ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Prices

 

Our common stock, par value $.001 per share (the “Common Stock”), is currently quoted on the OTC Bulletin Board under the symbol “ECOC”. The high/low market prices of our common stock were as follows for the periods below, as reported on http://finance.google.com. The quotations below reflect inter-dealer bid prices without retail markup, markdown, or commission and may not represent actual transactions. Additionally, our Merger with OCIS was consummated on July 27, 2007. Therefore, the quotations below for the first three quarters shown for the fiscal year ended September 30, 2007 reflect quotations prior to the completion of the reverse merger.

		High Close				Low Close
Fiscal Year 2010
1st Quarter (through November 16, 2009)		$	.55			$	.25
Fiscal Year 2009
1st Quarter		$	1.04			$	.65
2nd Quarter		$	.95			$	.25
3rd Quarter		$	.89			$	.31
4th Quarter		$	2.00			$	.40
Fiscal Year Ended September 30, 2008
1st Quarter		$	3.15			$	1.01
2nd Quarter		$	3.65			$	1.01
3rd Quarter		$	2.05			$	.52
4th Quarter		$	2.50			$	.51
Fiscal Year Ended September 30, 2007
1st Quarter		$	3.18			$	.76
2nd Quarter		$	2.22			$	1.46
3rd Quarter		$	4.85			$	1.59
4th Quarter		$	4.90			$	2.95

As of September 30, 2009, we had approximately 242 shareholders of record of our common stock.  As of that date, Equity 11 held 18,895,038 shares of our common stock if it converts all of its preferred shares into common shares.  We have agreed to register 4,340,000 common shares to be converted by Equity 11 from its convertible preferred shares  pursuant to our Securities Purchase Agreement and Convertible Preferred Securities Agreement with Equity 11.  The sale of all or a significant portion of the 4,340,000 shares held by Equity 11 could have a material negative effect on the price of our common stock.

Dividends

To date, we have paid no cash dividends on our shares of common stock and we do not expect to pay cash dividends on our common stock in the foreseeable future.  We intend to retain future earnings, if any, to provide funds for the operation of our business.  Our Securities Purchase Agreement with Equity 11 prevents the payment of any dividends to our common stockholders without the prior approval of Equity 11.  We have paid dividends due Equity 11 for its preferred shares by issuing additional preferred shares in lieu of cash.

Securities Authorized for Issuance Under Equity Compensation Plans

Our shareholders approved the 2007 Stock Option Plan and authorized 4,500,000 common shares to be reserved for options exercised under the Plan.  In fiscal year 2008, our Board of Directors authorized an additional 1,000,000 common shares to be reserved for exercises under the Plan.  The following table sets forth certain information as of September 30, 2009, concerning outstanding options and rights to purchase common stock granted to participants in all of our equity compensation plans and the number of shares of common stock remaining available for issuance under such equity compensation plans.

 

							Number of Securities
							Remaining Available for
		Number of Securities to be					Future Issuance Under Equity
		Issued Upon Exercise of			Weighted-Average Exercise		Compensation Plans
		Outstanding   Options, Warrants			Price of Outstanding Options,		(Excluding   Securities
		and Rights			Warrants and Rights		Reflected in Column (a))
Equity compensation plans approved by security holders		4,500,000			$1.22		-
Equity compensation plans not approved by security holders		631,119			.51		368,881

Recent Issuances of Unregistered Securities

Set forth below is a description of all of our sales of unregistered securities during the fiscal year ended September 30, 2009.  All sales were made to “accredited investors” as such term is defined in Regulation D promulgated under the Securities Act of 1933, as amended (the “Act”). All such sales were exempt from registration under Section 4(2) of the Act, as transactions not involving a public offering. Unless indicated, we did not pay any commissions to third parties in connection with the sales.

 

Set forth below is a description of all of our sales of unregistered securities during the last three years.  All sales were made to “accredited investors” as such term is defined in Regulation D promulgated under the Act.  All such sales were exempt from registration under Section 4(2) of the Act, as transactions not involving a public offering. Unless indicated, we did not pay any commissions to third parties in connection with the sales.

On August 28, 2008, we entered into a Securities Purchase Agreement with Equity 11 for the issuance of 5% convertible preferred shares at a price of $1,000 per share.  Under the Securities Purchase Agreement, Equity 11 may purchase up to $5,000,000 of 5% convertible preferred shares.  In addition, for each acquisition of convertible preferred shares, Equity 11 will be issued warrants to purchase up to 2,500,000 shares of our common stock at $.75 per share.  As of September 30, 2009, under the Securities Purchase  Agreement, Equity 11 had been issued 2,436 shares of 5% Convertible Preferred Shares and had been issued warrants to purchase 1,178,500 shares.

On May 15, 2009, we entered into a Convertible Preferred Securities Agreement (the “Preferred Securities Agreement”) with Equity 11 for the issuance and sale of 5.0% Cumulative Convertible Preferred Shares, Series B at a purchase price of $1,000 per share.  The Preferred Securities Agreement did not replace or terminate the terms of the Securities Purchase Agreement.  That is, the terms of the Securities Purchase Agreement will continue to apply to preferred stock and warrants issued under the Securities Purchase Agreement.  Similarly, the terms of the Preferred Securities Agreement will apply to preferred stock issued under the Preferred Securities Agreement.

Equity 11 may convert the convertible preferred shares into our common stock at a conversion price that is twenty percent (20%) of the average of the closing price of our common stock on the Over-The-Counter Bulletin Board for the five trading days prior to each investment.  As of September 30, 2009, we had issued 566 Convertible Preferred Shares to Equity 11 under the Preferred Securities Agreement.  On December 14, 2009, we extended the termination date of the Preferred Securities Agreement until the earlier to occur of June 15, 2010 or the acceptance by our Board of Directors of a new investment in us by a third party in an amount of at least $3,000,000.

On September 30, 2009, we and SAC, entered into a Securities Purchase Agreement for the issuance and sale of our 5.0% Cumulative Convertible Preferred Shares, Series B (the “Convertible Preferred Shares”) at a purchase price of $1,000 per share.  SAC is owned by Richard Stromback a former member of our Board of Directors.  Until April 1, 2010, SAC has the right to purchase up to 3,000 Convertible Preferred Shares.  The Convertible Preferred Shares have a liquidation preference of $1,000 per share.  SAC may convert the Convertible Preferred Shares into shares of our common stock at a conversion price that is seventy seven percent (77%) of the average closing price of our common stock on the Over-The-Counter Bulletin Board for the five trading days prior to each investment.  The Convertible Preferred Shares will pay cumulative cash dividends at a rate of 5% per annum, subject to declaration by our Board of Directors, on December 1 and June 1 of each year.  We have agreed to provide piggyback registration rights for common stock converted by SAC under a Registration Rights Agreement.  Fifty percent (50%) of each investment, up to a maximum of $500,000, will be placed in a fund and disbursed as directed by SAC to satisfy our outstanding debts, accounts payable and/or investor relations programs (“Discretionary Fund”).  On October 1, 2009, SAC acquired 240 of our Convertible Preferred Shares, Series B with a purchase price per share of $1,000.  We received $240,000 of gross proceeds and net proceeds of $120,000 after payments were made from the Discretionary Fund for outstanding obligations owed to Mr. Stromback.

We issued the following promissory notes during 2008:

Note Holder	Issue Date(s)	Amount Owing on September 30, 2009
Investment Hunter, LLC	March 1, 2008	$358,207
Mitchell Shaheen I	June 18, 2008	$198,787
Mitchell Shaheen II	July 14, 2008	$134,513
George Resta	March 1, 2008	$47,976

The notes had limited conversion rights until their dates of maturity.  They no longer have the ability to convert to our common stock but we may consider such conversion in order to conserve cash.

