**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-KSB**

 

**(MARK ONE)**

 
| **x** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-------------------------------------------------------------------------------------------|

 

**For the fiscal year endedDecember 31, 2001**

** **

**or**

 
| ** ̈** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-----------------------------------------------------------------------------------------|

 

**For the transition period from               to                **

** **

**Commission File Number:  1-12756**

** **

**ROTARY POWER INTERNATIONAL, INC.**

(Name of Small Business Issuer in Its Charter)

 

| **DELAWARE**                                                    |   | **13-3632860**                      |
|-----------------------------------------------------------------|--------|-------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. EmployerIdentification No.) |

 

# **Post Office Box 128, Wood-Ridge, New Jersey**

(Address of PrincipalExecutive Offices)

 

**07075-0128**

(Zip Code)

 

**(973) 470-7000**

(Issuer’s TelephoneNumber, Including Area Code)

 

Securities registered underSection 12(b) of the Exchange Act:  common stock, par value $.01 per share

 

Securities registered underSection 12(g) of the Exchange Act:  NONE

 

Check whether the issuer(1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x No  ̈

 

Check if there is no disclosure of delinquent filers in response to Item405 of Regulation S-B contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form10-KSB or any amendments to this Form 10-KSB.  ̈

 

The issuer’s revenues for its most recent fiscal year were $49,757.

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates was approximately $7,764,423.36, which is based on theaverage of the bid and ask price of $.37 on April 5, 2002.

 

The number of shares of common stock outstanding as of April 9, 2002 was22,004,928.

 

Transitional Small Business Disclosure Format (check one): Yes  ̈ No x

 

**FORM 10-KSB ANNUAL REPORT**

 

 

**INDEX**

 
|       | **PART I**                                                                                                        |   |
|------------|-------------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                              |   |
| Item 1.    | Description of Business                                                                                           |   |
| Item 2.    | Description of  Property                                                                                          |   |
| Item 3.    | Legal Proceedings                                                                                                 |   |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                                              |   |
|       |                                                                                                              |   |
|       | **PART II**                                                                                                       |   |
|       |                                                                                                              |   |
| Item  5.   | Market  for Common Equity and Related Stockholder Matters                                                         |   |
| Item  6.   | Management’s  Discussion and Analysis or Plan of Operation                                                   |   |
| Item 7.    | Financial Statements                                                                                              |   |
| Item  8.   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                             |   |
| Item  9.   | Directors,  Executive Officers, Promoters and Control Persons; Compliance with Section  16(a) of the Exchange Act |   |
| Item 10.   | Executive Compensation                                                                                            |   |
| Item  11.  | Security  Ownership of Certain Beneficial Owners and Management                                                   |   |
| Item  12.  | Certain  Relationships and Related Transactions                                                                   |   |
|       |                                                                                                              |   |
|       | **PART III**                                                                                                      |   |
|       |                                                                                                              |   |
| Item 13.   | Exhibits and  Reports on Form 8-K                                                                                 |   |
|       |                                                                                                              |   |
| Signatures |                                                                                                              |   |

 

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**PARTI**

 

 

**ITEM1.****                            ****DESCRIPTIONOF BUSINESS**

 

**General**

 

Rotary PowerInternational, Inc. (the “Company”) is in the business of developing andmanufacturing rotary engines forcommercial use.  The Company hastwo wholly-owned subsidiaries, Pegasus Technologies, Incorporated (“Pegasus”)and E-Drive Systems Corporation (“E-Drive”). Pegasus and E-Drive are currently inactive.  The Company intends to direct its product development andmanufacturing to three commercial areas where the Company’s products arebelieved to have intrinsic advantages over reciprocating engines: (i) marinepropulsion and shipboard use; (ii) energy generation; and (iii) prime moversfor rotating machinery, such as pumps and compressors.  The characteristics of the Company’sproducts, including their light weight, small size and ability to burn avariety of fuels, are a competitive advantage in each of these markets.

 

The Companybelieves that the design of its engines provides advantages over other internalcombustion engine designs.  Rotaryengines do not have reciprocating parts. The compact nature of the power trainof a rotary engine results in a high power-to-weight ratio. Since a rotaryengine does not require the use of conventional connecting rods between therotors and the crankshaft, engine volume reduction is realized making the powerdensity of the rotary engine superior to a conventional four-strokereciprocating engine. The Company believes that its stratified omnivorouscharge rotary engine (the “SCORETM engine”) offers severaladvantages over reciprocating engines, such as multi-fuel capability, superior sizeand weight characteristics for a given power output, low vibration, greaterreliability and design simplicity with a high commonality of parts and, in thenatural gas-fueled version, lower emissions of oxides of nitrogen. The Companyalso believes that its SCORETM engine can be manufactured andproduced at a significantly lower cost than turbine engines and will operatewith better fuel economy than turbine engines. The SCORETM engine is also ideally configured to operate athigh efficiency on heavy fuels, which includes diesel and jet fuel and theirderivatives.

 

In 1997, theCompany began redirecting its efforts to focus mainly on the production ofengines for commercial markets.  TheCompany believes that its rotary engines can be successfully marketed to a widevariety of commercial, industrial and marine markets in commercial buildquantities, after pilot production runs and selected field trials.  Based upon tests conducted by the Companyand independent testing companies, the Company believes that its rotary engineshave demonstrated important benefits which will allow them to compete favorablywith reciprocating diesel, gasoline and natural gas engines and turbines inchosen major market segments.

 

**History and Recent Developments**

 

The Company, a Delawarecorporation, was formed on October 23, 1991 for the purpose of purchasingsubstantially all of the assets and the business of the rotary engine divisionof John Deere Technologies International, Inc. (“JDTI”), which it completed onDecember 31, 1991.  JDTI had purchasedthe rotary engine division from Curtiss-Wright Corporation (“Curtiss-Wright”)in 1984.  JDTI, a wholly-ownedsubsidiary of Deere and Company, was, at the time, the leading company in theUnited States in the development and production of prototype rotaryengines.  As a result of the acquisitionfrom JDTI, the Company became the sole owner of all rotary engine assets ofJDTI and Curtiss-Wright, including all the proprietary technology developed byboth companies.

 

The Company formedan Industrial Products Group within the Company in March of 1994 to develop andsell natural gas rotary engines in commercial and industrial markets.  The Company executed a Development Agreementwith Mazda North America (“MANA”) of Flat Rock, Michigan and Mazda MotorCorporation of Hiroshima, Japan on December 7, 1993 and developed a natural gasversion of the Mazda rotary 

 

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during the 1994 and 1995calendar years designated as the Series 65 natural gas rotary engine.  To further augment its commercial productthrust, the Company created a wholly-owned subsidiary called Rotary PowerMarine, Inc. (“RPM”) on July 26, 1995 to address the development of its enginesfor the commercial pleasure craft marine market.  RPM purchased essentially all of the assets of Rotary MarineIndustries of Sandpoint, Idaho on August 30, 1995.

 

In December, 1996,the Company concluded an agreement with PowerCold Corporation (“PowerCold”)whereby PowerCold invested $1,000,000 in the Company in exchange for 2,000,000shares of the Company’s Common Stock. Simultaneously, the Company and PowerCold signed a Plan and Agreement ofMerger on March 21, 1997.  This Plan andAgreement was never completed and was terminated in August, 1997.  PowerCold remains a shareholder of theCompany, holding 1,935,000 shares of the Company’s Common Stock at December 31,2001.

 

In January, 1998,the Company’s management formulated a plan to restructure the Company’s productline, financial position and direction to become a volume manufacturer ofcommercial engines.  Management directedthe Company’s efforts toward the settlement of overdue debts, the reduction ofoperating costs, the attraction of key customers willing to purchase rotaryengines in advance of production, and the search for capital to finance ongoingoperations and new plant capacity.

 

In June, 1998, aportion of RPM’s assets were sold by the Company consisting of RPM’s name andlogo, the Series 65 marine engines, parts, the supplier agreement with MANA forthose engines as well as certain related production machinery, tooling anddocumentation.  As a result of suchtransaction, the Company renamed RPM “E-Drive Systems Corporation.”

 

On July 2, 1998,the Company entered into an agreement with Rotary Power Enterprises, Inc.(“RPE”), a value-added reseller of natural gas refrigeration and powergeneration equipment, pursuant to which the Company sold its 65 Series naturalgas rotary engine inventory, parts and intellectual property to RPE.  In 1999, the Company also entered into twoEngine Distributor Agreements with RPE, granting RPE the right to exclusivelydistribute the 580 Series natural gas rotary engines to commercial industrialmarkets worldwide.  In August, 2000, theCompany entered into a non-exclusive manufacturing licensing agreement (the“Licensing Agreement”) with RPE, whereby the Company agreed to license to RPEthe technology, know-how and technical information required for RPE tomanufacture the Company’s 580 Series natural gas rotary engine.  In consideration of the license, the Companywill receive a royalty equal to five percent (5%) of the net sales price ofeach 580 Series engine manufactured and sold by RPE.  The Licensing Agreement remains in effect unless and until anevent of default occurs thereunder and the Licensing Agreement is terminated byeither party in accordance with its terms. As a result of the execution of the Licensing Agreement, the existingengine distributor agreements between the Company and RPE, which originallygranted exclusive rights to RPE to distribute the 580 Series natural gas rotaryengine in certain specified markets, were amended to provide that those rightsare now non-exclusive, except with respect to certain RPE clients identified inthe engine distributor agreements.

 

In October andNovember, 1999, the Company entered into several agreements with LondonderryCapital Structuring Limited (“Londonderry Capital”) of Toronto, Ontario,Canada, whereby Londonderry Capital agreed to provide advisory and consultingservices in connection with the financial structure, operations and managementof the Company, including a consulting agreement, an investor-relationsagreement, a facilitation fee agreement and a subscription agreement, underwhich Londonderry Capital agreed to purchase up to 3,000,000 shares of theCompany’s common stock at $.18 per share. Under the terms of the facilitation agreement, Londonderry Capital orits nominee was entitled to receive a facilitation fee equal to ten percent(10%) of the gross proceeds of any financing proposal funded throughLondonderry Capital or through Londonderry Capital’s efforts exclusive of anyfinancing paid by Londonderry Capital or any parties involved in thefunding.  Londonderry Capital was alsoentitled to receive a facilitation fee equal to 10% of the amount 

 

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of any Company debt thatLondonderry Capital arranged to restructure to some form other than debt and atwo percent (2%) facilitation fee on all other sources of funding for theCompany.

 

On May 1, 2001, the Company entered into a Terminationand Settlement Agreement (the “Termination Agreement”), with LondonderryCapital and Londonderry Management Services Ltd. (“LondonderryManagement”).  Pursuant to the terms ofthe Termination Agreement, the Company and Londonderry Capital agreed toterminate, effective as of May 1, 2001, all of their existing agreements.  In consideration therefor and in order toenable Londonderry Capital to settle certain long-term commitments, the Companyagreed to (i) pay Londonderry Capital the sum of $50,000 to reimburse certainamounts and expenses; and (ii) issue to Londonderry Capital and/or itsdesignees and assignees, warrants to purchase 500,000 shares of the Company’srestricted Common Stock at a cash price of $5.00 per share (the “SettlementWarrants”).  The Settlement Warrants areimmediately exercisable until the third anniversary of the date ofissuance.  The Company issued to LondonderryCapital 83,333 common shares on September 14, 2001 in full consideration of the$50,000 payment due to Londonderry Capital under the TerminationAgreement.  The Company also agreed toissue 200,000 shares of restricted Common Stock to Londonderry Management andto grant McKeown an option under the Company’s stock option plan to purchase300,000 shares of Common Stock (the “Employment Option”).  See Item 10, “Executive Compensation” belowfor the terms of the Employment Option.

 

Simultaneously with the execution of the TerminationAgreement, the Company and Londonderry Management entered into a ManagementConsulting Agreement, dated as of May 1, 2001 (the “Consulting Agreement”),pursuant to which Londonderry Management agreed to provide managementassistance to the Company by making available the services of Ronald G. McKeownto serve as Executive Vice President and Director of Marketing of theCompany.  See Item 10, “ExecutiveCompensation” below for the terms of the Consulting Agreement.  Mr. McKeown is the President and soleshareholder of both Londonderry Capital and Londonderry Management.

 

A succession inthe management of the Company occurred in June, 2001.  Conway Davis, the former President, Chief Executive Officer andDirector, resigned from his positions and on June 7, 2001 the Board ofDirectors appointed Mr. McKeown to the position of interim President and ChiefExecutive Officer.  Mr. McKeown also wasappointed to the Board of Directors. Upon the succession in management of the Company that occurred, theBoard of Directors authorized the payment of $71,000 to Mr. Davis.  Mr. Davis held options to purchase 1,300,000Common Shares of the Company at the time of his resignation.  These options were not exercised and havesince expired.

 

In December, 2000,the Company made an offer to the holders of its outstanding 10.412% Bonds dueDecember 15, 2007 (the “Bonds”) to exchange each $2.00 of principal and accruedinterest through January 31, 2001 on the Bonds for one share of the Company’sCommon Stock.  The exchange offer closedon January 31, 2001 and the holders of 100% of the outstanding Bonds agreed toaccept the Company’s offer.  At January31, 2001, the principal of and accrued interest on the Bonds aggregatedapproximately $4,978,020 and the Company issued a total of 2,489,015 shares ofits Common Stock as part of the exchange. See Item 5, “Market for Common Equity and Related Stockholder Matters”below.

 

In December, 2000,the Company also entered into a settlement agreement with certain assignees ofAbejon Rotary Power Corporation (“Abejon”), a former customer of theCompany.  Under the terms of thesettlement agreement, the Company made a cash payment to such assignees in theamount of $25,000 and issued a promissory note to such assignees in theprincipal amount of $75,000 which bears interest at the rate of 8% per annumand was due on August 31, 2001.  Inaddition, the Company also issued 200,000 shares of its Common Stock to suchassignees of Abejon.  On November 11,2001, the promissory note was amended by the parties to increase the principalamount of the note to $90,000 in consideration for the modification of theterms of repayment.  Under the note, asmodified, the Company is now obligated to repay $5,000 in monthly installmentsfor the period of January to April 2002 and monthly installments of $10,000 thereafter

 

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until the note is repaidin full.  To date, no payments have beenmade by the Company under the note resulting in the Company being indefault.  The note holder initiated alawsuit against the Company on March 25, 2002 alleging breach of contract fornon-payment.  The Company is currentlyin negotiation with the note holder to resolve the matter.  See Item 3, “Legal Proceedings” below for adescription of the lawsuit.

 

The Companyentered into an agreement, effective January 31, 2001 (the “DeviationAgreement”) with JDTI which revises the payment obligations of the Company toJDTI set forth under the terms of the Purchase Agreement dated November 15,1991, as amended (the “Original Purchase Agreement”), pursuant to which theCompany acquired all of the assets and business of the rotary engine divisionof JDTI. Under the terms of the Original Purchase Agreement, the Company had aremaining obligation to make certain deferred acquisition payments (minimumroyalties) through the year 2006 in an aggregate amount of $4,725,000.  As a result of the Deviation Agreement, theCompany was obligated to make a cash payment of $100,000 to JDTI on January 31,2001 and additional cash payments of $100,000 and $150,000 in June and Novemberof 2001, respectively.  The Company isalso required to make royalty payments to JDTI based upon sales of its enginesin the amount of 3% of the sales price of each engine sold prior to February 1,2006, 2.5% of the sales price of each engine sold prior to February 1, 2011,and 2% of the sales price of each engine sold prior to February 1, 2016.  In exchange for the cash payments and theroyalty payments, JDTI agreed to waive its right to receive the $4,725,000 ofdeferred payments required by the Original Purchase Agreement.  If the Company failed to make any of thepayments required by the Deviation Agreement, the Deviation Agreement becamenull and void and the obligation to make the deferred payments required by theOriginal Purchase Agreement was restored. The Company paid the first two payments of $100,000 as above.  In October, 2001, JTDI agreed to defer thefinal payment of $150,000 due November, 2001, and the Company instead isobligated to make three payments of $50,000 on each of March 31, April 30 andMay 31, 2002.  As of the date of thisAnnual Report on Form 10-KSB, the Company had not paid the $50,000 payment thatwas due March 31, 2002.

 

On December 3,2001, the Company entered into an engagement letter (the “OEA Letter”) withOneEightyAssociates, LLC (“OEA”) pursuant to which OEA agreed to providecertain financial consulting services to the Company over a term of twelvemonths (the “OEA Engagement Term”).  Inconsideration of such services, the Company agreed, among other things, to payOEA a monthly consulting fee in the amount of $25,000 plus, for each month ofthe OEA Engagement Term, the Company agreed to issue OEA shares of Common Stockequal to one half of one percent (0.5%) of the outstanding common stock ownershipof the Company as of December 3, 2001, for the first six (6) months and onehalf of one percent (0.5%) of the outstanding common stock ownership of theCompany as of June 1, 2002, for the second six (6) months of the OEA EngagementTerm.  On February 7, 2002, the Companyadvised OEA that the Company was terminating the services provided by OEA as ofJanuary 23, 2002.  On March 14, 2002,the Company and OEA signed a settlement agreement in which the Company agreedto pay a termination payment to OEA of $50,000 payable on or before March 31,2002.  The terms of the settlementagreement provide that the termination payment date may be automaticallyextended to April 15, 2002 if the termination payment is not paid on March 31,2002.  The payment date was extended toApril 15, 2002 pursuant to the terms of the settlement agreement.  In the event that the Company does not paythe settlement amount to OEA by April 15, 2002, the OEA Agreement shall remainin full force and effect including the Company and OEA’s obligationsthereunder.

