NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 – ORGANIZATIONAL AND SIGNIFICANT ACCOUNTING POLICIES
A.
ORGANIZATION AND OPERATIONS
Cyclone
Power Technologies, Inc. (the “Company”, “our,” “Cyclone”) is the successor entity to the
business of Cyclone Technologies LLLP (the “LLLP”), a limited liability limited partnership formed in Florida in September
2004. The LLLP was the original developer and intellectual property holder of the Cyclone engine technology. Initiated in 2017,
the Company’s current business model, is to be primarily a research and development engineering company whose main purpose
is to develop, commercialize, market and license its Cyclone engine technology. Engines and related systems will be outsourced
for manufacturing but the company will invoice customers. Our prior business model also included engine manufacturing.
In
2012, the Company established Cyclone Performance LLC (“Cyclone Performance”) f/k/a Cyclone-TeamSteam USA, LLC. The
purpose of Cyclone Performance is to build, test and run various vehicles and vessels utilizing the Company’s engine. As
of March 31, 2018, the company had a 95% controlling interest in Cyclone Performance.
In
2010, the Company established a subsidiary WHE Generation Corp. f/k/a, Cyclone-WHE LLC (the “WHE Subsidiary”, “WheGen”),
to market the waste heat recovery systems for all Cyclone engine models. As of September 30, 2014 the Company had sold most of
its ownership and the balance was sold in the second quarter of 2016.
B.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The
condensed consolidated financial statements include the accounts of the Company and the accounts of our 95% owned subsidiary Cyclone
Performance LLC. All material inter-company transactions and balances have been eliminated in the condensed consolidated financial
statements
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting
principles applicable to interim financial information and the requirements of Form 10-Q and Article 8 of Regulation S-X of the
SEC. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted
in the United States for complete consolidated financial statements. Interim results are not necessarily indicative of results
for a full year. In the opinion of management, all adjustments, consisting of normal journal entries considered necessary for
a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.
Complete financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto
for the year ended December 31, 2017, as filed with the Securities and Exchange Commission as part of the Company’s Form
10-K.
The
results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results of operations to
be expected for the full fiscal year ending December 31, 2018.
The
Company prepares its consolidated financial statements in conformity with account principles generally accepted in the United
States (“U.S. GAAP”). The accounting principles utilized by the Company require the Company to make judgments, estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the condensed consolidated financial statements, the reported amounts of revenues and expenses, cash flows and
the related footnote disclosures during the periods. On an on-going basis, the Company reviews and evaluates its estimates and
assumptions, including, but not limited to, those that relate to the realizable value of inventory, identifiable intangible assets
and other long-lived assets, contracts, income taxes, derivative liabilities, and contingencies. Actual results could differ from
these estimates.
The
financial statements presented for the three months ended March 31, 2018 and 2017 are unaudited.
C.
CASH
Cash
includes cash on hand and cash in banks. At March 31, 2018 and December 31, 2017, the Company maintained cash balances at one
financial institution.
D.
COMPUTATION OF LOSS PER SHARE
Diluted
loss per share is not presented as the conversion of the preferred stock and exercise of outstanding stock options and warrants
would have an anti-dilutive effect. As of March 31, 2018 and 2017, total anti-dilutive shares related to the common stock
options plan amounted to approximately 13.9 million and 14.9 million shares, respectively. On a pro-forma basis if the
convertible debt and related interest and penalties were converted at respective conversion rates and applied discounts at the
quarter end common stock price, for the three months ended March 31, 2018 and 2017 an additional 6.82 billion and 1.13 billion
shares would be issuable, respectively.
E.
INCOME TAXES
Income
taxes are accounted for under the asset and liability method as stipulated by Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) 740, “
Income Taxes
” (“ASC 740”). Deferred
tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on deferred tax assets and liabilities
or a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced
to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance is applied when in management’s
view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the unlikely event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate
whether there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities.
Reserves for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of December
31, 2017, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability
to the taxing authorities. Interest related to the unrecognized tax benefits is not recognized in the consolidated financial statements
as a component of income taxes. The Company’s tax returns are subject to examination by the federal and state tax authorities
for the years ended 2013 through 2017.
F.
REVENUE RECOGNITION
In
May 2014, ASC 606 was issued related to revenue from contracts with customers. Under this guidance, revenue is recognized when
promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received
for those goods or services. The standard became effective for the Company’s fiscal year beginning January 1, 2018. The
adoption of ASC 606 did not have an impact on our financial position or results of operations, as the Company does not have any
revenue.