During the prior three years, we issued the following warrants:

Number of Warrants	Issue Date	Expiration Date	Acquisition Price per Share	Held By
500,000	December 18, 2006	December 18, 2016	$.90	Trimax, LLC
2,000,000	November 11, 2008	November 11, 2018	$.50	Trimax LLC
12,500	March 1, 2008	March 1, 2018	$1.75	George Resta
262,500	February 5, 2008	February 5, 2018	$2.00	Hayden Capital USA, LLC
125,000	March 1, 2008	March 1, 2018	$1.75	Investment Hunter. LLC
210,000	June 9, 2008	June 9, 2018	$2.00	Hayden Capital USA, LLC
100,000	June 21, 2008	June 21, 2018	$.75	Mitchell Shaheen
100,000	July 14, 2008	July 14, 2018	$.50	Mitchell Shaheen
15,000	July 14, 2008	July 14, 2018	$1.75	George Resta
15,000	July 14, 2008	July 14, 2018	$1.75	Investment Hunter, LLC
14,400	October 1, 2009	October 1, 2019	$.42	Stromback Acquisition Corporation
Total:  3,354,400

On July 21, 2007, we completed a Private Placement and raised $4,232,970 from the sale of our common stock to private investors.

The following summarizes the above recent sales of unregistered securities:

Title	Date	Underwriters Or Purchasers	Consideration	Exemption	Ability To Convert	Terms of Conversion	Use of Proceeds
Private Placement Memorandum	July 21, 2007	(1)	$2 per share	4(2) of ’33 Securities Act		-	Working Capital
Investment Hunter, LLC	March 1, 2008	-	$500,000	4(2) of ’33 Securities Act	Prior to June 30, 2008	Lower of $1.75 or price of “New Offering”	Working Capital
Mitchell Shaheen I	June 18, 2008	-	$150,000	4(2) of ’33 Securities Act	Prior to July 18, 2008	Lower of $.50 or price of “New Offering”	Working Capital
Mitchell Shaheen II	July 14, 2008	-	$100,000	4(2) of ’33 Securities Act	Prior to August 10, 2008	“New Offering” price	Working Capital
George Resta	March 1, 2008	-	$50,000	4(2) of ’33 Securities Act	Prior to June 30, 2008	Lower of $1.75 or price of “New Offering	Working Capital

(1)

The list of PPM purchasers include:  Daniel Ahlsrtrom, Edward F Andrews, Alan Andrews, Donald Bailey Trust, Eugene Baratta, Marty Bartnick, Michael Battaglia, Deanna Berman, John R Bourbeau, John Bourbeau, Jr., Kastytis Buitkus, Bruce C Bullard, James C Carson, Thomas Commes, William F Coyro, Jr., Jon Crouse, Shawn Van Drehle, Paul Dudgeon, Gary Dudgeon, Ferguson Financial Group, Albert Hodgson, James Hoen, Guy T Humeniuk, Rae Ann Hoffman Jones, Andrew & Danielle Kapoor, Jeffrey Knudson, F. Thomas Krotine, John Lindeman, Henry & Michelle Lindeman III, Michele & Maria Longordo, Chris Marquez, Simone Mastantuono, Neil Master, Steven & Antonia Mellos, John Morgan, James Padilla, Timothy Perkins, Sasha Prakash, Paul & Susan Prentis, Trimax, LLC, Grace Rosman, Joseph Savel, Scott Schaffer, Robert Sims, Stephen & Darlene Stephens, David T Sterrett, Jr., David Susko, Patrick Sweeney, Kristin Wikol, and Michael Wisniekski.

 

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ITEM 9A.

CONTROLS AND PROCEDURES

     

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were ineffective at September 30, 2009 to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  We have previously disclosed that errors occurred in calculating expense associated with stock options.  Those errors were found in the calculations for the Black-Scholes option-pricing model for the quarter ended March 31, 2009.  In a post-closing adjustment, we recognized an additional $74,243 in stock options expense.  We have taken steps to ensure in the future that two people will separately make calculations involving the Black-Scholes option-pricing model and that each review the other’s for accuracy and completeness.

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, our principal executive officer and principal financial officer and effected by our Board, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.

Our internal control over financial reporting is supported by policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.

 

We rely on computer systems to support our financial reporting capabilities and other operations. As with any computer systems, unforeseen issues may arise that could affect our ability to receive adequate, accurate and timely financial information, which in turn could inhibit effective and timely decisions. Furthermore, it is possible that our information systems could experience a complete or partial shutdown. If such a shutdown occurred, it could impact our ability to report our financial results in a timely manner or to otherwise operate our business.  Our financial data in our accounting software (QuickBooks) became corrupted and unusable in late July 2009. The backup system for our network computer system failed to backup the data.  An outside IT technical vendor was also unable to restore the file to working order.  Since the file could not be restored, we manually recreated our financial data back to the date of our most recent backup data file (November 20, 2008).  Due to the significant efforts incurred in recreating the data, we filed a Form 12b-25 with the SEC to extend the filing date for our Form 10-Q for the June 30, 2009 period for five calendar days.  As a result of this failure, we modified the backup procedures for our financial data.  Our CFO is manually backing up the financial data to CD disks on a weekly basis.  We have also undertaken tests to ensure the network backup system is working and have scheduled periodic testing to ensure continued network backup functionality.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s Report on Internal Control over Financial Reporting

Management assessed our internal control over financial reporting as of September 30, 2009, the end of our fiscal year. Management based its assessment on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls.

        Based on this assessment, management has concluded that as of September 30, 2009, our internal control over financial reporting was ineffective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.  We noted that we failed to disclose the impact on earnings per common share of preferred stock dividends and the beneficial conversion feature associated with the issuance of our convertible preferred shares, which are effectively a preferred dividend to preferred shareholders. We therefore conclude that our internal control over financial reporting was ineffective as of September 30, 2009. To address this weakness, we are considering forming a disclosure committee to be included as part of our internal control over financial reporting.  We have previously noted errors in calculating expense associated with stock options.  Those errors were found in the calculations for the Black-Scholes option-pricing model for the quarter ended March 31, 2009.  In a post-closing adjustment, we recognized an additional $74,243 in stock options expense.  We have taken steps to ensure in the future that the multiple calculations involving the Black-Scholes option-pricing model are reviewed several times for accuracy and completeness.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only Management’s report in this Form 10-K.

Management is aware that we have a lack of segregation of certain duties due to the small number of employees with responsibility for general administrative and financial matters. This constitutes a deficiency in financial controls. However, at this time, management has decided that considering the employees involved and the control procedures in place, the risks associated with such lack of segregation of duties are insignificant and the potential benefits of adding additional employees to clearly segregate duties do not justify the expenses associated with such increases. Management will periodically reevaluate this situation. If the volume of business increases and sufficient capital is secured, it is our intention to further increase staffing to mitigate the current lack of segregation of duties within the general, administrative and financial functions.

 

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Such limitations include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes or intentional circumvention of the established process.

 

Changes in Internal Control over Financial Reporting

 

During the three months ended September 30, 2009, there were no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that was conducted during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting except for the changes in the process of making the calculations for stock  option valuation  using the Black-Scholes option pricing model and the steps taken to ensure greater reliability of our backup systems for financial information.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

Ecology Coatings, Inc.

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

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ecology Coatings, Inc. and Subsidiary as of September 30, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 1, "Summary of Significant Accounting Policies", the consolidated financial statements have been restated to correct loss per share.

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.  As discussed in Note 9 to the consolidated financial statements, the Company’s recurring losses, negative cash flows from operations and net capital deficiency raise substantial doubt about its ability to continue as a going concern.  Management’s plans as to these matters are also discussed in Note 9.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ UHY LLP

Southfield, Michigan

December 22, 2009, except with respect to the

    matters discussed in Notes 1, 8 and 10,

    as to which the date is February 16, 2010

 

F-1

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Balance Sheets
ASSETS
		September 30, 2009				September 30, 2008
Current Assets
Cash and cash equivalents		$	-			$	974,276
Prepaid expenses			1,400				25,206
Total Current Assets			1,400				999,482
Property and Equipment
Computer equipment			30,111				22,933
Furniture and fixtures			21,027				18,833
Test equipment			9,696				7,313
Signs			213				213
Software			6,057				1,332
Video			48,177				48,177
Total fixed assets			115,281				98,801
Less: Accumulated depreciation			(48,609)				(22,634)
Property and Equipment, net			66,672				76,167
Other
Patents-net			443,465				421,214
Trademarks-net			6,637				5,029
Total Other Assets			450,102				426,243
Total Assets		$	518,174			$	1,501,892

 

 

 

See the accompanying notes to the audited consolidated financial statements.

