SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended July 31, 2009
 
OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES   EXCHANGE ACT OF 1934
 
For the transition period from ______________ to ______________
 
Commission File Number 000-52815
  
CODA OCTOPUS GROUP, INC.
(Exact name of registrant as specified in its charter)

Delaware
  
34-200-8348
(State or other jurisdiction of Incorporation or organization)
  
(I.R.S. Employer Identification Number)
     
164 West, 25th Street, 6R, New York
  
10001
(Address of principal executive offices)
  
(Zip Code)
     
Registrant's telephone number, including area code:
  
(212) 924-3442
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act (Check one):  o

Large accelerated filer  o
Accelerated filer  o
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

The number of shares outstanding of issuer's common stock, $0.001 par value as of October 2, 2009: 49,000,244.
 
 
INDEX

   
Page
  
PART I - Financial Information
  
1
  
 
     
Item 1: Financial Statements
  
1
  
       
Nine Months Ended July 31, 2009 and 2008
      
       
Condensed Consolidated Balance Sheet as of July 31, 2009 (Unaudited) and October 31, 2008
  
1
  
       
Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months Ended July 31, 2009 and 2008 (Unaudited)
  
2
  
 
     
Condensed Consolidated Statement of Deficiency in Stockholders’ Equity for the Nine Months Ended July 31, 2009 (Unaudited)
  
3
  
 
     
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 31, 2009 and 2008 (Unaudited)
  
4
  
       
Notes to Condensed Consolidated Financial Statements (Unaudited)
  
5
  
       
Item 2: Management's Discussion and Analysis or Plan of Operation
  
22
  
       
Item 4T:   Controls and Procedures
  
32
  
       
PART II - Other Information
  
33
  
       
Item 1: Legal Proceedings
  
33
  
       
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
  
33
  
       
Item 3: Defaults Upon Senior Securities
  
33
  
       
Item 4: Submission of Matters to a Vote of Security Holders
  
33
  
       
Item 5: Other Information
  
33
  
       
Item 6: Exhibits
  
33
  
       
Signatures
  
34
  
 
i
 
PART I. FINANCIAL INFORMATION
  
Item 1. Financial Statements
 
CODA OCTOPUS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
JULY 31, 2009 (UNAUDITED) AND OCTOBER 31, 2008
   
July 31,
2009
(Unaudited)
    
October 31,
2008
  
ASSETS
            
Current assets:
            
Cash and cash equivalents
   $ 574,905     $ 3,896,149  
Restricted cash, Note 2
    
1,394,847
      
1,017,007
  
Short-term investments, Note 4
    
34,000
      
153,000
  
Accounts receivable, net of allowance for doubtful accounts
    
1,773,922
      
2,589,174
  
Inventory
    
3,169,174
      
2,317,322
  
Due from related parties, Note 13
    
-
      
54,166
  
Unbilled receivables, Note 3
    
1,470,190
      
518,326
  
Other current assets, Note 5
    
435,397
      
407,080
  
Prepaid expenses
    
612,010
      
385,831
  
                 
Total current assets
    
9,464,445
      
11,338,055
  
                 
Property and equipment, net, Note 6
    
408,526
      
355,909
  
Deferred financing costs, net of accumulated amortization of $268,096 in 2009 and $181,596 in 2008, Note 12
    
1,331,702
      
1,513,297
  
Goodwill and other intangible assets, net, Note 7
    
4,255,909
      
3,832,023
  
                 
Total assets
   $ 15,460,582     $ 17,039,284  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                
Current liabilities:
                
Accounts payable, trade
   $ 2,048,168     $ 1,159,849  
Accrued expenses and other current liabilities
    
2,278,205
      
2,347,522
  
Deferred revenues, Note 3
    
267,538
      
268,650
  
Deferred payment related to acquisitions, Note 14
    
217,948
      
-
  
Accrued dividends on Series A preferred stock
    
-
      
53,874
  
Due to related parties, Note 13
    
-
      
41,904
  
Loans and notes payable, short term, Note 12
    
13,187,381
      
12,358,597
  
                 
Total current liabilities
    
17,999,240
      
16,230,396
  
                 
Loans and notes payable, long term, Note 12
    
172,499
      
162,700
  
                 
Total liabilities
    
18,171,739
      
16,393,096
  
                 
Deficiency in stockholders' equity, Note 8:
                
Preferred stock, $.001 par value; 5,000,000 shares authorized, 6,287 series A issued and outstanding, as of July 31, 2009 and October 31, 2008 respectively
    
6
      
6
  
Common stock, $.001 par value; 150,000,000 shares authorized, 49,000,244 and 48,853,664 shares issued and outstanding as of July 31, 2009 and October 31, 2008 respectively
    
49,000
      
48,854
  
Common stock subscribed
    
96,350
      
131,790
  
Additional paid-in capital
    
51,768,712
      
51,433,049
  
Accumulated other comprehensive loss
    
(721,033
)
    
(1,317,696
)
Accumulated deficit
    
( 53,904,192
)
    
(49,649,815
)
                 
Total (deficiency) surplus in stockholders' equity
    
(2,711,157
) 
    
646,188
  
                 
Total liabilities and deficiency in stockholders' equity
   $ 15,460,582     $ 17,039,284  
 
See accompanying notes to these unaudited condensed consolidated financial statements.
 
1
 
CODA OCTOPUS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE THREE AND NINE MONTHS ENDED JULY 31, 2009 and 2008
(UNAUDITED)

   
For the three
months
    
For the three
months
    
For the nine
Months
    
For the nine
months
  
   
ended July 31,
    
ended July 31,
    
ended July 31,
    
ended July 31,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net revenue
   $ 3,425,030     $ 5,008,525     $ 10,931,583     $ 13,232,440  
                                 
Cost of revenue
    
1,664,267
      
1,984,714
      
4,682,202
      
4,934,266
  
                                 
Gross profit
    
1,760,763
      
3,023,811
      
6,249,381
      
8,298,174
  
                                 
Research and development
    
256,929
      
880,339
      
1,317,087
      
2,333,840
  
Selling, general and administrative expenses
    
1,864,880
      
3,311,267
      
7,154,059
      
9,170,389
  
Total operating expenses
    
2,121,809
      
4,191,606
      
8,471,146
      
11,504,229
  
                                 
Operating income (loss)
    
(361,046
)
    
(1,167,795
)
    
(2,221,765
)
    
(3,206,055
)
                                 
Other income (expense)
                                
Other income
    
21,839
      
47,554
      
53,026
      
96,779
  
Interest expense
    
(432,018
)
    
(481,876
)
    
(1,256,256
)
    
(1,051,181
)
Impairment of investment in short term investment
    
-
      
-
      
(782,000
)
    
-
  
                                 
Total other income (expense)
    
(410,179
)
    
(434,322
)
    
(1,985,230
)
    
(954,402
)
                                 
Loss before income taxes
    
(771,225
)
    
(1,602,117
)
    
(4,206,995
)
    
(4,160,457
)
                                 
Provision for income taxes
    
-
      
-
      
-
      
-
  
                                 
Net loss
    
(771,225
)
    
(1,602,117
)
    
(4,206,995
)
    
(4,160,457
)
                                 
Preferred Stock Dividends:
                                
Series A
    
(15,794
)
    
(31,819
)
    
(47,382
)
    
(106,843
)
                                 
Net Loss Applicable to Common Shares
   $ (787,019
)
   $ (1,633,936
)
   $ (4,254,377
)
   $ (4,267,300
)
                                 
Loss per share, basic and diluted
    
(0.02
)
    
(0.03
)
    
(0.09
)
    
(0.09
)
                                 
Weighted average shares outstanding
    
49,000,244
      
48,540,133
      
48,967,260
      
48,369,873
  
                                 
Comprehensive loss:
                                
                                 
Net loss
   $ (771,225
)
   $ (1,602,117
)
   $ (4,206,995
)
   $ (4,160,457
)
                                 
Foreign currency translation adjustment
    
341,794
      
98,390
      
(66,337
)
    
(23,560
)
Unrealized gain (loss) on investment
    
  (34,000
)
    
(280,500
) 
    
(34,000
)
    
(663,000
)
                                 
Comprehensive loss
   $ (463,431
)
   $ (1,784,227
)
   $ (4,307,332
)
   $ (4,847,017
)
 
See accompanying notes to these unaudited condensed consolidated financial statements.
 
