UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2008
Commission File Number: 000-28153
QPC LASERS, INC
(Exact name of registrant as specified in its charter)
Nevada | 20-1568015 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
15632 Roxford Street, Sylmar, CA. | 91342 | |
(Address of principal executive offices) | (Zip Code) |
(818) 986-0000
(Registrant’s telephone number, including area code)
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company x |
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of May 6, 2008, there were 39,346,561 shares of the registrant’s Common Stock outstanding.
INDEX TO FORM 10-Q
PAGE | |
PART I FINANCIAL INFORMATION | |
Item 1. Condensed Consolidated Financial Statements | 3 |
Condensed Consolidated Balance Sheets at March 31, 2008 (unaudited) and December 31, 2007 | 3 |
Condensed Consolidated Statements of Operations for the three month periods ended March 31, 2008 and March 31, 2007 (unaudited) | 4 |
Condensed Consolidated Statements of Stockholders' Deficiency (unaudited) | 5 |
Condensed Consolidated Statements of Cash Flows for the three month periods ended March 31, 2008 and March 31, 2007 (unaudited) | 6 |
Notes to Unaudited Condensed Consolidated Financial Statements | 7 |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 22 |
Item 3. Quantitative and Qualitative Disclosures about Market Risk | 38 |
Item 4. Control and Procedures | 38 |
Item 4T. Control and Procedures | 39 |
PART II OTHER INFORMATION | |
Item 1. Legal Proceedings | 40 |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 40 |
Item 3. Defaults Upon Senior Securities | 40 |
Item 4. Submission of Matters to a Vote of Security Holders | 40 |
Item 5. Other Information | 40 |
Item 6. Exhibits | 40 |
SIGNATURES | 45 |
2
Item 1 Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2008 (Unaudited) | December 31, 2007 | ||||||
CURRENT ASSETS | |||||||
Cash | $ | 2,183,372 | $ | 6,431,744 | |||
Accounts receivable, Commercial customers, net of allowance for doubtful accounts of $226,288 at March 31, 2008 and $3,735 at December 31, 2007 | 2,727,709 | 2,283,425 | |||||
Accounts receivable, Government contracts, net | 163,007 | 609,874 | |||||
Unbilled Revenue | 280,640 | 194,537 | |||||
Inventory | 989,742 | 688,364 | |||||
Prepaid expenses and other current assets | 179,592 | 226,466 | |||||
Total Current Assets | 6,524,062 | 10,434,410 | |||||
Property and equipment, net of accumulated depreciation of $6,221,749 at March 31, 2008 and $6,051,713 at December 31, 2007 | 3,264,641 | 3,359,711 | |||||
Other assets | 203,415 | 203,415 | |||||
TOTAL ASSETS | $ | 9,992,118 | $ | 13,997,536 | |||
LIABILITIES AND STOCKHOLDER’S DEFICIENCY | |||||||
CURRENT LIABILITIES | |||||||
Accounts payable and other current liabilities | $ | 1,624,872 | $ | 1,737,581 | |||
Embedded Derivative Liability | 13,210,837 | 10,283,181 | |||||
Current portion of long term debt | 592,108 | 624,834 | |||||
Total Current Liabilities | 15,427,817 | 12,645,596 | |||||
Long term debt, less current portion | 13,615,223 | 11,435,133 | |||||
Total Liabilities | 29,043,040 | 24,080,729 | |||||
STOCKHOLDERS’ DEFICIENCY | |||||||
Preferred stock, $.001 par value, 20,000,000 shares authorized, none issued | - | - | |||||
Common stock, $.001 par value, 180,000,000 shares authorized, 38,676,783 issued and outstanding | 38,677 | 38,677 | |||||
Additional paid in capital | 51,237,262 | 51,095,087 | |||||
Accumulated deficit | (70,326,861 | ) | (61,216,957 | ) | |||
Total stockholders’ deficiency | (19,050,922 | ) | (10,083,193 | ) | |||
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY | $ | 9,992,118 | $ | 13,997,536 |
See accompanying Notes to Condensed Consolidated Financial Statements
3
QPC LASERS, INC.
CONDENSED CONSOLIDTED STATEMENTS OF OPERATIONS
For the three months Ended March 31, 2008 and 2007
(Unaudited)
Three months ended March 31, | |||||||
2008 | 2007 | ||||||
REVENUE | 1,648,194 | 1,106,579 | |||||
COST OF SALES | 851,093 | 855,781 | |||||
GROSS PROFIT | 797,101 | 250,798 | |||||
OPERATING EXPENSES | |||||||
Research and Development | 1,426,533 | 1,012,800 | |||||
Selling, General and Administrative | 2,653,707 | 1,216,524 | |||||
Total operating expenses | 4,080,240 | 2,229,324 | |||||
LOSS FROM OPERATIONS | (3,283,139 | ) | (1,978,526 | ) | |||
Interest Income | 29,261 | 1,754 | |||||
Interest Expense | (2,953,878 | ) | (468,399 | ) | |||
Change in fair value of embedded derivative | (2,927,656 | ) | - | ||||
Other income | 25,508 | 31,966 | |||||
NET LOSS | $ | (9,109,904 | ) | $ | (2,413,205 | ) | |
LOSS PER COMMON SHARE — Basic and Diluted | $ | (0.24 | ) | $ | (0.06 | ) | |
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, basic and diluted | 38,676,783 | 38,559,283 |
See accompanying Notes to Condensed Consolidated Financial Statements
4
QPC LASERS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended March 31, 2008 (Unaudited)
Common Stock | Additional | Accumulated | ||||||||||||||
Shares | Amount | Paid-in Capital | Deficit | Total | ||||||||||||
Balance, January 1, 2008 | 38,676,783 | $ | 38,677 | $ | 51,095,087 | $ | (61,216,957 | ) | $ | (10,083,193 | ) | |||||
Fair value of vested stock options | - | - | 142,175 | - | 142,175 | |||||||||||
Net loss for the three months ended March 31, 2008 | - | - | - | (9,109,904 | ) | (9,109,904 | ) | |||||||||
Balance, March 31, 2008 | 38,676,783 | $ | 38,677 | $ | 51,237,262 | $ | (70,326,861 | ) | $ | (19,050,922 | ) |
See accompanying Notes to Condensed Consolidated Financial Statements
5
QPC LASERS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, 2008 and 2007
(Unaudited)
Three Months Ended | |||||||
2008 | 2007 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES | |||||||
Net Loss | $ | (9,109,904 | ) | $ | (2,413,205 | ) | |
Adjustments to reconcile net loss to net cash used in operating activities: | |||||||
Depreciation and amortization | 170,035 | 247,767 | |||||
Amortization of loan discount | 2,319,829 | 240,221 | |||||
Amortization of Capitalized Loan Fees | 14,595 | ||||||
Change in fair value of embedded derivatives | 2,927,656 | ||||||
Fair value of vested options | 142,175 | 115,361 | |||||
Changes in operating assets and liabilities: | |||||||
Accounts receivable | 2,583 | 244,916 | |||||
Inventory | (301,378 | ) | (10,031 | ) | |||
Unbilled revenue | (86,103 | ) | (278,375 | ) | |||
Other assets | - | (146,990 | ) | ||||
Prepaid Expenses | 46,874 | 61,607 | |||||
Accounts payable and other current liabilities | (112,709 | ) | 595,179 | ||||
Net cash used in operating activities | (4,000,942 | ) | (1,328,955 | ) | |||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Purchase of property and equipment | (74,965 | ) | (48,785 | ) | |||
Net cash used in investing activities | (74,965 | ) | (48,785 | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Proceeds from borrowing | - | 500,000 | |||||
Principal payments on debt | (172,465 | ) | (238,143 | ) | |||
Net cash provided by financing activities | (172,465 | ) | 261,857 | ||||
NET INCREASE IN CASH | (4,248,372 | ) | (1,115,883 | ) | |||
CASH — Beginning of period | 6,431,744 | 1,429,077 | |||||
CASH — End of period | $ | 2,183,372 | $ | 313,194 | |||
Supplemental Disclosures of Cash Flow Information | |||||||
Cash paid during the period for: | |||||||
Interest | $ | 577,903 | $ | 199,364 | |||
Taxes | - | - |
See accompanying Notes to Condensed Consolidated Financial Statements
6
QPC LASERS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007 (UNAUDITED)
NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of QPC Lasers, Inc. (the Company) have been prepared, without audit, in accordance with U.S. generally accepted accounting principles for interim financial reporting. Accordingly, the condensed consolidated financial statements do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, such interim financial statements contain all adjustments (consisting of normal recurring items) considered necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods presented. The results of operations and cash flows for any interim period are not necessarily indicative of results that may be reported for the full fiscal year.
The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, and the notes thereto, included in our Annual Report on Form 10-KSB for the year ended December 31, 2007, as filed with the Securities and Exchange Commission.
ORGANIZATION AND NATURE OF OPERATIONS
The Company was originally incorporated in the State of Nevada on August 31, 2004 under the name “Planning Force, Inc.” (PFI) as a development stage company that planed to specialize in event planning for corporations. The Company offered two types of services: retreat training services and product launch event planning. This business generated minimal revenue for the Company since inception.
Effective May 1, 2006, Planning Force Inc., changed its name to QPC Lasers, Inc. On May 12, 2006 QPC Lasers, Inc. (QPC) executed a Share Exchange Agreement by and among Julie Moran, its majority shareholder, and Quintessence Photonics Corporation (Quintessence) and substantially all of its shareholders. Under the agreement QPC issued one share of its common stock to the Quintessence shareholders in exchange for each share of QPC common stock (QPC Shares). Upon closing, Quintessence Shares represented at least 87% of QPC’s common stock. Therefore, a change in control occurred and Quintessence also became a wholly owned subsidiary of QPC. Accordingly, the transaction was accounted for as a reverse merger (recapitalization) in the accompanying condensed consolidated financial statements with Quintessence deemed to be the accounting acquirer and QPC is deemed to be the legal acquirer. As such the condensed consolidated financial statements herein reflect the historical activity of Quintessence since its inception, and the historical stockholders’ equity of Quintessence has been retroactively restated for the equivalent number of shares received in the exchange after giving effect to any differences in the par value offset to paid in capital.
GOING CONCERN
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company had a net loss of $9,710,564 and utilized cash of $8,561,410 in operating activities during the year ended December 31, 2007, and had a stockholders’ deficiency of $10,083,193 at December 31, 2007. During the three months ended March 31, 2008, the Company had a net loss of $9,109,904 and utilized cash of $4,000,942 in operating activities. At March 31, 2008 the Company had a stockholders’ deficiency of $19,050,922. These factors raise substantial doubt about the Company's ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might result from this uncertainty.
7
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Quintessence Photonics Corporation. All intercompany transactions have been eliminated in consolidation.
Revenue Recognition
A portion of the Company’s revenues result from fixed-price contracts with U.S. government agencies. Revenues from fixed-price contracts are recognized under the percentage-of-completion method of accounting, generally based on costs incurred as a percentage of total estimated costs of individual contracts (“cost-to-cost method”). Revisions in contract revenue and cost estimates are reflected in the accounting period as they are identified. Provisions for the entire amount of estimated losses on uncompleted contracts are made in the period such losses are identified. No contracts were determined to be in an overall loss position at December 31, 2007 or March 31, 2008. In addition, the Company has certain cost plus fixed fee contracts with U.S. Government agencies that are being recorded as revenue is earned based on time and costs incurred. At December 31, 2007, there was no deferred revenue and approximately $194,537 of unbilled receivables related to these government contracts. At March 31, 2008 there was no deferred revenue and $280,640 of unbilled receivables related to these government contracts.
