for the Whe Gen engine in 2014. Also, general and administrative expenses increased by $53,824 (9%) primarily from higher professional and consulting expenses and increased patent maintenance fees partially offset by reduced stock issued for services.

 

Operating Loss. The operating losses for the quarters ended September 30, 2014 and 2013 were $853,699 and $698,193, respectively, an increased loss of $155,506 or 22%, due to the factors outlined above.

 

Other Income (Expense)  Net other income for the quarter ended September 30, 2014 was $2,193,568, due to a $2,443,506 gain on the sale and separation of the Whe Gen subsidiary, net of $281,158 of interest expense attributable to increased debt levels. Derivative income from notes payable was $31,220.

 

Net other expense for the quarter ended September 30, 2013 was $173,701, due primarily to interest expense of $140,778 and a $33,518 loss on debt conversion via common stock.

 

Net Loss and Loss per Share.  The net income for the quarter ended September 30, 2014 was $1,339,869, compared to a net loss of $871,894 for the same period in the previous year. The favorable variance of $2,211,763 or 254 % primarily relates to the gain on the sale of the Whe Gen subsidiary. The net income per weighted average share was $0.00 for the quarter ended September 30, 2014 and the net loss per weighted average share was $0.00 for the prior comparable quarter.

 

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

 

Revenue. For the nine months ended September 30, 2014 the Company had $315,527 of revenue, of which $140,527 was from the successful completion of the US Army Contract, and $175,000 from the Whe Gen license.

 

The Company recognized $715,382 in revenue in the nine months ended September 30, 2013 from the successful fulfillment of the first Phoenix milestone ($150,000), the third and fourth milestones under the U.S. Army Contract ($502,882) and recognition of the Great Wall deferred revenue ($62,500).

 

Gross Margin. The gross margin for the nine months ended September 30, 2014 was $229,650, inclusive of profit on the Army contract $ 54,650 and the Whe Gen license of $175,000. Gross margin for the nine months ended September 30, 2013 was $286,826, primarily attributable to the U.S. Army Contract.

 

Operating Expenses. Operating expenses incurred for the nine months ended September 30, 2014 were $2,339,202 as compared to $2,024,988 for the same period in the previous year, an increase of $314,214 or 16%. General and administrative expenses increased by $158,689 (11%) from higher professional, investor relations, consulting fees and increased patent maintenance costs. Research and development costs increased $139,637 ( 24%), attributable to Whe Gen engine research.

 

 

Operating Loss. The operating losses for the nine months ended September 30, 2014 and 2013 were $2,109,552 and $1,738,162, respectively, a higher loss of $371,390 or 21%, due to the factors outlined above.

 

Other Income (Expense)  Net other income for the nine months ended September 30, 2014 was $1,162,084 due to a $2,443,506 gain on the sale and separation of the Whe Gen subsidiary net of interest expense of $1,133,133 attributable to increase debt levels and $148,289 of debt related derivative expenses.

 

Net other expense for the nine months ended September 30, 2013 was $382,825, due primarily to interest expense.

 

Net Loss and Loss per Share.  The net loss for the nine months ended September 30, 2014 was $947,468, compared to a net loss of $2,120,987 for the same period in the previous year. The decreased loss of $1,173,519 or 55 % primarily relates to gain on the sale and separation of the Whe Gen subsidiary, net of increased interest expense of $761,231 and higher derivative expenses in the nine months ended September 30, 2014 of $148,884. The net loss per weighted average share was $0.00 and $0.01 for both the current and prior nine months, respectively.

 

Liquidity and Capital Resources

 

At September 30, 2014, the net working capital deficiency was $1,877,647 as compared to a deficiency of $5,994,870 at December 31, 2013, an improvement of $4,117,223 or 69%.

 

For the nine months ended September 30, 2014, cash increased by $288,957. Funds were provided by the $2,443,506 gain on the Whe Gen divestment, debt proceeds of $515,000, higher accounts payable and accrued expenses of $567,266, and an increase of $183,539 in related party payables and accrued expenses. Funds were used by the $3,390,974 loss (before the Whe Gen gain) and debt repayment of $38,615. Non-cash charges for the nine months were from: the issuance of common stock, warrants and options for services of $109,579, amortization of prepaid expenses paid with common stock of $434,724, derivative expenses related to debt valuation of $148,289, $836,853 of derivative debt discount amortization (charged as interest expense), and an $80,000 inventory valuation reserve.

 

During the last quarter of 2013, the Company’s Chairman and co-founder loaned approximately 37.4 million shares of Company common stock, valued at approximately $1.5 million, as reserve treasury shares pursuant to various debt covenants. These shares have been presented as value of shares loaned by stockholder in the accompanying condensed consolidated balance sheets. These shares were returned to the Chairman in March 2014 and the liability was reversed.

 

For the nine months ended September 30, 2013, cash increased by $136,167 from the beginning of the year. This is reflective of funds provided by $870,000 of new debt funding, the sale of common stock of $100,000, reduced inventory of $190,683, higher accounts payable and accrued expenses of $159,490, and increased payables and accrued expenses to related parties of $260,136. Funds were used by the net loss of ($2,120,987), debt repayment of $161,922 and a realization of deferred revenue of $210,400. Non-cash charges for the nine months were from the issuance of common stock, warrants and options for services of $577,401, $145,600 pursuant to the use of 1.8 million shares of Company common stock donated by officers/management for employee compensation, and $119,782 of warrants issued pursuant to repayment of debt in common stock.