 

**Technology**

 

*History*

 

The Wankel GmbHrotary engine, upon which the Company’s rotary engines are based, was firstdemonstrated in 1954 and is named after its developer, the late Dr. FelixWankel, a specialist in the design of sealing devices.  In 1958, Curtiss-Wright obtained the firstlicense for rotary engine technology from Wankel GmbH, which gaveCurtiss-Wright an exclusive license for North America and certain non-exclusiverights outside of North America. Curtiss-Wright’s research and development efforts initially involvedgasoline rotary engines with a wide range of power for use in military vehiclesand aircraft, and for various commercial uses 

 

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including automobiles,aircraft, marine pleasure craft and lawn mowers.  In the 1960’s, the early rotary engines experienced seriousproblems with gas sealing and poor reliability.  Enormous progress in materials technology, such as thedevelopment of advanced ceramic material, has significantly contributed to thesolution of past sealing and reliability problems.

 

Curtiss-Wrightalso initiated work on the stratified charge rotary engine in the mid-1960s inorder to provide the advantage of multi-fuel capability for use in military vehiclesand aircraft. JDTI purchased the rotary engine division of Curtiss-Wright in1984 and continued to develop stratified charge rotary engines, leading to aseries of patents covering stratified charge technology, seal design, coolingsystems and new longer life materials.

 

The Company hascontinued to develop and improve the rotary engine’s features, including thereduction in fuel consumption and emissions, the use of ceramics for increaseddurability, the use of high speed electronic fuel injection systems andcontrols, and increased power density.

 

*Description of the SCORETMEngine*

 

The stratifiedcharge combustion concept is used by the Company in its SCORETMengines in order to improve the burning of the fuel in the elongated combustionchamber.  In this process, there are twohigh-pressure injection nozzles.  Thepilot injector injects a small amount of fuel that is ignited by anelectrically energized source.  This createsa pilot flame which ignites a larger amount of fuel which is injected by themain injector into a stationary flame front as the rotor sweeps past it,creating a layered (stratified) charge. This dual injection system results in more complete combustion of thefuel, which in turn allows reduced emissions, better fuel economy and theengine’s ability to run on a wide range of fuels which burn at different rates(omnivorous).

 

The injection andignition system of the SCORETM engine allows the engine to operateusing heavy fuels over a wide horsepower and speed range.  The SCORETM engine is configuredto operate at high efficiency on heavy fuels, which include diesel fuel, jetfuel and their derivatives, as well as light bunker fuels.  Diesel fuel is the fuel of choice for thecommercial marine marketplace because of the safety of operation anddesirability for insurance coverage.

 

**EngineProducts**

 

The Company iscurrently focusing its efforts on the production of the three families ofdisplacement rotary engines described below. The table below also includes the series designation for each family,the displacement per rotor, the current and potential horsepower per rotor andthe maximum potential horsepower of each family of the Company’s rotaryengines.

 
| **Family**         |   | **Displacement per Rotor** |   | **Current Horsepower/Rotor** |   | **Potential Family  Horsepower Range** |   |
|--------------------|--------|----------------------------|--------|------------------------------|--------|----------------------------------------|--------|
|               |   |                       |   |                         |   | (1-6 Rotors)                           |   |
| 70 Series Liquid   |   | 0.67 liters                |   | 80-125                       |   | 80- 500                                |   |
| 580 Series Liquid  |   | 5.8 liters                 |   | 450-520                      |   | 450-3000                               |   |
| 580 Series Gaseous |   | 5.8 liters                 |   | 250                          |   | 250-1500                               |   |

 

Modularity is oneof the attributes of the rotary engine that does not exist with reciprocatingengines.  A given rotor and rotorhousing configuration constitute a unit power module. In each module the rotorand 

 

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rotor housing areidentical. Engines from one-rotor up to six-rotors can be constructed either bystacking the modules or by coupling two-rotor engines into four and six-rotorversions.

 

The latter is thepreferred choice by the Company for all rotary engines exceeding tworotors.  The power output is then equalto the power of the power module unit times the number of rotors or number ofpower module units.  The addition ofeach module requires adding an intermediate housing to separate the rotorhousings, to provide a bearing support and to accommodate cooling provisionsand lengthening the crankshaft, or the coupling of two-rotor enginestogether.  Accessory items, such as thestarter and pumps, must be re-sized to accommodate the increased engine size,but, because of this modularity, the commonality of parts between differentmodels of engines in the same family is greater than 90%, reducingmanufacturing cost and spare parts inventory.

 

**Research and Development Contracts**

 

The Companyreceived a contract from Omnitech Robotics in January, 2001 as a result of itsmembership in the Omni Team Consortium (the “Consortium”).  The Consortium was formed to create apreliminary design of an Unmanned Ground Combat Vehicle contract from theDefense Advanced Research Projects Agency (“DARPA”) of the U.S. Government.  The Company’s contract responsibilityincluded the creation of a preliminary design of a single rotor 70 Seriesliquid fueled rotary engine and engine associated components for the vehicle’son-board prime power generator set.  TheCompany fulfilled its obligations under the contract and received payment of$49,757 for its services.  TheConsortium was not awarded a subsequent contract by DARPA.

 

**Industrial and Commercial Markets**

 

Set forth below isa description of the various marine, commercial and industrial markets to whichthe Company believes it can successfully sell its engines whether it be workingon its own or through manufacturers, distributors, and dealers.  There can be no assurance, however, that theCompany will be able to sell its engines successfully into any of thesemarkets.

 

*Marine Propulsion*

 

Recent successfulhull designs, such as those utilized in high-speed fishing fleets and catamaranferries, strongly favor lightweight, powerful engines.  Additionally, a combination of environmentalpressures are forcing redesign of many traditional engines, such as two-strokediesels, outboards, ship engines and stationery generators.  All of these developments over the past fewyears are favorable for the Company’s products.

 

The Companybelieves that its rotary engines in the 1000 to 3000 horsepower category, andmultiples thereof, will be ideal for use in fast ferry boats and othercommercial marine craft and yachts.  TheCompany believes that the size, weight, smoothness of operation, accelerationand diesel fuel capability of its SCORETM engines are preferable inthe marine environment over reciprocating engines.  Design analyses have shown that the weight advantage of SCORETMengines results in higher speeds and payloads in boats using SCORETMengines than in boats using reciprocating engines.  The compact size advantage of the rotary engine also allows forsmaller engine compartments, which significantly increases the useable space onboard.

 

At 250 HP for atwo-rotor engine, the 70 Series engines are ideal for the marine pleasure craftmarket.  A variety of safety and economyissues are moving buyers in the marine market toward engines that burn dieselfuel.  Also, the size and weightadvantages of the rotary engines become a material decision factor in theoverall cost, space utilization and performance of a boat.

 

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*Energy Generation*

 

The Companybelieves that there is a substantial demand for its products in the industrialpower generation market, including its stationary, mobile and standbyoperations.  Two major factors in thebusiness environment also strongly favor the Company’s products in the energymarket, namely, the deregulation of power and the return by major refineries tothe production of diesel fuels as opposed to gasoline.  The latter trend comes in response to theworldwide environmental pressures that favor the use of diesel fuel.  The Company’s SCORETM enginetechnology allows a single engine, unmodified, to run on either fuel, but to bemore efficient when run on diesel fuel.

 

Reserves ofnatural gas far exceed reserves of oil. The Company has developed a family of 580 Series engines to run ongaseous fuels, including natural gas. These engines can satisfy a large market for electricity peak-shaving inbuildings, shopping malls and supermarkets, as well as cold-storage facilities.

 

Electricitysupplied by large utilities remains scarce in developing nations and theCompany’s rotary engines would be favorable in these markets.  Lightweight, powerful engine drivengenerators which incorporate the Company’s rotary engines may be easilytransported to remote locations and installed on rooftops where conventionalunits would require major structural reinforcement.  The rotary engine based generators can also run on any locallyavailable fuel.

 

The use of theCompany’s engines in electric generators provides other advantages.  In other markets, especially wheregenerators can be mortgaged as part of a long life asset, the cost of powergeneration with the Company’s products may be significantly less than the peakprice per kilowatt, and owning a generator would allow greater flexibility whendealing with power contracts that stipulate minimum and maximum usage.  The deregulation of power provides anopportunity to sell excess power back to the utility grid, which encouragesusers to install larger private generators than would be required for peakshaving alone.

 

Electricitygeneration is also a significant portion of wellhead costs for petroleumproduction.  The natural gas version ofthe 580 Series engine is a competitive product in this market as well asmarkets for the transportation and compression of natural gas in pipelines.

 

The ability of theCompany’s gaseous fueled series engines to run on producer gas or biogas, orgas generated by fermentation or heat decomposition of waste products rangingfrom rice hulls to cow manure, has attracted a high amount of interest.  The Company is currently involved withdevelopment programs to demonstrate the rotary engine’s ability to burnproducer gases of varying thermal content.

 

In 1992, theCompany initiated a natural gas development program which continued developmentoriginally started through funding from the Gas Research Institute.  The Company’s natural gas developmentprogram on its 580 Series engines is intended to lead to the production of lowemission rotary engines suitable for use in areas with stringent air qualityregulations.  Due to its uniquegeometry, the rotary engine is able to operate at a very lean fuel to air ratiocompared to reciprocating engines.  Thisratio results in relatively low emissions of oxides of nitrogen.  As a result of an internal developmentprogram at the Company, a 580 Series prototype engine operating on natural gashas demonstrated emissions of oxides of nitrogen of less than 1.0 gram perhorsepower hour which is substantially less than the 4.0 gram limit specifiedin 1998 by the California Air Resources Board for heavy-duty vehicles ofgreater than 14,000 pounds.

 

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*Military Markets*

 

The Company hasalso looked into the potential military application of the Company’s SCORETMengines.  There are some military usesfor engine/propulsion systems requiring the power density and multi-fuelcapability advantages of the Company’s SCORETM engines.  These opportunities may be addressed by theCompany following successful commercial market introduction and production ofthe 580 and/or 70 Series engines.  Thereare no assurances that any military prototype and production orders will bereceived by the Company.

 

**Regulation**

 

*Product Regulation — Government*

 

The Company’sproducts are regulated by various federal, state and local energy andenvironmental laws and regulations.  Allof these laws and regulations are subject to revocation or amendment, and theCompany cannot predict what effect revocation or amendment of any such laws orregulations may have on the Company’s sales, business or operations.

 

The 580 Series naturalgas engine development is subject to various provisions of the federal CleanAir Act as well as energy and environmental legislation enacted at state andlocal levels.

 

Federal regulatorystandards have been imposed only in connection with on-highway (*i.e.*,truck and bus) vehicles.  Additionally,the United States Environmental Protection Agency, in accordance with the 1990amendments to the Clean Air Act, has proposed regulations for engines innon-road equipment and vehicles of 50 horsepower or higher, includingagricultural and construction vehicles. Initial regulations for marine engines were implemented in 2001 but onlyapply to outboards and personal watercraft. Emission regulations on inboard, inboard/outboard and stern drives arenot expected before 2005.  Proposedregulations, however, require reduced NOx emissions, which favorsthe Company’s SCORETM engines.

 

The generators,chillers and co-generation products for which the Company will be supplyingengines also must comply with federal, state and local environmental laws andregulations.  Regulation of suchproducts is conducted primarily at the state and local levels and standards canvary from state to state and locally. The Company believes that its natural gas engines comply with all applicablefederal and state environmental standards, but the Company cannot predictwhether its products will continue to comply with any new environmentalstandards in the future or that new or modified environmental laws relating tothe Company’s business will not have a material adverse effect on the Company’sbusiness or operations.

 

Natural gas is oneof the many alternative fuels addressed by new laws and regulations.  Others include methanol, ethanol, liquefiedpetroleum gas, hydrogen and reformulated gasoline.  Although the Company believes that natural gas will become apreferred alternative fuel, there can be no assurance of this or that existingand future laws or regulations or their enforcement will create materiallong-term demand for natural gas fueled engines.

 

*Environmental Regulation*

 

The Companybelieves that it operates its facility in compliance with all applicablefederal, New Jersey, and local environmental laws and regulations.  Provisions in the lease for the space thatthe Company occupies on a month-to-month basis hold the Company harmless fromfines, suits, procedures, claims and/or actions associated with environmentalhazards or clean-ups arising from or resulting from prior use of the premisesby Curtiss-Wright, the Company’s previous landlord or others, or the subsequentuse by the current landlord or others.

 

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The discharge ofpollutants into the waters of the State of New Jersey is controlled andrestricted by the New Jersey Department of Environmental Protection (“NJDEP”)in accordance with applicable laws and regulations.  The Company uses clean, non-contact water in a closed loop systemfor cooling engines and test equipment. The cooling water is analyzed and treated monthly.  Discharge is for emergency only. Since theCompany has never discharged water during its operation, the NJDEP determinedthat as of March 21, 1995, the Company is no longer required to submit monthlydischarge monitor reports.

 

Outdoor noiselevels resulting from operations are in accordance with the town of Wood-RidgeOrdinance.

 

The Company had nounderground storage tanks at December 31, 2001.  Short term fuel and fuel oil storage is contained in above groundtanks surrounded by containment walls. The Company has a Spill Prevention Control and Countermeasures Plan asrequired by federal regulations.

 

The Company has onfile with the NJDEP a Notification of Hazardous Waste Activity in compliancewith the Resource Conservation and Recovery Act.  On an occurrence basis, transportation and disposal of hazardouswaste is handled for the Company by Safety Kleen Corporation in accordance withapplicable federal and State of New Jersey regulations.  The Company maintains a transport manifestof all hazardous waste removal from the facility.  The Company did not generate any hazardous waste from itsoperations during the fiscal year ended December 31, 2001.

 

**Manufacturing and Assembly**

 

The Company hadsufficient capital equipment and manufacturing space available to support itsoperations at December 31, 2001, and adequate space in its current facility tomanufacture and test prototypes and limited production quantities of the 70Series SCORETM, 580 Series SCORETM and 580 Series naturalgas rotary engines, and to assemble and test engine-generator units based onthese engines.

 

The Companypurchases most of the components used in its rotary engines from vendors andcompletely assembles each engine at its facility in New Jersey.  The Company believes that virtually all ofthe parts necessary to manufacture its engine, such as rotors, crankshafts,castings, and forgings, are available from a variety of vendors in the UnitedStates and Canada.

 

The Company iscurrently in discussions with Westerbeke Corporation (“Westerbeke”) to enterinto a manufacturing agreement whereby Westerbeke Corporation will assemble,test, paint and ship the Company’s rotary engines.  There is no assurance, however, that the Company will be able toenter into a definitive agreement with Westerbeke.

 

**Sales and Services**

 

The primary taskof an engine manufacturer is to produce high quality engines in quantity at amarketable price, with good availability and a high standard of service.  The Company’s sales and service policies aredirected toward these ends.  The Companyis currently producing engines on a limited basis to supply customers that wantto test the engines in their specific commercial application prior to placing alarger order.  The Company hasexpressions of interest with two major customers in the marine, electricalgeneration and industrial market segments.

 

In September, 2000, the Company signed a letter ofintent with Safe Boats International, LLC (“SBI”), pursuant to which SBIindicated its intent to purchase three production prototype two rotor 70 Seriesdiesel fueled rotary engines (the “Diesel Engines”) from the Company for thepurpose of installing the Diesel Engines into SBI’s boats.  Under the terms of the letter of intent, theCompany will supply the first Diesel Engine at no cost to SBI and the aggregatepurchase price for the two subsequent engines will be $30,000.  The first Diesel 

 

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Engine was delivered inNovember, 2001, and is currently undergoing sea trials by SBI and the Companyanticipates the delivery of the two subsequent Diesel Engines in June,2002.  Subject to the successfuldelivery by the Company of the three Diesel Engines and SBI’s satisfaction withtheir performance, SBI intends to purchase 75 to 150 additional Diesel Enginesfrom the Company over the subsequent twelve to twenty-four months at anestimated aggregate purchase price of $1,500,000 to $3,000,000.  The consummation of the transactionscontemplated by the terms of the letter of intent is subject to the negotiationand execution of a definitive agreement between the Company and SBI and therecan be no assurance that such a definitive agreement will be entered into.  The termination date of the letter of intentwas extended to December 31, 2002 by SBI on March 18, 2002.

 

In March, 2002, the Company entered into a purchaseagreement to build and sell three two-rotor engines and certain parts toTyrone, Inc. (“Tyrone”), a company that has operations in Toronto, Canada andShanghai, China for an aggregate purchase price of $102,000.  The Company agreed to supply the first twoengines and parts for pick up at the Company’s facilities by Tyrone on orbefore September 15, 2002 and the other engine and parts on or before November15, 2002.  The Company received adownpayment of $35,867 towards the costs of the engines which is refundable toTyrone in the event that the Company does not deliver the engines within thirty(30) days of the specified delivery dates The balance of the purchase price shall be payable by an irrevocableletter of credit in the amount of $66,612. The letter of credit shall be obtained by Tyrone thirty (30) days priorto the first delivery date.  The Companymay draw down the balance of the purchase price from the letter of credit whenthe engines are ready.

 

**Intellectual Property**

 

The Company ownsapproximately eighteen (18) patents covering the design, materials andmanufacture of its rotary engine.  TheCompany has reviewed its patent portfolio and has determined that such patentshave *deminimus* value and that the expiration, termination or invalidity ofsuch patents would not materially affect the Company’s business.