2
 
CODA OCTOPUS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN DEFICIENCY IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED JULY 31, 2009
(UNAUDITED)  
 
   
Preferred Stock
Series A
    
Preferred Stock
Series B
    
Common Stock
    
Common
Stock
    
Additional
Paid-in
    
Accumulated
Other
Comprehensive
    
Accumulated
        
   
Shares
    
Amount
    
Shares
    
Amount
    
Shares
    
Amount
    
Subscribed
    
Capital
    
Loss
    
Deficit
    
Total
  
Balance, October 31, 2008
    
6,287
    
$
6
      
-
    
$
-
      
48,853,664
    
$
48,854
      
131,790
    
$
51,433,049
    
$
(1,317,696
)
  
$
(49,649,815
)
  
$
646,188
  
                                                                                         
Stock issued for compensation
                                    
146,580
      
146
      
(35,440
)
  
$
30,163
                    
$
(5,131
)
                                                                                         
Fair value of options issued for compensation
                                                          
$
305,500
                    
$
305,500
  
                                                                                         
Preferred stock dividends Series A
                                                                          
$
(47,382
)
  
$
(47,382
)
                                                                                         
Foreign currency translation adjustment
                                                                  
$
(66,337
)
          
$
(66,337
)
                                                                                         
Realized loss on marketable securities reclassified to earnings
                                                                  
$
697,000
            
$
697,000
  
                                                                                         
Unrealized loss on marketable securities
                                                                  
$
(34,000
)
          
$
(34,000
)
                                                                                         
Net loss
                                                                          
$
(4,206,995
)
  
$
(4,206,995
)
                                                                                         
Balance July 31, 2009
    
6,287
    
$
6
      
-
    
$
-
      
49,000,244
    
$
49,000
    
$
96,350
    
$
51,768,712
    
$
(721,033
)
  
$
(53,904,192
)
  
$
(2,711,157
)
 
See accompanying notes to these unaudited condensed consolidated financial statements.

 
3
 
CODA OCTOPUS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JULY 31, 2009 and 2008
(UNAUDITED)

   
2009
    
2008
  
             
CASH FLOWS FROM OPERATING ACTIVITIES:
            
Net loss
  
$
(4,206,995
)
  
$
(4,160,457
)
Adjustments to reconcile net loss to net cash used by operating activities:
                
Depreciation and amortization
    
477,849
      
453,623
  
Stock based compensation
    
300,369
      
865,206
  
Financing costs
    
1,150,714
      
395,430
  
Impairment of investment in marketable securities
    
782,000
      
-
  
Changes in operating assets and liabilities:
                
(Increase) decrease in:
                
Accounts receivable
    
916,998
      
319,886
  
Inventory
    
(816,599
) 
    
424,225
  
Prepaid expenses
    
(226,180
) 
    
(65,927
)
Other receivables
    
(915,976
)
    
(1,515,028
)
Increase (decrease) in:
                
Accounts payable and accrued expenses
    
1,164,039
      
(792,797
) 
Due to related parties
    
(41,904
)
    
(41,945
)
                 
Net cash used in operating activities
    
(1,415,685
)
    
(4,117,784
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
                
Purchases of property and equipment
    
(121,943
)
    
(110,416
)
Purchases of intangible assets
    
(8,715
) 
    
(180,123
)
Increase in restricted cash
    
(377,840
)
    
-
  
Acquisitions
    
(214,317
)
    
(763,936
)
Cash acquired from acquisitions
    
877
      
-
  
                 
Net cash used in investing activities
    
(721,938
)
    
(1,054,475
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
                
(Payments for) proceeds from loans, net
    
(1,019,822
) 
    
10,453,421
  
Preferred stock dividend paid
    
(101,256
)
    
(127,541
)
                 
Net cash (used in) provided by financing activities
    
(1,121,078
) 
    
10,325,880
  
                 
Effect of exchange rate changes on cash
    
(62,543
)
    
(18,882
) 
                 
Net (decrease) increase in cash
    
(3,321,244
) 
    
5,134,739
  
                 
Cash and cash equivalents, beginning of period
    
3,896,149
      
916,257
  
                 
Cash and cash equivalents, end of period
  
$
574,905
    
$
6,050,996
  
                 
Cash paid for:
                
Interest
  
$
1,125,542
    
$
376,909
  
Income taxes
    
-
      
-
  
 
Supplemental Disclosures:  

During the nine months ended July 31, 2009, 146,580 shares of common stock were issued, 43,694 of which were subscribed for in the year ended October 31, 2008, and the other 102,886 shares were issued as payment of $18,520 of compensation.

During the nine months ended July 31, 2008, 391,256 shares of common stock were issued as payment of $238,476 of compensation that was earned, $4,200 of non-cash financing costs and $41,536 of Series A preferred stock dividends due.
 
Acquisition of Tactical Intelligence

Equipment, net
  
$
5,000
  
Customer relationships acquired
    
60,000
  
Non-compete agreements acquired
    
50,000
  
Goodwill
    
135,000
  
Deferred payments
    
(125,000
) 
Cash paid for acquisition
  
$
125,000
  

Acquisition of Dragon Design Ltd

Current assets acquired
  
$
147,039
  
Equipment, net
    
51,336
  
Current liabilities assumed
    
(201,166
)
Customer relationships acquired
    
29,740
  
Non-compete agreements acquired
    
29,740
  
Goodwill
    
282,533
  
Cash acquired
    
877
  
Deferred payments
    
(250,782
) 
Cash paid for acquisition
  
$
89,317
  
 
See accompanying notes to these unaudited condensed consolidated financial statements.
 
4
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
 
A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.
 
General

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with instructions to SEC form 10Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Accordingly, the results from operations for the nine month period ended July 31, 2009, are not necessarily indicative of the results that may be expected for the year ended October 31, 2009. The unaudited condensed financial statements should be read in conjunction with the consolidated October 31, 2008 financial statements and footnotes thereto included in the Company’s 10K filed on March 18, 2009 with the Securities Exchange Commission (SEC) as amended.

Business and Basis of Presentation
 
Coda Octopus Group, Inc. (”we”, “us”, “our company” or “Coda”), a corporation formed under the laws of the State of Florida in 1992 (since re-domiciled to Delaware in 2004), is a developer of underwater technologies and equipment for imaging, mapping, defense and survey applications. We are based in New York, with research and development, sales and manufacturing facilities located in the Utah, the United Kingdom and Norway, and additional sales locations in Florida and Washington, D.C.
 
The unaudited condensed consolidated financial statements include the accounts of Coda and our domestic and foreign subsidiaries that are more than 50% owned and controlled. All significant intercompany transactions and balances have been eliminated in the consolidated financial statements.
 
Use of Estimates
 
The preparation of unaudited condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. Although these estimates are based on management's best knowledge of current events and actions that we may undertake in the future, actual results may differ from those estimates.
 
