In accordance with
Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned,
hereunto duly authorize.
KNOW ALL PERSONS BY
THESE PRESENTS, that each person whose signature appears below constitutes and appoints, jointly and severally, Cecil Bond Kyte
and Greggory Bigger, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution
and re-substitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments
to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to
all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements
of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012
AND 2011
AND FOR THE PERIOD INCEPTION (FEBRUARY
18, 1998) TO DECEMBER 31, 2012
1.
|
Description of business
|
Description of business
Save The World Air,
Inc. (“STWA”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name
Mandalay Capital Corporation. The company changed its name to Save the World Air, Inc. on February 11, 1999, following the acquisition
of the marketing and manufacturing rights of the ZEFS technologies. Our executive offices are at 735 State Street, Suite 500, Santa
Barbara, California 93101. The telephone number is (805) 845-3561. The Company’s common stock is quoted under the symbol
“ZERO” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and
media articles are available at our corporate website,
www.stwa.com
.
Save The World Air,
Inc. develops and intends to commercialize energy efficiency technologies that assist in meeting increasing global energy demands,
improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual property
portfolio includes 41 domestic and international patents and patents pending, which have been developed in conjunction with and
exclusively licensed from Temple University. STWA's technology is called Applied Oil Technology™ (AOT™), a commercial-grade
crude oil pipeline transportation flow-assurance product. AOT™ has been proven in U.S. Department of Energy tests to increase
the energy efficiency of oil pipeline pump stations. The AOT product has transitioned from the research and development stage to
initial commercial production for the midstream pipeline marketplace. .
Consolidation policy
The accompanying consolidated
financial statements of Save the World Air, Inc. and Subsidiary include the accounts of Save the World Air, Inc. (the Parent) and
its wholly owned subsidiary STWA Asia Pte. Limited, incorporated on January 17, 2006. Intercompany transactions and
balances have been eliminated in consolidation.
2.
|
Summary of significant accounting policies
|
Development stage enterprise
The Company is a development
stage enterprise. All losses accumulated since the inception of the Company have been considered as part of the Company’s
development stage activities.
The Company’s
focus is on product development and marketing of proprietary devices that are designed to improve the operational parameters of
petrochemical pipeline transport systems and has not yet generated meaningful revenues. The Company is currently transitioning
from the product development cycle to the commercial manufacturing and sales cycle. Expenses have been funded through
the sale of shares of common stock for cash, issuance of convertible notes for cash and the proceeds from exercise of options and
warrants. The Company has taken actions to secure the intellectual property rights to the proprietary technologies and
is the worldwide exclusive licensee for the intellectual property the Company co-developed with its intellectual property partner,
Temple University of Philadelphia, PA.
Going concern
The accompanying financial
statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the accompanying financial statements, the Company had a net
loss of $13,092,387 and a negative cash flow from operations of $4,517,585 for the year ended December 31, 2012, and a stockholders’
deficiency of $2,897,520 at December 31, 2012. These factors raise substantial doubt about the Company’s ability to
continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability
to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be
necessary if the Company is unable to continue as a going concern.
At December 31, 2012,
the Company had cash on hand in the amount of $1,601,791. Management expects that the current funds on hand will be sufficient
to continue operations through June 2013. Management is currently seeking additional funds, primarily through the issuance of debt
and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with
the license and research and development agreements with Temple University; costs associated with product development and commercialization
of the AOT technology; costs to manufacture and ship the products; costs to design and implement an effective system of internal
controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports
with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial
contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain
severance payments to a former officer and consulting fees, during the remainder of 2013 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of
debt financing or cause substantial dilution for our stock holders, in case or equity financing.
Revenue Recognition
Policy
The Company recognizes
revenue based upon meeting the following criteria. Persuasive evidence of an arrangement exists; Delivery has occurred or services
rendered; The seller’s price to the buyer is fixed or determinable; and Collectability is reasonably assured.
The Company co-develops
with, and licenses from, its intellectual property as a joint-agreement with Temple University of Philadelphia, PA. The
Company’s business model is to contract with suppliers and manufacturers of oilfield equipment to sell into the oilfield
pipeline market. The Company negotiates an initial contract with the customer fixing the terms of the sale and then receive a letter
of credit or full payment in advance of shipment. Upon shipment, the Company will recognize the revenue associated with the sale
of the products to the customer.
Property and equipment
and depreciation
Property and equipment
are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and improvements that extend the useful lives of property
and equipment are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. Leasehold improvements
are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.
Impairment of long-lived
assets
Our long-lived assets,
such as property and equipment, are reviewed for impairment at least annually, or when events and circumstances indicate that depreciable
or amortizable long lived assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount of those assets. When specific assets are determined to be unrecoverable, the cost basis of the asset
is reduced to reflect the current value.
We use various assumptions
in determining the current fair value of these assets, including future expected cash flows and discount rates, as well as other
fair value measures. Our impairment loss calculations require us to apply judgment in estimating future cash flows, including forecasting
useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows.