 

F-2

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Balance Sheets
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
		September 30, 2009				September 30, 2008
Current Liabilities
Bank overdraft		$	200			$	-
Accounts payable			1,272,057				1,359,328
Credit card payable			114,622				92,305
Accrued liabilities			76,084				12,033
Franchise tax payable			-				800
Interest payable			189,051				133,332
Notes payable			582,301				894,104
Notes payable - related party			257,716				243,500
Preferred dividends payable			36,800				6,300
Total Current Liabilities			2,528,831				2,741,702
Total Liabilities			2,528,831				2,741,702
Commitments and Contingencies (Note 5)
Stockholders' Equity (Deficit)
Preferred Stock - 10,000,000 $.001 par value shares
authorized; 3,002 and 2,010 shares issued and outstanding
as of September 30, 2009 and September 30, 2008, respectively			2				2
Common Stock - 90,000,000 $.001 par value shares
authorized; 32,835,684 and 32,210,684
outstanding as of September 30, 2009 and
September 30, 2008, respectively			32,859				32,234
Additional paid in capital			20,645,299				13,637,160
Accumulated Deficit			(22,688,817	)			(14,909,206	)
Total Stockholders' Equity (Deficit)			(2,010,657)				(1,239,810	)
Total Liabilities and Stockholders'
Equity (Deficit)		$	518,174			$	1,501,892

 

 

 

See the accompanying notes to the audited consolidated financial statements.

 

 

F-3

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Operations
		For the Year Ended				For the Year Ended
		September 30, 2009				September 30, 2008
Revenues		$	-			$	25,092
Salaries and fringe benefits			1,481,111				2,006,776
Professional fees			3,101,606				2,735,360
Other general and administrative costs			327,757				637,668
Operating Loss			(4,910,474	)			(5,354,712	)
Other Income (Expenses)
Interest income			142				5,784
Interest expense			(271,860	)			(1,421,394	)
Total Other (Expenses), net			(271,718	)			(1,415,610	)
Net Loss		$	(5,182,192	)		$	(6,770,322	)
Preferred Dividends—Beneficial Conversion Feature			(2,488,011)				(2,225,415)
Preferred Dividends—Stock dividends			(109,408)				(6,300)
Net loss available to common shareholders, as restated		$	(7,779,611)			$	(9,002,037)
Basic and diluted net loss per share, as restated		$	(0.24	)		$	(0.28	)
Basic and diluted weighted average of
common shares outstanding			32,330,547				32,189,864

 

 

 

 

 

 

 

See the accompanying notes to the audited consolidated financial statements.

 

F-4

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Statement of Changes in Shareholders’ Equity (Deficit) for the Years Ended September 30, 2009 and 2008
																		Additional								Total
																		Paid In				Accumulated				Stockholders'
		Common Stock								Preferred Stock								Capital				Deficit				Equity
		Shares				Amount				Shares				Amount												(Deficit)
Balance at October 1, 2007			32,150,684			$	32,174				-			$	-			$	6,165,282			$	(5,907,169	)		$	290,287
Issuance of stock for debt extension			60,000				60				-				-				161,940				-				162,000
Issuance of warrants for debt extension			-				-				-				-				26,343				-				26,343
Issuance of preferred stock			-								2,010				2				1,500,585				-				1,500,585
Beneficial conversion feature on preferred stock			-				-				-				-				2,225,415				(2,225,415	)			-
Warrants issued with preferred stock			-				-				-				-				509,415				-				509,415
Beneficial conversion feature on debt			-				-				-				-				358,654				-				358,654
Stock option expense			-				-				-				-				1,847,639				-				1,847,639
Warrants issued with debt			-				-				-				-				841,887				-				841,887
Preferred dividends			-				-				-				-				-				(6,300	)			(6,300)
Net Loss			-				-				-				-				-				(6,770,322	)			(6,770,322)
Balance at September 30, 2008			32,210,684			$	32,234				2,010			$	2			$	13,637,160			$	(14,909,206	)		$	(1,239,810)
Issuance of preferred stock											913				-				867,970								867,970
Beneficial conversion feature on preferred stock																			2,488,011				(2,488,011)				-
Warrants issued with preferred stock																			45,530								45,530
Stock option expense																			3,182,773								3,182,773
Beneficial conversion feature on issuance of debt																			2,061								2,061
Warrants issued with debt																			63,511								63,511
Stock issued for services			575,000				575												254,425								255,000
Stock options exercised			50,000				50												24,950								25,000
Preferred dividends											79				-				78,908				(109,408)				(30,500)
Net Loss																							(5,182,192)				(5,182,192)
Balance at September 30, 2009			32,835,684			$	32,859				3,002			$	2				20,645,299				(22,688,817)				(2,010,657)

See the accompanying notes to the audited consolidated financial statements.

 

F-5

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
		For the Year				For the Year
		Ended				Ended
		September 30, 2009				September 30, 2008
OPERATING ACTIVITIES
Net  loss		$	(5,182,192	)		$	(6,770,322	)
Adjustments to reconcile net loss
to net cash  (used in) operating activities:
Depreciation and amortization			45,075				37,486
Option expense			3,182,773				1,847,639
Beneficial conversion expense			2,062				374,476
Issuance of stock for debt extension							162,000
Issuance of stock for payment of payables			200,000				-
Issuance of stock for services			55,000				-
Warrants			63,512				868,231
Changes in Asset and Liabilities
Miscellaneous receivable			-				1,118
Prepaid expenses			23,806				45,683
Accounts payable			(87,271	)			929,539
Accrued payroll taxes and wages			-				(13,960	)
Accrued liabilities			64,050				12,033
Franchise tax payable			(800	)
Credit card payable			22,317				77,533
Interest payable			55,718				117,481
Deferred revenue			-				(24,884	)
Net Cash Used in Operating Activities			(1,555,950	)			(2,335,947	)
INVESTING ACTIVITIES
Purchase of fixed assets			(16,480	)			(77,094	)
Purchase of intangibles			(42,961	)			(138,848	)
Net Cash Used in Investing Activities			(59,441	)			(215,942	)
FINANCING ACTIVITIES
Bank overdraft			200				-
Repayment of notes payable			(372,801	)			(591,998	)
Proceeds from notes payable and warrants			75,216				1,300,000
Issuance of preferred stock			913,500				2,010,000
Issuance of common stock			25,000				-
Net Cash Provided by Financing Activities			641,115				2,718,002
Net Increase (Decrease) in Cash and Cash Equivalents			(974,276)				166,113
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD			974,276				808,163
CASH AND CASH EQUIVALENTS AT END
OF PERIOD		$	-			$	974,276

 

See the accompanying notes to the audited consolidated financial statements.

 

F-6

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ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
		For the Year				For the Year
		Ended				Ended
		September 30, 2009				September 30, 2008
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Interest paid		$	132,000			$	79,284
Income taxes paid			-				-
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITIES
Issuance of common stock for payment of accounts and notes payable		$	425,000			$	-
Issuance of common stock for services		$	15,000			$	-
Issuance of common stock for debt extension		$	-			$	162,000

 

 

 

See the accompanying notes to the audited consolidated financial statements.

 

F-7

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ECOLOGY COATINGS, INC. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

SEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008

 

 
 

 

Note 1 — Summary of Significant Accounting Policies

 

Description of the Company.  We were originally incorporated on March 12, 1990 in California (“Ecology-CA”).  Our current entity was incorporated in Nevada on February 6, 2002 as OCIS Corp. (“OCIS”).  OCIS completed a merger with Ecology-CA on July 26, 2007 (the “Merger”). In the Merger, OCIS changed its name from OCIS Corporation to Ecology Coatings, Inc.  We develop nanotechnology-enabled, ultra-violet curable coatings that are designed to drive efficiencies and clean processes in manufacturing.  We create proprietary coatings with unique performance and environmental attributes by leveraging our platform of integrated nano-material technologies that reduce overall energy consumption and offer a marked decrease in drying time. Ecology’s target markets consist of electronics, automotive and trucking, paper products and original equipment manufacturers (“OEMs”).

 

Principles of Consolidation.  The consolidated financial statements include all of our accounts and the accounts of our wholly owned subsidiary Ecology-CA.  All significant intercompany transactions have been eliminated in consolidation.

 

Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents.  We consider all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.

