Summary of NCOAT, INC. - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This management's discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this report on Form10-Q.

This management's discussion and analysis, as well as other sections of this report on Form10-Q, may contain "forward-looking statements" that involve risks and uncertainties, including statements regarding our plans, future events, objectives, expectations, forecasts, or assumptions. Any statement that is not a statement of historical fact is a forward-looking statement, and in some cases, words such as "believe," "estimate," " project," "expect," "intend," "may," "anticipate," "plans," "seeks," and similar expressions identify forward-looking statements. These statements involve risks and uncertainties that could cause actual outcomes and results to differ materially from the anticipated outcomes or results, and undue reliance should not be placed on these statements. These risks and uncertainties include, but are not limited to uncertainties discussed in filings made with the Securities and Exchange Commission. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

The following Management's discussion and Analysis of financial Condition and Results of Operations ("MD&A") is intended to help the reader understand nCoat, Inc., our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto contained in Item 1 of this report. This overview summarizes MD&A, which includes the following sections:

· Overview - a general description of our business and the markets in which we operate; our objective; our areas of focus; and challenges and risks of our business.

· Significant Accounting Policies - a discussion of accounting policies that require critical judgments and estimates.

· Results of Operations - an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion in the MD&A on a consolidated basis.

· Liquidity and Capital Resources - an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; the impact of foregoing exchange; an overview of financial position; and the impact of inflation and changing prices.

We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of the Company as a whole. This discussion should be read in conjunction with our financial statements as of June 30, 2008, and the year then ended and the notes accompanying those financial statements.

Overview

nCoat, Inc., was incorporated as Tylerstone Ventures Corporation under the laws of the state of Delaware on September 24, 1998, with authorized common stock of 25,000,000 shares at a par value of $.001. Tylerstone was formed to develop a commercially profitable mining claim, including phases of data acquisition, aerial photograph interpretation, base map preparation, prospecting and report writing, as described in the appropriate periodic reports filed by the Company with the United State Securities and Exchange Commission (the "SEC or "Commission").

In the fall of 2006, the Tylerstone management began discussions with the management of nCoat, Inc. These discussions and eventual negotiations considered the possible mutual interest between the parties for possible economic business opportunities because by becoming a wholly owned subsidiary of Tylerstone, our shareholders could get greater liquidity because Tylerstone's common stock is publicly traded on the OTC Bulletin Board and Tylerstone would gain an operating subsidiary.

On February 3, 2007, Tylerstone entered into Share Exchange Agreement (the "Agreement") with nCoat Auto (formerly known as nCoat, Inc.) for the purpose of acquiring all of the issued and outstanding shares of common stock of nCoat Auto, par value $0.001 per share ("nCoat Auto Common Stock"), in exchange for new shares of Tylerstone's common stock, par value $0.0001 per share ("Company Common Stock").

On February 14, 2007, the parties to the Agreement completed the final steps of that Agreement (the "Closing") as contemplated by the Agreement. Pursuant to the terms of the Agreement, the Company acquired 11,554,545 shares of nCoat Auto's Common Stock from all shareholders of nCoat Auto which represented 100.0% of the issued and outstanding shares of nCoat Auto's Common Stock, in exchange for 2,542,000 pre-split shares of the Company's Common Stock, which represented 57.75% of the issued and outstanding shares of Company Common Stock. As a part of the Agreement, our existing shareholders returned 750,000 outstanding pre-spilt shares of Company Common Stock for no consideration which shares were canceled. Within a few days of the formal closing, our forward 20:1 split of the Common Stock was recognized by NASDAQ.

In connection with the Closing, Tylerstone changed its name to nCoat, Inc. As used in this Report, the terms, "nCoat," "Company," and "Registrant" means nCoat, Inc., and its subsidiaries, taken as a whole, unless the context indicates otherwise. The historical financial information contained herein, prior to the Closing refers to the historical financial information of the nCoat Auto.

