PART
I
Item
1. Business
Overview
QuantumSphere,
Inc., was incorporated in the State of Nevada on December 1, 2005 (referred to as the “Registrant”). On April 22,
2014, we entered into an Agreement and Plan of Merger with QuantumSphere, Inc., a California corporation (“QSI”),
whereby, among other things, QSI would merge with a wholly-owned subsidiary of the Registrant. On April 22, 2014, the parties
consummated the merger and QSI became a wholly-owned subsidiary of the Registrant. Subsequently, on April 25, 2014, we 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 Registrant.
As part of the short-form merger, we amended our Articles of Incorporation to changes our name from “Way Cool Imports, Inc.”
to “QuantumSphere, Inc.” The Articles of Merger were effective upon filing. In June 2014, the Company elected to change
its year end from December 31 to June 30. As used in this Annual Report on Form 10-K, the references to “we” or “our”
reflect the Registrant and its operations post-merger, i.e., inclusive of QSI and its operations.
We
have developed a process to manufacture metallic nanopowders with end-use application focused on the chemical sector. Our products
are used on a stand-alone basis, in the validation of our nano-iron catalysts coated onto commercial iron catalysts used in the
production of ammonia. Our major activities to date have included capital formation, research and development, marketing and commercial
validation of our metallic nanopowder products.
Platform
Technology & Catalyst Market
Our
high value, end use applications in the chemicals sectors emanate from our award winning, patented, nanocatalyst manufacturing
platform technology. Our platform technology allows us to manufacture, in an automated manner, highly uniform, 99.99% pure, narrowly
distributed, nano-particles with high catalytic activity. We view ourselves as a products company, rather than an advanced materials
company, with the products we distribute being made possible through our leading edge platform technology.
We
spent the first several years following our inception, along with $15 million of the $30+ million in investment capital procured
to date, designing, fabricating, testing, refining, improving, automating, and scaling our closed-loop, proprietary nanocatalyst
manufacturing platform technology. In terms of the production of advanced nanocatalyst materials, we have progressed from a few
grams per day to capacity of 300 kilograms per month in our existing manufacturing facility. This is essential as scale is required
with the ammonia application we are pursuing today and other end use applications in the future (e.g., light olefins and methanol).
In
2007 we secured two key broad patents on the QSI manufacturing technology process itself. In addition, in 2010, we achieved ISO
9001:2008 certification for quality management systems related to our nanocatalyst manufacturing platform technology. With respect
to our intellectual property relating to our platform technology, we have not disclosed our proprietary algorithms and software
that are used in the manufacturing process. We treat the foregoing as our “Coca-Cola” trade secret that will remain
proprietary at all times. Other key features of our platform technology include the ability to rapidly scale the manufacturing
process in a highly automated, modular fashion at a low capital cost.
The
following image depicts our nanocatalyst manufacturing platform technology and a portion of the periodic table of elements we
convert and integrate into various commercial products.
By
way of background, the catalyst market is a multi-billion dollar global industry. According to an industry study prepared by The
Freedonia Group, the global catalyst markets exceeded $14 billion in 2013 with worldwide demand for catalysts to increase to $19.5
billion in 2016.
1
Of this amount, nanocatalysts are expected to play a critical role in reducing costs and increasing
efficiency in the generation, storage, and usage of energy with an estimated market of $6.6 billion by 2018.
2
A
nanometer (nm) is one billionth of a meter, or 1,000 times smaller than the diameter of a human hair, or roughly the size of a
marble when compared to the earth. QSI catalysts typically measure 20-50 nm in size with a very narrow particle size distribution,
and have surface area of up to 100 meters square per gram, roughly covering the size of a soccer field with just a small amount
of material. A catalyst is a material that helps facilitate chemical reactions and can make chemical reactions happen more efficiently.
The greater the surface area of the catalyst, the more efficient the chemical reaction, resulting in lower cost, higher performance
end-use applications (e.g., chemical synthesis).
1
World Catalysts: Industry Study with Forecasts for 2016 & 2021, February 2013 (The Freedonia Group).
2
“Need to Curb Automobile & Industrial Emissions Drives the Global Nanocatalysts Market, According to New Report
by Global Industry Analysts, Inc.”, PRWEB, November 23, 2013 (http://www.benzinga.com/pressreleases/13/11/p4106559/need-to-curb-automobile-industrial-emissions-drives-the-global-nanocata).
Our
advanced catalysts have superior properties including their spherical shape, controlled oxide layer, narrow particle size distribution,
high purity, low agglomeration, and large surface area. We believe these combined physical characteristics translate into greater
efficiency in the generation, storage, and use of energy. Leveraging our patented, automated, highly scalable, and environmentally
safe nanocatalyst manufacturing process, we manufacture a number of high-quality metals, bi-metallic alloys, and catalysts at
the nano-scale including iron, silver, copper, nickel, manganese, and cobalt. We also offer custom dispersions and several specialty
metals and catalysts including gold, palladium, aluminum, and tin.
Presently,
we have sixteen dedicated gas phase condensation reactors which we utilize in the manufacture of nanocatalysts. With sixteen reactors,
our capacity is approximately 300 kilograms per month (the foregoing is based on nano-iron production utilizing three production
shifts, and the overall monthly kilogram production will depend on the catalysts being produced given varying production rates
among catalysts we manufacture). Given the manner in which we have designed our production reactors, we are able to quickly scale
and adjust production runs to satisfy our customers’ advanced material needs and delivery timelines. In addition, we leverage
our technical knowledge and process chemistry expertise to offer custom dispersions, alloys and integrated catalytic solutions
for the energy storage and chemical sectors.
Chemicals
Opportunity
QSI
catalysts have the potential to benefit multiple, multi-billion dollar process applications in the refining, petrochemical, chemical,
and pharmaceutical industries. Currently, the lead application and commercialization focus is in the global ammonia synthesis
market. Ammonia production is a highly critical and energy-intensive process that occurs by combining hydrogen and nitrogen under
high pressure and temperature in the presence of an iron catalyst. Though many incremental improvements have been achieved in
both process and catalyst technology over the last 100 years, the industry is ripe for a paradigm shift in ammonia synthesis efficiency.
Other applications of our nano catalysts in the chemicals industry, outside of the ammonia sector, are being pursued and are presently
in the lab validation phase (i.e., light olefins and methanol).
The
Critical Role of Catalysts within the Chemicals Industry
A
multi-billion dollar global industry, catalysts are essential to the world’s industrial production. As much as 90% of all
chemical processes utilize catalysts (e.g., petroleum refining, pollution abatement, and production of fuels and chemicals) and
60% of all consumer and industrial products (e.g., fertilizers, plastics, pharmaceuticals, and batteries) are made using catalysts.
3
Catalysts are now seen as a preferred way to improve process efficiency, lower costs, increase output, use less energy,
and meet both performance and environmental standards. This is placing a strong emphasis on the development of new catalysts with
higher activity, increased longevity, and reduced environmental and/or health impact. Our high surface area catalysts have demonstrated
the ability to deliver much higher activity in multiple lab validations and, thus, greater efficiencies than existing commercial
iron catalysts.
3
“Wide Participation in the 21st Annual Saudi-Japan Symposium “Catalysts in Petroleum Refining & Petrochemicals”
at
KFUPM”, King Fahd University of Petroleum &
Minerals Press Release dated November 29, 2011
(http://web.kfupm.edu.sa/SitePages/en/UniversityNewsDetails.aspx?CUSTOMID=147).
Ammonia
Market Overview
Globally,
the amount of ammonia produced annually consumes more than 1% of the world’s energy supply.
4
Nearly 80% of the
global ammonia output is used as agricultural fertilizer for both food and non-food crops including biofuel feedstock.
5
In addition, ammonia plants produce nearly 1% of the world’s total carbon dioxide emissions.
6
Annual world production
is heavily concentrated in China, accounting for more than 33% of ammonia produced today.
7
To
date, we have spent seven years testing internally and externally validating the increased efficiencies of our QSI-Nano® iron
catalysts, known as FeNIX™, with several industry leaders in the UK, Switzerland, Germany, and more recently in China. To
this end, we were able to achieve a commercial validation of our FeNIX™ catalyst in an ammonia plant owned and operated
by the JH Group in China in May 2015. JH Group, a subsidiary of Chem China, is the eleventh largest producer of ammonia in China.
We are now in the process of arranging a second commercial validation of our FeNIX™ catalyst in the western hemisphere in
the first half of 2017. Upon achieving a second commercial validation, our objective is to achieve commercial purchase orders
for our FeNIX™ catalyst by the middle of calendar 2017.
SALES
PIPELINE
QSI
is currently engaged in sales discussions with multiple plant operators. We have a particular focus on India due to their compelling
need and the size of the market (second largest global producer of ammonia, behind China only). India is under tremendous pressure
to increase food production and simultaneously lessen their carbon footprint. Since 1998, India has added an entire USA-worth
of population (300 million people) and in the next thirty years it is projected to add another entire USA again. The agriculture
sector has the mandate to increase output by four percent per year but is struggling to meet that mandate. This is particularly
due to the shrinking availability of farmland as the country urbanizes. Clearly, India needs more productivity on less land, which
translates to the need for better fertilizers, which translates to soaring demand for ammonia, which translates to the need for
more ammonia per plant and has plants scrambling to find new technological innovations that will assist in the foregoing. This
has caused the QSI FeNIX™ innovation to be very well received in recent high level meetings.
Within
India, QSI is working with the lead fertilizer trade association, FAI, as well as large conglomerates such as IFFCO and DCM Shriram.
IFFCO, the India Farmers Fertilizers Coop, is the largest producer of ammonia in India with five plants in operation and a very
large current refurbishment contract with QSI partner, Casale. Due to the interest and potential impact in India, FAI has recently
awarded QSI one of the five select spots to present its enhanced efficiency ammonia technology at their upcoming fertilizer conference
to be held in India in late November 2016.
4
“New Revelations in Ammonia Synthesis,” University of Cambridge Press Release, November 17, 2000 (http://www.cam.ac.uk/news/new-revelations-in-ammonia-synthesis).
5
“Ammonia Production,” Encyclopedia of Earth, March 15, 2012 (http://www.eoearth.org/view/article/170573).
6
“Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2012 – Executive Summary,” U.S. EPA, 2014,
(http://www.epa.gov/climatechange/Downloads/ghgemissions/US-GHG-Inventory-2014-Chapter-Executive-Summary.pdf).
7
“Biofuels Production, Improving Diets and Growing Economies in ‘BIC’ Countries Driving Global Demand for
Ammonia, New IHS Study Says,” IHS, March 5, 2014 (http://press.ihs.com/press-release/ammonia/biofuels-production-improving-diets-and-growing-economies-bic-countries-drivin).
Our
Competitive Advantage
The
figure below illustrates the performance difference between a FeNIX™ coated and an uncoated commercial iron catalyst used
in the production of ammonia. In sum, a 1.5% coating (by weight) of FeNIX™ catalysts onto existing commercial iron catalysts
produces up to a 20% increase in catalyst activity (per QSI in-house lab validation and thereafter confirmed in a China commercial
validation completed in May 2015 where we realized 10% to 15% production increase). In addition, our research and development
indicates an ammonia plant may alternatively choose to decrease the pressure and heat required for ammonia production, and achieve
the same ammonia production (output), and in doing so save up to 5% in energy costs and reduce emissions.
The
TEM image on the left below represents a commercial iron catalyst (uncoated), while the TEM image on the right is the commercial
iron catalyst coated with FeNix at a 1.5% loading.