G.
WARRANTY PROVISIONS
Current
contracts do not require warranty assistance subsequent to acceptance of the “deliverable R&D prototype” by the
customer. For products that the Company will sell in the future, warranty costs are anticipated to be borne by the manufacturing
vendor.
H.
INVENTORY
Inventory
is recorded at the lower of cost or market. Based on our revised R&D company business model, commencing in 2016, costs include
only material to develop a completed engine for sale. In our former business model costs include material, labor and allocated
overhead to manufacture a completed engine. These costs are periodically evaluated to determine if they have a net realizable
value. If the net realizable value is lower than the carrying amount, a reserve is provided. All inventory was fully reserved
at December 31, 2017.
I.
FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC
820, “
Fair Value Measurements and Disclosures
” requires disclosures of information about the fair value of
certain financial instruments for which it is practicable to estimate the value. The carrying amounts reported in the balance
sheet for cash, accounts payable and accrued expenses, and loans payable approximate their fair market value based on the short-term
maturity of these instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement date. Inputs refer broadly to the assumptions
that market participants would use in pricing the asset or liability, including assumptions about risk. Inputs may be observable
or unobservable. Observable inputs are based on market data obtained from sources independent of the Company. Unobservable inputs
reflect the Company’s own assumptions based on the best information available in the circumstances. The fair value hierarchy
prioritizes the inputs used to measure fair value into three broad levels. The three levels of the fair value hierarchy are defined
as follows:
Level
1
|
—
|
Inputs
are quoted prices in active markets for identical assets or liabilities as of the reporting date.
|
|
|
|
Level
2
|
—
|
Inputs
other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly,
as of the reporting date.
|
|
|
|
Level
3
|
—
|
Unobservable
inputs for the asset or liability that reflect management’s own assumptions about the assumptions that market participants
would use in pricing the asset or liability as of the reporting date.
|
The
summary of the quarterly fair values and changing values of financial instruments as of January 1, 2018 through March 31,
2018 is as follows:
|
|
Derivative
Liabilities
|
|
Balance,
January 1, 2018
|
|
|
1,424,001
|
|
Additions
|
|
|
-
|
|
Conversions
|
|
|
(267,969
|
)
|
Deletions
|
|
|
-
|
|
Fair
Value Adjustment –loss
|
|
|
424,968
|
|
Balance,
March 31, 2018
|
|
$
|
1,581,000
|
|
The
table above is based on Level 3 hierarchy using the Stochastic Process Forecasting Model valuation methodology
Please
refer to Note 16 for disclosure and assumptions used to calculate the fair value of the derivative liabilities.
J.
RESEARCH AND DEVELOPMENT
Research and development activities for product
development are expensed as incurred. Costs for the three month periods ended March 31, 2018 and 2017 were $81,943 and
$40,676, respectively.
K.
STOCK BASED COMPENSATION
The
Company applies the fair value method of ASC 718, “
Share Based Payment
”, in accounting for its stock based
compensation. This standard states that compensation cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting period. The Company values stock based compensation at the market
price for the Company’s common stock as of the date in which the obligation for payment of services is incurred.
L.
COMMON STOCK OPTIONS AND PURCHASE WARRANTS
The
Company accounts for common stock options and purchase warrants at fair value in accordance with ASC 815-40, “
Derivatives
and Hedging”.
The Black-Scholes option pricing valuation method (“BSM option pricing model”) is used to
determine fair value of these warrants consistent with ASC 718, “
Share Based Payment”.
Use of this method requires
that the Company make assumptions regarding stock volatility, dividend yields, expected term of the warrants and risk-free interest
rates.
The
Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on
the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “
Equity Based payments to Non-employees”
.
M.
ORIGINAL ISSUE DEBT DISCOUNT
The
original issue discount (OID) related to notes payable is amortized by the effective interest method over the repayment period
of the notes. The unamortized OID is represented as a reduction of the amount of the notes payable.
N.
PROPERTY AND EQUIPMENT
Property
and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives
of the assets as follows:
|
|
Years
|
|
Display
equipment for trade shows
|
|
|
3
|
|
Leasehold
improvements and furniture and fixtures
|
|
|
10
– 15
|
|
Shop
equipment
|
|
|
7
|
|
Computers
|
|
|
3
|
|
Expenditures
for maintenance and repairs are charged to operations as incurred.