 

Revenue Recognition.  Revenues from licensing contracts are recorded ratably over the life of the contract.  Contingency earnings such as royalty fees are recorded when the amount can reasonably be determined and collection is likely.

 

Loss Per Share (Restated).  We restated our basic and diluted net loss per share to include preferred stock dividends and the beneficial conversion feature associated with the issuance of preferred stock in the calculation of net loss per share.  These preferred stock dividends and associated beneficial conversion features are added to the net loss to arrive at net loss available to common shareholders. 

 

Basic loss per share is computed by dividing the net loss available to common shareholders by the weighted average number of shares of common stock outstanding during the period.  Diluted loss per share is computed by dividing the net loss available to common shareholders by the weighted average number of shares of common stock and potentially dilutive securities outstanding during the period.  Potentially dilutive shares consist of the incremental common shares issuable upon the exercise of stock options and warrants and the conversion of convertible debt and convertible preferred stock. Potentially dilutive shares are excluded from the weighted average number of shares if their effect is anti-dilutive.  We had a net loss for all periods presented herein; therefore, none of the stock options and/or warrants outstanding or stock associated with the convertible debt or with the convertible preferred shares during each of the periods presented were included in the computation of diluted loss per share as they were anti-dilutive.  As of September 30, 2009 and 2008, there were 20,323,996 and 12,031,220 potentially dilutive shares outstanding, respectively.

 

Income Taxes and Deferred Income Taxes.  We use the asset and liability approach for financial accounting and reporting for income taxes.  Deferred income taxes are provided for temporary differences in the bases of assets and liabilities as reported for financial statement purposes and income tax purposes and for the future use of net operating losses.  We have recorded a valuation allowance against the net deferred income tax asset.  The valuation allowance reduces deferred income tax assets to an amount that represents management’s best estimate of the amount of such deferred income tax assets that more likely than not will be realized.  We cannot be assured of future income to realize the net deferred income tax asset; therefore, no deferred income tax asset has been recorded in the accompanying consolidated financial statements.

 

As of September 30, 2009 and 2008, we had no unrecognized tax benefits due to uncertain tax positions.

 

Property and Equipment.  Property and equipment is stated at cost less accumulated depreciation.  Depreciation is recorded using the straight-line method over the following useful lives:

 

Computer equipment		3-10 years
Furniture and fixtures		3-7 years
Test equipment		5-7 years
Software Computer		3 years
Marketing and Promotional Video		3 years

 

Repairs and maintenance costs are charged to operations as incurred. Betterments or renewals are capitalized as incurred.

 

We review long lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

 

Patents.  It is our policy to capitalize costs associated with securing a patent.  Costs consist of legal and filing fees.  Once a patent is issued, it will be amortized on a straight-line basis over its estimated useful life.  Seven patents were issued as of September 30, 2009 and are being amortized over 8 years.

 

Stock-Based Compensation.  Employee and director stock-based compensation expense is measured utilizing the fair-value method.

 

We account for stock options granted to non-employees under the fair-value method with stock-based compensation expense being charged to earnings on the earlier of the date services are performed or a performance commitment exists.

 

Expense Categories.  Salaries and Fringe Benefits of $1,481,111 and $2,006,776 for the years ended September 30, 2009 and 2008, respectively, include wages paid to and insurance benefits for our officers and employees as well as stock based compensation expense for those individuals.  Professional fees of $3,101,606 and  $2,735,360,  for the years ended September 30, 2009 and  2008, respectively, include amounts paid to attorneys, accountants, and consultants, as well as the stock based compensation expense for those services.  Of the $3,101,606 in professional fees incurred in the year ended in September 30, 2009, $2,383,564 was for options expense.  Of this amount, $1,368,450 arose from the issuance of warrants in November 2008 to Trimax to acquire 2,000,000 shares of our common stock.  Another approximate $360,000 arose from the issuance of stock options to Sales Attack in September 2008 to acquire 531,000 shares of our common stock.

 

Recent Accounting Pronouncements

 

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, as amendment to SFAS No. 140 (SFAS166). SFAS 166 eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. SFAS 166 is effective for fiscal years beginning after November 15, 2009. We will adopt SFAS 166 in fiscal 2010 as applicable. It would not have had any impact on any of the financial statements that we’ve issued to date.

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” (SFAS 167). SFAS 167 amends FASB Interpretation No. 46 (Revised December 2003), “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51,” (FIN 46(R)) to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity; to add an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. SFAS 167 becomes effective on January 1, 2010. We do not anticipate SFAS 167 will have a material impact on our consolidated financial statements upon adoption.

 

Note 2 — Concentrations

 

For the years ended September 30, 2009 and  2008, we had no revenues and  revenues of  $25,092, respectively. One customer accounted for all of our revenues in the year ended September 30, 2008. As of September 30, 2009 and 2008, there were no amounts due from this customer.

 

We occasionally maintain bank account balances in excess of the federally insurable amount of $250,000.  The Company had cash deposits in excess of these limits on September 30, 2009 and September 30, 2008, of $0 and $724,276, respectively.

 

Note 3 — Related Party Transactions

 

We have borrowed funds for our operations from certain major stockholders, directors and officers as disclosed below:

 

We have an unsecured note payable due to Deanna Stromback, a principal shareholder and former director and sister of our former Chairman, Rich Stromback, that bears interest at 4% per annum with principal and interest due on December 31, 2009.  As of September 30, 2009 and September 30, 2008, the note had an outstanding balance of $110,500.  The accrued interest on the note was $13,235 and $8,407 as of September 30, 2009 and September 30, 2008, respectively.  The note carries certain conversion rights that allow the holder to convert all or part of the outstanding balance into shares of our common stock upon mutually agreeable terms and conversion price.

 

We have an unsecured note payable due to Doug Stromback, a principal shareholder and former director and brother of our former Chairman, Rich Stromback, that bears interest at 4% per annum with principal and interest due on December 31, 2009.  As of September 30, 2009 and September 30, 2008, the note had an outstanding balance of $133,000.    The accrued interest on the note was $15,936 and  $10,125 as of September 30, 2009 and September 30, 2008, respectively.  The note carries certain conversion rights that allow the holder to convert all or part of the outstanding balance into shares of our common stock upon mutually agreeable terms and conversion price.

 

We had an unsecured note payable due to Rich Stromback, our former Chairman and a principal  shareholder,  that bore interest at 4% per annum with principal and interest due on December 31, 2009.  As of September 30, 2009 and September 30, 2008, the note had an outstanding balance of $0. The unpaid accrued interest on the note was $2,584 as of September 30, 2009 and September 30, 2008, respectively.  The note carries certain conversion rights which allow the holder to convert all or part of the outstanding balance into shares of our common stock upon mutually agreeable terms and conversion price.

 

We have an unsecured  note payable to an entity controlled by JB Smith, a director of the company. This note bears interest at 5% per annum and is convertible under certain conditions. It is due within 15 days of demand by the holder. As of September 30, 2009 and  September 30, 2008, the note had an outstanding balance of $7,716 and $0, respectively.  Accrued interest of $96 was outstanding of September 30, 2009.

 

We have an unsecured note payable to an entity controlled by JB Smith, a director of the company. This note bears interest at 5% per annum and is convertible under certain conditions. It is due within 15 days of demand by the holder. As of September 30, 2009 and September 30, 2008,  the note had an outstanding balance of $6,500 and $0, respectively.  Accrued interest of $18 was outstanding of September 30, 2009.