 

**Competition**

 

The Company’ssuccess depends upon its ability to maintain a competitive position in thedevelopment and commercialization of its rotary engine technology in relationto other existing and emerging technologies and upon its ability to displacecurrent four-stroke and two-stroke reciprocating engines and turbines, all ofwhich have an established position in the field.  The Company is in competition with automobile enginemanufacturers and other engine manufacturing firms specializing in thedevelopment of both diesel and gasoline reciprocating engines that have greaterfinancial resources and capital than the Company.

 

The Company alsomay face competition from entities developing small turbines and small fuelcells for industrial sale.  Thesecompanies may have substantially greater resources for research, developmentand manufacturing than the Company.  Eventhough the Company has developed its rotary engine technology, its competitorsmay succeed in developing technologies and products that are more effective orcommercially acceptable than those developed by the Company.  In the given markets in which the Companyintends to sell, however, there are currently no competitive products with theweight, size, vibration or fuel range advantages of the Company’s rotaryengine.

 

**Employees**

 

At the present time, the Company’s personnel is contracted throughCompensation Solutions, Inc. (“CSI”). CSI is able to provide insurance and benefits to the Company’s personnelat a very competitive cost.  TheCompany’s personnel consists of eight individuals, five of which arefull-time.  Two individuals performadministrative tasks for the Company and the remaining six individuals conductthe Company’s technical and assembly operations.  In February, 2002, the Company issued shares of its Common Stockto four members of 

 

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the Company’s personnelin lieu of payments of unpaid compensation owing to such individuals.  The shares issued to these individuals wereregistered in a Registration Statement on Form S-8 filed with the Securitiesand Exchange Commission (the “SEC”) on March 15, 2002.  See Item 5, “Market for Common Equity andRelated Stockholder Matters” for a description of such issuances.

 

Additionally, the Company has entered into consulting agreements withcertain individuals and entities that provide various services to theCompany.  A copy of each of theseagreements was filed as an exhibit to a Registration Statement on Form S-8filed with the SEC by the Company on March 15, 2002.  In March, 2002, the Company issued shares of its Common Stock inlieu of payments of consulting fees to these consultants and registered theseshares in the Registration Statement on Form S-8 filed in March, 2002.  See Item 5, “Market for Common Equity andRelated Stockholder Matters” for a description of such issuances.

 

At December 31, 2001,none of the Company’s personnel was represented by a labor union and theCompany considers relations with its personnel to be good.

 

**ITEM2.****                            ****DESCRIPTIONOF PROPERTY**

 

**Property**

 

The Company leasesapproximately 18,600 square feet of manufacturing and test cell space fromWood-Ridge Industrial Property Owners, LLC (“WRIPO”) on a month-to-month basisat a base rent of $6,000 per month plus utilities.  The Company previously leased its space from Curtiss-Wright, whosold the building in which the Company is located in December, 2001 toWRIPO.  In addition, the Company leases2,000 square feet of office space from WRIPO on a month-to-month basis at abase rent of $1,200 per month plus utilities. The Company is current in its rent payments.  However, the Company owes Curtiss Wright $34,616 with respect torent amounts owing for lease periods prior to December 17, 2001.

 

In accordance witha previous settlement between the Company and Curtiss-Wright for payments owingfrom lease of space previously occupied by the Company, the Company issued a 4%promissory note to Curtiss-Wright for $400,000 due January 1, 2003.  As part of the tax credit sales transactionbetween the Company and Curtiss-Wright in 1999, the Company paid $50,000 of theoutstanding $400,000 note due Curtiss-Wright, leaving a balance on theprincipal amount of the note of $350,000 due on January 1, 2003, which bearsinterest at 4% per annum.  Requiredinterest payments under the note aggregating $28,000, as of the date of thisAnnual Report on Form 10-KSB, have not been paid to Curtiss-Wright, which hasresulted in the note being in default. The Company is currently in negotiation with Curtiss-Wright to revisethe terms of payment.

 

**ITEM3.****                            ****LEGALPROCEEDINGS**

 

At December 31,2001, the Company was not a party to, and the Company’s property was not thesubject of, any material pending legal proceedings.  However, in February, 2002, the Company received two notices fromthe State of New Jersey, Division of Fire Safety, stating that two judgmentshad been entered in the Superior Court of New Jersey, Law Division, against theCompany in January, 2002 in the aggregate amount of $5,685, plus interest, forthe Company’s alleged failure to pay registration fees under the Uniform FireSafety Act during the years 1997 through 1999. The alleged violations relate to the Company’s life hazard use in thespace that the Company leased at 22 and 64 Passaic Street.  The Company has timely filed an appeal withthe Division of Fire Safety disputing the amount of fees owing since theCompany essentially ceased operations in the beginning of 1997 and vacated itsspace located at 22 Passaic Street soon thereafter.  There can be no assurance, however, that the Company will besuccessful in its appeal.

 

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Additionally, onApril 1, 2002, the Company received a Summons and Complaint filed with theSuperior Court of California, County of San Diego, by Pauline E. Webber, theholder of the Abejon note.  Thecomplaint was filed on March 25, 2002 and alleges a breach of contract for theCompany’s failure to make payment on the Abejon note pursuant to the terms ofthe settlement agreement between the Company and Abejon.  The complaint demands relief of $90,000 indamages plus interest at an annual rate of ten percent (10%) and attorney’sfees.  The Company has thirty (30) daysfrom the date of receipt in which to file an answer.  The Company has not yet filed an answer and is currentlyattempting to negotiate with the note holder to resolve the matter.  The Company cannot make any assurances,however, that it will be successful in its negotiation with the note holder andobtaining a dismissal of the litigation.

 

Should the Companynot pay the $50,000 settlement amount with respect to the OEA settlementagreement, legal proceedings may be initiated against the Company by OEA.  Should the Company not be successful inrevising the terms of payment of the amounts owing to Curtiss-Wright, legalproceedings may be initiated against the Company by Curtiss-Wright.  There is no assurance that the Company wouldbe successful in any litigation that is initiated by any of these parties.

 

**ITEM4.****                            ****SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

                No matters were submitted to the shareholders of theCompany for a vote during the fourth quarter of the Company’s fiscal year endedDecember 31, 2001.

 

**PARTII**

 

**ITEM5.****                            ****MARKET FORCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

The Company’sCommon Stock (“Common Stock”), par value $.01, has been publicly traded sinceFebruary 9, 1994.  The Common Stocktraded in the over-the-counter market on the National Association of SecuritiesAutomated Quotation System (NASDAQ) Small Cap under the symbol RPII and on thePacific Stock Exchange (“PSE”) under the symbol RPX until December 14, 1996, inthe case of NASDAQ, and December 4, 1996, in the case of the PSE.  The Common Stock of the Company was delistedfrom NASDAQ on December 19, 1996 and was suspended from the PSE on December 4,1996.  Since December 19, 1996, theCompany’s Common Stock has been quoted on the Over-The-Counter Bulletin Board(“OTC Bulletin Board”).  On July 23,1998, the trading symbol for the Common Stock changed to “RPIN.”

 

                The followingtable sets forth the range of high and low bid prices for the Common Stock onthe OTC Bulletin Board for the fiscal quarters indicated.  All over-the-counter market quotationsreflect inter-dealer prices, without retail mark-up, mark-down or commission,and may not represent actual transactions.

 

|                       |   | **Common  Stock** |   |
|----------------------------|--------|-------------------|--------|
|                       |   | **High**          |   | **Low** |   |
| Fiscal Year Ended 12/31/00 |   |              |   |   |   |
| First Quarter              |   | $                 | 1.00   |   | $ | .187 |   |
| Second Quarter             |   | .906              |   | .25 |   |
| Third Quarter              |   | 1.125             |   | .40 |   |
| Fourth Quarter             |   | 1.03              |   | .375 |   |
|                            |        |                   |        |  |  |  |  |

 

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|                       |   | **Common  Stock** |   |
|----------------------------|--------|-------------------|--------|
|                       |   | **High**          |   | **Low** |   |
| Fiscal Year Ended 12/31/01 |   |              |   |   |   |
| First Quarter              |   | $                 | .94    |   | $ | .50 |   |
| Second Quarter             |   | 1.59              |   | .56 |   |
| Third Quarter              |   | 1.01              |   | .38 |   |
| Fourth Quarter             |   | 1.00              |   | .47 |   |
|                            |        |                   |        |  |  |  |  |

 

The Company hasnever paid any dividends on its Common Stock and does not anticipate paying anycash dividends in the foreseeable future. The Board of Directors of the Company currently anticipates retainingany available earnings for the growth and expansion of the Company’s business.  The declaration and payment of future cashdividends, if any, generally would depend upon the Company’s earnings,financial condition, results of operations, current and anticipated capitalrequirements, plans for expansion, if any, future prospects, restrictions underthen existing credit and other debt instruments and arrangements and otherfactors deemed relevant by the Board of Directors.

 

On April 9, 2002, there were approximately 284 holders ofrecord of the Company’s Common Stock.

 

In July, 2000, the Company issued a warrant toLondonderry Capital (the “Londonderry Warrant”) which permitted Londonderry topurchase up to 1,500,000 shares of Common Stock at a price of $0.25 pershare.  The Londonderry Warrant wasexercisable through July 12, 2002.  Asof December 31, 2001, Londonderry had assigned its rights to purchase allshares of Common Stock underlying the Londonderry Warrant to variousthird-party assignees who purchased such shares from the Company at a price of$0.25 per share.  The shares of Common Stock issued were notregistered under the Securities Act and are “restricted securities” forpurposes of the Securities Act issued by the Company pursuant to the exemptionfrom the registration requirements provided by Section 4(2) of the SecuritiesAct.

 

In the first quarter of 2001, the Company completed aprivate offering in which it sold an aggregate of 640,000 shares of its CommonStock at a price of $.50 per share to thirteen accredited investors.  The Company received gross proceeds of$320,000 from these sales and paid $64,000 to the Company’s placement agent inthe offering, thereby resulting in net proceeds to the Company of$256,000.  The shares of Common Stockissued in this offering were not registered under the Securities Act and are“restricted securities” for purposes of the Securities Act.  Such shares were offered and sold by theCompany pursuant to the exemption from the registration requirements providedby Section 4(2) of the Securities Act.

 

On January 31, 2001, the Company completed itsexchange offer with the holders of its outstanding 10.412% Bonds due December15, 2007.  The holders of 100% of theoutstanding Bonds agreed to accept the Company’s offer to exchange each $2.00of principal and accrued interest through January 31, 2001 on the Bonds for oneshare of the Company’s Common Stock.  TheCompany issued a total of 2,489,015 shares of Common Stock as part of theexchange.  The shares of Common Stockissued to the holders of the Bonds were not registered under the Securities Actand are “restricted securities” for purposes of the Securities Act.  In addition, under the terms of the exchangeoffer, the Bondholders will not be permitted to publicly offer or sell theshares of Common Stock before January 31, 2003 without the prior writtenconsent of the Company.  This exchangeoffer was conducted by the Company pursuant to the exemption provided bySection 3(a)(9) of the Securities Act.

 

In December, 2000, the Company entered into asettlement agreement with certain assignees of Abejon, a former customer of theCompany.  Under the terms of thesettlement agreement, the Company issued 200,000 shares of its Common Stock tosuch assignees of Abejon in consideration of the release of certain obligationsof the Company to Abejon.  The shares ofCommon Stock issued to the assignees of Abejon were 

 

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not registered under the Securities Act and are “restricted securities”for purposes of the Securities Act. These shares of Common Stock were issued by the Company pursuant to theexemption from the registration requirements provided by Section 4(2) of theSecurities Act.

 

In January, 2001, the Company issued two warrants topurchase an aggregate of 300,000 shares of Common Stock at an exercise price of$.25 per share to two individuals in consideration of services rendered to theCompany.  These individuals assigned thewarrants to a third-party in exchange for the transfer of shares of CommonStock held by such third-party assignee. The third-party assignee in turn assigned its right to exercise the warrantto several individuals in October, 2001. The warrants and the shares underlying the warrants that were issuedwere not registered under the Securities Act and are “restricted securities”for purposes of the Securities Act. These warrants and the shares were issued by the Company pursuant to theexemption from the registration requirements provided by Section 4(2) of theSecurities Act.

 

On January 25, 2001, the Company sold 291,668 sharesof Common Stock to three individuals at a price of $.60 per share.  In addition, these individuals receivedwarrants to purchase an aggregate of 145,834 shares of Common Stock at anexercise price of $1.20 per share.  Thewarrants expire on January 25, 2003. The Company received proceeds of $175,000.80 from the sale of theseshares and warrants.  Pursuant to theterms of the subscription agreement between the Company and such investors, theCompany was obligated to issue additional shares of Common Stock to suchinvestors in the event that the Company made a subsequent offering to investorsat a lower share price than that paid by the investors in this offering.  In February, 2002, the Company issued anaggregate of 373,335 shares of Common Stock to two of the investors in accordancewith the terms of the subscription agreement. The shares and warrants issued in this offering and the sharessubsequently issued to two of the investors were not registered under theSecurities Act and are “restricted securities” for purposes of the SecuritiesAct.  The shares and warrants wereoffered and sold by the Company pursuant to the exemption from the registrationrequirements provided by Section 4(2) of the Securities Act.

 

In February, 2001, the Company’s Board of Directorsapproved the grant of options to purchase an aggregate of 605,000 shares ofCommon Stock at $.60 per share to ten individuals, including the Company’sthree directors and its two Advisory Board Members.  Each option is exercisable for five years from the date of grant.  These options were granted under the Company’s2000 Stock Option Plan.  The options andthe shares of Common Stock underlying the options were not registered under theSecurities Act and are “restricted securities” for purposes of the SecuritiesAct.  Any shares issued upon exercise ofan option will be issued by the Company pursuant to an exemption from theregistration requirements provided by Section 4(2) of the Securities Act.

 

In September, 2001, the Company completed its privateoffering of units (the “Units”) at a price of $1.20 per Unit to accreditedinvestors.  Each Unit consisted of twoshares of Common Stock and one warrant to purchase an additional share ofCommon Stock at an exercise price of $1.20. Each warrant expires two years from the date of its issuance.  The Company sold 1,096,664 Units in theoffering and issued 2,193,328 shares of Common Stock and 1,096,664 warrants toinvestors in this private offering.  TheCompany received gross proceeds of $1,315,997 from the sale of the Units and paid$144,700 to the Company’s placement agent in the offering, thereby resulting innet proceeds to the Company of $1,184,397. The Company also issued warrants to purchase 219,333 shares of CommonStock at $1.20 per share to affiliates of the placement agent for its servicesin this offering.  The shares of CommonStock, the warrants comprising the Units and the warrants issued to theplacement agent and the shares of Common Stock underlying the warrants were notregistered under the Securities Act and are “restricted securities” forpurposes of the Securities Act.  TheUnits were offered and sold by the Company pursuant to the exemption from theregistration requirements provided by Section 4(2) of the Securities Act.

 

In accordance with the terms of the Termination andSettlement Agreement that the Company entered into with Londonderry Management,the Company issued or agreed to issue certain securities, including theEmployment Option, the Settlement Warrant and 200,000 shares of restrictedCommon Stock.  All securities 

 

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issued and which the Company agreed to issue under the Termination andSettlement Agreement, including the shares, the Settlement Warrant and theshares underlying the Settlement Warrant issued to Londonderry Capital, were notand will not be registered under the Securities Act and are and will be“restricted securities” for purposes of the Securities Act.  The securities issued to Londonderry Capitalwere issued and will be issued by the Company pursuant to the exemption fromthe registration requirements provided by Section 4(2) of the Securities Act.

 

In June, 2001, the Company issued 1,000,000 shares ofCommon Stock to Kenneth L. Brody, the Company’s former President, ChiefExecutive Officer and Director.  Theissuance of the shares was previously approved by the Board of Directors inMarch, 2000 as a compensation award in consideration of his management effortsfrom December, 1997 to April, 2000.  Theshares of Common Stock issued were not registered under the Securities Act andare “restricted securities” for purposes of the Securities Act.  These shares of Common Stock were issued bythe Company pursuant to the exemption from the registration requirementsprovided by Section 4(2) of the Securities Act.

 

In June and July, 2001, the Company issued anaggregate of 200,000 shares of Common Stock to three of its key personnel.  The issuance was previously approved by theBoard of Directors in March, 2000 as a compensation award in consideration ofsuch individual’s services to the Company. The shares of Common Stock were not registered under the Securities Actand are “restricted securities” for purposes of the Securities Act.  These shares of Common Stock were issued bythe Company pursuant to the exemption from the registration requirementsprovided by Section 4(2) of the Securities Act.

 

On June 18, 2001, the Board of Directors approved thegrant of options to purchase an aggregate of 30,000 shares of Common Stock tothe three new Advisory Board Members appointed on the same date.  Each option allows the holder to purchase10,000 shares of Common Stock at an exercise price of $1.01 per share, and isexercisable for five years from the date of grant.  These options were granted under the Company’s 2000 Stock OptionPlan.  The options and the shares ofCommon Stock underlying the options were not registered under the SecuritiesAct and are “restricted securities” for purposes of the Securities Act.  Any shares issued upon exercise of an optionwill be issued by the Company pursuant to an exemption from the registrationrequirements provided by Section 4(2) of the Securities Act.

 

In September, 2001,the Company issued 28,667 shares of Common Stock valued at $.60 pershare to an individual consultant as consideration for consulting servicesrendered to the Company.  The issuanceof Common Stock was made pursuant to a consulting agreement between the Companyand the individual. The Company also issued 260,629 shares of Common Stockvalued at $.60 per share to a partner of the law firm which serves as its legalcounsel as consideration for legal services rendered to the Company, and suchissuance was pursuant to a legal advisory agreement between the Company and itslegal counsel.  The Company has equatedthe number of shares of Common Stock to the value of the consulting and legalservices provided or to be provided by the individual and its legalcounsel.  The Company filed aRegistration Statement on Form S-8 on September 14, 2001 registering all of theshares issued to such individuals.