If actual results are
not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed
to future impairment losses that could be material to our results. Based upon management’s annual review, no impairments
were recorded for the years ended December 31, 2012 and 2011.
Loss per share
Basic loss per share
is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during
the period. Diluted loss per share reflects the potential dilution, using the treasury stock method that could occur if securities
or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock
that then shared in the loss of the Company. In computing diluted loss per share, the treasury stock method assumes that outstanding
options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period.
Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common
stock during the period exceeds the exercise price of the options and warrants. For the years ended December 31, 2012 and
2011, the dilutive impact of outstanding stock options of 27,278,098 and 24,067,892; outstanding warrants of 42,205,507, and 49,106,280
and notes convertible into -0- and 6,836,016 shares of our common stock respectively, have been excluded because their impact
on the loss per share is anti-dilutive.
Income taxes
Income taxes are recognized
for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets are recognized for the
future tax consequences of transactions that have been recognized in the Company’s consolidated financial statements or tax
returns. A valuation allowance is provided when it is more likely than not that some portion or entire deferred tax asset will
not be realized.
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 accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board 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. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's stock options and warrants grant is estimated using the Black-Scholes option pricing model, which uses certain
assumptions related to risk-free interest rates, expected volatility, expected life of the stock options or warrants, and future
dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes option pricing model, and based
on actual experience. The assumptions used in the Black-Scholes option pricing model could materially affect compensation expense
recorded in future periods.
Accounting for Warrants and Derivatives
The Company evaluates
all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially
recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated
statements of operations. For stock-based derivative financial instruments, the Company uses probability weighted
average series Black-Scholes Merton option pricing models to value the derivative instruments at inception and on subsequent
valuation dates.
The classification
of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the
end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current
based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet
date.
Business and credit concentrations
The Company’s
cash balances in financial institutions at times may exceed federally insured limits. As of December 31, 2012 and 2011, before
adjustments for outstanding checks and deposits in transit, the Company had $1,616,639 and $597,581, respectively, on deposit with
two banks. The deposits are federally insured up to $250,000 on each bank.
Estimates
The preparation of
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities 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. Certain significant estimates
were made in connection with preparing the Company’s financial statements. Actual results could differ from those estimates.
Fair value of financial
instruments
Effective January 1,
2008, fair value measurements are determined by the Company's adoption of authoritative guidance issued by the FASB, with the exception
of the application of the statement to non-recurring, non-financial assets and liabilities as permitted. The adoption of the authoritative
guidance did not have a material impact on the Company's fair value measurements. Fair value is defined in the authoritative
guidance as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy
was established, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
Level 1—Quoted prices
in active markets for identical assets or liabilities.
Level 2—Inputs, other
than the quoted prices in active markets, are observable either directly or indirectly.
Level 3—Unobservable
inputs based on the Company's assumptions.
The Company is required
to use of observable market data if such data is available without undue cost and effort.
The following table
presents certain investments and liabilities of the Company’s 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 as of December
31, 2012 and 2011.
|
|
|
Level 1
|
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Fair value of Derivative Liability, December 31, 2012
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
3,221,138
|
|
|
$
|
3,221,138
|
|
|
Fair value of Derivative Liability, December 31, 2011
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
1,643,139
|
|
|
$
|
1,643,139
|
|
Recent Accounting Pronouncements
In December 2011, the
Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11, “Balance
Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.” This ASU requires an entity to disclose information
about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements
on its financial position. ASU No. 2011-11 will be applied retrospectively and is effective for annual and interim reporting periods
beginning on or after January 1, 2013. The Company does not expect adoption of this standard to have a material impact on its consolidated
results of operations, financial condition, or liquidity.
In July 2012, the FASB
issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (ASU
2012-02), allowing entities the option to first assess qualitative factors to determine whether it is necessary to perform the
quantitative impairment test. If the qualitative assessment indicates it is more-likely-than-not that the fair value of an indefinite-lived
intangible asset is less than its carrying amount, the quantitative impairment test is required. Otherwise, no testing is required.
ASU 2012-02 is effective for the Company in the period beginning January 1, 2013. The Company does not expect the adoption of this
update to have a material effect on the consolidated financial statements.
Other recent accounting
pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the Securities Exchange Commission
(the "SEC") did not or are not believed by management to have a material impact on the Company's present or future consolidated
financial statements.
3.
|
Certain relationships and related transactions
|
Accounts Payable
to related parties
As of December
31, 2012 and December 31, 2011, the Company had accounts payable to related parties in the amount of $65,192 and $63,003, respectively.
These amounts are unpaid Directors Fees and expenses incurred by Officers and Directors.
Accrued expense
due to related parties
As of December
31, 2012 and December 31, 2011, the Company accrued the unpaid salaries, unused vacation and the corresponding payroll taxes of
its employees in the aggregate of $468,086 and $812,993, respectively. Included in these accruals are the unpaid salaries of the
former President of the Company of $255,429 and $376,515 respectively and the former Chief Finnacial Officer of the Company of
$155,000 and $320,000 respectively. The Company agreed to a monthly payment of $5,000 up to $15,000 to these formers officers of
the Company until their unpaid salaries are fully settled.
