Attached files
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended September 30, 2009
OR
|
|
o
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TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
|
For
the transition period from _________________ to
_________________
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Commission
file number 000-33155
COATES
INTERNATIONAL, LTD.
(Exact
Name of Registrant as Specified in its
Charter)
|
Delaware
|
22-2925432
|
|
(State
or other Jurisdiction of
|
(I.R.S.
Employer
|
|
Incorporation
or Organization)
|
Identification
No.)
|
Highway
34 & Ridgewood Road, Wall Township, New Jersey 07719
(Address
of Principal Executive Office) (Zip Code)
(732)
449-7717
(Registrant's
telephone number including area code)
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No o
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 o No o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.)
Yes o No x
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.
Large accelerated filer ‚ | Accelerated filer Non-accelerated filer ‚ |
Non-accelerated filer ‚ | Smaller reporting company x |
(Do not
check if a smaller reporting company)
As of
November 9, 2009, 274,766,803 shares of the Registrant’s common stock were
issued and outstanding.
1
COATES
INTERNATIONAL, LTD.
QUARTERLY
REPORT ON FORM 10-Q
CONTENTS
SEPTEMBER
30, 2009
Page
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|
PART
1 – FINANCIAL INFORMATION
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Item
1. Financial Statements:
|
|
Condensed
Balance Sheets
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3
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Condensed
Statements of Operations
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4
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Condensed
Statements of Cash Flows
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5
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Notes
to Condensed Financial Statements
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6-19
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Item
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
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20-28
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Item
3. Quantitative and Qualitative Disclosures About
Market Risk
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29
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Item
4T. Controls and Procedures
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29
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PART
II - OTHER INFORMATION
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30
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Item
1. Legal Proceedings
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30
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Item
1A. Risk Factors
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31
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Item
2. Unregistered Sales of Equity Securities and Use
of Proceeds
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31
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Item
3. Defaults Upon Senior Securities
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31
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Item
4. Submission of Matters to a Vote of Security
Holders
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31
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Item
5. Other Information
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31
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Item
6. Exhibits
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31
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SIGNATURES
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32
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2
Coates
International, Ltd.
Condensed Balance Sheets
September
30, 2009
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December
31, 2008
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||||||||
(Unaudited)
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|||||||||
Assets
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|||||||||
Current
Assets
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|||||||||
Cash
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$ | 102,446 | $ | 721,952 | |||||
Interest
reserve account - restricted
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100,000 | - | |||||||
Amount
due from customer
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25,000 | - | |||||||
Inventory,
net
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511,189 | 487,549 | |||||||
Prepaid
and other assets
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24,792 | 4,679 | |||||||
Total
Current Assets
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763,427 | 1,214,180 | |||||||
Property,
plant and equipment, net
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2,292,115 | 39,376 | |||||||
Deferred
licensing costs, net
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69,220 | 72,433 | |||||||
Security
deposits
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- | 197,500 | |||||||
Total
Assets
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$ | 3,124,762 | $ | 1,523,489 | |||||
Liabilities
and Stockholders' Deficiency
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|||||||||
Current
Liabilities
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|||||||||
Accounts
payable and accrued liabilities
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$ | 1,078,420 | $ | 1,248,173 | |||||
Amount
due to related party
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200,000 | - | |||||||
10%
Convertible note, due January 2010
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20,000 | - | |||||||
Mortgage
loan payable
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1,750,000 | - | |||||||
Total
Current Liabilities
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3,048,420 | 1,248,173 | |||||||
10%
Convertible note, due January 2010
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- | 20,000 | |||||||
Deferred
gain on sale of land and building
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- | 978,479 | |||||||
License
deposits
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375,000 | 375,000 | |||||||
Total
Liabilities
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3,423,420 | 2,621,652 | |||||||
Commitments
and Contingencies
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|||||||||
Stockholders'
Deficiency
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|||||||||
Preferred
Stock, $0.001 par value, 100,000,000 shares authorized, 10,000 shares
issued and outstanding at September 30, 2009 and no shares issued or
outstanding at December 31, 2008
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10 | - | |||||||
Common
Stock, $0.0001 par value, 1,000,000,000 shares authorized, 274,766,803 and
273,126,636 shares issued and outstanding at September 30, 2009 and
December 31, 2008, respectively
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27,477 | 27,313 | |||||||
Additional
paid-in capital
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21,941,569 | 20,722,899 | |||||||
Accumulated
deficit
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(22,267,714 | ) | (21,848,375 | ) | |||||
Total
Stockholders' Deficiency
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(298,658 | ) | (1,098,163 | ) | |||||
Total
Liabilities and Stockholders' Deficiency
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$ | 3,124,762 | $ | 1,523,489 |
The
accompanying notes are an integral part of these condensed financial
statements.
3
Coates
International, Ltd.
Condensed Statements of
Operations
Three
Months Ended
September
30,
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Nine
Months Ended
September 30,
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|||||||||||||||
2009
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2008
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2009
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2008
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Revenue
from research and development
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$ | - | $ | 490,183 | $ | 690,000 | $ | 1,190,183 | ||||||||
Gain
on sale of land and building
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- | - | 978,479 | - | ||||||||||||
Total
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- | 490,183 | 1,668,479 | 1,190,183 | ||||||||||||
Expenses
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||||||||||||||||
Research
and development costs
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- | 199,176 | 254,926 | 494,651 | ||||||||||||
General
and administrative expenses
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626,835 | 285,370 | 1,753,103 | 979,331 | ||||||||||||
Depreciation
and amortization
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11,118 | 9,417 | 20,820 | 28,250 | ||||||||||||
Total
Operating Expenses
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637,953 | 493,963 | 2,028,849 | 1,502,232 | ||||||||||||
Loss
from Operations
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(637,953 | ) | (3,780 | ) | (360,370 | ) | (312,049 | ) | ||||||||
Interest expense,
net
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50,877 | 98,185 | 58,968 | 290,610 | ||||||||||||
Loss
Before Income Taxes
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(688,830 | ) | (101,965 | ) | (419,338 | ) | (602,659 | ) | ||||||||
Provision
for income taxes
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- | - | - | - | ||||||||||||
Net
Loss
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$ | (688,830 | ) | $ | (101,965 | ) | $ | (419,338 | ) | $ | (602,659 | ) | ||||
Basic
and diluted loss per share
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$ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 0.00 | ||||||||
Basic
and diluted weighted average shares outstanding
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274,530,511 | 273,382,614 | 274,076,137 | 273,411,363 | ||||||||||||
The
accompanying notes are an integral part of these condensed financial
statements.
4
Coates
International Ltd.
Condensed Statements of Cash
Flows
Nine
Months Ended September 30,
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||||||||
2009
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2008
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|||||||
Net
Cash Used in Operating Activities
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$ | (1,045,502 | ) | $ | (346,820 | ) | ||
Cash
Flows from Investing Activities:
|
||||||||
Acquisition
of land and building
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(2,075,346 | ) | - | |||||
Net
Cash Used in Investing Activities
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(2,075,346 | ) | - | |||||
Cash
Flows from Financing Activities
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||||||||
Proceeds
of mortgage loan
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1,750,000 | |||||||
Issuance
of common stock and warrants
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676,342 | 7,952 | ||||||
Cash
proceeds from related party
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200,000 | - | ||||||
Establishment
of Interest reserve
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(100,000 | ) | - | |||||
Deferred
financing costs
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(25,000 | ) | - | |||||
Purchase
of treasury stock
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- | (89,485 | ) | |||||
Net
Cash Provided by (Used in) Financing Activities
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2,501,342 | (81,533 | ) | |||||
Net
Decrease in Cash
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(619,506 | ) | (428,353 | ) | ||||
Cash,
beginning of period
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721,952 | 959,181 | ||||||
$ | 102,446 | $ | 530,828 | |||||
Supplemental
Disclosure of Cash Flow Information:
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||||||||
Cash
paid during the period for interest
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$ | 28,438 | $ | 293,599 | ||||
Supplemental Disclosure
of Noncash Investing Activities:
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||||||||
Returned
lease security deposit applied towards purchase
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||||||||
price
of reacquired land and building
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$ | 195,000 | $ | - | ||||
The
accompanying notes are an integral part of these condensed financial
statements.
5
Coates
International, Ltd.
Notes
to Condensed Financial Statements
1.
|
BASIS
OF PRESENTATION
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The
accompanying unaudited condensed financial statements of Coates International,
Ltd. (the “Company”) have been prepared in accordance with accounting principles
generally accepted for interim financial information and rules and regulation of
the Securities and Exchange Commission (the “SEC”). Accordingly, they do not
include all of the information and notes required by accounting principles
generally accepted in the United States (“GAAP”) for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The results of operations for the three and nine month periods ended
September 30, 2009 and 2008 are not necessarily indicative of the results that
may be expected for any other interim period or for the full
year. The unaudited financial statements should be read in
conjunction with the financial statements and footnotes thereto included in the
Company’s annual report on Form 10-K for the year ended December 31, 2008 and
the quarterly reports on Form 10-Q for the quarters ended June 30, 2009 and
March 31, 2009.
The
Company incurred net losses for the three and nine month periods ended September
30, 2009 and, except for the year ended December 31, 2008, has incurred
recurring annual net losses since inception. As of September 30, 2009, the
Company had a Stockholders’ Deficiency of approximately $299,000. At September
30, 2009, the Company had negative working capital of approximately
($2,285,000), compared
with negative working capital of approximately ($34,000) at December 31, 2008.
In addition, the current economic environment, which is characterized by tight
credit markets, investor uncertainty about how to safely invest funds and low
investor confidence, has introduced additional risk and difficulty in the
Company’s challenge to secure needed additional working capital. These factors
raise substantial doubt about the Company’s ability to continue as a going
concern. Management has instituted a cost control program intended to cut
variable costs to only those expenses that are necessary to complete its
activities related to entering the production phase of its operations, develop
additional commercially feasible applications of the CSRV technology, seek
additional sources of working capital and cover the general and administrative
expenses in support of such activities. The Company has been actively
undertaking efforts to secure new sources of working capital. During
the nine months ended September 30, 2009, the Company received $690,000 from
research and development fees and received proceeds of approximately $676,000
from the sale of common stock and warrants. The Company continues to actively
seek out new sources of working capital; however, there can be no assurance that
it will be successful in these efforts. The accompanying financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
2.
|
ACCOUNTING
POLICIES
|
Net Income (Loss) per
Share
Basic net
income (loss) per share is based on the weighted average number of common shares
outstanding without consideration of potentially dilutive shares of common
stock. Diluted net income (loss) per share is based on the weighted average
number of common and potentially dilutive common shares outstanding, when
applicable.