 

Also on September 14, 2001, theCompany issued 83,333 shares of Common Stock valued at $.60 per shareto Londonderry Management in full and complete satisfaction of theunpaid sum of $50,000 owing to Londonderry in accordance with the terms of theSettlement and Termination Agreement. The Company additionally issued 33,333 shares of the Company’s CommonStock to Londonderry Management in full and complete satisfaction of unpaidinvoice amounts equal to $20,000 for Mr. McKeown’s bona fide services under theterms of the Consulting Agreement.  The shares of Common Stock issued were notregistered under the Securities Act and are “restricted securities” forpurposes of the Securities Act, and were issued by the Company pursuant to theexemption from the registration requirements provided by Section 4(2) of theSecurities Act.

 

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On the same date, theCompany also issued 31,715 shares of Common Stock valued at $.60 pershare to Virgil Wenger, the Chairman of the Company, in full and completesatisfaction of unpaid Director’s fees and expenses accrued over sixteen monthsequal to $19,029, which fees and expenses relate to Mr. Wenger’s services asthe Chairman and a Director of the Board. The shares of Common Stock issuedwere not registered under the Securities Act and are “restricted securities”for purposes of the Securities Act, and were issued by the Company pursuant tothe exemption from the registration requirements provided by Section 4(2) ofthe Securities Act.

 

On September 19, 2001,the Company’s Board of Directors approved the grant of non-qualified options topurchase an aggregate of 24,000 shares of Common Stock to eight of theCompany’s personnel.  Each option allowsthe holder to purchase 3,000 shares of Common Stock at an exercise price of$.45 per share for a two (2) year period from the date of grant.  These options were granted under theCompany’s 2000 Stock Option Plan.  Theoptions and the shares of Common Stock underlying the options were notregistered under the Securities Act and are “restricted securities” forpurposes of the Securities Act.  Anyshares issued upon exercise of an option will be issued by the Company pursuantto an exemption from the registration requirements provided by Section 4(2) ofthe Securities Act.

 

On November 16, 2001,  the Company’s Board of Directors approvedthe grant of options to purchase 10,000 shares of Common Stock at $.90 pershare to Dr Peter Fransham, a new Advisory Board Member.  The option is exercisable for five (5) yearsfrom the date of grant.  The option wasgranted under the Company’s 2000 Stock Option Plan.  Theoption and the shares of Common Stock underlying the option were not registeredunder the Securities Act and are “restricted securities” for purposes of theSecurities Act.  Any shares issued uponexercise of an option will be issued by the Company pursuant to an exemptionfrom the registration requirements provided by Section 4(2) of the SecuritiesAct.

 

During the fourth quarter of 2001 and in the firstquarter of 2002, the Company sold an aggregate of 1,852,060 shares of itsCommon Stock at a price of $.25 per share to fourteen accreditedinvestors.  The Company receivedproceeds of $463,015 from these sales. The shares of Common Stock issued in this Offering were not registeredunder the Securities Act and are “restricted securities” for purposes of theSecurities Act.  Such shares wereoffered and sold by the Company pursuant to the exemption from the registrationrequirements provided by Section 4(2) of the Securities Act.

 

In March, 2002, the Company issued 170,400 shares ofCommon Stock valued at $.25 per share to four members of the Company’spersonnel as compensation for services rendered to the Company in lieu ofpayment of salary, and the Company issued 339,590 shares of Common Stock valuedat $.25 per share to seven individuals of the Company as consideration forconsulting services rendered to the Company in lieu of payment of unpaid andowing consulting fees.  The Company fileda Registration Statement on Form S-8 on March 15, 2002 registering all of theshares issued to such individuals.

 

The Company additionally issued an aggregate of105,000 shares of Common Stock to three members of the Company’s personnel inconsideration of their services to the Company.  The shares of Common Stockissued were not registered under the Securities Act and are “restrictedsecurities” for purposes of the Securities Act, and were issued by the Companypursuant to the exemption from the registration requirements provided bySection 4(2) of the Securities Act.

 

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**ITEM6.****                            ****MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Results of Operations**

 

***Twelve Months Ended December 31, 2001 vs. Twelve MonthsEnded December 31, 2000***

 

Fiscal year 2001 was a year of continued efforts torestructure the Company and prepare for the commercial production ofengines.  The Company made substantialprogress to reduce the Company’s liabilities through debt settlementsaggregating approximately $9,800,000. The Company has manufactured and tested both 70 Series and 580 Seriesengines on a pre-production basis.

 

In November, 2001, the Company delivered the first ofthree engines to SafeBoats International, LLC and the engine now is undergoingsea trials.   The Company anticipatesdelivering the remaining two engines in June, 2002.

 

During fiscal year 2001, the Company generated revenueof $49,757 from the contract with Omnitech Robotics, an increase of $24,557 or97% over the $25,200 recorded for the fiscal year 2000.

 

Cost of revenues to the Company, which includesamortization, depreciation and direct costs, was $88,167, a reduction of$50,703 or 37% from $138,870 for the previous year.

 

General and administrative costs increased $529,204from $1,517,994, or 35%, to $2,047,198. The increase was primarily due to increased personnel costs foradministration, engine design support and engine production, reflecting theCompany’s increased activity. Additionally, the Company’s debt restructuring and financing activitiesresulted in increased legal and consulting expenses.

 

The loss from operations increased $416,323 or 25% toa loss of $2,085,608 for fiscal year 2001 from a loss of $1,669,285 for thesame period in 2000, reflecting increased general and administrative expenses.

 

Interest expense on the Company’s long-term debt andnotes payable decreased $677,327, or 86% to $108,684 from $786,011 for the sameperiod in 2000.  The decrease reflectsthe lowered interest costs resulting from the elimination of the Company’s debtpursuant to JDTI settlement and the bond exchange effected in January2001.  Other expenses of $129,918 forfiscal year 2001 is largely attributable to the elimination of the unamortizedbond issuance costs resulting from the bond exchange.

 

The net loss for the Company for fiscal year 2001before extraordinary income was $2,324,210, compared to a net loss for the sameperiod of 2000 of $2,184,230, which is an increase of $139,980 or 6%.

 

Inclusion of extraordinary income of $3,485,473 forfiscal year 2001, arising from the first quarter debt restructuring, resultedin a net profit of $1,161,263 compared to a loss of $2,184,230 for thecomparable period of 2000.

 

***Twelve Months Ended December 31, 2000 vs. Twelve MonthsEnded December 31, 1999***

 

                Fiscal year was a year ofcontinued efforts to restructure the Company toward the objective of creating acommercial engine production facility.

 

During fiscal years 1999 and 2000, the Companygenerated revenue solely from the sale of inventory.  During fiscal year 2000, the Company’s revenues decreased 62%, or$40,407, to $25,200 as compared to revenues of $65,607 for fiscal year 1999.  In fiscal year 2000, the Company alsoreceived proceeds of $267,721 from the sale of New Jersey net operating lossesand net proceeds of $859,000 from the sale of Common Stock 

 

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and warrants.

 

Cost of revenues to the Company, which includesamortization, depreciation and direct costs, was $138,870, a reduction of$490,355, or 78%, from $629,225 for the previous year, reflecting largely thereduced depreciation charged in fiscal year 2000.

 

General and administrative costs increased $1,236,020,reflecting increased personnel costs in both the areas of administration andengine production.  Additionally, thedebt restructuring and financing activities resulted in an increase in legaland accounting expenses.  Accordingly,the loss from operations increased $823,693, or 103%, from $845,592 in fiscalyear 1999 to $1,669,285 in fiscal year 2000.

 

Interest expense on the Company’s long-term debts andnotes payable increased $98,078 to $786,011, or 14%, from $687,933 in fiscalyear 1999.  Such increase reflectsadjustments in the method of booking the interest expense on the long-termdebt.

 

Other income increased $211,267 from $59,298 in fiscalyear 1999, reflecting largely an adjustment for accrued expenses of $693,047and the reduction in the carrying value of patents from $431,065 to $1.00.

 

The tax impact of the aforementioned debtrestructuring transactions and all asset categories were reviewed by managementduring fiscal year 2000 and, where appropriate, management made adjustments inthe carried values.

 

The net loss of $2,184,230 represents an increase of$1,805,904 over the net loss of $378,326 for the fiscal year 1999.

 

**Liquidityand Capital Resources**

 

The Company’scurrent monthly operating cash expenditures of approximately $100,000, togetherwith expenditures for the costs associated with its engine building operations,are being financed from the proceeds from the Company’s private equityofferings of Common Stock and/or warrants.

 

During the fiscalyear ended December 31, 2001, the Company received $1,662,298, net of anypayment of facilitation or placement fees, from the sale of shares of CommonStock and/or warrants and the exercise of certain warrants.

 

**“Safe Harbor” Statement**

 

This filing contains forward-looking statements.  The words “anticipated,” “believe,”“expect,” “plan,” “intend,” “seek,” “estimate,” “project,” “will,” “could,”“may,” and similar expressions are intended to identify forward-lookingstatements.  These statements include,among others, information regarding future operations, future capitalexpenditures, and future net cash flow. Such statements reflect the company’s current views with respect tofuture events and financial performance and involve risks and uncertainties,including, without limitation, general economic and business conditions,changes in foreign, political, social, and economic conditions, regulatoryinitiatives and compliance with governmental regulations, the ability toachieve further market penetration and additional customers, and various othermatters, many of which are beyond the company’s control.  Should one or more of these risks oruncertainties occur, or should underlying assumptions prove to be incorrect,actual results may vary materially and adversely from those anticipated,believed, estimated, or otherwise indicated. Consequently, all of the forward-looking statements made in this filingare qualified by these cautionary statements and there can be no assurance ofthe actual results or developments.

 

18

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**ITEM****7.****                            ****FINANCIALSTATEMENTS**

 
| Independent Auditors’  Report                                                                                            |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                          |   |
| Consolidated Balance Sheets  - December 31, 2001 and 2000                                                                     |   |
|                                                                                                                          |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2001 and 2000                                         |   |
|                                                                                                                          |   |
| Consolidated  Statements of Changes in Stockholders’ Equity (Deficiency) for the Years Ended  December 31, 2001 and 2000 |   |
|                                                                                                                          |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2001 and 2000                                         |   |
|                                                                                                                          |   |
| Notes to  Consolidated Financial Statements                                                                                   |   |

 

19

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ROTARY POWERINTERNATIONAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED FINANCIALSTATEMENTS

With IndependentAuditors’ Report

 

DECEMBER 31, 2001

 

----

 

ROTARY POWERINTERNATIONAL, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

 
| Independent Auditors’  Report                                                                                            |   |
|-------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                          |   |
| Consolidated Balance Sheets  - December 31, 2001 and 2000                                                                     |   |
|                                                                                                                          |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2001 and 2000                                         |   |
|                                                                                                                          |   |
| Consolidated  Statements of Changes in Stockholders’ Equity (Deficiency) for the Years  Ended December 31, 2001 and 2000 |   |
|                                                                                                                          |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2001 and 2000                                         |   |
|                                                                                                                          |   |
| Notes to  Consolidated Financial Statements                                                                                   |   |

 

----

 

INDEPENDENT AUDITORS’ REPORT

 

 

 

To the Board of Directors of

Rotary Power International, Inc.

 

 

                We have auditedthe accompanying consolidated balance sheets of Rotary Power International,Inc.  and subsidiaries (the “Company”)as of December 31, 2001 and 2000, and the consolidated statements ofoperations, changes in stockholders’ equity (deficiency), and cash flows forthe years then ended.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

                We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America.  Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

                In our opinion,the financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Rotary Power International,Inc. and subsidiaries as of December 31, 2001 and 2000 and the consolidatedresults of their operations and their cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America.

 

                The accompanyingfinancial statements have been prepared assuming that the Company will continueas a going concern.  As discussed in Note18 to the financial statements, the Company’s significant operating losses andits continuing effort to secure working capital raises substantial doubt aboutits ability to continue as a going concern. The financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

 

/s/ Demetrius & Company, L.L.C.

 

DEMETRIUS & COMPANY, L.L.C.

 

 

Wayne, New Jersey

March 20, 2002

 

F-1

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ROTARY POWER INTERNATIONAL, INC.AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2001 AND 2000

 
| ASSETS                                                                                                                                           |   |        |    |        |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|---------|-------------|--------|
|                                                                                                                                             |   | **2001**    |    | **2000**    |   |
| Current  assets:                                                                                                                                 |   |        |    |        |   |
| Cash                                                                                                                                             |   | $           | 70,583  |        | $      | 24,075 |   |
| Accounts  receivable                                                                                                                             |   | 9,619       |    | 18,790      |   |
| Income  taxes recoverable                                                                                                                        |   | —      |    | 357,811     |   |
| Inventories                                                                                                                                      |   | 824,912     |    | 71,875      |   |
| Other  Current Assets                                                                                                                            |   | 33,122      |    | 30,000      |   |
| Total  Current Assets                                                                                                                            |   | 938,236     |    | 1,102,551   |   |
| Fixed  assets, net                                                                                                                               |   | 14,538      |    | 17,627      |   |
| Patents                                                                                                                                          |   | 1           |    | 1           |   |
| Other  assets                                                                                                                                    |   | 26,001      |    | 189,730     |   |
|                                                                                                                                             |   | $           | 978,776 |        | $      | 1,309,909 |   |
| LIABILITIES AND SHAREHOLDERS’  DEFICIENCY                                                                                                   |   |        |    |        |   |
| Current  liabilities:                                                                                                                            |   |        |    |        |   |
| Accounts  payable                                                                                                                                |   | $           | 481,974 |        | $      | 207,297 |   |
| Accrued  liabilities                                                                                                                             |   | 267,839     |    | 288,376     |   |
| Other  current liabilities                                                                                                                       |   | 84,208      |    | 75,000      |   |
| Deferred  acquistion obligation — current                                                                                                   |   | 150,000     |    | 2,225,000   |   |
| Total  Current Liabilities                                                                                                                       |   | 984,021     |    | 2,795,673   |   |
| Long-term  liabilities:                                                                                                                          |   |        |    |        |   |
| Deferred  acquisition obligation                                                                                                                 |   | —      |    | 1,946,055   |   |
| Long-term  debt                                                                                                                                  |   | —      |    | 4,914,060   |   |
| Note  Payable                                                                                                                                    |   | 350,000     |    | 350,000     |   |
| Total  Liabilities                                                                                                                               |   | 1,334,021   |    | 10,005,788  |   |
| Commitments  and contingencies                                                                                                                   |   |        |    |        |   |
| Shareholders’  deficiency:                                                                                                                  |   |        |    |        |   |
| Preferred stock, $.01 par  value; 5,000,000 shares authorized; issued and outstanding:  2001 and 2000 — 50,000                         |   | 500         |    | 500         |   |
| Common stock, $.01 par value;  100,000,000 shares authorized; issued and outstanding:  2001 — 19,424,543;  2000 — 11,482,855 |   | 194,245     |    | 114,829     |   |
| Subscriptions  receivable                                                                                                                        |   | (10,000     | )       | (19,185     | )      |
| Paid-in  capital                                                                                                                                 |   | 20,076,383  |    | 12,985,613  |   |
| Accumulated  deficit                                                                                                                             |   | (20,616,373 | )       | (21,777,636 | )      |
| Total  Shareholders’ Deficiency                                                                                                             |   | (355,245    | )       | (8,695,879  | )      |
|                                                                                                                                             |   | $           | 978,776 |        | $      | 1,309,909 |   |

 

The accompanying notes are anintegral part of the statements.

 

F-2

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ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

 
|                                                              |   | **2001**   |      | **2000**   |   |
|-------------------------------------------------------------------|--------|------------|-----------|------------|--------|
| Revenues                                                          |   | $          | 49,757    |       | $      | 25,200 |   |
| Costs  and expenses:                                              |   |       |      |       |   |
| Cost  of revenues                                                 |   | 88,167     |      | 138,870    |   |
| General  and administrative                                       |   | 2,047,198  |      | 1,517,994  |   |
| Research  and development                                         |   | —     |      | 37,621     |   |
| Total  Cost and Expenses                                          |   | 2,135,365  |      | 1,694,485  |   |
| Loss  From Operations                                             |   | (2,085,608 | )         | (1,669,285 | )      |
| Other  income (expense):                                          |   |       |      |       |   |
| Interest  expense                                                 |   | (108,684   | )         | (786,011   | )      |
| Other,  net                                                       |   | (129,918   | )         | 271,066    |   |
| Total  Other Income (Expense)                                     |   | (238,602   | )         | (514,945   | )      |
| Net  Loss before Extraordinary Item                               |   | (2,324,210 | )         | (2,184,230 | )      |
| Extraordinary  income item, net of taxes of $357,811              |   | 3,485,473  |      | —     |   |
| Net  Income (Loss)                                                |   | $          | 1,161,263 |       | $      | (2,184,230 | ) |
| Basic:                                                            |   |       |      |       |   |
| Loss  from operations before extraordinary items per common share |   | $          | (0.14     | )          | $      | (0.25 | ) |
| Net  income per common share                                      |   | $          | 0.07      |       | $      | (0.25 | ) |
| Average  shares outstanding                                       |   | 16,653,938 |      | 8,620,955  |   |
| Diluted:                                                          |   |       |      |       |   |
| Loss  from operations before extraordinary items per common share |   | $          | (0.13     | )          |   |   |
| Net  income per common share                                      |   | $          | 0.06      |       |   |   |
| Average  shares outstanding                                       |   | 18,504,727 |      |       |   |

 

The accompanying notes are anintegral part of the statements.