Global
Ammonia Market
Ammonia
is the building block of the global nitrogen industry. According to a January 9, 2014 research report by Bank of America Merrill
Lynch,
8
approximately 78% of ammonia is used in fertilizer where it is processed into downstream products like urea
or direct-applied. Ammonia is produced in anhydrous form by catalytic reaction between nitrogen and hydrogen from natural gas
or coal. The same report states that the demand for ammonia has grown 2% per year since 2000 and is expected to grow 2.5% per
year through 2016 due to higher fertilizer demand in Asia and Latin America, where the capacity for ammonia has grown 2.5% per
year since 2000 and is expected to maintain that annual rate of growth through 2016. The chart below shows the global ammonia
supply and demand in 1,000 metric tons from 1991 to 2016.
8
Research report by Bank of America Merrill Lynch dated January 9, 2014 and entitled, “Move to Neutral from Buy; methanol
surge priced in?” (citing Fertecon, Green Markets, FMC, CRU BofA Merrill Lynch Global Research estimates).
In
addition to the foregoing, Fertecon has estimated global ammonia production as follows thru 2017, where the worldwide production
capacity is estimated to increase from 177,230,000 metric tons in 2009/2010 to 310,541,000 metric tons in the foreseeable future.
Ammonia
Production Capacity by Region (in 1000 metric tons)
9
Region
|
|
2009/10
|
|
|
2010/11
|
|
|
2011/12
|
|
|
2012/13
|
|
|
2013/14
|
|
|
2014/15
|
|
|
2015/16
|
|
|
2016/17
|
|
|
Indefinite
|
|
North
America
|
|
|
16,425
|
|
|
|
16,737
|
|
|
|
17,013
|
|
|
|
17,603
|
|
|
|
17,807
|
|
|
|
17,886
|
|
|
|
19,146
|
|
|
|
19,146
|
|
|
|
26,461
|
|
Latin
America
|
|
|
11,737
|
|
|
|
11,737
|
|
|
|
11,011
|
|
|
|
11,011
|
|
|
|
11,442
|
|
|
|
12,797
|
|
|
|
13,623
|
|
|
|
13,634
|
|
|
|
18,539
|
|
Western
Europe
|
|
|
12,491
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
|
|
12,391
|
|
Central
Europe
|
|
|
8,385
|
|
|
|
8,385
|
|
|
|
7,785
|
|
|
|
7,785
|
|
|
|
7,785
|
|
|
|
7,785
|
|
|
|
7,785
|
|
|
|
7,785
|
|
|
|
9,804
|
|
Eurasia
|
|
|
26,353
|
|
|
|
26,223
|
|
|
|
26,676
|
|
|
|
26,920
|
|
|
|
26,920
|
|
|
|
27,320
|
|
|
|
28,697
|
|
|
|
29,093
|
|
|
|
36,069
|
|
Africa
|
|
|
6,966
|
|
|
|
6,966
|
|
|
|
7,466
|
|
|
|
9,168
|
|
|
|
11,346
|
|
|
|
11,988
|
|
|
|
12,748
|
|
|
|
12,748
|
|
|
|
21,801
|
|
West
Asia
|
|
|
15,407
|
|
|
|
16,496
|
|
|
|
17,596
|
|
|
|
17,596
|
|
|
|
19,827
|
|
|
|
21,247
|
|
|
|
21,632
|
|
|
|
21,632
|
|
|
|
25,993
|
|
South
Asia
|
|
|
18,907
|
|
|
|
20,443
|
|
|
|
20,443
|
|
|
|
21,326
|
|
|
|
22,052
|
|
|
|
22,778
|
|
|
|
22,778
|
|
|
|
22,778
|
|
|
|
35,800
|
|
East
Asia
|
|
|
58,534
|
|
|
|
61,946
|
|
|
|
68,903
|
|
|
|
73,762
|
|
|
|
88,235
|
|
|
|
95,487
|
|
|
|
98,005
|
|
|
|
98,005
|
|
|
|
119,550
|
|
--
China
|
|
|
(47,327
|
)
|
|
|
(50,614
|
)
|
|
|
(57,571
|
)
|
|
|
(61,664
|
)
|
|
|
(76,137
|
)
|
|
|
(81,605
|
)
|
|
|
(83,463
|
)
|
|
|
(83,463
|
)
|
|
|
(101,326
|
)
|
Total
Asia
|
|
|
92,848
|
|
|
|
98,885
|
|
|
|
106,942
|
|
|
|
112,684
|
|
|
|
130,114
|
|
|
|
139,512
|
|
|
|
142,415
|
|
|
|
142,415
|
|
|
|
181,344
|
|
Oceania
|
|
|
2,025
|
|
|
|
2,025
|
|
|
|
2,110
|
|
|
|
2,110
|
|
|
|
2,259
|
|
|
|
2,259
|
|
|
|
2,259
|
|
|
|
2,259
|
|
|
|
4,133
|
|
World
Total
|
|
|
177,230
|
|
|
|
183,349
|
|
|
|
191,394
|
|
|
|
199,672
|
|
|
|
220,064
|
|
|
|
231,938
|
|
|
|
239,064
|
|
|
|
239,471
|
|
|
|
310,541
|
|
Ammonia
Production & Growth
Demand
for fertilizer is escalating worldwide. Countries around the globe are aggressively increasing their agricultural output of both
grains and livestock, and commodity crop prices are at record highs, encouraging farmers to fertilize heavily in search of higher
yields. As fertilizer demand grows, supply is ramping up to meet it, and in the case of the U.S., it has benefited from the rapid
expansion of the nation’s natural gas sector over the past several years given historically low prices.
But
unlike many of the industries capitalizing on the low price of natural gas, ammonia producers outside of China and India do not
typically use it as a fuel source. They use it as an ingredient—a source of abundant, accessible hydrogen. Ammonia production
is, relatively speaking, fairly simple. The inputs are nitrogen, hydrogen and energy used to stimulate a reaction understood by
first year chemistry students:
N
2
+ 3H
2
=> 2NH
3
The
nitrogen used in the process is taken from the air, but hydrogen sources vary depending on when and where ammonia production is
happening. When ammonia plants first came online in the 1940s, most used water as their source of hydrogen; energy-intensive electrolysis
decoupled the hydrogen and oxygen. By adding a catalyst, pressure and air, then a cooling phase, you can generate hydrogen with
some oxygen. However, electrolysis is an expensive proposition, and ammonia plants today have a far cheaper source of hydrogen:
hydrocarbons.
9
See,
Worldwide Ammonia Capacity Listing by Plant,
International Fertilizer Development Center (June 2013).
Over
the next several years, there will be as many as 14 new ammonia plants in the U.S., with nearly 12 million tons of new capacity
and $10 billion of expected investment. Several older plants are also being recommissioned and upgraded. Oklahoma, Louisiana,
Iowa, North Dakota, Wyoming, Texas and Indiana are among the planned or proposed sites. This boom, driven by low natural gas prices,
the main ingredient in ammonia production, will drive a corresponding surge in the industry’s already substantial carbon
footprint.
Ammonia’s
Greenhouse Impact
Globally,
ammonia production represents as much as 3% to 5% of carbon emissions, according to industry sources.
10
These figures
do not take into account the supply chain of natural gas production, energy-related emissions in the production process, fertilizer
application (and misapplication) or industrial use of urea and other ammonia products.
This
larger footprint is a concern, particularly as the industry expands. Glen Buckley, an industry consultant at NPK Fertilizer Advisory
Services (and former chief economist at U.S. fertilizer giant CF Industries), has estimated that only about six million tons of
the proposed U.S. capacity will actually get funding and get built—still, that’s a more than 50% increase in total
ammonia capacity nationwide.
Raw
Materials; Principal Suppliers
In
the manufacture of our nanocatalysts, we use a range of equipment from a number of suppliers in order to assemble our proprietary
reactors. As for the bulk raw materials and gases used in our nanocatalyst manufacturing process, we contract with a number of
companies and make our purchase decisions based on the prevailing market prices for such bulk raw materials and gases. We periodically
audit these suppliers to ensure the quality of the bulk raw materials and gases provided. We have not entered into any long-term
supply agreements for any of our equipment or bulk raw materials and gases.
Competition
and Differentiation
Our
value discipline combines safety, quality, price, service and an approach to doing business that customers reward with loyalty
and appreciation. This value discipline is designed to create a two-way street of value and profitability between QSI and our
customers. Our strategy is built on three central tenets:
|
●
|
Capture
revenue by market focus;
|
|
|
|
|
●
|
Enhancing
profitability through process development and the efficient use of assets; and
|
|
|
|
|
●
|
Creating
and enhancing customer value through continued innovation.
|
Our
nanocatalyst manufacturing process is capable of delivering high surface area nanocatalysts to a wide array of industries. Specifically,
our advanced materials and integrated catalytic solutions empower the chemical synthesis industry sector with the potential to
transform and revolutionize their product offerings. We believe that our proprietary manufacturing technology offers measurable
improvement over existing manufacturing processes and has the potential to transform nanoscale catalysts applications from costly,
inefficient processes to feasible, dynamic, and profitable assets.
10
Ibid.
We
believe that our state-of-the-art technology offers:
|
●
|
Industry-low
manufacturing costs;
|
|
|
|
|
●
|
Highly
scalable, fully automated manufacturing process;
|
|
|
|
|
●
|
Consistent
particle size distribution;
|
|
|
|
|
●
|
Low
levels of agglomeration and impurities;
|
|
|
|
|
●
|
Highly
uniform dispersion; and
|
|
|
|
|
●
|
Environmentally
friendly process.
|
In
terms of the catalyst market, we will face potential worldwide competition from advanced materials and chemical companies, and
suppliers of traditional materials. The actual or potential competitors are larger, more established and more diversified than
we are. Although we are focusing on specific market segments and opportunities where our nanocatalysts have demonstrated increased
efficiencies and performance, we will compete against lower priced traditional materials for certain customer applications. In
some product or process applications, the benefits of using nanomaterials may not be viewed as justifying a process change or
outweigh the additional costs of such a process change.
Many
of our competitors have greater market presence, longer operating histories, stronger name recognition, larger customer bases
and significantly greater financial, technical, sales and marketing, research and development, manufacturing and other resources
than we have. In addition, the number of start-up and development-stage companies involved in nanomaterials continues to grow
on a global basis, posing increasing competitive risks. Although a number of these companies are associated with university or
national laboratories and may be engaged primarily in funded research rather than commercial production, they may represent competitive
risks in the future. Moreover, if one or more of our competitors were to merge or partner with another of our competitors or develop
alternatives to our nanocatalysts or our manufacturing process, our ability to compete effectively will be adversely affected.
We anticipate that foreign competition will play a greater role in the nanomaterials arena in the future.
Research
and Development
We
maintain a disciplined approached to planning, tracking and conducting our research and development projects. Research and development
ideas present themselves from both internal and external sources.
As
depicted below, our science team meets frequently for brainstorming activities and maintains a master list of potential research
and development ideas. In addition, our board of directors receives periodic briefings on all major research and development efforts
and proposed initiatives.
To
leverage our research and development capabilities, we have previously entered into and continue to discuss establishing research
and development agreements with strategic parties in the chemical manufacturing industry and the battery industry.
Intellectual
Property
Since
our inception, our strategy has been to invest heavily in intellectual property protection and to build a strong IP portfolio
around core nanocatalysts manufacturing, process integration technologies, as well as targeted end-use applications where our
solutions add significant value and breakthrough results. This is done in such a way as to maximize the potential for prevailing
in litigation and inhibiting competition from choosing to litigate. The QSI team includes an expert patent litigator with 20+
years of industry experience who has prevailed in multiple high profile patent cases, both in the U.S. and abroad. QSI maintains
a patented production process and, as of October 13, 2016, has ten issued patents and two pending patent application related to
the manufacturing process and various end-use applications before the United States Patent and Trademark Office. In addition,
we have three registered trademarks.