 

Future maturities of related party long-term debt as of September 30, 2009 are as follows:

12 Months Ended September 30,
2010		$	257,716

 

We have a payable to a Richard Stromback and an entity controlled by him totaling $145,191 and  $63,775 as of September 30, 2009 and September 30, 2008, respectively, included in accounts payable on the consolidated balance sheets. See also Note 10—Subsequent Events

Note 4 — Notes Payable

 

We have the following notes:

		September  30, 2009			September 30, 2008
Chris Marquez Note:  Convertible note payable, 15% per annum interest rate, principal and interest payment was due May 31, 2008; unsecured, convertible at holder’s option into common shares of the Company at $1.60 per share. Accrued interest of $15,367 was outstanding at September 30, 2008.	$	--			$	94,104
George Resta Note:  Subordinated note payable, 25% per annum, unsecured, principal and interest was due June 30, 2008; the Company extended the maturity for 30 days, to July 30, 2008 in exchange for warrants to purchase 15,000 shares of the Company’s common stock at $1.75 per share. Additionally, the Company granted the note holder warrants to purchase 12,500 shares of the Company’s common stock at $1.75 per share. On November 14, 2008, we agreed to pay the note holder $10,000 per month until the principal and accrued interest is paid off. We made such payments in October and November of 2008, but did not make payments thereafter. Accrued interest of $9,232 and $7,329 was outstanding as of September 30, 2009 and September 30, 2008, respectively.		38,744				50,000
Investment Hunter, LLC Note:  Subordinated note payable, 25% per annum, unsecured, principal and interest was due June 30, 2008; the Company extended the maturity for 30 days, to July 30, 2008 in exchange for warrants to purchase 15,000 shares of the Company’s common stock at $1.75 per share. Additionally, the Company granted the note holder warrants to purchase 125,000 shares of the Company’s common stock at $1.75 per share. On November 13, 2008, we agreed to pay the note holder $100,000 per month until the principal and accrued interest is paid off. The payments for October, November, and December were made, but none have been made since.  Accrued interest of $64,650 and $73,288 was outstanding as of September 30, 2009 and September 30, 2008, respectively.		293,557				500,000
Mitchell Shaheen Note:  Subordinated note payable, 25% per annum, unsecured, principal and interest was due July 18, 2008. Additionally, the Company issued a warrant to purchase 100,000 shares of the Company’s common stock at a price equal to $.75 per share (the “Warrant”). The Warrant is exercisable immediately and carries a ten (10) year term. The Holder may convert all or part of the then-outstanding Note balance into shares at $.50 per share. If applicable, the Company has agreed to include the Conversion Shares in its first registration statement filed with the Securities and Exchange Commission. Demand for repayment was made on August 27, 2008. Accrued interest of $48,787 and $10,685 was outstanding as of September 30, 2009 and September 30, 2008, respectively.		150,000				150,000
Mitchell Shaheen Note:  Subordinated note payable, 25% per annum, unsecured, principal and interest was due August 10, 2008. Additionally, the Company issued a warrant to purchase 100,000 shares of the Company’s common stock at a price equal to $.50 per share (the “Warrant”). The Warrant is exercisable immediately and carries a ten (10) year term. The Holder may convert all or part of the then-outstanding Note balance into shares at $.50 per share. If applicable, the Company has agreed to include the Conversion Shares in its first registration statement filed with the Securities and Exchange Commission. Demand for repayment was made on August 27, 2008. Accrued interest of $34,513 and $5,548 was outstanding as of September 30, 2009 and September 30, 2008, respectively.		100,000				100,000
		$582,301				$894,104

 

All of the notes shown in the table above are in default and are currently due and payable.

 

The notes held by Investment Hunter, LLC, George Resta and Mitchell Shaheen had convertibility features when they were issued.  As of September 30, 2009, the convertibility features had expired.

 

All of the notes payable in the table above initially had conversion rights and warrants.  We recognized an embedded beneficial conversion feature present in these Notes.  We allocated the proceeds based on the fair value of $340,043 to the warrants.  The warrants are exercisable through March 31, 2018 and the fair value was amortized to interest expense over the term of the Notes.

 

 Note 5 — Commitments and Contingencies

 

Consulting Agreements.

 

On June 1, 2007, we entered into a consulting agreement with The Rationale Group, LLC (“Rationale Group”).  The managing member of Rationale Group is Dr. William Coyro, Jr., who serves as the chairman of Ecology’s business advisory board.  The agreement expired June 1, 2009.  Ecology pays Rationale Group $11,000 per month under the Agreement.  Additionally, Ecology granted Rationale Group 200,000 options to purchase shares of our common stock for $2.00 per share.  Of these options, 50,000 options vested on December 1, 2007, 50,000 options vested on June 1, 2008, 50,000 options vested on December 1, 2008, and the remaining 50,000 options vested on June 1, 2009.  Additionally, we agreed to reimburse Rationale Group for all reasonable expenses incurred by Rationale Group in the conduct of our business. On February 11, 2009, we amended the agreement upon the following terms:

 

·	Six monthly payments to Rationale Group of $5,000, with payments ended on July 1, 2009.

·	Re-pricing of the 50,000 options that vested on December 1, 2007 by our Board to an exercise price of $.50 per share

·	Rationale Group forgave $121,000 owed by us to them.

·	Rationale Group transferred options to purchase 50,000 shares of common stock that vest on June 1, 2009 to Equity 11, our largest shareholder.  J.B. Smith, a director of our Board, is the managing partner and majority owner of Equity 11.

 

 

On July 26, 2007, we entered into a consulting agreement with DMG Advisors, LLC, owned by two former officers and directors of OCIS Corporation.  The terms of the agreement call for the transfer of the $100,000 standstill deposit paid to OCIS as a part of a total payment of $200,000.  The balance will be paid in equal installments on the first day of each succeeding calendar month until paid in full.  The agreement calls for the principals to provide services for 18 months in the area of investor relations programs and initiatives; facilitate conferences between Ecology and members of the business and financial community; review and analyze the public securities market for our securities; and introduce Ecology to broker-dealers and institutions, as appropriate.  The agreement expired on February 28, 2009.

On July 21, 2009, we entered into a Settlement and Release Agreement with DMG Advisors, LLC, Kirk Blosch and Jeff Holmes which terminated the parties’ July 26, 2007 Consulting Agreement. We agreed to issue 500,000 shares of our common stock as payment for services owed under the Former Consulting Agreement.

On July 21, 2009, we entered into a new Consulting Agreement with DMG Advisors.  DMG Advisors will provide investor, business and financial services to us under the New Consulting Agreement and will be paid $5,000 per month for services by the issuance of 25,000 shares of the our common stock per month.  The Agreement has a term of six months and terminates on January 15, 2010.

On April 2, 2008, we entered into a letter agreement with Dr. Robert Matheson to become chairman of our Scientific Advisory Board.  The letter agreement provides that we will grant Dr. Matheson options to purchase 100,000 shares of our common stock.  Each option is exercisable at a price of $2.05 per share.  The options vest as follows: 25,000 immediately upon grant; 25,000 on October 3, 2008; 25,000 on April 3, 2009, and the remaining 25,000 on October 3, 2009.  The options will all expire on April 3, 2018.

 

On September 17, 2008, we entered into an agreement with Sales Attack LLC, an entity owned by J.B. Smith, a director of the Company and managing partner of Equity 11 who is our largest shareholder.  This agreement is for business and marketing consulting services.  This agreement expires on September 17, 2010 and calls for monthly payments of $20,000, commissions on licensing revenues equal to 15% of said revenues, commissions on product sales equal to 3% of said sales, and a grant of options to purchase 531,000 shares of our common stock for $1.05 per share. 177,000 of the options became exercisable on March 17, 2009, 177,000 of the options become exercisable on September 17, 2009, and 177,000 of the options become exercisable on March 17, 2010.  The options expire on December 31, 2020.  We paid $60,000 to Sales Attack LLC during the year ended September 30, 2009. On May 15, 2009, we issued 100 Series B Convertible Preferred Securities in full settlement of all monthly payment amounts then outstanding and terminated any future monthly obligations of this Agreement.

On September 17, 2008, we entered into an agreement with RJS Consulting LLC (“RJS”), an entity owned by our chairman of the board of directors, Richard Stromback, under which RJS will provide advice and consultation to us regarding strategic planning, business and financial matters, and revenue generation.  The agreement expires on September 17, 2011 and calls for monthly payments of $16,000, commissions on licensing revenues equal to 15% of said revenues, commissions on product sales equal to 3% of said sales, $1,000 per month to pay for office rent reimbursement, expenses associated with RJS’s participation in certain conferences, information technology expenses incurred by the consultant in the performance of duties relating to the Company, and certain legal fees incurred by Richard Stromback during his tenure as our Chief Executive Officer.

On September 17, 2008, we entered into an agreement with DAS Ventures LLC (“DAS”) under which DAS will act as a consultant to us.  DAS Ventures, LLC is wholly owned by Doug Stromback, a principal shareholder and former director and brother of our Chairman, Rich Stromback,  Under this agreement, DAS will provide business development services for which he will receive commissions on licensing revenues equal to 15% of revenues and commissions on product sales equal to 3% of said sales and reimbursement for information technology expenses incurred by the consultant in the performance of duties relating to the Company. This agreement expires on September 17, 2011.