O.
IMPAIRMENT OF LONG LIVED ASSETS
Intangible
assets, consisting primarily of patents, are deemed to be critical for the furtherance of our business objectives and our engine
products. There have been no impairments of our intangible assets, as we are developing our products and obtaining new contracts
based on the engine and associated technology patents.
The
Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are
any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover
the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company
has not recognized any impairment charges.
P.
RECENT ACCOUNTING PRONOUNCEMENTS
In
February 2016, the Financial Accounting Standards Board (“FASB”) issued amended accounting guidance that changes the
accounting for leases and requires expanded disclosures about leasing activities. Under the new guidance, lessees will be required
to recognize a right-of-use asset and a lease liability, measured on a discounted basis, at the commencement date for all leases
with terms greater than twelve months. Lessor accounting will remain largely unchanged, other than certain targeted improvements
intended to align lessor accounting with the lessee accounting model and with the updated revenue recognition guidance issued
in 2014. Lessees and lessors must apply a modified retrospective transition approach for leases existing at, or entered into after,
the beginning of the earliest comparative period presented in the financial statements. The amended guidance is effective for
annual reporting periods (including interim periods within those periods) beginning after December 15, 2018, and early application
is permitted. The Company’s adoption of this guidance did not result in a material adjustment to the financial statements.
From
time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard
setting bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact
of recently issued standards that are not yet effective will not have a material impact on our financial position or results of
operations upon required dates of adoption.
Q.
CONCENTRATION OF RISK
The
Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to
be the two assets most likely to subject the Company to concentrations of credit risk. The Company’s policy is to maintain
its cash with high credit quality financial institutions to limit its risk of loss exposure.
As
of March 31, 2018, the Company maintained its cash in one quality financial institution. The Company has not experienced any losses
in its bank accounts through March 31, 2018. The company had no accounts receivable at March 31, 2018 and December 31, 2017.
R.
DERIVATIVE FINANCIAL INSTRUMENTS
Accounting
and reporting standards for derivative instruments and for hedging activities were codified by ASC Topic 815,
Derivatives and
Hedging
(“ASC Topic 815”). It requires that all derivatives be recognized in the balance sheet and measured at
fair value. Gains or losses resulting from changes in the fair value of derivatives are recognized in earnings or recorded in
other comprehensive income (loss) depending on the purpose of the derivatives and whether they qualify and have been designated
for hedge accounting treatment. The Company has derivative liabilities pursuant to convertible debt and common stock warrants,
and has recognized net expenses on the condensed consolidated statements of operations. The Company does not have any derivative
instruments for which it has applied hedge accounting treatment.
NOTE
2 - GOING CONCERN
As
shown in the accompanying consolidated financial statements, the Company sustained substantial operating and other losses and
expenses of approximately $.7 million for the three months ended March 31, 2018 and $2.1 million for the year ended December 31,
2017. The cumulative deficit since inception is approximately $63.7 million. The Company has a working capital deficit at March
31, 2018 of approximately $5.4 million. There is no guarantee whether the Company will be able to generate enough revenue and/or
raise capital to support its operations. This raises substantial doubt about the Company’s ability to continue as a going
concern. The ability of the Company to continue as a going concern is dependent on management’s plans which include implementation
of its business model to generate revenue from development contracts, licenses and product sales, and continuing to raise funds
through debt or equity raises. The Company will also likely continue to rely upon related-party debt or equity financing.
The
consolidated condensed financial statements do not include any adjustments that might result from the outcome of these
uncertainties. The Company is currently raising working capital to fund its operations via debt, advance contract payments (deferred
revenue) and advances from and deferred payments to related parties.
NOTE
3 – INVENTORY, NET
Initiated in 2016, based on our revised R&D
company business model, inventory principally consists of raw material to develop an engine. Under our prior business model, inventory
consisted of raw material engine parts, work in process engines, labor and overhead, net of realization, valuation and obsolescence
reserves. In the aggregate inventory is stated at the lower of cost or market. All inventory was fully reserved at March 31,
2018.