The
patent for QSI’s platform gas phase condensation process was awarded on October 16, 2007, and includes broad claims on the
manufacturing system that produces advanced metals and catalysts at the nano-scale. Additional patent applications have been filed
covering QSI-Nano® catalysts in raw metal powder form, QSI-Nano® catalysts dispersed into custom liquid solutions / ink
formulations used for coating various monolithic structures and membrane structures, QSI-Nano® catalysts integrated into physical
electrode assemblies for other energy storage (battery) components, and QSI-Nano® iron catalysts used in the ammonia synthesis
production process.
On
March 15, 2016, the Company announced that it had been issued a patent by the U.S. Patent and Trademark Office for a key patent
related to its advanced FeNIX™ nanocatalyst accelerator technology. The patent covers claims around the application of iron
nanocatalysts, applied as a coating onto existing commercial ammonia catalysts, for increased catalytic activity and production
efficiency in ammonia synthesis.
QSI’s
patent portfolio protects the following principal areas that we are focused on from a commercial perspective:
|
●
|
Advanced
catalyst manufacturing; and
|
|
|
|
|
●
|
Thermo-catalysis
(highly efficient chemical production).
|
Development
results are formally vetted through a short list of criteria for assessing whether to seek to protect a “development”
via a patent or whether to preserve it as a trade secret. This vetting process has produced a more efficient use of the capital
QSI has allocated for its IP portfolio. Generally, if the development rests upon a methodology that is not likely to be either
easily reverse engineered or invented independently by a competitor, then QSI elects to protect such methodology as a trade secret
and preserve it with appropriate confidentiality procedures. QSI has relied on such confidentiality procedures for our software
and algorithms that are associated with our nano-catalyst manufacturing process.
To
the extent that the development has commercial value to QSI – either because it reflects a viable product in the future
for QSI to manufacture and sell, or it reflects technology likely to be adopted by a competitor - then it is worthwhile to consider
seeking patent protection. QSI believes that even in those cases where QSI is not going to market a product, it is wise to protect
an invention that a competitor is likely to adopt. Thus far, this approach has resulted in ten high-value patents issued and two
patent applications pending.
Depending
upon the timeline for developing the technology at issue, or how well the development concept has been crystallized, it may be
appropriate to simply file a provisional patent application rather than a non-provisional application. In the case where it is
still early in development or concept, QSI will typically file what is essentially a white paper as a provisional application,
which does not get examined, but secures an early priority date of invention. Where the technology at issue is fairly advanced
in development, or the concept is sufficiently crystallized to know the full scope of the advantages over the prior art, QSI will
typically file a non-provisional patent application. At that point, QSI develops a claim strategy that focuses on (1) highlighting
the “gee whiz” that reflects the solution to the problem addressed while distinguishing the closest known prior art,
and (2) addressing who the potential infringers might be (e.g., manufacturers, OEMs, distributors, customers, users, etc.). This
claim strategy also takes into account the regions in which QSI intends to file for patent protection. All claims are formulated
with an eye toward broad protection and litigation strategy. Active assessments are made as to how to prevail in cases in which
QSI could choose to threaten potential infringers as well as to inhibit others from potentially challenging QSI.
Government
Regulation
We
are subject to federal, state and local laws and regulations applicable to businesses generally. Before we commercially introduce
our products into certain markets, we may be required, or may voluntarily determine to obtain approval of our materials and/or
products from one or more of the organizations engaged in regulating product safety. These approvals could require significant
time and resources from our technical staff, and, if redesign were necessary, could result in a delay in the introduction of our
products in those markets. Due to the continuous changes in the regulatory landscape, we cannot assure investors that federal,
state or local laws, rules or regulations will not be amended or adopted in the future that could make compliance much more difficult
or expensive.
The
chemicals sector is governed by a variety of local, county, state, national and foreign rules and regulations. We are anticipating
selling our nano-iron catalysts to ammonia plant operators for purposes of coating existing commercial iron catalysts to increase
ammonia production yield and/or decrease energy consumption at these ammonia plants. Our ammonia plant customers will continue
to handle all compliance with such laws, rules and regulations in their respective countries. With respect to the manufacture
of the nano-iron catalysts, we have taken significant best practice measures in close coordination with various environmental
agencies and advocate groups in relation to the manufacture and transport of catalysts. Despite the foregoing, there can be no
assurance that additional or modified regulations relating to tariffs, as well as the transportation, importability, storage,
use and disposal of nanomaterials, particularly nano-iron, will not be imposed by the U.S. or the countries into which our nano-iron
catalysts may be shipped in the future.
Environmental,
Health and Safety Policy
It
is our environmental, health and safety, or EH&S, policy to ensure that our business practices continuously enhance the safety
and health of all team members, the communities we operate in, and the environment. As a responsible corporate citizen, we observe
strict compliance with all applicable laws, regulations, and responsible practices. In addition, we maintain an open partnership
approach with regulatory agencies to develop guidance, regulations, and best practices for safely working with nanomaterials.
We have a “
Vision of Zero
” –
zero incidents, zero injuries and
illnesses, zero accidents and zero environmental harm. Our EH&S policy is guided by our safety values of:
Leadership.
We take an active leadership role in understanding and managing potential risks and hazards arising from working with nanomaterials.
Our management provides the vision, the driving force, and resources needed to involve all employees in establishing a safe and
healthy workplace environment.
Knowledge.
As nanomaterials pose new challenges to understanding, predicting, and managing potential hazards and risks, we conduct periodic
worksite analyses that study all working conditions to identify, prevent, and eliminate existing or potential hazards. The results
of these studies are shared with all employees under a comprehensive EH&S training program as well as posted in product Material
Safety Data Sheets (“MSDS”). We have also participated in various government-funded university research studies dealing
with environmental safety and handling concerns. In addition, pertinent data is made available to customers, partners, industry
groups, regulatory agencies, universities and community first responders.
Prevention.
To prevent any harmful impact to the safety and health of the employees, the community, and the environment, we employ established
safety systems in our operations, including, without limitation, administrative and engineering controls, personal protective
equipment, safe work practices, preventive maintenance, and emergency preparedness programs.
Sustainability.
We actively work to conserve resources and minimize or eliminate adverse EH&S effects and risks that may be associated
with our products, services and operations. In addition, we will strive towards a “green supply chain” by the choice
of suppliers, materials, services, and process and plant designs to ensure sustainability of operations and lifecycle product
stewardship.
Continuous
Improvement.
We manages our business and operations with the goal of continuously upgrading our understanding of the EH&S
impact of nanomaterials and systematically adapting our mode of operations to reach and maintain our policy of “Vision of
Zero.”
Employees
As
of October 13, 2016, we have 7 employees and 1 independent contractor. None of our employees are represented under a collective
bargaining agreement.
Properties
We
lease our principal offices located at 2905 Tech Center Dr., Santa Ana, California, consisting of 7,357 square feet of offices,
laboratory and manufacturing space. Effective March 1, 2014, we entered into a new lease of our current facilities for a period
of three years and concluding on February 28, 2017. The lease rate for the period March 1, 2015 through February 29, 2016 is $8,336
per month. The lease rate for the period March 1, 2016 through February 28, 2017 is $8,586 per month.
Item
1A. Risk Factors
The
investment in our common stock involves a number of significant risks. You should consider carefully the following information
about these risks before investing in our common stock. If any of the following risk events actually occur, the business, our
results of operations, and our financial condition would likely suffer, and investors could lose part or all of their investment.
It is impossible to accurately predict the results to investors, as we have no operating history as a public company. Prior to
purchasing any of our common stock, you should carefully consider the following risks.
Risks
Related to Our Business
We
have a limited operating history and have experienced operating losses since our inception and may incur additional operating
losses in the future. If we fail to generate significant revenue from the sale of our products, we may be unable to continue operations.
From
inception through June 30, 2016, we have generated losses in excess of $46.5 million on revenues of approximately $2.2 million.
As we have not yet generated substantive revenues, we will not be profitable until we establish a significant customer base and
realize several million dollars in annual revenues. We expect to continue to lose money unless we are able to generate sufficient
revenues and cash flows. If we are unable to generate sufficient revenues and cash flows to meet our costs of operations, we may
be forced to cease our business. Our continued operations are dependent upon our ability to generate revenues from operations
and obtain further financing. If we are unable to generate sufficient revenues and obtain sufficient financing, our current business
plans could fail and we may be forced to close our business.
Our
capitalization is limited and we may need additional funds to sustain our operations. If we are unable to raise additional capital,
as needed, the future growth of our business and operations could be severely limited.
A
limiting factor on our growth, including our ability to penetrate new markets such as the chemicals sector, attract new customers
and deliver new products in a timely matter, is our limited capitalization compared to other companies in the industry. Our currently
available capital resources are limited, and are only adequate to fund our operations and business objectives until October 31,
2016, assuming no revenues are realized from our current business plan, no equity or debt financing is procured, and no exercise
of derivative securities (i.e., expiring options and warrants with a low exercise price per share) occurs. We will require additional
financing, and we are presently offering equity securities of the Company for sale via a private placement. If additional financing
is not procured, we may not achieve our revenue and profit objectives and may be forced to cease some or all of our operations.
There can be no assurance that future debt or equity financing will be available to us on a timely basis, on acceptable terms,
or at all. If we are unable to raise additional funds on acceptable terms, our business operations and business prospects may
be adversely affected.
We
have not generated significant revenue and may never be profitable.
Our
ability to generate significant revenue and achieve profitability depends on our ability to complete additional commercial validations
of our nanocatalysts in chemical production and receive significant purchase orders. We do not anticipate generating measurable
revenues from sales of our nanocatalysts in chemical production until calendar Q1 of 2017 at the earliest, following an anticipated
second commercial validation in a commercial ammonia plant located in the western hemisphere.
Because
of the numerous risks and uncertainties associated with our additional commercial validations and obtaining significant purchase
orders, we are unable to predict the timing or amount of increased expenses, and when, or if, we will be able to achieve or maintain
profitability. Even if we are able to generate significant revenues from the sale of our products, we may not become profitable
and may need to obtain additional funding to continue operations.
We
have not generated gross profit and may never generate gross profit.
Our
ability to generate gross profit depends on our ability to achieve significant revenue to cover our fixed costs of goods sold
and our variable costs of goods sold related to materials production. We do not anticipate generating gross profit until calendar
Q1 2017 at the earliest, and if at all, as we do not anticipate generating significant revenue until that time at the earliest.
If we do not generate significant revenues, we may need to obtain additional funding to continue our operations.
We
are dependent on our key personnel to operate our business, which could adversely affect our ability to operate if we are unable
to retain or replace these persons. We may also require additional personnel, however, there can be no assurance that we will
be able to hire or retain qualified personnel.
Our
future performance will be substantially dependent on the continued services and on the performance of our senior management and
other key personnel, particularly, Kevin D. Maloney, our Chief Executive Officer and President and Gregory L. Hrncir, our Chief
Strategy Officer, among others. Our performance also depends on our ability to attract, retain and motivate other officers and
key employees. The loss of the services of Messrs. Maloney and Hrncir, or any other key personnel could have a material adverse
effect on our business, prospects, financial condition and results of operations. Our success will also depend upon our ability
to recruit and retain additional qualified personnel.
There
can be no assurance that sales, if any, of our nanocatalysts for use in the chemicals sector will result in profitability.