 

F-3

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ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’EQUITY (DEFICIENCY)

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

 
|                                          |   | **Series 3 Convertible  Preferred Stock** |   | **Common Stock** |   |       |       |          |   |                         |    |                |      |
|-----------------------------------------------|--------|-------------------------------------------|--------|------------------|--------|------------|------------|---------------|--------|------------------------------|---------|---------------------|-----------|
|                                          |   | **Shares**                                |   | **Par Value**    |   | **Shares** |       | **Par Value** |   | **Subscriptions Receivable** |    | **Paid-In Capital** |      | **Accumulated Deficit** |   | **Shareholders’ Equity (Deficiency)** | ** ** |
| Balance at December 31, 1999                  |   | 225,000                                   |   | $                | 2,250  |       | 6,212,855  |          | $      | 62,129                       |    |                |      | $ | 11,685,657 |   | $ | (19,593,406 | ) | $ | (7,843,370 | ) |
| Conversion of preferred stock to common stock |   | (175,000                                  | )      | (1,750           | )      | 700,000    |       | 7,000         |   |                         |    | (5,250              | )         | — |   | — |   |
| Issuance of   common stock               |   |                                      |   |             |   | 4,570,000  |       | 45,700        |   | $                            | (19,185 | )                   | 1,305,206 |   | — |   | 1,331,721 |   |
| Net loss                                      |   |                                      |   |             |   |       |       |          |   |                         |    |                |      | (2,184,230 | ) | (2,184,230 | ) |
| Balance at December 31, 2000                  |   | 50,000                                    |   | 500              |   | 11,482,855 |       | 114,829       |   | (19,185                      | )       | 12,985,613          |      | (21,777,636 | ) | (8,695,879 | ) |
| Collections of subscriptions receivable       |   |                                      |   |             |   |       |       |          |   | 19,185                       |    |                |      |   |   | 19,185 |   |
| Issuance of common stock                      |   |                                      |   |             |   | 7,941,688  |       | 79,416        |   | (10,000                      | )       | 7,090,770           |      | — |   | 7,160,186 |   |
| Net income                                    |   |                                      |   |             |   |       |       |          |   |                         |    |                |      | 1,161,263 |   | $ | 1,161,263 |   |
| Balance at December 31, 2001                  |   | 50,000                                    |   | $                | 500    |       | 19,424,543 |          | $      | 194,245                      |    | $                   | (10,000   | ) | $ | 20,076,383 |   | $ | (20,616,373 | ) | $ | (355,245 | ) |

 

Theaccompanying notes are an integral part of the statements.

 

F-4

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ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
|                                                                     |   | **2001**   |      | **2000** |   |
|--------------------------------------------------------------------------|--------|------------|-----------|----------|--------|
| Cash flows from operating activities:                                    |   |       |      |     |   |   |   |
| Net loss                                                                 |   | $          | 1,161,263 |     | $      | (2,184,230 | ) |
| Adjustments to reconcile to net cash used in  operating activities:      |   |       |      |     |   |
| Depreciation                                                             |   | 3,468      |      | —   |   |
| Amortization                                                             |   | 1,950      |      | 84,984   |   |
| Interest, net                                                            |   | 95,397     |      | 767,921  |   |
| Other                                                                    |   | (5,918     | )         | —   |   |
| Taxes related to forgiveness debt                                        |   | 357,811    |      | —   |   |
| Revaluation of patents                                                   |   | —     |      | 431,064  |   |
| Research costs offset against accounts receivable                        |   | —     |      | 37,621   |   |
| Adjusting the loss on a contract termination                             |   | —     |      | (693,047 | )      |
| Warrants issued for services                                             |   |       |      | 60,000   |   |
| Write-off of deferred bond issuance costs                                |   | 161,779    |      |     |   |
| Forgiveness of debt                                                      |   | (3,843,284 | )         | —   |   |
| Inventory allowance                                                      |   | 40,000     |      | —   |   |
| Changes in assets and liabilities:                                       |   |       |      |     |   |
| Accounts receivable                                                      |   | 9,049      |      | 14,167   |   |
| Income taxes recoverable                                                 |   | —     |      | 267,721  |   |
| Inventories                                                              |   | (193,037   | )         | 2,701    |   |
| Other current assets                                                     |   | (3,000     | )         | 1,030    |   |
| Other assets                                                             |   | (379       | )         | 53,337   |   |
| Accounts payable                                                         |   | 514,863    |      | 283,795  |   |
| Accrued liabilities                                                      |   | 255,063    |      | 231,663  |   |
| Net  Cash Used in Operating Activities                                   |   | (1,444,975 | )         | (641,273 | )      |
| Cash  flows from investing activities:                                   |   |       |      |     |   |
| Purchases  of fixed assets                                               |   | —     |      | (17,627  | )      |
| Net  Cash Provided by (Used in) Investing Activities                     |   | —     |      | (17,627  | )      |
| Cash  flows from financing activities:                                   |   |       |      |     |   |
| Payment  on notes payable                                                |   | —     |      | (25,000  | )      |
| Payments  for deferred acquisition obligation                            |   | (200,000   | )         |     |   |
| Issuance  of common stock, net of issuance costs of $191,200 and $84,094 |   | 1,672,298  |      | 654,680  |   |
| Proceeds  from subscriptions receivable                                  |   | 19,185     |      |     |   |
| Net  Cash Provided by Financing Activities                               |   | 1,491,483  |      | 629,680  |   |
| Net  Increase (Decrease) in Cash                                         |   | 46,508     |      | (29,220  | )      |
| Cash  at beginning of year                                               |   | 24,075     |      | 53,295   |   |
| Cash  at End of Year                                                     |   | $          | 70,583    |     | $      | 24,075 |   |
| Supplemental  disclosures of cash flow information:                      |   |       |      |     |   |
| Interest  paid during the year                                           |   | $          | 95,397    |     | $      | 18,090 |   |
| Income  taxes recoverable during the year                                |   | —     |      | 267,721  |   |

 

The accompanying notes are anintegral part of the statements.

 

F-5

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ROTARY POWER INTERNATIONAL, INC. AND SUBSIDIARIES

NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000

1.             NATURE OFOPERATIONS

 

Rotary Power International, Inc. (“RPI” or the“Company”) and its wholly-owned subsidiaries, E-Drive Systems, Corp.(“E-Drive”) and Pegasus Technologies Incorporated (“Pegasus”) are engaged inthe development and production of rotary engines capable of operating on avariety of liquid fuels and natural gases. The Company’s objective is to penetrate the worldwide market for marine,recreational and industrial engines. The Company’s efforts are focusing on natural gas rotary engines forcommercial refrigeration, compressors, generators, and on diesel engines for thecommercial and recreational marine market and for commercial generatorsets.  E-Drive and Pegasus wereinactive.

 

 

2.             SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

 

a.                                       Principles of Consolidation

 

The consolidated financial statements include theaccounts of the Company and its wholly-owned subsidiaries E-Drive andPegasus.  All significant intercompanyaccounts and transactions have been eliminated.

 

b.             Cashand Cash equivalents

 

Cash and cash equivalents would consist of cash andhighly liquid investments with an original maturities of three months or less.

 

c.             Inventories

 

Inventories are stated at the lower of cost ormarket.  Cost is determined on anaverage cost basis.

 

d.             FixedAssets

 

Fixed assets are stated at cost, less accumulateddepreciation provided on the straight-line method over the estimated usefullives of the respective assets.

 

When fixed assets are sold, no longer in use, orotherwise disposed of, the cost and related accumulated depreciation areremoved from the accounts and any resulting gain or loss is reflected in thestatement of operations for the period.

 

e.             RevenueRecognition

 

Revenues from the sales of engines are recognized whenengines are shipped to the customer. There were no commercial sales during the year.

 

F-6

----

 

f.              Estimates

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Estimates are usedwhen accounting for inventory evaluations, depreciation, certain accruedexpenses and any contingency allowances required.  Actual results could differ from the estimates.

 

                g.             Patents

 

Patents are amortized on a straight-line basis overtheir useful lives, generally seventeen years. Management reviews annually the value of patents for any impairment ofvalue.

 

                h.             Income Taxes

 

Deferred income taxes are recorded to reflect the taxconsequences on future years of temporary differences between the tax bases ofassets and liabilities, principally inventory, fixed assets and their financialreporting amounts at each year-end and net operating loss carryforwards.

 

i.              NetIncome (Loss) Per Common Share

 

Basic and diluted net income (loss) per common shareis based on the net income (loss) divided by the weighted average number ofcommon shares outstanding during the period. The exercise of stock options and warrants was not assumed as theireffect would be anti-dilutive.

 

                j.              Stock Based Compensation

 

The Company accounts for employee stock compensationplan in accordance with the intrinsic value-based method permitted by Statementof Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-BasedCompensation”, which does not result in compensation cost.

 

The Company has elected to follow APB Opinion No. 25,to account for its stock option plans. Under APB No. 25, when the exercise price of the stock option equals orexceeds the fair value price of the underlying stock on the date of grant, nocompensation expense is recognized in the Company’s financial statements.

 

The Company applies the provisions of SFAS No. 123,for non-employee stock compensation. The estimated value is calculated using the Black-Scholes option-pricingmodel.

 

F-7

----

 

                k.             RecentAccounting Pronouncements

 

In June 2001, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 141, “BusinessCombinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”.  These statements become effective for theCompany on January 1, 2002.  Inaddition, in June 2001, the FASB also issued SFAS No. 143, “Accounting forAsset Retirement Obligations”, effective for years beginning after June 15,2002 and in August 2001, SFAS No. 144, “Accounting for Impairment or Disposalof Long-Lived Assets”, effective for years beginning after December 15,2001.  Management has reviewed thestatements and does not believe the statements will have a material effect onthe Company’s financial position or results of operations.

 

3.             PATENTS

 

The Company hadpreviously reviewed the future utilization value of the patents in 2000and  determined that the value of thepatents were de minimus and therefore adjusted the unamortized balance to avalue of $1.00. (See Note 6).

 

4.             INVENTORIES

 

Inventories atDecember 31, 2001 and 2000 consisted of the following:

 
|                   |   | **2001** |    | **2000** |   |
|------------------------|--------|----------|---------|----------|--------|
| Work in Process  (WIP) |   | 119,938  |    | -0-      |   |
| Parts                  |   | 704,974  |    | 671,875  |   |
|                   |   | $        | 824,912 |     | $      | 671,875 |   |
|                        |        |          |         |          |        |  |  |

 

At December 31,2001, the Company’s inventory had a cost basis of $1,431,951.  The realizable value is estimated to be$824,912.  While the ultimate realizablevalue may differ, management believes that any additional adjustment should nothave a material impact on the Company’s financial position.

 

F-8

----

 

5.             FIXED ASSETS

 

Fixed assets atDecember 31, 2001 and 2000 consisted of the following:

 
|                           |   | **Useful  Lives** |   | **2001**  |      | **2000**  |   |
|--------------------------------|--------|-------------------|--------|-----------|-----------|-----------|--------|
| Machinery and  equipment       |   | 7                 |   | $         | 2,719,008 |      | $      | 2,719,008 |   |
| Furniture and  fixtures        |   | 7                 |   | 27,080    |      | 27,080    |   |
| Office equipment               |   | 7                 |   | 46,803    |      | 46,305    |   |
| Computer  equipment            |   | 5                 |   | 17,508    |      | 14,537    |   |
| Tooling                        |   | 3                 |   | 181,689   |      | 181,689   |   |
|                           |   |              |   | 2,992,088 |      | 2,988,619 |   |
|                           |   |              |   |      |      |      |   |
| Less accumulated  depreciation |   |              |   | 2,977,550 |      | 2,970,992 |   |
|                           |   |              |   | $         | 14,538    |      | $      | 17,627 |   |

 

6.             IMPAIRMENTOF LONG-LIVED ASSETS

 

Long-lived assets consistof intangible assets and certain capital assets.  The carrying value of these assets is regularly reviewed toverify that they are valued properly. If the facts and circumstances suggest that the value has been impaired,the carrying value of the assets will be reduced appropriately.  There were no required adjustments in orderto comply with this requirement during 2001.

 

In August 2001, the FASBissued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” which replaces SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and Long-Lived Assets to be Disposed Of.”  SFAS No. 144 provides updated guidanceconcerning the recognition and measurement of an impairment loss for certaintypes of long-lived assets.  SFAS No.144 is effective for the Company on January 1, 2002.  The Company does not expect the adoption of SFAS No. 144 to havea material impact on the Company’s 2002 financial statements.

 

 

7.             DEFERREDACQUISITION OBLIGATION

 

Pursuant to the acquisition of certain assets fromDeere and Company at the Company’s inception in 1991, a deferred acquisitionobligation was incurred, which at December 31, 2000, amounted to $4,171,055.

 

The fair value ofthis obligation approximated carrying value. In addition to the deferred acquisition obligation, the Company wasrequired to make additional payments to the seller based upon a certainpercentage of engine sales.

 

F-9

----

 

The Company entered into an agreement, effectiveJanuary 31, 2001 (the “Deviation Agreement”) with John Deere TechnologiesInternational (“JDTI”) which revised the payment obligations of the Company setforth under the terms of the Purchase Agreement dated November 15, 1991, asamended (the “Original Purchase Agreement”), pursuant to which the Companyacquired all of the assets and business of the rotary engine division ofJDTI.  Under the terms of the OriginalPurchase Agreement, the Company had a remaining obligation to make  certain deferred acquisition payments(minimum royalties) through the year 2006 in an aggregate amount of$4,725,000.  As a result of theDeviation Agreement, the Company was obligated to make a cash payment of$100,000 to JDTI on January 31, 2001 and additional cash payments of $100,000and $150,000 in June and November 2001, respectively.  The Company paid $100,000 on January 29, 2001 and $100,000 onJune 26, 2001.

 

The Company is also required to make royalty paymentsto JDTI based upon sales of its engines in the amount of 3% of the sales priceof each engine sold prior to February 1, 2006, 2.5% of the sales price of eachengine sold prior to February 1, 2011, and 2% of the sales price of each enginesold prior to February 1, 2016.  Inexchange for the cash payments and the royalty payments, JDTI agreed to waiveits right to receive the $4,725,000 of deferred payments required by theOriginal Purchase Agreement.  If theCompany fails to make any of the payments required by the Deviation Agreement,the Deviation Agreement becomes null and void and the obligation to make thedeferred payments required by the Original Purchase Agreement is restored.  The Company did not make the November 2001payment of $150,000 and the terms of the Deviation Agreement were modified bythe parties.  In accordance with themodification, payments totaling $150,000 will be made in $50,000 installmentson or before March 31, 2002, April 30, 2002 and May 31, 2002.  The balance of the indebtedness was forgivenand has been recorded as an extraordinary item (net of taxes) in the amount of$3,485,473.

 

8.             NOTE PAYABLE

 

In December 1997,the Company issued a $400,000 promissory note to its landlord in satisfactionof rent due through December 31, 1997. In December 1999, the Company repaid $50,000 of this note.  The note is due January 1, 2003 and bearsinterest at 4% per annum.  The note iscollateralized by a second position in inventory and property and equipment.  The balance of the note for the year endingDecember 31, 2001 was $350,000.  As ofDecember 31, 2001, the Company was in default regarding required interestpayments under the note.

 

9.             LONG-TERM DEBT

 

Long-term debt as of December 31, 2000 consisted of$10,000,000 of 10.412% Bonds (the “Bonds”) due December 15, 2007 with aremaining balance of $4,914,060.

 

F-10

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On January 31,2001, the Company closed its offer to the holders of its outstanding Bonds toexchange each $2.00 of principal and accrued interest through January 31, 2001on the Bonds for one share of the Company’s Common Stock (the “Exchange”).  The holders of 100% of the outstanding Bondsagreed to accept the Company’s offer. At January 31, 2001, the principal of and accrued interest on the Bondsaggregated approximately $4,978,020, and the Company issued a total of2,489,015 shares of its Common Stock as part of the Exchange.  The shares of Common Stock issued to theholders of the Bonds are “restricted securities” for the purposes of theSecurities Act and, under the terms of the Exchange, the Bondholders will notbe permitted to publicly offer or sell the shares of Common Stock beforeJanuary 31, 2003 without the prior written consent of the Company.

 

10.           COMMITMENTS AND CONTINGENCIES

 

The Company rents spaceon a month to month basis for the office, manufacturing and test cells.  The annual rent cost for the years endedDecember 31, 2001 and 2000 was $100,352 and $131,206, respectively.

 

11.           RELATED PARTY TRANSACTIONS

 

As of November, 1999, theCompany had entered into a series of agreements with Londonderry CapitalStructuring Ltd. (“Londonderry”) of Toronto, Canada, an investment bankingfirm, which were renewable on a periodic basis.  As part of  these agreements,Londonderry signed a stock subscription agreement for the purchase of up to3,000,000 shares of common stock. During the year 2000, Londonderry and its assignees acquired all ofthese shares.  In addition, the Companyowed fees amounting to  $187,395 and$328,000 to Londonderry in the years 2001 and 2000, respectively; and of theseamounts, $117,591 and $90,900, respectively, were paid in cash.  During the year 2000, Londonderry wasgranted a warrant to purchase 1,500,000 shares of common stock at $.25 pershare exercisable through July 10, 2002. Certain assignees of Londonderryexercised the right to purchase 1,500,000 shares underlying the warrant duringthe years 2001 and 2000.

