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 September 30, 2008, and the year then ended and the notes accompanying those financial statements.

Overview

nCoat continues to focus on its core business of providing high quality, nano-scale and micronized particle surface treatment materials (coatings) that provide heat management, corrosion management, abrasion reduction, and porosity reduction to multiple mature industries. We focus on creating a competitive company with scalable processes, equipment and facilities to meet customer demand and to provide newly innovated nano-formulated materials with novel properties.

Our principal business strategy includes the following components:

Internal Organic Growth. We have integrated into the existing "book of business" of our two acquired subsidiaries, which creates additional product offerings for both entities as cross sales opportunities from the sister company's product lines. Operationally we have created common core formulations that represent the best-of-breed from all sources acquired or owned. Our emphasis on the after-market retail customer continues to be one of the two major segments of our business. In additional to the aftermarket sector, we continue to develop customers in the OEM market segment. nCoat products are becoming more recognized as a standard product for reducing corrosion and heat in diesel engines. The initial market for these products has been heavy duty over-the-road diesel engine trucks. nCoat is now beginning to expand into other sub-segments of the diesel engine markets including marine, locomotives, military vehicles and sea-going vessels, recreational vehicles, stationary generators, pumps and other fixed applications, agriculture, heavy duty equipment, aftermarket re-manufactured engines and other areas. In addition, we are expanding our customer base in gasoline powered engines as well including into increased activity in motorcycle and racing venues. A strong source for internal organic growth in the next three years is the continued 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. nCoat also continues to innovate new nano-products that meet the needs of our customers. nCoat is in beta testing of a new anti-oxidation nano-coating to eliminate discoloration of chrome on vehicle exhaust systems. This product appears to be a unique innovation that to the knowledge of the Company is not offered by any other competitive company. nCoat expects these kinds of new products to create cross selling opportunities with existing customers and opportunities to expand the market base with product offerings to existing and new market segments. nCoat expects these product opportunities to add to the internal growth of our customer base and revenues. Because of our initial focus on automotive, trucking, motorcycles and recreational vehicles, we expect that our revenues will remain subject to (1) seasonal build schedules of our OE and aftermarket customers, (2) volume adjustments dictated by macro-economic conditions, and (3) changing consumer spending trends. Year to date, Company revenues are down approximately twenty percent (20%) as our customers have adjusted to lower consumer demand consumer confidence in current and future economic conditions. We have not lost any major accounts during this period of reductions in manufacturing output, however, total unit volumes in our largest market segment are significantly reduce year-over-year from 2008 levels and year-over-year 2008 levels were significantly reduced from 2007 levels. Until current economic trends and credit restrictions improve, we expect that our revenues from existing customers will not substantially improve.

Licensed Application and Joint Venture Development. We continue to work to develop technology licensing and/or joint venture business agreements to establish on-site coatings application as part of the assembly-line process within the manufacturing and/or assembly process of a large customer. This business model will become increasing viable as nCoat products continue to gain acceptance in our targeted markets and as we increase volume production to levels that make on-site licensing financially viable for our customers. nCoat currently has two OEM customers employing a licensing model and we continue to have discussions with other prospects. The savings on handling, shipping, inventory, logistics management and other similar expenses that comes from having the on-site process is the principle benefit for our larger customers. Prime targets for licensed applications include engine builders, vehicles manufactures, engine re-manufacturers, automotive parts manufacturers, and other major industry applications.

Licensing Intellectual Property. We continue to enter into protective "field of use" licensing with manufacturers that are tier-one suppliers of large OEM companies or who deploy a licensed application or joint venture model as described above. However, unlike the licensed application and/or joint venture 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 where nCoat is not likely to engage in application services in the future and are structured as joint ventures to avoid creating competition in our own current market space.

Acquisitions. We completed the acquisition, transition and integration of HPC and MCCI which have given us a base of operations and market presence. We have minimized work on merger and acquisition activity during the current global economic downturn and to reduce expenses in our current condition of low available cash. As capital, the economy and opportunities allow, we may identify new specific target companies in target markets for acquisition.

Strengthen nTech's research and development efforts. On January 15, 2008, nCoat announced that North Carolina Agricultural and Technical State University (NC A&T) in Greensboro, North Carolina, and nCoat Inc. had established a technical collaboration agreement for characterization and development of nanotechnology based materials and industrial coatings. The Memorandum of Understanding ("MOU") was signed December 20th, 2007 with the Division of Research and Economic Development at the university's campus in Greensboro, North Carolina. Under the MOU, nCoat collaborates with NC A&T's Center for Advanced Materials and Smart Structures (CAMSS) in areas of advanced composites, carbon nanotubes, nano enhanced slurry coatings and metallic degradation from extreme thermal and chemical environments. CAMSS has a track record in nano-science based advanced materials as applied to thin film research, nano-composites, tribological and environmental coatings.