We
have developed and patented a process to manufacture a variety of nanocatalysts, and have used these nanocatalysts to augment
chemical production in an ammonia plant in China that resulted in commercial validation in May 2015. However, there is no guarantee
that the use of nanocatalysts in chemicals applications will result in profitability or long-term viability. Our future success
is a function of use of our nanocatalysts in the chemicals sector, and in particular a follow-on commercial validation utilizing
Casale technology. There are no guarantees that use of one or more of our catalysts for one or more applications in the chemicals
sector will occur. In the event this does not occur, our results of operations would be adversely affected and we may be forced
to cease its business.
We
only have one manufacturing facility
We
manufacture all of our nano-catalysts at our Santa Ana, California facility. In the event of a fire, flood, tornado, earthquake
or other form of a catastrophic event, we would be unable to fulfill any then existing demand for our products, if any, and would
not be able to do so for several quarters, depending upon the severity of the event. While we carry what we believe to be sufficient
property and casualty insurance, given the nature of our operations and our manufacturing equipment being of a bespoke nature,
we will not be able to quickly replace our manufacturing and other equipment in a rapid fashion. As a result, should a catastrophic
event occur which results in the loss of all or a measurable portion of our manufacturing equipment, our financial condition and
results of operation would be materially adversely affected.
Our
operations may expose us to litigation, tax, environmental and other legal compliance risks.
We
are subject to a variety of litigation, tax, environmental, health and safety, and other legal compliance risks. These risks include,
among other things, possible liability relating to product liability matters, personal injuries, intellectual property rights,
contract-related claims, government contracts, taxes, tariffs, health and safety liabilities, environmental matters and compliance
with U.S. and foreign laws, competition laws and laws governing improper business practices. We or one of our business units could
be charged with wrongdoing as a result of such matters. If convicted or found liable, we could be subject to significant fines,
penalties, repayments or other damages (in certain cases, treble damages). As a global business, we are subject to complex laws
and regulations in the U.S. and other countries in which we intend to operate. Those laws and regulations may be interpreted in
different ways. They may also change from time to time, subject to related interpretations and other guidance. Changes in laws
or regulations could result in higher expenses, payments, tariffs and taxes, and uncertainty relating to laws or regulations may
also affect how we conduct our operations and structure our investments and could limit our ability to enforce our rights.
In
the area of taxes, changes in tax laws and regulations in the U.S. and other countries, as well as changes in related interpretations
and other tax guidance could materially impact our tax receivables and liabilities and our deferred tax assets and tax liabilities.
Additionally, in the ordinary course of business, we are subject to examinations by various authorities, including tax authorities.
Although we are not subject to any current investigations, there could be additional investigations launched in the future by
governmental authorities in various jurisdictions and existing investigations could be expanded. The global and diverse nature
of our operations means that these risks will continue to exist and legal proceedings and contingencies may arise from time to
time. Our results may be affected by the outcome of legal proceedings and other contingencies that cannot be predicted with certainty.
We
face competition from companies that have substantially greater capital resources, research and development, manufacturing and
marketing resources than we have in the chemicals sector.
While
we believe that we have significant competitive benefits offered by our proprietary platform technology for use in the chemicals
sector, there are competitors with much longer operating histories, greater name recognition, larger customer bases and significantly
greater financial, technical and marketing resources than we do. Such competition could materially adversely affect our business,
operating results or financial condition.
Our
future revenues are very difficult to predict with any accuracy.
It
is not feasible to predict with accuracy or assurance the timing or the amount of revenues that we will receive from the sale,
or license, of our products. Any delay in the integration of one or more of our nanocatalysts in the chemicals sector, could result
in significant delays in the realization of revenues, the need to raise additional capital through the issuance of additional
equity or debt securities sooner than we intend, and may allow competitors to reach certain of such markets with products before
we do. In view of the emerging nature of the technology involved in certain of these markets, and the attendant uncertainty as
to whether our products will achieve meaningful commercial acceptance, if at all, there can be no assurance that we will realize
revenues sufficient to achieve profitability.
We
will have to establish distribution channels in the chemicals sector.
We
have no experience in the commercial license and sale of nanocatalysts in the chemicals sector. Given that we lack deep domain
expertise in the chemicals sector, we are utilizing our partner, Casale, to handle license and sale of our nanocatalysts alongside
its reactor technology. In the event we are unsuccessful in establishing external sales through Casale, our business, operating
results and financial condition could be adversely affected.
We
may face increased pricing pressures from current and future competitors and, accordingly, there can be no assurance that competitive
pressures will not require us to reduce our prices on our nanocatalysts.
It
is likely that we will experience significant competitive pressure over time. Accordingly, the use and pricing of our nanocatalysts
in the chemicals sector may decline as the market becomes more competitive. Any material reduction in the price of our nanocatalysts
will negatively affect our gross margin and results of operations.
We
rely heavily on collaborative partners such as distributors, manufacturers and vendors and our relationships with such parties
may restrict or limit our business operations.
We
are currently working with several third party entities in the validation and optimization of our nanocatalysts for use in the
chemicals sector. Our current and future collaborations and joint ventures are important as they allow greater access to funds,
to research, development and testing resources, validation, and to manufacturing, sales and distribution resources that we would
otherwise not have. We intend to continue to significantly rely on such collaborative and joint venture arrangements. Some of
the risks and uncertainties related to the reliance on such collaborations and joint ventures in the chemicals sector include
the fact that such relationships could actually serve to limit or restrict us, while our partners are free to pursue other catalyst
solutions either on their own or with others. Further, our partners may terminate a collaborative technology relationship and
such termination may require us to seek other partners, or expend substantial resources to pursue these activities independently.
We
may be subject to product liability claims, which could damage our reputation, cause us to lose customers, and expose us to liabilities
in excess of our product liability insurance coverage to cover any claims.
Our
nanocatalysts proposed to be used in the chemicals sector must be handled according to strict guidelines to ensure safety. We
have obtained product liability insurance, but we can make no assurance that the product liability insurance we have procured
will be sufficient to cover any potential product liability claim. Failure to maintain sufficient insurance coverage could have
a material adverse effect on our business, prospects and results of operations if claims are made that exceed the coverage we
have obtained.
The
anticipated growth of our business will result in a corresponding growth in the demands on our management and our operating systems
and internal controls.
Any
future growth may strain existing management resources and operational, financial, human and management information systems and
controls, which may not be adequate to support our operations and will require us to develop further financial and management
controls, reporting systems and procedures. There can be no assurance that we will be able to develop such controls, systems or
procedures effectively, or on a timely basis. Our failure to do so could have a material adverse effect on our business, operating
results and financial condition.
Although
we have entered into confidentiality and non-compete agreements with all of our employees and consultants, if we are unable to
protect our proprietary information against unauthorized use by others, our competitive position could be harmed.
Our
proprietary information is critically important to our competitive position and is a significant aspect of the products we provide.
If we are unable to protect our proprietary information against unauthorized use by others, our competitive position could be
harmed. We enter into confidentiality and noncompete agreements with our employees and consultants, and control access to, and
distribution of, our documentation and other proprietary information. Despite these precautions, we cannot assure you that these
strategies will be adequate to prevent misappropriation of our proprietary information. Therefore, we could be required to expend
significant amounts to defend our rights to proprietary information in the future if a breach were to occur.
Risks
Related to the Chemicals Production Industry
We
have no experience operating in the multi-billion global chemicals industry.
While
we have significant experience in the manufacturing of nanocatalysts over the last 13 years, we have no experience working with
conglomerates in the chemicals industry. We are highly reliant on our commercial partner, Casale and our operating results and
overall business prospects and condition will be a function of the success Casale has in the marketplace selling our nanocatalysts
alongside its reactor technology.
As
part of the sale of our QSI-Nano® iron catalysts, we will be required to coat these catalysts onto existing commercial iron
catalysts used by ammonia producers and we have no commercial experience in doing so.
As
part of the sale of QSI-Nano® iron catalysts to ammonia plants we are required to coat our catalysts onto commercial iron
substrates. Although we have developed our own coating machine that has demonstrated favorable results based on the commercial
validation in China and the coating of over 23 metric tons of base catalyst with 360 kilograms of FeNIX catalsyt, the coating
process has many risks and is a critical part of our overall value proposition. If we are not successful in implementing the coating
process on a large scale basis in each geographic region in which we anticipate operating, then our business condition and results
of operation will be adversely affected.
We
presently have sixteen gas-phase condensation reactors in our prototype facility in Santa Ana, California and will require significant
scale-up should significant purchase orders be received.
If
we are successful in achieving significant purchase orders for our QSI-Nano® iron catalysts, we will likely be required to
significantly expand our base of reactors in a relatively short period of time. We have no experience in large-scale manufacturing,
including the planning, design, permitting, build-out, and operation phases. Further, if we are required to expand we would likely
need to do so in a state other than California, such as southern Nevada or Utah, given the extremely high electricity costs in
California, and electricity being the largest component of our cost of goods. In sum, there is a host of issues surrounding a
major manufacturing expansion, which will place significant burden on our management, financial, and other resources, all of which
could have an effect on our overall business.
Warranty
claims and product liability claims could harm our business, results of operations and financial condition.
Through
the introduction of our nanocatalysts for use in the chemicals sector (with ammonia being the lead application), we will be exposed
to potential warranty and product liability claims in the event that our products fail to perform as expected or such failure
of our products results, or is alleged to result, in bodily injury or property damage (or both). Although we do not anticipate
any claims, such claims may arise despite our quality controls and proper testing, either due to a defect during manufacturing
or due to any individual or enterprise’s improper use of our products. In addition, if any of our products are or are alleged
to be defective, then we may be required to participate in a recall of them. If a warranty or product liability claim is brought
against us, regardless of merit or eventual outcome, such claim or recall may result in damage to our reputation, breach of contracts
with our customers, decreased demand for our products, costly litigation, loss of revenue, and the inability to commercialize
some products.
Risks
Related to our Common Stock
You
may find it difficult to sell our common stock.
There
has been a limited trading market in our common stock. While we expect that this may change in the future, we cannot assure you
that an active trading market for our common stock will develop or be sustained. Regardless of whether an active and liquid public
market exists, negative fluctuations in our actual or anticipated operating results will likely cause the market price of our
common stock to fall, making it more difficult for you to sell our common stock at a favorable price, or at all.
We
intend to issue additional stock options to employees and consultants in the future, which will result in dilution to existing
and new investors.
In
the future, we will provide additional compensation to our employees, officers, directors, consultants and independent contractors
through an equity incentive plan. Our equity incentive plan permits the issuance of options to purchase shares of common stock
and restricted shares of our common stock. Because stock options granted under the plan will generally only be exercised when
the exercise price for such option is below the then market value of the common stock, the exercise of such options will cause
dilution to the book value per share of our common stock and to existing and new investors.
We
do not intend to pay dividends on our common stock in the foreseeable future.
You
should not rely on an investment in our common stock to provide dividend income. It is our present intention that all future earnings,
if applicable, will be reinvested and used for ongoing product development as well as working capital. Any determination to pay
dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations,
financial conditions, contractual restrictions, restrictions imposed by applicable laws and other factors that our board of directors
deems relevant. In addition, our ability to pay dividends may be limited or prohibited by the terms of future financings and/or
credit facilities. Accordingly, investors in our common stock should not expect dividends to be paid on their shares of common
stock in the foreseeable future. Further, investors must rely on sales of their common stock after price appreciation, which may
never occur, as the only way to realize any return on their investment. As a result, investors seeking cash dividends should not
purchase our common stock.
Anti-takeover
provisions in our Articles of Incorporation and Bylaws or provisions of Nevada law could prevent or delay a change in control,
even if a change of control would benefit our stockholders.
