FORM 10-Q QUARTERLY REPORT SEPTEMBER 30, 2014
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________________ to ___________________________
Commission File Number: 000-53913
QUANTUMSPHERE, INC.
(Exact name of registrant as specified in its charter)
| Nevada | | 20-3925307 |
(State or other jurisdiction of incorporation or
organization) | | (I.R.S. Employer Identification No.) |
| | | |
| 2905 Tech Center Drive, Santa Ana, CA | | 92705 |
| (Address of principal executive offices) | | (Zip Code) |
714-545-6266
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | | Accelerated filer | ¨ |
| Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 14, 2014: 22,235,217
CAUTIONARY STATEMENT
All statements included or incorporated by reference in this Quarterly Report on Form 10-Q (this “Form 10-Q”), other than statements or characterizations of historical fact, are “forward-looking statements.” Examples of forward-looking statements include, but are not limited to, statements concerning projected sales, costs, expenses and gross margins; our accounting estimates, assumptions and judgments; the prospective demand for our products; the projected growth in our industry; the competitive nature of and anticipated growth in our industry; and our prospective needs for, and the availability of, additional capital. These forward-looking statements are based on our current expectations, estimates, approximations and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by such words as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are set forth in the “Risk Factors” section of this Report, which could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. These forward-looking statements speak only as of the date of this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.
TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
QUANTUMSPHERE, INC.
CONDENSED BALANCE SHEETS
| | | September 30,
2014
(unaudited) | | | June 30, 2014 | |
| | | | | | | |
| ASSETS | | | | | | | | |
| | | | | | | | | |
| Current Assets | | | | | | | | |
| Cash | | $ | 1,509,807 | | | $ | 2,702,889 | |
| Accounts receivable | | | 1,433 | | | | 3,183 | |
| Prepaid expenses and other current assets | | | 80,651 | | | | 57,003 | |
| Total current assets | | | 1,591,891 | | | | 2,763,075 | |
| | | | | | | | | |
| Property and equipment, net | | | 1,608,298 | | | | 1,533,588 | |
| Patents, net | | | 112,617 | | | | 112,299 | |
| Other assets | | | 24,578 | | | | 24,578 | |
| | | | | | | | | |
| Total assets | | $ | 3,337,384 | | | $ | 4,433,540 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| | | | | | | | | |
| Current Liabilities | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 528,605 | | | $ | 501,051 | |
| Note payable, net of discount | | | 143,563 | | | | 130,786 | |
| Total current liabilities | | | 672,168 | | | | 631,837 | |
| | | | | | | | | |
| Notes Payable, long-term portion, net of discount | | | 312,988 | | | | 358,245 | |
| | | | | | | | | |
| Total Liabilities | | | 985,156 | | | | 990,082 | |
| | | | | | | | | |
| Stockholders’ Equity | | | | | | | | |
| Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued or outstanding | | | – | | | | – | |
| Common stock, $0.001 par value, 500,000,000 shares authorized, 21,560,217 and 21,385,217 shares issued and outstanding as of September 30, 2014 and June 30, 2014, respectively | | | 21,560 | | | | 21,385 | |
| Additional paid-in capital | | | 40,639,476 | | | | 40,232,630 | |
| Accumulated deficit | | | (38,308,808 | ) | | | (36,810,557 | ) |
| Total stockholders’ equity | | | 2,352,228 | | | | 3,443,458 | |
| | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 3,337,384 | | | $ | 4,433,540 | |
The accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| | | | | | | |
| Net Sales | | $ | 14,023 | | | $ | 85,017 | |
| | | | | | | | | |
| Cost of Sales | | | 241,510 | | | | 85,420 | |
| | | | | | | | | |
| Gross Loss | | | (227,487 | ) | | | (403 | ) |
| | | | | | | | | |
| Operating Expenses | | | | | | | | |
| Research and development | | | 594,254 | | | | 184,281 | |
| Selling, marketing and advertising | | | 5,967 | | | | 1,220 | |
| General and administrative | | | 646,036 | | | | 377,182 | |
