UNITED STATES
 
Securities and Exchange Commission
Washington, D.C. 20549
 
Form 10-Q/A
     
þ
 
QUARTERLY REPORT PURUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended December 31, 2009
 

     
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                     
 
Commission file number: 333-91436
 
 
ECOLOGY COATINGS, INC.
(Exact Name of Registrant as Specified in Its Charter)

     
Nevada
 
26-0014658
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
2701 Cambridge Court, Suite 100, Auburn Hills, MI  48326
 
(Address of principal executive offices) (Zip Code)
 
(248) 370-9900
 
(Registrant’s telephone number)
 

 
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 Date 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).
 
 
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  o
 

Large Accelerated Filer  o
Accelerated Filer o
Non-accelerated filer o
Smaller Reporting Company  x
 
 

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares of common stock of the issuer outstanding as of February 1, 2010 was 32,910,684.

 
 
 

 
1

 

EXPLANATORY NOTE
In connection with our quarterly report on Form 10-Q for the three months ended on December 31, 2009, we are filing this Amendment No. 1 to include the following information:
 
1. We have concluded that our internal control over financial reporting was ineffective due to our failure to disclose the impact on earnings per share of preferred stock dividends and the beneficial conversion feature associated with our convertible preferred shares and, therefore, we have amended Item 4T, "Controls and Procedures" of Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations".
 
2. We have amended Item 3, "Defaults Upon Senior Securities" to disclose that certain other notes were also in default as of December 31, 2009.
 
With the exception of the foregoing changes, no other information in the report on Form 10-Q for the three months ended December 31, 2009 has been supplemented, updated or amended.

 
2

 


Item 1.  Financial Statements
 
ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Balance Sheets
 
ASSETS
     
 
December 31, 2009
September 30, 2009
 
Unaudited
 
     
Current Assets
   
Cash and cash equivalents
 $27,323
 $ -
Accounts Receivable
5,457
  -
Prepaid expenses
1,400
      1,400
     
Total Current Assets
34,180
   1,400
     
Property and Equipment
   
Computer equipment
  30,111
30,111
Furniture and fixtures
   21,027
  21,027
Test equipment
     9,696
    9,696
Signs
        213
     213
Software
     6,057
   6,057
Video
   48,177
   48,177
Total property and equipment
  115,281
115,281
Less: Accumulated depreciation
   (55,178)
  (48,609)
     
Property and Equipment, net
60,103
66,672
     
Other Assets
   
Patents-net
217,103
 443,465
Trademarks-net
  7,180
6,637
     
Total Other Assets
224,283
450,102
     
Total Assets
 $318,566
 $518,174
 

 

 
See the accompanying notes to the unaudited consolidated financial statements.

 

 
 

 


 

ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Balance Sheets
     
LIABILITIES AND STOCKHOLDERS' DEFICIT
 
December 31, 2009
September 30, 2009
 
Unaudited
 
Current Liabilities
   
Bank overdraft
 $                     -
 $                          200
Accounts payable
                 1,256,612
                 1,272,057
Credit card payable
                      114,622
114,622
Accrued liabilities
                      50,321
                      76,084
Interest payable
                      238,715
                    189,051
Convertible notes payable
                    582,301
                    582,301
Notes payable - related party
261,316
                    257,716
Preferred dividends payable
                        14,612
                        36,800
Total Current Liabilities
2,518,499
2,528,831
     
Total Liabilities
2,518,499
2,528,831
     
Commitments and Contingencies (Note 5)
                              -
                              -
     
Stockholders' Deficit
   
Preferred Stock - 10,000,000 $.001 par value shares
                               4
                               2
authorized; 3,513 and 3,002 shares issued and outstanding
   
as of December 31, 2009 and September 30, 2009, respectively
   
Common Stock - 90,000,000 $.001 par value shares
   
authorized; 32,910,684 and 32,835,684
   
outstanding as of December 31, 2009 and
   
September 30, 2009, respectively
                      32,934
                      32,859
Additional paid in capital
               22,112,573
20,645,299
Accumulated Deficit
              (24,345,444)
              (22,688,817)
     
Total Stockholders' Deficit
                (2,199,933)
                (2,010,657)
     
     
Total Liabilities and Stockholders' Deficit
 $                 318,566
 $              518,174
 

 

 
See the accompanying notes to the unaudited consolidated financial statements.