Provisions
of our Articles of Incorporation and Bylaws, as well as provisions of Nevada law, could discourage, delay or prevent a merger,
acquisition or other change in control, even if a change in control would benefit our stockholders. These provisions:
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Establish
advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted
upon by stockholders at stockholder meetings;
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Authorize
our board of directors to issue “blank check” preferred stock to increase the number of outstanding shares and
thwart a takeover attempt;
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Require
the written request of at least 75% of the voting power of our capital stock in order to compel management to call a special
meeting of the stockholders; and
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Prohibit
stockholder action by written consent and require that all stockholder actions be taken at a meeting of our stockholders,
unless otherwise specifically required by our Articles of Incorporation or the Nevada Revised Statutes.
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In
addition, the Nevada Revised Statutes contain provisions governing the acquisition of a controlling interest in certain Nevada
corporations. These laws provide generally that any person that acquires 20% or more of the outstanding voting shares of certain
Nevada corporations in the secondary public or private market must follow certain formalities before such acquisition or they
may be denied voting rights, unless a majority of the disinterested stockholders of the corporation elects to restore such voting
rights in whole or in part. These laws will apply to us if we have 200 or more stockholders of record, at least 100 of whom have
addresses in Nevada, unless our Articles of Incorporation or Bylaws in effect on the tenth day after the acquisition of a controlling
interest provide otherwise. These laws provide that a person acquires a “controlling interest” whenever a person acquires
shares of a subject corporation that, but for the application of these provisions of the Nevada Revised Statutes, would enable
that person to exercise
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One-fifth
or more, but less than one-third;
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One-third
or more, but less than a majority; or
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A
majority or more, of all of the voting power of the corporation in the election of directors.
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Once
an acquirer crosses one of these thresholds, shares, which it acquired in the transaction taking it over the threshold and within
the 90 days immediately preceding the date when the acquiring person acquired or offered to acquire a controlling interest, become
“control shares.” These laws may have a chilling effect on certain transactions if our Articles of Incorporation or
Bylaws are not amended to provide that these provisions do not apply to us or to an acquisition of a controlling interest, or
if our disinterested stockholders do not confer voting rights in the control shares.
Nevada
law also provides that if a person is the “beneficial owner” of 10% or more of the voting power of certain Nevada
corporations, such person is an “interested stockholder” and may not engage in any “combination” with
the corporation for a period of three years from the date such person first became an interested stockholder, unless the combination
or the transaction by which the person first became an interested stockholder is approved by the board of directors of the corporation
before the person first became an interested stockholder. Another exception to this prohibition is if the combination is approved
by the affirmative vote of the holders of stock representing a majority of the outstanding voting power not beneficially owned
by the interested stockholder at a meeting, no earlier than three years after the date that the person first became an interested
stockholder. These laws generally apply to Nevada corporations with 200 or more stockholders of record, but a Nevada corporation
may elect in its Articles of Incorporation not to be governed by these particular laws.
Nevada
law also provides that directors may resist a change or potential change in control if the directors determine that the change
is opposed to, or not in the best interest of, the corporation.
Risks
Related to Our Securities, Tax Concerns And Reporting Requirements
Our
stock price is likely to be volatile.
There
is generally significant volatility in the market prices and limited liquidity of securities of companies at our stage. Contributing
to this volatility are various events that can affect our stock price in a positive or negative manner. These events include,
but are not limited to: governmental regulations or actions; market acceptance and sales growth of our products; litigation involving
our industry; developments or disputes concerning our patents or other proprietary rights; departure of key personnel; future
sales of our securities; fluctuations in our financial results or those of companies that are perceived to be similar to us; investors’
general perception of us; announcements by us of significant contracts, acquisitions, strategic partnerships, joint ventures or
capital commitments, and general economic, industry and market conditions. If any of these events occur, it could cause our stock
price to fall.
The
price of our common stock may be adversely affected by the future issuance and sale of shares of our common stock or other equity
securities.
We
cannot predict the size of future issuances or sales of our common stock or other equity securities future acquisitions or capital
raising activities, or the effect, if any, that such issuances or sales may have on the market price of our common stock. The
issuance and sale of substantial amounts of common stock or other equity securities or announcement that such issuances and sales
may occur, could adversely affect the market price of our common stock. As of October 13, 2016, we had 22,857,082 shares of common
stock issued and outstanding, and an additional 477,142,918 shares of common stock and 10,000,000 shares of preferred stock authorized
for issuance. Any decline in the price of our common stock may encourage short sales, which could place further downward pressure
on the price of our common stock and may impair our ability to raise additional capital through the sale of equity securities.
Our
reduced stock price may adversely affect our liquidity.
Our
common stock has limited trading history. Many market makers are reluctant to make a market in stock with a trading price of less
than $5.00 per share, as well as shares quoted on the OTCQB. To the extent that we have fewer market makers for our common stock,
our volume and liquidity will likely decline, which could further depress our stock price.
Additional
risks may exist since we became public through a “reverse merger.”
Because
we became public by means of a “reverse merger,” we may not be able to attract the attention of major brokerage firms.
Securities analysts of major brokerage firms may not provide coverage of us since there is little incentive to brokerage firms
to recommend the purchase of our common stock. We cannot assure you that brokerage firms will want to conduct any secondary offerings
on our behalf in the future.
Our
reporting obligations as a public company are costly.
Operating
a public company involves substantial costs to comply with reporting obligations under federal securities laws, which are continuing
to increase as provisions of the Sarbanes-Oxley Act of 2002 are implemented. We may not reach sufficient size to justify our public
reporting status. If we were forced to become a private company following the Merger, then our stockholders may lose their ability
to sell their shares and there would be substantial costs associated with becoming a private company.
Our
shares are “penny stock”.
In
general, “penny stock” includes securities of companies which are not listed on the principal stock exchanges and
have a bid price in the market of less than $5.00; and companies with net tangible assets of less than $2 million ($5 million
if the issuer has been in continuous operation for less than three years), or which have recorded revenues of less than $6 million
in the last three years. As “penny stock,” our stock therefore is subject to Rule 15g-9, which imposes additional
sales practice requirements on broker-dealers which sell such securities to persons other than established customers and “accredited
investors” (generally, individuals with net worth in excess of $1 million or annual incomes exceeding $200,000, or $300,000
together with their spouses, or individuals who are the officers or directors of the issuer of the securities). For transactions
covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s
written consent to the transaction prior to sale. Consequently, this rule may adversely affect the ability of broker-dealers to
sell our stock, and therefore may adversely affect stockholders’ ability to sell the stock in the public market.
The
requirements of being a public company may strain our resources, divert management’s attention and affect our ability to
attract and retain qualified members of the board of directors.
As
a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange
Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the OTCBB and other applicable securities rules and
regulations. Compliance with these rules and regulations requires significant legal and financial compliance costs, makes some
activities more difficult, time-consuming or costly and increases demand on our systems and resources. The Exchange Act requires,
among other things, that we file annual, quarterly and current reports with respect to our business and operating results. The
Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control
over financial reporting. In order to maintain and, if required, improve our disclosure controls and procedures and internal control
over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s
attention may be diverted from other business concerns, which could harm our business and operating results. Although we have
already hired additional employees to comply with these requirements, we may need to hire more employees in the future, which
will increase our costs and expenses.
In
addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty
for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws,
regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result,
their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could
result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure
and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment
may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating
activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities
intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings
against us and our business may be harmed.
We
also expect that being a public company with these new rules and regulations will make it more expensive for us to obtain director
and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain
coverage. These factors could also make it more difficult for us to attract and retain qualified members for our board of directors,
particularly to serve any committees, and qualified executive officers.
As
a result of disclosure of information in filings required of a public company, our business and financial condition will become
more visible, which we believe may result in threatened or actual litigation, including by competitors and other third parties.
If such claims are successful, our business and operating results could be harmed, and even if the claims do not result in litigation
or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of
our management and harm our business and operating results.
We
will be obligated to develop and maintain proper and effective internal controls over financial reporting.
We
are required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on, among other things, the
effectiveness of our internal control over financial reporting annually. This assessment will need to include disclosure of any
material weaknesses identified by our management in our internal control over financial reporting.
We
may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and
testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable
to assert that our internal controls are effective.
If
we are unable to assert that our internal control over financial reporting is effective, or if our auditors are unable to express
an opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of
our financial reports, which would cause the price of our common stock to decline.
The
JOBS Act allows us to postpone the date by which we must comply with certain laws and regulations and to reduce the amount of
information provided in reports filed with the SEC.
We
cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less
attractive to investors. We are and we will remain an “emerging growth company,” as defined in the JOBS Act until
the earliest to occur of: (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; (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.
For
so long as we remain an emerging growth company, we will not be required to:
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Have
an auditor report on our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act;
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Comply
with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation
or a supplement to the auditor’s report providing additional information about the audit and the financial statements
(i.e., an auditor discussion and analysis);
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Submit
certain executive compensation matters to shareholder non-binding advisory votes;
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Submit
for shareholder approval golden parachute payments not previously approved; and
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Disclose
certain executive compensation related items such as the correlation between executive compensation and financial performance
and comparisons of the Chief Executive Officer’s compensation to median employee compensation, when such disclosure
requirements are adopted.
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In
addition, Section 102(b)(1) of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition
period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. An emerging
growth company can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to
private companies. We have elected to use the extended transition period for complying with new or revised accounting standards
under Section 102(b)(1) of the JOBS Act. As a result of this election, our financial statements may not be comparable to companies
that comply with public company effective dates.
We
cannot predict if investors will find our common stock less attractive because we may rely on some of these exemptions. If some
investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and
our stock price may be more volatile. If we avail ourselves of certain exemptions from various reporting requirements, our reduced
disclosure may make it more difficult for investors and securities analysts to evaluate us and may result in less investor confidence.
Sales
of a substantial number of shares of our common stock in the public market by our existing stockholders could cause our stock
price to fall.
We
have not entered into any lock-up agreements with any of our existing shareholders. As a result, sales of a substantial number
of shares of our common stock in the public market could depress the market price of our common stock and could impair our ability
to raise capital through the sale of additional equity securities. We are unable to predict the effect that sales may have on
the prevailing market price of our common stock.
Item
1B Unresolved Staff Comments
None.
Item
2. Properties
We
lease our principal offices located at 2905 Tech Center Dr., Santa Ana, California, consisting of 7,357 square feet of offices,
laboratory and manufacturing space. Effective March 1, 2014, we entered into a new lease of our current facilities for a period
of three years and concluding on February 28, 2017. The lease rate for the period March 1, 2015 through February 29, 2016 is $8,336
per month. The lease rate for the period March 1, 2016 through February 28, 2017 is $8,586 per month.
Item
3. Legal Proceedings
From
time to time the Registrant may be named in claims arising in the ordinary course of business. Currently, no legal proceedings
or claims are pending against us or involve us that, in the opinion of our management, could reasonably be expected to have a
material adverse effect on our business or financial condition.
Item
4. Mine Safety Disclosures
None.
PART
II
Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchase of Equity Securities
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Market
Information
Our
common stock is quoted on the Over the Counter Bulletin Board (“OTCBB”), under the symbol “QSIM.”
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Closing
Bid
|
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Closing
Ask
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2015
- 2016
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High
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|
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Low
|
|
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High
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|
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Low
|
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July
1, 2015 thru June 30, 2016
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|
$
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3.75
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$
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0.15
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|
|
$
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4.00
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|
|
$
|
0.25
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|
The
above quotations, as provided by OTC Markets Group, Inc., represent prices between dealers and do not include retail markup, markdown
or commission. In addition, these quotations do not represent actual transactions.