 

 

Cash Flow Management Plan 

 

As shown in the accompanying financial statements, the Company incurred substantial operating losses for the nine months ended September 30, 2014 of approximately $2.1 million. Cumulative operating losses since inception are approximately $23.8 million.  The Company has a working capital deficit at September 30, 2014 of approximately $1.9 million. There is no guarantee whether the Company will be able to support its operations on a long term basis. This raises doubt about the Company’s ability to continue as a going concern. If additional funds cannot be raised or otherwise generated, the Company may be forced to reduce staff, minimize its research and development activities, or in a worst case scenario, shut-down operations.

  

 

In the first quarter of 2015, the company projects $400,000 in revenue from the completion of the Combi Mark 5 contract. Also we anticipate to deliver company designed, customized atomizers and pumps, produced by our primary sourced manufacturer. This is a new system application for use in hydrocarbon extractor units that require high temperatures and pressures to extract residual recyclable products from the waste of oil fracking and contamination spills. Projected revenue from this order is $135,000. Also we await $150,000 pursuant to the Whe Gen separation.

 

Additionally, we have potential contracts in various stages of negotiation that could generate another $2 million in revenue over the following 12 to 24 months. We cannot guarantee that we will be successful in closing these new contracts, but we are cautiously optimistic that these or other opportunities will materialize in the coming quarters.  

 

Off-Balance Sheet Arrangements

 

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not required for smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

We carried out an evaluation as required by paragraph (b) of Rule 13a-15 and 15d-15 of the Exchange Act, under the supervision and with the participation of our management, including our President (Chief Executive Officer) and Chief Financial Officer, of the effectiveness of our financial disclosures, controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30, 2014.

 

A material weakness can be defined as an insufficiency of internal controls that may result in a more than remote likelihood that a material misstatement will not be prevented, detected or corrected in a company’s financial statements.

 

Based upon that evaluation, our President (Chief Executive Officer) and Chief Financial Officer concluded that our disclosure controls and procedures were not effective, based on the following deficiencies:

 

-	Weaknesses in Accounting and Finance Personnel: We have a small accounting staff and we do not have the robust employee resources and expertise needed to meet complex and intricate GAAP and SEC reporting requirements of a U.S. public company. Additionally, numerous adjustments and proposed adjustments have been noted by our auditors. This is deemed by management to be a material weakness in preparing financial statements.
-	We have written accounting policies and control procedures, but we do not have sufficient staff to implement the related controls. Management had determined that this lack of the implantation of segregation of duties, as required by our written procedures, represents a material weakness in our internal controls.
-	Internal control has as its core a basic tenant of segregation of duties. Due to our limited size and economic constraints, the Company is not able to segregate for control purposes various asset control and recording duties and functions to different employees. This lack of segregation of duties had been evaluated by management, and has been deemed to be a material control deficiency.

  

 

The Company has determined that the above internal control weaknesses and deficiencies could result in a reasonable possibility for interim financial statements that a material misstatements will not be prevented or detected on a timely basis by the Company's internal controls.

 

Management is currently evaluating what steps can be taken in order to address these material weaknesses. As a growing small business, the Company continuously devotes resources to the improvement of our internal control over financial reporting. Due to budget constraints, the staffing size, proficiency and specific expertise in the accounting department is below requirements for the operation. The Company is anticipating correcting deficiencies as funds become available.

 

Changes in Internal Control Over Financial Reporting and Procedures.

 

There were no changes in internal control over financial reporting and procedures from the previous quarter.

 

PART II. OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

The Company is not engaged in any legal proceeding or threatened proceeding at this time, and management has no knowledge of any actions or inactions taken by the Company or its management that could reasonably lead to a legal proceeding.

 

ITEM 1A.  RISK FACTORS

 

Not required.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

In the third quarter of 2014 the Company issued:

 

An aggregate of 288,412,566 shares of common stock to 7 investment funds in connection with the conversion of approximately $315,000 in principal and interest on several separate convertible promissory notes. These securities were offered pursuant to an exemption under Section 4(2) of the Securities Act and Regulation D thereunder. The debt holders had previously completed Accredited Investor Questionnaires and Subscription Agreements, and received a copy of the Company’s Annual Report in connection with the issuance.   15,000,000 shares of common stock, valued at $ 49,500 pursuant to settlement of a common stock warrant agreement.

 

 

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.    MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5.    OTHER INFORMATION

 

None.

  

 

ITEM 6.    EXHIBITS

 

Exhibit Number			Description
31.1			Certification of the President (Principal Executive Officer), as required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2			Certification of Principal Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1			Certification of the President (Chief Executive Officer), as required by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2			Certification of the Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*			XBRL Instance
101.SCH*			XBRL Taxonomy Extension Schema
101.CAL*			XBRL Taxonomy Extension Calculation
101.DEF*			XBRL Taxonomy Extension Definition
101.LAB*			XBRL Taxonomy Extension Labels
101.PRE*			XBRL Taxonomy Extension Presentation

 

The certification attached as Exhibits 32.1 and 32.2 that accompany this Quarterly Report on Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Cyclone Power Technologies, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

* Information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

  SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Cyclone Power Technologies, Inc.
January 2, 2015	/s/ Frankie Fruge
	Frankie Fruge
	President
	(Principal executive officer)
January 2, 2015	/s/ Bruce Schames.
	Bruce Schames
	Chief Financial Officer
	(Principal financial and accounting officer)

 

 

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