Cash Bonus Paid to Chief Executive Officer
General and administrative expenses for
the year ended December 31, 2012, include a cash bonus of $100,000 paid to the Company’s Chief Executive Officer.
4.
|
Property and Equipment
|
At December 31, 2012 and 2011, property
and equipment consists of the following:
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Office equipment
|
|
$
|
91,288
|
|
|
$
|
75,685
|
|
Furniture and fixtures
|
|
|
16,128
|
|
|
|
15,589
|
|
Machinery and equipment
|
|
|
49,986
|
|
|
|
49,986
|
|
Testing equipment
|
|
|
147,312
|
|
|
|
147,312
|
|
Subtotal
|
|
|
304,714
|
|
|
|
288,572
|
|
Less accumulated depreciation
|
|
|
(249,040
|
)
|
|
|
(212,963
|
)
|
Total
|
|
$
|
55,674
|
|
|
$
|
75,609
|
|
Depreciation expense
for the years ended December 31, 2012 and 2011 was $36,077 and $34,717, respectively. Depreciation expense for the period
from inception February 18, 1998 through December 31, 2012 was $530,976.
5.
|
Convertible notes and warrants
|
From December 13, 2010
through July 23, 2012, the Company conducted private offerings of up to $10,000,000 aggregate face amount of its convertible
notes. A total of $8,302,153 aggregate face amount of the notes were sold for an aggregate purchase price of $7,547,411.
During the year
ended December 31, 2011, the Company issued its convertible notes in the aggregate of $6,232,979 for a total cash consideration
of $5,360,070, original issue discount of $566,634 and conversion of $306,275 of accounts payable. The notes does not bear any
interest, however, the Company used an implied interest rate of 10%, are unsecured, will mature in one year and convertible to
24,931,916 shares of common stock at a conversion price of $0.25 per share. Furthermore, each of the investors in the offerings
received, for no additional consideration, warrants to purchase a total of 24,931,916 shares of common stock. Each warrant is exercisable
on a cash basis only at a price of $0.30 per share, and is exercisable immediately upon issuance and will expire within two (2)
from the date of issuance.
The aggregate relative
fair value of the warrants issued in the 2011 offerings were valued at $2,970,311 using the Black-Scholes-Merton option valuation
model with the following average assumptions: risk-free interest rate of .28%; dividend yield of 0%; volatility rate of 118% based
upon the Company’s historical stock price; and an expected life of two (statutory term). The Company also determined that
the notes contained a beneficial conversion feature of $2,696,034 since the market price of the Company’s common stock were
higher than the conversion price of the notes when they were issued. The value of the 2011 Offering Warrants, the beneficial
conversion feature and the original issue discount in the aggregate of $6,232,979 was considered as debt discount and was amortized
over the term of the notes or in full upon the conversion of the corresponding notes.
During the year ended
December 31, 2012, the Company issued its convertible notes in the aggregate of $2,069,174 for total cash consideration of $1,835,840,
resulting in an original issue discount of $180,963 and conversion of $52,371 of accounts payable. The notes does not bear any
interest, however, the Company used an implied interest rate of 10%, are unsecured, will mature in one year and convertible to
7,423,316 shares of common stock at a conversion price of $0.25 up to $0.40 per share. Furthermore, each of the investors in the
offerings received, for no additional consideration, warrants to purchase a total of 7,423,316 shares of common stock. Each warrant
is exercisable on a cash basis only at a price of $0.30 up to $0.40 per share, and is exercisable immediately upon issuance and
will expire within two (2) to three (3) years from the date of issuance.
The aggregate relative
fair value of the warrants issued in the 2012 offerings were valued at $839,131 using the Black-Scholes-Merton option valuation
model with the following average assumptions: risk-free interest rate of 0.26%; dividend yield of 0%; volatility rate of 111% based
upon the Company’s historical stock price; and an expected life of two to three years (statutory term). The Company also
determined that the notes contained a beneficial conversion feature of $1,049,080 since the market price of the Company’s
common stock were higher than the conversion price of the notes when they were issued. The value of the 2012 Offering Warrants,
the beneficial conversion feature and the original issue discount in the aggregate of $2,069,174 was considered as debt discount
and was amortized over the term of the notes or in full upon the conversion of the corresponding notes.
During the years ended
December 31, 2012 and 2011, the Company converted $3,789,634 and $4,965,370 respectively of these notes to 14,305,159 and 19,861,478
shares of common stock (see Note 8) and amortized to interest expense $3,626,223 and $5,069,446 respectively of the corresponding
note discount.
As of December 31,
2012, all of the notes had been converted.