Security
Holders
As
of October 13, 2016, we had 22,857,082 shares of common stock outstanding held of record by approximately 274 stockholders.
Dividends
We
have not paid dividends on our common stock to date. We currently intend to retain future earnings, if any, to fund our operations
and the development and growth of our business and, therefore, do not anticipate paying cash dividends on our common stock within
the foreseeable future. Any future payment of dividends on our common stock will be determined by our board of directors and will
depend on our financial condition, results of operations, contractual obligations and other factors deemed relevant by our board
of directors.
Securities
Authorized for Issuance under Equity Compensation Plans
Our
2014 Equity Incentive Plan (our “Incentive Plan”) is administered by our Board of Directors and provides for the granting
of stock awards to employees, officers, directors and other service providers of the Registrant. Security holders have approved
the stock plan. The following table sets forth certain information with respect our Incentive Plan as of June 30, 2016:
Plan
category
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|
Number
of securities
to be issued upon exercise
of outstanding options,
warrants and rights
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|
|
Weighted-average
exercise price of
outstanding options,
warrants and rights
|
|
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Number
of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column(a))
|
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(a)
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(b)
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|
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(c)
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Equity
compensation plans approved by security holders
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5,416,034
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$
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1.49
|
|
|
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1,206,799
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|
Equity
compensation plans not approved by security holders
|
|
|
—
|
|
|
|
—
|
|
|
|
—
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|
Total
|
|
|
5,416,034
|
|
|
$
|
1.49
|
|
|
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1,206,799
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Recent
Sales of Unregistered Securities
None.
Item
6. Selected Financial Data
Not
applicable.
Item
7.
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Management’s
Discussion and Analysis of Financial Conditions and Results of Operations
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Forward
Looking Statements
This
Annual Report on Form 10-K 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 15
of this Form 10-K, 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:
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our
future operating results and business prospects;
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our
ability to develop and market products that compete effectively in our targeted market segments;
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market
acceptance of our current and future products and the degree and nature of our competition;
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our
ability to meet customer demand;
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our
ability to protect and enforce our current and future intellectual property;
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our
ability to obtain sufficient funding to continue to pursue our business plan;
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our
ability to implement a long-term business strategy that will be profitable or generate sufficient cash flow;
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our
ability to manage our foreign business opportunities, coating operations and international business risks;
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the
loss of any of our key members of management;
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changes
in our industry, interest rates or the general economy; and
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changes
in governmental regulations, tax rates and similar matters.
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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.
On
May 5, 2015, the Company announced that commercial validation of its nano-iron catalyst had been achieved in a production-scale
ammonia plant in China.
On
May 27, 2015, the Company entered into a multi-year Joint Development Agreement with Swiss-based Casale, S.A. (Casale), a global
leader in production technologies for ammonia, urea, melamine, methanol, syngas, nitrates and phosphates. Casale’s reactor
production technologies are utilized in approximately 38 percent of global ammonia production and 39 percent of global methanol
production. Casale and QSI have agreed to collaborate on commercial technologies for ammonia, methanol, and other industrial chemicals,
which collectively account for several hundred billion USD of production annually. Casale also agreed to utilize QSI as its exclusive
provider of nanocatalysts for its chemical synthesis processes during the term of the agreement based on QSI’s demonstrated
increase in catalytic activity and patented high-volume manufacturing process. The first objective of the Joint Development Agreement
is to validate and optimize QSI-Nano catalysts with Casale production reactor technologies. Following a successful validation
phase, the second objective is to enter into a long-term agreement with Casale for the joint global distribution and sale of QSI-Nano
catalysts with Casale reactor technologies to chemical plant owners and operators.
On
March 8, 2016, the Company entered into a multi-year Commercialisation Partnership Agreement with Swiss-based
Casale S.A.
(Casale), pursuant to which the parties agreed to the terms of commercialization of the Company’s QSI-Nano iron catalysts
for ammonia synthesis. During the term, Casale is restricted from entering into any agreement with any third party for any purpose
relating to the use of nano-sized particle based catalysts in ammonia synthesis. Further, during the term, Casale has exclusive
rights to commercially market, co-brand and sell the FeNIX™ product into the ammonia market globally, with the exception
of China. The Company will not license the FeNIX™ product for use outside of China to an ammonia plant owner/operator if
such party does not commit to use the ammonia technology developed and owned by Casale.
On
March 15, 2016, the Company announced that it had been issued a patent by the U.S. Patent and Trademark Office for a key patent
related to its advanced FeNIX™ nanocatalyst accelerator technology. The patent covers claims around the application of iron
nanocatalysts, applied as a coating onto existing commercial ammonia catalysts, for increased catalytic activity and production
efficiency in ammonia synthesis.
On
April 25, 2016, Marc Goroff, Steven Myers, Robert Venable, and Jeffery Palmer voluntarily resigned from the Board of Directors,
effective immediately and from their respective roles as members of the company’s Audit, Compensation, Nominating, and Governance
Committees. All have agreed to serve as non-director advisors to the Company. Kevin Maloney and Francis Poli, our lead director,
continue to serve as directors of the Company. Francis Poli serves as chairman of each of the board committees.
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:
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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;
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Reduced
disclosure about our executive compensation arrangements;
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No
requirement that we hold non-binding advisory votes on executive compensation or golden parachute arrangements; and
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Exemption
from the auditor attestation requirement in the assessment of our internal control over financial reporting.
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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.
Cash
and Cash Equivalents.
The Company considers demand deposits, U.S. treasury securities and highly-liquid debt investments purchased
with original maturities of three months or less to be cash equivalents. The Company did not have any cash equivalents as of June
30, 2016 and June 30, 2015.
The
Company maintains its cash in major banks. From time to time, the Company’s cash balances exceed the Federal Deposit Insurance
Corporation limit. The Company has not experienced and does not anticipate any losses relating to these amounts.
Accounts
Receivable.
The Company makes periodic evaluations of the creditworthiness of its customers and manages its exposure to losses
from bad debts by limiting the amount of credit extended whenever deemed necessary and generally does not require collateral.
The Company maintains an allowance for estimated uncollectible accounts receivable, as appropriate, and such losses have historically
been minimal and within management’s expectations. There were no allowances for estimated uncollectible accounts at June
30, 2016 and 2015.
Inventory.
Inventory consists primarily of manufactured nano materials and is comprised of raw materials, labor and manufacturing overhead.
Inventory is stated at the lower of cost, determined on a first-in, first-out basis, or market. An inventory reserve is created
when potentially slow-moving or obsolete inventories are identified in order to reflect the appropriate inventory value. While
the Company’s inventory is not perishable and does not degrade with time, the Company recorded a reserve as its inventory
was over one year old and there is no certainty that the inventory will be sold. At June 30, 2016, all inventory was reserved.
At June 30, 2015 the Company did not have an excess and obsolete reserve.
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 June 30, 2016, ten patents have been issued and two patents are pending. 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.
Fair
Value of Financial Instruments and Certain Other Assets and Liabilities.
The Company follows the guidance of U.S. GAAP with
respect to assets and liabilities that are measured at fair value. U.S. GAAP establishes a three-tier fair value hierarchy, which
prioritizes the inputs used in measuring fair value as follows:
●
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Level
1
: Observable inputs such as quoted prices in active markets;
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Level
2
: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
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●
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Level
3
: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own
assumptions
|
The Company’s financial
instruments consist of cash, accounts receivable, accounts payable and accrued expenses and debt. The carrying amount approximates
fair value because of the short-term nature of these items.
Other
than derivative liabilities, the
Company did not have any assets or liabilities that are measured
at fair value on a recurring or nonrecurring basis during the years ended June 30, 2016 and 2015.
Derivative
Liabilities.
A derivative is an instrument whose value is “derived” from an underlying instrument or index such
as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative
instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial
derivatives or engage in hedging transactions. However, we have entered into certain financing transactions that involve financial
equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in
other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives
are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such
new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives
often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate
of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value
of derivative liabilities on the statement of operations. Furthermore, depending on the terms of a derivative, the valuation of
derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other
security. The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes
as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification.
There is no limit on the number of times a contract may be reclassified.
Research
and Development.
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.
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 16,890,179 and 12,921,728, have been excluded from the computations
of diluted net loss per share because the effect would have been anti-dilutive for the years ended June 30, 2016 and 2015.
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.
Going
Concern.
The Company has incurred recurring losses from operations from inception and has limited working capital. As of June
30, 2016, the Company had an accumulated deficit of approximately $46.5 million. The Company’s activities will necessitate
significant uses of working capital beyond fiscal 2016. 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 working
on securing additional debt 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. The Company currently has sufficient cash for operations through October
2016 and is presently undertaking a private placement of equity securities for working capital purposes.
Results
of Operations
The
following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the years ended
June 30, 2016 and 2015. This discussion and analysis should be read in conjunction with our financial statements appearing elsewhere
in this Form 10-K. 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 15 of this Form 10-K.
Year
Ended June 30, 2016 Compared to Year Ended June 30, 2015
The
following discussions are based on the balance sheets as of June 30, 2016 and June 30, 2015 and statements of operations for the
years ended June 30, 2016 and 2015 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 both dollars and percentage change. The columns present the
following:
|
●
|
The
first two data columns in each table show the dollar results for each period presented.
|
|
|
|
|
●
|
The
columns entitled “Dollar variance” and “% variance” show the change in results, both in dollars and
percentages. These two columns show 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 in both columns. Conversely, when expenses
increase from one period to the next, that change is shown as a negative in both columns.
|
Year
Ended June 30, 2016 Compared to Year Ended
June 30,
2015
|
|
Year
Ended
June 30, 2016
|
|
|
Year
Ended
June 30, 2015
|
|
|
Dollar
variance
favorable
(unfavorable)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
$
|
46,669
|
|
|
$
|
48,047
|
|
|
$
|
(1,378
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales
|
|
|
11,828
|
|
|
|
14,448
|
|
|
|
2,620
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
34,841
|
|
|
|
33,599
|
|
|
|
1,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
1,114,051
|
|
|
|
2,137,628
|
|
|
|
1,023,577
|
|
Selling,
marketing, and advertising
|
|
|
25,474
|
|
|
|
73,862
|
|
|
|
48,388
|
|
General
and administrative
|
|
|
3,841,256
|
|
|
|
2,392,467
|
|
|
|
(1,448,789
|
)
|
Total
operating expenses
|
|
|
4,980,781
|
|
|
|
4,603,957
|
|
|
|
(376,824
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Operations
|
|
|
(4,945,940
|
)
|
|
|
(4,570,358
|
)
|
|
|
(375,582
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(457,208
|
)
|
|
|
(80,131
|
)
|
|
|
(377,077
|
)
|
Interest
expense – amortization of note discounts
|
|
|
(909,861
|
)
|
|
|
(228,404
|
)
|
|
|
(681,457
|
)
|
Gain
(loss) from change in fair value of derivative liabilities
|
|
|
2,020,698
|
|
|
|
(449,600
|
)
|
|
|
2,470,298
|
|
Loss
from debt extinguishment
|
|
|
(68,972
|
)
|
|
|
-
|
|
|
|
(68,972
|
)
|
Gain
on disposal of assets
|
|
|
9,400
|
|
|
|
17,353
|
|
|
|
(7,953
|
)
|
Loss
on intangible assets
|
|
|
(6,592
|
)
|
|
|
(12,283
|
)
|
|
|
5,691
|
|
Other
income
|
|
|
50
|
|
|
|
15,284
|
|
|
|
(15,234
|
)
|
Total
other expense, net
|
|
|
587,515
|
|
|
|
(737,781
|
)
|
|
|
1,325,296
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
Before Provision for Income Taxes
|
|
|
(4,358,425
|
)
|
|
|
(5,308,139
|
)
|
|
|
949,714
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
800
|
|
|
|
800
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(4,359,225
|
)
|
|
$
|
(5,308,939
|
)
|
|
$
|
949,714
|
|
Net
Sales.