 

Effective May 1, 2001,the Company entered into a Termination and Settlement Agreement (the“Termination and Settlement Agreement”) with Londonderry and LondonderryManagement Services Ltd. (“Londonderry Services”) pursuant to which the Companyagreed to issue under the Termination and Settlement Agreement, warrants topurchase 500,000 shares of restricted common stock at $5.00 per share exercisablefor a three year period ending from the date of the issuance of the warrants.

 

In the event the Companyachieves a total of $5,000,000 in net sales (“the revenue target”) over thenext five succeeding years then Londonderry will be entitled to receive an additional200,000 shares of restricted common stock.

 

F-11

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The Company hasconsulting agreements with Londonderry Services and First Drew Financial Corp.(“Drew”) to provide the services of Mr. Ronald McKeown and Mr. Douglas Drew asChief Executive Officer and President and Chief Financial Officer,respectively.  Londonderry Services’monthly fee of $9,500 includes Mr. McKeown’s compensation of $7,000 and thereimbursement of administrative costs of $2,500.  Drew’s monthly fee of $5,000 represents compensation of $5,000,and Drew will be reimbursed for any reasonable amount of expenses incurred incarrying out its responsibilities. These agreements are subject to cancellationupon 30 days prior notice.  During theyear 2001, the annual service costs for these individuals totaled $136,000and  $60,000, respectively.

 

In addition, Mr.McKeown has been granted an option to purchase 300,000 shares of restrictedcommon stock exercisable when the Company achieves the revenue target.

 

In the event thatthe revenue target is not achieved within the exercisable period, then theoptions will expire.

 

Virgil E. Wenger,Chairman of the Board of Directors of the Company, is the father of DavidWenger, who was associated with the placement agent for several of theCompany’s private placement offerings. To date, the Company has paid approximately $191,200 to the placementagent and issued to affiliates of the placement agent warrants to purchase219,333 shares of Common Stock at $1.20 per share for its services rendered inconnection with the private placement offerings.

 

12.           SHAREHOLDERS’ EQUITY

 

**Preferred Stock**:

 

The shareholdersat the annual meeting held on July 11, 2000, approved an amendment to theCertificate of Incorporation to increase the number of authorized shares ofpreferred stock to 5,000,000.  TheCompany’s Board of Directors, may issue from time to time the authorized andunissued shares of Preferred Stock in one or more series, and may determine asto each series the dividend rights and terms, conversion rights, voting rights,redemption rights and terms, liquidation preferences, sinking funds and anyother rights, preferences, privileges and restrictions applicable to each suchseries of Preferred Stock.

 

**Common Stock:**

 

The shareholders at theannual meeting, held on July 11, 2000, approved an amendment to the Certificateof Incorporation, to increase the number of authorized shares of common stockfrom 10,000,000 to 100,000,000.

 

F-12

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13.           STOCK OPTION PLAN

 

In 2000, the Boardof Directors adopted the 2000 Stock Option Plan (the “Plan”) and canceled the1992 stock option plan under which there were no options outstanding.  Under the terms of the Plan, incentive stockoptions to purchase up to 5,000,000 shares of common stock may be granted toemployees, directors and consultants of the Company at the fair market value atthe date of grant (or 110% of the fair market value for grants issued toholders of more than 10% of the voting stock of the Company).  Options granted under the Plan becomeexercisable in whole or in part from time to time as determined by the Board ofDirectors, provided, however, in no event shall any option become exercisableearlier than the date six months following the date on which the option isgranted and limited to five years for 10% or more shareholders.

 

Options grantedunder the Plan shall have a maximum term of ten years from the date of grant,and are limited to five years for 10% or more shareholders.  The option price must be paid in full on thedate of exercise in cash or in common shares of the Company having a fairmarket value on the date of exercise equal to the option price.

 

Option status andactivity were as follows for the year ended December 31, 2001 and 2000:

 
|                                        |   | **2001**  |   | **2000**  |   |
|---------------------------------------------|--------|-----------|--------|-----------|--------|
| Reserved for  grants at beginning           |   | 4,975,000 |   | 5,000,000 |   |
| Granted and  exercisable                    |   | 909,000   |   | 25,000    |   |
| (Exercise prices  range from $.59 to $1.01) |   | 4,066,000 |   | 4,975,000 |   |
| Forfeited                                   |   | 120,000   |   | —    |   |
| Reserved for  grants at end                 |   | 4,186,000 |   | 4,975,000 |   |

 

Weighted averageof exercise price and expected life of options granted at December 31, 2001 is$.62 and four years.

 

The Company measuresstock based compensation costs using the intrinsic value based method ofaccounting prescribed by APB Opinion No. 25, “Accounting for Stock Issued toEmployees”.  The Company has adoptedduring the year, the disclosure-only provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation.” Accordingly, no compensation cost has been recognized for these stockoption plans.

 

F-13

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Had compensation cost forthe stock option plans been determined based on the fair value at the grantdate for awards made in the years 2001 and 2000, consistent with the provisionsof SFAS No. 123, the Company’s net income (loss) per share would have beenreduced to the pro forma amounts indicated below:

 
|                      |   | **2001** |      | **2000** |        |
|---------------------------|--------|----------|-----------|----------|-------------|
| Net Income  (Loss)        |   |     |      |     |        |
| As Reported:              |   | $        | 1,161,263 |     | ($2,184,231 | ) |
| Pro forma                 |   | $        | 1,012,283 |     | ($2,508,705 | ) |
| Earnings (Loss) per share |   |     |      |     |        |
| As Reported:              |   |     |      |     |        |
| Basic                     |   | $        | .07       |     | ($.25       | ) |
| Diluted                   |   | $        | .06       |     | ($.25       | ) |
| Pro Forma:                |   |     |      |     |        |
| Basic                     |   | $        | .07       |     | ($.29       | ) |
| Diluted                   |   | $        | .05       |     | ($.29       | ) |

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants in 2001 and 2000: weighted-average risk-free interest rate of 4.00 and5.23 percent; and expected volatility of 50 percent.  The effects of applying SFAS No. 123 on the pro forma net income(loss) may not be representative of the effects on pro forma net income (loss)for future years.

 

Warrants andOptions Not Granted Under the Stock Option Plan

 

During 2001 and 2000, theCompany granted an aggregate of 773,333 and 3,145,000, respectively, optionsand warrants for common stock for services to certain employees, consultantsand directors.  The options were notgranted under any stock option plan maintained by the Company.   The exercise prices range from $1.20 to$5.00 and $.25 to $.50, respectively. Appropriate service costs have been charged to income.  The options and warrants are exercisable overtwo (2) to five (5) years.

 

14.           RETIREMENT PLAN

 

The Company is thesponsor of an inactive defined contribution retirement savings plan.  Employees of the Company would be eligiblefor participation after one year of service. The Company matches 100% of pre-tax contributions up to 3.0% of theparticipant’s total salary.  There wereno matching contributions for 2001 and 2000.

 

F-14

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15.           INCOME TAXES

 

Deferred taxaccounts as of December 31, 2001 and 2000 comprise the following:

 
|                                    |   | **2001**  |      | **2000**  |   |
|-----------------------------------------|--------|-----------|-----------|-----------|--------|
| Net operating  loss carryforwards (NOL) |   | $         | 4,180,000 |      | $      | 5,755,000 |   |
| Valuation  allowance                    |   | 4,180,000 |      | 5,755,000 |   |
| Net deferred tax  assets                |   | $         | -0-       |      | $      | -0- |   |

 

As of December 31, 2001,the Company has federal and state Net Operating Loss Carryforwards (“NOL’s”)available for tax purposes of approximately $11,480,000 and $3,100,000,respectively, expiring from 2006 to 2021.

 

Under a program sponsoredby the State of New Jersey (the “State”) during 1999, the Company arranged tosell the tax benefits relating to its New Jersey NOL’s approximating $13,500,000.  The State approved an allocation of NOL’sequal to taxes in the amount of $1,211,686. Of this amount, the State authorized the sale of NOL’s equal to grosstax benefits of $904,878 or $10,054,000 of NOL’s for the two-year period endedDecember 31, 2001.

 

The balance of the NewJersey NOL’s will be used to offset future New Jersey Taxable Income.

 

16.           SUPPLEMENTAL CASH FLOW INFORMATION

 

On January 31,2001, 2,489,015 common shares were issued in exchange for the reduction of$4,978,020 of bond indebtedness (See Note 9).

 

Accounts payableand accrued expenses which included employee compensation and professional andconsulting fees in the amount of $515,786 were paid through the issuance of1,637,677 of the Company’s common shares during 2001.

 

Accounts payableof $217,041 was offset against subscriptions receivable during 2000.

 

On December 1,2000, 200,000 common shares were issued in payment of $400,000 in advances fromAbejon.

 

F-15

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17.           CONTINGENCIES

 

The Company is subject to various lawsuits and claimsarising out of the normal course of business. In the opinion of management, the ultimate liabilities resulting fromsuch lawsuits and claims will not materially affect the Company’s financialstatements.

 

 

18.           GOING CONCERN

 

The Company incurred net operating losses of$16,399,891 for the six (6) years ended December 31, 2001.  At December 31, 2001, the Company had aworking capital deficiency of $45,785 and its total liabilities exceeded totalassets by $355,245.  These factors, aswell as the uncertain conditions that the Company faces regarding obtainingfinancing or additional capital investment create uncertainty about theCompany’s ability to continue as a going concern.  The ability of the Company to continue as a going concern isdependent upon the Company obtaining future financing and successfullymarketing its commercial products.  Thefinancial statements do not include any adjustments that might be necessary ifthe Company is unable to continue as a going concern.

 

 

F-16

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**ITEM8.****                            ****CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON****ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM9.****                            ****DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL****PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGEACT**

 

**Management**

 

The Company currently has three directors and twoexecutive officers.  The Board ofDirectors appointed Douglas M. Drew in November, 1999, Virgil Wenger in May,2000 and Ronald G. McKeown in June, 2001 to fill vacant positions on theBoard.  Messrs. Drew and Wenger werere-elected as directors of the Company and Mr. McKeown was elected as adirector at the Company’s annual shareholders’ meeting held on July 2,2001.  The Company’s Advisory Board wascreated on July 2, 2000 and is currently comprised of Richard Dowden, theformer chief executive officer of Volvo-North America Corporation, Steve Baksa,managing director of The Vertical Group, Dr. Peter Fransham, president of EnconEnterprises Inc. and William Partanen, former CEO of B.G. Technologies,Inc.  Hans Angermueller and TedKnetzger, former Advisory Board Members, resigned in October, 2001.  The options that each of them held thereforeexpired in January, 2002.

 

Members of the Company’s Advisory Board do notparticipate in decisions made by the Board of Directors or any of the Company’sofficers, but render consulting advice to the Board and the officers onstrategic planning and other related matters based upon their individual areasof expertise.  Each member receives anoption to purchase 10,000 shares of the Company’s Common Stock upon theirappointment and an option for an additional 10,000 shares of Common Stock fortheir services in each subsequent year and is reimbursed for any out-of-pocketexpenses incurred in connection with serving on the Advisory Board.  The Advisory Board Members are expected todevote not more than ten to fifteen days per year to the affairs of theCompany, and in the event that a member devotes additional time to the affairsof the Company at the Company’s request, the Company shall compensate suchmember at a per diem rate or by the grant of additional options in such amountas is mutually agreed to by the Company and such member.

 

The following persons are the Company’s currentofficers and directors:

 
| **Name**          |   | **Age** |   | **Position(s)**                                                                                       |
|-------------------|--------|---------|--------|-------------------------------------------------------------------------------------------------------|
| Ronald  McKeown   |   | 48      |   | Chief  Executive Officer, President, Executive Vice President and Director of  Marketing and Director |
| Virgil  E. Wenger |   | 71      |   | Chairman  of the Board and Director                                                                   |
| Douglas  M. Drew  |   | 69      |   | Vice  President, Finance, Corporate Secretary, Treasurer and Director                                 |

 

The following is biographical information about eachof the officers and directors.

 

Mr. McKeown is currently thePresident, Chief Executive Officer and sole shareholder of Londonderry Capitaland Londonderry Management.  Prior tobecoming Chief Executive Officer, President and Director of the Company on June7, 2001, Mr. McKeown headed his own consulting and management company for approximatelyfourteen years, during which time he consulted with many privately and publiclyowned companies on restructuring and financial management issues, as well aswork-out programs and investor relations. Prior to operating his consulting and management company, Mr. McKeownworked for the Toronto Star newspaper in 

 

20

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various capacities for approximately 20years.  Mr. McKeown is a Canadiancitizen who resides in Ontario, Canada.

 

Mr. Wenger retired in 1990 aftera thirty-seven year career with Ernst & Young LLP and Arthur Young &Company, where he was a partner in the New York international office withresponsibility for the firm’s involvement in nineteen countries throughoutSoutheast Asia and the Middle East. Since 1990, he has been an independent consultant and financialadvisor.  He also serves as a Trustee ofthe Pittsburgh and West Virginia Railroad. Mr. Wenger is a graduate of the University of Kansas and the HarvardBusiness School Advanced Management Program. He is a Certified Public Accountant and a member of the AmericanInstitute of Certified Public Accountants.

 

Mr. Drew is an independent financial consultant inCanada and has been the President and sole shareholder of First Drew FinancialCorp since 1980.  He was a Director ofMed-Tech Environmental Limited, a subsidiary of Stericycle, Inc. and a formerVice President of Smith, Barney and Company. He has been involved in several business reorganizations.  Mr. Drew is a Canadian citizen and residentof Toronto and is a graduate of the University of Western Ontario, School ofBusiness.

 

**Compliance with Section 16(a) of theSecurities Exchange Act of 1934**

 

The SecuritiesExchange Act of 1934 requires the Company’s executive officers and directors,and any persons owning more than 10% of a class of the Company’s common stockto file certain reports of ownership and changes in ownership with theSEC.  Copies of these reports must alsobe furnished to the Company.

 

For the fiscalyear ended December 31, 2001, Mr. McKeown timely filed a Form 3 Statement ofBeneficial Ownership.  Messrs. Davis,Wenger, Drew and McKeown each filed one Form 4 Statement of Changes inBeneficial Ownership on a late basis and Messrs. Wenger and McKeown timelyfiled all other Form 4 Statements disclosing their transactions during thefiscal year.  Messrs. McKeown, Wengerand Drew filed each of their Form 5 Annual Statements of Changes in BeneficialOwnership on a late basis.  PowerColdCorporation, a beneficial owner of greater than 5% of the Company’s outstandingCommon Stock, did not file any reports of ownership or changes in ownershipduring the fiscal year ended December 31, 2001.

 

**ITEM10.****                     ****EXECUTIVECOMPENSATION**

 

The followingtable sets forth the compensation during the last three fiscal years of the ChiefExecutive Officer of the Company and any other executive officer, if any, whoseannual salary and bonus exceeded $100,000 for services in all capacities to theCompany during the last fiscal year through December 31, 2001.

 

**SummaryCompensation Table**

** **
|                                           |   |     |   | **Annual  Compensation** |    | **Long Term  Compensation Awards** |   |
|------------------------------------------------|--------|----------|--------|--------------------------|---------|------------------------------------|--------|
| **Name of  Individual and Principal Position** |   | **Year** |   | **Salary ($)**           |    | **Bonus ($)**                      |   | **Securities  Underlying Options** |   | **All Other  Compensation ($)** |   |
| Conway Davis                                   |   | 2000     |   | $                        | 42,000  |                               | — |   | 1,200,000 | (1) | — |   |
|                                           |   | 2001     |   | $                        | 42,000  |                               |   |   |   |   |   |   |
| Ronald G.  McKeown                             |   | 2001     |   | $                        | 136,000 |                               | — |   | 300,000 | (2) | 250,000 | (3) |

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                  (1) Includes anoption to purchase 1,000,000 shares of Common Stock at $.25 and an option topurchase 200,000 shares of Common Stock at $.50.  The options have not been exercised and have expired.

 

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                  (2) Includesan option to purchase 300,000 shares of Common Stock at an exercise price pershare equal to the average of the closing bid prices per share of the Company’sCommon Stock for the ten (10) trading days preceding such date after May 1,2001 when the gross revenues earned by the Company, minus any adjustments orallowances for product returns, equal, on a cumulative basis, at least$5,000,000 (the “Effective Date”).  Theoption is exercisable until the earlier to occur of the fifth anniversary ofthe Effective Date or the tenth anniversary of the date of grant.

                  (3) Doesnot include the right to receive 200,000 shares of restricted Common Stockpursuant to the terms of the Termination and Settlement Agreement.  Includes a warrant to purchase 500,000shares of Common Stock at $5.00 per share exercisable through May 1, 2004.  Such warrant is owned indirectly throughLondonderry Capital, of which Mr. McKeown is the President and soleshareholder.  The value of suchcompensation is based upon the closing bid price of the Company’s Common Stockat December 31, 2001 multiplied by the number of shares of Common Stockunderlying the warrant.

 

The following table sets forth certain information concerningindividual issues of options made during the year ended December 31, 2001 tothe Company’s executive officers.