| Total operating expenses | | | 1,246,257 | | | | 562,683 | |
| | | | | | | | | |
| Loss from Operations | | | (1,473,744 | ) | | | (563,086 | ) |
| | | | | | | | | |
| Other Expense | | | | | | | | |
| Interest expense, net | | | (23,568 | ) | | | (68,698 | ) |
| Interest expense – amortization of note discounts | | | (939 | ) | | | (86,471 | ) |
| Total other expense, net | | | (24,507 | ) | | | (155,169 | ) |
| | | | | | | | | |
| Net Loss | | $ | (1,498,251 | ) | | $ | (718,255 | ) |
| | | | | | | | | |
| Basic and Diluted Loss Per Common Share | | $ | (0.07 | ) | | $ | (0.06 | ) |
| | | | | | | | | |
| Basic and Diluted Weighted-Average Common Shares Outstanding | | | 21,455,597 | | | | 11,056,059 | |
The accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| | | | | | | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | |
| Net loss | | $ | (1,498,251 | ) | | $ | (718,255 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | | | |
| Depreciation and amortization | | | 94,274 | | | | 14,491 | |
| Stock based compensation expense | | | 232,021 | | | | 171,411 | |
| Change in warrants liabilities | | | - | | | | (201,515 | ) |
| Discount amortization on note payable | | | 939 | | | | 287,986 | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 1,750 | | | | 4,802 | |
| Prepaid expenses and other current assets | | | (23,648 | ) | | | (29,295 | ) |
| Accounts payable and accrued expenses | | | 88,972 | | | | 125,153 | |
| Deferred revenue | | | - | | | | 30,750 | |
| Net cash used in operating activities | | | (1,103,943 | ) | | | (314,472 | ) |
| | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | | | | | | | |
| Payments for development of patents | | | (1,527 | ) | | | (6,550 | ) |
| Purchase of property and equipment | | | (167,775 | ) | | | (37,386 | ) |
| Net cash used in investing activities | | | (169,302 | ) | | | (43,936 | ) |
| | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | | | | | | |
| Proceeds from issuances of convertible notes payable | | | - | | | | 900,000 | |
| Payments of notes payable | | | (33,419 | ) | | | - | |
| Common stock buy back | | | (61,418 | ) | | | - | |
| Proceeds from exercise of common stock options | | | 175,000 | | | | - | |
| Net cash provided by financing activities | | | 80,163 | | | | 900,000 | |
| | | | | | | | | |
| NET INCREASE (DECREASE) IN CASH | | | (1,193,082 | ) | | | 541,592 | |
| | | | | | | | | |
| CASH – beginning of period | | | 2,702,889 | | | | 389,394 | |
| | | | | | | | | |
| CASH – end of period | | $ | 1,509,807 | | | $ | 930,986 | |
| | | | | | | | | |
| ADDITIONAL CASH FLOW INFORMATION | | | | | | | | |
| Interest paid | | $ | 23,618 | | | $ | 807 | |
The accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
September 30, 2014
1. ORGANIZATION AND BUSINESS
QuantumSphere, Inc., formerly known as Way Cool Imports, Inc., was incorporated in the State of Nevada on December 1, 2005 (referred to as the “Company”). On April 22, 2014, the Company entered into an Agreement and Plan of Merger (“Merger”) with QuantumSphere, Inc., a California corporation (“QSI”), whereby, among other things, QSI would merge with Way Cool Merger Sub, Inc., a Nevada corporation (“Merger Sub”), a wholly-owned subsidiary of the Company. As a result of the Merger, QSI became a wholly-owned subsidiary of the Company, and the Company issued shares of the Company’s common stock to holders of QSI common stock at a rate of one-to-one. Although from a legal perspective the Company acquired QSI, from an accounting perspective the Merger is viewed as a public shell reverse merger whereby QSI acquired the Company, which had insignificant assets, liabilities, and operations.
The Merger is viewed as a public shell reverse merger because post-Merger QSI’s shareholders own approximately 82% of the outstanding shares of the Company, QSI’s directors and officers now serve as the directors and officers of the Company, and the operations of QSI are the ongoing business of the Company. Therefore, the merger has been accounted for as a recapitalization of QSI, which resulted in QSI becoming a public company. All outstanding stock options and warrants are exercisable into shares of common stock of the legal parent entity.