Net sales decreased by $1,378 in the year ended June 30, 2016 compared to the year ended June 30, 2015, reflecting
a decrease in sales of batteries and various nanometals offset by an increase in electrodes.
For
the years ended June 30, 2016 and 2015, 57% and 30% of net sales were to two and one company, respectively.
For
the year ended June 30, 2016, 39% of net sales were to China, 26% of net sales were to the United States, and 26% of net sales
were to South Korea. For the year ended June 30, 2015, 36% of net sales were to South Korea and 13% of net sales were to Canada.
Gross
Profit.
Gross profit increased by $1,242 in the year ended June 30, 2016 compared to the year ended June 30, 2015. The increase
resulted from decreases of $392,067 in manufacturing salaries and related expenses, $117,585 in utilities, $116,468 in production
materials, $24,056 in miscellaneous expenses, $30,400 in warehouse supplies and maintenance, and $9,113 in depreciation, offset
by decreases of $377,723 allocation to Research and Development for production of nano iron for validation in China, $243,678
in allocation to Research and Development for ammonia research, $65,668 to inventory for nano iron produced for future sales,
and $1,378 in sales.
Research
and Development.
Research and development expenses decreased by $1,023,577 in the year ended June 30, 2016 compared to the
year ended June 30, 2015. The decrease resulted from decreases of $377,723 in production of nano iron for validation in China,
$277,351 in salaries and related expenses, $243,678 in research on ammonia production, $98,133 less in research on the MetAir®
Ranger battery, $14,466 less travel expenses, $11,216 less outside consultant expenses, and $1,010 less miscellaneous expenses.
Selling,
Marketing and Advertising Expenses.
Selling, marketing and advertising expenses decreased by $48,388 in the year ended June
30, 2016 compared to the year ended June 30, 2015. The decrease resulted from decreases of $40,187 in marketing expense, $4,253
in outside consultants and $3,948 in miscellaneous expenses.
General
and Administrative Expenses.
General and administrative expenses increased by $1,448,789 in the year ended June 30, 2016 compared
to the year ended June 30, 2015. The increase resulted from increases of $1,805,246 in outside services, $101,455 in board compensation,
$65,668 in inventory reserve, $17,959 in property taxes, and $14,456 in travel and conferences, offset by decreases of $433,933
in payroll and related expenses, $62,493 in business insurance (primarily D&O insurance), $29,452 in audit expenses, $16,886
in outside consulting expenses, and $13,231 in miscellaneous expenses.
Interest
Expense.
Interest expense increased by $377,077 in the year ended June 30, 2016 compared to the year ended June 30, 2015.
The increase resulted from an increase of $897,058 in convertible notes and a net increase of $625,224 in promissory notes.
Interest
Expense – Amortization of Note Discounts.
Debt discount amortization increased by $681,457 in the year ended June 30,
2016 compared to the year ended June 30, 2015. The increase was due to an increase of $897,058 in convertible notes and a net
increase of $625,224 in promissory notes.
Gain
(Loss) from Change in Fair Value of Derivative Liabilities.
Gain (loss) from change in fair value of derivative liabilities
increased by $2,470,298 to a gain of $2,020,698 in the year ended June 30, 2016 compared to a loss of $449,600 in the year ended
June 30, 2015. Fair value was recalculated at June 30, 2016 on the Series O-2 notes. The gain resulted primarily from a significant
decrease in the market price of our stock at June 30, 2016 and thus a decrease in fair value of the derivative liabilities. Fair
value was recalculated at June 30, 2015 for the Series O-1 notes. The loss resulted from an increase in the fair value of the
derivative liabilities.
Loss
from Debt Extinguishment.
Loss on debt extinguishment increased by $68,972 in the year ended June 30, 2016 compared to the
year ended June 30, 2015. The loss was the result of the conversion of Series O-1 notes to Series O-2 notes in December 2015.
Gain
on Disposal of Assets
. Gain on disposal of assets decreased by $7,953 in the year ended June 30, 2016 compared to the year
ended June 30, 2015. Two fully depreciated pieces of equipment were sold for a total of $9,400 in the year ended June 30, 2016
compared to one fully depreciated piece of equipment sold for $17,353 in the year ended June 30, 2015.
Loss
on Intangible Assets
. Loss on intangible assets decreased by $5,691 in the year ended June 30, 2016 compared to the year ended
June 30, 2015. Upon review of the legal work in relation to potential patents applications, we determined that some patent applications
would no longer be pursued and thus we expensed those capitalized costs.
Other
Income.
Other income decreased by $15,234 in the year ended June 30, 2016 compared to the year ended June 30, 2015. Other
income of $15,284 for the year ended June 30, 2015 was the result of personal property tax refunds.
Liquidity
and Capital Resources
As
of June 30, 2016, we had current assets of $223,919, including $180,805 in cash and cash equivalents.
Cash
decreased $217,765 from $398,570 at June 30, 2015 to $180,805 at June 30, 2016. Net cash used in operating activities of $1,538,610
in the year ended June 30, 2016 included $4,359,225 operating loss, $2,813 increase in prepaid expenses, $1,220 increase in accounts
receivable, and non-cash item of $2,020,698 for gain from change in fair value of derivative liabilities, offset by $1,424,034
increase in accounts payable and accrued expenses, and non-cash items of $1,476,924 stock issued for services, $909,861 discount
amortization on notes payable, $511,047 stock based compensation expense, $388,840 depreciation and amortization, $65,668 increase
in inventory reserve, and $68,972 for loss from debt extinguishment. Net cash used in operating activities was $3,384,767 for
the year ended June 30, 2015.
$23,729
of cash was used in investing activities in the year ended June 30, 2016. $14,126 of cash was used for the purchase of property
and equipment, and $9,603 of cash was used for the development of patents. $180,609 of cash was used in investing activities in
the year ended June 30, 2015.
$1,344,574
in cash was provided by financing activities in the year ended June 30, 2016, due to $1,197,500 in notes issued and $625,000 in
convertible notes issued, offset by $458,526 payments on notes payable and $19,400 in buy backs of common stock. $1,261,057 in
cash was provided by financing activities in the year ended June 30, 2015.
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.
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 June 30, 2016, the Company had
approximately $220,000 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. We expect that any capital we raise will be through the issuance of equity
securities, the exercise of warrants and options, or the issuance of debt instruments, including convertible debt instruments.
We believe that we will be able to obtain financing when and as needed, but the capital may be expensive.
The
Company has incurred recurring losses from operations from inception and has limited working capital. As of June 30, 2016, the
Company had an accumulated deficit of approximately $46.5 million. The Company’s activities will necessitate significant
uses of working capital beyond fiscal 2016. 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 working on securing
additional debt 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. The Company currently has sufficient cash for operations through October
2016 and is presently undertaking a private placement of equity securities for working capital purposes.
Other
Commitments and Contingencies
Our
commitments and contingencies as of June 30, 2016 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 June 30,
|
|
Amount
|
|
2017
|
|
$
|
70,926
|
|
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.
We
do not have any off-balance sheet arrangements.
We
do not believe that the current levels of inflation in the United States have had a significant impact on our operations. If current
levels of inflations hold steady, we do not believe future operations will be negatively impacted.
The
following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the years ended
June 30, 2015 and 2014. This discussion and analysis should be read in conjunction with our financial statements appearing elsewhere
in this Form 10-K. 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 15 of this Form 10-K.
Year
Ended June 30, 2015 Year Compared to Year Ended June 30, 2014
The
following discussions are based on the balance sheets as of June 30, 2015 and June 30, 2014 and statement of operations for the
years ended June 30, 2015 and June 30, 2014 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 both dollars and percentage change. The columns present the
following:
|
●
|
The
first two data columns in each table show the dollar results for each period presented.
|
|
|
|
|
●
|
The
columns entitled “Dollar variance” and “% variance” show the change in results, both in dollars and
percentages. These two columns show 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 in both columns. Conversely, when expenses
increase from one period to the next, that change is shown as a negative in both columns.
|
Year
Ended June 30, 2015 Compared to Year Ended
June 30,
2014
|
|
Year
Ended
June 30, 2015
|
|
|
Year
Ended
June 30, 2014
(unaudited)
|
|
|
Dollar
variance
favorable
(unfavorable)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
$
|
48,047
|
|
|
$
|
176,382
|
|
|
$
|
(128,335
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales
|
|
|
14,448
|
|
|
|
55,594
|
|
|
|
41,146
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
33,599
|
|
|
|
120,788
|
|
|
|
(87,189
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
2,137,628
|
|
|
|
1,365,111
|
|
|
|
(772,517
|
)
|
Selling,
marketing, and advertising
|
|
|
73,862
|
|
|
|
46,313
|
|
|
|
(27,549
|
)
|
General
and administrative
|
|
|
2,392,467
|
|
|
|
2,563,441
|
|
|
|
170,974
|
|
Total
operating expenses
|
|
|
4,603,957
|
|
|
|
3,974,865
|
|
|
|
(629,092
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Operations
|
|
|
(4,570,358
|
)
|
|
|
(3,854,077
|
)
|
|
|
(716,281
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(80,131
|
)
|
|
|
(494,727
|
)
|
|
|
414,596
|
|
Interest
expense – amortization of note discounts
|
|
|
(228,404
|
)
|
|
|
(86,784
|
)
|
|
|
(141,620
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from increase in fair value of warrants
|
|
|
(449,600
|
)
|
|
|
-
|
|
|
|
(449,600
|
)
|
Gain
on disposal of assets
|
|
|
17,353
|
|
|
|
8,000
|
|
|
|
9,353
|
|
Loss
on intangible assets
|
|
|
(12,283
|
)
|
|
|
-
|
|
|
|
(12,283
|
)
|
Other
income
|
|
|
15,284
|
|
|
|
69,500
|
|
|
|
(54,216
|
)
|
Total
other expense, net
|
|
|
(737,781
|
)
|
|
|
(504,011
|
)
|
|
|
(233,770
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
Before Provision for Income Taxes
|
|
|
(5,308,139
|
)
|
|
|
(4,358,088
|
)
|
|
|
(950,051
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
800
|
|
|
|
1,600
|
|
|
|
800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(5,308,939
|
)
|
|
$
|
(4,359,688
|
)
|
|
$
|
(949,251
|
)
|
Net
Sales.
Net sales decreased by $128,335 in the year ended June 30, 2015 compared to the year ended June 30, 2014, reflecting
a decrease in sales of $102,500 of silver palladium to one customer and the balance various nanomaterials and electrodes.
For
the years ended June 30, 2015 and 2014, 30% and 58% of net sales were to one and one company, respectively.
For
the year ended June 30, 2015, 36% of net sales were to Korea. For the year ended June 30, 2014, 58% of net sales were to Israel.
Gross
Profit.
Gross profit decreased by $87,189 in the year ended June 30, 2015 compared to the year ended June 30, 2014. The decrease
resulted from decrease of $128,335 in sales and increases of $470,269 in manufacturing salaries and related expenses, $305,730
in depreciation, $96,087 in utilities, $37,848 in production materials, $17,412 in miscellaneous expenses, and $10,604 in repairs
and maintenance, offset by increased allocation of $535,705 to Research and Development for ammonia research, $377,723 to Research
and Development for production of nano iron for validation in China, and $65,668 to inventory for nano iron produced for future
sales.
Research
and Development.