CAMSS is an extensively equipped and staffed materials research facility located on the campus of NC A&T in Greensboro a few miles from nCoat's location in Whitsett. CAMSS is a NC A&T-wide umbrella center receiving support from the National Science Foundation (Center for Research Excellence in Science and Technology), Department of Energy, Department of Defense (Center for Nanoscience and Nanomaterials), Air Force, and many industries. The center has extensive nano characterization equipment including recent multiple innovations in atomic and electron scanning microscopy and optical technologies. NC A&T has been recognized as one of the leading nano materials research and development centers in the United States.

The agreement outlines joint efforts between nCoat and NC A&T to identify, characterize, develop and commercialize new nano technology enhancements for functional coatings and materials with applications in aerospace, medical, energy, automotive, industrial, textile, advance composites, diesel engine applications and other industries.

Among other activities, the MOU is intended to establish a framework for conceptualization and implementation of R&D projects with subsequent commercialization. The agreement outlines governance of jointly and separately developed intellectual property and potential patent alliances for inventions. The agreement is also designed to establish joint revenues through technology licensing for commercial applications.

Some of the initial collaborative commercialization activities will be in the nano-structured surface engineered systems to improve thermal barrier, corrosion, tribological properties, biocompatibility and creating surface technologies that create a cleaner environment. The MOU also allows nCoat to collaborate with CAMSS on testing, prototyping and development of materials specific to enhancing nCoat industry needs.

This agreement and others under discussion with outside research and development groups, including technology transfer offices of universities, private laboratories and other small start-up technology companies are designed to continue to strengthen and exploit our research and development capacities while reducing R&D costs. 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 immediate critical problems.

In the second quarter, 2009, we identified additional research and development opportunities with NC A&T and continue to develop technology prospects toward commercialization.

Completed Acquisitions

The acquisitions of HPC and Jet-Hot have created certain market strengths for the combined company. As a whole, the combination of the companies gives nCoat the opportunity to scale our operations to meet larger OE customer demands.

Acquisition of MCCI/Jet-Hot

With respect to the acquisition of Jet-Hot in June, 2007, we have realized key synergies which include:

1. Jet-Hot had a plant in Arizona as did HPC. The plants were about 10 miles apart. These were consolidated into a single location.
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. Key strengths of each company have be used to create best-of-breed know-how at all operating plants.
3. Two corporate headquarters existed. The Jet-Hot accounting, human resources, legal, purchasing, sales and marketing, R&D and company management were consolidated into our North Carolina headquarter.
4. HPC and JET-HOT sales and marketing groups were consolidated for maximum production and efficiency, including advertising budgets.
5. Jet-Hot R&D and technical services were consolidated to nTech, for efficiency and intellectual property synergies.
6. HPC and JET-HOT sales prospects include many of the same names, including several where the two companies are the only two competitors for the account. This list was sorted into HPC and MCCI responsibilities, creating a non-competing sales effort.
7. 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 operations for each of our major market sectors.
8. Competition between MCCI and HPC for stand-alone coatings sales (no applications services) has been eliminated and we are offering "best of breed" coating from each company to customers.
9. JET-HOT has more thermal barrier customers than HPC. HPC has more corrosion resistance and lubritic coatings customers than JET-HOT. Cross selling now occurs in each company's customer base to attempt to raise same-customer revenue. In addition, JET-HOT did not sell internal engine coatings. Their product line was for coatings on external parts only. HPC internal engine coatings are now offered to all of JET-HOT's approximate 9000 annual individual aftermarket customers.

Since the acquisition of JET-HOT, we have gradually transition most aftermarket product sales and services across all companies into JET-HOT to leverage the JET-HOT brand in the marketplace for consumer products and we have gradually transitioned most OE product sales and services to HPC to leverage the HPC brand for engineered products for industry applications.

Company contact information

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 2009 Compared to First Six Months of 2008

Performance Overview

The comparative revenue for the three months ending June 30, 2008, to June 30, 2009, shows a decrease of $1,609,265 or 27.9%. Aftermarket sales began to experience declines in June, 2008 as consumer confidence plummeted and uncertain and negative economic conditions began to impact consumer spending. Quarter over quarter aftermarket sales experienced 60% reduction in the fourth quarter of 2008 as economic conditions and consumer uncertainty worsened. In the first and second quarters of 2009, aftermarket sales were down 32.7% compared to the first six months of last year. Additionally, OEM sales have been negatively impacted by reductions in demand with diesel engine manufacturers. Many diesel manufacturers ceased production of new 2009 model trucks choosing to sell out existing inventories and prepare for new 2010 model year vehicles which are required to meet new EPA emissions standards. The weakness in this sector may continue into the third quarter of 2009, although we have seen some renewal in 2009 engine platform production. Media sources continue to report year-over-year engine build rates the past two years as being down over 60% from pre-2007 levels.