 

**OPTION GRANTS IN LAST FISCAL YEAR**

**(INDIVIDUAL GRANTS)**

** **
| **Name**          |   | **Number of Securities Underlying Options****Granted** |   | **Percentage of Total Options Granted to Employees in Fiscal****Year** |   | **Exercise Price** |   | **Market Price****per Share onDate of Grant** |   | **Expiration****Date** |   |
|-------------------|--------|--------------------------------------------------------|--------|------------------------------------------------------------------------|--------|--------------------|--------|-----------------------------------------------|--------|------------------------|--------|
| Conway Davis      |   | 100,000                                                |   | 10.88                                                                  | %      | $                  | .60    |                                          | $      | .78                    |   | 9/5/01 |   |
| Ronald G. McKeown |   | 300,000                                                |   | 32.64                                                                  | %      | (1                 | )      | (1                                            | )      | (2                     | )      |
|                   |        |                                                        |        |                                                                        |        |                    |        |                                               |        |                        |        |  |  |

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                  (1) The option isexercisable at an exercise price per share equal to the average of the closingbid prices per share of the Company’s Common Stock for the ten (10) tradingdays preceding such date after May 1, 2001 when the gross revenues earned bythe Company, minus any adjustments or allowances for product returns, equal, ona cumulative basis, at least $5,000,000 (the “Effective Date”).

                  (2) Theoption is exercisable until the earlier to occur of the fifth anniversary ofthe Effective Date or the tenth anniversary of the date of grant.

 

The following table sets forth information with respect to thenumber and value of outstanding options held by executive officers named in theSummary Compensation Table above at December 31, 2001.

 

**FISCAL YEAR-END OPTION VALUES**

 
| **Name**          |   | **Number of Securities Underlying****Unexercised Options at Year End** |   | **Value of Unexercised In-the-Money****Options at Year End** |   |
|-------------------|--------|------------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|
|              |   | **Exercisable**                                                        |   | **Unexercisable**                                            |   | **Exercisable** |   | **Unexercisable** |   |
| Conway Davis      |   | -0-                                                                    |   | -0-                                                          |   | -0- |   | -0- |   |
| Ronald G. McKeown |   | -0-                                                                    |   | 300,000                                                      |   | -0- |   | -0- |   |

 

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**Compensation Pursuant to Plans**

 

*Stock Option Plan*

 

The Company adopted a 2000 StockOption Plan (the “Plan”) in July, 2000 containing the terms describedbelow.  The Company terminated itsprevious stock option plan at the same time of adoption of the Plan.  Options to purchase 644,000 shares of CommonStock at exercise prices from $1.01 to $.45 per share have been granted toofficers and directors, personnel and consultants to the Company under thePlan.  The Company also granted anoption to purchase 300,000 shares of its Common Stock under the Plan to Mr.McKeown pursuant to the Termination and Settlement Agreement.  See the terms of such option under“Employment Agreements” below.  Optionsto purchase 120,000 shares granted under the Plan held by certain individualsexpired due to those individuals’ resignation.

 

Under the Plan, the Company hasreserved 5,000,000 shares of Common Stock which may be issued upon the exerciseof either incentive stock options (“Incentive Stock Options”) or nonqualifiedoptions (“Nonqualified Options”) granted under the Plan, subject to increase ordecrease.  If any option (“Option”)granted under the Plan shall expire, terminate or be cancelled for any reasonwithout having been exercised in full, the number of shares as to which suchOption was not exercised shall again be available for purposes of the Plan.

 

An Option under the Plan may begranted to any current or contingent director of the Company and any employeeof, or consultant to, the Company or a subsidiary who performs services for theCompany or a subsidiary.  TheCompensation Committee (as that term is defined in the Plan) may from time totime in its discretion grant Nonqualified Stock Options to directors andconsultants and Incentive Stock Options and/or Nonqualified Stock Options toemployees who may or may not be executive officers.  Each Option granted under the Plan shall be evidenced by anoption agreement (the “Option Agreement”) between the Company and the Optionee(as that term is defined in the Plan) in such form as the CompensationCommittee shall approve.  No Optiongranted under the Plan shall be transferable by the Optionee otherwise than by willor the laws of descent and distribution, and each such Option shall beexercisable during the Optionee’s lifetime only by the Optionee.

 

Nothing in the Plan or in anyOption Agreement shall give any right to an employee or consultant to remainemployed or retained by the Company or a subsidiary thereof in any particularposition or at any particular rate of compensation.

 

The exercise price, subject toadjustment, of each (i) Incentive Stock Option shall not be less than thehigher of the par value or 100% of the Fair Market Value (as that term isdefined in the Plan) of the shares of Common Stock subject to the Option on thedate the Option is granted; and (ii) Nonqualified Stock Option shall be theamount determined by the Compensation Committee as set forth in the applicableOption Agreement, provided that such amount shall not be less than the higherof the par value or 85% of the Fair Market Value of Common Stock subject to theOption on the date the Option is granted.

 

The term during which an Optionis exercisable shall be that period and such date determined by theCompensation Committee as set forth in the applicable Option Agreement,provided that no Option shall have a term that exceeds a period of ten (10)years from the date of its grant.  AllOptions under the Plan shall be granted within ten (10) years from the date thePlan is adopted by the Board of Directors of the Company or the date the Planis approved by stockholders of the Company, whichever is earlier.  Notwithstanding, no Incentive Stock Optionmay be granted that would cause the Incentive Stock Option limits to beexceeded with respect to an Optionee. The Compensation Committee, in its sole discretion, may prescribe adifferent vesting schedule for any Incentive Stock Option granted under thisPlan if necessary to prevent the Option from violating the limitation onIncentive Stock Options.

 

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When an installment of Optionshas become exercisable, the Optionee may exercise that installment, in whole orin part, at any time prior to the expiration or termination of theOptions.  The Compensation Committee mayaccelerate the time at which outstanding Options may be exercised.

 

Notwithstanding, any Option willbecome immediately exercisable in full upon the occurrence of particular eventsor as the Compensation Committee may thereafter determine to be advisable;provided that: (i) at the time of such occurrence or determination, theOptionee has remained continuously employed by the Company or any subsidiaryfor at least six (6) months from the date of grant of such Option, and (ii) inthe case of an Incentive Stock Option, such acceleration would not cause theIncentive Stock Option limits to be violated. Without limitation, those particular events include the following: (i) achange in control of the Company in a transaction or occurrence, or a relatedseries of transactions or occurrences, resulting from a material change inownership of Common Stock and evidenced by cessation in service as directors ofa majority of those persons theretofore serving as members of the Board; (ii)the sale by the Company of all or substantially all of its assets and thediscontinuance of its business, or the merger or consolidation of the Companywith another entity, or the liquidation of the Company in connection with thoseevents, any of which results in a change of control as described in clause (i);or (iii) a Board determination that immediate exercisability would be in thebest interests of the Company and advisable for protection of the rightsintended to be granted under the Option.

 

No Incentive Stock Option shallbe granted to any employee who owns, directly or indirectly within the meaningof Section 424(d) of the Internal Revenue Code, stock possessing more than 10%of the total combined voting power of all classes of stock of the Company orany subsidiary, unless at the time the Incentive Stock Option is granted, theexercise price of the Incentive Stock Option is at least 110% of the FairMarket Value of the Common Stock subject to such Incentive Stock Option andsuch Incentive Stock Option, by its terms, is not exercisable after theexpiration of five years from the date such Incentive Stock Option is granted.

 

The Plan shall be administeredby the Compensation Committee consisting of two or more Directors appointed bythe Board of Directors.  TheCompensation Committee shall have the exclusive authority and soleresponsibility to administer the Plan and make all determinations thereunderwith respect to the participation therein as well as the terms of each OptionAgreement.  The Compensation Committeemay waive any provisions of any Option Agreement previously approved by suchCompensation Committee, provided such waiver is not inconsistent with the termsof the Plan as then in effect.

 

The Plan may be amended at anytime and from time to time by the Board, but no amendment shall be effectiveunless and until the same is approved by the affirmative vote of the holders ofa majority of the voting securities of the Company.  No amendment to the Plan shall, without the consent of anOptionee, affect such Optionee’s rights under an Option previously granted.

 

The Board may at any timeterminate the Plan as of any date specified in a resolution adopted by theBoard. If not earlier terminated, the Plan shall terminate on the day prior tothe tenth anniversary of the date on which the Plan is adopted by the Board orthe date on which the Plan is approved by stockholders of the Company,whichever is earlier.  No Options may begranted after the Plan has terminated but the Compensation Committee shallcontinue to supervise the administration of Options previously granted.

 

The number of shares of CommonStock of the Company authorized for issuance under the Plan, as well as theprice to be paid and the number of shares of Common Stock issued upon exerciseof outstanding Options, shall be subject to adjustment by the CompensationCommittee, in its sole discretion, to reflect any stock split, stock dividend,recapitalization, merger, consolidation, reorganization, combination orexchange of shares or other similar event. The Compensation Committee may, with the consent of the holder of anyOption granted under the Plan, cancel such Option and grant a new Option insubstitution therefore, provided that the Option as so substituted shallsatisfy all of the requirements of the Plan as of the date such new Option isgranted.

 

24

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**Employment Agreements**

 

Mr. McKeown, the President and Chief Executive Officerof the Company since June, 2001, has a consulting agreement with the Companythat is cancelable by either party upon thirty (30) days written notice.  Pursuant to the terms of the agreement, Mr.McKeown’s firm, Londonderry Management, receives compensation of $9,500 permonth for its services, with $7,000 of that amount being designated ascompensation for Mr. McKeown and the remaining $2,500 intended to serve ascompensation for the administrative services which Londonderry Managementagreed to provide to Mr. McKeown.

 

As additional consideration for his agreement to serveas its Executive Vice President and Director of Marketing, the Company alsoagreed to grant McKeown an option under the Plan to purchase 300,000 shares ofCommon Stock (the “Employment Option”). McKeown will be fully vested in the Employment Option immediately uponits grant and the Employment Option will remain fully exercisable at all timeswhether or not he is still serving in any capacity with the Company.  The Employment Option will becomeexercisable as of the first date after it is determined that the Company hasmet the Revenue Target (the “Effective Date”) and will remain exercisable untilits expiration date.  For purposes ofthe Employment Option, the Revenue Target will be met if and when the grossrevenues earned by the Company after May 1, 2001, minus any adjustments orallowances for product returns, equal, on a cumulative basis, at least$5,000,000.  The Employment Option willentitle McKeown to purchase the shares at an exercise price per share equal tothe average of the closing bid prices per share of the Company’s Common Stockfor the ten (10) trading days preceding the Effective Date.  The Employment Option will expire on the earlierto occur of the fifth anniversary of the Effective Date or the tenthanniversary of the date of grant of the Employment Option.

 

Mr. Davis, the Company’s former President and ChiefExecutive Officer who resigned in June, 2001, had a consulting agreement withthe Company and, upon his resignation, the Company authorized payment of$71,000 to him for certain unpaid amounts owing to him under his consultingagreement.

 

Mr. Drew, adirector and the Vice President of Finance of the Company since November, 1999,has a consulting agreement with the Company that is cancelable by either partyupon thirty (30) days written notice. Pursuant to the terms of the agreement as it has been amended effectiveJanuary 1, 2001, Mr. Drew’s firm, First Drew Financial Corp., receivescompensation of up to $5,000 per month for Mr. Drew’s time spent providingadvisory services to the Company and for his services as a director of theCompany, which includes attendance at Board meetings.  Mr. Drew also receives reimbursement for any out-of-pocketexpenses subject to the Company’s prior approval.

 

There are no other executive officers or directors of the Companythat have an employment or consulting agreement with the Company.

 

**Compensation of Directors**

 

The Company paid $1,000 per quarter to outsidedirectors for their attendance at meetings of the Board.  In February, 2001, the Board increased thecompensation to Virgil Wenger, Chairman of the Board and currently theCompany’s only outside director, to $1,000 per month retroactive to May 1, 2000and granted to Mr. Wenger a non-accountable expense allowance of $150.00 permonth retroactive to May 1, 2000.  InFebruary, 2001, the Board approved the grant of an option to Messrs. Drew andDavis to purchase 100,000 shares of Common Stock each and to Mr. Wenger topurchase 200,000 shares of Common Stock. Each of these options is exercisable at $.60 per share for five yearsfrom the date of grant.  The optionsgranted to Mr. Davis for his services as a director expired in September, 2001.

 

25

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**ITEM11**.                      **SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The followingtable sets forth certain information regarding the beneficial ownership of theCompany’s Common Stock by each person or group that is known by the Company tobe the beneficial owner of more than 5% of its outstanding Common Stock, eachdirector of the Company and each person named in the Summary CompensationTable, and all directors and executive officers of the Company as a group as ofthe date of this Annual Report on Form 10-KSB. Unless otherwise indicated, the Company believes that the persons namedin the table below, based on information furnished by such owners, have solevoting and investment power with respect to the Common Stock beneficially ownedby them, subject to community property laws, where applicable.

 
| **Name and Address of****Beneficial Owner(1)**                                                                            |   | **Number of Shares****of Common StockBeneficially Owned** |   | **Percentage Ownership****of Common StockOutstanding(2)** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|--------|-----------------------------------------------------------|--------|
| Ronald G. McKeown  c/o Londonderry Capital Structuring Ltd.  RR#4, 22 International Parkway Stouffville,  Ontario L4A 7X5 |   | 1,390,000                                                 | (3)    | 6.10                                                      | %      |
| Virgil E. Wenger                                                                                                          |   | 755,000                                                   | (4)    | 3.37                                                      | %      |
| Douglas M. Drew                                                                                                           |   | 400,000                                                   | (5)    | 1.79                                                      | %      |
| PowerCold Corporation  103 Guadalupe Drive  Cibolo, Texas 78108                                                           |   | 1,935,000                                                 |   | 8.79                                                      | %      |
| Londonderry Capital  Structuring Ltd.  RR#4, 22 International Parkway  Stouffville, Ontario L4A7X5                        |   | 1,390,000                                                 | (6)    | 6.10                                                      | %      |
| Tanelorn Investments Limited                                                                                              |   | 1,400,000                                                 |   | 6.36                                                      | %      |
| All Executive Officers and  Directors  as a Group (3 Persons)                                                             |   | 2,545,000                                                 |   | 10.86                                                     | %      |

----

            (1) Unless otherwise indicated, theaddress of each beneficial owner is c/o Rotary Power International, Inc., PostOffice Box 128, Wood-Ridge, New Jersey 07075-0128.

            (2) Unless otherwise indicated, theCompany believes that all persons named in the table have sole voting andinvestment power with respect to all shares of Common Stock beneficially ownedby them.  The percentage for eachbeneficial owner listed above is based on 22,004,928 shares outstanding as ofthe date of this Annual Report on Form 10-KSB. In accordance with the rules of the SEC, options and warrants topurchase shares of Common Stock that are exercisable within sixty (60) days ofthe date of this Annual Report on Form 10-KSB, are deemed to be outstanding andbeneficially owned by the person holding such options for the purpose ofcomputing such person’s percentage ownership, but are not deemed to beoutstanding for the purpose of computing the percentage ownership of any otherperson.  Additionally, the beneficialownership of certain security holders included in this table and the footnotesthereto reflect the ownership of shares of Common Stock issued to them uponconversion of outstanding Series 3 Preferred Stock held by those securityholders.

            (3) Includes (i) 590,000 shares ofCommon Stock held by Londonderry Capital, of which Mr. McKeown is the Presidentand sole shareholder; (ii) a warrant to purchase 500,000 shares of Common Stockat $5.00 per share held by Londonderry Capital; and (iii) an option to purchase300,000 shares of Common Stock upon the terms described under Item 10,“Executive Compensation” above.  Doesnot include the shares that Londonderry Management will receive pursuant to theTermination and Settlement Agreement between the Company and LondonderryCapital.

 

26

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            (4) Includes (i) an option to purchase225,000 shares of Common Stock at $.50 per share; and (ii) an option topurchase 200,000 shares of Common Stock at $.60 per share.

            (5) Includes (i) an option to purchase200,000 shares of Common Stock at $.50 per share; and (ii) an option topurchase 100,000 shares of Common Stock at $.60 per share.

            (6) Includes (i) 590,000 shares ofCommon Stock; (ii) a warrant to purchase 500,000 shares of Common Stock at$5.00 per share; and (iii) an option to purchase 300,000 shares of Common Stockupon the terms described under Item 10, “Executive Compensation” above.  Does not include the shares LondonderryManagement will receive pursuant to the Termination and Settlement Agreementbetween the Company and Londonderry Capital.

 

**ITEM12.****                     ****CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

The Company willnot enter into any transactions with officers, directors or other beneficialowners of the Company’s securities disclosed in the beneficial ownership tableunder Item 11 unless the transactions are approved by a majority ofdisinterested directors.  No suchtransactions were in effect or entered into during 2001.

 

Virgil E. Wenger, Chairman of the Board of Directorsof the Company, is the father of David Wenger, who was associated with theplacement agent for several of the Company’s private placement offerings.  To date, the Company has paid approximately$191,200 to the placement agent and issued to affiliates of the placement agentwarrants to purchase 219,333 shares of Common Stock at $1.20 per share for itsservices rendered in connection with the private placement offerings.