Subsequent to the Merger, on April 25, 2014, the Company filed Articles of Merger with the Nevada Secretary of State for the purposes of effecting a short-form merger of QSI with and into the Company. The merger of the Company with QSI, its then wholly-owned subsidiary, is referred to as a short-form merger (the “Short-Form Merger”). As part of the Articles of Merger, the Company amended its Articles of Incorporation to change its name from “Way Col Imports, Inc.” to “Quantumsphere, Inc.”
In June 2014, the Company elected to change its year end from December 31 to June 30.
Since beginning operations in 2003, we have developed a process to manufacture metallic nanopowders with end-use applications in the battery and chemicals sector. The Company’s products are used on a stand-alone basis, in the validation of Company’s nano-iron catalysts coated onto commercial iron catalysts used in the production of ammonia on a prospective basis, and research, development, and initial marketing of zinc-air battery products. The Company anticipates introducing zinc-air battery products on a commercial basis in the second quarter of 2015. The Company’s major activities to date have included capital formation, research and development, and marketing of its metallic nanopowder products.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and applicable sections of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary to make the financial statements not misleading have been included. The condensed balance sheet as of June 30, 2014 was derived from audited financial statements. Operating results for the three months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2015. For further information, refer to our Annual Report on Form 10-K for the year ended June 30, 2014.
Use of Estimates
The accompanying financial statements are prepared in conformity with U.S. GAAP and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. The use of estimates may also affect the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include, among others, realization of capitalized assets, valuation of equity instruments, and deferred income tax asset valuation allowances. Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenue when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability is reasonably assured. The Company does not grant customers the right to return the products after such products have been accepted. Amounts billed for shipping and handling are recorded as a component of net sales and the cost incurred for freight is included as a component of operating expenses in the statements of operations.
Property and Equipment
Purchased property and equipment is stated at cost, less accumulated depreciation. Repairs and maintenance of equipment are charged to expense as incurred. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Gains or losses on dispositions of property and equipment are included in the results of operations when realized. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the shorter of terms of the leases or their estimated useful lives. Depreciation expense on assets acquired under capital leases is included in depreciation expense.
Patents
Costs incurred in applying for patents relating to the Company’s process for production of nanopowders have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of September 30, 2014, nine patents have been issued and three patents are pending approval. Amortization relating to issued patents was not significant during the periods presented. Additional significant costs may be required for the continued development of end-use applications for the Company’s technology.
Impairment of Long-Lived Assets
Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the assets with the estimated undiscounted future cash flows associated with them. Should the review indicate that an asset is not recoverable, the Company’s carrying value of the asset would be reduced by the estimated shortfall to fair value.
Research and Development Costs
Research and development costs are expensed as incurred. Costs incurred for research and development for new or improved processes to produce nanopowders as well as end use applications for the nanopowders are expensed until the production process or applications have been determined to be commercially viable. Costs incurred after the production process is viable and a working model of the equipment has been completed will be capitalized as long-lived assets.
Income Taxes
Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities.
The Company provides for tax contingencies, if any, for federal, state and local exposures relating to audit results, tax planning initiatives and compliance responsibilities. The development of these reserves requires judgments about tax issues, potential outcomes and timing. Although the outcome of such matters is uncertain, in management’s opinion adequate provisions for income taxes have been made for potential liabilities emanating from these reviews. If actual outcomes differ materially from these estimates, they could have a material impact on the Company’s results.
Loss Per Share
The Company calculates basic loss per share by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if such additional common shares had been issued and were dilutive.
Potential common shares, consisting of options and warrants, totaling 12,271,327 and 11,688,395, have been excluded from the computations of diluted net loss per share because the effect would have been anti-dilutive for the three months ended September 30, 2014 and 2013, respectively.
Stock-Based Compensation
The Company measures all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocates the related expense over the requisite service period. The expected volatility is based on the historical volatility of the Company’s stock as determined by its private placement offerings, the expected life of the award is based on the simplified method.
The Company accounts for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.
Risks and Uncertainties
The Company faces risks and uncertainties relating to its ability to successfully implement and fulfill its strategy. Among other things, these risks include the ability to obtain revenues; manage operations; competition; attract, retain and motivate qualified personnel; maintain and develop new strategic relationships; and the ability to anticipate and adapt to the changing nanotechnology market and any changes in government regulations.