NOTE
4 – PROPERTY AND EQUIPMENT, NET
Property
and equipment consists of the following:
|
|
March
31, 2018
|
|
|
December
31, 2017
|
|
Display
equipment for trade shows
|
|
$
|
6,270
|
|
|
$
|
6,270
|
|
Leasehold
improvements and furniture and fixtures
|
|
|
93,922
|
|
|
|
93,922
|
|
Equipment
and computers
|
|
|
202,578
|
|
|
|
202,578
|
|
Total
|
|
|
302,770
|
|
|
|
302,770
|
|
Accumulated
depreciation
|
|
|
(241,157
|
)
|
|
|
(236,938
|
)
|
Net
property and equipment
|
|
$
|
61,613
|
|
|
$
|
65,832
|
|
Depreciation
expense for the three months ended March 31, 2018 and 2017 was $4,219 and $7,345 respectively.
NOTE
5 – PATENTS, TRADEMARKS AND COPYRIGHTS
Patents,
trademarks and copyrights consist of legal fees paid to file and perfect these claims. The net balances as of March 31, 2018 and
December 31, 2017, were $ 86,209 and $90,173, respectively. There were no capitalized additions to patents, trademarks and copyrights
during the three months ended March 31, 2018 and the year ended December 31, 2017. For the three months ended March 31, 2018 and
the year ended December 31, 2017, the Company recorded net charges of $0 and $62,857, respectively, included in general and administrative
expenses, for various expired patents; the basic patents for the Cyclone technology are still protected.
As of March 31, 2018, the Company had 3 active
and 8 expired patents issued on its technology both in the U.S. and internationally. Pursuant to new US Patent Office regulations,
upon approval, expired patents can be reinstated upon payment of unpaid maintenance fees.
Patents,
trademarks and copyrights are amortized over the life of the intellectual property which is 15 years. Amortization expenses for
the three months ended March 31, 2018 and 2017 were $3,964 and $6,362, respectively.
NOTE
6 – NOTES AND OTHER LOANS PAYABLE
A
summary of non related notes and other loans payable is as follows:
|
|
March
31, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
12%
convertible notes payable, maturing at various dates from November 2013 through October 2017 (A)
|
|
$
|
72,948
|
|
|
$
|
61,196
|
|
|
|
|
|
|
|
|
|
|
10%
convertible note payable, monthly payments commencing in December 2013 through July 2014 (B)
|
|
|
19,963
|
|
|
|
19,963
|
|
|
|
|
|
|
|
|
|
|
10%
convertible notes payable maturing at various dates from May 2016 through February 2017 (C)
|
|
|
76,000
|
|
|
|
76,000
|
|
|
|
|
|
|
|
|
|
|
10%
convertible notes payable, maturing at various dates from December 2016 through January 2017 (D)
|
|
|
-
|
|
|
|
26,192
|
|
|
|
|
|
|
|
|
|
|
10%
convertible notes payable maturing at various dates from February 2016 through August 2016 (E)
|
|
|
112,200
|
|
|
|
140,658
|
|
|
|
|
|
|
|
|
|
|
12%
convertible notes payable, maturing at various dates from April 2016 through May 2016 (F)
|
|
|
12,832
|
|
|
|
35,936
|
|
|
|
|
|
|
|
|
|
|
10% note payable,
maturing Feb 3, 2017
|
|
|
50,000
|
|
|
|
50,000
|
|
|
|
|
|
|
|
|
|
|
Various
notes payable, maturing 2017 and 2018 (G)
|
|
|
72,650
|
|
|
|
72,650
|
|
|
|
|
|
|
|
|
|
|
6
% note payable, maturing Oct 12, 2019, (I)
|
|
|
1,500
|
|
|
|
1,500
|
|
|
|
|
|
|
|
|
|
|
Various
notes payable, maturing 2017 and 2018
|
|
|
12,200
|
|
|
|
12,200
|
|
|
|
|
|
|
|
|
|
|
Total
non third party notes –net of discount
|
|
|
430,293
|
|
|
|
496,295
|
|
|
|
|
|
|
|
|
|
|
Less-Current
Portion
|
|
|
428,793
|
|
|
|
494,795
|
|
|
|
|
|
|
|
|
|
|
Total
non-current third party notes
|
|
$
|
1,500
|
|
|
$
|
1,500
|
|
|
(A)
|
Notes
issued net of 10% original discount (fully amortized). This note is in default. (does this exist still) starts with B
|
|
|
|
|
(B)
|
Note
issued net of original discount (fully amortized). Effective May 8, 2016, the Company is subject to a default judgment of
approximately $175,000, plus subsequent penalty interest for non-payment of convertible debt and interest. The Company is
negotiating a reduced settlement. Unpaid interest, default penalties and default interest is included in accounts payable
and accrued liabilities In 2018 the company negotiated a reduced settlement for $150,000 via the issuance of company stock.