 

 
 

 


 

ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Operations
(Unaudited)
 
 
For the three months ended
 
For the three months ended
 
December 31, 2009
 
December 31, 2008
       
       
Revenues
$                                            5,457
 
 $                                                  -
       
Salaries and fringe benefits
316,258
 
                                         482,570
Professional fees
                                      184,143
 
                                         2,048,747
Other general and administrative costs
                                           288,184
 
98,312
Total General and Administrative Expenses
                                      788,585
 
                                      2,629,629
       
Operating Loss
                                    (783,128)
 
                                    (2,629,629)
       
Other Income (Expense)
     
Interest Income
                                                -
 
                                             142
Interest Expense
                                       (52,788)
 
                                         (124,622)
Total Other Expenses - net
                                       (52,788)
 
                                         (124,480)
       
Net Loss
 $                                    (835,916)
 
 $                                 (2,754,109)
       
Preferred Dividends—Beneficial Conversion
     
Feature
(768,544)
 
-
Preferred Dividends—Stock Dividends
(53,074)
 
(44,461)
       
Net Loss available to common shareholders
$                                 (1,657,534)
 
$                                 (2,798,570)
       
Basic and diluted net loss per share
 $                                          (0.05)
 
 $                                          (0.09)
       
Basic and diluted weighted average of
     
common shares outstanding
32,873,456
 
32,233,600
 

 

 

 

 

 

 
See the accompanying notes to the unaudited consolidated financial statements.

 

 
 

 


 

ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
     
 
For the three months ended
For the three months ended
 
December 31, 2009
December 31, 2008
     
OPERATING ACTIVITIES
   
Net  loss
 $                        (835,916)
 $                        (2,754,109)
Adjustments to reconcile net loss
   
to net cash used in operating activities:
   
Depreciation and amortization
                                 11,185
                                   11,026
Option expense
165,044
                               1,997,949
Warrant expense
-
63,512
Shares issued in exchange for services
22,500
-
Patent Abandonment
222,112
-
Changes in Asset and Liabilities
   
Accounts Receivable
(5,457)
-
Prepaid expenses
-
16,268
Bank overdraft
(200)
4,528
Accounts payable
                                 (15,445)
                               69,461
Accrued liabilities
                                   (25,763)
7,549
Credit card payable
                                   -
                                 2,069
Franchise tax payable
                                     -
(800)
Interest payable
                                49,663
                                   (75,045)
Net Cash Used in Operating Activities
                              (412,277)
                              (657,593)
     
INVESTING ACTIVITIES
   
Purchase of fixed assets
                              -
                                (16,480)
Purchase of intangibles
                                  -
                                  (8,400)
Net Cash Used in Investing Activities
                                -
                                (24,880)
     
FINANCING ACTIVITIES
   
Repayment of debt
-
                                        (311,803)
Proceeds from issuance of convertible preferred shares
436,000
-
Proceeds from debt
                                 3,600
                                         20,000
Net Cash From (Used) in Financing Activities
                              439,600
                                        (291,803)
     
Net Increase (Decrease) in Cash and Cash Equivalents
27,323
                              (974,276)
     
CASH AND CASH EQUIVALENTS AT BEGINNING
   
OF PERIOD
                               -
974,276
CASH AND CASH EQUIVALENTS AT END
   
OF PERIOD
 $                             27,323
 $                           -
 

 
See the accompanying notes to the unaudited consolidated financial statements.

 

 
 

 


 


ECOLOGY COATINGS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
     
     
 
For the three months ended
For the three months ended
 
December 31, 2009
December 31, 2008
     
     
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
   
INFORMATION
   
Interest paid
 $                                      -
 $                           132,000
Income taxes paid
 $                                      -
$                                       -
 

 
See the accompanying notes to the unaudited consolidated financial statements.