Therefore, the Company may be subject to the risks of delays in consummating contracts with customers and suppliers, raising sufficient capital to achieve its objectives and other uncertainties, including financial, operational, technological, regulatory and other risks associated with an emerging business, including the potential risks of business failure. Technology and manufacturing companies with whom the Company is expected to compete, in general, are well capitalized. The Company is competing against entities with the financial and intellectual resources and expressed intent of performing rapid technological innovation. The Company’s resources are limited and must be allocated to focus objectives in order to succeed.
Going Concern
The Company has suffered recurring losses from operations from inception and has limited working capital. As of September 30, 2014, the Company had an accumulated deficit of approximately $38.3 million. The Company’s activities will necessitate significant uses of working capital beyond 2015. Additionally, the Company’s capital requirements will depend on many factors, including the success of its continued research and development efforts and the status of competitive products. The Company plans to continue financing its operations with cash received from financing activities. Management is currently attempting to raise additional capital from financing activities to sustain operations until the Company is able to generate sufficient cash flows from operations. There is no assurance that the Company will be able to raise sufficient capital to continue operations and, if available, on terms satisfactory to the Company.
3. NOTE PAYABLE
On June 19, 2014, the Company signed a loan and security agreement with Novus Capital Group that provides up to two loans, each in the amount of $500,000. The initial loan of $500,000 was funded on June 19, 2014. The second loan in the amount of $500,000 is to be funded upon: (a) the Company having secured additional equity financing of not less than $3,000,000 on or before December 31, 2014; (b) the monthly payments on the initial loan being made as agreed; and (c) the Company is not in default on any of its obligations with any of its creditors. The loans accrue at an annual rate of 15.5%, have a term of thirty-six months, and monthly payments on each loan are $17,455, beginning August 10, 2014 for the initial loan. The agreement includes a warrant to purchase 30,000 shares of common stock at an exercise price of $2.00 per share that expires July 1, 2019; 20,000 warrants vested upon the initial funding of $500,000, and 10,000 warrants vest upon the second funding of $500,000. The initial vested warrants were valued at approximately $11,000, using the Black Scholes Merton option pricing model, and recorded as a discount to the note payable. The Company has not yet met the conditions for funding on the second note.
4. STOCKHOLDERS’ EQUITY
Common Stock
In early April 2014, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of September 30, 2014, the Company had approximately $290,000 of accrued liabilities associated with the share cancellation.
Stock Options
During the three months ended September 30, 2014, the Company issued to employees, officers, directors, advisory board and consultants options to purchase 80,000 shares of common stock, which are exercisable at a price of $2.00 per share.
In August of 2014, 175,000 options were exercised at a price of $1.00 per share.
The fair value of stock options granted were estimated on their respective grant dates using the Black-Scholes-Merton option pricing model and the following assumptions for the three months ended September 30, 2014 and 2013:
| | | Three Months Ended September 30, | |
| | | 2014 | | | 2013 | |
| Risk free interest rate | | | 0.89 | % | | | 1.40 | % |
| Expected term | | | 5 years | | | | 6 years | |
| Expected volatility | | | 44.2 | % | | | 45.3 | % |
| Dividend yield | | | – | | | | – | |
5. CONCENTRATIONS
For the three months ended September 30, 2014, 55% of net sales were to Asia and 24% of net sales were to Canada. For the three months ended September 30, 2013, 61% of net sales were to Israel and 25% of net sales were to Asia. For the three months ended September 30, 2014, 69% of net sales were to two customers. For the three months ended September 30, 2013, 74% of net sales were to two customers.
6. SUBSEQUENT EVENTS
In October 2014, 415,000 common stock options were exercised at a price of $1.00 each.
In November 2014, 260,000 common stock options were exercised at a price of $1.00 each.
