Notes to Financial Statements
For the Three and Six Months Ended June 30, 2014 and 2013,
(unaudited)
1.
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Background Information
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Turbine Truck Engines, Inc. (the “Company”) is a company that was incorporated in the state of Delaware on November 27, 2000, and converted to a Nevada corporation in 2008. To date, the Company’s activities have been limited to raising capital, organizational matters, and the structuring of its business plan. The corporate headquarters is located in Paisley, Florida.
The Company is a business whose planned principal operations are the development of the (a) Detonation Cycle Gas Turbine Engine (DCGT); (b) Hydrogen Production Burner System (HPBS); and (c) the Gas to Methanol Technology (GTM). In addition, the Company is planning to pursue both intellectual property and/or operating company asset candidates to merge into the Company. No specific candidate has been identified at this time. The Company is in the process of raising capital to support these activities. The Company’s activities are subject to significant risks and uncertainties, including failing to secure additional funding to commercialize the Company’s current technology before another company develops similar technology.
Effective August 29, 2013, the Company amended its Articles of Incorporation filed with the Nevada Secretary of State, to reflect the Board of Directors adoption of a resolution, consented to by those holding a majority of the common shareholder votes, which increased the authorized common stock of the company to 499,000,000 shares of common stock, having a par value of $0.001.
Effective June 18, 2014, the Company amended its Articles of Incorporation filed with the Nevada Secretary of State to reflect the Board of Directors adoption of a resolution to create “Series B Convertible Preferred Stock.” The Board of Directors designated 350,000 shares as Series B Convertible Preferred. The Series B Convertible Preferred, par value $0.001, provides for no voting rights and the shares are convertible after six months on a 20 to 1 ratio at the option of the preferred shareholder. As of June 30, 2014, no shares have been issued.
In the opinion of management, all adjustments consisting only of normal recurring adjustments necessary for a fair statement of (a) the results of operations for the three and six month periods ended June 30, 2014 and 2013, (b) the financial position at June 30, 2014 and December 31, 2013, and (c) cash flows for the six month periods ended June 30, 2014 and 2013, have been made.
The unaudited financial statements and notes are presented as permitted by Form 10-Q. Accordingly, certain information and note disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying financial statements and notes should be read in conjunction with the audited financial statements and notes of the Company for the fiscal year ended December 31, 2013. The results of operations for the three and six month periods ended June 30, 2014 are not necessarily indicative of those to be expected for the entire year.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. For the six months ended June 30, 2014, the Company had a net loss of $496,380. As of June 30, 2014, the Company has a working capital deficit of $251,754. In view of these matters, the Company’s ability to continue as a going concern is dependent upon the Company’s ability to begin operations and to achieve a level of profitability. The Company intends on financing its future development activities and its working capital needs largely from the sale of public equity securities with some additional funding from other traditional financing sources, including term notes and proceeds from sub-licensing agreements until such time that funds provided by operations are sufficient to fund working capital requirements. The financial statements of the Company do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.
4.
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Significant Accounting Policies
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The significant accounting policies followed are:
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 reported amounts of assets and liabilities and disclosure of contingent 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 is maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash balances were fully insured at June 30, 2014 and December 31, 2013. Insurance coverage was $250,000 per depositor at each financial institution. At June 30, 2014 and December 31, 2013, there were no amounts held in excess of federally insured limits.
The Company’s financial instruments include cash, accounts payable, accrued liabilities and notes payable. The carrying amounts of cash, accounts payable and accrued liabilities approximate their fair value, due to the short-term nature of these items. The carrying amount of notes payable approximates their fair value due to the use of market rates of interest and maturity schedules for similar issues. The derivative liability is recorded at fair value (see Note 7).
Furniture and equipment are recorded at cost and depreciated on a declining balance and straight-line basis over their estimated useful lives, principally two to seven years. Accelerated methods are used for tax depreciation. Maintenance and repairs are charged to operations when incurred. Betterments and renewals are capitalized. When furniture and equipment are sold or otherwise disposed of, the asset account and related accumulated depreciation account are relieved, and any gain or loss is included in operations.
The Company evaluates the recoverability of its long-lived assets or asset groups whenever adverse events or changes in business climate indicate that the expected undiscounted future cash flows from the related assets may be less than previously anticipated. If the net book value of the related assets exceed the undiscounted future cash flows of the assets, the carrying amount would be reduced to the present value of their expected future cash flows and an impairment loss would be recognized. There have been no impairment losses in any of the periods presented.