 
 

 


 

 
ECOLOGY COATINGS, INC. AND SUBSIDIARY
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
DECEMBER 31, 2009 AND DECEMBER 31, 2008
 
 
 
Note 1 — Summary of Significant Accounting Policies
 
           Interim Reporting. While the information presented in the accompanying interim consolidated financial statements is unaudited, it includes all normal recurring adjustments, which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented in accordance with accounting principles generally accepted in the United States of America.  These interim consolidated financial statements follow the same accounting policies and methods of their application as the September 30, 2009 audited annual consolidated financial statements of Ecology Coatings, Inc. (“we”, “us”, the “Company” or “Ecology”).  It is suggested that these interim consolidated financial statements be read in conjunction with our September 30, 2009 annual consolidated financial statements included in the Form 10-K/A we filed with the Securities and Exchange Commission on February 16, 2010.
 
Our operating results for the three months ended December 31, 2009 are not necessarily indicative of the results that can be expected for the year ending September 30, 2010 or for any other period.
 
      Going Concern. In connection with their audit report on our consolidated financial statements as of September 30, 2009, the Company’s independent registered public accounting firm expressed substantial doubt about our ability to continue as a going concern.  Continuance of our operations is dependent upon our ability to raise sufficient capital.  The consolidated 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.
 
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 product sales are recognized on the date that the product is shipped. 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.  Basic loss per share is computed by dividing the net loss 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 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 potential conversion of debt and Preferred Series A and Preferred Series B 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 potential conversion of debt or with Preferred Series A and Preferred Series B shares during each of the periods presented were included in the computation of diluted loss per share as they were anti-dilutive.  As of December 31, 2009 and September 30, 2009, there were 24,183,419 and 20,323,996 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 December 31, 2009 and September 30, 2009, 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. During the three months ended December 31, 2009, we abandoned a number of patent applications and recognized an expense of $222,112 as a result of this.
 
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 $316,258 and $482,570 for the three months ended December 31, 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 $181,143 and  $2,048,747, for the three months ended December 31, 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 $2,048,747 in professional fees incurred in the three months ended December 31, 2008, $1,752,318 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.
 
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 three months ended December 31, 2009 and  2008, we had revenues of $5,457 and  $-0-, respectively. One customer accounted for all of our revenues for the three months ended December 31, 2009. As of December 31, 2009 $5,457 was due from this customer.
 
We occasionally maintain bank account balances in excess of the federally insurable amount of $250,000.  We did not exceed this limit as of December 31, 2009 and September 30, 2009.
 
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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $110,500.  The accrued interest on the note was $14,486 and $13,235 as of December 31, 2009 and September 30, 2009, 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.  The note is in default and is currently due and payable.
 
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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $133,000.    The accrued interest on the note was $17,442 and  $15,936 as of December 31, 2009 and September 30, 2009, 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.  The note is in default and is currently due and payable.
 
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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $0. The unpaid accrued interest on the note was $2,584 as of December 31, 2009 and September 30, 2009, 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.  The interest is in default and is currently due and payable.
 
We have an unsecured  note payable to an entity controlled by J.B. 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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $7,716.  Accrued interest of $195 and $96 was outstanding of December 31, 2009, September 30, 2009.
 
We have an unsecured note payable to an entity controlled by J.B. 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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $6,500  Accrued interest of $100 and $18 was outstanding of December 31, 2009 and September 30, 2009.
 

We have an unsecured note payable to an entity controlled by J.B. 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 December 31, 2009 and September 30, 2009, the note had an outstanding balance of $3,600 and $0, respectively. Accrued interest of $15 and $0 was outstanding of December 31, 2009 and September 30, 2009.
 