6.
|
Research and Development
|
AOT Testing
The Company is currently
conducting research and development of its AOT technology prototypes in a testing facility in Midwest, Wyoming, located at the
U.S. Department of Energy Rocky Mountain Oilfield Testing Center, Naval Petroleum Reserve #3 (US DOE). The Company constructs
the AOT technology prototypes through the assistance of various third party entities, located in Casper, Wyoming. Costs
incurred and expensed includes fees charged by the US DOE, purchase of test equipment, pipeline pumping equipment, crude oil tank
batteries, viscometers, SCADA systems, computer equipment and other related equipment and various logistical expenses for the purposes
of evaluating and testing its AOT prototypes.
Total expenses incurred
during the years ended December 31, 2012 and 2011 amounted to $318,184 and $734,997 respectively and has been reflected in Research
and Development expenses on the accompanying consolidated statement of operations.
Temple University
Research & Development Agreement
On August 1, 2011,
the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License
Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated
with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology
to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the
territory licensed to the Company is worldwide and replace previously issued License Agreements.
Pursuant to the two
licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000;
(ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing
agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon.
Temple also agreed to cancel $37,500 of the amount due if the Company agrees to fund at least $250,000 in research or development
of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon
the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing
agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights.
Total expenses recognized
during the year ended December 31, 2012 and 2011 pursuant to these two agreements amounted to $187,500 and $395,286 respectively
and has been reflected in Research and Development expenses on the accompanying consolidated statement of operations.
As of December 31,
2012 and 2011, the Company accrued a total of $128,350 and $178,125 respectively pursuant to these licensing agreements which are
included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets.
As of December 31,
2012, there were no revenues generated from these two licenses.
Temple University Sponsored Research
Agreement
On March 19, 2012,
the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University (“Temple”),
whereby Temple, under the direction of Dr. Rongjia Tao, will perform ongoing research related to the Company’s AOT device
(the “Project”), for the period April 1, 2012, through April 1, 2014. All rights and title to intellectual
property resulting from Temple’s work related to the Project shall be subject to the Exclusive License Agreements between Temple and
the Company, dated August 1, 2011. In exchange for Temple’s research efforts on the Project, the Company
has agreed to pay Temple $500,000, payable in quarterly installments of $62,500.
During the year ended
December 31, 2012, the Company recognized a total of $187,500 pursuant to this agreement.
As of December 31,
2012 and 2011, the Company accrued a total of $187,500 and $0 respectively pursuant to this agreement which are included as part
of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. In January 2013, the
Company and Temple agreed to defer payment of the amount due pending renegotiation of the agreement.
In June 2010, the FASB
issued authoritative guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. Under
the authoritative guidance, effective January 1, 2010, instruments which do not have fixed settlement provisions are deemed to
be derivative instruments. The strike price of the warrants issued by the Company, in connection with certain convertible
note offerings made during 2009 and 2010, in the aggregate of 8,522,500 warrants, exercisable at $0.30 per share, contains exercise
prices that may fluctuate based on the occurrence of future offerings or events. As a result, theses warrants are not
considered indexed to the Company’s own stock. The Company characterized the fair value of these warrants as derivative
liabilities upon issuance. During 2012, 220,000 of these warrants expired and 3,690,000 were exercised. The FASB’s
guidance requires the fair value of these liabilities be re-measured at the end of every reporting period with the change in value
reported in the accompanying statement of operations.
The derivative liabilities
were valued using a probability weighted average series of Black-Scholes-Merton models as a valuation technique with the following
assumptions:
|
|
|
|
|
Fair Value of Warrants
|
|
|
|
No. of
Warrants
|
|
|
December 31,
2011
|
|
|
2012
Issuance
|
|
December 31,
2012
|
|
Risk-free interest rate
|
|
|
|
|
0.12%
|
|
|
–
|
|
0.02%
|
|
Expected volatility
|
|
|
|
|
92%
|
|
|
–
|
|
165%
|
|
Expected life (in years)
|
|
|
|
|
0.75 – 1.00
|
|
|
–
|
|
0.04
|
|
Expected dividend yield
|
|
|
|
|
0%
|
|
|
–
|
|
0%
|
|
Fair Value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 Summer Warrants
|
|
|
–
|
|
|
$
|
332,998
|
|
|
|
–
|
|
$
|
–
|
|
2009 Wellfleet Warrants
|
|
|
–
|
|
|
|
17,807
|
|
|
|
–
|
|
|
–
|
|
2009 Fall Warrants
|
|
|
4,412,500
|
|
|
|
1,292,334
|
|
|
$
|
–
|
|
|
3,221,138
|
|
Total Fair Value
|
|
|
4,412,500
|
|
|
$
|
1,643,139
|
|
|
$
|
–
|
|
$
|
3,221,138
|
|
The risk-free interest
rate is based on the yield available on U.S. Treasury securities. The Company estimates volatility based on the historical
volatility of its common stock. The expected life warrants are based on the expiration date of the related warrants. The
expected dividend yield was based on the fact that the Company has not paid dividends to stockholders in the past nor is it expected
to pay any dividends in the foreseeable future.