Research and development costs are charged to operations when incurred and are included in operating expenses. There were no amounts charged to research and development for each of the three and six month periods ended June 30, 2014 and 2013.
Deferred income tax assets and liabilities arise from temporary differences associated with differences between the financial statements and tax basis of assets and liabilities, as measured by the enacted tax rates, which are expected to be in effect when these differences reverse. Deferred tax assets and liabilities are classified as current or non-current, depending on the classification of the assets or liabilities to which they relate. Deferred tax assets and liabilities not related to an asset or liability are classified as current or non-current depending on the periods in which the temporary differences are expected to reverse.
The Company follows the provisions of FASB ASC 740-10 “
Uncertainty in Income Taxes
” (ASC 740-10), January 1, 2007. The Company has not recognized a liability as a result of the implementation of ASC 740-10. A reconciliation of the beginning and ending amount of unrecognized tax benefits has not been provided since there are no unrecognized benefits at June 30, 2014 and December 31, 2013. The Company has not recognized interest expense or penalties as a result of the implementation of ASC 740-10. If there were an unrecognized tax benefit, the Company would recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses.
The Company entered into various loan agreements with a Canadian company. In accordance with the loan agreements, the Company issued shares of common stock to the Canadian company as additional costs in obtaining the financing. These shares have been accounted for as contra-equity deferred non-cash offering issuance costs and they are being amortized as interest expense over the life of the notes which are five years. Foreign currency translation gains and losses, when material, have been recorded as other comprehensive income or loss.
Basic loss per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding and dilutive options outstanding during the year. Common stock equivalents for the three and six month periods ended June 30, 2014 and 2013 were anti-dilutive due to the net losses sustained by the Company during these periods. For the three months ended June 30, 2014 and 2013 potentially dilutive common stock options and warrants of 6,046,500 and 6,655,413 have been excluded from dilutive earnings per share due to the Company’s losses in all periods presented. For the six months ended June 30, 2014 and 2013 potentially dilutive common stock options and warrants of 6,046,500 and 6,655,413 have been excluded from dilutive earnings per share due the Company’s losses in all periods presented. Additionally, potential common shares from convertible preferred stock are excluded from the computation of diluted earnings per share of 500,000 shares.
The Company recognizes all share-based payments to employees, including grants of employee stock options, as compensation expense in the financial statements based on their fair values. That expense will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
The Company issues common stock and common stock options and warrants to consultants for various services. For these transactions, the Company follows the guidance in FASB ASC Topic 505. Costs for these transactions are measured at the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measureable. The value of the common stock is measured at the earlier of (i) the date at which a firm commitment for performance by the counterparty to earn the equity instrument is reached or (ii) the date at which the counterparty’s performance is complete.
In September 2006, the Financial Accounting Standards Board (FASB) introduced a framework for measuring fair value and expanded required disclosure about fair value measurements of assets and liabilities. The Company adopted the standard for those financial assets and liabilities as of the beginning of the 2008 fiscal year and the impact of adoption was not significant. FASB Accounting Standards Codification (ASC) 820 “
Fair Value Measurements and Disclosures
” (ASC 820) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
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Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
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Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
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Level 3 - Inputs that are both significant to the fair value measurement and unobservable.
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Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of June 30, 2014. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These financial instruments include accounts receivable, other current assets, accounts payable, accrued compensation and accrued expenses. The Company had a derivative liability at December 31, 2013 associated with an embedded conversion option that was included as a level 2 input.
Recent accounting pronouncements
Recent accounting pronouncements other than below issued by the FASB (including its EITF), the AICPA and the SEC did not or are not believed by management to have a material effect on the Company’s present or future financial statements.
In June 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-10, “Development Stage Entities (Topic 915) Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation”. This ASU does the following among other things: a) eliminates the requirement to present inception-to-date information on the statements of income, cash flows, and shareholders’ equity, b) eliminates the need to label the financial statements as those of a development stage entity, c) eliminates the need to disclose a description of the development stage activities in which the entity is engaged, and d) amends FASB ASC 275, Risks and Uncertainties, to clarify that information on risks and uncertainties for entities that have not commenced planned principal operations is required. The amendments in ASU No. 2014-10 related to the elimination of Topic 915 disclosures and the additional disclosure for Topic 275 are effective for public companies for annual and interim reporting periods beginning after December 15, 2014. Early adoption is permitted. The Company has evaluated this ASU and determined that it will early adopt beginning with the quarterly period ended June 30, 2014.