Future maturities of related party long-term debt as of September 30, 2009 are as follows:
         
12 Months Ended December 31,
       
                   2010
 
$
261,316
 
       
 
We have a payable to  Richard Stromback and an entity controlled by him totaling $98,730 and  $145,191 as of December 31, 2009 and September 30, 2009, respectively, included in accounts payable on the consolidated balance sheets.

Note 4 — Notes Payable
 
We have the following notes:

   
December 31, 2009
September 30, 2009
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 $12,264 and $9,232 was outstanding as of December 31, 2009 and September 30, 2009, respectively.
 
$38,744
     
$38,744
 
               
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 2008 were made, but none have been made since.  Accrued interest of $87,284 and $64,650 was outstanding as of December 31, 2009 and September 30, 2009, respectively.
 
293,557
     
293,557
 
               
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 $61,348 and $48,787 was outstanding as of December 31, 2009 and September 30, 2009, 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 $43,013 and $34,513was outstanding as of
December 31, 2009 and September 30, 2009, respectively.
 
100,000
     
100,000
 
               
   
$582,301
     
$582,301
 


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 December 31, 2009, the convertibility features had expired.
 
All of the notes payable in the table above initially had conversion rights and warrants.  These Notes may be converted for the principal balance and any unpaid accrued interest to Common Stock. 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 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 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.
 
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 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 the 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 the 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 the 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.

On November 18, 2009, Investment Hunter, LLC, one of our note holders, filed suit in the Supreme Court of New York for repayment of $360,920 plus interest, attorneys fees and costs.  We have previously made payments totaling $300,000 to Investment Hunter.  We have engaged counsel in New York and filed a response to Investment Hunter’s pleadings.

On December 15, 2009, McLarty Associates LLC, one of our prior consultants, filed suit in the Superior Court in Washington, D.C. against us seeking an additional $150,000 from us under our consulting agreement.  We have previously paid McLarty Associates $210,000 and issued 90,000 shares of common stock yet we have not received anything tangible from McLarty Associates.  We are in the process of filing a response to the complaint.

On January 11, 2010, John Henke, the attorney who represented Trimax, LLC, filed suit in the 52nd District Court in Rochester Hills, MI to recover $13,750 owed to him as attorneys fees under the Settlement Agreement we reached with Trimax on November 11, 2008.  We are in the process of filing a response to the complaint.
 
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 three months ended December 31, 2009 and 2008 was $5,400 and $5,400, 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 expenses for the three months ended December 31, 2009 and 2008 were $9,023 and $8,133, respectively.
       

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 7.0 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 8.0 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 8.0 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 8.0 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 8.3 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 8.3 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 8.3 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 8.3 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 8.3 years.
 
We issued the following immediately vested warrants to Equity 11 in conjunction with Equity 11’s purchases of our Preferred Series A 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 August 28, 2008, we entered into an agreement with Equity 11 to issue up to $5,000,000 in convertible preferred securities “Preferred Series A”).  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 Series A shares carry “as converted” voting rights.  As of December 31, 2009, we had issued 2,497 of these Preferred Series A shares.  As we sold additional Preferred Series A shares under this agreement, we issued attached warrants (500 warrants for each $1,000 Preferred Series A 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 Preferred Series A stock through December 31, 2009.
 

On May 15, 2009, we entered into an agreement with Equity 11 to issue convertible preferred securities at $1,000 per share (“Preferred Series B”). 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 December 31, 2009, we have issued 776 of these Preferred Series B shares. These shares are convertible into 8,954,371 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 Preferred Series B 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 (“Preferred Series B”).  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 Preferred Series B shares.  The Preferred Series B shares have a liquidation preference of $1,000 per share.  Purchaser may convert the Preferred Series B 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 Preferred Series B 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.  As of December 31, 2009, we had issued 240 of these Preferred Series B shares. Those shares are convertible into 571,429 shares of our common stock. 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.
 