|
|
|
|
|
(C)
|
Notes
issued net of discount from derivative liabilities (fully amortized). At March 31, 2018, the Company held approximately 97
million shares in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants. This
note is in default.
|
|
|
|
|
(D)
|
Notes
issued net of discount (fully amortized). This note is in default.
|
|
|
|
|
(E)
|
Notes
issued net of discount from derivative liabilities (fully amortized). At March 31, 2018, the Company held 202 million shares
in reserve to cover the potential conversion of this note into common stock pursuant to debt covenants. These notes are in
default.
|
|
|
|
|
(F)
|
Notes
issued net of discount from derivative liabilities (fully amortized). The Company is subject to litigation judgment of approximately
$150,000, plus subsequent penalty interest for non–payment. Company is seeking to arrange a settlement. Unpaid interest,
default penalties and default interest is included in accounts payable and accrued liabilities. The company negotiated the
settlement of the debt, interest and penalties via the conversion of company stock.
|
|
|
|
|
(G)
|
Interest
on $62,000 of notes to be paid in 6,000,000 shares of restricted company common stock Other notes are various interest rates.
These notes are in default.
|
A
summary of related party notes and other loans payable is as follows:
|
|
March
31, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
6%
demand loans per Operations Agreement with Schoell Marine Inc., a company owned by Cyclone’s Chairman and controlling
shareholder (A)
|
|
$
|
156,738
|
|
|
$
|
161,005
|
|
6%
non-collateralized loans from officer and shareholder, payable on demand. The original principal balances were $157,101.
|
|
|
89,246
|
|
|
|
101,546
|
|
12%
non-collateralized loans from officer and shareholder, payable on demand
|
|
|
15,860
|
|
|
|
21,044
|
|
Accrued
Interest
|
|
|
121,853
|
|
|
|
116,278
|
|
Total
current related party notes, inclusive of accrued interest
|
|
$
|
383,697
|
|
|
$
|
399,873
|
|
|
(A)
|
This
note arose from services and salaries incurred by Schoell Marine on behalf of the Company. The Schoell Marine note bears an
interest rate of 6% and repayments occur as cash flow of the Company permits.
|
NOTE
7 – RELATED PARTY TRANSACTIONS-Deferred Compensation
Included
in accounts payable and accrued expenses - related parties as of March 31, 2018 and December 31, 2017, are $756,250 and $687,500
respectively, of accrued and deferred officers’ salaries compensation for the President and the CTO which may be paid as
funds are available. These are non-interest bearing and due on demand.
NOTE
8 – PREFERRED STOCK
At March 31, 2018 and December 31, 2017 the
Series A Preferred Stock had 750,000 shares authorized and no shares issued and outstanding. In the first quarter of 2018, the
company has a signed binding letter of intent (“LOI”) by an investor to provide $5 million to the company for
additional development of the Cyclone Engines. The payment of the $5 million is scheduled through 2020. The consideration is to
be the issuance of Preferred A shares, convertible into effectively 20% of the Common shares of the company at the completion
of funding.
The
Series B Preferred Stock is majority voting stock and is held by the two co-founders of the Company. Ownership of the Series B
Preferred Stock shares assures the holders thereof a 51% voting control over the common stock of the Company. The 1,000 Series
B Preferred Stock shares are convertible on a one-for-one basis with the common stock in the instance the Company is merged, sold
or otherwise dissolved.
NOTE
9 – STOCK TRANSACTIONS
The Company authorized an increase of Common
Stock to 6 Billion shares in the last quarter of 2017. This increase in the amount of authorized share capital is a requirement
by debt covenants to cover old convertible debt. This is required as the stock price has fallen and shares have to be available
at 4 times the conversion rate.
During
the three months ended March 31, 2018, the Company:
|
a-
|
Amortized
(based on vesting) $350 of common stock options for employee services.
|
|
|
|
|
b-
|
Issued
approximately 1,862 million shares of common stock pursuant to conversions of approximately $222,000 of notes payable, accrued
interest and related liabilities.
|
|
|
|
|
c-
|
The
Company issued 571 million shares of common stock valued at approximately $135,00 for accrued liabilities for consulting services.
|
In the first quarter of 2018, the company
has a signed binding LOI from an investor to provided $5 million to the company. The consideration is to be the issuance of Preferred
A shares, convertible into effectively 20% of the Common shares of the company at the complete funding estimated through 2020.