5.
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Commitments and Contingencies
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The Company leased its corporate headquarters on a month-to-month basis. For each of the three and six months ended June 30, 2014 and 2013, rent expense was approximately $6,250, $12,500, $6,250 and $12,500, respectively.
A total of CAN $300,000 was advanced under the Loan Agreement with 2367416 Ontario, Inc, and was delivered to ETS, as the initial payment on the first machine to be delivered under a purchase order agreement for a Hydrogen Production Burner System (HPBS). Despite positive initial reports from ETS during the manufacturing of the Equipment, they did not deliver the machine as promised under the Agreement. The Company has declared ETS to be in default and the Company has asked to be refunded as per the purchase order agreement. 2367416 Ontario, Inc. has received CAN 50,000, directly from ETS, which has been recorded as a reduction in the outstanding note payable and the deposit. Both 2367416 Ontario, Inc. and the Company are in negotiations to receive the CAN 250,000 plus interest owed, which, when received, will also be shown as a reduction of the outstanding note payable and the deposit. During the quarter ended June 30, 2014, the Company filed a criminal complaint with the DA office in Taipei Taiwan charging ETS and its principles of alleged fraud. The Company provided a reserve in the amount of $59,354 against this deposit on its balance sheet on June 30, 2014.
The Company is now in final negotiations directly with the Inventor, Dr. Chang and his new Company ZHENG YU CO. (ZYC), to provide the Company with the equipment necessary to fulfill the Company’s business plan. ZYC has agreed to sell us the rights to the technology for $1.8 million US for the H2 generator upon the completion and certification of the generator. The Company is currently working to formalize this agreement and expect to do so in the third quarter of 2014.
The Company has entered into various other agreements that have been disclosed in previous 10K and 10Q filings. These agreements have been put on hold but will be further pursued as adequate funding is generated.
On July 30, 2013, the Company signed an Agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the initial sum of CAN $450,000 and a maximum of CAN $10,000,000 in accordance with the terms of the Agreement. The financing to be provided is to be funded in tranches, and will have terms between three (3) and five (5) years, with each tranche being separately negotiated. As a part of the loan costs, 236 shall be issued restricted common stock equal to the issued and outstanding common shares of the Company at the time of the initial advance, with such shares being subject to a Lock Up/Leak Out Agreement to be negotiated between the parties. These shares are considered an additional cost in obtaining the financing and the value of these shares at the commitment date is recorded as a contra equity and amortized to interest expense over five years.
The initial advance of CAN $450,000 is covered by a Loan Agreement dated June 19, 2013, and was signed on July 30, 2013 (the “Loan Agreement”), which provides that (a) the interest rate shall be 20% per annum; and (b) CAN $90,000 shall be withheld by lender in interest rate reserve account for the payment of the first years interest. The total of CAN $300,000 under the Loan Agreement was received during the three months ended September 30, 2013 and delivered to Energy Technology Services Co., Ltd., (ETS) as the initial payment on the first machine to be delivered under a purchase order agreement. As of June 30, 2014, the Company has recorded $330,785 as a note payable and $178,060 as a deposit (net of the reserve of $59,354). During the six months ended June 30, 2014, $48,385 was paid back from the deposit and applied towards the note.
During the year ended December 31, 2013, the Company, as part of the above agreement, is required to issue 124,000,000 shares of restricted common stock to 236. These shares were valued at $0.008 which was the share price at the commitment date. On March 1, 2014, 236 modified the required number of shares to be issued to include an additional 12,341,598 shares. These shares are valued at $0.07 which was the share price at commitment date on March 1, 2014. As of June 30, 2014, the Company has issued 136,341,598 shares to 236 and recorded $1,855,912 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt issuance costs at June 30, 2014 was $1,616,540. This modification did not have a material impact on the Company’s March 31, 2014 Form 10-Q and therefore did not need to be restated.