Use of
Estimates
The
preparation of the Company’s financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. These significant estimates
include determining a value for Series A Preferred Stock issued and certain
limited anti-dilution rights granted to George J. Coates as more fully described
in Note 13, assigning useful lives to the Company’s property, plant and
equipment, determining an appropriate amount to reserve for obsolete and slow
moving inventory, a valuation allowance for deferred tax assets, assigning
expected lives to and estimating the rate of forfeitures of stock options
granted and selecting a volatility factor for the Company’s stock options in
order to estimate the fair value of the Company’s stock options on the date of
grant. Actual results
could differ from those estimates.
6
Subsequent
Events
The
Company evaluated subsequent events occurring from the end of the fiscal quarter
through November 16, 2009, the date of the financial statement issuance to
determine if disclosure was warranted in these notes to financial
statements.
3.
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RECENTLY
ISSUED ACCOUNTING STANDARDS
|
Effective
July 1, 2009, with the objective of reducing the complexity inherent in
recognizing numerous sources of generally accepted accounting principles
(“GAAP”), the Financial Accounting Standards Board (“FASB”) changed the
authoritative source of GAAP to a single new source, the FASB Accounting
Standards Codification TM
(“ASC”). The Company has adopted this change effective with the
issuance of these financial statements, and, accordingly, disclosure of changes
in accounting standards will now be based on the applicable sections of the
ASC.
In May
2009, the FASB issued an update to the principles and disclosure requirements
for subsequent events which was adopted by the Company effective with the
issuance of these financial statements. This update requires that subsequent
events occurring between the balance sheet date and the date the financial
statements are issued be evaluated to determine if disclosure should be made in
the notes to the financial statements. This update also describes the
circumstances under which subsequent events should be recognized in financial
statements and the disclosure requirements for subsequent events.
4.
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AGREEMENTS
WITH WELL TO WIRE ENERGY, INC.
|
On
September 29, 1999, the Company signed a sublicense agreement with Well to Wire
Energy, Inc. ("WWE"), a company based in Canada operating in the oil and gas
industry. This agreement exclusively licenses within Canada the use
of the CSRV system technology for industrial engines to be fueled by natural gas
to generate electrical power for the oil and gas industry (the “Canadian
License”). The agreement provided for a license fee of $5,000,000. A deposit
payment in the amount of $300,000 was received at that time. A separate research
and development agreement provided for WWE to pay a $5,000,000 fee to the
Company in consideration for the development and delivery of certain prototype
engines. The Company completed development of the prototypes in accordance with
this agreement at the end of 2007. The research and development agreement has
not been reduced to the form of a signed written agreement. As of September 30,
2009, the Company had been paid a total of approximately $4,003,000 by WWE under
these agreements.
Additional
provisions of the Canadian License agreement are as follows:
●
|
WWE
shall have the exclusive right to use, lease and sell electric power
generators that are based on the CSRV System technology within Canada for
use in the oil and gas industry.
|
●
|
WWE
shall have a specified right of first refusal to market the electric power
generators worldwide in the oil and gas industry and landfill
operations.
|
●
|
Upon
commencement of the production and distribution of the electric power
generators, the minimum annual number of generators to be purchased by WWE
in order to maintain exclusivity is 120. Until otherwise agreed
between the parties, the price per generator shall be $150,000. The
Company received a firm order from WWE for approximately 7,400 CSRV system
technology engine generators at a mutually agreed upon increased price per
unit of $159,000. In the event WWE fails to purchase the minimum 120
Coates generator engines during any year, WWE will automatically lose its
exclusivity. In such case, WWE would retain non-exclusive rights to
continue to use the Coates generator engine in the territory of
Canada.
|
●
|
WWE
shall not be required to pay any royalties as part of the agreements
between the parties.
|
●
|
All
licensed rights under the Canadian License related to the CSRV system
technology will remain with the
Company.
|
7
In 2008,
the Company entered into a conditional second sublicense agreement with
WWE for the territory of the United States (the “US License”). The US
License provides for a license fee of $50 million and annual minimum purchases
of the Company’s CSRV Systems as a condition of exclusivity. The US
license has been deposited into an escrow account and the grant under the
license is not effective until the conditions for release from escrow are
satisfied.
The
Escrow Agreement was established to provide a more secure mechanism for the
Company to collect payments due under both the Canadian licensing and research
and development agreements and the $50 million US License (the “Escrow
Agreement”). The Escrow Agreement provides that the US License shall
be held until WWE remits a release payment (the “Release
Payment”). The Release Payment consists of (i) an initial down payment
required under the US License of $1 million and (ii) $8.5 million in payment of
the balance of the monies due to the Company, at the date of the Escrow
Agreement, in connection with the license for the territory of Canada,
including the Canadian License agreement and the research and development
agreement (the “Canadian Agreements”). While the US License is held in escrow,
there shall not be any grant of license to WWE. WWE is expected to make
non-refundable periodic payments to the Company in unspecified amounts as
partial payments of the Release Payment until the Release Payment has been paid
in full. The first $3.8 million of the Release Payment, which has been
designated as payment of the fees due under the research and development
Agreement, is being recognized as revenue at the time the cash payments are
received. WWE has made nonrefundable payments to the Company totaling $1.5
million prior to 2008. The Company received additional non-refundable payments
from WWE totaling $-0- and $690,000, during the three and nine month periods
ended September 30, 2009, respectively, and totaling approximately $490,000 and
$1,190,000 during the three and nine month periods ended September 30, 2008,
respectively. These payments have been recognized as research and development
revenue in the accompanying statements of operations. Upon full
satisfaction of the Release Payment, WWE would be granted a license for the
territory of the United States under the US License agreement.
WWE is a
privately held company and its ability to make the license payments due to the
Company and to honor the minimum purchase requirements under the licenses is
dependent on the success of its continued efforts to raise new equity
capital. At September 30, 2009, the remaining balance of the Release
Payment was approximately $6,997,000, not including compounded interest on the
unpaid balance at 5% per annum of approximately $494,000. To the extent
that WWE is not successful or experiences delays in raising such additional new
equity capital, the Company’s cash flow, results of operations and financial
condition could be adversely affected.
WWE was
unable to remit the entire remaining amount of the Release Payment required to
be made under the Amended Escrow Agreement by September 30, 2009 (the “Extended
Payment Period”). In consideration of the severe world-wide economic climate and
WWE’s continued good faith efforts to continue to make periodic, non-refundable
installments of the Release Payment, the Company has entered into negotiations
with WWE regarding a mutually agreeable, revised schedule of payments for the
remaining balance of the Release Payment and accrued interest. The Company has
notified WWE that, during this period of negotiations with WWE, it intends to
enter into discussions with other interested third parties for the sale of
products manufactured with the CSRV system technology, including products
designed for applications in the oil and gas industry.
8
During
the period of negotiations, interest continues to accrue on the unpaid balance
of the Release Payment at the rate of 5% per annum. Such interest
shall only be recognized as income upon receipt from WWE.
Upon
payment of the entire Release Payment under the Escrow Agreement, the US License
would grant to WWE the right to use, sell and lease Licensed Products
manufactured by the Company, as the power source for the generation of
electrical energy for the oil and gas industry and
landfills. Licensed Products consist of CSRV Valve Systems, CSRV
Valve Seals, CSRV Rotary Valve Spheres, CSRV Valve Components and CSRV Engines
for the oil and gas industry and landfills.
Under the
license agreement, the manufacture of any Licensed Products by WWE is
prohibited. WWE is required to procure all internal combustion
engines incorporating the CSRV system technology from the Company or its
designee. The license to be granted to WWE would be exclusive within the
territory of the United States provided that WWE satisfies the minimum annual
purchase commitment of 120 internal combustion engines incorporating the CSRV
System, the Coates Engines and all component parts. The agreement would also
grant WWE a right of first refusal in the event that the Company negotiates an
offer with another third party for a worldwide license to use the Licensed
Product in the oil and gas industry or landfill operations.
Upon
payment of the entire Release Payment due under the Escrow Agreement, the
remaining unpaid balance of the US License fee of $49 million is payable in
quarterly installments. Such installments were to commence October 2008 in an
amount equal to WWE’s prior quarter net profits. As WWE has not generated a net
profit to date, no quarterly installment payments have been required. In any
event, the entire balance of the licensing fee must be paid in full on or before
February 12, 2012.
Acceleration
of the balance of the licensing fee payments shall be required in the event that
WWE completes a stock offering or private placement offering. The
entire unpaid balance of the licensing fee shall become due and payable if WWE
raises $100 million or more from such an offering.
In 2008,
WWE secured an equipment lease finance commitment from Meek Development
Corporation, (formerly known as Canada West Corporate Finance, Inc.)
(“MDC”), which is to be utilized for its CSRV engine generator purchases
and related equipment and parts over a five-year period pursuant to its
licensing agreement with the Company. The five-year WWE business plan on which
this agreement was based provides for the purchase of approximately 7,400 Engine
Generators. Although the initial price per unit under the firm order
received from WWE was $159,000, the maximum price per unit provided for under
this finance commitment is $222,000. Should WWE fulfill its five year business
plan at the $159,000 unit price, the Company would earn revenues of almost $1.2
billion. The current economic environment, which is characterized by tight
credit markets, investor uncertainty about how to safely invest their funds and
low investor confidence, has introduced additional risk and difficulty for
borrowers. Accordingly, there can be no assurance that tight credit markets will
not affect the availability of funds under the financing commitment obtained
from MDC by WWE.
The Company paid $25,000 of expenses of WWE related financing
transactions it was exploring while working at the Company's offices. This
amount, which is included in amount due from customer on the accompanying
balance sheet at September 30, 2009, was repaid in full in October 2009.
5.
|
INVENTORY
|
Inventory
consisted of the following:
September
30, 2009
|
December
31, 2008
|
|||||||
Raw
materials
|
$ | 390,272 | $ | 366,632 | ||||
Work-in-process
|
32,099 | 32,099 | ||||||
Finished
goods
|
240,000 | 240,000 | ||||||
Reserve
for obsolescence
|
(151,182 | ) | (151,182 | ) | ||||
Total
|
$ | 511,189 | $ | 487,549 |
9
6.
|
TERMINATION
OF LEASE
|
In 2005,
the Company entered into a sale/leaseback arrangement of the property which
houses its headquarters and research and development facility. In
accordance with GAAP, this transaction was required to be accounted for under
the lease finance method until November 2008, because the Company had a
continuing interest in the property represented by an option to repurchase the
property. This option lapsed unexercised in November 2008. The
monthly rental payments provided for by the lease agreement were being accounted
for as interest expense, which amounted to $-0- and $97,500 in the accompanying
statement of operations for the three months ended September 30, 2009 and 2008,
respectively. For the nine months ended September 30, 2009 and 2008, the monthly
rental payment accounted for as interest expense amounted to $-0- and $292,500,
respectively.