We granted non-statutory options as follows during the three months ended December 31, 2009:

 
Weighted Average Exercise Price Per Share
Number of Options
Weighted Average (Remaining) Contractual Term
Outstanding as of September 30, 2009
$1.13
5,131,119
8.5
Granted
$-
-
-
Exercised
  $-
-
-
Forfeited
$-
-
-
Outstanding as of December 31, 2009
$1.13
5,131,119
8.5
Exercisable
$1.01
3,070,119
6.2
 

3,070,119 of the options were exercisable as of December 31, 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 December 31, 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 Ecology.
 
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 per share exercise price, the options outstanding at December 31, 2009 had a total unrecognized compensation cost of $483,287 which will be recognized over the remaining weighted average vesting period of .5 years. Options cost of $165,044 was recorded as an expense for the three months ended December 31, 2009 of which $162,212 was recorded as compensation expense and $2,832 was recorded as consulting expense.
 
Note 8 — 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 three months ended December 31, 2009 and 2008, we incurred net losses of ($835,916) and ($2,754,109), respectively.  As of December 31, 2009 and September 30, 2009, we had stockholders’ deficits of ($2,199,933) and ($2,010,657), 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 9 — Subsequent Events

We evaluated subsequent events for potential recognition and/or disclosure through February 16, 2010, the date the consolidated financial statements were issued.

On January 13, 2010, we issued 55 Preferred Series B, at an aggregate price of $55,000 to Equity 11. These shares can be converted into 1,100,000 shares of our common stock.

        On February 3, 2010, we entered into a Commercialization Agreement with WS Packaging Group, Inc. (“WSP”).  The Agreement provides the terms and conditions for WSP’s purchase of our coatings for use on labels and packaging manufactured by WSP.
 
 

 

 

 
 

 

 

 
 

 


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Except for statements of historical fact, the information presented herein constitutes forward-looking statements. These forward-looking statements generally can be identified by phrases such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “foresees,” “intends,” “plans,” or other words of similar import.  Similarly, statements herein that describe our business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements.  Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  Such factors include, but are not limited to, our ability to: successfully commercialize our technology; generate revenues and achieve profitability in an intensely competitive industry; compete in products and prices with substantially larger  and better capitalized competitors; secure, maintain and enforce a strong intellectual property portfolio; attract immediate additional capital sufficient to finance our working capital requirements, as well as any investment of plant, property and equipment; develop a sales and marketing infrastructure; identify and maintain relationships with third party suppliers who can provide us a reliable source of raw materials; acquire, develop, or identify for our own use, a manufacturing capability; attract and retain talented individuals; continue operations during periods of uncertain general economic or market conditions, and; other events, factors and risks previously and from time to time disclosed in our filings with the Securities and Exchange Commission, including, specifically, the “Risk Factors” enumerated herein.
 
Overview
 
We develop “clean tech”, nanotechnology-enabled, ultra-violet (“UV”) curable coatings that are designed to drive efficiencies, reduce energy consumption, create new performance characteristics and virtually eliminate pollutants in the manufacturing sector.  We create proprietary coatings with unique performance and environmental attributes by leveraging our platform of integrated clean technology products that reduce overall energy consumption and offer a marked decrease in drying time.
 
Our patent and intellectual property activities to date include:
 
 
·
five patents covering elements of our technology from the United States Patent and Trademark Office(“USPTO”)
 
 
·
one European patents allowed and five pending patent applications in foreign countries
 
 
·
three trademarks issued by the USPTO – “EZ Recoat™”, “Ecology Coatings™” and “Liquid Nanotechnology™”
 
    ·  
200+ proprietary coatings formulations.
 
We continue to work independently on developing our clean technology products further. Our target markets include the electronics, steel, construction, automotive and trucking, paper products and original equipment manufacturers (“OEMs”).  Our business model contemplates both licensing and direct sales strategies.  We intend to license our technology to industry leaders in our target markets, through which products will be sold to end users.  We plan to use direct sales teams and third party agents in certain target markets, such as OEMs, and third party distributors in broad product markets, such as paper products, to develop our product sales.
 
Operating Results
 
Three Months Ended December 31, 2009 and 2008
 
Revenues.  Product sales generated revenues of  $5,457 for the three months ended December 31, 2009. We had no revenue for the corresponding period in 2008.
 