Revenue Recognition
 
We record revenue in accordance with the guidance of the SEC's Staff Accounting Bulletin SAB No. 104 (SAB 104), which supersedes SAB No. 101 in order to encompass Emerging Issues Task Force (EITF) No. 00-21, Revenue Arrangements with Multiple Deliverables. Our revenue is derived from sales of underwater technologies and equipment for imaging, mapping, defense and survey applications, as well as from the performance of various engineering and manufacturing contracts. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectability is reasonably assured. No right of return privileges are granted to customers after shipment.

For arrangements with multiple deliverables, we recognize product revenue by allocating the revenue to each deliverable based on the fair value of each deliverable in accordance with EITF No. 00-21 and SAB No. 104, and recognize revenue for equipment upon delivery and for installation and other services as performed. EITF No. 00-21 was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003.
 
Our contracts sometimes require customer payments in advance of revenue recognition. These deposit amounts are reflected as liabilities and recognized as revenue when the Company has fulfilled its obligations under the respective contracts.
 
Revenues derived from our software license sales are recognized in accordance with Statement of Position (SOP) No. 97-2, “Software Revenue Recognition”, and SOP No. 98-9, “Modifications of SOP No. 97-2 , Software Revenue Recognition with Respect to Certain Transactions”. For software license sales for which any services rendered are not considered essential to the functionality of the software, we recognize revenue upon delivery of the software, provided (1) there is evidence of an arrangement, (2) collection of our fee is considered probable and (3) the fee is fixed and determinable. 
 
5
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Foreign Currency Translation
 
Coda translates the foreign currency financial statements of its foreign subsidiaries in accordance with the requirements of SFAS No. 52, Foreign Currency Translation. Assets and liabilities are translated at exchange rates existing at the balance sheet dates, related revenue and expenses are translated at average exchange rates in effect during the period and stockholders’ equity, fixed assets and long-term investments are recorded at historical exchange rates. Resulting translation adjustments are recorded as a separate component in stockholders' equity as part of accumulated other comprehensive income (loss). Foreign currency transaction gains and losses are included in the statement of income.
 
Income Taxes
 
Deferred income taxes are provided using the asset and liability method for financial reporting purposes in accordance with the provisions of SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax assets and liabilities are recognized for temporary differences between the tax bases of assets and liabilities and their carrying values for financial reporting purposes, and for operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be removed or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of operations in the period that includes the enactment date.
 
Cash and Cash Equivalents
 
Cash equivalents are comprised of highly liquid investments with maturity of three months or less when purchased. We maintain our cash in bank deposit accounts, which at times, may exceed insured limits. We have not experienced any losses in such accounts.
 
Concentrations of Credit Risk
 
Financial instruments and related items, which potentially subject us to concentrations of credit risk, consist primarily of cash and cash equivalents and accounts receivable. We place our cash and temporary cash investments with credit quality institutions. At times, such investments may be in excess of applicable government mandated insurance limits.

Accounts Receivable
 
We periodically review our trade receivables in determining our allowance for doubtful accounts. Allowance for doubtful accounts was nil for the period ended July 31, 2009 and $74,897 for the year ended October 31, 2008.
 
Fair Value of Financial Instruments
 
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments", requires disclosure of the fair value of certain financial instruments. The carrying value of cash and cash equivalents, accounts receivable, other receivables, accounts payable and short-term borrowings, as reflected in the balance sheets, approximate fair value because of the short-term maturity of these instruments. Our long-term debt has interest rates that approximate market and therefore the carrying amounts approximate their fair values.

SFAS No. 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. SFAS No. 157 establishes three levels of inputs that may be used to measure fair value:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities.
 
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
 
6
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input that is significant to the fair value measurement.

Items recorded or measured at fair value on a recurring basis in the accompanying financial statements consisted of the following items as of July 31, 2009: 
 
         
Quoted Prices
in Active
Markets for
Identical
Instruments
    
Significant
Other
Observable
Inputs
    
Significant
Unobservable
Inputs
  
   
Total
    
Level 1
    
Level 2
    
Level 3
  
Assets:
                        
Short term Investment
  
$
34,000
    
$
34,000
              
Total
  
$
34,000
    
$
34,000
      
-
      
-
  
Liabilities:
                                
Notes Payable
  
$
 13,184,357
    
$
 13,184,357
      
 -
      
 -
  
Total
  
$
  13,184,357
    
$
  13,184,357
      
 -
      
 -
  
 
With the exception of assets and liabilities included within the scope of FSP FAS No. 157-2, the Company adopted the provisions of SFAS No. 157 prospectively effective as of the beginning of the year ended October 31, 2008.  For financial assets and liabilities included within the scope of FSP FAS No. 157-2, the Company will be required to adopt the provisions of SFAS No. 157 prospectively as of the year beginning November 1, 2009.  The adoption of SFAS No. 157 did not have a material impact on our financial position or results of operations, and the Company do not believe that the adoption of FSP FAS No. 157-2 will have a material impact on our financial position or results of operations.
 
The fair value of the short term investments and notes payable at July 31, 2009 was grouped as Level 1 valuation as the market price was readily available, and there has been no change to the fair value at July 31, 2009.
 
Debt and Equity Securities
 
The Company follows the provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115). The Company classifies debt and equity securities into one of three categories: held-to-maturity, available-for-sale or trading. These security classifications may be modified after acquisition only under certain specified conditions. Securities may be classified as held-to-maturity only if the Company has the positive intent and ability to hold them to maturity. Trading securities are defined as those bought and held principally for the purpose of selling them in the near term. All other securities must be classified as available-for-sale.
 
7
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Held-to-maturity securities are measured at amortized cost in the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings or in a separate component of capital. They are merely disclosed in the notes to the consolidated financial statements.
 
Available-for-sale securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses are not included in earnings but are reported as a net amount (less expected tax) in a separate component of capital until realized.
 
Trading securities are carried at fair value on the consolidated balance sheets. Unrealized holding gains and losses for trading securities are included in earnings.
 
Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.

Inventory
 
Inventory is stated at the lower of cost or market using the first-in first-out method. Inventory is comprised of the following components at July 31, 2009 and October 31, 2008:
 
   
2009
    
2008
  
Raw materials
  
$
1,500,303
    
$
1,917,566
  
Work in process
    
138,564
      
113,942
  
Finished goods
    
1,530,306
      
285,814
  
                 
Total inventory
  
$
3,169,174
    
$
2,317,322
  
 
Property and Equipment
 
We record our equipment at historical cost. We expense maintenance and repairs as incurred. Depreciation is provided for by the straight-line method over three to four years, the estimated useful lives of the property and equipment.
 
Long-Lived Assets
 
We follow SFAS No. 144, "Accounting for Impairment of Disposal of Long-Lived Assets", which established a "primary asset" approach to determine the cash flow estimation period for a group of assets and liabilities that represents the unit of accounting for a long-lived asset to be held and used. Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. No impairment loss was recognized during the period ended July 31, 2009 or the year ended October 31, 2008.
 
8
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Research and Development
 
Research and development costs consist of expenditures for the present and future patents and technology, which cannot be capitalized. We are eligible for United Kingdom tax credits related to our qualified research and development expenditures. Tax credits are classified as a reduction of research and development expense. We recorded tax credits of $204,081 during the period ended July 31, 2009 and nil during the year ended October 31, 2008.
 
Marketing
 
We charge the costs of marketing to expense as incurred. For the period ended July 31, 2009 marketing costs were $459,713 and $1,237,175 for the year ended October 31, 2008.