Background and History of nCoat Auto and its Operating Subsidiaries and Affiliates

We specialize in nanotechnology research, licensing, and the commercialization, distribution and application of nano-formulated, as well as traditional, surface coatings. Our specialized coatings are used by the automotive, diesel engine, trucking, recreational vehicle, motorcycle, aerospace and oil and gas industries for heat management, corrosion resistance, friction reduction, bond strength and appearance. Operations are headquartered in Whitsett, North Carolina, along with our largest production facility. In addition, the Company maintains satellite production facilities in Bluffdale, Utah; Tempe, Arizona; Oklahoma City, Oklahoma; Pascagoula, Mississippi; and Quakertown, Pennsylvania. As previously reported by us, we have historically had franchise agreements in France, New Zealand and Australia under which we have sold a minimal volume of its coatings to the franchisees. As of the date of this filing, the franchise agreements in Australia had been terminated either by the expiration of the original term of the franchise agreement or due to the closure of the franchisee's business. We are currently evaluating restructuring the relationships with the operations in New Zealand and France.

nCoat Auto operated as an unincorporated association from September 25, 2004, until January 2005 when it was incorporated in Delaware under the name and style of NanoCoat, Inc. NanoCoat, Inc. was a development stage enterprise until it completed the acquisition of High Performance Coatings, Inc. ("HPC") on September 30, 2005. In the fall of 2006, NanoCoat, Inc., in the interest of going forward with branding and other commercial marketing efforts, elected to change its name to nCoat, Inc. and then later to nCoat Automotive Group, Inc. to allow for the nCoat/Tylerstone merger. From September 30, 2005, the date of the HPC acquisition, nCoat has been a fully operating company.

In May 2006, nCoat Auto formed nTech, Inc. ("nTech"), a Delaware corporation that is a wholly owned subsidiary, designated to develop and hold proprietary intellectual property for the nCoat Auto group of companies. On June 29, 2007, we acquired all of the common stock of MCC, Inc. (Metallic Ceramic Coatings, Inc., or "MCCI"), a Pennsylvania corporation doing business under the brand name of Jet-Hot®.

Part of our business focuses on nanotechnology research, licensing, and the commercialization, distribution and application of nano-formulated, as well as traditional, surface coatings. Nanotechnology is the branch of science dealing with manipulating, building, and organizing material from extremely small particles, some at the molecular level. These diminutive particles can be combined in new, disruptive materials that have unique properties.

We have developed a business strategy to commercialize these new products, we have focused thus far on our specialized coatings that are used by the automotive, diesel engine, trucking recreational vehicle, motorcycle, aerospace and oil and gas industries for heat management, corrosion resistance, friction reduction, bond strength and appearance.

Since inception, we have focused our resources on the following areas:

1) Develop proprietary nanotechnology coatings formulations into commercially viable nano-formulated coatings and materials products.

2) Fund the acquisitions of profitable high performance coating (surface treatment) companies in a highly fragmented cottage industry and to provide operating and expansion capital for growth of those acquisitions.

3) Exploit the organic growth prospects in HPC, MCCI and in all future acquisitions. (See discussion below.)

4) Provide a corporate structure for the daily management of all companies, interests, and stock held by nCoat and its subsidiaries, including preparation of all accounting and finance, operations, information, marketing, sales, human resource, management and other systems and process to support transition and integration of an aggressive acquisition strategy.

5) Create competitive diversification by incorporating a "distributed" production model into the specialty coatings industry that is currently rare in the high performance coatings arena.

6) Create competitive diversification by incorporating a "licensing" model into our business plans. This licensing will allow us to provide other applicators with our coatings.

7) Operate nTech, HPC and MCCI and other future acquisitions to develop, integrate and sell commercially viable proprietary nano-formulated and traditional coatings products.

In anticipation of achieving growth through acquisitions and internal growth of existing operating entities, we added facilities, personnel, systems and processes to support business growth and acquisition activities. Details of these expenses are discussed below.

In September 2005, we acquired HPC, a 23-year-old Oklahoma company that has specialized in thermal barrier, corrosion resistant, lubritic and appearance high performance coatings for the motor sports and other industries. Building on these race car roots, we expanded HPC's market-base beyond coating specialized engines and exhaust systems, to include corporate accounts of manufacturers of commercial trucks, recreational vehicles, defense applications, motorcycles, aerospace components, aviation parts, oil and gas industry suppliers, energy producers and other sophisticated users, while continuing to provide coatings and services to the after-market customer.