On August 1, 2013, the Company entered into a note agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the amount of CAN $25,000 for working capital needs. The agreement provides for interest rate at 20% per annum, with interest payable monthly and principle is due five years from the date of advance. As part of the above agreement, the Company is required to issue 5,000,000 shares of restricted common stock to 236. These shares are valued at $0.02 which was the share price at commitment date. As of June 30, 2014, the Company recorded a note payable in the amount of $23,225 and $100,000 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt offering costs at June 30, 2014 was $81,753.
On August 22, 2013, the Company entered into a note agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the amount of CAN $50,000 to pay off a convertible note the Company owed. The agreement provides for interest rate at 20% per annum, with interest payable monthly and principle is due five years from the date of advance. As part of the above agreement, the Company is required to issue 13,157,895 shares of restricted common stock to 236. These shares are valued at $0.01 which was the share price at commitment date. As of June 30, 2014, the Company recorded a note payable in the amount of $48,385 and $131,579 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt offering costs at June 30, 2014 was $109,084.
On October 20, 2013, the Company entered into a note agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the amount of CAN $25,000 for working capital needs. The agreement provides for interest rate at 20% per annum, with interest payable monthly and principle is due five years from the date of advance. As part of the above agreement, the Company is required to issue 5,000,000 shares of restricted common stock to 236. These shares are valued at $0.008 which was the share price at commitment date. As of June 30, 2014, the Company recorded a note payable in the amount of $23,555 and $40,000 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt offering costs at June 30, 2014 was $34,445.
On December 3, 2013, the Company entered into a note agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the amount of CAN $20,000 for working capital needs. The agreement provides for interest rate at 20% per annum, with interest payable monthly and principle is due five years from the date of advance. As part of the above agreement, the Company is required to issue 4,000,000 shares of restricted common stock to 236. These shares are valued at $0.015 which was the share price at commitment date. As of June 30, 2014, the Company recorded a note payable in the amount of $19,953 and $60,000 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt offering costs at June 30, 2014 was $53,129.
On April 15, 2014, the Company entered into a note agreement with 2367416 Ontario, Inc., a Canadian company (“236”), whereby 236 agrees to provide financing to the Company in the amount of CAN $50,000 for working capital needs. The agreement provides for interest rate at 20% per annum, with interest payable monthly and principle is due five years from the date of advance. As part of the above agreement, the Company is required to issue 10,000,000 shares of restricted common stock to 236. These shares are valued at $0.037 which was the share price at commitment date. As of June 30, 2014, the Company recorded a note payable in the amount of $45,515 and $370,000 in deferred non-cash debt offering costs which are amortized over five years. The balance of these deferred non-cash debt offering costs at June 30, 2014 was $354,592.
7.
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Convertible Notes and Derivative liability
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On April 24, 2012 (the “Closing date”), the Company issued a convertible promissory note for $278,000. The lender funded $75,000 to the Company, and the lender at their discretion may fund additional amounts to the Company. The note matures one year from the closing date. If the Company pays the note within 90 days of the closing date, the interest rate is 0%. If the note is not paid within 90 days of the closing date, a one-time interest charge of 5% will be applied to the unpaid principal amount. The conversion option price associated with the note is the lesser of $0.10 or 70% of the lowest trade price in the 25 trading days previous to any conversion. The note is convertible at any time. As a result of the variable feature associated with the conversion option, pursuant to ASC Topic 815, the Company bifurcated the conversion option, and utilized the black Scholes model to determine the fair value of the conversion option. At the issuance date, the Company recorded a debt discount and derivative liability of $75,000 and $100,415, respectively. The debt discount was fully amortized since the Company fully converted the remaining principle of $10,356 into 1,479,000 shares of common stock during the six months ended June 30, 2014. The derivative liability has been adjusted to fair value each reporting period with unrealized gain (loss) reflected in other income and expense and extinguished due to it being fully converted.
For the three and six months ended June 30, 2014, the unrealized loss on the above derivatives was $0 and $5,129, respectively.
Liabilities measured at fair value on a recurring basis by level within the fair value hierarchy as of June 30, 2014 and December 31, 2013 related to the above derivative liability are as follows:
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Fair Value
Measurements at
June 30, 2014 (1)
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Fair Value
Measurements at
December 31, 2013 (1)
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Using
Level 2
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Total
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Using
Level 2
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Total
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Liabilities:
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Derivative liabilities
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$
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-
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$
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-
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$
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(6,702
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)
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$
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(6,702
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)
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Total liabilities
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$
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-
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$
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-
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$
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(6,702
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)
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$
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(6,702
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)
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________________
(1)
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The Company did not have any assets or liabilities measured at fair value using Level 1 or Level 3 of the fair value hierarchy as of June 30, 2014 and December 31, 2013.