Intangible Assets
 
Intangible assets consist principally of the excess of cost over the fair value of net assets acquired (or goodwill), customer relationships, non-compete agreements and licenses. Goodwill was allocated to our reporting units based on the original purchase price allocation. Goodwill is not amortized and is evaluated for impairment annually or more often if circumstances indicate impairment may exist. Customer relationships, non-compete agreements, patents and licenses are being amortized on a straight-line basis over periods of 2 to 10 years. The Company amortizes its amortizable intangible assets using the straight-line method over their estimated period of benefit. We periodically evaluate the recoverability of intangible assets and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists.
 
We test for impairment at the reporting unit level as defined in SFAS No. 142, “Goodwill and Other Intangible Assets”. This test is a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value, which is based on future cash flows, exceeds the carrying amount, goodwill is not considered impaired. If the carrying amount exceeds the fair value, the second step must be performed to measure the amount of the impairment loss, if any. The second step compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. In the fourth quarter of each year, we evaluate goodwill on a separate reporting unit basis to assess recoverability, and impairments, if any, are recognized in earnings. An impairment loss would be recognized in an amount equal to the excess of the carrying amount of the goodwill over the implied fair value of the goodwill. SFAS No. 142 also requires that intangible assets with determinable useful lives be amortized over their respective estimated useful lives and reviewed annually for impairment in accordance with SFAS No. 144.
 
Stock Based Compensation
 
SFAS No. 123, “Accounting for Stock-Based Compensation”, established and encouraged the use of the fair value based method of accounting for stock-based compensation arrangements under which compensation cost is determined using the fair value of stock-based compensation determined as of the date of the grant or the date at which the performance of the services is completed and is recognized over the periods in which the related services are rendered. The statement also permitted companies to elect to continue using the current intrinsic value accounting method specified in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, to account for stock-based compensation to employees. Prior to the adoption of SFAS 123(R) we elected to use the intrinsic value based method for grants to our employees and directors and have disclosed the pro forma effect of using the fair value based method to account for our stock-based compensation to employees.
 
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R (revised 2004), “Share-Based Payment” (“Statement 123R”) which is a revision of SFAS No. 123.
 
Statement 123R supersedes APB opinion No. 25 and amends SFAS No. 95, “Statement of Cash Flows”. Generally, the approach in Statement 123R is similar to the approach described in Statement 123. However, Statement 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro-forma disclosure is no longer an alternative. This statement does not change the accounting guidance for share based payment transactions with parties other than employees provided in SFAS No. 123(R). This statement does not address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” On April 14, 2005, the SEC amended the effective date of the provisions of this statement. The effect of this amendment by the SEC is that the Company had to comply with Statement 123R and use the Fair Value based method of accounting no later than the first quarter of 2006. We implemented SFAS No. 123(R) on January 1, 2006 using the modified prospective method. The fair value of each option grant issued after January 1, 2006 will be determined as of grant date, utilizing the Black-Scholes option pricing model. The amortization of each option grant will be over the remainder of the vesting period of each option grant.  We did not have any unvested amounts of stock based compensation grants issued and outstanding at the date of implementation. 
 
9
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
We use the fair value method for equity instruments granted to non-employees and use the Black-Scholes model for measuring the fair value. The stock based fair value compensation is determined as of the date of the grant or the date at which the performance of the services is completed (measurement date) and is recognized over the periods in which the related services are rendered.
 
Comprehensive Income
 
SFAS No. 130, "Reporting Comprehensive Income", establishes standards for reporting and displaying of comprehensive income, its components and accumulated balances. Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, SFAS 130 requires that all items that are required to be recognized under current accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income includes gains and losses on foreign currency translation adjustments and is included as a component of stockholders' equity.

Deferred Financing Costs
 
Deferred financing costs primarily include debt issuance costs incurred by the Company in connection with the issuance of convertible debt in February 2008 (see Note 12). Amortization is provided on a straight-line basis over the terms of the respective debt instruments to which the costs relate and is included in interest expense. Deferred financing cost expense was $181,595 and $181,596 in the period ended July 31, 2009 and the year ended October 31, 2008, respectively.

Loss Per Share
 
We use SFAS No. 128, “Earnings per Share” for calculating the basic and diluted loss per share. We compute basic loss per share by dividing net loss and net loss attributable to common shareholders by the weighted average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential shares had been issued and if the additional shares were dilutive. Common equivalent shares are excluded from the computation of net loss per share if their effect is anti-dilutive.
 
Per share basic and diluted net loss amounted to $0.09 and $0.09 for the periods ended July 31, 2009 and 2008, respectively. For the periods ended July 31, 2009 and 2008, 50,571,559 and 48,896,559 potential shares, respectively, were excluded from the shares used to calculate diluted earnings per share as their inclusion would reduce net loss per share.
 
New Accounting Pronouncements
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”).  SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value.  Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” applies to all entities with available-for-sale and trading securities.  SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provision of SFAS No. 157, “Fair Value Measurements”.  The adoption of SFAS No. 159 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
 
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS No. 141(R) is effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. The company has adopted SFAS No. 141(R) for its acquisition in the current quarter.
 
10
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interest in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS No. 160”), which will change the accounting and reporting for minority interests, which will be re-characterized as non-controlling interests and classified as a component of equity within the consolidated balance sheets. SFAS No. 160 is effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited and the Company is currently evaluating the effect, if any that the adoption will have on its consolidated financial position, results of operations or cash flows.

In June 2007, the FASB ratified the consensus in EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities” (EITF 07-3), which requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development (R&D) activities be deferred and amortized over the period that the goods are delivered or the related services are performed, subject to an assessment of recoverability. EITF 07-3 will be effective for fiscal years beginning after December 15, 2007. The Company does not expect that the adoption of EITF 07-3 will have a material impact on its consolidated financial position, results of operations or cash flows.
 
In December 2007, the FASB ratified the consensus in EITF Issue No. 07-1, “Accounting for Collaborative Arrangements” (EITF 07-1). EITF 07-1 defines collaborative arrangements and requires collaborators to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) the other collaborators based on other applicable authoritative accounting literature, and in the absence of other applicable authoritative literature, on a reasonable, rational and consistent accounting policy is to be elected. EITF 07-1 also provides for disclosures regarding the nature and purpose of the arrangement, the entity’s rights and obligations, the accounting policy for the arrangement and the income statement classification and amounts arising from the agreement. EITF 07-1 will be effective for fiscal years beginning after December 15, 2008, which will be the Company’s fiscal year 2010, and will be applied as a change in accounting principle retrospectively for all collaborative arrangements existing as of the effective date. The Company has not yet evaluated the potential impact of adopting EITF 07-1 on its consolidated financial position, results of operations or cash flows.
 
In March 2008, the FASB” issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment to FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows.  Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  It is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early adoption encouraged.  The Company is currently evaluating the impact of SFAS No. 161, if any, will have on its consolidated financial position, results of operations or cash flows.

In April 2008, the FASB issued FSP No. SFAS No. 142-3, “Determination of the Useful Life of Intangible Assets”. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. The Company is required to adopt FSP 142-3 on September 1, 2009, earlier adoption is prohibited. The guidance in FSP 142-3 for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after adoption, and the disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, adoption.  The Company is currently evaluating the impact of FSP 142-3 on its consolidated financial position, results of operations or cash flows.
 
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”).  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy).  SFAS No. 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  The Company does not expect the adoption of SFAS No. 162 to have a material effect on its consolidated financial position, results of operations or cash flows.

In May 2008, the FASB issued FSP Accounting Principles Board (“APB”) 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”).   FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate.  FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis. The Company is currently evaluating the potential impact, if any, of the adoption of FSP APB 14-1 on its consolidated financial position, results of operations or cash flows.
 