Salaries and Fringe Benefits.  The decrease of approximately $157,000 in such expenses for the three months ended December 31, 2009 compared to the three months ended December 31, 2008 is the result of the elimination of one salaried employee and the reduction of the salary of one employee effective September 1, 2009.  These reductions were partially offset by the expense associated with options issued to three employees in September of 2009, and the restoration, in November, 2009, of certain salary reductions that were made in November, 2008 .
 
Professional Fees.  The decrease of approximately $1,864,000 in these expenses for the three months ended December 31, 2009 compared to the three months ended December 31, 2008 is the result of the issuance of 2,000,000 options to Trimax in November, 2008.  These options vested upon issuance, so the entire charge of $1,368,000 was recognized in that month. Additionally, approximately $360,000 associated with options issued to Sales Attack were recognized in the three months ended December 31, 2008 and approximately $90,000 in consulting fees were recognized in the three months ended December 31, 2008 and they did not recur in the corresponding period for 2009.
 
Other General and Administrative.  The increase of approximately $180,000 in these expenses for the three months ended December 31, 2009 compared to the three months ended December 31, 2008 reflects the recognition of the write off of certain patents totaling approximately $222,000. This was partially offset by a reduction in travel expenses for the three months ended December 31, 2009.
 
Operating Losses.  The decreased loss between the reporting periods is explained in the discussion above.
 
Interest Expense. The decrease of approximately $62,000 for the three months ended December 31, 2009 compared to the three months ended December 31, 2008 is the result of the revaluing of previously issued detachable warrants during the three months ended December 31, 2008.
 
Income Tax Provision.  No provision for income tax benefit from net operating losses has been made for the three months ended December 31, 2009 and 2008 as we have fully reserved the asset until realization is more reasonably assured.
 
Net Loss.  The decrease in the Net Loss of approximately $1,920,000 for the three months ended December 31, 2009 compared to the three months ended December 31, 2008 is fully explained in the foregoing discussions of the various expense categories.
 
Basic and Diluted Loss per Share. The change in basic and diluted net loss per share for the three months ended December 31, 2009 reflects the decreased Net Loss discussed as well as by the increase in weighted average shares outstanding during the three months ended December 31, 2009.
 
Liquidity and Capital Resources
 
Cash and cash equivalents as of December 31, 2009 and September 30, 2008 totaled $27,323 and $0, respectively.  The increase reflects cash used in operations of $411,195 and cash used to purchase fixed and intangible assets of $1,082. These uses were more than  offset by borrowings of $3,600 and the issuance of $436,000 in Preferred Series B stock.
 
We have incurred an accumulated deficit of $24,343,256.  We have incurred losses primarily as a result of general and administrative expenses, salaries and benefits, professional fees, and interest expense.  Since our inception, we have generated very little revenue, though we did generate $5,457 in the three months ended December 31, 2009.  
 
We expect to continue using substantial amounts of cash to: (i) develop and protect our intellectual property; (ii) further develop and commercialize our products; (iii) fund ongoing salaries, professional fees, and general administrative expenses.  Our cash requirements may vary materially from those now planned depending on numerous factors, including the status of our marketing efforts, our business development activities, the results of future research and development, competition and our ability to generate revenue .
 
Historically, we have financed operations primarily through the issuance of debt and the sale of equity securities.  In the near future, as additional capital is needed, we expect to rely primarily on the sale of convertible preferred securities.
 
As of December 31, 2009, we had notes payable to five separate parties on which we owed approximately $804,336 in principal and accrued interest.  These notes do not contain any restrictive covenants with respect to the issuance of additional debt or equity securities by us.  Notes and the accrued interest totaling $786,209 owing to three note holders were due prior to September 30, 2008 and their holders demanded payment.  We have paid $320,000 in principal and accrued interest against the remaining principal and interest balance on two of these notes.  We have not made any payment to the third note holder to whom we owed approximately $294,351 in principal and accrued interest as of December 31, 2009.  Additionally, we have notes owing to shareholders totaling approximately $278,01 including accrued interest as of December 31, 2009.  These notes are due and payable on December 31, 2009. None of the debt is subject to restrictive covenants.  All of the debt is unsecured.
 