The
lapsing of this option in November 2008 required that subsequent monthly rent
payments be accounted for as rent expense under an operating lease. For the
three and nine month periods ended September 30, 2009, the amount of monthly
rent payments reported as rent expense amounted to approximately $-0- and
$179,000, respectively. In addition, the lapsing of this option required the
recognition of the sale of the property and recognition of the gain on this sale
of approximately $2,474,000, of which approximately $1,467,000 was recognized in
November 2008. The remaining portion of the gain was being recognized over the
remaining life of the lease agreement. However, in June 2009, the Company
reacquired the property by submitting a winning bid at an auction of the
property. The reacquisition of the property effectively terminated the lease.
Accordingly, the entire remaining balance of the deferred gain on sale of land
and building was recognized upon the closing. As a result, for the three and
nine month periods ended September 30, 2009, approximately $-0- and $978,000,
respectively, of this deferred gain was recognized and is included in gain on
sale of land and building in the accompanying statement of
operations.
The
repurchase of the property was financed with a $1,750,000 mortgage loan which
bears interest at 7.5% per annum, or approximately $11,000 per month. Prior
thereto, the monthly lease payments under the terminated operating lease were
$32,500.
7.
|
REPURCHASE
OF LAND AND BUILDING
|
In June
2009, the Company reacquired the property which houses its headquarters and
research and development facility by submitting a winning bid at an auction of
the property. The total acquisition cost, which amounted to approximately
$2,199,000, was paid from the proceeds of a mortgage loan in the amount of
$1,750,000 as more fully discussed in Note 8, application of a security deposit
held by the seller of $195,000 and a cash payment of approximately $254,000. The
total purchase price was allocated approximately $1,235,000 to the land and
$964,000 to the building, based on the relative estimated fair values at the
date of acquisition. The building is being depreciated on the straight-line
basis over a period of 40 years.
8.
|
MORTGAGE
LOAN PAYABLE
|
In June
2009, the Company reacquired the land and building that serves as its
headquarters and research and development facility for approximately
$2,199,000. The purchase was funded in part from the proceeds of a
$1,750,000 mortgage loan which bears interest at the rate of 7.5% per annum.
Interest-only payments are required for the first year. The initial term is for
one year and the loan may be extended for one additional year at the option of
the borrower, provided that the entire unpaid balance of the Release Payment due
from WWE is paid during the first year of the mortgage loan; and, further
provided that the Company receives at least $3 million of working capital or
earned net income and generated positive cash flow of at least $1 million during
the first year of the mortgage loan. Monthly payments during the
second year are comprised of interest only, plus $2,100. The Company incurred
approximately $25,000 of expenses in connection with securing this mortgage
loan. This amount, net of periodic amortization, is included in prepaid and
other assets in the accompanying balance sheet as of September 30, 2009. This
amount is being amortized to interest expense over the initial one year term.
The loan is collateralized by a security interest in all of the Company’s
assets, the pledge of 5 million shares of common stock of the Company owned by
George J. Coates, which were deposited into escrow for the benefit of the lender
and the personal guarantee of George J. Coates. The Company has also deposited
$100,000 into an interest- bearing interest reserve account with the lender,
which cannot be drawn upon by the Company. The Company received a waiver from
the lender alleviating it of the obligation to deposit an additional $50,000 to
the interest reserve account in September 2009. The Company is not permitted to
create or permit any secondary mortgage or similar liens on the property or
improvements thereon without prior consent of the lender. Up to $500,000 of the
principal balance of the mortgage loan may be prepaid each year without penalty.
A prepayment penalty of 2% of the outstanding loan amount would be imposed if
the loan is repaid in full at or before maturity unless such prepayment funds
are obtained from a permanent mortgage loan obtained from the
lender.
10
9.
|
10%
CONVERTIBLE NOTE DUE JANUARY 2010
|
The
Convertible Note is convertible at the option of the holder into shares of the
Company’s common stock at an initial conversion rate that is determined by
dividing the principal amount of the note being converted by $0.45. Interest
shall accrue at the rate of 10% per annum and shall be payable in cash only at
maturity. All interest shall be forfeited upon conversion, in which case the
holder would be entitled to dividends declared, if any, on the Company’s common
stock during the time the convertible note was outstanding. The Company has
reserved 44,444 shares of its common stock for conversion of the balance of this
note.
10.
|
AMOUNT
DUE TO RELATED PARTY
|
In July
2009, the Company received $200,000 from the son of a director. The Company and
the payee are negotiating the terms and conditions of this borrowing. The
Company has estimated a market rate of interest on this borrowing at the rate of
22% per annum and, accordingly, has recorded accrued interest of approximately
$8,000 for the three months ending September 30, 2009.
11.
|
CONTRACTUAL
OBLIGATIONS
|
The
following table summarizes the Company’s contractual obligations at September
30, 2009:
Amount
Due Within
|
||||||||||||||||
Total
|
2009
|
2010
|
2011
|
|||||||||||||
Employment
Agreements(1)
|
$ | 833,333 | $ | 100,000 | $ | 400,000 | $ | 333,333 | ||||||||
Mortgage
Loan Payable(2)
|
1,750,000 | - | 1,750,000 | - | ||||||||||||
10%
Convertible Note
|
20,000 | - | 20,000 | - | ||||||||||||
Total
|
$ | 2,603,333 | $ | 100,000 | $ | 2,170,000 | $ | 333,333 |
(1)
|
The
Company’s obligation under employment agreements would increase to
$550,000 per year through October 23, 2011, upon the Company’s
achievement of an adequate level of working capital, as
defined.
|
|
(2)
|
The
mortgage loan payable provides for an option to extend the maturity for
one additional year at the Company’s option, provided that the entire
unpaid balance of the Release Payment due from WWE is paid during the
first year of the mortgage loan; and, further provided that the Company
receives at least $3 million of working capital; or earns net income and
generates positive cash flow of at least $1 million during the first year
of the mortgage loan.
|
11
12.
|
COMMON
STOCK
|
In the
third quarter of 2009, the Company sold 398,500 shares of its common stock under
the equity line of credit with Dutchess Private Equities Fund, Ltd. and received
proceeds of approximately $266,000 which were used for working capital purposes
(See Note 14.)
In April
2009, the Company sold 428,571 shares of common stock and warrants to purchase
428,571 shares of its common stock at an exercise price of $0.35 per share in
private sales of unregistered, restricted securities to the son of a
director pursuant to stock purchase agreements and received net proceeds of
$150,000 which were used for working capital purposes.
In March
2009, the Company sold 838,096 shares of its common stock, warrants to
purchase 333,333 shares of its common stock at an exercise price of $0.30 per
share and warrants to purchase 85,714 shares of its common stock at an exercise
price of $0.35 per share in private sales of unregistered,
restricted securities to the son of a director pursuant to stock purchase
agreements and received net proceeds of $260,000 which were used for working
capital purposes.
In
connection with the settlement of litigation in March 2009, a certificate
representing the ownership of 25,000 shares of common stock was surrendered by
one of the parties. These shares were retired and returned to authorized, but
unissued status.
In
January 2008, the Company sold 15,000 shares of its common stock under the
equity line of credit with Dutchess Private Equities Fund, Ltd. and received
proceeds of approximately $8,000 which were used for working capital purposes
(See Note 14.)
In June
2009, the Company granted certain limited anti-dilution rights to George J.
Coates, President and Chief Executive Officer in consideration of his pledge of
5 million shares of the Company’s common stock personally owned by him and his
personal guarantee of the new mortgage loan, the proceeds of which were used to
finance a portion of the purchase price of the Company’s headquarters and
research and development facility, as more fully discussed in Notes 8 and
13.
13.
|
PREFERRED
STOCK AND ANTI-DILUTION RIGHTS
|
In June
2009, the board designated 25,000 shares of the total 100,000,000 shares of
authorized shares of preferred stock as Series A Preferred Stock, $0.001 par
value per share. Each share of Series A Preferred Stock entitles the holder of
record to the right to vote 10,000 shares of common stock with respect to all
matters that are submitted to a vote of shareholders. The Series A Preferred
Stock does not provide the holder any rights to share in dividends or any
distribution of assets to any other shareholders of any other class of the
Company’s securities in a liquidation or for any other purpose.
In June
2009, George J. Coates agreed to pledge his shares of common stock of the
Company to the extent required by the lender and provide a personal guaranty as
additional collateral for a mortgage loan in the amount of $1,750,000, the
proceeds of which were used to finance a portion of the repurchase of the
Company’s headquarters and research and development facility. In addition, he
made a commitment to pledge additional shares of his common stock of the Company
and give his personal guarantee in connection with (i) a working capital loan to
fund the start up of production, and (ii) a mortgage loan to finance the
possible acquisition of a manufacturing plant which the Company has been
considering as part of its short term business plan. In consideration of this
pledge of Mr. Coates’ shares of common stock of the Company and his personal
guaranty, the Company issued 10,000 shares of fully paid and non-assessable
Series A Preferred Stock, $0.001 par value, and provided limited anti-dilution
protection to Mr. Coates.
The
issuance of these shares of Preferred Stock reduced the voting percentage of all
other shareholders, but did not affect their rights with respect to any
dividends and other distributions made by the Company and will have no affect on
the earnings per share applicable to holders of common stock.
12
Based on
274,368,303 shares of common stock outstanding as of June 30, 2009, the end of
the quarter in which these actions were taken, the voting rights of the holders
of the Company’s common stock were affected as follows:
Percentage
of voting rights held:
|
George
J. Coates
|
All
Other Shareholders
|
As
of June 30, 2009
|
75.91%
|
24.09%
|
Change
resulting from issuance of the Series A Preferred Stock
|
82.35%
|
17.65%
|
All
shares of the Company’s common stock directly or beneficially owned by George J.
Coates (“GJC Shares”) were granted conditional anti-dilution protection. Such
anti-dilution protection will only be triggered in the event that any GJC Shares
pledged as collateral for any indebtedness of the Company are sold by the lender
in order to satisfy all or any portion of the Company’s outstanding
indebtedness, including any related unpaid accrued interest or other unpaid
obligations arising out of such indebtedness. In any such event, the Company
shall issue additional shares of common stock to George J. Coates so that he
shall hold the same percentage of the then resulting new total of outstanding
common shares after the issuance of such new shares of common stock to George J.
Coates as the percentage he held before the issuance of such new shares of
common stock.
In the
event that the conditional anti-dilution protection is triggered, the ownership
interests, share of dividends or any other distributions from the Company and
voting interests of all other holders of the Company’s common stock would be
diluted.