11
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

In June 2008, the FASB issued FSP Emerging Issues Task Force (EITF) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” Under the FSP, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing EPS. The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. The Company does not expect the adoption of FSP EITF No. 03-6-1 to have a material effect on its consolidated financial position, results of operations or cash flows.
 
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company’s present or future condensed consolidated financial statements.

In June 2008, the FASB issued Emerging Issues Task Force No. 07-5 (EITF 07-5), Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock. EITF 07-5 requires entities to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock by assessing the instrument’s contingent exercise provisions and settlement provisions. Instruments not indexed to their own stock fail to meet the scope exception of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, paragraph 11(a), and should be classified as a liability and marked-to-market. The statement is effective for fiscal years beginning after December 15, 2008 and is to be applied to outstanding instruments upon adoption with the cumulative effect of the change in accounting principle recognized as an adjustment to the opening balance of retained earnings. The Company is assessing the impact of this pronouncement on its financial statements.

Liquidity
 
As of July 31, 2009 we have cash and cash equivalents of $574,905, a working capital deficit of $8,534,795 and a deficiency in stockholders' equity of $2,711,157. For the period ended July 31, 2009, we had a net loss of $4,206,995 and negative cash flow from operations of $1,415,685. We also have an accumulated deficit of $53,904,192 at July 31, 2009.

NOTE 2 – RESTRICTED CASH

Under terms of the Company’s secured convertible debenture dated February 26, 2008, we maintained a $1,000,000 interest-bearing deposit in a restricted bank account until such time as advances under an accounts receivable factoring agreement were repaid in full and the agreement and related liens were terminated.  As of October 31, 2008, the Company had $1,017,007 in the restricted cash account, which was released to the Company in December 2008 after the factoring agreement was terminated and settled in full in October 2008 and the debenture holders perfected their security in December 2008.

On March 16, 2009, the Company and the holder of the secured convertible debenture (“the Noteholder”) entered into a Cash Control Framework Agreement, pursuant to which it is assumed that, subject to the Company being fully compliant with the terms of this agreement and those set out in the Transaction Documents entered into between the Company and the Noteholder on February 21, 2008, no adverse actions will be taken by the Noteholder. The agreement provides, among other things, for the placement of approximately $2.15 million into a segregated cash account. Under the terms of the agreement, we may request the release of funds from the account from time to time for working capital purposes, subject to the Noteholder’s consent and agreed upon terms and conditions. Under the terms of the agreement, we must also adhere to a strict cost cutting program which involves reducing our SG&A, R&D and capital expenditure by an annualized $3.35 million. We believe that the terms of this agreement may provide us with sufficient liquidity to operate for fiscal 2009.

At July 31, 2009 we have received net advances from this facility of $755,153.
 
12
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 3 - CONTRACTS IN PROGRESS
 
Costs and estimated earnings in excess of billings on uncompleted contracts represent accumulated project expenses and fees which have not been invoiced to customers as of the date of the balance sheet. These amounts are stated on the balance sheet as Unbilled Receivables of $1,470,190 and $518,326 as of July 31, 2009 and October 31, 2008 respectively.
 
Billings in excess of cost and estimated earnings on uncompleted contracts represent project invoices billed to customers that have not been earned as of the date of the balance sheet. These amounts are stated on the balance sheet as Deferred Revenue of $31,954 and $57,513 as of July 31, 2009 and October 31, 2008 respectively.
 
Revenue received as part of sales of equipment includes a provision for warranty and is treated as deferred revenue, along with extended warranty sales, with these amounts amortized over 12 months from the date of sale. These amounts are stated on the balance sheet as Deferred Revenue of $235,583 and $211,137 as of July 31, 2009 and October 31, 2008 respectively.
 
NOTE 4 - INVESTMENTS

During the year ended October 31, 2007, the Company received marketable securities in settlement of $533,147 loan and $316,853 of accounts receivable. As of October 31, 2008, the Company had an investment of $153,000 that was considered available-for-sale for financial reporting purposes which included an unrealized loss of $697,000 included in the determination of comprehensive loss. As of April 30, 2009, this investment had a value of $68,000, with an unrealized loss of $782,000. This unrealized loss has, until now been included in the determination of comprehensive loss, but, during the period ended July 31, 2009, we have determined that this investment in marketable securities is impaired because we believe that the fair market value of the investment has permanently declined. Accordingly, we have written off the $782,000 during the period ended July 31, 2009. The remaining fair value of this investment is $34,000 as of July 31, 2009.
 
13
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 5 - OTHER CURRENT ASSETS
 
Other current assets on the balance sheet total $435,397 and $407,080 at July 31, 2009 and October 31, 2008 respectively. These totals comprise the following:

   
2009
    
2008
  
Deposits
  
$
95,402
    
$
110,548
  
Value added tax (VAT)
    
19,307
      
262,090
  
Other receivable
    
320,689
      
34,442
  
                 
Total
  
$
435,397
    
$
407,080
  
  
NOTE 6 - FIXED ASSETS
 
Property and equipment at July 31, 2009 and October 31, 2008 is summarized as follows:
 
   
2009
    
2008
  
Machinery and equipment
  
$
1,253,649
    
$
1,076,950
  
Accumulated depreciation
    
(845,123
)
    
(721,041
)
                 
Net property and equipment assets
  
$
408,526
    
$
355,909
  
 
Depreciation expense recorded in the statement of operations for the period ended July 31, 2009 and year ended October 31, 2008 is $124,412 and $176,147, respectively.

NOTE 7 - INTANGIBLE ASSETS AND GOODWILL
 
The Company has adopted SFAS No. 142, Goodwill and Other Intangible Assets, whereby the Company periodically tests its intangible assets for impairment. On an annual basis, and when there is reason to suspect that their values have been diminished or impaired, these assets are tested for impairment, and write-downs will be included in results from operations.
 
The identifiable intangible assets acquired and their carrying value at July 31, 2009 and October 31, 2008 is:
  
   
2009
    
2008
  
Customer relationships (weighted average life of 9.2 years)
  
$
784,242
    
$
694,503
  
Non-compete agreements (weighted average life of 2.8 years)
    
278,650
      
198,911
  
Patents (weighted average life of 10 years)
    
72,412
      
63,695
  
Licenses (weighted average life of 2 years)
    
100,000
      
100,000
  
                 
Total amortized identifiable intangible assets - gross carrying value
    
1,235,304
      
1,057,109
  
Less accumulated amortization
    
(496,503
)
    
(324,661
)
                 
Net
    
738,801
      
732,448
  
                 
Residual value
  
$
738,801
    
$
732,448
  
 
14
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Our acquisition of Dragon Design Ltd (“Dragon”) in December 2008 resulted in the valuation of Dragon’s customer relationships and covenants not to compete as intangible assets (see Note 14), which have an estimated useful life of 3 years each, and as such are being amortized on a straight-line basis over that period. In addition, we recognized goodwill of $282,533 that represents the excess of the purchase price we paid over the fair value of Dragon’s net tangible and intangible assets we acquired.
 
Our acquisition of the assets of Tactical Intelligence, LLC (“Tactical”) In November 2008 resulted in the valuation of Tactical’s customer relationships and covenants not to compete as intangible assets (see Note 14), which have an estimated useful life of 3 years each, and as such are being amortized monthly over that period. In addition, we recognized goodwill of $135,000 that represents the excess of the purchase price we paid over the fair value of Tactical’s net tangible and intangible assets acquired.