During the years ended
December 31, 2012 and 2011, the Company recorded a loss of $4,023,094 and a gain of $2,021,536 respectively due to the change in
the fair value of the derivatives. Furthermore, during the years ended December 31, 2012, the Company recognized a gain of $2,445,095
due to the extinguishment of the derivative liabilities resulting from the expiration of 220,000 warrants and exercise of 3,690,000
warrants to shares of common stock. At December 31, 2012, the Company determined the fair value of these derivative liabilities
to be $3,221,138.
8.
|
Common Stock Transactions
|
Issuances of Common Stock-2012
During the year ended
December 31, 2012, the Company issued an aggregate of 29,394,100 shares of its common stock as follows:
|
·
|
The Company issued 2,525,000 shares of our common stock for services
valued in the aggregate at $1,228,250. We valued the shares at market prices at the date of the agreements ranging from $0.30 to
$1.07 per share.
|
|
·
|
The Company issued 14,305,156 shares of its common stock in exchange
for conversion of $3,789,634 of Convertible Notes pursuant to the convertible notes conversion prices of $0.25 up to $0.40 per
share. See note 5.
|
|
·
|
The Company issued 776,667 shares of its common stock for exercised
options valued at $0.27 to $0.30 per share with an aggregate value of $364,700.
|
|
·
|
The Company issued 11,787,277 shares of its common stock for exercise
of warrants at an average price of $0.28 and valued at $3,317,181.
|
Issuances of Common Stock-2011
During the year ended
December 31, 2011 the Company issued an aggregate of 22,820,276 shares of its common stock as follows:
|
·
|
The Company issued 2,800,000 shares of its common stock for services
valued in the aggregate at $862,000. The Company valued the shares at the trading price at the date of the agreements ranging from
$0.25 to $0.60 per share.
|
|
·
|
The Company issued 19,861,478 shares of its common stock in exchange
for conversion of $4,965,370 of Convertible Notes pursuant to the convertible notes conversion prices of $0.25 per share.
|
|
·
|
The Company issued 77,778 shares of its common stock for exercised
options valued at $0.27 per share or $21,000.
|
|
·
|
The Company issued 81,020 shares of its common stock for cashless exercise
of warrants.
|
9.
|
Stock options and warrants
|
The Company periodically
issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing
costs. Options vest and expire according to terms established at the grant date.
Options
The Company currently
issues stock options to employees, directors and consultants under the 2004 Stock Option Plan (the Plan). The Company could issue
options under the Plan to acquire up to 5,000,000 shares of common stock. In February 2006, the board approved an amendment
to the Plan (approved by the Shareholders in May 2006), increasing the authorized shares by 2,000,000 shares to 7,000,000 shares.
At December 31, 2012, 2,750,442 were available to be granted under the Plan. Prior to 2004, the Company granted 3,250,000 options
outside the Plan to officers of the Company.
On February 1, 2012,
the Company issued 4,000,000 options to its Chief Financial Officer, valued at $1,207,193 using Black-Scholes-Merton calculation.
The options have an exercise price of $0.25 per share, vest over a four year period, and expire ten years from date of grant. Twelve
and a half percent vested immediately, twelve and a half percent will vest on the first anniversary date, and twenty-five percent
will vest on the following three anniversary dates.
On May 18, 2012, the
Company issued 850,000 options to its employees, valued at $242,963 using Black-Scholes-Merton calculation. The options have an
exercise price of $0.30 per share, vesting immediately, and expire ten years from date of grant.
On October 1, 2012,
the Company issued 8,000 options to its employees, valued at $5,851 using Black-Scholes-Merton calculation. The options have an
exercise price of $0.83 per share, vesting immediately, and expire ten years from date of grant.
During the years ended
December 31, 2012 and 2011, the Company recognized amortization expense of $1,904,887 and $1,802,134 respectively based upon the
vesting of these options. Future compensation expense on the options which were not exercisable at December 31, 2012 is $5,229,090
which will be amortized as compensation cost in future periods.
Employee options vest
according to the terms of the specific grant and expire from 5 to 10 years from date of grant. Non-employee option grants
to date are vested upon issuance. The weighted-average, remaining contractual life of employee options outstanding at December
31, 2012 was 8.1 years. Stock option activity for the period January 1, 2004 to December 31, 2012, was as follows:
|
|
Weighted Avg.
Options
|
|
|
Weighted Avg.