The
Company arranged for an independent professional services firm to determine the
estimated fair value of the shares of Series A Preferred Stock and the limited
anti-dilution protection provided to Mr. Coates. The aggregate value of the
Series A Preferred Stock and the limited anti-dilution protection amounted to
$10,000. This amount, which was recorded as deferred financing costs, is
included in prepaid expenses and other assets in the accompanying balance sheet
as of September 30, 2009 and is being amortized to interest expense over the
twelve month term of the related mortgage loan.
14.
|
INVESTMENT
AGREEMENT WITH DUTCHESS PRIVATE EQUITIES FUND, LTD. AND REGISTRATION OF
SECURITIES
|
In April
2007, the Company entered into an Investment Agreement with Dutchess Private
Equities Fund, Ltd. (the “Investor”). Pursuant to this Agreement, the Investor
has committed to purchase up to $10,000,000 of the Company’s common stock over
the course of thirty-six (36) months. The amount that the Company shall be
entitled to request from each purchase (a "Put") shall be equal to, at the
Company’s election, either (i) up to $500,000 or (ii) 200% of the average daily
volume (U.S. market only) of the common stock for the ten (10) trading days
prior to the applicable Put notice date, multiplied by the average of the three
(3) daily closing bid prices immediately preceding the put date. The Put date
shall be the date that the Investor receives a put notice of a draw down from
the Company. The purchase price shall be set at ninety-three percent (93%) of
the lowest closing Best Bid price of the common stock during the pricing period.
The pricing period shall be the five (5) consecutive trading days immediately
after the Put notice date. There are Put restrictions applied on days between
the put date and the closing date with respect to that particular Put. During
this time, the Company shall not be entitled to deliver another Put notice.
Further, the Company shall reserve the right to withdraw that portion of the Put
that is priced below seventy-five percent (75%) of the lowest closing bid prices
for the 10-day trading period immediately preceding each put
notice.
In
connection with this transaction, the Company filed a registration statement
with the Securities and Exchange Commission (“SEC”) covering 15,000,000 shares
of the common stock underlying the Investment Agreement which became effective
in 2007. The Company shall have an ongoing obligation to register additional
shares of its common stock as necessary underlying the draw downs.
13
During
the nine months ended September 30, 2009, the Company sold 398,500 shares of its
common stock under the equity line of credit with Dutchess Private Equities
Fund, Ltd. and received proceeds of approximately $266,000. During the nine
months ended September 30, 2008, the Company sold 15,000 shares of its common
stock under this equity line of credit and received proceeds of approximately
$8,000. At September 30, 2009, the remaining unused portion of the $10,000,000
equity line of credit was approximately $8,500,000.
15.
|
LOSS
PER SHARE
|
At
September 30, 2009, the Company had 2,852,062 shares of common stock potentially
issuable upon assumed conversion of (i) $20,000 principal amount of a 10%
convertible note into 44,444 shares of common stock, (ii) 42 outstanding
warrants to purchase 210,000 shares of common stock at a price per share of
$1.10; and, (iii) warrants to purchase 333,333 shares of common stock at a price
per share of $0.30 and warrants to purchase 514,285 shares of common stock at a
price per share of $0.35 and (iv) 1,166,665 vested stock options and 583,335
non-vested stock options to purchase shares of common stock at a price per share
of $0.44.
For the
nine months ended September 30, 2009 and 2008, no potentially issuable shares of
common stock were assumed to be converted for the loss per share calculation
because the Company incurred a net loss in those periods and the effect of
including them in the calculation would have been
anti-dilutive.
16.
|
STOCK
OPTIONS
|
The
Company’s 2006 Stock Option and Incentive Plan (the “Stock Plan”) which has been
adopted by the Company’s stockholders, provides for the grant of stock-based
awards to employees, officers and directors of, and consultants or advisors to,
the Company and its subsidiaries, if any. Under the Stock Plan, the
Company may grant options that are intended to qualify as incentive stock
options (“incentive stock options”) within the meaning of Section 422 of
the Internal Revenue Code of 1986, as amended, options not intended to qualify
as incentive stock options (“non-statutory options”), restricted stock and other
stock-based awards. Incentive stock options may be granted only to
employees of the Company. A total of 12,500,000 shares of common
stock may be issued upon the exercise of options or other awards granted under
the Stock Plan. The maximum number of shares with respect to which
awards may be granted to any employee under the Stock Plan shall not exceed 25%
of the 12,500,000 shares of common stock covered by the Stock Plan.
The Board
of Directors or Compensation Committee may, in its sole discretion, amend,
modify or terminate any award granted or made under the Stock Plan, so long as
such amendment, modification or termination would not materially and adversely
affect the participant.
On
January 19, 2009, options to purchase 1,750,000 shares of the Company’s common
stock at an exercise price of $0.29 per share were granted to the Company’s
officers and directors. These options were scheduled to become vested on January
19, 2010. In July 2009, the board of directors cancelled all of the stock
options granted on January 19, 2009 at an exercise price of $0.29 per share. In
accordance with GAAP, the cancellation of these stock options triggers the
recording of the entire balance of the unrecognized stock-based compensation
expense at the date of cancellation. Accordingly, the Company recorded
stock-based compensation expense amounting to approximately $251,000 in the
third quarter of 2009 for these cancelled stock options. No stock options were
granted during the three and nine month periods ended September 30,
2008.
The
weighted-average fair value of 583,335 non-vested stock options at September 30,
2009 was approximately $235,000. Total compensation cost related to non-vested
stock options at September 30, 2009 that has not been recognized was
approximately $12,000. This non-cash compensation expense will be recognized in
the future over a remaining weighted average period of approximately 0.62
years.
14
At
September 30, 2009, the fair value of 10,000 unvested, non-employee stock
options granted to the Company’s general corporate counsel was approximately
$4,000.
For the
three months ended September 30, 2009 and 2008, the Company recorded non-cash
stock-based compensation expense amounting to approximately $268,000 and
$58,000, respectively, relating to stock option grants. For the three months
ended September 30, 2009 and 2008, approximately $-0- and $47,000, respectively,
of this amount was included in research and development expenses and
approximately $268,000 and $11,000, respectively, of this amount was included in
general and administrative expenses in the accompanying statements of
operations. Included in stock option expense for the nine months ended September
30, 2009 was $459,000 of stock-based compensation expense related to the stock
options granted in January 2009 and cancelled in July 2009.
For the
nine months ended September 30, 2009 and 2008, the Company recorded non-cash
stock-based compensation expense amounting to approximately $533,000 and
$185,000, respectively, relating to stock option grants. For the nine months
ended September 30, 2009 and 2008, approximately $115,000 and $135,000,
respectively, of this amount was included in research and development expenses
and approximately $418,000 and $50,000, respectively, of this amount was
included in general and administrative expenses in the accompanying statements
of operations.
A summary
of the activity for the nine months ended September 30, 2009 in the Company’s
Stock Option Plan for employees and directors is as follows:
Per
Share Exercise Prices
|
Number
Outstanding
|
Weighted
Average Remaining Contractual Life (Years)
|
Number
Exercisable
|
Weighted
Average Exercise Price
|
Weighted
Average Fair Value Per Share at Date of Grant
|
|||||||||||||||||||
Balance,
1/1/09
|
$ | 0.44 | 1,775,000 | 13 | 1,161,665 | $ | 0.44 | $ | 0.40 | |||||||||||||||
$ | 0.29 | - | - | - | - | |||||||||||||||||||
Granted,
1/19/09
|
0.29 | 1,750,000 | 15 | - | 0.29 | 0.27 | ||||||||||||||||||
Cancellation
and Forfeitures
|
0.44 | (50,000 | ) | (30,000 | ) | |||||||||||||||||||
Cancellation
and Forfeitures
|
0.29 | (1,750,000 | ) | - | ||||||||||||||||||||
Vesting
|
0.44 | 35,000 | ||||||||||||||||||||||
Balance,
9/30/09
|
$ | 0.44 | 1,725,000 | 13 | 1,166,665 | $ | 0.44 | $ | 0.40 | |||||||||||||||
$ | 0.29 | - | - | - | $ | 0.29 | $ | 0.27 |
A summary
of the activity for the nine months ended September 30, 2008 in the Company’s
Stock Option Plan for employees and directors is as follows:
Per
Share Exercise Price
|
Number
Outstanding
|
Weighted
Average Remaining Contractual Life (Years)
|
Number
Exercisable
|
Weighted
Average Exercise Price
|
Weighted
Average Fair Value Per Share at Date of Grant
|
|||||||||||||||||||
Balance,
1/1/08
|
$ | 0.44 | 1,775,000 | 14 | 583,333 | $ | 0.44 | $ | 0.40 | |||||||||||||||
Vesting
|
0.44 | 35,000 | ||||||||||||||||||||||
Balance,
9/30/08
|
$ | 0.44 | 1,775,000 | 14 | 618,333 | $ | 0.44 | $ | 0.40 |
15
The
weighted average fair value of the Company's stock-based compensation expense of
$0.27 per share for the stock options granted in January 2009 and $0.40 per
share for stock options granted in April 2007 was estimated using the
Black-Scholes option pricing model which requires subjective assumptions
including the expected stock price volatility. These assumptions were as
follows:
Granted January 2009
|
Granted April 2007
|
||||
●
|
Historical
stock price volatility
|
180
|
180
|
||
●
|
Risk-free
interest rate
|
1.26%
|
4.56%-4.64%
|
||
●
|
Expected
life (in years)
|
4
|
4
|
||
●
|
Dividend
yield
|
0.00%
|
0.00%
|
The
valuation assumptions were determined as follows:
●
|
Historical
stock price volatility: The Company obtained the volatility factor of
other publicly traded engine manufacturers that were also in the research
and development stage.
|
●
|
Risk-free
interest rate: The Company bases the risk-free interest rate on the
interest rate payable on U.S. Treasury securities in effect at the time of
the grant for a period that is commensurate with the assumed expected
option life.
|
●
|
Expected
life: The expected life of the options represents the period of time
options are expected to be outstanding. The Company has very limited
historical data on which to base this estimate. Accordingly, the Company
estimated the expected life based on its expectation that its employees,
officers and directors will be subject to frequent black out periods
during the time that the stock options will be exercisable and
based on the Company’s expectation that it will commence its initial
production phase. The vesting period of these options was also considered
in the determination of the expected life of each stock option
grant.
|
●
|
No
expected dividends.
|
The same
methodology and assumptions were utilized in estimating the fair value of
non-employee stock options granted to the Company’s general corporate counsel,
as discussed above.
17.
|
INCOME
TAXES
|
Deferred
tax assets increased by approximately $254,000 and $90,000 for the three months
ended September 30, 2009 and 2008, respectively. Deferred tax assets decreased
by approximately ($218,000) and ($60,000) for the nine months ended September
30, 2009 and 2008, respectively. These amounts were fully offset by a
corresponding increase or decrease in the tax valuation allowance resulting in
no net change in deferred tax assets, respectively during these
periods.