Estimated annual amortization expense as of July 31, 2009 is as follows:
  
2009
  
$
50,967
  
2010
    
143,592
  
2011
    
131,537
  
2012
    
76,696
  
2013 and thereafter
    
336,008
  
         
Total
  
$
738,801
  
 
Amortization of patents, customer relationships, non-compete agreements and licenses included as a charge to income amounted to $171,842 and $189,621 for the period ended July 31, 2009 and year ended October 31, 2008, respectively. Goodwill is not being amortized.
 
As a result of the acquisitions of Martech, Colmek, Dragon and Tactical, the Company has goodwill in the amount of $3,517,108 as of July 31, 2009 and $3,099,575 as of October 31, 2008. The changes in the carrying amount of goodwill for the period ended July 31, 2009 and year ended October 31, 2008 are recorded below.
  
   
2009
    
2008
  
Beginning goodwill balance at November 1:
                
CodaOctopus Colmek, Inc.
  
$
2,038,699
    
$
2,038,669
  
CodaOctopus Martech Ltd
    
998,591
      
998,591
  
CodaOctopus Products Ltd
    
62,315
      
62,315
  
Goodwill recorded upon acquisition:
                
CodaOctopus Tactical Intelligence, Inc.
    
135,000
      
-
  
Dragon Design Ltd
    
282,533
      
-
  
                 
Balance at July 31, 2009 and October 31, 2008
  
$
3,517,108
    
$
3,099,575
  
 
Considerable management judgment is necessary to estimate fair value. We enlist the assistance of an independent valuation consultant to determine the values of our intangible assets and goodwill, both at the dates of acquisition and at specific dates annually. Based on various market factors and projections used by management, actual results could vary significantly from managements' estimates.
 
NOTE 8 - CAPITAL STOCK
 
The Company is authorized to issue 150,000,000 shares of common stock with a par value of $.001 per share. As of July 31, 2009 and October 31, 2008, the Company has issued and outstanding 49,000,244 shares and 48,853,664 shares of common stock, respectively. The Company is also authorized to issue 5,000,000 shares of preferred stock with a par value of $.001 per share. We have designated 50,000 preferred shares as Series A preferred stock and 50,000 preferred shares as Series B preferred stock. The remaining 4,900,000 shares of preferred stock is undesignated. There were 6,287 Series A preferred shares outstanding at July 31, 2009 and October 31, 2008 respectively, and nil Series B preferred shares outstanding at the same dates.
 
15
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Series A Preferred Stock
 
We designated 50,000 shares of our preferred stock, par value $.001, as Series A Preferred Stock. The Series A Preferred Stock ranks senior to all classes of common and preferred stock and has no liquidation preference above par. The Series A Preferred Stock is sold as units of $100 (or £100 where stock has been sold to investors in British Pounds) and has a dividend rate of 12% per year, ie. $12 per $100 unit, paid every six months, in May and November each year. The Series A Preferred Stock and accrued dividends is convertible at the option of the holder into shares of our common stock at a conversion price of $1.00 per share, and at the option of the Company when the stock price reaches or exceeds $3.00.
 
During the year ended October 31, 2008, we issued 200 shares of Series A Preferred Stock, which were subscribed for in March 2007 and converted 320 shares of Series A Preferred Stock into 32,000 shares of common stock. The total of Series A preferred stock outstanding is 6,287 shares at October 31, 2008 and July 31, 2009, convertible into 1,013,670 shares of common stock.

Series B Preferred Stock
 
We designated 50,000 shares of our preferred stock, par value $.001, as Series B Preferred Stock. The Series B Preferred Stock ranks junior to our issued and outstanding Series A preferred Stock and senior to all classes of common stock. The Series B Preferred Stock has a dividend rate of 8% per year. The Series B Preferred Stock and accrued dividends are convertible at the option of the holder into shares of our common stock at a conversion price of $1.00 per share. As of October 31, 2008 and July 31, 2009, we have no shares of Series B Preferred Stock outstanding. 
 
Common Stock
 
During the period ending July 31, 2009 we issued 146,580 shares of common stock, valued at $30,310, to employees, directors and consultants for services, of which $11,790 was subscribed for during the year ending October 31, 2008, leaving a charge for compensation in the period ending July 31, 2009 of $18,520.

During the year ended October 31, 2008 we issued 452,937 shares of common stock, valued at $263,476, to employees, directors and consultants for services. We also issued 38,319 shares as dividends on Series A Preferred Stock, which had accrued over the period August 2006 to April 2008, valued at $41,537. A further 60,000 shares of common stock were issued to an investor, which were subscribed for during the year to October 31, 2007, plus 4,200 shares for financing, and 56,640 shares to an investor on conversion of 320 shares of Series A Preferred stock.
 
Other Equity Transactions
 
During the period ended July 31, 2009, we did not issue any common share purchase options. However, options issued in earlier periods vested, resulting in a charge of $305,501 in this period. There were also 210,000 options cancelled connected with staff departures, of which 95,000 were exercisable.
 
During the year ended October 31, 2008, we issued in the aggregate 1,870,000 common share purchase options to employees and consultants, with exercise prices of $1.30 to $1.50. The initial fair value of the options was $872,170 using the Black-Scholes method at the date of grant of the options based on the following assumptions: (1) risk free interest rate of 3.43%-5.25%; (2) dividend yield of 0%; (3) volatility factor of the expected market price of our common stock of 222% - 246%; and (4) an expected life of the options of 2 years. The fair value of the options has been expensed in this period. In accordance with EITF 96-18, the fair value of consultant vesting options will be recomputed at each reporting period and any increase will be charged to expense. Due to staff departures, 50,000 options were cancelled, all of which had exercise prices of $1.70. During the year ended October 31, 2008, $257,547 was charged to expense.
 
16
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 9 - WARRANTS AND STOCK OPTIONS
 
Transactions involving stock options and warrants issued are summarized as follows:

Warrants
  
Nine months ended
July 31, 2009
    
Year ended
October 31, 2008
  
   
Number
    
Weighted
Average Exercise
Price
    
Number
    
Weighted
Average Exercise
Price
  
                         
Outstanding at beginning of the period
    
32,583,418
    
$
1.42
      
31,983,418
    
$
1.42
  
Granted during the period
    
-
      
-
      
600,000
      
1.50
  
Terminated during the period
    
-
      
-
      
-
      
-
  
                                 
Outstanding at the end of the period
    
32,583,418
    
$
1.42
      
32,583,418
    
$
1.42
  
                                 
Exercisable at the end of the period
    
32,583,418
    
$
1.42
      
32,583,418
    
$
1.42
  

 The number and weighted average exercise prices of warrants outstanding as of July 31, 2009 are as follows:

Range of
Exercise Prices
  
Number
Outstanding
    
Weighted Average
Contractual Life
 (Yrs)
    
Total Exercisable
  
0.50
    
750,000
      
1.75
      
750,000
  
0.58
    
400,000
      
1.67
      
400,000
  
1.00
    
2,750,000
      
2.60
      
2,750,000
  
1.30
    
14,341,709
      
2.42
      
14,341,709
  
1.50
    
-
      
-
      
-
  
1.70
    
14,341,709
      
2.42
      
14,341,709
  
1.80
    
-
      
-
      
-
  
Totals
    
32,583,418
      
2.47
      
32,583,418
  


 Stock Options
  
Nine months ended
July 31, 2009
    
Year ended
October 31, 2008
  
   
Number
    
Weighted
Average Exercise
Price
    
Number
    
Weighted
Average Exercise
Price
  
                         
Outstanding at beginning of the period
    
5,755,900
    
$
1.18
      
4,535,900
    
$
1.16
  
Granted during the period
    
-
      
-
      
1,270,000
      
1.30
  
Terminated during the period
    
(210,000
) 
    
1.32
      
(50,000
)
    
1.70
  
                                 
Outstanding at the end of the period
    
5,545,900
    
$
1.18
      
5,755,900
    
$
1.18
  
                                 
Exercisable at the end of the period
    
4,889,100
    
$
1.16
      
4,578,000
    
$
1.14
  
   
The number and weighted average exercise prices of stock purchase options outstanding as of July 31, 2009 are as follows:  
  
Range of
Exercise Prices
  
Number
Outstanding
    
Weighted Average
Contractual Life
 (Yrs)
    
Total Exercisable
  
0.50
    
-
      
-
      
-
  
0.58
    
-
      
-
      
-
  
1.00
    
3,045,900
      
1.12
      
3,045,900
  
1.30
    
1,705,000
      
3.57
      
1,048,200
  
1.50
    
425,000
      
2.45
      
425,000
  
1.70
    
310,000
      
2.92
      
310,000
  
1.80
    
60,000
      
3.15
      
60,000
  
Totals
    
5,545,900
      
2.10
      
4,889,100
  
 
NOTE 10 - INCOME TAXES
 
The Company has adopted Financial Accounting Standard No. 109 which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes are insignificant.
 