Effective November 1, 2014, Dr. Douglas Carpenter, CTO of the Company, is taking a medical leave of absence. It is presently unknown how long Dr. Carpenter will be on leave, but Company management is confident that it has the necessary resources in place to handle all of Dr. Carpenter’s day-to-day duties and his absence will not have a material effect on the Company.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Forward Looking Statements
This Form 10-Q contains statements that must be deemed “forward-looking” statements under Section 27A of the Securities Act, including, among other things, discussions as to our business strategies, expectations, market position and services, anticipated revenues and performance, future operations, profitability, liquidity and capital resources. Words including, but not limited to, “may,” “will,” “likely,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “continue,” “seek,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in such forward-looking statements are generally reasonable and reflect the current views of our management, such statements are inherently uncertain, and we can give no assurance that such statements will ultimately prove to be correct. Our operations are subject to a number of uncertainties and risks, many of which are outside our control, and any one of which, or any combination of which, could materially adversely affect our results of operations. Important factors, including, but not limited to, those discussed in the section titled “Risk Factors,” beginning on page 23 of our Form 10-KT filed on September 26, 2014, could cause actual results to differ materially from such statements. Therefore, you are cautioned not to place undue reliance on these forward-looking statements.
These forward-looking statements may relate to the following:
| · | our future operating results and business prospects; |
| · | our ability to develop and market products that compete effectively in our targeted market segments; |
| · | market acceptance of our current and future products and the degree and nature of our competition; |
| · | our ability to meet customer demand; |
| · | our ability to protect and enforce our current and future intellectual property; |
| · | our ability to obtain sufficient funding to continue to pursue our business plan; |
| · | our ability to implement a long-term business strategy that will be profitable or generate sufficient cash flow; |
| · | our ability to manage our foreign manufacturing and development operations and international business risks; |
| · | the loss of any of our key members of management; |
| · | changes in our industry, interest rates or the general economy; and |
| · | changes in governmental regulations, tax rates and similar matters. |
We believe that the expectations reflected in the forward-looking statements are reasonable. However, there may be events in the future that we are not able to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements, whether as a result of any new information, future events, or otherwise.
Overview
QuantumSphere, Inc. was incorporated in the State of Nevada on December 1, 2005 and formerly known as Way Cool Imports, Inc. (“WYCC”). On April 22, 2014, WYCC entered into the Merger Agreement with QuantumSphere, Inc., a California corporation (“QSI”), whereby, among other things, QSI would merge with Way Cool Merger Sub, Inc., a Nevada corporation and wholly-owned subsidiary of WYCC. On April 22, 2014, the parties consummated the merger and QSI became a wholly-owned subsidiary of WYCC. As part of the merger, WYCC issued 17,185,217 shares of common stock to QSI shareholders, options to purchase 5,942,078 shares of common stock, and warrants to purchase 9,883,233 shares of common stock. The merger was considered a public shell reverse merger and, accordingly, accounted for as a recapitalization of QSI.
Subsequent to the merger, on April 25, 2014, WYCC filed Articles of Merger with the Nevada Secretary of State for the purposes of effecting a short-form merger of WYCC with and into QSI. The merger of WYCC with QSI, its wholly-owned subsidiary, is referred to as a short-form merger and did not require the approval of WYCC’s stockholders. As part of the Articles of Merger, WYCC amended its Articles of Incorporation to change its name from “Way Cool Imports, Inc.” to “QuantumSphere, Inc.” The Articles of Merger were effective upon filing.
On June 23, 2014, we reported our decision to change our fiscal year end to June 30 from a fiscal year ending on December 31. This action created a “transition period” (as defined), which is the six month period ended June 30, 2014. Under the SEC’s reporting rules, a registrant is required to file a separate transition report for transition periods that cover a period of six months or greater. Rule 13a-10 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), requires registrants that have a transition period of six months or greater to file audited financial statements for that transition period on the form appropriate for annual reports of the registrant. Accordingly, our audited statement of operations and cash flows for the six month transition period ended June 30, 2014 were filed on Form 10-KT on September 26, 2014.
Emerging Growth Company
We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). We will remain an emerging growth company until the earlier of the following: (1) the last day of the fiscal year following the fifth anniversary of the date of the first sale of our common stock pursuant to an effective registration statement under the Securities Act of 1933, as amended (the “Securities Act”); (2) the last day of the fiscal year where we have total annual gross revenues of at least $1.0 billion; (3) the date on which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeded $700.0 million as of the prior June 30; and (4) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.