The Company recognizes revenues on product sales, other than fixed-price contracts, based on the terms of the customer agreement. The customer agreement takes the form of either a contract or a customer purchase order and each provide information with respect to the product or service being sold and the sales price. If the customer agreement does not have specific delivery or customer acceptance terms, revenue is recognized at the time of shipment of the product to the customer. Revenue for services, such as non-recurring engineering charges, is recognized upon delivery of a technical report or other deliverable as specified in the contract or purchase order.
Management periodically reviews all product returns and evaluates the need for establishing either a reserve for product returns or a product warranty liability. As of March 31, 2008, management has concluded that neither a reserve for product returns nor a warranty liability is required.
Accounts receivable are reviewed for collectibility. A reserve is established at the end of a quarter in which management determines there is a collectibility problem, with the amount of the reserve based on management’s estimate of the potential bad debt. When management abandons all collection efforts it will directly write off the account and adjust the reserve accordingly.
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
8
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Stock-Based Compensation
Fair Value of Financial Instruments
The recorded values of cash, accounts receivable, accounts payable and other current liabilities approximate their fair values based on their short-term nature. The carrying amount of the notes payable and long term debt at March 31, 2008 and December 31, 2007 approximates fair value because the related effective interest rates on the instruments approximate rates currently available to the Company.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents placed with high credit quality institutions and account receivable due from government agencies and commercial customers. The Company places its cash and cash equivalents with high credit quality financial institutions. From time to time such cash balances may be in excess of the FDIC insurance limit of $100,000. Accounts receivable are typically unsecured and are derived from revenues earned from customers. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses; historically, such losses have been immaterial and within management's expectations. At March 31, 2008, three customers accounted for a total of 68% of the accounts receivable balance, and each of these customers individually accounted for more than 10% of the accounts receivable balance.
Allowance for Doubtful Accounts
The Company generally, requires no collateral or deposits from its customers and relies upon its own evaluation of a customer’s creditworthiness. The Company records an allowance for doubtful accounts receivable for credit losses at the end of each period based on an analysis of individual aged accounts receivable balances. As a result of this analysis, the Company believes that its allowance for doubtful accounts is adequate at March 31, 2008 and December 31, 2007. If the financial condition of the Company's customers should deteriorate, or other events occur which result in an impairment of collectibility of the receivable, additional allowances will be recorded.
Loss per Common Share
Basic loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted loss per share is calculated assuming the issuance of common shares, if dilutive, resulting from the exercise of stock options and warrants. At March 31, 2008 and 2007, potentially dilutive securities consisted of outstanding common stock purchase warrants and stock options to acquire an aggregate of 43,200,449 and 11,997,547 shares, respectively. Since the Company reported a net loss for the three months ended March 31, 2008 and 2007, these potentially dilutive common shares were excluded from the diluted loss per share calculation because they were anti-dilutive.
9
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Accounting for Derivative Instruments
Statement of Financial Accounting Standard (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, requires all derivatives to be recorded on the balance sheet at fair value. In September 2000, the Emerging Issues Task Force (“EITF”) issued EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company’s Own Stock,” (“EITF 00-19”) which requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value on a company’s balance sheet, with any changes in fair value recorded in the company’s results of operations. These derivatives, including embedded derivatives in the debentures issued in April and May 2007 that are discussed in Note 6, are separately valued and accounted for on our balance sheet, and revalued at each reporting period. The net change in the value of embedded derivative liability is recorded as change in fair value of derivative liability in the consolidated statement of operations, and is included in other income and expense.
Fair Value Instruments
Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This Statement defines fair value for certain financial and nonfinancial assets and liabilities that are recorded at fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This guidance applies to other accounting pronouncements that require or permit fair value measurements. On February 12, 2008, the FASB finalized FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157. This Staff Position delays the effective date of SFAS No. 157 for nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of SFAS No. 157 had no effect on the Company’s consolidated financial position or results of operations.
The Company partially adopted SFAS 157 on January 1, 2008, delaying application for non-financial assets and non-financial liabilities as permitted. This statement establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels as follows:
• | Level 1 — quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date. Financial assets and liabilities utilizing Level 1 inputs include active exchange-traded securities and exchange-based derivatives. |
• | Level 2 — inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data. Financial assets and liabilities utilizing Level 2 inputs include fixed income securities, non-exchange-based derivatives, mutual funds, and fair-value hedges. |
• | Level 3 — unobservable inputs for the asset or liability only used when there is little, if any, market activity for the asset or liability at the measurement date. Financial assets and liabilities utilizing Level 3 inputs include infrequently-traded, non-exchange-based derivatives and commingled investment funds, and are measured using present value pricing models. |
10
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In accordance with SFAS 157, the Company determines the level in the fair value hierarchy within which each fair value measurement in its entirety falls, based on the lowest level input that is significant to the fair value measurement in its entirety.
The following table presents the embedded derivative, the Company’s only financial assets measured and recorded at fair value on the Company’s Consolidated Balance Sheets on a recurring basis and their level within the fair value hierarchy during the three months ended March 31, 2008:
Fair Value | |||||||||||||
As of March 31, 2008 | Level 1 | Level 2 | Level 3 | Total | |||||||||
Embedded derivative liabilities | $ | - | $ | 13,210,837 | $ | - | $ | 13,210,837 |
The following table reconciles, for the period ended March 31, 2008, the beginning and ending balances for financial instruments that are recognized at fair value in the consolidated financial statements:
Balance of Embedded derivative at December 31, 2007 | $ | 10,283,181 | ||
Loss on fair value adjustments to embedded derivatives | 2,927,656 | |||
Balance at March 31, 2008 | $ | 13,210,837 |
The valuation of the derivatives are calculated using a complex binomial pricing model that is based on changes in the volatility of our shares and our stock price and the time to conversion of the related financial instruments. See Note 6 for more information on the valuation methods used.
Income Taxes
Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. The Company considers future taxable income and ongoing, prudent and feasible tax planning strategies, in assessing the value of its deferred tax assets. If the Company determines that it is more likely than not that these assets will not be realized, the Company will reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on the Company’s judgment. If the Company subsequently determines that the deferred tax assets, which have a full valuation allowance, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made. The company’s adoption of Fin 48 on January 1, 2007 had no effect on the company’s income taxes.
Recent Accounting Pronouncements
In December 2007, the FASB issued FASB Statement No. 141 (R), “Business Combinations” (FAS 141(R)), which establishes accounting principles and disclosure requirements for all transactions in which a company obtains control over another business. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.
11
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS No. 160 establishes accounting and reporting standards that require that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently. SFAS No. 160 also requires that any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value when a subsidiary is deconsolidated. SFAS No. 160 also sets forth the disclosure requirements to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS No. 160 must be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements are applied retrospectively for all periods presented.
In March 2008, the FASB issued SFAS No. 161 “Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends SFAS 133 by requiring expanded disclosures about an entity’s derivative instruments and hedging activities. SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. SFAS 161 is effective for the Company as of January 1, 2009. The Company is currently assessing the impact of SFAS 161 on its consolidated financial statements.
12
NOTE 3 – INVENTORY
Inventory consists of the following:
March 31, 2008 (Unaudited) | December 31, 2007 | ||||||
Raw materials | $ | 830,397 | $ | 549,792 | |||
Work in process | 142,378 | 126,003 | |||||
Finished Goods | 18,590 | 14,192 | |||||
Reserve for slow moving and obsolescence | (1,623 | ) | (1,623 | ) | |||
$ | 989,742 | $ | 688,364 |
NOTE 4 – PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
March 31, 2008 (Unaudited) | December 31, 2007 | Useful Lives | ||||||||
Computer software | $ | 86,803 | $ | 86,803 | 3 years | |||||
Furniture and fixtures | 124,380 | 124,380 | 6 years | |||||||
Computer equipment | 171,327 | 161,310 | 3 years | |||||||
Office equipment | 73,258 | 72,230 | 5 years | |||||||
Lab and manufacturing equipment | 5,132,965 | 5,071,681 | 5 years | |||||||
Leasehold improvements | 3,889,307 | 3,886,670 | 14 years | |||||||
Construction in progress | 8,350 | 8,350 | ||||||||
9,486,390 | 9,411,424 | |||||||||
Less accumulated depreciation and amortization | (6,221,749 | ) | (6,051,713 | ) | ||||||
Property and equipment, net | $ | 3,264,641 | $ | 3,359,711 |
Depreciation and amortization expense related to property and equipment amounted to $170,035 and $247,767, respectively for the three months ended March 31, 2008 and 2007.
13
As of December 31, 2007, long term debt consisted of the following:
Loan Balance | Loan discount | Current portion | Noncurrent Portion | ||||||||||
Subordinated Secured Convertible Notes (a) | $ | 145,169 | $ | (10,494 | ) | $ | 134,675 | $ | — | ||||
Finisar Secured Note (b) | 5,618,256 | — | 340,431 | 5,277,825 | |||||||||
Secured Equipment Financing (c) | 403,755 | — | 149,728 | 254,027 | |||||||||
April Secured Debentures (d) | 7,976,146 | (5,151,261 | ) | — | 2,824,885 | ||||||||
May Secured Debentures (e) | 10,554,500 | (7,476,104 | ) | — | 3,078,396 | ||||||||
$ | 24,697,826 | $ | (12,637,859 | ) | $ | 624,834 | $ | 11,435,133 |
As of March 31, 2008, long term debt consisted of the following:
Loan Balance | Loan discount | Current portion | Noncurrent Portion | ||||||||||
Subordinated Secured Convertible Notes (a) | $ | 87,660 | $ | (6,996 | ) | $ | 80,664 | $ | — | ||||
Finisar Secured Note (b) | 5,536,211 | — | 348,764 | 5,187,447 | |||||||||
Secured Equipment Financing (c) | 370,845 | — | 162,680 | 208,165 | |||||||||
April Secured Debentures (d) | 7,976,146 | (4,154,243 | ) | — | 3,821,903 | ||||||||
May Secured Debentures (e) | 10,554,500 | (6,156,792 | ) | — | 4,397,708 | ||||||||
$ | 24,525,362 | $ | (10,318,031 | ) | $ | 592,108 | $ | 13,615,223 |
(a) Subordinated Secured Convertible Notes Payable
During 2005, the Company issued $1,280,000 of subordinated, secured notes to nine note holders. The terms of the notes include interest only payments for 24 months, thereafter the loans were to be paid in full over the next twelve months. The loans are secured by all the assets of the Company. The interest rate on the loans is 10% per annum. The loans, at the option of the note holder, may be extended an additional three years, with the same terms as the original three year period. If the note holders elect to extend the loan, they will receive additional warrants to purchase 26,666 shares of the Company’s common stock for every $100,000 loaned to the Company. The conversion feature which is in effect during the time the loan is outstanding, allows the note holder to convert outstanding principal and interest into common stock at an initial conversion price of $3.75. The conversion price is subject to downward revision upon the occurrence of certain stock offerings. The downward revision is subject to a floor of $0.90 and allows the note holder to convert at the price of the most recent stock offering. The conversion price was reduced to $1.25 in December 2005, and reduced to $1.05 in April 2007. During April 2007, six of the note holders converted the remaining principal balance of their notes of $1,050,000 into the April 2007 Debentures (see (d) below).
14
NOTE 5 – LONG TERM DEBT (CONTINUED)
The Company issued warrants to purchase 320,000 shares of the Company’s common stock in connection with this debt offering during 2005. The warrants were valued at $0.73 a warrant or $233,600, using an option pricing model and were reflected as a loan discount amount, which has been netted against the loan principal balance. The assumptions used in the model were: risk free interest rate, 4.41%, expected life, 5 years, expected volatility, 70%, no expected dividends. The loan discount fee is being amortized over the life of the loan. Interest expense includes $3,498 and $19,467 relating to the amortization of this discount during the three months ended March 31, 2008 and 2007, respectively. The effective interest rate on these loans, giving effect for the modified terms and the loan discount is 22%.