Exercise Price
|
|
Options, January 1, 2004
|
|
|
13,250,000
|
|
|
$
|
0.11
|
|
Options granted
|
|
|
1,172,652
|
|
|
|
1.03
|
|
Options exercised
|
|
|
–
|
|
|
|
–
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2004
|
|
|
14,422,652
|
|
|
|
0.18
|
|
Options granted
|
|
|
2,085,909
|
|
|
|
0.92
|
|
Options exercised
|
|
|
–
|
|
|
|
–
|
|
Options cancelled
|
|
|
(10,000,000
|
)
|
|
|
0.10
|
|
Options, December 31, 2005
|
|
|
6,508,561
|
|
|
|
0.53
|
|
Options granted
|
|
|
1,313,605
|
|
|
|
1.21
|
|
Options exercised
|
|
|
(2,860,000
|
)
|
|
|
0.10
|
|
Options forfeited
|
|
|
(962,607
|
)
|
|
|
0.84
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2006
|
|
|
3,999,559
|
|
|
|
0.99
|
|
Options granted
|
|
|
238,679
|
|
|
|
0.55
|
|
Options exercised
|
|
|
–
|
|
|
|
–
|
|
Options forfeited
|
|
|
(49,793
|
)
|
|
|
1.96
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2007
|
|
|
4,188,445
|
|
|
$
|
0.95
|
|
Options granted
|
|
|
2,700,000
|
|
|
|
0.28
|
|
Options exercised
|
|
|
–
|
|
|
|
–
|
|
Options forfeited
|
|
|
(2,287,220
|
)
|
|
|
1.00
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2008
|
|
|
4,601,225
|
|
|
$
|
0.53
|
|
Options granted
|
|
|
333,333
|
|
|
|
0.30
|
|
Options exercised
|
|
|
(83,333
|
)
|
|
|
0.27
|
|
Options forfeited
|
|
|
–
|
|
|
|
–
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2009
|
|
|
4,851,225
|
|
|
$
|
0.52
|
|
Options granted
|
|
|
181,818
|
|
|
|
0.55
|
|
Options exercised
|
|
|
(195,555
|
)
|
|
|
0.27
|
|
Options forfeited
|
|
|
–
|
|
|
|
–
|
|
Options cancelled
|
|
|
–
|
|
|
|
–
|
|
Options, December 31, 2010
|
|
|
4,837,488
|
|
|
$
|
0.52
|
|
Options granted
|
|
|
19,800,000
|
|
|
|
0.26
|
|
Options exercised
|
|
|
(77,778
|
)
|
|
|
0.27
|
|
Options forfeited
|
|
|
(310,000
|
)
|
|
|
0.76
|
|
Options cancelled
|
|
|
(181,818
|
)
|
|
|
0.55
|
|
Options, December 31, 2011
|
|
|
24,067,892
|
|
|
$
|
0.30
|
|
Options granted
|
|
|
4,858,000
|
|
|
|
0.30
|
|
Options exercised
|
|
|
(776,667
|
)
|
|
|
0.47
|
|
Options forfeited
|
|
|
(871,127
|
)
|
|
|
0.98
|
|
Options, December 31, 2012
|
|
|
27,278,098
|
|
|
$
|
0.27
|
|
The weighted average exercise prices, remaining
contractual lives for options granted, exercisable, and expected to vest under the Plan as of December 31, 2012 were as follows:
|
|
|
Outstanding Options
|
|
|
Exercisable Options
|
|
Option
Exercise Price
Per Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Weighted
Average Exercise
Price
|
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
|
$ 0.21 - $ 0.99
|
|
|
|
27,196,679
|
|
|
8.1
|
|
|
$
|
0.27
|
|
|
|
9,616,679
|
|
|
$
|
0.29
|
|
$ 1.00 - $ 1.99
|
|
|
|
81,419
|
|
|
2.8
|
|
|
$
|
1.36
|
|
|
|
81,419
|
|
|
$
|
1.36
|
|
|
|
|
|
|
27,278,098
|
|
|
|
|
|
$
|
0.27
|
|
|
|
9,698,098
|
|
|
$
|
0.30
|
|
As of December 31,
2012 the market price of the Company’s stock was $0.98 per share. At December 31, 2012 the aggregate intrinsic value
of the options outstanding was $19,438,106.
Black-Scholes value of options
During the years ended December 31,
2012 and 2011, the Company valued options for pro-forma purposes at the grant date using the Black-Scholes-Merton valuation model
with the following average assumptions:
|
|
|
2012
|
|
|
|
2011
|
|
Expected life (years)
|
|
|
5.0 – 7.0
|
|
|
|
6.00
|
|
Risk free interest rate
|
|
|
0.62 – 1.27
|
%
|
|
|
1.95
|
%
|
Volatility
|
|
|
125% – 140
|
%
|
|
|
141.97
|
%
|
Expected dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
The weighted average fair value for options
granted in 2012 and 2011 were $0.30 and $0.37, respectively.
Warrants
The following table summarizes certain information
about the Company’s stock purchase warrants.