To Date $195,000 has been funded by the investor.
NOTE
10 – STOCK OPTIONS AND WARRANTS
A.
COMMON STOCK OPTIONS
Per
the employment contracts with certain officers, for the three months ended March 31, 2018, the company issued 450,000 common stock
options, valued at $90 (pursuant to the Black Scholes valuation model) that are exercisable into shares of common stock at an
average exercise price of $.0002 and with a maturity life of 10 years. For the three months ended March 31, 2018, the amortization
of stock options was $350 and the unamortized balance was $381. As of March 31, 2018, the intrinsic value on all options was
zero.
A
summary of the common stock options for the period from December 31, 2017 through March 31, 2018 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg.
Exercise Price
|
|
|
Weighted
Avg.
Remaining
Contractual Life
(Years)
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
December 31, 2017
|
|
|
13,400,000
|
|
|
$
|
0.064
|
|
|
|
5.8
|
|
Options
issued
|
|
|
450,000
|
|
|
|
.0002
|
|
|
|
10.0
|
|
Options
expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance,
March 31, 2018
|
|
|
13,850,000
|
|
|
$
|
0.062
|
|
|
|
5.7
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested Options
Outstanding
|
|
|
Weighted
Avg.
Exercise Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life (Years)
|
|
|
|
|
|
|
|
|
|
|
|
Balance
March 31, 2018
|
|
|
12,500,000
|
|
|
$
|
.057
|
|
|
|
5.3
|
|
The
fair value of new stock options, re-priced stock options, new purchase warrants and re-priced purchase warrants granted using
the Black-Scholes option pricing model was calculated using the following assumptions:
|
|
Three
Months
Ended
March 31, 2018
|
|
|
Three
Months
Ended
March 31, 2017
|
|
Risk
free interest rate
|
|
|
2.39
|
%
|
|
|
1.5
|
%
|
Expected
volatility
|
|
|
132
|
%
|
|
|
134
|
%
|
Expected
term
|
|
|
3
|
|
|
|
3
|
|
Expected
dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Average value
per options and warrants
|
|
$
|
.0002
|
|
|
$
|
.0015
|
|
Expected
volatility is based on historical volatility of the Company’s common stock price. Short Term U.S. Treasury rates were utilized
at the risk free interest rate. The expected term of the options and warrants was calculated using the alternative simplified
method newly codified as ASC 718 “
Accounting for Stock Based Compensation,
” which defined the expected life
as the average of the contractual term of the options and warrants and the weighted average vesting period for all issuances.
B.
COMMON STOCK WARRANTS
As
of March 31, 2018 and December 31, 2017, there were no common stock warrants outstanding.
NOTE
11 – INCOME TAXES
In
December 2017, a new tax known as Tax Cut and Jobs Act of 2017 was enacted. The new tax law includes significant changes to the
U.S. corporate tax systems including a rate reduction from 35% to 21% beginning in January of 2018, a change in the treatment
of foreign earnings going forward, a deemed repatriation transition tax, and changes to allow net operating losses to be carried
forward indefinitely. In addition, net operating losses arising after December 31, 2017 will be limited to the lesser of the available
net operating loss or 80% of the pre-net operating loss taxable income. In accordance with ASC 740, the impact of a change in
tax law is recorded in the period of enactment.