On June 29, 2007, we acquired MCCI, a primary competitor of HPC. Management believes that MCCI's 26-year market share growth and customer base in automotive aftermarket and original equipment manufacturing (OEM) markets could effectively double the revenues of nCoat.

Our management and science advisors, together with HPC's and MCCI's management, have determined that many of the coatings produced and used by us could be reformulated and patented into nano-formulated coatings, creating more efficient and effective coatings than currently produced by the industry. nTech has developed trade secret formulations using nano-scale particles to enhance the performance of its coatings. Currently, we have applied for five patents on our newly nano-formulated coatings and processes which are unique and novel to the industry. With the acquisition of MCCI, nCoat's customer-base of over 9,000 companies and individuals is presently being served by 200 employees.

Our principal business strategy includes the following components:

Acquisitions. We completed the acquisition of HPC and MCCI which have given us a base of operations and market presence. During the next three years, we will identify additional specific target companies for acquisition. The high performance coating industry includes a number of "sub-niche" sectors, such as piston manufacturing and protection, lubritic dry film coatings, coating for weapons and military applications, gas and oil tools, valves and pipelines, marine applications, both in engine parts and anti-fouling technologies to name just a few. The fragmentation of the industry provides us with a large number of small to medium size companies that we will investigate to determine our best additions to our first two acquisitions.

Internal Organic Growth. We have already taken the existing "book of business" of our two subsidiaries and introduced into it additional products, both as cross sales from the sister company's product lines as well as the introduction of nano-formulated coatings. Our emphasis on the after-market retail customer is one of the two major sectors of our business. In additional to the aftermarket sector, we have already developed and are presently developing additional customers in the OEM sector. One of our strongest sources for internal organic growth in the next three years is an emphasis by the manufacturers of diesel, gasoline and hybrid fueled engines to meet demanding environmental requirements imposed on their respective industries as we seek to improve emissions, fuel economy and safety.

Distributed Model Development The "distributed" business model is our establishment of on-site coatings application as part of the assembly-line process within the manufacturing and/or assembly process of a large customer. We have already undertaken this approach with one of our OEM customers and are presently in discussion with others. The savings on handling, shipping, inventory, logistics management and other similar expenses that comes from having the on-site "plant" is the main element of interest for our larger customers. We are presently in discussion with other customers to increase the awareness of the benefits of this approach.

Licensing Intellectual Property. Within the next twelve months, we intend to enter into protective "field of use" licensing with some of the manufacturers that may be tier-one suppliers of large OEM companies or who deploy a distributed production model described above. However, unlike the distributed model where application expertise and management control are inherent elements of the model, our "field of use" license agreements supply proprietary coatings to third parties already applying coating at their plants. The license agreements will be limited to targeted applications and industries and structured as joint ventures to avoid creating competition in our own current market space.

Strengthen nTech's research and development efforts. We have entered into a series of discussions with outside research and development groups, including technology transfer offices of universities, private laboratories and other small start-up technology companies for the express purpose of continuing to strengthen and exploit our research and development capacities. We expect to formalize these discussions prior to the end of the fourth quarter of this year. All of nTech's research activities are focused on projects that can show commercialization within three to six months, rather than long term R&D projects. Many research projects are driven by direct requests from customers seeking immediate solutions to present critical problems.

Acquisitions

Management believes that there is a strategic acquisition opportunity resulting from the market dynamics of the high performance coatings markets. Acquisitions of HPC and Jet-Hot have further validated our strategic research. We expect to search for, complete due diligence on and acquire other coatings companies that
(i) have a customer base that includes enterprise level customers in a mature market, (ii) enjoy strong and stable market presence in our targeted primary markets, (iii) are profitable, (iv) have a brand presence similar to HPC, and
(v) have an existing product mix whose performance and functionality can be significantly improved by the integration of nanotechnology know-how.