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
Warrants outstanding, January 1, 2004
|
|
|
14,252,414
|
|
|
|
0.48
|
|
Warrants granted
|
|
|
2,372,500
|
|
|
|
1.27
|
|
Warrants exercised
|
|
|
(960,500
|
)
|
|
|
0.20
|
|
Warrants cancelled
|
|
|
–
|
|
|
|
–
|
|
Warrants outstanding, December 31, 2004
|
|
|
15,664,414
|
|
|
|
0.62
|
|
Warrants granted
|
|
|
5,198,574
|
|
|
|
1.16
|
|
Warrants exercised
|
|
|
(50,500
|
)
|
|
|
0.99
|
|
Warrants cancelled
|
|
|
(20,000
|
)
|
|
|
1.50
|
|
Warrants outstanding, December 31, 2005
|
|
|
20,792,488
|
|
|
|
0.75
|
|
Warrants granted
|
|
|
3,624,894
|
|
|
|
1.28
|
|
Warrants exercised
|
|
|
(2,328,452
|
)
|
|
|
0.68
|
|
Warrants cancelled
|
|
|
(1,191,619
|
)
|
|
|
1.46
|
|
Warrants outstanding, December 31, 2006
|
|
|
20,897,311
|
|
|
$
|
0.81
|
|
Warrants granted
|
|
|
3,602,701
|
|
|
|
0.64
|
|
Warrants exercised
|
|
|
–
|
|
|
|
–
|
|
Warrants cancelled
|
|
|
(6,580,984
|
)
|
|
|
1.06
|
|
Warrants outstanding, December 31, 2007
|
|
|
17,919,028
|
|
|
$
|
0.67
|
|
Warrants granted
|
|
|
3,931,708
|
|
|
|
0.42
|
|
Warrants exercised
|
|
|
(1,064,650
|
)
|
|
|
0.50
|
|
Warrants cancelled
|
|
|
(10,386,083
|
)
|
|
|
0.56
|
|
Warrants outstanding, December 31, 2008
|
|
|
10,400,003
|
|
|
$
|
0.70
|
|
Warrants granted
|
|
|
5,247,276
|
|
|
|
0.36
|
|
Warrants exercised
|
|
|
–
|
|
|
|
–
|
|
Warrants cancelled
|
|
|
(2,300,515
|
)
|
|
|
0.95
|
|
Warrants outstanding, December 31, 2009
|
|
|
13,346,764
|
|
|
$
|
0.52
|
|
Warrants granted
|
|
|
14,058,032
|
|
|
|
0.32
|
|
Warrants exercised
|
|
|
–
|
|
|
|
–
|
|
Warrants cancelled
|
|
|
(4,425,728
|
)
|
|
|
0.53
|
|
Warrants outstanding, December 31, 2010
|
|
|
22,979,068
|
|
|
$
|
0.52
|
|
Warrants granted
|
|
|
29,781,916
|
|
|
|
0.30
|
|
Warrants exercised
|
|
|
(224,000
|
)
|
|
|
0.47
|
|
Warrants cancelled
|
|
|
(3,430,704
|
)
|
|
|
0.56
|
|
Warrants outstanding, December 31, 2011
|
|
|
49,106,280
|
|
|
$
|
0.32
|
|
Warrants granted
|
|
|
9,273,316
|
|
|
|
0.31
|
|
Warrants exercised
|
|
|
(12,039,846
|
)
|
|
|
0.29
|
|
Warrants cancelled
|
|
|
(4,134,243
|
)
|
|
|
0.49
|
|
Warrants outstanding, December 31, 2012
|
|
|
42,205,507
|
|
|
$
|
0.31
|
|
During the year ended
December 31, 2012, the Company granted warrants to consultants to purchase 1,850,000 shares of its common stock. The
warrants have an exercise price of $0.30 per share, fully vested and will expire in two to three years from grant date. Total
fair value of the warrant amounted to $517,777 using the Black-Scholes Merton valuation model with the following average assumptions:
risk-free interest rate of 0.23% to 0.39%; dividend yield of 0%; volatility of 111%; and an expected life of three years.
During the year ended
December 31, 2012, the Company granted 7,423,316 warrants to acquire share of its common stock in connection of its issuance of
convertible notes. The warrants have an average exercise price of $0.29 per share, fully vested, and will expire in
two to three years from date of grant. (See Note 5)
During the years ended
December 31, 2012 and 2011, the Company recognized amortization expense of $165,539 and $438,827 respectively based upon the vesting
of warrants granted to employees and $641,747 and $411,888 respectively based upon the vesting of warrants granted to consultants.
Future compensation expense on the warrants which were not exercisable at December 31, 2012 is $310,578.
At December 31, 2012
the price of the Company’s common stock was $0.98 per share and the aggregate intrinsic value of the warrants outstanding
was $28,411,354.
|
|
|
Outstanding
Warrants
|
|
|
Exercisable
Warrants
|
|
Warrant
Exercise Price
Per Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Weighted
Average Exercise
Price
|
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
|
$ 0.30 - $ 0.99
|
|
|
|
41,705,507
|
|
|
1.4
|
|
|
$
|
0.30
|
|
|
|
40,338,840
|
|
|
$
|
0.30
|
|
$ 1.00 - $ 1.99
|
|
|
|
500,000
|
|
|
1.5
|
|
|
$
|
1.00
|
|
|
|
500,000
|
|
|
$
|
1.00
|
|
|
|
|
|
|
42,205,507
|
|
|
|
|
|
$
|
0.31
|
|
|
|
40,838,840
|
|
|
$
|
0.31
|
|
Included in the table
above are 4,412,500 warrants at an exercise price of $0.25 per share. Based upon these warrant agreements, the
exercise price may be reduced if the Company sells equity to any person or entity at a price per share or conversion price or exercise
price per share which shall be less than the Warrant exercise price in respect of the Warrant Shares then in effect. The
reset of the warrant exercise price gives rise to the characterization of these instruments as derivative liabilities. See
Note 7.