A
reconciliation of the differences between the effective income tax rates and the statutory federal tax rates for the three months
ended March 31, 2018 and 2018 are as follows:
|
|
Three
Months
ended
March 31, 2018
|
|
|
|
|
|
Three
Months
ended
March 31, 2017
|
|
|
|
|
Tax
benefit at U.S. statutory rate
|
|
$
|
47,860
|
|
|
|
21
|
%
|
|
$
|
134,493
|
|
|
|
34
|
%
|
State
taxes, net of federal benefit
|
|
|
9,116
|
|
|
|
4
|
|
|
|
15,823
|
|
|
|
4
|
|
Change
in valuation allowance
|
|
|
(56,976
|
)
|
|
|
(25
|
)
|
|
|
(150,316
|
)
|
|
|
(38
|
)
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
The
tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at March
31 2018 and December 31, 2017 consisted of the following:
Deferred
Tax Assets
|
|
March
31, 2018
|
|
|
December
31, 2017
|
|
Net
Operating Loss Carry-forward
|
|
$
|
11,029,921
|
|
|
$
|
10,951,258
|
|
Deferred
Tax Liabilities – Accrued Officers’ Salaries
|
|
|
(1,008,743
|
)
|
|
|
(987,056
|
)
|
Net
Deferred Tax Assets
|
|
|
10,021,178
|
|
|
|
9,964,202
|
|
Valuation
Allowance
|
|
|
(10,021,178
|
)
|
|
|
(9,964,202
|
)
|
Total
Net Deferred Tax Assets
|
|
$
|
-
|
|
|
$
|
-
|
|
As
of March 31, 2018, the Company had a net operating loss carry forward for income tax reporting purposes of approximately $17.2
million that may be offset against future taxable income through 2031. Current tax laws limit the amount of loss available to
be offset against future taxable income when a substantial change in ownership occurs. Therefore, the amount available to offset
future taxable income may be limited. No tax asset has been reported in the financial statements because the Company believes
there is a 50% or greater chance the carry forwards will expire unused. Accordingly, the potential tax benefits of the loss carry
forwards are offset by a valuation allowance of the same amount.
NOTE
12- LEASE OBLIGATIONS
A.
LEASE ON FACILITIES
The
Company leases a 6,000 square foot warehouse and office facility located at 601 NE 26th Court in Pompano Beach, Florida. The original
lease, was at an annual rent of $60,000. The lease period ended December 2016 and the current lease is monthly with a 3% rate
increase. Occupancy costs for each of the three months ended March 31, 2018 and 2017 were $16,983 and $15,900, respectively.
B .CAPITAL LEASE OBLIGATIONS
The company is in default on its remaining
capital lease obligation to Leaf Capital Funding, LLC.
Effective October 13, 2017 the Company was subject to a summary judgment of $ 37,278 plus attorney fees for
non-payment of 3 capital leases from Marlin Business Bank. This amount is including $11,379 of past due lease payments, accelerated
lease payments, late charges and other fees. The $37,278 has been reflected in accrued expenses with an appropriate reduction of
the capital lease liability.
In the third quarter of 2017, the company recognized a summary judgment of $7,266 plus accrued interest for
non-payment of a capital lease from Navitas Lease Corp. This amount is including $4,177 of past due lease payments, accelerated
lease payments, interest expense, late charges and other fees. The $7,266 has been reflected in accrued liabilities with an appropriate
reduction of the capital lease liability.
The balance of capitalized lease obligations
payable at March 31, 2018 was $5,522, which is due during 2018.
NOTE
13 – COMMITMENTS AND CONTINGENCIES
The
Company has employment agreements with Harry Schoell, Chairman and CTO (previously, CEO), at $150,000 per year and Frankie Fruge,
President, at $120,000 per year; (collectively, the “Executives”). These agreements provide for a term of three (3)
years from their Effective Date (July 2007 with automatically renewing successive one year periods starting on the end of the
second anniversary of the Effective Date. If the Executive is terminated “without cause” or pursuant to a “change
in control” of the Company, as both defined in the respective agreements, the Executive shall be entitled to (i) any unpaid
Base Salary accrued through the effective date of termination, (ii) the Executive’s Base Salary at the rate prevailing at
such termination through 12 months from the date of termination or the end of his Term then in effect, whichever is longer, and
(iii) any performance bonus that would otherwise be payable to the Executive were he/she not terminated, during the 12 months
following his or her termination.
NOTE
14 –CONSOLIDATED SUBSIDIARY
In
2012, the Company established a 100% owned subsidiary (renamed) Cyclone Performance LLC. The purpose of Cyclone Performance is
to build, test and run a vehicle utilizing the Company’s engine. In the last quarter of 2012, the Company sold a 5% equity
investment to an unrelated investor for $30,000. Subsequent to December 31, 2012, this 5% equity investment was acquired by a
corporate officer of the Company. Losses of the subsidiary are currently fully borne by the Company, as there is no guarantee
of future profits or positive cash flow of the subsidiary. As of March 31, 2018, the cumulative unallocated losses to the non-controlling
interests of this subsidiary are approximately $1,000 and are to be recovered by the parent from future subsidiary profits if
they materialize.
NOTE
15 – RECEIVABLES, DEFERRED REVENUE AND BACKLOG
As
of March 31, 2018, total backlog for prototype engines to be delivered was $400,000 from the Combilift agreement, of which $100,000
has been paid and has been recorded as deferred revenue. As of March 31, 2018, 3 other customers have $56,950 of advances
as deposits on contracts for engines to be delivered.