On November 11, 2008, we settled the lawsuit we filed against Trimax, LLC (“Trimax”) on September 11, 2008 for breach of contract.  Under the terms of the settlement, we will pay Trimax $7,500 per month for twelve months under a new consulting agreement and will pay $15,000 in 12 equal monthly payments of $1,250 to Trimax’s attorney.   Additionally, we will pay Trimax a commission of 15% for licensing revenues and 3% for product sales that Trimax generates for the Company.   On June 12, 2009, we terminated the agreement and replaced it with a new one in which the sole compensation paid to Trimax will be a commission of 15% for licensing revenues and 3% for product sales to Daewoo. This new agreement expires June 12, 2010 and can be terminated on 90 days written notice by either party.

On January 1, 2009, we entered into a new agreement with McCloud Communication to provide investor relations services to us.  The new agreement calls for monthly payments of $5,500 for 12 months.  In addition, the consultant forgave $51,603 in past due amounts owed by the Company in exchange for a reset of the exercise price on options to purchase 25,000 shares of our common stock that we issued to the consultant on April 8, 2008. The exercise price at the time of issuance was $4.75 per share.  This price was re-set by our Board to $.88 per share on February 6, 2009.

On January 5, 2009, we entered into an agreement with James Juliano to provide debt consulting services to us. Mr. Juliano is a principal in Equity 11. The agreement calls for twelve monthly payments of $7,500 and expires on December 31, 2009.  No monthly payments were made to Mr. Juliano for the year ended on September 30, 2009.  On May 15, 2009, we issued 37.5 Convertible Preferred Securities in full settlement of all amounts then outstanding and terminated the agreement.

 

Employment Agreements.

 

On January 1, 2007, we entered into an employment agreement with Sally J.W. Ramsey, Vice President New Product Development, that expires on January 1, 2012.  Upon expiration, the agreement calls for automatic one-year renewals until terminated by either party with thirty days written notice.  Pursuant to the agreement, the officer will be paid an annual base salary of $180,000 in 2007; an annual base salary of $200,000 for the years 2008 through 2011; and an annual base salary of $220,000 for 2012.  On December 15, 2008, we amended the agreement to reduce Ms. Ramsey’s annual base salary to $60,000.  In addition, 450,000 options were granted to the officer to acquire our common stock at $2.00 per share. 150,000 options will vest on January 1, 2010, 150,000 options will vest on January 1, 2011 and the remaining 150,000 options will vest January 1, 2012.  The options expire on January 1, 2022.

 

On September 21, 2009, we entered into a second amendment to the employment agreement with Ms. Ramsey that amends her employment agreement with us dated January 1, 2007 to provide for an annual salary of $75,000 effective November 1, 2009.  From December 15, 2008 until September 21, 2009, Ms. Ramsey's annual salary was $60,000.

 

On February 1, 2007, we entered into an employment agreement with Kevin Stolz, Chief Financial Officer, Controller and Chief Accounting Officer, that expired on February 1, 2008. Pursuant to the agreement, the officer was paid an annual base salary of $120,000 and was granted 25,000 options to acquire our common stock at $2.00 per share.  These options were re-priced to $1.05 per share on September 15, 2008.  All of the options vested on February 1, 2008. The options expire on February 1, 2017. On February 1, 2008, we entered into a new agreement with this officer.  This new agreement expires on February 1, 2010 and calls for an annual salary of $140,000.  Further, Mr. Stolz was granted 50,000 options to purchase shares of our common stock at $3.00 per share.  These options were re-priced to $1.05 per share on September 15, 2008.  25,000 options vest on February 1, 2009 and the remaining 25,000 options vest on February 1, 2010.  This agreement was modified effective October 1, 2008.  Under the modified agreement, Mr. Stolz receives an annual base salary of $70,000, subject to increase to $140,000 upon the achievement by the Company of revenues of at least $100,000.  Additionally, we granted Mr. Stolz options to purchase 10,000 shares of our common stock at $1.05 per share.  The options become exercisable on September 17, 2009 and expire on September 17, 2018. Mr. Stolz assumed the additional title of Chief Financial Officer on March 26, 2009.  On July 24, 2009, this agreement was terminated by mutual agreement of the parties. Mr. Stolz continues in his positions of Chief Financial Officer, Controller and Chief Accounting Officer.

 

On May 21, 2007, we entered into an employment agreement with David W. Morgan, Chief Financial Officer, that expired on May 21, 2009.  Pursuant to the agreement, Mr. Morgan was paid an annual base salary of $160,000 and was granted 300,000 options to acquire our common stock at $2.00 per share.  These options were re-priced to $1.05 per share on September 15, 2008. 75,000 of the options vested on May 21, 2008, and 225,000 of the options vested on May 21, 2009.  The options expire on May 21, 2017. On October 1, 2007, the Company modified the employment agreement to increase the salary from $160,000 to $210,000.  This agreement was terminated on December 3, 2008 and Mr. Morgan continued to serve as our Chief Financial Officer and was being paid $60,000 per annum. Mr. Morgan resigned on March 26, 2009 and his employment agreement was terminated. We will pay medical insurance premiums of $1,128 per month through September of 2009 for him.

On September 21, 2009, we entered into an employment agreement with Robert G. Crockett , our CEO. Mr. Crockett has served as our CEO since September 15, 2008. The agreement expires on September 21, 2012. Mr. Crockett will receive an annual base salary of $200,000. The Compensation Committee of the Board of Directors may review Mr. Crockett’s salary to determine what, if any, increases shall be made thereto. In addition, the vesting for Mr. Crockett’s previously awarded stock options was adjusted so that 110,000 stock options will vest 12 months, 18 months and 24 months respectively from Mr. Crockett’s initial date of employment (September 15, 2008).  Mr. Crockett was also granted stock options to purchase 670,000 shares of our common stock, one-quarter of which shall vest at 30, 36, 42 and 48 months from Mr. Crockett’s initial date of employment with us (September 15, 2008) with an exercise price of $.51 per share. The agreement may be terminated prior to the end of the term for cause. If Mr. Crockett’s employment is terminated without cause or for “good reason,” as defined in the agreement, he is entitled to 50% of salary that would have been paid over the balance of the term of the agreement. Further, a termination within one year after a change in control shall be deemed to be a termination without cause.

On September 21, 2009, we entered into an employment agreement with Daniel V. Iannotti, our Vice President, General Counsel & Secretary. Mr. Iannotti  has served as our Vice President, General Counsel since August 11, 2008. The agreement expires on September 21, 2012. Effective November 1, 2009, Mr. Iannotti will receive an annual base salary of $150,000. The Compensation Committee of the Board of Directors may review Mr. Iannotti’s salary to determine what, if any, increases shall be made thereto. In addition, the vesting for Mr. Iannotti’s previously awarded stock options was adjusted so that 110,000 stock options will vest 12 months, 18 months and 24 months respectively from Mr. Iannotti’s initial date of employment (August 11, 2008).  Mr. Iannotti was also granted stock options to purchase 70,000 shares of our common stock, one-quarter of which shall vest at 30, 36, 42 and 48 months from Mr. Iannotti’s’s initial date of employment with us (August 11, 2008) with an exercise price of $.51 per share. The agreement may be terminated prior to the end of the term for cause. If Mr. Iannotti’s employment is terminated without cause or for “good reason,” as defined in the agreement, he is entitled to 50% of salary that would have been paid over the balance of the term of the agreement. Further, a termination within one year after a change in control shall be deemed to be a termination without cause.

On September 21, 2009, we entered into an employment agreement with F. Thomas Krotine, our COO. The agreement expires on September 21, 2010. Effective November 1, 2009, Mr. Krotine will receive an annual base salary of $65,000. The Compensation Committee of the Board of Directors may review Mr. Krotine’s salary to determine what, if any, increases shall be made thereto. Mr. Krotine was also granted stock options to purchase 169,000 shares of our common stock, one-quarter of which shall vest at 6, 12, 18 and 24 months from September 21, 2009 with an exercise price of $.51 per share. The agreement may be terminated prior to the end of the term for cause. If Mr. Krotine’s employment is terminated without cause or for “good reason,” as defined in the agreement, he is entitled to 50% of salary that would have been paid over the balance of the term of the agreement. Further, a termination within one year of a change in control shall be deemed to be a termination without cause.