The Company has analyzed the terms of the conversion feature and warrants issued to the note holders and has determined that such features do not give rise to an embedded derivative as defined by SFAS 133 and EITF 00-19 as the instruments are not derivative liabilities based on the analysis, principally because they are convertible into unregistered common shares, the Company has sufficient authorized shares available for conversion, there is a fixed maximum number of shares required to be issued, and there are no provisions that could require a net cash settlement.
(b) Finisar Senior Secured Note
During the year ended December 31, 2006, an agreement between Finisar and QPC to terminate the License Agreement dated September 18, 2003 became effective. In consideration of the termination of the license, the Company issued Finisar a $6 million promissory note. Payment terms of the note require that $1,000,000 of the principal, together with interest thereon payable at the rate of 9.7% per annum, be paid in thirty-six monthly installments, commencing on October 18, 2006. The remaining $5,000,000 of the principal shall be paid in full on September 18, 2009 and accrues interest at the rate of 9.7% per annum payable in arrears, on the 18th day of each calendar month commencing on October 18, 2006. The note is secured by substantially all of our assets.
(c) Secured Equipment Financing
On February 8, 2007, the Company completed a secured equipment lease financing transaction with a financing company. The Company sold and leased back certain manufacturing equipment that had been purchased by the Company between July and December 2006. The gross amount of the loan was $500,000. Repayments under the loan require a monthly payment of $21,990 for the first 30 months, $4,850 for the next 30 months, and then an option to extend for an additional 60 months for $2,800 per month. Additionally, at the end of the first 60 payments, the Company has the option of acquiring the equipment at the greater of 20% of the original cost ($100,000) or fair market value at the time.
The Company has determined that the substance of this lease was a financing transaction and reflected the amount payable to the lender as a secured debt in the accompanying financial statements. The Company calculated the interest rate implicit in the lease based on the stream of payments over the first 60 months of the lease, at which time management estimates they would exercise the purchase option for $100,000. As such, the interest rate implicit in the lease was calculated to be 33.5%. The Company is allocating its payments to principal and interest based upon this payment stream and implicit interest rate. The Company further determined that as the gross proceeds of the loan approximated the net book value of the assets on the date of the agreement, and no gain was recognized.
In accordance with the lease, the Company paid a security deposit of $125,000 that has been classified as other assets in the accompanying balance sheet that is secured by certain manufacturing equipment purchased by the company between July and December 2006.
15
NOTE 5 – LONG TERM DEBT (CONTINUED)
(d) April Secured Debentures
In April 2007, the Company entered into securities purchase agreements with certain investors, pursuant to which the Company issued the investors secured convertible debentures (the “April Secured Debentures”) in the aggregate principal amount of $7,976,146 at an original issue discount of 10% resulting in gross proceeds to the Company of $7,178,531. The April Secured Debentures have a term of 2 years and pay interest at the rate of 10% per annum, and are secured by all of our shares in Quintessence Photonics Corporation, the operating subsidiary which owns all of our operating assets. The April Secured Debentures are convertible into shares of the Company’s common stock at an initial conversion price of $1.05 per share, subject to adjustments as set forth therein and any applicable Milestone Adjustments. The initial fair value of this conversion feature was $4,738,682 using a complex Binomial Lattice pricing model using the assumptions provided below.
In connection with the April 2007 Debenture Offering, the Company granted warrants to purchase 11,394,494 shares of common stock to certain investors and warrants to purchase 212,796 shares of common stock to the dealers in that offering. The above warrants have an initial exercise price of $1.05 per share, subject to adjustments as set forth therein and any applicable Milestone Adjustments, and expire five years from the date of issuance. The aggregate purchase price for the April Secured Debentures and the warrants issued in connection with the April 2007 Debenture Offering was $7,178,531. The initial fair value of the investor warrants was estimated at approximately $10,112,590 using a complex Binomial Lattice pricing model suitable to value path dependent American options. The significant assumptions used in the model are as follows: (1) dividend yield of 0%; (2) expected volatility of 63%, (3) risk-free interest rate of 4.64%, (4) expected life of 5 years, and (5) the probability of the occurrence of certain factors impacting the future fair value due to possible adjustment.
The aggregate fair value of the conversion feature and the investor warrants was $14,851,272 on the date of issuance. The value of the compound embedded derivative up to the $7,178,531 amount of the loan less the original issue discount was accounted for as a loan discount which has been netted against principal balance, to be amortized over the term of the loan. Interest expense includes $997,018 related to the amortization of this discount during the three months ended March 31, 2008. The excess $7,672,741 fair value of the embedded derivative was charged to private placement costs during the year ended December 31, 2007.
See Note 6 for a description of the compound embedded derivative.
(e) May Secured Debentures
On May 22, 2007, the Company entered into securities purchase agreements with certain investors (the “May Investors”), pursuant to which the Company issued the May Investors secured convertible debentures (the “May Secured Debentures” and collectively with the April Secured Debentures, the “Secured Debentures”) in the aggregate principal amount of $10,554,500 at an original issue discount of 10% resulting in gross proceeds to the Company of $9,500,000. The May Secured Debentures have a term of 2 years and pay interest at the rate of 10% per annum, and are secured by all of our shares in Quintessence Photonics Corporation, the operating subsidiary which owns all of our operating assets. The May Secured Debentures are convertible into shares of the Company’s common stock at an initial conversion price of $1.05 per share, subject to adjustments as set forth therein and any applicable Milestone Adjustments. The initial fair value of this beneficial conversion feature was approximately $4,974,818 using a complex Binomial Lattice pricing model using the assumptions provided below. The Company paid the following fees (including fees for advisors, placement agents and finders) in connection with the May 2007 Debenture Offering: (i) $795,000 in cash, and (ii) warrants to purchase up to 2,571,171 shares of common stock valued at $1,907,809.
16
NOTE 5 – LONG TERM DEBT (CONTINUED)
In connection with the May 2007 Debenture Offering, the Company granted warrants to purchase 15,077,857 shares of common stock to the May Investors and warrants to purchase 2,571,171 shares of common stock to the dealers in that offering. All of the above warrants have an initial exercise price of $1.05 per share, subject to adjustments as set forth therein and any applicable Milestone Adjustments, and expire five years from the date of issuance. The aggregate purchase price for the May Secured Debentures and the warrants issued in connection with the May 2007 Debenture Offering was $9,500,000 paid in cash. The initial fair value of the investor warrants was estimated at approximately $11,182,902 using a complex Binomial Lattice pricing model suitable to value path dependent American options. The significant assumptions used in the model are as follows: (1) dividend yield of 0%, (2) expected volatility of 63%, (3) risk-free interest rate of 4.82%, (4) expected life of 5 years, and (5) the probability of the occurrence of certain factors impacting the future fair value due to possible adjustment.
The aggregate fair value of the beneficial conversion feature and the investor warrants was $16,157,720 on the date of issuance. The value of the compound embedded derivative up to $9,500,000, the amount of the loan less the original issue discount was accounted for as a loan discount which has been netted against principal balance, to be amortized over the term of the loan. Interest expense includes $1,319,313 related to the amortization of this discount during the three months ended March 31, 2008. The excess $6,657,720 fair value of the embedded derivative was charged to private placement costs during the year ended December 31, 2007.
See Note 6 for a description of the compound embedded derivative.
The Secured Debentures issued in April and May 2007 are secured by all of our shares in Quintessence Photonics Corporation, the operating subsidiary which owns all of our operating assets.
17
NOTE 6 – COMPOUND EMBEDDED DERIVATIVE
The conversion price of the Secured Debentures may be adjusted downwards if the Company fails to meet certain revenue milestones for any one or more of the following periods (“Milestone Adjustments”):
o | $5,000,000 in revenues for the nine (9) month period ending September 30, 2007, | |
o | $7,750,000 in revenues for the twelve (12) month period ending December 31, 2007 | |
o | $6,000,000 in revenues for the six (6) month period ending June 30, 2008. |
If a Milestone Adjustment occurs the conversion price will be the lower of $1.05 or the market price as determined on the date that is five trading days after the Company files its next Form 10-Q with the SEC following the applicable Milestone period. Any Milestone Adjustment is permanent notwithstanding any future revenue or achievement of any other milestones. Any Milestone Adjustment may only adjust the conversion price downward. The Secured Debentures are subject to a conversion cap which limits the number of shares issuable upon conversion of the Secured Debentures. The number of shares currently issuable upon conversion of the Secured Debentures is at the maximum level permitted by the conversion cap. Consequently, if a Milestone Adjustment occurs, the Secured Debenture holders will not acquire additional shares upon conversion. The Company, however, will be obligated to redeem that portion of the Secured Debenture that can not be converted into common stock.
In connection with the April 2007 Debenture Offering, we granted warrants to purchase 11,394,494 shares of common stock to certain investors and warrants to purchase 212,796 shares of common stock to the dealers in that offering. In connection with the May 2007 Debenture Offering, we granted warrants to purchase 15,077,857 shares of common stock to the May Investors and warrants to purchase 2,571,171 shares of common stock to the dealers in that offering. All of the above warrants have an initial exercise price of $1.05 per share, subject to adjustments as set forth therein and any applicable Milestone Adjustments, and expire five years from the date of issuance.
EITF 05-02 requires that instruments provide holders with an option to convert into a fixed number of shares (or an equivalent amount of cash at the discretion of the issuer) in order to be treated as conventional convertible securities. The Company determined that the Secured Debentures were not eligible for treatment as conventional convertible securities because the conversion price is subject to milestone adjustments.
The Company then compared the terms of the debentures to the provisions of EITF 00-19. Per EITF 00-19, contracts that include any provision that could require net-cash settlement cannot be accounted for as equity of the company (that is, asset or liability classification is required for those contracts). Based on our review we determined that the since the debentures require a net cash settlement in the event that the conversion price is reduced, the conversion feature requires bifurcation and is a derivative.
We performed the same analysis on the warrants, and determined that an event of default as described in the Warrants would trigger a mandatory redemption and cash payment. The mandatory redemption amount is payable in cash or cash equivalent within five business days of the date of the applicable default notice. Since these circumstances would require a net cash settlement, under EITF 00-19 they are treated as a derivative.
18
NOTE 6 – COMPOUND EMBEDDED DERIVATIVE (CONTINUED)
We concluded that both the debentures conversion features and the detached warrants should be accounted for as a compound embedded derivative and had a valuation performed which concluded that the value of these features value exceeded the value of the funds raised. See Note 5 for a description of the assumptions used in the complex binomial lattice pricing model to determine the fair value of the compound embedded derivative at issuance.
As of March 31, 2008 the fair value of the embedded derivative liability related to our April and May debentures’ conversion features and the detached warrants was $13,210,837 an increase of $2,927,656 from the fair value of $10,283,181at December 31, 2007. The change in fair value of the derivative liability was recorded in other losses in the accompanying statement of operations.
NOTE 7 – STOCK OPTIONS AND WARRANTS
A summary of option activity as of March 31, 2008 and changes during the three months then ended is presented below:
Options | Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value | |||||||||
Outstanding at January 1, 2008 | 4,417,666 | $ | 0.84 | 7.7 | |||||||||
Granted | 635,000 | $ | 0.68 | 10 | |||||||||
Exercised | — | ||||||||||||
Forfeited or expired | (65,000 | ) | $ | 0.75 | |||||||||
Outstanding at March 31, 2008 | 4,987,666 | $ | 0.82 | 7.8 | $ | 732,688 | |||||||
Exercisable at March 31, 2008 | 2,877,472 | $ | 0.70 | 6.7 | $ | 673,938 |
The value of options vesting during the three months ended March 31, 2008 and 2007 was $142,175 and $115,361 respectively, and has been reflected as compensation cost. As of March 31, 2008, the Company has unvested options valued at $2,423,987 which will be reflected as compensation cost in future periods as the options vest.