Acquisition of Jet-Hot

With respect to the acquisition of Jet-Hot, we believe key synergies to our business plan include:

1. Jet-Hot and HPC had plants in Arizona that were are approximately 10 miles apart. The plants were consolidated in the 4th quarter of 2007.
2. Jet-Hot plants are built for high through-put and packaging of individual aftermarket production. HPC plants are built for high volume of OEM parts production.
3. We have acquired sufficient market and operational experience to realize that a single coating entity has a competitive disadvantage in attempting to create high volume productions of both aftermarket parts and OEM parts. The addition of MCCI allows us to create focused plants for each of our major market sectors.
4. Competition between MCCI and HPC for stand-alone coatings sales (no applications services) will be eliminated and we will carry one "best of breed" coating from each area in which we have needs.
5. JET-HOT has more thermal barrier customers than HPC. HPC has more corrosion resistance and lubritic coatings customers than JET-HOT. Cross selling can occur to each company's customer base to raise same-customer revenue. In addition, JET-HOT does not currently sell internal engine coatings. Their product line is for coatings on external parts only. HPC internal engine coatings can now be offered to all of JET-HOT's approximate 9,000 annual individual aftermarket customers.

Our headquarters' address is 7237 Pace Drive, P.O. Box 38, Whitsett, NC 27377, and our phone number is (336) 447-2000.

Results of Operations

Performance in First Six Months of 2008 Compared to First Six Months of 2007

Performance Overview

The comparative revenue for the six months ending June 30, 2007 and June 30, 2008 shows an increase of 3,170,853 that was attributable to both the June 29, 2007 acquisition of MCCI and the increase in HPC revenues. Revenues were also impacted by changes being implemented by our diesel engine manufacturing customers. According to industry sources, heavy-duty truck sales have fallen 42.5% for 2007. One major truck manufacture reported a 71% decrease in year to year unit sales. Beginning in January 2007, our diesel engine manufacturing customers were required to introduce new engine platforms to meet new Environmental Protection Agency (EPA) requirements to lower harmful particulates in engine emissions in order to comply with Federal clean air standards. nCoat sells and applies coatings that aide diesel emissions systems to meet these new standards. The standards affected those engine platforms commencing in 2007 and the complete 2007 year was a period of "wait and see" as the new engineering was road-proven prior to the acceptance by the market. The downturn of active new unit purchases was further affected by the dramatic increase in fuel prices which caused many fleet buyers to postpone expenditures in order to remain competitive.

Cost of Sales.

Cost of sales as a percentage of sales decreased from 87% in the first six months of 2007 to 64% the six months ended June 30, 2008. With the acquisition of MCCI, we have increased the percentage of our business related to after market products, which typically have a higher margin than our OEM products.

General and Administrative Expenses.

General and administrative expenses for the six months ended June 30, 2008 decreased by approximately $732,000 and decreased as a percentage of sales from 176% to 65% for the same period in 2007. One of the strongest contributors to this reduction was that the 2007 general and administrative expenses included costs related to our commencement as a public company and the associated costs.

Sales and Marketing Expense.

Sales and marketing expense for the six months ended June 30, 2008, increased by approximately $33,000 but decreased to less than 6% of sales compared to 11% for the same period in 2007. Management has restructured the marketing and sales group, consolidated the MCCI sales to North Carolina and revamped its commission structures to allow for more effective sales efforts.

Interest Expense.

The greatest impact seen in our financial reports is the interest expense which has been attributed to the contractual redemption premium computations. We are in technical default under the terms of the Series A and Series B Promissory Notes and hence we must show the premium computed on a redemption right granted to the holders of the Notes. We have had no indication from the Note holders of demand, or other negative impacts and are working to complete further negotiations with them in order to extinguish the triggering events which have lead to the accounting entries.

Earnings per Share.

As a result of the share exchange transaction discussed in the filing, exercise of warrants, conversion of debt the number of outstanding shares have increased to 97,826,650 at June 30, 2008 and the weighted average shares have increased from 73,222,808 at December 31, 2007 to 94,535,699 shares at June 30, 2008.

The Company incurred losses of $51,558,543, including the interest expense discussed above and $5,186,656 during the six months ended June 30, 2008, and June 30, 2007, respectively.