In 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 corrosion resistant coatings created to protect engines from corrosive agents in the emissions re-circulated during use of new technology that aides diesel emissions systems to meet these new standards. The new 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, rapid and broad tightening of available credit in response to global financial turbulence, followed by the economic recession. Additionally, the national economic downturn and severe limitations on corporate credit resources beginning in the fall of 2008 continued the limitations of unit sales. Until economic activity shows signs of rebounding, and liquidity returns to the financial markets, transportation companies will defer capital expenditures on rolling stock. Once markets begin to thaw a combination of aging fleets, increasing EPA requirements and potential government incentives will ultimately produce an increased volume of production to relieve the demand. Our earliest expectation would be the fourth quarter of 2009, but this weakness may continue into 2010 and beyond.

Cost of Sales

Cost of sales was $2,301,522 for the first six months of 2009, a reduction of 38% from the same period last year. The company continues to realize efficiencies stemming from closing Mississippi and Utah plant locations. Additionally we continue to improve processes and reduce variable cost and waste through our lean manufacturing program and Six-Sigma management training. In the second quarter, six members of our management and supervisory team achieved Six Sigma black-belt designations after completing training provided to the company by North Carolina State University as a free service from the North Carolina Department of Commerce as an economic incentive to the our company.

General and Administrative Expenses

General and administrative expenses for the six months ended June 30, 2009, decreased by approximately $1,041,000 or 32% over same period 2008 expenses. Management has instituted a number of steps designed to reduce these expenses including:

1) Closing Mississippi and Utah plant locations, relocating their capacity to other existing facilities and consolidating the JET-HOT and HPC plants in Arizona.

2) Increasing the effectiveness of communications and reducing unnecessary travel.

3) Realigning upper management positions to more closely track the size and present revenues of the Company.

Sales and Marketing Expense

Sales and marketing expense for the three months ended June 30, 2009, decreased by approximately $24,000 or 7% compared to the same period in 2008. Management has restructured the marketing and sales group, revamped commission structure and reduced print advertising expense. However, management believes some expense reductions have impacted aftermarket sales and OE sales and that further reductions to advertising and direct marketing and sales efforts will adversely impact both aftermarket and OE sales efforts and thereby revenues and the overall financial condition of the Company. Management believes that some increase in marketing and sales expenditures will be necessary to sustain sales and customer services.

Interest Expense

Management's greatest concern remains that all of the significant positive changes that have been made to reach operating profitability have been overshadowed by the great impact seen in our financial reports of the interest expense is 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 are subject to the premium computed on a redemption right granted to the holders of the Notes. As of the date of this report management has received demand from one note holder for the redemption of its Series A note. The note was originally issued May 31, 2007 with the face amount of $1,500,000. The note holder has previously converted a portion of its note ($35,000) as reflected in the financial statements set forth herein. The demand was later withdrawn, and the same investor converted $7,500 at a share price of $.0015 for 5,000,000 shares in May of this year. No other demand has been made by the remaining note holders for redemption of the Series A and B Notes. We have had no indication from the other Note holders of demand, or other negative impacts and are working to complete further negotiations with them in order to restructure the triggering events which have lead to the accounting entries.

Earnings per Share

As a result of the share exchange transaction discussed in the overview section above, exercise of warrants and conversion of debt, the number of outstanding shares increased to 107,108,606 as of June 30, 2009. For the six month period ended June 30, 2009 there was a loss per share of 4.82.

Financial Statements, One-Time Charges and Capital Expenditures

Cost reduction activities have been underway since our anticipated funding was only partially completed in 2007. We continue to realize reductions in personnel, consolidation of facilities and emphasis on lean and efficient manufacturing practices. Our resulting operational savings have been encouraging.

1. Facilities - Since the first quarter of 2007, facilities have been shut down in Mississippi and Utah and consolidated in Arizona. The capacity was shifted to other existing facilities, reducing our overhead and improving our labor productivity.

Our plans call for a second OEM production line in North Carolina in 2009 at a cost of approximately $250,000 for its installation. Most of this cost will be for installation of existing equipment which has already been relocated due to the consolidation of the Mississippi, Utah and Arizona plant locations.

2. Personnel - The Company has reduced the workforce from over 200 employees in July, 2007 to approximately 116 employees as of June 30, 2009. This decrease comes from operating plants more efficiently and reducing the number of plant locations. Additionally the first quarter of last year included some management positions which presumed full funding of our investments and subsequent growth. The current management staff level is in line with existing business levels. We continue to focus 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 were $160,418 for the six months ended June 30, 2009. Expenditures for the first six months of 2008 totaled $215,747.

4. Financing - Expenses in the first six months of 2009 show Redemption premium interest expense of $515,614,712. This is the current calculation for the penalty associated with the default on the A and B notes discussed at length elsewhere in this report.

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 retirement of pre-offering liabilities and the working capital portion of the offering did not get raised prior to our contractual obligation to close the . . .