 

**PARTIII**

 

**ITEM13.****                     ****EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)           EXHIBITS TO 10-KSB

 
| 3.1    |   | Certificate of  Incorporation of the Company, as amended(1)                                                                  |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                         |
| 3.2    |   | By-laws of the Company(1)                                                                                                    |
|   |   |                                                                                                                         |
| 3.3    |   | Certificate of  Designations, Preferences and Rights of Preferred Stock of the Company, as  amended(1)                       |
|   |   |                                                                                                                         |
| 3.4    |   | Certificate of  Designations, Preferences and Rights of Preferred Stock of the Company’s  Series 3 Preferred Shares(11) |
|   |   |                                                                                                                         |
| 4.0    |   | Warrant Agreement dated  June 29, 1992 between the Company and Rickel & Associates, Inc.(1)                              |
|   |   |                                                                                                                         |
| 4.1    |   | Non-Transferable  Warrant to Purchase 25,000 Shares of   Common Stock of Rotary Power International, Inc.(3)            |
|   |   |                                                                                                                         |
| 4.2    |   | Non-Transferable  Warrant to Purchase 175,000 Shares of Common Stock of Rotary Power  International, Inc.(3)                 |

 

 

27

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| 4.3    |   | Non-Transferable  Warrant to Purchase 200,000 Shares of Common Stock of Rotary Power  International, Inc.(5)                                                      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                              |
| 4.4    |   | Non-Transferable  Warrant to purchase 250,000 Shares of Common Stock of Rotary Power  International, Inc.(8)                                                      |
|   |   |                                                                                                                                                              |
| 10.1   |   | Contract dated  August 15, 1989 between the United States Marine Corps and John Deere Technologies  International, Inc. and novated to the Company, as amended(1) |
|   |   |                                                                                                                                                              |
| 10.2   |   | Contract dated  April 23, 1991 between FMC Corporation and John Deere Technologies  International, Inc. and novated to the Company, as amended(1)                 |
|   |   |                                                                                                                                                              |
| 10.3   |   | Contract dated January  21, 1993 between the National Aeronautics and Space Administration and the  Company, as amended(1)                                        |
|   |   |                                                                                                                                                              |
| 10.4   |   | Licensing  Agreement dated October 20, 1992 between Wankel GmbH and the Company(1)                                                                                |
|   |   |                                                                                                                                                              |
| 10.5   |   | Teaming Agreement  dated May 10, 1993 between Dornier GmbH and the Company(1)                                                                                     |
|   |   |                                                                                                                                                              |
| 10.6   |   | Teaming Agreement  dated June 30, 1993 between Martin Marietta Corporation and the Company(1)                                                                     |
|   |   |                                                                                                                                                              |
| 10.7   |   | Purchase  Agreement dated November 15, 1991 between John Deere Technologies  International, Inc. and the Company(1)                                               |
|   |   |                                                                                                                                                              |
| 10.8   |   | Loan Agreement  dated June 1, 1992 between New Jersey Economic Development Authority and the  Company(1)                                                          |
|   |   |                                                                                                                                                              |
| 10.9   |   | Asset Purchase  Agreement dated August 6, 1992 between ROTEC Manufacturing and Engineering  Corp., Michael Soimar and the Company(1)                              |
|   |   |                                                                                                                                                              |
| 10.10  |   | Asset Purchase  Agreement dated August 12, 1992 between Defense Group Industries, Inc. and  the Company(1)                                                        |
|   |   |                                                                                                                                                              |
| 10.11  |   | Assignment and  Transfer of Receivables Agreement dated April 10, 1992 between Commerce  Funding Corporation and the Company(1)                                   |
|   |   |                                                                                                                                                              |
| 10.12  |   | Employment  Agreement dated November 1, 1991 between Richard M.H. Thompson and the  Company, as amended(1)                                                        |
|   |   |                                                                                                                                                              |
| 10.13  |   | Employment  Agreement dated December 16, 1991 between Robert L. Osborn and the Company(1)                                                                         |
|   |   |                                                                                                                                                              |
| 10.14  |   | Employment  Agreement dated December 16, 1991 between Gary A. LaBouff and the Company(1)                                                                          |
|   |   |                                                                                                                                                              |
| 10.15  |   | Consulting  Agreement dated June 1, 1992 between Loeb Partners Corporation and the  Company, as amended by Agreement dated May 3, 1993(1)                         |

 

28

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| 10.16  |   | Lease dated  January 1, 1992 between Curtiss-Wright Flight, Inc. and the Company, as  amended(1)                                                                                                                                                       |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                   |
| 10.17  |   | Rotary Power  International, Inc. 1992 Stock Option Plan(1)                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                   |
| 10.18  |   | Stockholders  Agreement dated December 31, 1991 between the Company and its Stockholders(1)                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                   |
| 10.19  |   | Modification  P00035, P00036, P00037 and P00038 to the contract between the Company and the  USMC (incorporated by reference to Exhibit 10.1 contained in the Company’s  10-QSB for the period ending September 30, 1994, dated November 7, 1994) |
|   |   |                                                                                                                                                                                                                                                   |
| 10.20  |   | Letter Contract  dated November 8, 1994 between Martin Marietta Ordnance Systems and the  Company(2)                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                   |
| 10.21  |   | Letter Contract  dated December 21, 1994 between the USMC and the Company(2)                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                   |
| 10.22  |   | Not used                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                   |
| 10.23  |   | Teaming Agreement  dated July 25, 1995 between Teledyne Vehicle Systems and the Company(4)                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                   |
| 10.24  |   | Assets Purchase  Agreement dated August 4, 1995 between Rotary Marine Industries, Inc. and the  Company(4)                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                   |
| 10.25  |   | Engine  Distributor Agreement dated October 5, 1995   between Abejon Rotary Power Corporation and the Company(4)                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                   |
| 10.26  |   | Sales Agreement  dated October 16, 1995 between Hussmann Corporation and the Company(4)                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                   |
| 10.27  |   | Modifications  P00039 through P00044 to the contract between the Company and the USMC  referred to in Exhibit 10.1(6)                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                   |
| 10.28  |   | Amendment, dated  September 30, 1995, to Employment between Richard M. H. Thompson and the  Company referred to in Exhibit 10.12*(6)                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                   |
| 10.29  |   | Amendment, dated  September 30, 1995, to Employment Agreement between Robert L. Osborn the  Company referred to in Exhibit 10.13*(6)                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                   |
| 10.30  |   | Amendment, dated  September 30, 1995, to Employment Agreement between Gary A. LaBouff and the  Company referred to in Exhibit 10.14*(6)                                                                                                                |
|   |   |                                                                                                                                                                                                                                                   |
| 10.31  |   | Agreement by and  among Mazda Motor Corporation, Mazda (North America), Inc., and the Company  dated November 10, 1995 with Addendum(6)                                                                                                                |
|   |   |                                                                                                                                                                                                                                                   |
| 10.32  |   | Contract dated  December 22, 1995 between the United States Marine Corps and the Company with  modification P00001 thereto(6)                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                   |
| 10.33  |   | Advice to Wankel  GmbH, dated January 10, 1996 terminating the Wankel Licensing Agreement  referred to in Exhibit 10.4(6)                                                                                                                              |

 

 

29

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| 10.34  |   | 65 Series  Distribution Agreement dated January 22, 1996 between Abejon Rotary Power  Corporation and the Company(6)                                                                                                                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                |
| 10.35  |   | Amendment 1,  dated February 6, 1996, to Engine Distributor Agreement between Abejon Rotary  Power Corporation and the Company referred to in Exhibit 10.25(6)                                                                                      |
|   |   |                                                                                                                                                                                                                                                |
| 10.36  |   | Purchase Order,  dated February 6, 1996, from Abejon Rotary Power Corporation(6)                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                |
| 10.37  |   | Consulting  Agreement, dated February 6, 1996, pursuant to the sale of 1,000,000 shares  of the Company’s Common Stock to Abejon Rotary Power Corporation(6)                                                                                   |
|   |   |                                                                                                                                                                                                                                                |
| 10.38  |   | Loan Agreement,  dated February 6, 1996, between Abejon,   Hydro Lance Maritime Transport, Inc. and the Company  pursuant to the sale of 1,000,000 shares  of the Company’s Common Stock to Abejon Rotary Power Corporation(6)       |
|   |   |                                                                                                                                                                                                                                                |
| 10.39  |   | Promissory Note,  dated February 6, 1996, by Hydro Lance   Maritime Transport, Inc. pursuant to the sale of 1,000,000 shares of  the Company’s Common Stock to Abejon Rotary Power Corporation(6)                                         |
|   |   |                                                                                                                                                                                                                                                |
| 10.40  |   | Pledge Agreement,  dated February 6, 1996, between Abejon and the Company pursuant to the sale  of 1,000,000 shares of the Company’s Common Stock to Abejon Rotary Power  Corporation(6)                                                       |
|   |   |                                                                                                                                                                                                                                                |
| 10.41  |   | Pooling  Agreement, dated February 6, 1996, between Abejon, Hydro Lance Maritime  Transport, Inc. and Affiliates of the Company pursuant to the sale of  1,000,000 shares of the Company’s Common Stock to Abejon Rotary Power  Corporation(6) |
|   |   |                                                                                                                                                                                                                                                |
| 10.42  |   | Settlement  Agreement, dated March 1, 1996, between Lockheed Martin Ordnance Systems,  Inc. and the Company referred to in Exhibit 10.20(6)                                                                                                         |
|   |   |                                                                                                                                                                                                                                                |
| 10.43  |   | Deviation From  Purchase Agreement between John Deere Technologies International, Inc. and  the Company, dated February 19, 1996, as referred to in Exhibit 10.7(7)                                                                                 |
|   |   |                                                                                                                                                                                                                                                |
| 10.44  |   | Investment  Banking Consulting Agreement for One Year with R.D. White & Company dated  June 25, 1996(9)                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                |
| 10.45  |   | Letter from  Shearman & Sterling, attorneys representing Wankel GmbH, dated 19  September 1996, to the Company accepting the termination of the Wankel  License Agreement referred to in Exhibit 10.4 by mutual consent(9)                      |
|   |   |                                                                                                                                                                                                                                                |
| 10.46  |   | Vessel Purchase  and Sales Agreement (Partial Interest) between Abejon and Rotary Power  International, Inc. dated as of October 31, 1996(9)                                                                                                        |
|   |   |                                                                                                                                                                                                                                                |
| 10.47  |   | Mar-Trans  Affiliates LLC: Operating Agreement between Abejon and Rotary Power  International, Inc. dated as of October 31, 1996(9)                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                |
| 10.48  |   | Agreement of  Merger between International Cryogenic Systems Corporation and Rotary Power  International, Inc. dated as of March 21, 1997(9)                                                                                                        |

 

30

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| 10.49  |   | Security Agreement, dated December 1, 1997, between Sentinel Trust  Company, trustees for the holders of the $10,000,000 bonds due December 15,  2007(11)              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                   |
| 10.50  |   | Indentureof Trust between Sentinel Trust  Company and Rotary Power International, Inc, dated December 1, 1997(11)                                                      |
|   |   |                                                                                                                                                                   |
| 10.51  |   | Curtiss-WrightSecurity Agreement, dated December 22,  1997(11)                                                                                                         |
|   |   |                                                                                                                                                                   |
| 10.52  |   | Curtiss-Wright Settlement of Claims with Rotary Power International, Inc.,  dated December 22, 1997(11)                                                                |
|   |   |                                                                                                                                                                   |
| 10.53  |   | Asset PurchaseAgreement, dated June 4, 1998, with Rotary Power Marine  Corporation , for the sale of Series 65 gasoline engines(10)                                    |
|   |   |                                                                                                                                                                   |
| 10.54  |   | Asset SaleAgreement, dated July 2, 1998, for the sale of certain assets of  the Company (Series 65 NGRE engines) to Rotary Power Enterprise, Inc.(10)                  |
|   |   |                                                                                                                                                                   |
| 10.55  |   | Subscription  Agreement between Rotary Power International, Inc. and Londonderry Capital  Structuring Ltd. dated October 27, 1999(12)                                  |
|   |   |                                                                                                                                                                   |
| 10.56  |   | Agreement for  Investor-Relations Services between Rotary Power International, Inc. and  Londonderry Capital Structuring Ltd. dated November 1, 1999(12)               |
|   |   |                                                                                                                                                                   |
| 10.57  |   | Consulting  Agreement between Rotary Power International, Inc. and Londonderry dated  November 1, 1999(12)                                                             |
|   |   |                                                                                                                                                                   |
| 10.58  |   | Facilitation Fee  Letter Agreement between Rotary Power International, Inc. and Londonderry  dated November 6, 1999(12)                                                |
|   |   |                                                                                                                                                                   |
| 10.59  |   | 2000 Rotary Power  International, Inc. Stock Incentive Plan(13)                                                                                                        |
|   |   |                                                                                                                                                                   |
| 10.60  |   | Amendment to the  Facilitation Fee Letter Agreement by and between Londonderry Capital  Structuring Ltd. and Rotary Power International, Inc. dated April 30, 2000(13) |
|   |   |                                                                                                                                                                   |
| 10.61  |   | Non-Exclusive  Manufacturing License Agreement by and between Rotary Power International,  Inc. and Rotary Power Enterprise, Inc. dated August 16, 2000(13)            |
|   |   |                                                                                                                                                                   |
| 10.62  |   | Second Deviation  from Purchase Agreement by and between John Deere Technologies International,  Inc. and Rotary Power International, Inc. dated January 31, 2001(13)  |
|   |   |                                                                                                                                                                   |
| 10.63  |   | Consulting  Agreement between Rotary Power International, Inc. and William T. Figart  dated September 7, 2001(14)                                                      |
|   |   |                                                                                                                                                                   |
| 10.64  |   | Legal Advisory  Agreement between Rotary Power International, Inc. and Wilentz, Goldman &  Spitzer, P.A. dated September 7, 2001(14)                               |
|   |   |                                                                                                                                                                   |
| 10.65  |   | Consulting  Agreement between Rotary Power International, Inc. and W. Robert Finkle dated  as of September 17, 2001(15)                                                |
|   |   |                                                                                                                                                                   |
| 10.66  |   | Consulting Agreement  between Rotary Power International, Inc. and William Tomol dated as of June  1, 2001(15)                                                         |

 

31

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| 10.67  |   | Consulting  Agreement between Rotary Power International, Inc. and Callos and Associates  dated as of August 1, 2001(15)            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                |
| 10.68  |   | Consulting  Agreement between Rotary Power International, Inc. and James Gibbs dated as  of October 1, 2001(15)                     |
|   |   |                                                                                                                                |
| 10.69  |   | Consulting  Agreement between Rotary Power International, Inc. and Christie Art and  Communication dated as of November 1, 2001(15) |
|   |   |                                                                                                                                |
| 10.70  |   | Consulting  Agreement between Rotary Power International, Inc. and Robert Farrington  dated as of May 1, 2001(15)                   |
|   |   |                                                                                                                                |
| 11     |   | Calculation of  Income (Loss) per Common Share                                                                                      |
|   |   |                                                                                                                                |
| 21     |   | Subsidiaries of  the Company(12)                                                                                                    |

 

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| *      |   | Management contract or  compensatory plan or arrangement required to be filed as an exhibit to this  Form 10-KSB.                                                           |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                        |
| (1)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s  Registration Statement on Form SB-2, (File No. 33-71334) dated November 5,  1994. |
|   |   |                                                                                                                                                                        |
| (2)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for year ending December 31, 1994.                                    |
|   |   |                                                                                                                                                                        |
| (3)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form S-8  (File No. 33-93836) dated June 22, 1995.                                 |
|   |   |                                                                                                                                                                        |
| (4)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-QSB for nine months ended September 30, 1995.                             |
|   |   |                                                                                                                                                                        |
| (5)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form S-8  (File No. 33-98584) dated October 26, 1995.                              |
|   |   |                                                                                                                                                                        |
| (6)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for the year ending December 31, 1995.                                |
|   |   |                                                                                                                                                                        |
| (7)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-QSB for the three  months ended  March 31, 1996.                     |
|   |   |                                                                                                                                                                        |
| (8)    |   | Incorporated by  reference to exhibit of the same number   contained in the Company’s Form S-8 (File No. 333-06557) dated June  21, 1996.                         |
|   |   |                                                                                                                                                                        |
| (9)    |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for the year ended December 31, 1996.                                 |
|   |   |                                                                                                                                                                        |
| (10)   |   | Incorporated  by reference to exhibit of the same number  contained in the Company’s Form 10-KSB for the year ending December 31, 1997.                           |
|   |   |                                                                                                                                                                        |
| (11)   |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for the year ending December 31, 1998.                                |
|        |        |                                                                                                                                                                             |  |

 

 

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| (12)   |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for the year ending December 31, 1999.                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                          |
| (13)   |   | Incorporated by  reference to exhibit of the same number contained in the Company’s Form  10-KSB for the year ending December 31, 2000.                  |
|   |   |                                                                                                                                                          |
| (14)   |   | Incorporated by  reference to the Company’s Registration Statement on Form S-8 filed with the  Securities and Exchange Commission on September 17, 2001. |
|   |   |                                                                                                                                                          |
| (15)   |   | Incorporated by  reference to the Company’s Registration Statement on Form S-8 filed with the  Securities and Exchange Commission on March 15, 2002.     |

 

(b)     REPORTSON FORM 8-K

 

                              The Company filed no current reportson  Form 8-K during the fourth quarterof the fiscal year ended December 31, 2001.

 

33

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**SIGNATURES**

 

In accordance withSection 13 of 15(d) of the Exchange Act, the registrant caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|   | **ROTARY POWER INTERNATIONAL, INC.** |                                    |
|--------|--------------------------------------|-----------------------------------------|
|   |                                 |                                    |
|   | By:                                  | /s/ Ronald G. McKeown                   |
|   | Name:                                | Ronald G. McKeown                       |
|   | Title:                               | President, Chief  Executive Officer and |
|   |                                 | Director                                |
|        |                                      |                                         |  |  |

 

Dated:  April 9, 2002

 

 

In accordance withthe Exchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 
| /s/ Virgil E. Wenger  | Chairman | April 9, 2002 |
|-----------------------|----------|---------------|
| Virgil E. Wenger      |     |          |
|                  |     |          |
| /s/ Ronald G. McKeown | Director | April 9, 2002 |
| Ronald G. McKeown     |     |          |
|                  |     |          |
| /s/ Douglas M. Drew   | Director | April 9, 2002 |
| Douglas M. Drew       |     |          |

 

 

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