The Company calculates the fair value of employee stock options using a Black-Scholes option pricing model at the time the stock options are granted and that amount is amortized over the vesting period of the options, which is generally four years. The fair value for employee stock option grants for the three months ended March 31, 2008 and 2007 was calculated based on the following assumptions: risk-free interest rate of 3.02% to 4.5%; dividend yield of 0%; volatility factor of 63% to 73.5%; and a weighted average expected life of the options of 7 years. The risk-free interest rate was based on the applied yield currently available on U.S treasury zero-coupon issues. The expected weighted-average volatility factor is based on the historical stock prices of competitors of the Company whose shares are publicly traded over the most recent period.
There were no stock purchase warrants granted, exercised, cancelled or expired during the three months ended March 31, 2008. As of March 31, 2008 there were 38,212,783 warrants outstanding. There was no intrinsic value to any of the warrants outstanding at March 31, 2008 as all of the outstanding warrants have an exercise price higher than the stock price on March 31, 2008.
19
NOTE 8 – INCOME TAXES
Accordingly, the Company has not recognized a deferred tax asset for this benefit. Upon the attainment of taxable income by the Company, management will assess the likelihood of realizing the tax benefit associated with the use of the carryforwards and will recognize a deferred tax asset at that time.
SFAS No. 109 requires that a valuation allowance be established when it is more likely than not that all or a portion of deferred tax assets will not be realized. Due to restrictions imposed by Internal Revenue Code Section 382 regarding substantial changes in ownership of companies with loss carry-forwards, the utilization of the Company’s net operating loss carry-forwards will likely be limited as a result of cumulative changes in stock ownership. The company has not recognized a deferred tax asset and, as a result, the change in stock ownership has not resulted in any changes to valuation allowances.
Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). —an interpretation of FASB Statement No. 109, Accounting for Income Taxes. The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of December 31, 2007, the Company does not have a liability for unrecognized tax benefits.
The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company is subject to U.S. federal or state income tax examinations by tax authorities for years after 2002. During the periods open to examination, the Company has net operating loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these NOLs and tax credit carry forwards may be utilized in future periods, they remain subject to examination.
20
NOTE 9 - SUBSEQUENT EVENTS
Between April 3 and April 23, 2008, holders of our April and May Debentures converted $703,267 of principal into 669,778 shares of common stock in accordance with the original terms of the debentures (see Note 5). These conversions reduce the amount of principal that is to be repaid to the debenture holders by the Company. Following these conversions, there were 39,346,561 shares of common stock outstanding.
21
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.
FORWARD LOOKING STATEMENTS
This Quarterly Report contains forward looking statements with respect to our expectations, plans or intentions (such as those relating to future business or financial results, products in development and our business strategies). These statements are subject to risks and uncertainties and are based on judgments concerning various factors that are beyond our control. Forward-looking statements may be identified by words such as “may,” “ should,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. Our actual results may differ materially from those anticipated in any forward looking statements as a result of various developments including those set forth below under the heading “Risk Factors That May Affect Future Performance”. Except as required by law or regulation, we assume no obligation to update any forward-looking statements.
Background
QPC Lasers, Inc. designs and manufactures laser diodes through its wholly-owned subsidiary, Quintessence Photonics Corporation. Quintessence was incorporated in November 2000 by Jeffrey Ungar, Ph.D. and George Lintz, MBA (our “Founders”). The Founders began as entrepreneurs in residence with DynaFund Ventures in Torrance, California and wrote the original business plan during their tenure at DynaFund Ventures from November 2000 to January 2001. The business plan drew on Dr. Ungar’s 17 years of experience in designing and manufacturing semiconductor lasers and Mr. Lintz’s 15 years of experience in finance and business; the primary objective was to build a state of the art wafer fabrication facility and hire a team of experts in the field of semiconductor laser design.
After operating as a private company for almost six years, on May 12, 2006 and June 13, 2006, the stockholders of Quintessence entered into Share Exchange Agreements with QPC in which all of the stockholders of Quintessence exchanged their shares, warrants and options for shares warrants and options of QPC. QPC was a public reporting company; and as a result of the Share Exchange, QPC was the surviving entity and is now a public reporting company. Our predecessor public company was incorporated in the State of Nevada on August 31, 2004 as Planning Force, Inc. The transaction was accounted for as a reverse merger (recapitalization) with Quintessence deemed to be the accounting acquirer and Planning Force deemed the legal acquirer.
Our originally targeted market was fiber optic telecommunications. As it became clear within the first two years of operations that the telecommunication market was experiencing a slump, we investigated other markets that could benefit from our laser diode technology and decided to focus on materials processing, printing and medical applications, as well as the burgeoning defense/homeland security laser market.
We released our first Generation I products in the second quarter of 2004, and released some of our Generation II products in early 2006. We released our initial Generation III products during 2007 with further commercialization expected in 2008-2009. Generation I and II products have been sold to customers in the medical, printing, and defense industries. Generation III products have been sold to customers in the medical and consumer industries.
QPC signed its first government development contract in the second quarter of 2002 and we shipped our first commercial product in the second quarter of 2004. We hired our first salesman in the fourth quarter of 2003, added a Director of Worldwide Sales in the third quarter of 2004 and a Senior Vice President of Marketing and Sales in the second quarter of 2005.
22
Total sales grew from $89,161 in 2002; to $229,079 in 2003; to $1,050,816 in 2004 to $1,073,091 in 2005. Total sales for the year ended December 31, 2006 were $3,073,332 and total sales for the year ended December 31, 2007 were $7,932,182.
Our product development efforts have been advanced by a number of government contracts. We have been awarded five Phase I “Small Business Innovation Research” contracts; three of them have progressed to Phase II contracts. In general, these contracts are cancelable and in some cases include multiple phases associated with meeting technical milestones. In the second quarter of 2006, we signed a sub-contract with Telaris, Inc. as part of a team working on a project for the Defense Advance Research Project Agency (“DARPA”). Our portion of the DARPA contract is $3.1 million which is to be performed in two phases over three years. This contract will fund development of semiconductor lasers to be used for directed energy weapons and the technology overlaps with our development of lasers for the industrial materials processing markets.
In the second quarter of 2006, QPC was also awarded a subcontract with Fibertek, Inc. as part of a team working on a project for the United States Missile Defense Agency to develop lasers that emit mid-infrared wavelengths. Management believes these lasers may be used in systems designed to defend military and commercial aircraft against heat seeking missiles. We also believe that this effort will bring us closer to creating a compact and affordable system for detection of biochemical agents in public places. The contract is a Phase III follow-on contract from an earlier contract that QPC completed which demonstrated the early phases of feasibility of our technology. Our portion of this Phase III contract is $800,000 and is to be performed over twelve months through June 2007. As of March 31,2008, we have recognized $790,000 of revenue from this contract.
The United States Army Research Laboratory awarded us a Phase II development contract in the first quarter of 2006 and we began performing under this contract in the second quarter of 2006. The contract is a follow-on contract from an earlier contract with the same customer in which QPC demonstrated its ability to develop diode lasers that emit wavelengths that are safer to the human eye than conventional high power diode wavelengths. Management believes that upon successful completion of the diode laser project, these lasers may be used in both military and commercial systems to limit accidental damage to human eyes of system operators, friendly forces, and bystanders. The Army contract amount is $673,028 and is to be performed by March 2008. As of March 31, 2008, we have recognized $673,028 of revenue from this contract.
During the second quarter of 2007, the United States Navy awarded us two contracts totaling $1.5 million to deliver high-energy laser engine prototypes for naval aviation directed energy weapons applications. The concurrent nine-month contracts build upon the Company's previous high-brightness chip-based laser development for the U.S. Navy, as well as for the DARPA, the U.S. Army, the Missile Defense Agency, and the Israeli Ministry of Defense.
In addition to U.S. Government funds, we have received development funds from U.S. prime defense contractors as well as a major foreign military contractor. The funds that we have received and expect to receive are for development that overlaps with our commercial development.
During the fourth quarter of 2007, the Company entered into a contract with an international manufacturer of consumer electronics to develop and deliver lasers to be used in rear projection televisions. We realized revenues during the fourth quarter of approximately $1 million including non-recurring engineering fees for the development and delivery of initial prototypes. The contract also provides for an $11 million non-cancellable order if and when product specifications have been met.
In the medical laser market, QPC has received production orders and new product development orders from a large medical laser manufacturer. Other medical equipment manufacturers have also ordered from us. In the industrial market, QPC has received an order for development and production of optical sensing lasers.
23
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses for each period. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.
On January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses financial accounting and reporting for the disposal of long-lived assets and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” The adoption of this statement did not have a material effect on the Company’s results of operations or financial condition. Management regularly reviews property, equipment and other long-lived assets for possible impairment. This review occurs quarterly, or more frequently if events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. If there is indication of impairment, then management prepares an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying amount of the asset, an impairment loss is recognized to write down the asset to its estimated fair value. Management believes that the accounting estimate related to impairment of its property and equipment, is a “critical accounting estimate” because: (1) it is highly susceptible to change from period to period because it requires management to estimate fair value, which is based on assumptions about cash flows and discount rates; and (2) the impact that recognizing an impairment would have on the assets reported on our balance sheet, as well as net income, could be material. Management’s assumptions about cash flows and discount rates require significant judgment because actual revenues and expenses have fluctuated in the past and are expected to continue to do so.
Revenue Recognition
A portion of the Company’s revenues result from fixed-price contracts with U.S. government agencies. Revenues from fixed-price contracts are recognized under the percentage-of-completion method of accounting, generally based on costs incurred as a percentage of total estimated costs of individual contracts (“cost-to-cost method”). Revisions in contract revenue and cost estimates are reflected in the accounting period as they are identified. Provisions for the entire amount of estimated losses on uncompleted contracts are made in the period such losses are identified. No contracts were determined to be in an overall loss position at December 31, 2007 or March 31, 2008. In addition, the Company has certain cost plus fixed fee contracts with U.S. Government agencies that are being recorded as revenue is earned based on time and costs incurred. At December 31, 2007, there was no deferred revenue and approximately $194,537 of unbilled receivables related to these government contracts. At March 31, 2008 there was no deferred revenue and $280,640 of unbilled receivables related to these government contracts.
The Company recognizes revenues on product sales, other than fixed-price contracts, based on the terms of the customer agreement. The customer agreement takes the form of either a contract or a customer purchase order and each provide information with respect to the product or service being sold and the sales price. If the customer agreement does not have specific delivery or customer acceptance terms, revenue is recognized at the time of shipment of the product to the customer. Revenue for services, such as non-recurring engineering charges, is recognized upon delivery of either technical report or other deliverable as specified in the contract or purchase order.
Management periodically reviews all product returns and evaluates the need for establishing either a reserve for product returns or a product warranty liability. As of March 31, 2008, management has concluded that neither a reserve for product returns nor a warranty liability is required.
24
Accounts receivable are reviewed for collectibility. When management determines a potential collection problem, a reserve is established, based on management’s estimate of the potential bad debt. When management abandons all collection efforts it will directly write off the account and adjust the reserve accordingly.
The Company generally, requires no collateral or deposits from its customers and relies upon its own evaluation of a customer’s creditworthiness. The Company records an allowance for doubtful accounts receivable for credit losses at the end of each period based on an analysis of individual aged accounts receivable balances. If the financial condition of the Company's customers should deteriorate, or other events occur which result in an impairment of collectibility of the receivable, additional allowances will be recorded.