 

Contingencies.

 

Lease Commitments.

	a.		The Company leases office and lab facilities in Akron, OH on a month-to-month basis for $1,800.  Rent expense for the year ended September 30, 2009 and 2008 was $23,600 and $21,600, respectively.
	b.		On September 1, 2008, we executed a lease for our office space in Auburn Hills, Michigan.  The lease calls for average monthly rent of $2,997 and expires on September 30, 2010.  The landlord is a company owned by a shareholder and director of Ecology. Rent expense for the year ended September 30, 2009 and September 30, 2008 were $34,699 and $10,723 respectively.
	c.		On June 17, 2007, we leased computer equipment with 36 monthly payments of $42. We recognized expense of $504 and $504 for the years ended September 30, 2009  and 2008, respectively, related to this lease.
	d.		On July 17, 2007, we leased computer equipment with 36 monthly payments of $44. We recognized expense of $528 and  $528 for the years ended September 30, 2009 and 2008, respectively, related to this lease.
	e.		On September 22, 2008, we leased a multi-purpose copier with 36 monthly payments of $526. The first payment was due November 3, 2008.  We recognized expense of 5,786 and $0 for the years ended September 30, 2009 and 2008, respectively

 

 

Minimum future rental payments under the above operating leases as of September 30, 2009 are as follows:

Year Ending September 30,	Amount
2010	$44,530
2011	$5,260
TOTAL:	$49,790

 

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Note 6 — Equity

Reverse Merger.  A reverse merger with OCIS Corporation was consummated on July 26, 2007.  The shareholders of Ecology-CA acquired 95% of the voting stock of OCIS. OCIS had no significant operating history.  The purpose of the acquisition was to provide Ecology with access to the public equity markets in order to more rapidly expand its business operations.  The consideration to the shareholders of OCIS was approximately 5% of the stock, at closing, of the successor company.  The final purchase price was agreed to as it reflects the value to Ecology of a more rapid access to the public equity markets than a more traditional initial public offering.

 

 

Warrants.  On December 16, 2006, we issued warrants to Trimax, LLC to purchase 500,000 shares of our stock at $2.00 per share.  On November 11, 2008, the exercise price of the warrants was reset to $.90 per share.  The warrants vested on December 17, 2007. The weighted average remaining life of the warrants is 7.3 years.

 

On February 6, 2008, we issued warrants to Hayden Capital  to purchase 262,500 shares of our common stock at the lower of $2.00 per share or at the average price per share at which the Company sells its debt or and/or equity in its next private or public offering.  The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.3 years.

 

On March 1, 2008, we issued warrants to George Resta to purchase 12,500 shares of our common stock at the lower of $2.00 per share or at the average price per share at which the Company sells its debt or and/or equity in its next private or public offering.  The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.3 years.

 

On March 1, 2008, we issued warrants to Investment Hunter, LLC to purchase 125,000 shares of our common stock at the lower of $2.00 per share or at the average price per share at which the Company sells its debt or and/or equity in its next private or public offering.  The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.3 years.

 

On June 9, 2008, we issued warrants to Hayden Capital to purchase 210,000 shares of our common stock at the lower of $2.00 per share or at the average price per share at which the Company sells its debt or and/or equity in its next private or public offering.  The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.6 years.

 

On June 21, 2008, we issued warrants to Mitchell Shaheen to purchase 100,000 shares of our common stock at $.75 per share.  The warrants vested upon issuance. The weighted average remaining life of the warrants is 8.6 years.

 

On July 14, 2008, we issued warrants to Mitchell Shaheen to purchase 100,000 shares of our common stock at $.50 per share.  The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.6 years.

 

On July 14, 2008, we issued warrants to George Resta to purchase 15,000 shares of our common stock at $1.75 per share. The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.6 years.

 

On July 14, 2008, we issued warrants to Investment Hunter, LLC to purchase 15,000 shares of our common stock at $1.75 per share. The warrants vested upon issuance.  The weighted average remaining life of the warrants is 8.6 years.

 

We issued the following immediately vested warrants to Equity 11 in conjunction with Equity 11’s purchases of our 5% convertible preferred stock:

 

		Strike		Date		Expiration
Number		Price		Issued		Date
100,000		$0.75		July 28, 2008		July 28, 2018
5,000		$0.75		August 20, 2008		August 20, 2018
25,000		$0.75		August 27, 2008		August 27, 2018
500,000		$0.75		August 29, 2008		August 29, 2018
375,000		$0.75		September 26, 2008		September 26, 2018
47,000		$ 0.75		January 23, 2009		January 23, 2014
15,000		$ 0.75		February 10, 2009		February 10, 2014
12,500		$ 0.75		February 18, 2009		February 18, 2014
20,000		$ 0.75		February 26, 2009		February 26, 2014
11,500		$ 0.75		March 10, 2009		March 10, 2014
40,000		$ 0.75		March 26, 2009		March 26, 2014
10,750		$0.75		April 14, 2009		April 14, 2014
16,750		$0.75		April 29, 2009		April 29, 2014

 

On November 11, 2008, we issued warrants to purchase 2,000,000 shares of our common stock at $.50 per share to Trimax. The warrants vested upon issuance.  The weighted average remaining life of the warrants is 9.0 years.

 

Shares.  On February 6, 2008, we entered into an allonge to the promissory note made to Christopher Marquez on February 28, 2006.  The amount owed, including principal and accrued interest, totaled $142,415 and the note matured on December 31, 2007 (See Note 4).  The maturity date of the note was extended to May 31, 2008, with interest continuing at 15% per annum.  In consideration of this extension, we issued 60,000 shares of our common stock to the note holder and granted the holder certain priority payment rights.  This note has been paid in full.

 

On August 28, 2008, we entered into an agreement with Equity 11 to issue up to $5,000,000 in convertible preferred securities.  The securities accrue cumulative dividends at 5% per annum and the entire amount then outstanding is convertible at the option of the investor into shares of our common stock at $.50 per share.  The preferred securities carry “as converted” voting rights.  As of June 30, 2009, we had issued 2,436 of these convertible preferred shares.  As we sell additional convertible preferred securities under this agreement, we will issue attached warrants (500 warrants for each $1,000 convertible preferred share sold).  The warrants will be immediately exercisable, expire in five years, and entitle the investor to purchase one share of our common stock at $.75 per share for each warrant issued.  The table above identifies warrants issued in conjunction with Equity 11’s additional purchases of our 5% convertible preferred stock through September 30, 2009.

 

On May 15, 2009, we entered into an agreement with Equity 11 to issue convertible preferred securities at $1,000 per share. The securities accrue cumulative dividends at 5% per annum and the entire amount then outstanding is convertible at the option of the investor into shares of our common stock at a price equal to 20% of the average closing price of our common shares for the five trading days immediately preceding the date of issuance. The preferred securities carry “as converted” voting rights.  As of September 30, 2009, we have issued 566 of these convertible preferred securities. These shares are convertible into 5,802,377 of our common shares at the sole discretion of Equity 11.

 

In the event of a voluntary or involuntary dissolution, liquidation or winding up, Equity 11 will be entitled to be paid a liquidation preference equal to the stated value of the convertible preferred shares, plus accrued and unpaid dividends and any other payments that may be due on such shares, before any distribution of assets may be made to holders of capital stock ranking junior to the preferred shares.

 

On September 30, 2009, Ecology Coatings, Inc. we and Stromback Acquisition Corporation, entered into a Securities Purchase for the issuance and sale of our 5.0% Cumulative Convertible Preferred Shares, Series B at a purchase price of $1,000 per share.  Stromback Acquisition Corporation is owned by Richard Stromback a former member of our Board of Directors.  Until April 1, 2010, Purchaser has the right to purchase up to 3,000 Convertible Preferred Shares.  The Convertible Preferred Shares have a liquidation preference of $1,000 per share.  Purchaser may convert the Convertible Preferred Shares into common stock of the Company at a conversion price that is seventy seven percent (77%) of the average closing price of Company’s common stock on the Over-The-Counter Bulletin Board for the five trading days prior to each investment.  The Convertible Preferred Shares will pay cumulative cash dividends at a rate of 5% per annum, subject to declaration by our Board of Directors, on December 1 and June 1 of each year.  We have agreed to provide piggyback registration rights for common stock converted by Purchaser under a Registration Rights Agreement.  See also Note 10—Subsequent Events

Fifty percent (50%) of each investment, up to a maximum of $500,000, will be placed in a fund and disbursed as directed by Purchaser to satisfy our outstanding debts, accounts payable and/or investor relations programs (“Discretionary Fund”).