18.
|
RELATED
PARTY TRANSACTIONS
|
Coates Motorcycle Company,
Ltd.
The
Company had an approximately 30% ownership interest in Coates Motorcycle
Company, Ltd. (“Coates Motorcycle”), a company that was researching and
developing a heavy cruiser motorcycle equipped with the CSRV engine. George J.
Coates, Gregory Coates and The Coates Family Trust collectively held the
majority of the shares of common stock of Coates Motorcycle. In 2007, Coates
Motorcycle disbursed all of its remaining cash, curtailed all of its operations
and has been insolvent since that time. In July 2009, the Company notified
Coates Motorcycle that the license agreement for the sale of motorcycles in the
territory of the Western Hemisphere was terminated under the provisions of the
license due to its insolvency. Coates Motorcycle was dissolved in July 2009. As
the Company has not been engaged in any other activities with Coates Motorcycle
and its investment in Coates Motorcycle has previously been written down to
$-0-, this did not have any impact on the Company’s financial position or
results of operations. For the three months ended September 30, 2009 and 2008,
Coates Motorcycle incurred losses of approximately $-0- and $22,000,
respectively. For the nine months ended September 30, 2009 and 2008, Coates
Motorcycle incurred losses of approximately $44,000 and $68,000, respectively.
The losses primarily resulted from the recording of stock-based compensation
expense.
16
Compensation and Benefits
Paid
The
approximate amount of compensation and benefits paid to George J. Coates,
Gregory Coates and Bernadette Coates, exclusive of non-cash stock-based
compensation for employee stock options granted to George J. Coates and Gregory
Coates is summarized as follows:
For the Three Months
Ended September 30,
|
For the Nine Months
Ended September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
George
J. Coates
|
$ | 68,000 | $ | 80,000 | $ | 220,000 | $ | 201,000 | ||||||||
Gregory
Coates
|
39,000 | 39,000 | 133,000 | 103,000 | ||||||||||||
Bernadette
Coates
|
18,000 | 18,000 | 58,000 | 52,000 |
Included
in the above amounts is compensation paid for vacation earned but not taken
during the nine months ended September 30, 2009 and 2008.
Barry C.
Kaye, Treasurer and Chief Financial Officer was paid compensation of
approximately $21,000 and $15,000 during the three months ended September 30,
2009 and 2008, respectively, and approximately $78,000 and $53,000 during the
nine months ended September 30, 2009 and 2008, respectively.
Other
As
discussed in Note 10, the Company received $200,000 from the son of a director
in July 2009 and has accrued interest expense of approximately $8,000 for the
three months ended September 30, 2009.
19.
|
LITIGATION
AND CONTINGENCIES
|
Mark D.
Goldsmith, a former executive of the Company, filed a lawsuit in January 2008 in
which he asserts that the Company is liable to him for breach of an employment
contract that never became effective. In the opinion of management, Mr.
Goldsmith’s performance was unsatisfactory and, accordingly, he was offered the
opportunity to resign. Further, management is of the opinion that the claim of
Mr. Goldsmith is baseless because the Company had cause to terminate its
relationship with Mr. Goldsmith. The Company intends to vigorously defend this
lawsuit and has instituted a counterclaim against Mr. Goldsmith. The Company
believes that Mr. Goldsmith misrepresented his background and capabilities in
order to induce it and/or Coates Motorcycle Company, Ltd. ("CMC") to hire him.
The Company is also contending that certain of Mr. Goldsmith's business
decisions were made to further his self interest rather than the interests of
the Company. The Company believes that Mr. Goldsmith's claims have no basis in
fact and, accordingly, that the outcome of this legal action will not be
material to its financial condition or results of operations. As a result of the
information disclosed in the deposition of Mr. Goldsmith, the Company filed a
dispositive motion for summary judgment. This motion together with a cross
motion for summary judgment that was filed by Mr. Goldsmith (the “Cross Motion”)
were argued with other motions on October 23, 2009. At the conclusion of these
arguments, the Court entered an order denying Mr. Goldsmith’s Cross Motion and
the Company’s motion for summary judgment. Trial has been scheduled to commence
on December 8, 2009. The Company intends to vigorously defend against Mr.
Goldsmith’s claims and pursue its counterclaims.
17
In March
2004, the Company, certain of its officers and directors and other related and
unrelated parties were named as co-defendants, along with WWE in a lawsuit
brought in the Superior Court of New Jersey captioned H. Alton Neff v. George
Coates, Coates International, Ltd. et al. A countersuit was also instituted by
the Company and WWE. A plaintiff contended that he was the assignee of 1107
North West Central Avenue Inc. ("1107"). Preliminary agreements and an amendment
thereto relating to purchase of a certain license by 1107 from the Company
provided, inter alia, that a $500,000 deposit made by 1107 to the Company would
convert to shares of the Company’s restricted common stock if certain conditions
were not met by 1107. The Company maintained that such conditions were not met
and therefore, the deposit converted into shares of the Company’s restricted
common stock. The claims were settled in March 2009 through mediation. Pursuant
thereto, the Company and WWE each paid $92,500 to 1107. The Company’s $92,500
portion of the settlement was charged to expense in December 2008. All
parties executed mutual releases and all claims have been dismissed with
prejudice. As a condition of the settlement, Mr. Sommer of 1107 endorsed to the
Company a stock certificate evidencing 25,000 shares of the Company’s common
stock. In March 2009, the shares of stock evidenced by that stock certificate
were retired and restored to authorized, unissued common stock status. The
Company was not required to return the $500,000 deposit originally made by 1107
and previously converted into shares of its common stock.
In 2007,
the Company received a demand letter from a law firm requesting payment of
approximately $77,000 in connection with a promissory note issued to the law
firm as security for the payment of future services to the Company. The Company
had notified the holder of this note that it does not intend to honor the
promissory note because the law firm did not provide the services contemplated
to be performed as consideration for the promissory note. No further action to
pursue collection of this promissory note has been taken to date by the holder.
In the opinion of management, the likelihood of the Company being required to
make any payments to the holder of the note is remote and, accordingly, no
amount has been accrued.
The
Company is not a party to any other litigation that is material to its
business.
20.
|
SUBSEQUENT
EVENTS
|
Joint Venture
Formation
In
October 2009, the Company entered into a joint venture (“JV”) arrangement with
an independent third party for the purpose of undertaking a private offering of
collateralized zero coupon bonds to institutional investors. If successful, the
net proceeds are expected to be approximately $300 million, which would become
available to the Company for working capital purposes as needed to fulfill its
business plan. The Company intends to use a large portion of the net proceeds
over the first twelve months for the start up capital necessary to commence
production in New Jersey while it is setting up large scale manufacturing in
Oklahoma. Thereafter, remaining net proceeds from this offering would be
employed in establishing additional large scale manufacturing for other
applications of its CSRV system technology.
The
Company is required to pay an up front $400,000 engagement and services fee to
its JV partner. The Company paid $50,000 of this fee in October 2009.
Although the Company will own 90% of the JV entity, it will be allocated 100% of
the JV entity’s profits and losses. Although the JV entity would be the issuer
of the zero coupon bonds, the JV entity would have liens on all of the assets of
the Company, including all of its intellectual property. This entity’s financial
condition and results of operations will be required to be consolidated into the
Company’s financial statements in future reporting periods.
18
Issuance of Promissory
Notes
In late
October 2009, the Company received $100,000 from The Coates Family Trust, a
trust owned and controlled by George J. Coates and $100,000 from one of its
directors and issued promissory notes which mature in July 2010 and provide for
interest at the rate of 17% per annum, compounded monthly. A transaction fee of
$7,500 related to each promissory note is also payable at maturity. For
accounting purposes, the transaction fees will be amortized to interest expense
over the term of the promissory notes resulting in a combined effective annual
rate of interest of approximately 28.7%.
Grant
of Employee Stock Options
In
November 2009, the Company granted 50,000 employee stock options each to George
J. Coates and one of its directors pursuant to the Stock Plan. Each stock option
vests upon one year of service, expires in November 2024 and may be exercised to
purchase one share of the Company’s common stock at a price per share of
$0.43.
19
Item
2. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward Looking
Statements
This
quarterly report on Form 10-Q contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 and Federal
securities laws, and is subject to the safe-harbor created by such Act and laws.
Forward-looking statements may include our statements regarding our goals,
beliefs, strategies, objectives, plans, including product and service
developments, current dependence on our agreements with Well to Wire Energy,
Inc., future financial conditions, results or projections or current
expectations. In some cases, you can identify forward-looking statements by
terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,”
“believe,” “estimate,” “predict,” “potential” or “continue,” the negative of
such terms, or other comparable terminology. These statements are subject to
known and unknown risks, uncertainties, assumptions and other factors that may
cause actual results to be materially different from those contemplated by the
forward-looking statements. The business and operations of Coates International,
Ltd. are subject to substantial risks, which increase the uncertainty inherent
in the forward-looking statements contained in this report. Except as required
by law, we undertake no obligation to release publicly the result of any
revision to these forward-looking statements that may be made to reflect events
or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. Further information on potential factors that could affect
our business is described in our various periodic reports filed with the SEC.
Readers are also urged to carefully review and consider the various disclosures
we have made in this and such previously filed reports.
Background
We have
completed development of the Coates spherical rotary valve engine (“CSRV”)
system technology. We believe that the CSRV system technology delivers
significant competitive advantages over conventional internal combustion
engines, including a substantial improvement in fuel efficiency, a substantial
reduction in harmful emissions and longer intervals between scheduled engine
maintenance. This technology has been successfully applied to natural gas fueled
industrial electric power generator engines, automobile engines, residential
generators and high performance racing car engines. We have also completed
designing and retrofitting the CSRV system technology into a diesel engine for
heavy trucks. The next steps on this diesel truck engine include completing the
mapping of the computer circuitry for certain truck functions powered by the
engine and testing. We have been developing plans for transitioning
to large scale production in order to be properly positioned to take advantage
of this technology as it achieves acceptance in the marketplace. This
includes searching for the optimal location, shipping logistics, manufacturing
facility and qualified labor pool for such large scale
manufacturing. We continue to actively seek out new sources of
working capital to fund our plans for the commencement of manufacturing
activities.
We are
also engaged in new research and development activities in connection with
applying this technology to other commercially feasible internal combustion
engine applications and are planning to manufacture engines and/or license the
technology to third party Original Equipment Manufacturers (“OEMs”) for multiple
other applications and uses. We believe the CSRV system technology has wide
applicability to products of all types powered by internal combustion
engines.
We are
actively engaged in efforts to raise working capital to fund our ongoing
operations and the start up of large scale production of our products
incorporating the CSRV system technology.