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Accounting for Derivative Instruments
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, requires all derivatives to be recorded on the balance sheet at fair value. In September 2000, the Emerging Issues Task Force (“EITF”) issued EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in, a Company’s Own Stock,” (“EITF 00-19”) which requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, asset or a liability. Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value on a company’s balance sheet, with any changes in fair value recorded in the company’s results of operations. These derivatives are separately valued and accounted for on our balance sheet, and revalued at each reporting period. The net change in the value of embedded derivative liability is recorded as income or loss on derivative instruments in the consolidated statement of operations, included in other income.
Stock Based Compensation
The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The Company adopted SFAS No. 123R effective January 1, 2006, and is using the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123R for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with EITF No. 96-18: "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18 “Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees” whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached, or (b) at the date at which the necessary performance to earn the equity instruments is complete.
Fair Value Instruments
Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This Statement defines fair value for certain financial and nonfinancial assets and liabilities that are recorded at fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This guidance applies to other accounting pronouncements that require or permit fair value measurements. On February 12, 2008, the FASB finalized FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157. This Staff Position delays the effective date of SFAS No. 157 for nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of SFAS No. 157 had no effect on the Company’s consolidated financial position or results of operations.
25
The following table reconciles, for the period ended March 31, 2008, the beginning and ending balances for financial instruments that are recognized at fair value in the consolidated financial statements:
Balance of Embedded derivative at December 31, 2007 | $ | 10,283,181 | ||
Loss on fair value adjustments to embedded derivatives | 2,927,656 | |||
Balance at March 31, 2008 | $ | 13,210,837 |
The valuation of the derivatives are calculated using a complex binomial pricing model that is based on changes in the volatility of our shares and our stock price and the time to conversion of the related financial instruments. See note 6 in the accompanying financial statements for more information on the valuation methods used.
26
REVENUE. During the three months ended March 31, 2008, the Company recognized revenue of $1,648,194 as compared to revenue of $1,106,579 during the quarter ended March 31, 2007, representing an increase of approximately 49%. The increase in revenues was due in significant part to non-recurring engineering fees earned in connection with development work for new commercial customers. The increase was offset by the Company’s cessation of work for a major medical customer that commenced Chapter 11 proceedings during the quarter. Revenues were also adversely impacted by unexpected delays in an anticipated award from a defense agency. We believe that our expanded product offerings, our entry into the consumer electronics market and opportunities in the defense and medical markets offer potential for significant growth. However, our ability to grow our revenues is subject to significant risks including, without limitation, our limited marketing budget, the limited track record for our products, difficulties encountered in trying to displace incumbent products and technologies, the long sales and qualification process required for our products and the risk that our competitors will develop products that diminish or eliminate any technological advantages of our products. In addition, our ability to grow our revenues could be adversely affected by uncertain economic conditions, financial difficulties encountered by some of our customers and shifting defense priorities.
COST OF REVENUE; GROSS PROFIT. Cost of revenue, which consists of direct labor, overhead and material costs, was $851,093 or 52% of revenues for the quarter ended March 31, 2008 as compared to $855,781 or 77% of revenues for the quarter ended March 31, 2007. As a percentage of revenue, cost of sales decreased as we benefited from higher pricing on our higher brightness higher powered modules, improved efficiencies as a result of allocating our fixed costs over a higher number of units sold and higher yields on direct materials and labor. If we can continue to increase our sales, then our fixed costs should continue to decline as a percentage of sales. As a result of the foregoing, gross profit was $797,101 for the three months ended March 31, 2008 as compared to $250,798 for the three months ended March 31, 2007, representing gross margins of approximately 48% and 23%, respectively.
RESEARCH AND DEVELOPMENT COSTS. Research and development costs which consist of salaries, professional and technical support fees, material and overhead, totaled $1,426,533 for the three months ended March 31, 2008, as compared to $1,012,800 for the three months ended March 31, 2007. This increase in research and development spending is largely attributable to additional costs incurred as we develop new products for the consumer electronics markets. We currently expect research and development costs to increase moderately as we seek to maintain our technological edge and develop new products for various applications.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses totaled $2,653,707 for the quarter ended March 31, 2008, as compared to $1,216,524 for the quarter ended March 31, 2007, which represents an increase of approximately 118%. This year-over-year increase in selling, general and administrative costs is a result of several factors including approximately $370,000 in sales and marketing costs; $570,000 in investor relations costs; bad debt expense of $225,000 and increases in legal and accounting fees. The bad debt expense represents the recording of a reserve against accounts receivable from a customer that recently sought protection under Chapter 11 of the federal bankruptcy laws. We believe there is a significant likelihood that additional reserves will be required as the current recession and constraints in the credit market adversely affect a number of our customers. We also expect selling, general and administrative costs to increase as we expand our sales and marketing efforts.
As mentioned above, we recognized an expense of approximately $225,000 related to setting up an allowance for the accounts receivable outstanding for one of our customers that declared bankruptcy during the first quarter of 2008, as we believe there is a likelihood that we will not be paid for the amounts outstanding. We stopped work on all orders from that customer, and did not recognize any revenue for sales to this customer during the first quarter of 2008.
27
OTHER INCOME AND EXPENSE. Other Income and Expense includes interest expense of $2,953,878 for the three months ended March 31, 2008 compared to $468,399. The increase in interest expenses includes the amortization of loan discounts of $2,319,829 and $240,221 for the first quarters of 2008 and 2007 respectively. This increase in interest expense relates to the loan discount amortization and cash interest paid to holders of debentures that were issued in April and May 2007. Other expenses also include $2,927,656 for the change in fair value of the embedded derivative liability during the three months ended March 31, 2008. This change in fair value is primarily caused by an increase in our stock price from December 31, 2007 to March 31, 2008. No similar charge was recorded in the first quarter of 2007 as the derivative liability is related to the conversion feature and detached warrants that were issued to the holders of the debentures that were issued in April and May 2007. The conversion feature and detached warrants have been bifurcated and are treated as embedded derivatives.
The determination of the change in value of the embedded derivatives requires the use of a complex valuation model and can fluctuate significantly between periods based on the price of our shares and the time remaining in the life of the underlying financial instruments. Increases in our stocks market price increases the value of the derivative creating losses in our income statement and increasing the derivative liability on our balance sheet while decreases in our stock’s market value reduces the value of the derivatives, creating gains in our income statements and decreasing the derivative liability on our balance sheet.
Other Expenses is offset by interest income of $29,261 for the quarter ended March 31, 2008 compared to interest income of $1,754 for the quarter ended March 31, 2007.
NET LOSS. QPC had a net loss of $9,109,904 for the quarter ended March 31, 2007 as compared to a net loss of $2,413,205 for the quarter ended March 31, 2007. The loss in the first quarter of 2008 was in significant part attributable to interest expense including amortization of loan discount of $2,953,878 and the change in fair value of embedded derivatives of $2,927,656. In addition, increases in research and development spending, investor relations costs, and bad debt expense as described above contributed to the increase in overall net loss for the quarter.
While we anticipate that revenues should continue to grow from the amounts recorded in 2007, we do not expect to achieve profitability during the next 12 months.
CASH FLOWS FROM OPERATING ACTIVITIES. Our net loss has been significantly impacted by the non-cash items discussed above. During the first quarter of 2008, we had a negative cash flow from operations of approximately $4,000,000, an increase of approximately $2,672,000 as compared to our negative cash flow from operations of approximately $1,329,000 in the first quarter of 2007. The increase in negative cash flow during the quarter is related to increased research and development spending and purchase of additional inventory to prepare for the fulfillment of several customer orders. In addition, interest payments for the first quarter of 2008 totaled $577,903 compared to $199,364 during the first quarter of 2007. We do not anticipate becoming cash flow positive in the immediate future.
We continue to operate with a negative cash flow from operations, and depend upon external financing to maintain our operations. QPC lost $9,109,904 during the quarter ended March 31, 2008 and has a cumulative deficit of $70,326,861 at March 31, 2008. Our negative cash flow from operations during the quarter ended March 31, 2008 was $4,000,942. We currently anticipate that we will continue to have a negative cash flow from operations for at least the next 12 months.
We will need to raise additional funds to continue our operations. During 2008, we may incur significant expenditures to build out additional manufacturing and office space at our Sylmar facility . Moreover, although we expect our revenues to continue to grow, the funds available from such increased revenues are not expected to be sufficient to meet our debt obligations that mature in 2009. Those obligations are in excess of $25 million, and even if all of the Secured Debentures are converted, our payment obligation on our outstanding debt in 2009 will be nearly $6 million.
28
The Secured Debentures issued in April and May 2007 are secured by all of our shares in Quintessence Photonics Corporation, the operating subsidiary which owns all of our operating assets. In addition, all of our assets and intellectual property is pledged as collateral on certain indebtedness. As a result, it may be difficult or impossible for us to borrow money as we have no collateral to provide for any loan.
The Company is currently offering a minimum of $500,000 and up to maximum of $3,500,000 in a private placement (the “Convertible Debenture Financing”) of its convertible unsecured debentures (the “Debentures”) and warrants (the “Warrants”). The debentures may be converted into shares of the Company’s common stock at a price of $1.05 per share; the warrants may be exercised any time during the next five years for shares of the Company’s common stock at an exercise price of $1.05 per share. The convertible debentures are being offered at a 10% original issue discount. The Convertible Debenture Financing is being effected through a private placement offered solely to accredited investors as that term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933 (the “Securities Act”). The convertible debentures and warrants are not being registered under Section 5 of the Securities Act and may not be offered for sale, sold or resold in the United States absent such registration, except pursuant to an applicable exemption from such registration requirements.
While we anticipate that the proceeds from the Convertible Debenture Financing will meet our immediate cash requirements, we expect to seek additional financing in the near future. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise the needed funds, we might be forced to make substantial reductions in our operating expenses, which could adversely affect our ability to implement our current business plan and ultimately our viability as a company.
Our consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The factors described above raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might result from this uncertainty. Our independent registered public accounting firm has included an explanatory paragraph expressing doubt about our ability to continue as a going concern in their audit report for the fiscal years ended December 31, 2007 and 2006.
Our current obligations require us to make the following payments over the next five years including principal and interest:
Payments by Period
Remainder of 2008 | 2009 | 2010 and Beyond | ||||||||
Subordinated Secured Notes Payable | 89,674 | — | — | |||||||
Finisar Secured Note Payable | 653,411 | 5,653,408 | — | |||||||
Secured Equipment Financing | 197,910 | 178,180 | 221,250 | |||||||
April Secured Debentures | 587,128 | 8,056,707 | — | |||||||
May Secured Debentures | 794,925 | 10,390,628 | — | |||||||
Total | $ | 2,323,048 | $ | 24,278,923 | $ | 221,250 |
Between April 3 and April 23, 2008, holders of our April and May Debentures converted $703,267 of principal into 669,778 shares of common stock. These conversions reduce the amount of principal that is to be repaid to the debenture holders by the Company during 2009. The table above reflects these conversions and the reduction in principal that is no longer outstanding. Following these conversions, there were 39,346,561 shares of common stock outstanding.
29
We secured our first round of equity financing in August 2001, led by Finisar Corporation (NASDAQ: FNSR), a telecommunications component manufacturer, headquartered in Sunnyvale, California. Finisar invested $5 million and DynaFund Ventures invested $2 million in our preferred stock. Other investors, including small funds and individuals, invested $2.03 million in the first round of financing. We issued Series A Preferred Stock at a price of $2.8466 per share to the investors.
In addition to Finisar’s equity investment, Finisar made a five-year term loan to us for $7 million, closing in two tranches between August 2001 and January 2002. The total investment of Finisar in our Company was $12 million, including the preferred equity and debt. The total equity and debt capital invested in our Company, as of January 2002, was $16 million.