NOTE
16 – DERIVATIVE FINANCIAL INSTRUMENTS
Prior
to 2016, the Company entered into convertible note agreements (subject to derivative accounting treatment). The conversion prices
into common stock ranged from a discount of 30% to 45% of the lowest closing prices in the 10 to 20 trading days prior to the
conversion. Under provisions of ASC Topic 815-40, this conversion feature triggered derivative accounting treatment because the
convertible note was convertible into an indeterminable number of shares of common stock. The fair value of the embedded conversion
option was required to be presented as a derivative liability and adjusted to fair value at each reporting date, with changes
in fair value reported in the condensed consolidated statements of operation. As of March 31, 2018, the Company has outstanding
stock options and convertible debt that upon exercise could exceed the number of shares authorized.
In
the three months ended March 31, 2018, the Company recorded a non-cash charge of $424,968 of derivative losses related
to adjusting the derivative liability to fair value. At March 31, 2018, the derivative related fair value of debt and related
convertible liabilities was $1,581,000. The company also amortized to interest expense $30,764 of derivative debt discount.
The
Company calculates the estimated fair values of the liabilities for derivative instruments at each quarter-end using the Stochastic
Process Forecasting models (Monte Carlo simulations). Volatility, expected term and risk free interest rates used to estimate
the fair value of derivative liabilities are indicated in the table below. The volatility was based on historical volatility,
the expected term is equal to the remaining term of the debt and the risk free rate is based upon rates for treasury securities
with the same term.
|
|
Three
Months ended
March 31, 2018
|
|
|
Three
Months ended
March 31, 2017
|
|
Volatility
|
|
|
477
|
%
|
|
|
121
|
%
|
Risk
Free Rate
|
|
|
1.73
|
%
|
|
|
1.0
|
%
|
Expected
Term (years)
|
|
|
.25
|
|
|
|
.25
|
|
Dividend
Rate
|
|
|
0
|
%
|
|
|
0
|
%
|
NOTE
17 – LITIGATION
Effective
May 8, 2016, the Company is subject to a default judgment of approximately $175,000, plus subsequent penalty interest for non-payment
of convertible debt and interest Tonaquint Inc. filed and received a judgment and the Company is negotiating a reduced settlement.
As at March 31 2018, outstanding interest, default interest and default judgment penalties are included in accrued liabilities.
In 2018, the Company negotiated a reduced settlement for $150,000 via the issuance Company stock.
In
August 2016, the Company is subject to litigation of approximately $150,000, plus subsequent penalty interest for non -payment
of a liability. JSJ filed and received a judgment and the Company entered into a settlement agreement for conversion of judgment
based on value and conversions of original note on January 9, 2017. As at March 31, 2018, outstanding interest, default
interest and default judgment penalties for debt are included in accrued liabilities.
Effective October 13, 2017 the Company was
subject to a summary judgment of $37,278 plus attorney fees for non-payment of 3 capital leases from Marlin Business Bank. This
amount includes $11,379 of unpaid lease payments, accelerated lease payments, late charges and other fees. The $37,278
has been reflected in accrued expenses with an appropriate reduction of the capital lease liability.
In the third quarter of 2017, the company recognized a summary judgment of $7,266 plus accrued interest for
non-payment of a capital lease from Navitas Lease Corp. This amount is including $4,177 of past due lease payments, accelerated
lease payments, interest expense, late charges and other fees. The $7,266 has been reflected in accrued liabilities with an appropriate
reduction of the capital lease liability.
NOTE
18 – SUBSEQUENT EVENTS
In
the second quarter of 2018, the Company engaged in the following transactions:
In
the first quarter of 2018, the company has a binding letter of intent by an investor to provide $5 million to the company for
additional development of the Cyclone Engines. The consideration is to be the issuance of Preferred A shares, convertible into
effectively 20% of the Common shares of the company at the completion of funding. The funds are to be paid over a 2 year period
upon reaching various milestones. Currently the Company has met all its milestones and has received $100,000 in the first quarter
of 2018 and $99,500 in the second quarter of 2018.
In
the May 2018, the Company established a wholly owned subsidiary, Emerging Power Solutions Inc., whose purpose is to provide alternative
power solutions for various industries based on the application of the Cyclone Engine.