 

Note 7 — Stock Options

 

Stock Option Plan.  On May 9, 2007, we adopted a stock option plan and reserved 4,500,000 shares for the issuance of stock options or for awards of restricted stock. On December 2, 2008, our Board of Directors authorized the addition of 1,000,000 shares of our common stock to the 2007 Plan.  All prior grants of options were included under this plan.  The plan provides for incentive stock options, nonqualified stock options, rights to restricted stock and stock appreciation rights.  Eligible recipients are employees, directors, and consultants.  Only employees are eligible for incentive stock options.

 

The vesting terms are set by the Board of Directors. All options expire 10 years after issuance.

 

The Company granted non-statutory options as follows during the year ended September 30, 2009:

	Weighted Average Exercise Price Per Share	Number of Options	Weighted Average (Remaining) Contractual Term
Outstanding as of September 30, 2008	$1.83	4,642,119	9.2
Granted	$.61	1,439,000	9.8
Exercised	$.50	50,000	7.8
Forfeited	$2.13	900,000	7.8
Outstanding as of September 30, 2009	$1.13	5,131,119	8.5
Exercisable	$1.06	2,925,119	6.7

 

 

2,925,119 of the options were exercisable as of September 30, 2009.  The options are subject to various vesting periods between June 26, 2007 and January 1, 2012.   The options expire on various dates between June 1, 2016 and January 1, 2022. Additionally, the options had no intrinsic value as of September 30, 2009.  Intrinsic value arises when the exercise price is lower than the trading price on the date of grant.

 

Employee and director stock-based compensation expense is measured utilizing the fair-value method.

 

We account for stock options granted to non-employees under the fair-value method with stock-based compensation expense being charged to earnings on the earlier of the date services are performed or a performance commitment exists.

 

In calculating the compensation related to employee/consultants and directors stock option grants, the fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model and the following weighted average assumptions:

Dividend	None
Expected volatility	86.04%-101.73%
Risk free interest rate	.10%-5.11%
Expected life	5 years

 

The expected volatility was derived utilizing the price history of another publicly traded nanotechnology company.  This company was selected due to the fact that it is widely traded and is in the same equity sector as our Company.

 

The risk free interest rate figures shown above contain the range of such figures used in the Black-Scholes calculation.  The specific rate used was dependent upon the date of the option grant.

 

Based upon the above assumptions and the weighted average $1.13 exercise price, the options outstanding at September 30, 2009 had a total unrecognized compensation cost of $648,330 which will be recognized over the remaining weighted average vesting period of .5 years. Options cost of $3,182,773 was recorded as an expense for the year ended September 30, 2009 of which $799,209 was recorded as compensation expense and $2,383,564 was recorded as consulting expense.  Of this amount, $1,368,450 was consulting expense due to the issuance of warrants to Trimax LLC in November 2008 to acquire 2,000,000 shares of our common stock.

Note 8 -- Income Taxes

 

A reconciliation of the provision for income taxes for the years ended September 30, 2009 and 2008 is as follows:

	2009	2008
Income tax expense at the statutory rate	$(1,761,945)	$(2,301,909)
Permanent differences	1,536	1,920
Cash to accrual differences	87,613	182,340
Change in valuation allowance	1,672,796	2,482,329
	$ --	$ --

 

         We have incurred losses since operations commenced in 1990.  We have a net operating loss carry forward for income tax purposes of approximately $10,440,946. The total loss carry forward expiring on September 30, 2029 is $2,093,526, expiring on September 30, 2028 is $3,959,334, expiring on September 30, 2027 is $3,513,085, expiring on September 30, 2026 is $426,697, expiring on September 30, 2025 is $203,978, expiring on September 30, 2024 is $198,988, expiring on September 30, 2023 is $25,597 and expiring on September 30, 2022 is $19,741.  We changed its year-end to September 30th from February 28th effective in fiscal 2006.

 

         Deferred income taxes arise from timing differences resulting from income and expense items reported for financial accounting and tax purposes in different periods.

 

         The principal sources of timing differences are different accrual versus cash accounting methods used for financial accounting and tax purposes; the timing of the utilization of the net operating losses, and different book versus tax depreciation methods.

 

         As of September 30, 2009 and 2008, the deferred tax asset based on a 34% tax bracket consists of the following:

 

			2009		2008
Assets:
Federal loss carry forwards			$      3,549,921		$      2,537,985
Cash basis accounting differences			397,142		451,603
Stock option differences			1,799,635		1,066,345
Liability:
Depreciation timing differences			1,227		(804)
Deferred tax asset			5,727,925		4,055,129
Valuation  allowance			(5,727,925)		(4,055,129)
Net deferred tax asset			$                     -		$                    -

 

The tax benefit from net operating losses and differences in timing differ from the federal statutory rate primarily due to the $959,506 change in the deferred tax asset valuation allowance from September 30, 2008.  As of September 30, 2009 and 2008, the Company had no unrecognized tax benefits due to uncertain tax positions.

 

Note 9 — Going Concern

 

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  For the years ended September 30, 2009 and 2008, we incurred net losses of ($5,182,192) and ($6,770,322), respectively.  As of September 30, 2009 and September 30, 2008, we had stockholders’ deficits of ($2,010,657) and ($1,239,810), respectively.

 

Our continuation as a going concern is dependent upon our ability to generate sufficient cash flow to meet our obligations on a timely basis, to obtain additional financing or refinancing as may be required, to develop commercially viable products and processes, and ultimately to establish profitable operations.  We have financed operations primarily through the issuance of equity securities and debt and through some limited operating revenues.  Until we are able to generate positive operating cash flows, additional funds will be required to support our operations.  We will need to acquire additional immediate funding in fiscal year 2010 to continue our operations.  The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

 

Note 10 — Subsequent Events

We evaluated subsequent events for potential recognition and/or disclosure for the period beginning September 30, 2009 through December 22, 2009, the date the consolidated financial statements were originally issued.  We have extended the date of our evaluation through February 16, 2010 and concluded there were no other events or transactions occurring during this period that required recognition or additional disclosure in the financial statements.

On October 1, 2009, we issued 240 Convertible Preferred Shares at an aggregate purchase price of $240,000 under our securities purchase agreement with Stromback Acquisition Corporation.  These securities can be converted into 571,429 shares of our common stock. A warrant was issued to Purchaser granting rights to purchase 14,400 shares of our common stock at a purchase price of $.42 per share. Per the terms of the agreement and at Mr. Stromback’s direction, we paid $120,000 to him on that date in settlement of past payables owed to him directly or to RJS Ventures, LLC, a company controlled by him.

On November 9, 2009, we issued 50 Convertible Preferred Shares, Series B, at an aggregate price of $50,000 to Equity 11. These shares can be converted into 714,286 shares of our common stock.

On November 30, 2009, we issued a note for $3,600 to JB Smith, LC. This company is owned by J.B. Smith, a member of our board of directors. The interest bears interest at 5% per annum and is payable with 15 days of demand by the holder.

On December 1, 2009, we issued 61 Convertible Preferred Shares, Series A, to Equity 11 in payment of the dividend due on that date. These shares are convertible into 122,000 shares of our common stock.

On December 1, 2009, we issued 14 Convertible Preferred Shares, Series B, to Equity 11 in payment of the dividend due on that date. These shares are convertible into 175,000 shares of our common stock.

On December 4, 2009, we issued 65 Convertible Preferred Shares, Series B, at an aggregate price of $65,000 to Equity 11. These shares can be converted into 812,500 shares of our common stock.

On December 16, 2009, we issued 31 Convertible Preferred Shares, Series B, at an aggregate price of $31,000 to Equity 11.  These shares can be converted into 606,000 shares of our common stock.

 
 

 

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