In the third quarter of 2003, we raised a second round of equity financing. Finisar converted the $5 million remaining principal balance on their term loan into our Series B Preferred Stock and we raised an additional $2.8 million in new cash. The price per share of Series B Preferred Stock was $3.118998. Three of the five members of the Board of Directors at that time, founders Dr. Ungar and Mr. Lintz and independent director, Dr. Israel Ury, each purchased preferred stock in the Series B round of financing. As a condition to Finisar’s investment in Series B Preferred Stock, we granted Finisar a non-exclusive royalty free perpetual license to our existing and future intellectual property pursuant to a certain License Agreement, dated September 16, 2003, by and between Quintessence and Finisar (“License Agreement”). The License Agreement allowed for termination by us by paying a fee on or before September 18, 2008. We subsequently terminated the license by issuing a promissory note in the amount of $6 million to Finisar as of September 18, 2006. As of March 31, 2008, the outstanding principal balance of the Finisar secured note was $5,536,211.
In the second quarter of 2004, we entered into a senior secured two-year note transaction with various investors and raised $3.25 million. We issued 2,437,500 warrants to purchase common stock to the lenders as part of this transaction. The exercise price of these warrants was initially $3.75 per share. In the second quarter of 2005, approximately $2.1 million of the $2.4 million outstanding balance was extended for an additional year. We issued an additional 840,000 warrants to purchase common stock as part of this transaction, and adjusted the exercise price of 2,325,000 warrants to $1.25 per share in January 2006 upon the closing of the Brookstreet Tranche I offering. The new exercise price was subject to downward adjustment if future financings were completed at a price lower than $3.75 per share. The exercise price was ultimately fixed at $1.25 per share at the time of the Share Exchange in May 2006. The largest participant in the note transaction, investing $2.5 million, was Envision Partners of which QPC’s Chief Financial Officer, Mr. Lintz, is a 50% partner. In April 2007, $554,631 of principal was exchanged for April Secured Debentures. The remaining balance was paid in full as of May 31, 2007.
From the fourth quarter of 2004 through the first quarter of 2005, we raised $5.9 million in a third round of equity financing. Approximately 60 accredited investors participated in this round. We issued Series C Preferred Stock at a price of $3.75 per share and warrants to purchase common stock with an exercise price of $3.75 per share. In subsequent transactions from November 2005 to June 2006, all but 222,749 warrants were exchanged for common stock in a ratio of three shares for four warrants. The exercise price of remaining warrants was adjusted from $3.75 to $1.25 per share.
In the third quarter of 2005, we raised $221,000 through a sale of our common stock to eight high net worth individuals at a price of $1.00 per share.
In the third quarter of 2005 we entered into a subordinated secured note with various investors for $1,280,000. In April 2007, six of the note holders converted the remaining principal balance of their notes into the April Secured Debentures. As of June 30, 2007, the outstanding principal balance was $230,000. We issued 320,000 warrants to purchase common stock to these lenders. The exercise price of the warrants and the conversion price of the loan are variable. The initial price was $3.75 per share and is to be adjusted downward if there are any subsequent financings of at least $1,000,000 in which stock is sold for less than $3.75 per share. The exercise price for the warrants and the conversion price for the loan were reset to $1.05 per share in conjunction with the April Secured Debenture offering. The “floor” of minimum price that is applicable to the exercise price of the warrants and the conversion price of the loan is $0.90 per share. In addition to these warrants issued at the time of the loan, we offered the lenders the option of receiving an additional 341,325 warrants on the same terms if they extended their loan for an additional three years at any time during the term of the loan. To date, one lender has given us notice of extension of his $100,000 loan and has been issued 26,666 additional warrants.
30
In November 2005, we offered each holder of preferred stock (Series A, B and C) a share dividend of one share of common stock per share of preferred stock that they owned as consideration for giving management their proxy and power of attorney to exchange all of their securities of Quintessence for shares of a publicly traded company, subject to reporting requirements of the Commission in a reverse merger transaction. We offered additional incentive to the Series C investors by offering to either (1) exchange the warrants that they received as part of their investment in the Series C preferred stock, for common stock or (2) lower the exercise price on the warrants from $3.75 to $1.25 per share.
In November 2005, we raised $500,000 pursuant to a 10% secured note financing with Jeffrey Ungar, our Chief Executive Officer, and George Lintz, our Chief Financial Officer. Pursuant to these bridge notes, we issued these lenders warrants to purchase 320,000 shares of common stock at $1.25 per share (“Bridge Warrants”). In connection with extensions of the maturity date of these bridge notes from January 2006 to April 2006, we granted 900,000 additional Bridge Warrants to these lenders. The bridge notes were paid in full as of April 25, 2006.
In January 2006, through a private placement offering, referred to as the Brookstreet Tranche I offering, we raised $2,862,630 from the sale of 572,526 units of our securities, each unit consisting of four shares of common stock and one warrant to purchase one share of common stock at $1.50 per share (for a total of 2,290,104 shares of common stock and 572,526 warrants).
In a series of private placement closings between March 31, 2006 and September 30, 2006, referred to as the Brookstreet Tranche II offering, we raised $11,795,721 from the sale of 9,436,577 shares of common stock at a price of $1.25 per share. In addition, the Company issued warrants to purchase 2,345,341 shares of the Company’s common stock to Brookstreet in connection with the underwriting.
Purchasers in the Brookstreet Tranche I and Tranche II were granted registration rights. The Company filed and later withdrew, prior to effectiveness, a registration statement filed on behalf of the Brookstreet investors. None of the Brookstreet investors are currently seeking registration of their shares.
On February 8, 2007, the Company completed a financing transaction with Boston Financial and Equity Corporation, a financing company, which was structured as sale and leaseback of certain manufacturing equipment that had been purchased by the Company between July and December 2006 for $500,000. The gross amount of the loan was $500,000, and the Company paid a security deposit of $125,000 and first and last month’s lease payment of $43,980. Monthly lease payments including interest at 33.65% per annum are $21,990 through July 2009 and $4,850 through January 2012.
In April 2007, we issued to certain investors secured convertible debentures in the aggregate principal amount of $7,976,146 at an original issue discount of 10%. The April Secured Debentures are convertible into shares of the Company’s common stock at an initial conversion price of $1.05 per share, subject to certain adjustments. In addition, the Company issued to the investors five year warrants to purchase up to 11,394,494 shares of the common stock at an exercise price of $1.05 per share, subject to certain adjustments. The aggregate purchase price for the April Secured Debentures and the warrants was $ 7,178,531.
The purchase price consisted of (i) $ 5,013,900 in cash, (ii) outstanding notes in the aggregate principal amount of $1,604,631 which were exchanged for April Secured Debentures, (iii) promissory notes for the aggregate principal sum of $100,000 payable to the Company, that are due in 30 days and (iv) promissory notes for the aggregate principal sum of $460,000 payable to the Company, that are due in 45 days. The Company paid the following fees (including fees for advisors, placement agents and finders) in connection with the April 2007 Debenture Offering: (i) $404,068 in cash, (ii) warrants to purchase up to 212,796 shares of common stock, and (iii) 100,000 shares of common stock.
31
In May 2007, we issued to certain investors secured convertible debentures in the aggregate principal amount of $10,554,500 at an original issue discount of 10%. The May Secured Debentures are convertible into shares of the Company’s common stock at an initial conversion price of $1.05 per share, subject to certain adjustments. In addition the Company issued to the investors in the May Secured Debentures five year warrants to purchase up to 15,077,857 shares of common stock at an exercise price of $1.05, subject to certain adjustments. The aggregate purchase price for the May Secured Debentures and warrants was $9,500,000 paid in cash. The Company paid the following fees (including fees for advisors, placement agents and finders) in connection with the May 2007 Debenture Offering: (i) $795,000 in cash, and (ii) warrants to purchase up to 2,571,171 shares of common stock.
Capital Expenditures
From January 1, 2008 to March 31, 2008, we spent approximately $75,000 on manufacturing equipment, office equipment, computer equipment and software, and furniture. We expect our capital expenditures to increase based on the growth of our operations, and increased orders and personnel. We plan to expand our manufacturing area by up to 10,000 square feet in order to meet anticipated growth in our sales during 2008. Our facility has warehouse space that is contiguous to our present manufacturing area which we plan to use for the manufacturing area expansion. We expect the expansion to cost in the range of $1 million to $3 million.
Recent Accounting Pronouncements
In December 2007, the FASB issued FASB Statement No. 141 (R), “Business Combinations” (FAS 141(R)), which establishes accounting principles and disclosure requirements for all transactions in which a company obtains control over another business. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS No. 160 establishes accounting and reporting standards that require that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently. SFAS No. 160 also requires that any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value when a subsidiary is deconsolidated. SFAS No. 160 also sets forth the disclosure requirements to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS No. 160 must be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements are applied retrospectively for all periods presented.
In March 2008, the FASB issued SFAS No. 161 “Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends SFAS 133 by requiring expanded disclosures about an entity’s derivative instruments and hedging activities. SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. SFAS 161 is effective for the Company as of January 1, 2009. The Company is currently assessing the impact of SFAS 161 on its consolidated financial statements.
32
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
RISK FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
You should carefully consider the following risk factors, the other information included herein and the information included in our other reports and filings. Our business, financial condition, and the trading price of our common stock could be adversely affected by these and other risks.
RISKS OF THE BUSINESS
Our consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The factors described below raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might result from this uncertainty. Our independent registered public accounting firm has included an explanatory paragraph expressing doubt about our ability to continue as a going concern in their audit reports for the fiscal years ended December 31, 2007 and 2006.
We have relied upon outside financing to fund our operations. As a result, our ability to sustain and build our business has depended upon our ability to raise capital from investors and we do not know if we will be able to continue to raise sufficient funds from investors. We have operated on a negative cash flow basis since our inception and we have never earned a profit. We anticipate that we will continue to incur losses for at least the next 12 months and that we will continue to operate on a negative cash flow basis for at least the next 12 months. We have financed our operations to date through the sale of stock, other securities and certain borrowings.
In April and May 2007 we received net proceeds of approximately $13,900,000 through the sale of Secured Debentures and common stock purchase warrants. Most of these funds have been used to sustain our operations and we need to raise additional funds to continue operations and to meet our debt obligations as discussed below.
If we raise additional funds through the issuance of equity securities, this may cause significant dilution of our common stock, and holders of the additional equity securities may have rights senior to those of the holders of our common stock. If we obtain additional financing by issuing debt securities, the terms of these securities could restrict or prevent us from paying dividends and could limit our flexibility in making business decisions.
We do not have sufficient revenues to service our debt. As of April 30, 2008, we had $23,791,013 of debt secured by our fixed assets and intellectual property. Of this amount, $7,828,379 accrues interest at a rate of 10% per annum and requires monthly interest payments until April 2009, when the balance is due in full; $9,999,000 accrues interest at a rate of 10% per annum and requires monthly interest payments until May 2009 when the balance is due in full; $68,169 accrues interest at a rate of 10% per annum and requires monthly payments until September 30, 2008; $5,536,211 accrues interest at a rate of 10% per annum and requires monthly payments until September 18, 2009 at which time the balance of $5,031,872 is due and payable; and $359,254 accrues interest at a rate of 33.65% and requires monthly payments until January 2012. If we are unable to service our debt, our assets, including our patents and other intellectual property, may be subject to foreclosure. Accordingly, if the Secured Debentures are not converted we will default unless we are able to raise additional funds through the sale of new securities. It is our expectation that most or all of the Secured Debentures will be converted into shares of common stock. However, we can not predict how many Secured Debentures will be converted and, even if all the Secured Debentures are converted, we will still owe more than $5,800,000 in 2009. We do not currently have the ability to service this debt without obtaining additional cash resources. If we are unable to service our debt, our assets, including our patents and other intellectual property, may be subject to foreclosure and our common stock may become worthless. We are currently exploring a number of alternatives to address our inability to service our debt. A number of these alternatives would require the consent of 67% or our Secured Debentures and will also require the consent of 67% of the debentures to be sold in the Convertible Note Financing. We do not know if such consents can be obtained, or if an acceptable financing plan can be implemented to enable us to service our outstanding debt. In addition, if our revenues fail to increase sufficiently, our debt service requirements may reduce our working capital and, therefore, adversely affect our ability to operate our business.