Financial Statements, One-Time Charges and Capital Expenditures

As we commenced our planned growth with the promise of funding, we experienced higher costs which were attributable to the infrastructure of a company with a larger footprint. During the second half of 2007 as it became more apparent to management that funding commitments had been disappointing, efforts were commenced to reduce costs. We have included reductions in personnel, consolidation of facilities and emphasis on lean manufacturing practices. Our resulting operational savings have been encouraging.

1. Facilities - Following the acquisition of MCCI Jet -Hot ®, we consolidated the two plants located in Arizona into a single plant. As of the date of this report we are exploring further plant consolidation to increase the use capacity in existing locations. Although location consolidation provides for long-range savings, in some cases the additional one-time charges associated with such closure appear to affect earnings directly.

Our plans also call for a second OEM production line in late 2008 or early 2009 at a cost of approximately $750,000 for its installation. Another production line dedicated solely to our aftermarket production is slated in 2nd quarter of 2009 at a cost of approximately $250,000 and a fourth production line, again for OEM, is planned for 4th quarter 2009 with a cost of approximately $1,000,000.

2. Personnel - The Company has reduced the workforce from over 200 employees to approximately 145 employees. This decrease comes from operating plants more efficiently and reducing management personnel which had been originally brought on to accommodate the accelerated growth projected with full funding. We have focused on completion of Standard Operating Procedure documentation, preparation of information systems, accounting, human resource, production, communications, mixing and blending, strategic finance and other systems to accommodate rapid growth from internal and acquisition growth.

3. Research and Development - Our expenditures for research and development have been reduced from $302,000 in the first half of 2007 to $216,000 in the first half of 2008. The savings reflects consolidation of facilities rather than a reduction in emphasis.

4. Financing - Expenses in the first half of 2007 and 2008 differ in nature. In 2007 we experienced expenses relating to the money-raising process, including fees relating to engaging advisors to assist the Company in future financings and expenses related to creating the strategic relationships necessary to successfully execute the business plan. In 2008, the majority of the expense involved in the financing relates to interest expense, particularly the dramatic accounting for the redemption premium.

Liquidity and Capital Resources -

nCoat is a company with limited operating history and experience upon which to base an evaluation of its performance. In September of 2005, we acquired High Performance Coatings, Inc. ("HPC"), an operational coatings company, which was responsible for the majority of our consolidated revenues. In 2006, we formed an intellectual property and development entity, nTech, Inc. ("nTech"), and in June 2007, we acquired all of the common stock of Metallic Ceramic Coatings, Inc. ("MCCI"), a primary competitor of HPC with 26 years of coatings experience and historical revenues similar to HPC.

On April 13, 2007, we converted $2,000,000 of convertible debentures and $67,752 of accrued interest into 4,135,503 shares of our common stock at $0.50 per share. The remaining $500,000 of convertible debentures, along with accrued interest of $18,107, was converted to 1,036,215 shares of common stock at $0.50 per share on August 24, 2007.

From May 25, 2007, through July 9, 2007, we issued $9,000,000 of Series A 6% convertible promissory notes (the "Series A Notes") and warrants to purchase 22,500,000 shares of common stock, exercisable at $1.00 per share through May 31, 2012. The Series A Notes are convertible into common stock at $0.40 per share through May 31, 2010 when the Series A Notes are due. On May 31, 2007, the Company issued $3,250,000 of Series B 6% convertible promissory notes (the "Series B Notes") and warrants to purchase 8,125,000 shares of common stock at $0.80 per share through May 31, 2010. The Series B Notes are convertible into common stock at $0.40 per share through May 31, 2010 when the Series B Notes are due. The Series A and B private placement offerings included the conversion of $800,000 of advances from investors of which $700,000 had been received prior to March 31, 2007. The Company received $10,618,916 of proceeds from the issuance of the Series A and Series B convertible notes, net of the $700,000 of advances previously recognized and net of cash offering costs of $931,064.

In the final stages of the offering, after we had closed on the purchase of MCCI, a subscribed investor did not fund its portion of offering. Our intended use of proceeds included retirement of debt and related accrued interest of $3,677,286, $5,000,000 for the acquisition of MCCI, payment of significant pre-offering liabilities and establishing a working capital reserve. The . . .