Significant
Estimates
The
preparation of our financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. These significant estimates include determining a value for
the Series A Preferred Stock issued and certain limited anti-dilution rights
granted to George J. Coates, assigning useful lives to our property, plant and
equipment, determining an appropriate amount to reserve for obsolete and slow
moving inventory, a valuation allowance for deferred tax assets, assigning
expected lives to and estimating the rate of forfeitures of stock options
granted and selecting a volatility factor for our stock options in order to
estimate the fair value of our stock options on the date of grant.
20
Agreements with Well to Wire Energy, Inc.
On
September 29, 1999, we signed a sublicense agreement with Well to Wire Energy,
Inc. (“WWE”), a company based in Canada that services the oil and gas industry.
This agreement exclusively licenses within Canada the use of the CSRV system
technology for industrial engines to be fueled by natural gas to generate
electrical power for the oil and gas industry (the “Canadian License”). The
agreement provided for a license fee of $5,000,000. A deposit payment in the
amount of $300,000 was received at that time. A separate research and
development agreement provided for WWE to pay us a $5,000,000 fee in
consideration for the development and delivery of certain prototype engines. We
completed development of the prototypes in accordance with this agreement at the
end of 2007. The research and development agreement has not been reduced to the
form of a signed, written agreement. As of September 30, 2009, we have been paid
a total of approximately $4,003,000 by WWE under these agreements.
Additional
provisions of the Canadian License agreement are as follows:
●
|
WWE
shall have the exclusive right to use, lease and sell electric power
generators that are based on the CSRV System technology within Canada for
use in the oil and gas industry.
|
●
|
WWE
shall have a specified right of first refusal to market the electric power
generators worldwide in the oil and gas industry and landfill
operations.
|
●
|
Upon
commencement of the production and distribution of the electric power
generators, the minimum annual number of generators to be purchased by WWE
in order to maintain exclusivity is 120. Until otherwise agreed between
the parties, the price per generator shall be $150,000. We received a firm
order from WWE for approximately 7,400 engine generators at a mutually
agreed upon increased price per unit of $159,000. In the event WWE fails
to purchase the minimum 120 Coates generator engines during any year, WWE
will automatically lose its exclusivity. In such case, WWE would retain
non-exclusive rights to continue to use the Coates generator engine in the
territory of Canada.
|
●
|
WWE
shall not be required to pay us any royalties as part of the agreements
between the parties.
|
●
|
All
licensed rights under the Canadian License related to the CSRV system
technology will remain with Coates.
|
In 2008,
we entered into a conditional second sublicense agreement with WWE for
the territory of the United States (the “US License”). The US License
provides for a license fee of $50 million and annual minimum purchases of Coates
CSRV Systems as a condition of exclusivity. The US license has been
deposited into an escrow account and the grant under the license is not
effective until the conditions for release from escrow are
satisfied.
The
Escrow Agreement was established to provide a more secure mechanism for us to
collect payments due under both the Canadian licensing and research and
development agreements and the $50 million US License (the “Escrow
Agreement”). The Escrow Agreement provides that the US License shall be
held until WWE remits a release payment (the “Release Payment”). The
Release Payment consists of (i) an initial down payment required under the US
License of $1 million and (ii) $8.5 million in payment of the balance of the
monies due to us, at the date of the Escrow Agreement, in connection
with the license for the territory of Canada, including the Canadian License
agreement and the research and development agreement (the “Canadian
Agreements”). While the US License is held in escrow, there shall not be any
grant of license to WWE. WWE is expected to make non-refundable periodic
payments to us in unspecified amounts as partial payments of the Release Payment
until the Release Payment has been paid in full. The first $3.8 million of the
Release Payment, which has been designated as payment of the fees due under the
research and development Agreement, is being recognized as revenue at the time
the cash payments are received. WWE has made nonrefundable payments to us
totaling $1.5 million in prior years. In 2009, we received $690,000 of
non-refundable payments from WWE. For the year ended December 31, 2008, we
received $1,813,000 of such payments. These payments were recognized as research
and development revenue. Upon full satisfaction of the Release Payment, WWE
would be granted a license for the territory of the United States under the US
License agreement.
21
WWE is a
privately held company and its ability to make the license payments due to us
and to honor the minimum purchase requirements under the licenses is dependent
on the success of its continued efforts to raise new equity capital. At
September 30, 2009, the remaining balance of the Release Payment was
approximately $6,997,000. Interest on the unpaid balance at 5% per annum of
approximately $494,000 is also due. To the extent that WWE is not successful or
experiences delays in raising such additional new equity capital, our cash flow,
results of operations and financial condition could be adversely
affected.
WWE was
unable to remit the entire remaining amount of the Release Payment required to
be made under the Amended Escrow Agreement by September 30, 2009 (the “Extended
Payment Period”). In consideration of the severe world-wide economic climate and
WWE’s continued good faith efforts to continue to make periodic, non-refundable
installments of the Release Payment, the Company has entered into negotiations
with WWE regarding a mutually agreeable, revised schedule of payments for the
remaining balance of the Release Payment and accrued interest. The Company has
notified WWE that, during this period of negotiations with WWE, it intends to
enter into discussions with other interested third parties for the sale of
products manufactured with the CSRV system technology, including products
designed for applications in the oil and gas industry.
During
the period of negotiations, interest continues to accrue on the unpaid balance
of the Release Payment at the rate of 5% per annum. Such interest
shall only be recognized as income upon receipt from WWE.
Upon
payment of the entire Release Payment under the Escrow Agreement, the US License
would grant to WWE the right to use, sell and lease Licensed Products
manufactured by the Company, as the power source for the generation of
electrical energy for the oil and gas industry and
landfills. Licensed Products consist of CSRV Valve Systems, CSRV
Valve Seals, CSRV Rotary Valve Spheres, CSRV Valve Components and CSRV Engines
for the oil and gas industry and landfills.
Under the
license agreement, the manufacture of any Licensed Products by WWE is
prohibited. WWE is required to procure all internal combustion
engines incorporating the CSRV system technology from the Company or its
designee. The license to be granted to WWE would be exclusive within the
territory of the United States provided that WWE satisfies the minimum annual
purchase commitment of 120 internal combustion engines incorporating the CSRV
System, the Coates Engines and all component parts. The agreement would also
grant WWE a right of first refusal in the event that the Company negotiates an
offer with another third party for a worldwide license to use the Licensed
Product in the oil and gas industry or landfill operations.
Upon
payment of the entire Release Payment due under the Escrow Agreement, the
remaining unpaid balance of the US License fee of $49 million is payable in
quarterly installments. Such installments were to commence October 27, 2008 in
an amount equal to WWE’s prior quarter net profits. As WWE has not
generated a net profit to date, no quarterly installment payments have been
required. In any event, the entire balance of the licensing fee must be paid in
full on or before February 12, 2012.
22
Acceleration
of the balance of the licensing fee payments shall be required in the event that
WWE completes a stock offering or private placement offering. The
entire unpaid balance of the licensing fee shall become due and payable if WWE
raises $100 million or more from such offering.
In 2008,
WWE secured an equipment lease finance commitment from Meek Development
Corporation, (formerly known as Canada West Corporate Finance, Inc.)
(“MDC”), which is to be utilized for its CSRV engine generator purchases
and related equipment and parts over a five-year period pursuant to its
licensing agreement with us. The five-year WWE business plan on which this
agreement was based provides for the purchase of approximately 7,400 Engine
Generators. Although the initial price per unit under the firm order
we received from WWE was $159,000 per unit, the maximum price per unit provided
for under this finance commitment is $222,000. Should WWE fulfill its five year
business plan at a price per unit of $159,000, we would earn revenues of almost
$1.2 billion. The current economic environment, which is characterized by tight
credit markets, investor uncertainty about how to safely invest funds and low
investor confidence, has introduced additional risk and difficulty for
borrowers. Accordingly, there can be no assurance that tight credit markets will
not affect the availability of funds under the financing commitment obtained
from MDC by WWE.
We do not
currently have the production capacity to fulfill orders for this number of
engine generators over the next five years. Management believes that
we could be successful in entering into a procurement contract with one or more
major engine suppliers in the United States to deliver engine blocks
incorporating our proprietary pistons and heads. Under this approach,
we would complete the production of the engines by incorporating the CSRV system
technology into these engine blocks.
There are
a number of inherent risks associated with achieving this level of revenues over
the next five years, including:
·
|
Although
we intend to pursue numerous other opportunities to generate revenues from
production of internal combustion engines incorporating the CSRV system
technology and/or licensing of this technology to original equipment
manufacturers, until we are able to enter into definitive agreements with
new customers, our revenues will be concentrated with a single customer,
WWE. WWE will be required to remit periodic installments of the
Release Payment due us under the Escrow Agreement to retain their
exclusivity.
|
·
|
There
can be no assurances that we will have adequate capital resources to
acquire an appropriate manufacturing plant and procure a sufficient number
of engine blocks, inventory and parts on a timely basis, as well as cover
the payroll costs for an increased labor force and overhead that would be
required in order to fulfill orders for this volume of engine generators
over the next five years. In the event that we are unable to fulfill this
volume of orders, our revenues and profitability would be negatively
impacted to the extent of any such
shortfall.
|
Results of Operations –
Three Months Ended September 30, 2009 Compared to Three Months Ended September
30, 2008
In the
third quarter of 2009, we completely shifted our emphasis towards efforts to
raise working capital and discontinued our efforts on research and development.
As a result, there was a corresponding increase in compensation costs allocated
to general and administrative expenses and no research and development expenses
in this quarter.
Revenue
from research and development was approximately $-0- and $490,000 in 2009 and
2008, respectively. The revenue from research and development
was comprised of non-refundable partial payments of the Release Payment provided
for by our Escrow Agreement with WWE established in connection with our
licensing and research and development agreements.
Research
and development expenses in connection with developing other commercially viable
applications of the CSRV system technology to internal combustion engines were
approximately $-0- and $199,000 for the three months ended September 30, 2009
and 2008, respectively. There were no research and development expenses in the
2009 period because we devoted almost all of our time during this period towards
seeking out new sources of working capital and new business opportunities.
Included in research and development costs for the three months ended September
30, 2008 were approximately $136,000 of allocated compensation and benefits and
approximately $47,000 of stock-based compensation expense.