For income tax reporting purposes, the Company's aggregate US unused net operating losses approximate $45,400,000 which expire through 2029, subject to limitations of Section 382 of the Internal Revenue Code, as amended. The deferred tax asset related to the carry forward is approximately $15,436,000. The Company has provided a valuation reserve against the full amount of the net operating loss benefit, because in the opinion of management based upon the earning history of the Company, it is more likely than not that the benefits will not be realized.
 
For income tax reporting purposes, the Company's aggregate UK unused net operating losses approximate $7,344,000, with no expiration. The deferred tax asset related to the carry-forward is approximately $2,277,000. The Company has provided a valuation reserve against the full amount of the net operating loss benefit, because in the opinion of management based upon the earning history of the Company, it is more likely than not that the benefits will not be realized.
 
17
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Income tax expense for 2008 represents income taxes on our Norwegian subsidiary.
 
Components of deferred tax assets as of July 31, 2009 and October 31, 2008 are as follows:
  
Non-Current
  
2009
    
2008
  
             
Net Operating Loss Carry Forward
  
$
17,713,000
    
$
16,485,000
  
Valuation Allowance
    
(17,713,000
)
    
(16,485,000
)
                 
Net Deferred Tax Asset
  
$
-
    
$
-
  

NOTE 11 - CONTINGENCIES AND COMMITMENTS
 
Litigation
 
The Company is currently engaged in a lawsuit involving the former Chief Executive Officer of its subsidiary, Coda Octopus Colmek, Inc. The former CEO claims breach of his employment contract, tortuous interference with his contract, termination in violation of public policy and failure to pay wages when due. He filed a complaint on November 10, 2008 and an amended complaint on December 10, 2008. We answered the amended complaint on December 22, 2008 denying the allegations, raising affirmative defenses and intend to defend ourselves vigorously.  We believe that the final disposition should not have a material adverse effect on our financial position or results of operations.

We may become subject to other legal proceedings and claims, which arise in the ordinary course of our business. Although occasional adverse decisions or settlements may occur, we believe that the final disposition of any matters should not have a material adverse effect on our financial position or results of operations.
 
Factoring Agreement
 
Until October 31, 2008, we factored certain of our receivables pursuant to a number of factoring agreements with Faunus Group International (“FGI”). Advances received pursuant to the agreement are secured by our accounts receivable and other assets of the Company. An initial factoring agreement was entered into on August 17, 2005 between FGI and Coda Octopus Group, Inc., for a maximum borrowing in the US of up to $1 million. Subsequent agreements were added in November 2006 covering our UK businesses, Martech Systems Ltd and Coda Octopus Products Ltd. Under the arrangement, FGI typically advanced to the Company 80% of the total amount of accounts receivable factored. FGI retained 20% of the outstanding factored accounts receivable as a reserve, which it holds until the customer pays the factored invoice to FGI. The cost of funds for the accounts receivable portion of the borrowings with FGI was 1.85% for the initial 30 day credit period, up to a maximum of 45 days; thereafter, an additional fee of 0.5% was charged for each 10 day period.

Over the course of the year ended October 31, 2008, we factored invoices totaling $7,545,200 in receivables and we received $5,828,550 in proceeds from FGI. As of October 31, 2008 all FGI agreements were terminated and advances repaid in full.
 
On February 20, 2008, FGI, RBS entered into an inter-creditor agreement with the Company, regulating the priority of each creditor’s debts.
  
Operating Leases
 
We occupy our various office and warehouse facilities pursuant to both term and month-to-month leases. Our term leases expire at various times through September 2013. Future minimum lease obligations are approximately $1,716,013, with the minimum future rentals due under these leases as of July 31, 2009 as follows:
 
2009
  
$
150,615
  
2010
    
492,973
  
2011
    
468,810
  
2012
    
258,389
  
2013 and thereafter
    
345,224
  
         
Total
  
$
1,716,013
  

Concentrations
 
We had no concentrations of purchases of over 5% during either of the period ended July 31, 2009 and year ended October 31, 2008. We had a sales concentration of over 5% for the period ended July 31, 2009 and for the year ended October 31, 2008 due to a sale to a customer for $1,178,783 and $1,557,130 respectively.
 
18
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 12 - NOTES AND LOANS PAYABLE
 
A summary of notes payable at July 31, 2009 and October 31, 2008 is as follows:
   
July 31,
2009
    
October 31,
 2008
  
The Company has a secured convertible debenture for $12M with a life of 7 years from February 26, 2008, maturing at 130% of face value, and with interest payable every six months, starting in February 2009, at a rate of 8.5%; During the term, the debentures are convertible into our common stock at the option of the Noteholders at a conversion price of $1.05. We may also force the conversion of these Notes into our common stock after two years in the event that we obtain a listing on a national exchange and our stock price closes on 40 consecutive trading days at or above $2.50 between the second and third anniversaries of this agreement; $2.90 between the third and fourth anniversaries of this agreement; and $3.50 after the fourth anniversary of this agreement or where the daily volume weighted average price of our stock as quoted on OTCBB or any other US National Exchange on which our securities are then listed has, for at least 40 consecutive trading days closed at the agreed price. The Company has failed to comply with certain covenants contained in the debenture agreement.
  
$
13,184,357
    
$
12,348,493
  
                 
The Company, through its UK subsidiary Coda Octopus Products Ltd has a 7 year unsecured loan note for £100,000; interest rate of 12% annually; repayable at borrower’s instigation or convertible into common stock when the share price reaches $3.
    
165,241
      
162,700
  
                 
The Company through its US subsidiary Coda Octopus Colmek, Inc., has an unsecured loan note payable to a director and former officer of the Company, which is being repaid in the short term.
    
-
      
10,104
  
                 
The Company through its UK subsidiary, Dragon Design Ltd, has an outstanding loan note payable for £14,000 over 36 months, commencing in November 2007, with monthly payments of £454.42 and an annual interest rate of 14.5%. By the end of July 2009, 17 payments remained on this note.
    
10,282
      
-
  
                 
The Company through its UK subsidiary, Dragon Design Ltd, has an unsecured revolving line of credit with their bank for £40,000, which is repayable on demand. The amount outstanding on this line of credit was reduced to zero in February 2009.
    
-
      
-
  
                 
Total
  
$
13,359,880
    
$
12,521,297
  
                 
Less: current portion
    
13,187,381
      
12,358,597
  
                 
Total long-term portion
  
$
172,499
    
$
162,700
  

In connection with the secured convertible debenture noted above and the Cash Control Framework Agreement (see below), we carry $1,331,702 deferred financing costs as an asset on the consolidated balance sheet at July 31, 2009, which represents $1,694,893 in financing closing costs we incurred, net of $363,191 in amortization expense at July 31, 2009 and $181,596 in amortization expense at October 31, 2008. We amortize deferred financing costs over the life of the financing facility using the straight line method.