10.
|
Commitments and contingencies
|
There are no current
or pending litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the
normal course of business.
Leases
In March 2009, the
Company entered into a sublease agreement for its executive offices in Santa Barbara, California. The term of the lease was for
$3,520 per month from April 1, 2010 through December 31, 2010 and $3,630 per month from January 1, 2010 to December 31, 2010. In
November 2010, the Company amended the lease agreement. Pursuant to the amendment, the term of the lease was for $5,830 per month
from January 1, 2011 to December 31, 2013. In February 2012, the Company entered into a lease agreement to expand its offices in
Santa Barbara, California. Pursuant to the agreement, the term of the lease was for $5,845 per month from February 1, 2012 to December
31, 2013.
Total rent expense
under this lease and other operating leases in effect during the years ended December 31, 2012 and 2011, was $144,875 and $73,080,
respectively which are included as part of Operating Expenses in the attached consolidated statements of operations. The following
is a schedule by years of future minimum rental payments required under the non-cancellable operating leases as of December 31,
2012. Remaining lease commitments under all non-cancellable leases at December 31, 2012 were $140,000 through the end of 2013.
The Company did not
record an income tax provision for 2012 and 2011, other than $800 for the minimum state tax provision. A reconciliation of income
taxes with the amounts computed at the statutory federal rate follows:
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Computed tax provision (benefit) at federal statutory rate (34%)
|
|
$
|
(1,434,000
|
)
|
|
$
|
(1,175,000
|
)
|
State income taxes, net of federal benefit
|
|
|
(373,000
|
)
|
|
|
(305,000
|
)
|
Permanent items
|
|
|
0
|
|
|
|
0
|
|
Valuation allowance
|
|
|
1,803,800
|
|
|
|
1,480,800
|
|
Income tax provision
|
|
$
|
800
|
|
|
$
|
800
|
|
The deferred tax assets
and deferred tax liabilities recorded on the balance sheet are as follows:
|
|
December 31, 2012
|
|
|
December 31, 2011
|
|
Net operating loss carry forwards
|
|
|
15,900,000
|
|
|
|
13,700,000
|
|
Valuation allowance
|
|
|
(15,900,000
|
)
|
|
|
(13,700,000
|
)
|
Total deferred taxes net of valuation allowance
|
|
$
|
–
|
|
|
$
|
–
|
|
As of December 31,
2012, the Company had net operating losses available for carry forward for federal tax purposes of approximately $39 million expiring
beginning in 2019. These carry forward benefits may be subject to annual limitations due to the ownership change limitations imposed
by the Internal Revenue Code and similar state provisions. The annual limitation, if imposed, may result in the expiration of net
operating losses before utilization.
As of December 31,
2012, the Company has recorded a $15,900,000 valuation allowance against a portion of its deferred tax assets, since at that time
it was believed that such assets did not meet the more likely than not criteria to be recoverable through projected future profitable
operations in the foreseeable future.
Effective January 1,
2007, the Company adopted FASB guidance that 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 this guidance, the Company 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 50% likelihood of being realized upon ultimate
settlement. The FASB also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting
in interim periods and requires increased disclosures. As of December 31, 2012 and 2011, the Company does not have a liability
for unrecognized tax benefits.
The Company files income
tax returns in the U.S. federal jurisdiction and the state of California. 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
net operating losses and tax credit carry forwards may be utilized in future periods, they remain subject to examination. The Company’s
policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of December 31, 2012, the Company
has no accrued interest or penalties related to uncertain tax positions. The Company believes that it has not taken any uncertain
tax positions that would impact its consolidated financial statements as of December 31, 2012 or 2011.
Increase in Outstanding Shares
During the period from
January 1, 2013 through February 13, 2013, the Company issued 5,265,496 shares of its common stock. This was comprised
of the following:
The Company issued
50,000 shares of its common stock per consulting agreement valued at $49,000.
The Company issued 5,215,496 shares of its common stock upon
exercise of warrants for aggregate proceeds of $1,205,738. Included in these issuances were 3,912,500 shares of common stock
issued upon exercise of warrants that contained a reset provision that required these warrants to be accounted for as derivative
liability. Upon exercise of these warrants, $3,441,752 of derivative liabilities will be extinguished and accounted for in
the first quarter of 2013.
Continental Divide
Agreement
On January 2,
2013, the Company entered into an agreement with Continental Divide, LLC to market the AOT technology as an affiliate of the
Company. The term of the agreement is for a period of one year with a monthly fee of $5,000. A copy of this agreement is
attached to this report as Exhibit 10.105. Mr. Ryan Zinke, CEO of Continental Divide, LLC is a member of the Company’s
Board of Directors.
F-28