23
General
and administrative expenses increased to approximately $627,000 for the three
months ended September 30, 2009 from approximately $285,000 in the corresponding
period in 2008. This net increase of approximately $341,000 primarily resulted
from the following: An approximately $257,000 increase in stock-based
compensation expense. This increase was due to the recognition of the remaining
unrecognized stock-based compensation recorded in July 2009, upon cancellation
the stock options granted in January 2009 of approximately $251,000. In
addition, for the three months ended September 30, 2009, all of stock-based
compensation expense was allocated to general and administrative expenses. For
the nine months ended September 30, 2008, approximately 83% of the stock-based
compensation expense of $58,000 was allocated to research and development
expenses. Other increases in general and administrative expenses resulted from
an approximately $123,000 increase in compensation and benefits due primarily to
the discontinuance of allocating any compensation and benefits to research and
development expense in the 2009 period, an increase in travel and entertainment
expenses of approximately $4,000 and a net increase in other expenses of
approximately $4,000, offset by a decrease in patent maintenance expenses of
approximately ($26,000), a decrease in marketing expenses of approximately
($16,000) and a decrease in postage of approximately ($5,000).
Depreciation
and amortization expense increased to approximately $11,000 in the three months
ended September 30, 2009 from approximately $9,000 in the comparable period in
2008.
Interest
expense, net, amounted to approximately $51,000 for the three months ended
September 30, 2009 primarily related to interest expense on the mortgage loan.
For the three months ended September 30, 2008 interest expense, net amounted to
approximately $98,000 in connection with the accounting for the sale/leaseback
transaction on our principal facility which was being accounted for in
accordance with the lease finance method of accounting for leases during that
period.
The
change in deferred tax assets for the three months ended September 30, 2009 and
2008 was fully offset by a valuation allowance, resulting in a $-0- net income
tax provision.
We
incurred net losses for the three months ended September 30, 2009 and 2008 of
approximately ($689,000) and ($102,000), respectively.
Results of Operations – Nine
Months Ended September 30, 2009 Compared to Nine Months Ended September 30,
2008
In the
second and third quarter of 2009, we shifted our emphasis towards efforts to
raise working capital and substantially reduced the extent of our efforts on
research and development. As a result, general and administrative expenses
increased as a significantly lower portion of compensation and benefits and
stock-based compensation expense was allocated to research and development
expenses. We also repurchased the property which serves as our headquarters and
research and development facility resulting in recognition of the approximately
$978,000 balance of the gain on sale of that property which had been deferred
since the sale in 2005.
Revenue
from research and development for the nine months ended September 30, 2009 and
2008, respectively, was approximately $690,000 and $1,190,000, respectively. The
revenue from research and development was comprised of non-refundable partial
payments of the Release Payment provided for by our Escrow Agreement with WWE
established in connection with our licensing and research and development
agreements. Gain on sale of land and building for the nine months ended
September 30, 2009 and 2008 was approximately $978,000 and $-0, respectively.
The gain on sale of land and building in 2009 resulted from the recognition of
the entire remaining balance of the deferred gain on sale of the property which
houses our office, and research and development facility. This entire balance
was recognized as a result of the repurchase of this property, whereupon the
operating lease effectively terminated.
24
Research
and development expenses in connection with developing other commercially viable
applications of the CSRV technology to internal combustion engines were
approximately $255,000 and $495,000 for the nine months ended September 30, 2009
and 2008, respectively. The reduction in research and development expenses in
the 2009 period resulted primarily from a reduction in the effort devoted to
research and development activities as we devoted significantly more time in the
second and third quarter of 2009 towards seeking out new sources of working
capital and new business opportunities. Included in research and development
costs for the nine months ended September 30, 2009 and 2008 were approximately
$138,000 and $315,000, respectively, of allocated compensation and benefits and
approximately $115,000 and $135,000, respectively, of allocated stock-based
compensation expense. There was a net decrease in the amount of stock-based
compensation expense in the first nine months of 2009 resulting from a lower
allocation of this expense to research and development expenses in the second
and third quarters of 2009 due to the shift in our emphasis toward raising
working capital and pursuing new business opportunities. This was partially
offset by the grant of additional employee stock options in January 2009 to
purchase 1,750,000 shares of common stock. The stock options granted in January
2009 were cancelled in July 2009.
General
and administrative expenses increased to approximately $1,753,000 for the nine
months ended September 30, 2009 from approximately $979,000 in the corresponding
period in 2008. This net increase of approximately $774,000 resulted in part
from an approximately $367,000 increase in stock-based compensation expense.
This increase was due to the recording of the remaining unrecognized stock-based
compensation expense of approximately $251,000 recorded in July 2009, upon
cancellation of the stock options granted in January 2009. In addition, for the
nine months ended September 30, 2009, there was a significant reduction in the
amount of stock-based compensation expense allocated to research and development
expenses. General and administrative expenses were also higher because of an
approximately $197,000 increase in compensation and benefits due primarily to
the significant reduction in the amount of allocated compensation and benefits
to research and development expense in the second and third quarter of 2009 and
an increase in rent expense of approximately $179,000 in connection with the
lease of our principal facility. The conditions for recognition of the gain on
this transaction were satisfied in November 2008. Subsequent thereto, payments
under the related lease were recorded as rent expense in accordance with the
accounting for an operating lease. Prior to recognition of this gain, the
transaction met the conditions of the lease finance method of accounting for
leases which requires that the lease payments be recorded as interest expense.
Other increases in general and administrative expenses included: an increase in
legal and professional fees of approximately $48,000, an increase in marketing
and printing of approximately $36,000 and an increase in travel and
entertainment of approximately $18,000, an increase in office expenses of
approximately $4,000, an increase in building expenses of approximately $4,000
and a net increase in other expenses of approximately $3,000, offset by a
decrease in patent maintenance expenses of approximately ($45,000), a decrease
in show expenses of approximately ($18,000), a decrease in shop supplies and
tools of approximately ($15,000) and a decrease in property insurance of
approximately ($4,000).
Depreciation
and amortization expense decreased to approximately $21,000 in the nine months
ended September 30, 2009 from approximately $28,000 in the comparable period in
2008. The net decrease was primarily due to the discontinuance of
depreciation of our building and improvements which were removed from our books
at the time the gain on sale of our land and building was recognized.
Depreciation increased upon reacquisition of our land and building in June
2009.
Interest
expense, net, amounted to approximately $59,000 for the nine months ended
September 30, 2009 primarily related to interest expense on the mortgage loan
which was funded in mid-June 2009. For the nine months ended September 30, 2008,
interest expense, net, amounted to approximately $291,000 in connection with the
accounting for the sale/leaseback transaction on our principal facility which
was being accounted for in accordance with the lease finance method of
accounting for leases during that period.
The
change in deferred tax assets for the nine months ended September 30, 2009 and
2008 was fully offset by a valuation allowance, resulting in a $-0- net income
tax provision.
We
experienced a net loss for the nine months ended September 30, 2009 and 2008 of
approximately ($419,000) compared to a net loss for the corresponding period in
2008, of approximately ($603,000).
25
Liquidity and Capital
Resources
Our cash
position at September 30, 2009 was approximately $102,000, a decrease of
approximately $620,000 from the cash position of approximately $722,000 at
December 31, 2008. We had negative working capital of approximately ($2,285,000)
at September 30, 2009 which represents an approximately ($2,251,000) decrease
from the approximately ($34,000) of negative working capital at December 31,
2008. Our current liabilities of approximately $3,048,000 at September 30, 2009
increased by approximately $1,800,000 from approximately $1,248,000 at December
31, 2008. The increase in current liabilities was primarily due to
the new mortgage loan in the amount of $1,750,000 used to partially fund the
repurchase of the property that serves as our headquarters and research and
development facility and borrowings from a related party of $200,000, offset by
a reduction in accounts payable and accrued liabilities of approximately
$170,000.
Operating
activities utilized cash of approximately ($1,046,000) in the nine months ended
September 30, 2009. Cash utilized by operating activities in the nine months
ended September 30, 2009 consisted primarily of net loss for the period of
approximately ($419,000), reduced by the non-cash gain on sale of land and
building of approximately $978,000, non-cash expenses for stock-based
compensation expense of approximately $533,000, depreciation and amortization of
approximately $21,000, accrued interest expense of approximately $31,000 and
other non-cash expenses of approximately $2,000. In addition, operating cash was
utilized for a cash reduction of accounts payable and accrued liabilities of
approximately ($190,000), reimbursable expenses incurred on behalf of Well to
Wire Energy, Inc. of ($25,000) and inventory purchases of approximately
($24,000), offset by a reduction in prepaid and other assets of approximately
$5,000.
We used
cash for investing activities of approximately $2,075,000 for the nine months
ended September 30, 2009 to reacquire the land and building which serves as our
headquarters and research and development facility for approximately $2,004,000
and an improvement to the land of approximately $71,000. No cash was utilized
for investing activities during the nine months ended September 30,
2008.
Financing
activities generated cash of $2,501,000 for the nine months ended September 30,
2009 comprised of the proceeds of the $1,750,000 mortgage loan, net proceeds of
approximately $676,000 from sales of common stock and warrants and borrowings of
$200,000 from a related party offset by the establishment of a $100,000 interest
reserve account and deferred financing costs incurred of $25,000.
In June
2009, we repurchased the property which houses our headquarters and research and
development facility. Prior thereto, we leased the property under an operating
lease which required monthly lease payments of $32,500. This lease
effectively terminated upon closing of the repurchase transaction. The
repurchase was financed with a $1,750,000 mortgage loan which bears interest at
7.5% per annum, or approximately $11,000 per month. As a result, we will realize
a monthly cash savings of approximately $21,500 per month, or $258,000 during
the one year term of the mortgage loan.
The
Company incurred net losses for the three and nine month periods ended September
30, 2009 and, except for the year ended December 31, 2008, has incurred
recurring annual net losses since inception. As of September 30, 2009, the
Company had a Stockholders’ Deficiency of approximately ($299,000). At September
30, 2009, the Company had negative working capital of approximately
($2,285,000), compared
with negative working capital of approximately ($34,000) at the end of 2008. In
addition, the current economic environment, which is characterized by tight
credit markets, investor uncertainty about how to safely invest funds and low
investor confidence, has introduced additional risk and difficulty in the
Company’s challenge to secure needed additional working capital. These factors
raise substantial doubt about the Company’s ability to continue as a going
concern. Our Independent Registered Accounting Firm has stated in its
independent auditors’ report on our financial statements as of December 31, 2008
and for the year then ended that these factors raise substantial doubt about the
Company’s ability to continue as a going concern.
26
For the
nine months ended September 30, 2009, we raised approximately $676,000 of new
working capital from sales of our common stock and stock warrants. We also
received $690,000 in Release Payments from WWE which is being used for working
capital purposes and we received $200,000 from a related party. In late October
2009, we received $100,000 from George J. Coates and $100,000 from one of our
directors and issued them promissory notes which mature in July
2010.