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The Company’s derivative liabilities are classified within Level 2 of the fair value hierarchy. The Company utilizes the Black-Scholes Option Pricing Model to value the derivative liabilities utilizing observable inputs such as the Company’s common stock price, the exercise price of the warrants, and expected volatility, which is based on historical volatility. The Black-Scholes model employs the market approach in determining fair value.
8.
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Related Party Transactions
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During the year ended December 31, 2003, the Company signed a note payable with a related party in the amount of $15,000. The balance at June 30, 2014 and December 31, 2013 is $1,901. This note payable was unsecured, non-interest bearing and has no specific repayment terms, however, payment is not expected prior to June 30, 2015.
As of June 30, 2014 and December 31, 2013, accounts payable included $11,920 and $12,220, respectively, for various accounting services, due to the Company’s Chief Accounting Officer who is also a director of the Company.
During the year ended December 31, 2012, the Company’s CEO advanced the Company $1,430 with no specific terms of repayment and no stated interest rate.
The above terms and amounts are not necessarily indicative of the terms and amounts that would have been incurred had comparable transactions been entered into with independent parties.
During July 2014, the Company has executed a Settlement and Release Agreement with the Chief Executive Officer, President and Director to terminate his 2011 Employment Agreement, effective July 1, 2014, which was set to expire September 30, 2014. This agreement provides that the employee shall continue to hold and perform the duties and responsibilities for the positions of Chief Executive Officer, President, Director with the Company with the employee agreeing to specifically forego any salary and/or other compensation for such Positions from and after the date of July 1, 2014, serving in such positions without compensation until such time as the Board of Directors may determine, in their sole and absolute direction.
During July 2014, the Company has executed a Settlement and Release Agreement with the Vice-President, Secretary-Treasurer and Director to formally terminate her 2013 Employment Agreement which expired December 31, 2013. This agreement provides that the employee shall continue to hold and perform the duties and responsibilities for the positions of Director, Secretary & Treasurer with the Company with the employee agreeing to specifically forego any salary and/or other compensation for such Positions from and after the date of January 1, 2014, serving in such Positions without compensation until such time as the Board of Directors may determine, in their sole and absolute discretion.
During July 2014, the Company has executed a Settlement and Release Agreement with the former Chief Information Officer to formally terminate his 2013 Employment Agreement which expired December 31, 2013.
During July 2014, the Company has executed Settlement and Release Agreements with the CEO-President, Vice-President/Secretary-Treasurer and the former Chief Information Officer to forgive a total of $481,410 of accrued salary and payroll. The Company will record the forgiveness of accrued salary and payroll of $481,410 as a contribution to capital and $32,014 of accrued payroll taxes as forgiveness income in the third quarter. These agreements stipulate no additional accrual of payroll and salary for all 3 employees effective July 1, 2014.
During July 2014, the Company has executed Settlement and Release Agreements with the CEO-President, Vice-President/Secretary-Treasurer and the former Chief Information Officer rescinding the rights for stock option compensation issued in 2011 and 2013, under separate Employment Agreements, for a cumulative total of 2,100,000 shares.
During July 2014, the Company has executed a Settlement and Release Agreement with the Chief Executive Officer that rescinds the CEO’s rights to receive 5,000,000 common shares of termination compensation as defined under Section 7 of the CEO’s October 2011 Employment Agreement.
During July 2014, the Chief Executive Officer has elected to convert 500,000 shares of Series A Convertible Preferred Stock into 500,000 shares of common stock.
During the 3
rd
quarter 2014, the Company is in discussions and a due diligence phase with certain shareholders of the Company, which might lead to the potential addition and removal of members of the Company’s Board of Directors, Corporate Officers and/or Senior Management.
The Company has begun discussions with Alpha Engines, Inc to negotiate both a reduction of the accrued royalty payments and future financial considerations related to the Company’s exclusive licensing agreement with Alpha Engines, Inc. for the Detonation Cycle Gas Turbine (DCGT) engine. Additionally, the Company has begun early stage discussions with a North American based entity to re-initiate research and development of the DCGT engine technology.