On March 16, 2009, the Company and the holder of the secured convertible debenture (“the Noteholder”) entered into a Cash Control Framework Agreement, pursuant to which it is assumed that, subject to the Company being fully compliant with the terms of this agreement and those set out in the Transaction Documents entered into between the Company and the Noteholder on February 21, 2008, no adverse actions will be taken by the Noteholder. The agreement provides, among other things, for the placement of approximately $2.15 million into a segregated cash account. Under the terms of the agreement, we may request the release of funds from the account from time to time for working capital purposes, subject to the Noteholder’s consent and agreed upon terms and conditions. Under the terms of the agreement, we must also adhere to a strict cost cutting program which involves reducing our SG&A, R&D and capital expenditure by an annualized $3.35 million. We believe that the terms of this agreement may provide us with sufficient liquidity to operate for fiscal 2009.

NOTE 13 - RELATED PARTY TRANSACTIONS
 
We have been indebted to various related parties for advances for payments of operating expenses and dividends. These related parties include our biggest shareholder and other entities controlled by this shareholder. Advances are non interest bearing and are due on demand. At the end of the period ending July 31, 2009, nil was due to related parties, compared with $41,904 for the year ending October 31, 2008.
 
We are also owed by related parties a sum of nil at July 31, 2009 compared to $54,166 at October 31, 2008.
 
19
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 14 - ACQUISITIONS

Acquisition of Tactical Intelligence

In November 2008, the Company formed a new subsidiary called Coda Octopus Tactical Intelligence, Inc. (“Tactical”) to facilitate our entry into the counter-terrorism and anti-piracy training markets, which we believe are integral to our efforts to help major customers deploy real time 3D sonar systems in hot spots around the world.  On November 10, 2008, Tactical acquired the assets of Tactical Intelligence International, LLC and Tactical Executive Services, LLC, which consisted of some plant and machinery, valued at $5,000, customer relationships, valued at $60,000, non-compete agreements, valued at $50,000, and goodwill, valued at $135,000.The purchase price consisted of an initial cash outlay of $125,000, a convertible promissory note in the amount of $125,000 due on November 10, 2009, and 50,000 options to acquire common shares of Coda Octopus Group, Inc., which are due to be issued in June 2009. As part of the transaction we acquired the services of two specialists in the field of real world security training for domestic and international military units and government agencies to spearhead this drive. These individuals have designed or led more than 50 such training programs throughout the world since September 11, 2001, using up to 100 freelance specialists on a contract basis. The expertise of this part of the Group will be used to leverage our Echoscope and UIS capabilities in sales and training.

The acquisition of Tactical was accounted for using the purchase method in accordance with SFAS 141. The results of operations for Tactical have been included in the Consolidated Statements of Operations since the date of acquisition. In accordance with SFAS No. 141, the total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The estimate of fair value of the assets acquired was based on management’s estimates. The total purchase price was allocated to the assets and liabilities acquired as follows:

Equipment, net
  
$
5,000
  
Customer relationships acquired
    
60,000
  
Non-compete agreements acquired
    
50,000
  
Goodwill
    
135,000
  
Total purchase price
  
$
250,000
  
 
The intangible assets acquired consisted of customer relationships and non-compete agreements, which have an estimated useful life of 3 years each and as such will be amortized monthly over those periods. Goodwill of $135,000 represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired.

Acquisition of Dragon Design Ltd

In December 2008, the Company acquired the assets of Dragon Design Ltd (“Dragon”), an electronics manufacturing and design business based in Weymouth, UK, and situated next to its Martech subsidiary. Management believes the companies have complementary skills and capabilities that can enhance revenues and opportunities for both companies. The purchase price for the assets consisted of an initial cash outlay of £56,250 ($83,000) and a further £56,250 in deferred consideration, payable on the first anniversary of closing. The terms of the acquisition also included a potential earn out payment of £112,500, which is dependent on Dragon meeting future agreed performance criteria, that has also been accrued on the acquisition date.
 
The acquisition of Dragon was accounted for using the purchase method in accordance with SFAS 141(R). The results of operations for Dragon have been included in the Consolidated Statements of Operations since the date of acquisition. In accordance with SFAS No. 141(R), the total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The estimate of fair value of the assets acquired was based on management’s estimates. The total purchase price was allocated to the assets and liabilities acquired as follows:

Current assets acquired
  
$
147,039
  
Equipment, net
    
51,336
  
Current liabilities assumed
    
(201,166
)
Customer relationships acquired
    
29,740
  
Non-compete agreements acquired
    
29,740
  
Goodwill
    
282,533
  
Cash acquired
    
877
  
Total purchase price
  
$
340,099
  
 
20
 
CODA OCTOPUS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The intangible assets acquired, comprising customer relationships and non-compete agreements, have an estimated useful life of 3 years each and as such will be amortized monthly over those periods. Goodwill of $282,533 represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired.
 
The following unaudited pro forma results of operations for the period ended July 31, 2009 assume that the acquisition of Dragon occurred on November 1, 2008. These unaudited pro forma results are not necessarily indicative of the actual results of operations that would have been achieved nor are they are necessarily indicative of future results of operations.
  
   
2009
  
       
Revenue
  
$
11,063,282
  
Net loss
    
(4,262,059
)
Loss per common share
  
$ 
(0.09
)

NOTE 15 - SEGMENT INFORMATION
 
Due to the nature of our businesses, we are operating in two reportable segments, which are managed separately based upon fundamental differences in their operations. Martech, Dragon, Colmek, Tactical and Innalogic operate as contractors, and the balance of our operations is comprised of product sales.
 
Segment operating income is total segment revenue reduced by operating expenses identifiable with the business segment. Corporate includes general corporate administrative costs.
 
The Company evaluates performance and allocates resources based upon operating income. The accounting policies of the reportable segments are the same as those described in the summary of accounting policies.

There are inter-segment sales between our engineering contracting businesses and our products businesses, which have been removed from the information shown below.
 
The following table summarizes asset and operating balances by reportable segment.
 
   
July 31, 2009
    
October 31, 2008
  
   
Contracting
    
Products
    
Corporate
    
Contracting
    
Products
    
Corporate
  
Current assets, excl. interco.
  
$ 
4,532,515
    
$
2,399,373
    
$
2,532,557
    
$
3,370,812
    
$
4,181,440
    
$
4,137,564
  
Property and equipment, net
    
211,825
      
113,578
      
83,122
      
163,238
      
141,189
      
51,483
  
Deferred financing costs
    
-
      
-
      
1,331,702
      
-
      
-
      
1,513,297
  
Goodwill
    
3,454,793
      
62,315
      
-
      
3,037,260
      
62,315
      
-
  
Other intangible assets
    
691,154
      
-
      
47,647
      
689,760
      
-
      
42,688
  
Total assets
    
8,890,287
      
2,575,266
      
3,995,028
      
7,261,070
      
4,384,945
      
5,745,032
  
                                                 
Current liabilities, excl. interco.
    
2,475,517
      
1,216,137
      
14,307,585
      
1,470,179
      
900,709
      
13,859,509
  
Long term liabilities
    
7,258
      
165,241
      
-
      
-
      
162,700
      
-
  
Total liabilities
    
2,482,775
      
1,381,378
      
14,307,585
      
1,470,179
      
1,063,409
      
13,859,509
  
                                                 
Capital expenditure
    
251,668