In
October 2009, we entered into a joint venture arrangement with an independent
third party for the purpose of undertaking a private offering of collateralized
zero coupon bonds to institutional investors. If successful, the net proceeds
are expected to be approximately $300 million which would become available to us
for working capital purposes as needed to fulfill our business plan. We intend
to use the net proceeds over the first twelve months for the start-up capital
necessary to commence production in New Jersey while we are also setting up
large scale manufacturing in Oklahoma. Thereafter, remaining net proceeds from
this offering would be employed in establishing additional large scale
manufacturing for other applications of our CSRV system technology.
In the
opinion of management, we will be required to continue to raise additional
working capital to fully achieve our objectives as we are planning to enter the
production phase of our operations and continue research and development
activities in connection with developing other commercially viable applications
of our CSRV system technology to internal combustion engines. The source of such
additional working capital is anticipated to come from the cash flows under the
Escrow Agreement with WWE, the equity line of credit established with Dutchess
Private Equities Fund, Ltd. (“Dutchess”) and the offering of our equity
securities to prospective institutional investors introduced by Stonegate
Securities. We are carefully managing the pace at which we draw working capital
from the equity line of credit with Dutchess. There can be no assurance that we
will be able to obtain the necessary working capital for our production phase on
a time frame that will enable us to optimize our production
capacity. We continue to actively seek out additional sources of new
working capital.
Contractual Obligations and
Commitments
The
following table summarizes our contractual obligations and commitments at
September 30, 2009:
Amount
Due Within
|
||||||||||||||||
Total
|
2009
|
2010
|
2011
|
|||||||||||||
Employment
Agreements(1)
|
$ | 833,333 | $ | 100,000 | $ | 400,000 | $ | 333,333 | ||||||||
Mortgage
Loan Payable(2)
|
1,750,000 | - | 1,750,000 | - | ||||||||||||
10%
Convertible Note
|
20,000 | - | 20,000 | - | ||||||||||||
Total
|
$ | 2,603,333 | $ | 100,000 | $ | 2,170,000 | $ | 333,333 |
(1)
|
The
Company’s obligation under employment agreements would increase to
$550,000 per year upon the Company’s achievement of an adequate level of
working capital, as defined.
|
|
(2)
|
The
mortgage loan payable provides for an option to extend the maturity for
one additional year at the Company’s option, provided that the entire
unpaid balance of the Release Payment due from WWE is paid during the
first year of the mortgage loan; and, further provided that the Company
receives at least $3 million of working capital; or earns net income and
generates positive cash flow of at least $1 million during the first year
of the mortgage loan.
|
27
Plan of
Operation
We have
completed development of the CSRV System-based generator engine and are
preparing to commence the production phase of our operations provided we can
successfully raise sufficient new working capital for this purpose. Initially,
we intend to sell the engine/generators to WWE. WWE has delivered a firm
purchase order for over 7,400 CSRV system technology Industrial Electric Power
Generators intended to be installed in oil and gas fields throughout Canada over
a five-year period. Once production of these orders commences, fulfillment is
expected to occur over a five year period. We intend to take advantage of the
fact that essentially all the components of the CSRV generator engine may be
readily sourced and acquired from subcontractors and, accordingly, expect to
manufacture the generator engine in the two following ways:
●
|
Assembly
– to develop assembly lines at a new manufacturing facility to be acquired
in the future. We have been evaluating proposals from certain
state officials interested in securing our commitment to establish large
scale manufacturing operations within their state and expect to make a
final decision in this regard during 2009. When the demand for our
products justifies it, we will take the required steps in order to
increase our work force. We anticipate that we will recruit a
significant number of new employees and make substantial capital
expenditures in connection with establishing such large scale
operations.
|
●
|
Licensing
the technology to Original Equipment Manufacturers (“OEM's”) – to take
advantage of third party manufacturers’ production capacity by signing OEM
agreements.
|
Our
ability to establish such manufacturing operations, recruit plant workers,
finance initial manufacturing inventories and fund capital expenditures is
highly dependent on our ability to successfully raise substantial new working
capital in an amount and at a pace which matches our business plans. Sources of
such new working capital include sales of our equity and/or debt securities
through private placements and/or secondary public offerings, pursuing and
entering into additional sublicensing agreements with OEM's and/or distributors,
additional payments from WWE for the Escrow Release Payment and positive working
capital generated from sales of our CSRV products to WWE and others. There can
be no assurance that we will be successful in raising adequate new working
capital or even any new working capital to carry out our business
plans. The current economic environment, which is characterized by
tight credit markets, investor uncertainty about how to safely invest funds and
low investor confidence, has introduced additional risk and difficulty in our
challenge to secure such additional working capital.
We intend
to increase our expenditures for marketing and branding activities over the next
year in order to increase market awareness and acceptance of the CSRV
technology. We believe that we can be successful in our efforts to
attract new customers and parties interested in licensing our
technology.
The
extent to which we can carry out this plan of operations will be highly
dependent on our success in raising new sources of capital and generating cash
flows from operations in the production phase.
Going
Concern
As shown
in the accompanying financial statements, with the exception of the year ended
December 31, 2008, we have incurred recurring losses from operations since
inception and, as of September 30, 2009, had a Stockholders’ Deficiency of
approximately ($299,000). This factor raises substantial doubt about our ability
to continue as a going concern. Our Independent Registered Accounting Firm has
stated in its independent auditors’ report on our financial statements as of
December 31, 2008 and for the year then ended that these factors raise
substantial doubt about the Company’s ability to continue as a going
concern.
Management
is continuing to carefully monitor its costs and is restricting variable costs
to only those expenses that are necessary to carry out our business plans. We
continue to actively seek out new sources of working capital; however, there can
be no assurance that we will be successful in these efforts.
The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
28
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not
applicable.
Item
4T. CONTROLS AND PROCEDURES
a)
Evaluation of Disclosure Controls. Pursuant to Rule 13a-15(b) under the
Securities Exchange Act of 1934 (“Exchange Act”), the Company carried out an
evaluation, with the participation of the Company’s management, including the
Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”)
(the Company’s principal financial and accounting officer), of the effectiveness
of the Company’s disclosure controls and procedures (as defined under Rule
13a-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Company’s CEO and CFO concluded that the
Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in the reports that the
Company files or submits under the Exchange Act, is recorded, processed,
summarized and reported, within the time periods specified in the SEC’s rules
and forms, and that such information is accumulated and communicated to the
Company’s management, including the Company’s CEO and CFO, as appropriate, to
allow timely decisions regarding required disclosure.
(b)
Changes in internal control over financial reporting. There have
been no changes in our internal control over financial reporting that occurred
during the last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
29
PART
II - OTHER INFORMATION
Mark D.
Goldsmith, a former executive of CIL, filed suit on January 2008, in which he
asserts that we are liable to him for breach of an employment contract that
never became effective. In the opinion of management, Mr. Goldsmith’s
performance was unsatisfactory and, accordingly, he was offered the opportunity
to resign. Further, management is of the opinion that the claim of Mr. Goldsmith
is baseless because we had cause to terminate our relationship with Mr.
Goldsmith. We intend to vigorously defend this lawsuit and have instituted a
counterclaim against Mr. Goldsmith. We believe that Mr. Goldsmith misrepresented
his background and capabilities in order to induce us and/or Coates Motorcycle
Company, Ltd. ("CMC") to hire him. We are also contending that certain of Mr.
Goldsmith's business decisions were made to further his self interest rather
than the interests of CIL. We believe that Mr. Goldsmith's claims have no basis
in fact and, accordingly, that the outcome of this legal action will not be
material to our financial condition or results of operations. As a result of the
information disclosed in the deposition of Mr. Goldsmith, we filed a dispositive
motion for summary judgment. This motion together with a cross motion for
summary judgment that was filed by Mr. Goldsmith (the “Cross Motion”) were
argued with other motions on October 23, 2009. At the conclusion of these
arguments, the Court entered an order denying Mr. Goldsmith’s Cross Motion and
our motion for summary judgment. Trial has been scheduled to commence on
December 8, 2009. We intend to vigorously defend against Mr. Goldsmith’s claims
and pursue our counterclaims.
In March
2004, the Company, certain of its officers and directors and other related and
unrelated parties were named as co-defendants, along with WWE in a lawsuit
brought in the Superior Court of New Jersey captioned H. Alton Neff v. George
Coates, Coates International, Ltd. et al. A countersuit was also instituted by
CIL and WWE. A plaintiff contended that he was the assignee of 1107 North West
Central Avenue Inc. ("1107"). Preliminary agreements and an amendment thereto
relating to purchase of a certain license by 1107 from the Company provided,
inter alia, that a $500,000 deposit made by 1107 to the Company would convert to
shares of the Company’s restricted common stock if certain conditions were not
met by 1107. The Company maintained that such conditions were not met and
therefore, the deposit converted into shares of the Company’s restricted common
stock. The claims were settled in March 2009 through mediation. Pursuant
thereto, the Company and WWE each paid $92,500 to 1107. The Company’s $92,500
portion of the settlement was charged to expense in December 2008. All
parties executed mutual releases and all claims have been dismissed with
prejudice, without costs to any party. As a condition of the settlement,
Mr. Sommer of 1107 endorsed to the Company a stock certificate evidencing 25,000
shares of the Company’s common stock. In March 2009, the shares of stock
evidenced by that stock certificate were retired and restored to authorized,
unissued common stock status. The Company was not required to return the
$500,000 deposit originally made by 1107 and previously converted into shares of
its common stock.
In April
2007, we received a demand letter from a law firm requesting payment of
approximately $77,000 in connection with a promissory note issued to the law
firm as security for the payment of future services to us. We have notified the
holder of this note that we do not intend to honor the promissory note because
the law firm did not provide the services contemplated to be performed as
consideration for the promissory note. No further action to pursue collection of
this promissory note has been taken to date by the holder. In the opinion of
management, the likelihood that we will be required to make any payments to the
holder of the note is remote and, accordingly, no amount has been
accrued.
We are
not a party to any other litigation that is material to our
business.
30
Item
1A. RISK FACTORS
Item
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
None.
None
None.
(a) Reports
on Form 8-K and Form 8K-A
None
(b)
Exhibits
Exhibit
Number
|
Description
|
31.1
*
|
Section
302 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
31.2
*
|
Section
302 Certification of Principal Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934 as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
32.1
*
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
|
32.2
*
|
Certification
of Principal Financial Officer pursuant to 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
* Filed
herewith.
31
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.
COATES
INTERNATIONAL, LTD.
|
||
Date:
November 13, 2009
|
By:
|
/s/ George J. Coates
|
George
J. Coates
|
||
President,
Chief Executive Officer
and
Principal Executive Officer
|
Date:
November 13 , 2009
|
By:
|
/s/ Barry C. Kaye
|
Barry
C. Kaye
|
||
Treasurer,
Chief Financial Officer
and
Principal Financial Officer
|
32