On four separate occasions beginning November 9, 2009 and concluding December 30, 2009, Equity 11 purchased a total of 186 Preferred Series B shares under our May 15, 2009 agreement at $1,000 per share.  This brought their total holdings of such shares to 776 Preferred Series B shares.  Equity 11 also holds 2,497 Preferred Series A shares and 1,178,500 warrants under our August 28, 2008 agreement.  In addition, Stromback Acquisition Corporation purchased 240 Preferred Series B shares on October 1, 2009.  We will need to raise immediate additional funds in the first quarter of calendar year 2010 to continue our operations.  At present, we do not have any binding commitments for additional financing.  If we are unable to obtain additional financing, we would seek to negotiate with other parties for debt or equity financing, pursue additional bridge financing, and negotiate with creditors for a reduction and/or extension of debt and other obligations through the issuance of stock.  At this point, we cannot assess the likelihood of achieving these objectives.  If we are unable to achieve these objectives, we would be forced to cease our business, sell all or part of our assets, and/or seek protection under applicable bankruptcy laws.
 
On December 31, 2009, we had 32,910,684 common shares issued and outstanding and 3,513 Preferred Series A and Preferred Series B shares issued and outstanding.  These preferred shares and accumulated and unpaid dividends can be converted into a total of 14,519,799 shares of our common stock.  As of December 31, 2009, options and warrants to purchase up to 8,058,019 shares of common stock had been granted.
 
 
Off-Balance Sheet Arrangements
 
See Notes to the Consolidated Financial Statements in this Form 10-Q beginning on page 1. The details of such arrangements are found in Note 5 – Commitments and Contingencies and Note 9 – Subsequent Events.
 
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles. Preparation of the statements in accordance with these principles requires that we make estimates, using available data and our judgment, for such things as valuing assets, accruing liabilities and estimating expenses. The following is a discussion of what we feel are the most critical estimates that we must make when preparing our financial statements.
 
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.
 
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 our 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.
 
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
 
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 with 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 is amortized on a straight-line basis over its estimated useful life. For purposes of the preparation of the audited, consolidated financial statements, we have recorded amortization expense associated with the patents based on an eight year useful life.
 
Stock-Based Compensation.  We have a stock incentive plan that provides for the issuance of stock options, restricted stock and other awards to employees and service providers. We calculate compensation expense under SFAS 123(R) using a Black-Scholes option pricing model. In so doing, we estimate certain key assumptions used in the model. We believe the estimates we use, which are presented in Note 7 of Notes to the Consolidated Financial Statements, are appropriate and reasonable.
 
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.

 
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Not applicable since we are a smaller reporting company under the applicable SEC rules.

Item 4T.  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 as of the end of the period covered by this report 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 in that our auditors made adjustments to our Black-Scholes calculations used to expense stock options and warrants.

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.

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.
 
        We made changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  Those changes includes implementation of controls concerning the issuance of invoices upon the sale of our coatings and the generation of sales and accounts receivable reporting.  Additionally, our CFO no longer backs up our accounting software on a weekly basis on CDs as our IT consultant has reported that the automatic back up is functional.

 
 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

As of December 31, 2009, the Company was in default in the payment of principal and interest on the following promissory notes:

Note Holder
Issue Date(s)
Amount Owing on December 31, 2009
     
Investment Hunter, LLC
March 1, 2008
$380,841
     
Mitchell Shaheen I
September 21, 2008
$211,348
     
Mitchell Shaheen II
July 14, 2008
$143,013
     
George Resta
March 1, 2008
$51,008
     
 Rich Stromback  November 13, 2003  $2,584
     
 Deanna Stromback  December 15, 2003  $124,986
     
 Douglas Stromback  August 10, 2004 $150,442