33
Failure to collect our accounts receivable will diminish our cash resources, resulting in increased reliance upon outside sources of financing to meet our cash requirements. At March 31, 2008, we had accounts receivable of approximately $2,900,000, with an average age of 58 days. During the quarter, we recorded an allowance for doubtful accounts of $225,000 in connection with the bankruptcy filing of one of our major customers. We believe that financial difficulties and credit constraints faced by some of our customers may result in additional allowances for doubtful accounts. As an emerging company seeking to establish new customer relationships, we generally do not impose strict credit requirements for new customers, nor do we generally require deposits or stand-by letters of credit before accepting purchase orders. As a result, we may face an elevated risk of non-payment or slow payment from certain customers, particularly during difficult economic times. At March 31, 2008, three customers accounted for a total of 68% of the accounts receivable balance, and each of these customers individually accounted for more than 10% of the accounts receivable balance. Failure to timely collect our accounts receivable will result in our having less cash available to fund our operations and will increase our dependence upon outside sources for financing.
We are an early stage company with a short operating history and limited revenues. We were formed in November 2000. Since that time, we have engaged in the formulation of a business strategy and the design and development of technologically advanced products. We have recorded limited revenues from various government-funded research programs, and we have generated only limited revenues from the sale of products. Our ability to implement a successful business plan remains unproven and no assurance can be given that we will ever generate sufficient revenues to sustain our business.
Our products are not proven. We are currently engaged in the design and development of laser diode products for certain medical, industrial and defense applications. Our first commercial sales occurred in 2004. Our most advanced technologies, including without limitation, our “Generation III” products, are in the design or prototype stage. While we have shipped Generation I and Generation II products, most of our products do not have an established commercial track record. We have received only a limited number of purchase orders for our products and we only have a limited number of contractual arrangements to sell our products.
We are dependent on our customers and vulnerable to their sales and production cycles. For the most part, we do not sell end-user products. We sell laser components that are incorporated by our customers into their products. Therefore, we are vulnerable to our customers’ prosperity and sales growth. Failure of our customers to sell their products will ultimately hurt their demand for our products, and thus, have a material adverse effect on our revenues.
We depend on a limited number of customers for a substantial portion of our revenue, and the loss of, or a significant reduction in orders from, any key customer could significantly reduce our revenue. The loss of any of our key customers, or a significant reduction in sales to any one of them, could significantly reduce our revenue and adversely affect our business. Three large customers accounted for 77% and 63% of our total revenue for the first quarter of 2008 and 2007, respectively. The largest three customers were different customers during the first quarter of 2008 compared to the first quarter of 2007. In 2007, four customers accounted for 33% of our total revenue. As an emerging company, we are dependent on sales to certain large customers, some of whom are in turn development stage companies. Our operating results in the foreseeable future will continue to depend on our ability to effect sales to these customers, as well as the ability of these customers to sell products that utilize our technologies and products. In the future, these customers may decide not to incorporate our technologies for use in their systems, purchase fewer products than they did in the past or alter their purchasing patterns. The loss of, or a significant reduction in purchases by, any of our major customers could adversely affect our business, financial condition, results of operations and cash flows.
Unusually long sales cycles may cause us to incur significant expenses without offsetting revenue. Customers often view the purchase of our products as a significant strategic decision. Accordingly, customers carefully evaluate and test our products before making a decision to purchase them, resulting in a long sales cycle. While our customers are evaluating our products and before they place an order, we may incur substantial expenses for sales and marketing and research and development to customize our products to the customer's needs. After evaluation, a potential customer may not purchase our products. As a result, these long sales cycles may cause us to incur significant expenses without ever receiving revenue to offset those expenses.
The markets for our products are subject to continuing change that may impair our ability to successfully sell our products. The markets for laser diode products are volatile and subject to continuing change. For example, since 2001, the market for telecommunications and data communications products has been severely depressed while a more robust market for defense and homeland security applications has developed. We must continuously adjust our marketing strategy to address the changing state of the markets for laser diode products. We may not be able to anticipate changes in the market and, as a result, our product strategies may be unsuccessful.
Our products may become obsolete if we are unable to stay abreast of technological developments. The photonics industry is characterized by rapid and continuous technological development. If we are unable to stay abreast of such developments, our products may become obsolete. We lack the substantial research and development resources of some of our competitors. This may limit our ability to remain technologically competitive.
34
We are dependent for our success on a few key executive officers. Our inability to retain those officers would impede our business plan and growth strategies, which would have a negative impact on our business and the value of your investment. Our success depends on the skills, experience and performance of key members of our management team. We are heavily dependent on the continued services of Jeffrey Ungar, our Chief Executive Officer, George Lintz, our Chief Financial Officer and Chief Operating Officer and Paul Rudy, our Senior Vice President of Marketing and Sales. We do not have long-term employment agreements with any of the members of our senior management team. Each of those individuals may voluntarily terminate his employment with the Company at any time upon short notice. Were we to lose one or more of these key executive officers, we would be forced to expend significant time and money in the pursuit of a replacement, which would result in both a delay in the implementation of our business plan and the diversion of limited working capital. We maintain $8.0 million and $2.0 million key man insurance policies on Mr. Ungar and Mr. Lintz, respectively.
We are also dependent for our success on our ability to attract and retain technical personnel, sales and marketing personnel and other skilled management. Our success depends to a significant degree upon our ability to attract, retain and motivate highly skilled and qualified personnel. Failure to attract and retain necessary technical personnel, sales and marketing personnel and skilled management could adversely affect our business. If we fail to attract, train and retain sufficient numbers of these highly qualified people, our prospects, business, financial condition and results of operations will be materially and adversely affected. Although we intend to issue stock options or other equity-based compensation to attract and retain employees, such incentives may not be sufficient to attract and retain key personnel.
Our business is dependent upon proprietary intellectual property rights. We have employed proprietary information to design our products. We believe that our proprietary technology is critical to our ability to compete. We seek to protect our intellectual property rights through a combination of patent filings, trademark registrations, confidentiality agreements and inventions agreements. However, no assurance can be given that such measures will be sufficient to protect our intellectual property rights. Competitors may challenge the validity of patents we obtain. They may also contend that our patents do not prevent them from selling products that are similar but not identical to our products. Patent litigation is expensive and time-consuming. Competitors may seek to take advantage of our limited financial resources by contesting our patent and other intellectual property rights. If we cannot protect our rights, we may lose our competitive advantage. Moreover, if it is determined that our products infringe on the intellectual property rights of third parties, we may be prevented from marketing our products.
We currently rely on R&D Contracts with the U.S. Government. Currently, a significant part of our near term revenue is expected to be derived from research contracts from the U.S. Government. Changes in the priorities of the U.S. Government may affect the level of funding of certain defense and homeland security programs. Changes in priorities of government spending may diminish interest in sponsoring research programs in our area of expertise. For example, current defense priorities emphasize support for on-going ground operations in Iraq and Afghanistan which appears to have delayed a number of programs that might have resulted in additional awards to the Company. In addition, budgetary constraints faced by defense and homeland security agencies may result in cancellation or delay of programs in which we have an interest, thereby diminishing our prospects for future Government revenues.
We face intense competition, including competition from companies with significantly greater resources than ours, and if we are unable to compete effectively with these companies, our market share may not grow and our business could be harmed. The laser diode industry is highly competitive with numerous competitors from well-established manufacturers to innovative start-ups. A number of our competitors have significantly greater financial, technological, engineering, manufacturing, marketing and distribution resources than we do. Their greater capabilities in these areas may enable them to compete more effectively on the basis of price and production and more quickly develop new products and technologies. In addition, new companies may enter the markets in which we compete, further increasing competition in the laser industry. As we expand our marketing efforts, we expect to increasingly compete with companies that produce diode-pumped solid state and fiber lasers. We may face substantial resistance from prospective customers who are reluctant to change incumbent technologies. We believe that our ability to compete successfully and grow our business depends on a number of factors, including the strength of our technology platform and related intellectual property rights, the capabilities of our scientists and technical staff and our reputation for product innovation and reliability. We may not be able to compete successfully in the future, and increased competition may result in price reductions, reduced profit margins, lost growth opportunities and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products.
35
If our facilities were to experience catastrophic loss, our operations would be seriously harmed. Our facilities could be subject to a catastrophic loss from fire, flood, earthquake or terrorist activity. All of our research and development activities, manufacturing, our corporate headquarters and other critical business operations are located near major earthquake faults in Sylmar, California, an area with a history of seismic events. Any such loss at this facility could disrupt our operations, delay production, and revenue and result in large expenses to repair or replace the facility. While we have obtained insurance to cover most potential losses, we cannot assure you that our existing insurance coverage will be adequate against all other possible losses.
The relative lack of public company experience of our management team may put us at a competitive disadvantage. Our management team lacks public company experience, which could impair our ability to comply with legal and regulatory requirements such as those imposed by Sarbanes-Oxley Act of 2002. The individuals who now constitute our senior management have never had responsibility for managing a publicly traded company. Such responsibilities include complying with federal securities laws and making required disclosures on a timely basis. Our senior management may not be able to implement programs and policies in an effective and timely manner that adequately respond to such increased legal, regulatory compliance and reporting requirements. For example, we concluded that our disclosure controls were not effective as of June 30, 2006 and September 30, 2006. Our failure to comply with all applicable requirements could lead to the imposition of fines and penalties and distract our management from attending to the growth of our business. In addition, our failure to comply with applicable requirements could result in re-statements or other disclosures which could result in a loss of investor confidence in our financial reports and a decline in our stock price.
MARKET RISKS.
Our common stock is thinly traded, so you may be unable to sell at or near ask prices or at all if you need to sell your shares to raise money or otherwise desire to liquidate your shares. Prior to the Share Exchange in May 2006, QPC’s shares were not publicly traded. Through this Share Exchange, QPC has essentially become public without the typical initial public offering procedures which usually include a large selling group of broker-dealers who may provide market support after going public. Thus, we have undertaken efforts to develop market recognition for our stock. As of April 30, 2008, we had approximately 1,800 stockholders and our market capitalization was approximately $29,116,455. As a result, there is limited market activity in our stock and we are too small to attract the interest of many brokerage firms and analysts. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained. While we are trading on the OTC Bulletin Board, the trading volume we will develop may be limited by the fact that many major institutional investment funds, including mutual funds, as well as individual investors follow a policy of not investing in Bulletin Board stocks and certain major brokerage firms restrict their brokers from recommending Bulletin Board stocks because they are considered speculative, volatile and thinly traded.