As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that may otherwise be applicable to public companies. These provisions include:
| · | Only two years of audited consolidated financial statements in addition to any required unaudited interim financial statements with correspondingly reduced “Management’s Discussion and Analysis of Financial Condition and Results of Operations” disclosure; |
| · | Reduced disclosure about our executive compensation arrangements; |
| · | No requirement that we hold non-binding advisory votes on executive compensation or golden parachute arrangements; and |
| · | Exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting. |
We have taken advantage of some of these reduced burdens and may continue to do so for so long as we remain an emerging growth company, and thus the information we provide stockholders may be different from what you might receive from other public companies in which you hold shares.
To the extent that we continue to qualify as a “smaller reporting company,” as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), after we cease to qualify as an emerging growth company, certain of the exemptions available to us as an emerging growth company may continue to be available to us as a smaller reporting company, including: (1) not being required to comply with the auditor attestation requirements of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002; (2) scaled executive compensation disclosures; and (3) the requirement to provide only two years of audited financial statements, instead of three years.
Critical Accounting Policies and Estimates
Use of Estimates. We make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. The use of estimates may also affect the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include, among others, realization of capitalized assets, valuation of equity instruments, and deferred income tax valuation allowances. Actual results could differ from those estimates.
Revenue Recognition. We recognize revenue when all four of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured. We do not grant customers the right to return the products after such products have been accepted. Amounts billed for shipping and handling are recorded as a component of net sales and the cost incurred for freight is included as a component of operating expenses in the statements of operations.
Property and Equipment. Purchased property and equipment is stated at cost, less accumulated depreciation. Repairs and maintenance of equipment are charged to expense as incurred. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Gains or losses on dispositions of property and equipment are included in the results of operations when realized. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the shorter of terms of the leases or their estimated useful lives. Depreciation expense on assets acquired under capital leases is included in depreciation expense.
Patents. Costs incurred in applying for patents relating to our process for production of nanomaterials have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of September 30, 2014, nine patents have been issued and three patents are pending approval. Additional significant costs may be required for the continued development of end-use applications for our technology.
Impairment of Long-Lived Assets. Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We evaluate potential impairment by comparing the carrying amount of the assets with the estimated undiscounted future cash flows associated with them. Should the review indicate that an asset is not recoverable, our carrying value of the asset would be reduced by the estimated shortfall to fair value.
Income Taxes. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities.
Stock-Based Compensation. We measure all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocate the related expense over the requisite service period. The expected volatility is based on the historical volatility of our stock as determined by its private placement offerings, the expected life of the award is based on the simplified method. We account for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.
Results of Operations
The following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the three months ended September 30, 2014 and 2013. This discussion and analysis should be read in conjunction with our financial statements appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors,” beginning on page 23 of our Form 10-KT filed on September 26, 2014.
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
The following discussions are based on the consolidated balance sheets as of September 30, 2014 and June 30, 2014 and statements of operations for the three months ended September 30, 2014 and September 30, 2013 and notes thereto.