Future sales of our equity securities could put downward selling pressure on our stock and adversely affect the stock price. Future sales of substantial amounts of our equity securities in the public market, or the perception that such sales could occur, could put downward selling pressure on our stock and adversely affect the market price of our common stock. This downward pressure could be magnified as a result of the large number of shares issuable upon the exercise of outstanding warrants, the conversion of our convertible debt and the exercise of outstanding options. We have filed a registration statement that has been declared effective with respect to the shares issuable upon conversion of our Secured Debentures. Certain of our outstanding warrants, including the warrants issued in connection with the April 2007 Debenture Offering and the May 2007 Debenture Offering, have registration rights. As of April 30, 2008, 37,712,783 shares of our common stock are issuable upon exercise of warrants at an exercise price ranging between $1.05 to $1.50, 17,043,379 shares of our common stock are issuable upon the conversion of our convertible debt at a conversion price of $1.05 and 5,017,666 shares of our common stock are issuable upon exercise of options. In order to meet our on-going cash requirements, we might restructure our current debt in a manner that would increase the number of shares issuable upon conversion of the Secured Debentures. In addition, any restructuring might increase the likelihood that current holders of our Secured Debentures and warrants will exercise their rights to acquire shares of our common stock. Moreover, the notes and warrants being offered in the Convertible Note Financing may be converted into, or exercised for shares of our common stock. We might issue additional securities that could be converted into, or exercised to acquire, shares of our common stock. The prospect of such additional shares being sold into the market could result in further downward pressure on our stock price.
36
The application of the “penny stock” rules to our common stock could limit the trading and liquidity of the common stock, adversely affect the market price of our common stock and increase your transaction costs to sell those shares. As long as the trading price of our common stock is below $5 per share, the open-market trading of our common stock will be subject to the “penny stock” rules, unless we otherwise qualify for an exemption from the “penny stock” definition. The “penny stock” rules impose additional sales practice requirements on certain broker-dealers who sell securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together with their spouse). These regulations, if they apply, require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser’s written agreement to a transaction prior to sale. These regulations may have the effect of limiting the trading activity of our common stock, reducing the liquidity of an investment in our common stock and increasing the transaction costs for sales and purchases of our common stock as compared to other securities.
The market price for our common stock may be particularly volatile given our status as a relatively unknown company with a small and thinly traded public float, limited operating history and lack of profits which could lead to wide fluctuations in our share price. The market price of our common stock could be subject to wide fluctuations in response to:
· | quarterly variations in our revenues and operating expenses; |
· | announcements of new products or services by us; |
· | fluctuations in interest rates; |
· | significant sales of our common stock, including “short” sales; |
· | the operating and stock price performance of other companies that investors may deem comparable to us; and |
· | news reports relating to trends in our markets or general economic conditions. |
The stock market in general, and the market prices for penny stock companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. In addition, there are approximately 31,341,662 shares of our common stock which were sold in private transactions, which are now eligible for sale in accordance with Rule 144 under the Securities Act.
Stockholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include: (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the volatility of our share price.
37
Limitations on director and officer liability and indemnification of our officers and directors by us may discourage stockholders from bringing suit against a director. QPC’s Articles of Incorporation and Bylaws provide, with certain exceptions as permitted by governing state law, that a director or officer shall not be personally liable to us or our stockholders for breach of fiduciary duty as a director, except for acts or omissions which involve intentional misconduct, fraud or knowing violation of law, or unlawful payments of dividends. These provisions may discourage stockholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by stockholders on our behalf against a director. In addition, QPC’s Articles of Incorporation and Bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by governing state law.
We do not expect to pay dividends for the foreseeable future, and we may never pay dividends. We currently intend to retain any future earnings to support the development and expansion of our business and do not anticipate paying cash dividends in the foreseeable future. Our payment of any future dividends will be at the discretion of our Board of Directors after taking into account various factors, including but not limited to, our financial condition, operating results, cash needs, growth plans and the terms of any credit agreements that we may be a party to at the time. In addition, our ability to pay dividends on our common stock may be limited by state law. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize their investment. In addition, the Company is contractually prohibited from paying dividends based on the terms of certain outstanding indebtedness.
Our executive officers and directors beneficially own or control at least 20% of our outstanding common stock, which may limit your ability and the ability of our other stockholders, whether acting alone or together, to propose or direct the management or overall direction of our Company. Additionally, this concentration of ownership could discourage or prevent a potential takeover of our Company that might otherwise result in you receiving a premium over the market price for your shares. We estimate that approximately 20% of our outstanding shares of common stock is beneficially owned and controlled by a group of insiders, including our directors and executive officers. Such concentrated control of the Company may adversely affect the price of our common stock. Our principal stockholders may be able to control matters requiring approval by our stockholders, including the election of directors, mergers or other business combinations. Such concentrated control may also make it difficult for our stockholders to receive a premium for their shares of our common stock in the event we merge with a third party or enter into different transactions which require stockholder approval. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. In addition, certain provisions of Nevada law could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. Accordingly, the existing principal stockholders together with our directors and executive officers will have the power to control the election of our directors and the approval of actions for which the approval of our stockholders is required. If you acquire shares of our common stock, you may have no effective voice in the management of the Company.
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4 Control and Procedures
Not applicable.
38
Item 4T Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report. | |
(b) | During the first quarter of 2008, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute assurance, that its objectives will be met. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. |
39
PART II- Other Information
Item 1 Legal Proceedings
Item 1A Risk Factors
Please see the discussion entitled "Risk Factors That May Affect Future Performance" under Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations of Part I of this Form 10-Q.
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits
Number | Description of Document | |
2.1 | Share Exchange Agreement by and among Quintessence, the Company, the stockholders of Quintessence, and Julie Morin dated May 12, 2006 (1) | |
3.1 | Articles of Incorporation of QPC Lasers, Inc. as filed with the State of Nevada, as amended. (1) | |
3.2 | Bylaws of QPC Lasers, Inc. (1) | |
4.1 | Registration Rights Agreement (2) | |
4.2 | Form of Investor Warrant (2) | |
4.3 | Form of Placement Agent Warrant (2) | |
4.4 | Form of Warrant dated September 2005 (3) |
40
4.5 | Form of Amended and Restated Warrant dated May 2004 (3) | |
4.6 | Form of Warrant dated April 2005 (3) | |
4.7 | Form of Consultant Warrant (3) | |
4.8 | Form of Promissory Note, as amended (4) | |
4.9 | Form of Warrant issued on or about January 25, 2006 (4) | |
4.10 | Secured Promissory Note dated September 18, 2006, issued by Quintessence to Finisar (6) | |
4.11 | Form of Subordinated Secured Note dated as of August 1, 2005 (4) | |
4.12 | Form of Warrant issued in connection with Subordinated Secured Note (4) | |
4.13 | Form of Senior Secured Note dated as of May 24, 2004 (4) | |
4.14 | Form of Warrant issued in connection with Senior Secured Note (“Original Senior Secured Warrant”) (4) | |
4.15 | Form of Amended and Restated Warrant amending the Original Senior Secured Warrant (4) | |
4.16 | Form of First Amendment to Senior Secured Note dated as of March 24, 2005 (4) | |
10.1 | 2006 Stock Option Plan (2) | |
10.2 | Bridge Loan Agreement (2) | |
10.3 | Real Property Lease (2) | |
License Agreement dated September 16, 2003 by and between Quintessence and Finisar (2) | ||
10.5 | Form of Subscription Agreement (2) | |
10.6 | Lock-up Agreement by the Company and George Lintz (3) | |
10.7 | Lock-up Agreement by the Company and Jeffrey Ungar (3) | |
10.8 | Purchase Agreement between Rafael Ltd. and the Company dated June 6, 2005 (3) | |
10.9 | Subcontract Agreement effective as of June 2, 2006 by and between the Company and Fibertek, Inc. (3) | |
10.10 | Agreement of Collaboration dated April 27, 2006 between the Company and Telaris, Inc. (3) * | |
10.11 | Consulting Agreement by and between Quintessence and Capital Group Communications, Inc. dated as of April 3, 2006 (4) |
41
10.12 | Loan Agreement by and among Quintessence and Jeffrey Ungar and George Lintz dated as of November 25, 2005 (4) | |
10.13 | First Amendment to Loan Agreement by and among Quintessence and Jeffrey Ungar and George Lintz dated as of January 25, 2006 (4) | |
10.14 | Security Agreement by and among Quintessence and M.U.S.A. Inc., Jeffrey Ungar and George Lintz dated as of August 1, 2005 (4) | |
10.15 | License Termination Agreement dated September 18, 2006, by and between Quintessence and Finisar(6) | |
10.16 | Security Agreement dated September 18, 2006, by and between Quintessence and Finisar (6) | |
10.17 | Form of Series C Preferred Stock Offering (Tranche I) Subscription Agreement (4) | |
10.18 | Form of Series C Preferred Stock Offering (Tranche II) Subscription Agreement (4) | |
10.19 | Security Agreement by and between Quintessence and DBA Money USA, as collateral agent, dated as of August 1, 2005 (4) | |
10.20 | Loan Agreement by and among the Quintessence and senior secured lenders dated as of May 21, 2004 (4) | |
10.21 | Security Agreement by and between the Company and DBA Money USA, as collateral agent, dated as of May 21, 2004 (“Security Agreement regarding Senior Secured Notes”) (4) | |
10.22 | First Amendment to Loan Agreement by and among Quintessence and senior secured lenders dated as of March 24, 2005 (4) | |
10.23 | First Amendment to Security Agreement regarding Senior Secured Notes dated as of March 24, 2005 (4) | |
10.24 | Phase II Award/Contract dated as of March 24, 2006 by and between the U. S. Army and the Company (7) ** | |
10.25 | April Securities Purchase Agreement*** | |
10.26 | Form of April Secured Debenture (8) | |
10.27 | Form of April Warrant (8) | |
10.28 | April Registration rights Agreement ((8) | |
10.29 | April Security Agreement (8) | |
10.30 | May Securities Purchase Agreement*** |
42
10.31 | Form of May Secured Debenture (9) | |
10.32 | Form of May Warrant (9) | |
May Registration Rights Agreement (9) | ||
10.34 | May Security Agreement (9) | |
10.35 | Intercreditor Agreement (9) | |
10.36 | Transaction Fee Agreement by and between the Company and T.R. Winston & Company, LLC* | |
10.37 | Joint Development and Supply Agreement by and between the Company and Purchaser, dated November 21, 2007 (10)*** | |
16.1 | Letter on change of certifying accountant, dated November 7, 2006 from Bagell Josephs, Levine & Company, L.L.C. to the Commission (5) | |
21.1 | Subsidiaries of the Company (8) | |
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (11) | |
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (11) | |
32.1 | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (11) | |
32.2 | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (11) |
(1) | Filed with the Registrant’s Current Report on Form 8-K filed on May 12, 2006 | |
(2) | Filed with the Registrant’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2006 filed on August 15, 2006 | |
(3) | Filed with the Registrant’s Registration Statement on Form SB-2 filed on September 18, 2006 | |
(4) | Filed with the Registrant's Amendment No. 2 to the Registration Statement on Form SB-2 filed on December 1, 2006 | |
(5) | Filed with the Registrant’s Current Report on Form 8-K filed on November 8, 2006 | |
(6) | Filed with the Registrant’s Current Report on Form 8-K filed on November 2, 2006 | |
(7) | Filed with the Registrant’s Registration Statement on Form SB-2/Pre-Effective Amendment No. 3 filed on January 26, 2007 |
43
(8) | Filed with Registrant’s Current Report on Form 8-K on April 20, 2007 | |
(9) | Filed with Registrant’s Current Report on Form 8-K on May 31, 2007 | |
(10) | Filed with Registrant’s Current Report on Form 8-K on November 30, 2007 | |
(11) | Filed Herewith | |
(*) | Confidential treatment requested as to portions of the Exhibit. Omitted materials filed separately with the Commission. | |
(**) | Filed with Registrant’s Pre Effective Amendment No. 1 to Form SB-2 filed on August 1, 2007 | |
(***) | Confidential treatment requests have been granted by the Commission. Omitted materials filed separately with the Commission. |
44
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: May 15, 2008 | QPC Lasers, Inc. |
/s/ George Lintz | |
George Lintz | |
Chief Operating Officer, Chief Financial Officer | |
/s/ Jeffrey Ungar | |
Jeffrey Ungar Chief Executive Officer |
45