The tables presented below, which compare QSI’s results of operations from one period to another, present the results for each period and the change in those results from one period to another in dollars. The columns present the following:
| · | The first two data columns in each table show the dollar results for each period presented. |
| · | The column entitled “Dollar variance” shows the change in results in dollars. This column shows favorable changes as positive and unfavorable changes as negative. For example, when net sales increase from one period to the next, that change is shown as a positive number. Conversely, when expenses increase from one period to the next, that change is shown as a negative. |
| | | 2014 | | | 2013 | | | Dollar variance
favorable
(unfavorable) | |
| | | | | | | | | | |
| Net Sales | | $ | 14,023 | | | $ | 85,017 | | | $ | (70,994 | ) |
| | | | | | | | | | | | | |
| Cost of Sales | | | 241,510 | | | | 85,420 | | | | (156,090 | ) |
| | | | | | | | | | | | | |
| Gross Loss | | | (227,487 | ) | | | (403 | ) | | | (227,084 | ) |
| | | | | | | | | | | | | |
| Operating Expenses | | | | | | | | | | | | |
| Research and development | | | 594,254 | | | | 184,281 | | | | (409,973 | ) |
| Selling, marketing and advertising | | | 5,967 | | | | 1,220 | | | | (4,747 | ) |
| General and administrative | | | 646,036 | | | | 377,182 | | | | (268,854 | ) |
| Total operating expenses | | | 1,246,257 | | | | 562,683 | | | | (683,574 | ) |
| | | | | | | | | | | | | |
| Loss from Operations | | | (1,473,744 | ) | | | (563,086 | ) | | | (910,658 | ) |
| | | | | | | | | | | | | |
| Other Expense | | | | | | | | | | | | |
| Interest expense, net | | | (23,568 | ) | | | (68,698 | ) | | | 45,130 | |
| Interest expense – amortization of note discounts | | | (939 | ) | | | (86,471 | ) | | | 85,532 | |
| Total other expense, net | | | (24,507 | ) | | | (155,169 | ) | | | 130,662 | |
| | | | | | | | | | | | | |
| Net Loss | | $ | (1,498,251 | ) | | $ | (718,255 | ) | | $ | (779,996 | ) |
Net Sales. Net sales decreased by $70,994 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013, reflecting a decrease in sales of various nanomaterials and electrodes.
For the three months ended September 30, 2014 and 2013, 69% and 74% of net sales were to two and two companies, respectively.
For the three months ended September 30, 2014, 55% of net sales were to Asia. For the three months ended September 30, 2013, 61% of net sales were to Israel and 25% of net sales were to Asia.
Gross Loss. Gross loss increased by $227,084 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase resulted from decrease of $70,994 in sales and increases of $210,762 in manufacturing salaries and related expenses, $91,719 in utilities, $75,673 in depreciation, $68,458 in production materials, and $16,253 in miscellaneous expenses, offset by $306,775 allocation of nano iron production costs to research and development.
Research and Development. Research and development expenses increased by $409,973 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase resulted from increases of $306,775 in production of nano iron for commercial validation purposes, $75,940 in salaries and related expenses due to more employees, and $36,657 in research on the MetAir® Ranger battery, offset by a decrease of $9,399 in miscellaneous expenses. Nano iron was produced to be placed in use in an ammonia plant in China to verify prior laboratory results and thus is considered to still be part of research & development. The nano iron provided is not considered a sale as no income is to be received for it.
Selling, Marketing and Advertising Expenses. Selling, marketing and advertising expenses increased by $4,747 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase resulted from increases of $2,048 in marketing expense and $2,699 in miscellaneous expenses.
General and Administrative Expenses. General and administrative expenses increased by $268,854 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase resulted from $83,071 in board members compensation, $52,640 in audit expense, $43,624 in legal expenses, $42,574 in business insurance, $26,810 in payroll and related expenses, $9,453 in outside consultants, and $10,682 in miscellaneous expenses.
Interest Expense. Interest expense decreased by $45,130 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The decrease resulted from the conversion to common stock in April 2014 of $2,667,500 in convertible notes payable at September 30, 2013, offset by a new note payable of $500,000 at September 30, 2014.
Interest Expense – Amortization of Note Discounts. Debt discount amortization decreased by $85,532 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The decrease resulted from the conversion to common stock in April 2014 of $2,667,500 in convertible notes payable at September 30, 2013, offset by a new note payable of $500,000 at September 30, 2014.
Liquidity and Capital Resources
As of September 30, 2014, we had current assets of $1,591,891, including $1,509,807 in cash and cash equivalents.
Cash decreased $1,193,082 from $2,702,889 at June 30, 2014 to $1,509,807 at September 30, 2014. Net cash used in operating activities of $1,103,943 in the three months ended September 30, 2014 included $1,498,251 operating loss and $23,648 increase in prepaid expenses, offset by non-cash expenses of $232,021 for stock based compensation, $94,274 for depreciation and amortization, and $939 for discounts on notes payable, and $88,972 increase for accounts payable and accrued expenses, and $1,750 decrease in accounts receivable. $314,472 in cash was used in operating activities for the three months ended September 30, 2013.
$169,302 of cash was used in investing activities in the three months ended September 30, 2014. $167,775 of cash was used for the purchase of property and equipment and $1,527 of cash was used for the development of patents. $43,936 of cash was used in investing activities in the three months ended September 30, 2013.
$80,163 in cash was provided by financing activities in the three months ended September 30, 2014. $175,000 was provided by the exercise of stock options offset by $61,418 common stock buy backs and $33,419 principal payments on a note payable. $900,000 in cash was provided by financing activities in the three months ended September 30, 2013.
Immediately prior to the consummation of the Merger, the Company completed a private placement of 1,267,000 units consisting of 1,267,000 shares of common stock and warrants to purchase 633,500 shares of common stock for $2,534,000 in cash and converted all of its debt obligations totaling $6,642,500 and $574,281 in related interest expense into 5,447,194 shares of common stock and warrants to purchase 1,805,645 shares of common stock. Upon consummation of the Merger, the Company did not have any outstanding debt instruments. The Company incurred a $500,000 note payable in June 2014.
Immediately prior to the consummation of the Merger, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of September 30, 2014, the Company had approximately $290,000 of accrued liabilities associated with the share cancellation.
We monitor our financial resources on an ongoing basis and may adjust planned business activities and operations as needed to ensure that we have sufficient operating capital. We evaluate our capital needs, and the availability and cost of capital on an ongoing basis and expect to seek capital when and on such terms as deemed appropriate based upon an assessment of then-current liquidity, capital needs, and the availability and cost of capital. Given our stage of operations, we do not expect that bank or other institutional debt financing will be available. We expect that any capital we raise will be through the issuance of equity securities, warrants or similar securities. We believe that we will be able to obtain financing when and as needed, but may be required to pay a high price for capital.
Other Commitments and Contingencies
Our commitments and contingencies as of September 30, 2014 consisted of our lease agreement for our principal corporate offices located in Santa Ana, California and leased equipment. Accordingly, the following table only summarizes our minimum lease payments for the next five years and thereafter:
| Year Ending September 30, | | Amount | |
| 2015 | | $ | 103,286 | |
| 2016 | | | 106,253 | |
| 2017 | | | 44,049 | |
| Total | | $ | 253,588 | |
The above minimum lease payments include a new lease for our principal corporate offices that was signed in March 2014. The lease period is from March 2014 through February 2017.
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not required by smaller reporting companies.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures.
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls as of the end of the period covered by this report, September 30, 2014. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer, Mr. Kevin Maloney, and Chief Financial Officer, Mr. Stephen Gillings, (the “Certifying Officers”). Based upon that evaluation, our Certifying Officers concluded that as of the end of the period covered by this report, our disclosure controls and procedures are effective in timely alerting management to material information relating to us and required to be included in our periodic filings with the Securities and Exchange Commission (the “Commission”).
Our officers further concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the issuer in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms and are also effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow time for decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting.
There were no changes in the Company's internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS
Not Applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5. OTHER INFORMATION.
None
ITEM 6. EXHIBITS
Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-K.
Exhibit No. | | Title of Document | | Location |
| | | | | |
| 31 | | Certification of the Principal Executive Officer/ Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | | Attached |
| | | | | |
| 32 | | Certification of the Principal Executive Officer/ Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* | | Attached |
| | | | | |
| 101.INS | | XBRL Instance Document | | Attached |
| | | | | |
| 101.SCH | | XBRL Taxonomy Extension Schema Document | | Attached |
| | | | | |
| 101.CAL | | XBRL Taxonomy Calculation Linkbase Document | | Attached |
| | | | | |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document | | Attached |
| | | | | |
| 101.LAB | | XBRL Taxonomy Label Linkbase Document | | Attached |
| | | | | |
| 101.PRE | | XBRL Taxonomy Presentation Linkbase Document | | Attached |
The Exhibits attached to this Form 10-Q shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act") or otherwise subject to liability under that section, nor shall they be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as expressly set forth by specific reference in such filing.
SIGNATURES
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.
QUANTUMSPHERE, INC.
Date: November 14, 2014
| By: | /s/Kevin Maloney | |
| Kevin Maloney, Chief Executive Officer |
| |
| By: | /s/Stephen Gillings | |
| Stephen Gillings, Chief Financial Officer |