Research and development expenses increased by $772,517 in the year ended June 30, 2015 compared to the year
ended June 30, 2014. The increase resulted from increases of $535,705 in research on ammonia production, $377,723 in production
of nano iron for validation in China, and $15,884 in miscellaneous expenses, offset by $108,964 less salaries and related expenses
due to less employees and $47,831 less in research on the MetAir® Ranger battery.
Selling,
Marketing and Advertising Expenses.
Selling, marketing and advertising expenses increased by $27,549 in the year ended June
30, 2015 compared to the year ended June 30, 2014. The increase resulted from increases of $14,940 in outside consultants and
$14,250 in marketing expense, offset by $1,641 less miscellaneous expenses.
General
and Administrative Expenses.
General and administrative expenses decreased by $170,974 in the year ended June 30, 2015 compared
to the year ended June 30, 2014. The decrease resulted from decreases of $384,581 legal expenses (primarily related to the reverse
merger of April 2014), $22,668 outside consultants, $12,540 audit expense, and $13,977 miscellaneous expense, offset by increases
of $111,225 insurance (primarily D&O insurance), $107,384 board members compensation (primarily options expenses), $19,631
payroll and related expenses, $13,141 public filing expenses, and $11,411 outside services.
Interest
Expense.
Interest expense decreased by $414,596 in the year ended June 30, 2015 compared to the year ended June 30, 2014.
The decrease resulted from the conversion of $6,642,500 of notes payable to common stock on April 22, 2014 as part of the reverse
merger.
Interest
Expense – Amortization of Note Discounts.
Interest expense – amortization of note discounts increased by $141,620
in the year ended June 30, 2015 compared to the year ended June 30, 2014. $182,100 of the increase resulted from the May 2015
calculation of the fair value of the derivative liabilities for the $510,000 convertible notes payable issued in May 2015. Fair
value of $692,100 was determined by the Monte Carlo simulation. $510,000 was recorded as a discount to the convertible notes payable
and the amount ($182,100) that the fair value exceeded the value of the notes was recorded to expense.
Loss
from Change in Fair Value of Derivative Liabilities.
Loss from change in fair value of derivative liabilities increased by
$449,600 in the year ended June 30, 2015 compared to the year ended June 30, 2014. Fair value was recalculated at June 30, 2015
using the Monte Carlo simulation. The result is an increase in fair value of $449,600.
Gain
on Disposal of Assets
. Gain on disposal of assets increased by $9,353 in the year ended June 30, 2015 compared to the year
ended June 30, 2014. A fully depreciated piece of equipment was sold for $17,353 in the year ended June 30, 2015 compared to two
fully depreciated pieces of equipment sold for $8,000 in the year ended June 30, 2014.
Loss
on Intangible Assets
. Loss on intangible assets increased by $12,283 in the year ended June 30, 2015 compared to the year
ended June 30, 2014. Upon review of the legal work in relation to potential patents applications, we determined that some patent
applications would no longer be pursued and thus we expensed those capitalized costs.
Other
Income.
Other income decreased by $54,216 in the year ended June 30, 2015 compared to the year ended June 30, 2014. Other
income of $15,284 for the year ended June 30, 2015 was the result of personal property tax refunds. Other income of $69,500 for
the year ended June 30, 2014 was the result of favorable settlements of amounts owed by or owed to the Company.
Item
7A. Quantitative and Qualitative Disclosures About Market Risk
None.
ITEM
8. Financial Statements and Supplementary Data
Reference
is made to the financial statements and accompanying notes included in this report, which begin on page F-1.
ITEM
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item
9A. Controls and Procedures
Disclosure
Controls and Procedures
Based
on their evaluation as of June 30, 2016, which is the end of the period covered by this annual report on Form 10-K, our principal
executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e) of the Exchange Act) are effective, based upon an evaluation of those controls and procedures required
by paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Exchange Act.
Internal
Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules
13a-15(f) or Rule 15(d)-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting
is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting principles generally accepted in the United States of
America. Internal control over financial reporting includes those written policies and procedures that:
|
●
|
pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
of our assets;
|
|
|
|
|
●
|
provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with accounting principles generally accepted in the United States of America;
|
|
|
|
|
●
|
provide
reasonable assurance that our receipts and expenditures are being made only in accordance with authorization of our management;
and
|
|
|
|
|
●
|
provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that
could have a material effect on our consolidated financial statements.
|
Internal
control over financial reporting includes the controls themselves and monitoring and actions taken to correct deficiencies as
identified.
Our
management assessed the effectiveness of our internal control over financial reporting as of June 30, 2016. Our management’s
assessment was based on criteria for effective internal control over financial reporting described in “Internal Control
– Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Our management’s
assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational
effectiveness of our internal control over financial reporting. Based on this assessment, our management determined that, as of
June 30, 2016, we maintained effective internal control over financial reporting.
There
have been no changes in our internal controls over financial reporting identified in connection with the evaluation required by
paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting above.
Item
9B. Other Information
None.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
1. ORGANIZATION
AND BUSINESS
QuantumSphere,
Inc. (the “Company” or “QuantumSphere”) was organized under the laws of the State of Nevada on December
1, 2005. The Company has developed a process to manufacture metallic nanopowders with end-use application focused on the chemical
sector. The Company’s products are used on a stand-alone basis, in the validation of the Company’s nano-iron catalysts
coated onto commercial iron catalysts used in the production of ammonia on a prospective basis. The Company’s major activities
to date have included capital formation, research and development, and marketing of its metallic nanopowder products.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
Cash
and Cash Equivalents
The
Company considers demand deposits, U.S. treasury securities and highly-liquid debt investments purchased with original maturities
of three months or less to be cash equivalents. The Company did not have any cash equivalents as of June 30, 2016 and June 30,
2015.
The
Company maintains its cash in major banks. From time to time, the Company’s cash balances exceed the Federal Deposit Insurance
Corporation limit. The Company has not experienced and does not anticipate any losses relating to these amounts.
Inventory
Inventory
consists primarily of manufactured nano materials and is comprised of raw materials, labor and manufacturing overhead. Inventory
is stated at the lower of cost, determined on a first-in, first-out basis, or market. An inventory reserve is created when potentially
slow-moving or obsolete inventories are identified in order to reflect the appropriate inventory value. While the Company’s
inventory is not perishable and does not degrade with time, the Company recorded a reserve as its inventory was over one year
old and there is no certainty that the inventory will be sold. At June 30, 2016, all inventory was reserved. At June 30, 2015
the Company did not have an excess and obsolete reserve.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
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 June 30, 2016, ten patents have been issued and two 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. Patents costs are reviewed periodically as to if any patents are no
longer being pursued and associated costs should be written off. For the year ended June 30, 2016, the Company wrote off $6,592
in capitalized patents costs.
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.
Fair
Value of Financial Instruments and Certain Other Assets and Liabilities
The
Company follows the guidance of U.S. GAAP with respect to assets and liabilities that are measured at fair value. U.S. GAAP establishes
a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
●
|
Level
1
: Observable inputs such as quoted prices in active markets;
|
|
|
●
|
Level
2
: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
|
|
|
●
|
Level
3
: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own
assumptions
|
The
Company’s financial instruments consist of cash, accounts receivable, accounts payable and accrued expenses and debt. The
carrying amount approximates fair value because of the short-term nature of these items.
Other
than derivative liabilities, the Company did not have any assets or liabilities that are measured at fair value on a recurring
or nonrecurring basis during the years ended June 30, 2016 and 2015.
The
following details the fair value measurement within the fair value hierarchy of the Company’s financial assets and liabilities
at June 30, 2016.
|
|
Fair
Value Measurement
|
|
|
|
Total
Fair Value
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
7,387
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
7,387
|
|
The
following details the fair value measurement within the fair value hierarchy of the Company’s financial assets and liabilities
at June 30, 2015.
|
|
Fair
Value Measurement
|
|
|
|
Total
Fair Value
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
1,141,700
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,141,700
|
|
There
were no transfers among Level 1, Level 2 and Level 3 during the years ended June 30,2016 and 2015.
The
change in fair value of the derivative liabilities during the years ended June 30, 2016 and 2015 are summarized as follows:
Fair value at June 30, 2014
|
|
$
|
-
|
|
Issuance of derivative liabilities
|
|
|
692,100
|
|
Change in fair value
|
|
|
449,600
|
|
Fair value at June 30, 2015
|
|
|
1,141,700
|
|
Issuance of derivative liabilities
|
|
|
871,611
|
|
Change in fair value
|
|
|
(2,020,698
|
)
|
|
|
|
|
|
Fair value at June 30, 2016
|
|
$
|
7,387
|
|
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
Derivative
Liabilities
A
derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward,
swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded
in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage
in hedging transactions. However, we have entered into certain financing transactions that involve financial equity instruments
containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex
financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured
at fair value using the Block Scholes Merton model and marked to market through earnings. However, such new and/or complex instruments
may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant
estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative
liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on
the statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed
from the financial statements upon exercise or conversion of the underlying instrument into some other security. The classification
of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during
a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit
on the number of times a contract may be reclassified.
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 convertible notes payable options and warrants, totaling 16,890,179 and 12,921,728, have been excluded
from the computations of diluted net loss per share because the effect would have been anti-dilutive for the years ended June
30, 2016 and 2015.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
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 determined using 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.
Going
Concern
The
Company has incurred recurring losses from operations from inception and has limited working capital. As of June 30, 2016, the
Company had an accumulated deficit of approximately $46.5 million. The Company’s activities will necessitate significant
uses of working capital beyond fiscal 2017. 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 working on securing
additional debt 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. These factors raise substantial doubt about the Company’s ability
to continue as a going concern.
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 focused objectives in order to succeed.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
Recent
Accounting Pronouncements
The
FASB issued ASU 2016-02,
Leases
, which will require a lessee
to recognize assets and liabilities for leases of more than 12 months. Both capital and operating leases will need to be recognized
on the balance sheet. The guidance is effective for annual reporting periods beginning after December 15, 2018. The Company is
currently evaluating the impact of this guidance on the financial statements.
In
August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements-Going Concern (Subtopic 205-40).”
This ASU provides guidance to determine when and how to disclose going-concern uncertainties in the financial statements. The
new standard requires management to assess an entity’s ability to continue as a going concern, and to provide related footnote
disclosure in certain circumstances. ASU 2014-15 will be effective for all entities in the first annual period ending after December
15, 2016. Earlier adoption is permitted. ASU 2014-15 will be effective for the Company beginning June 30, 2017. The Company does
not believe that this pronouncement will have a significant impact on its financial statements.
In
May 2014, the FASB issued ASU 2014-09, as amended by ASU 2015-14, “Revenue from Contracts with Customers (Topic 606),”
which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under
U.S. GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services
to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods
or services. In July 2015, the FASB issued ASU 2015-14 to defer the effective date by one year to December 15, 2017 for interim
and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original
effective date of December 15, 2016. The Company is currently evaluating the impact of adopting this guidance.
3. SELECTED
FINANCIAL STATEMENT CAPTIONS
Property
and equipment as of June 30, 2016 and 2015 consisted of the following:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Production
equipment
|
|
$
|
1,948,794
|
|
|
$
|
1,948,794
|
|
Computer
equipment and software
|
|
|
60,896
|
|
|
|
57,864
|
|
Office
furniture and equipment
|
|
|
11,972
|
|
|
|
11,972
|
|
Leasehold
improvements
|
|
|
11,842
|
|
|
|
11,842
|
|
Scientific
equipment
|
|
|
72,379
|
|
|
|
61,284
|
|
Lab
furniture and fixtures
|
|
|
41,942
|
|
|
|
41,942
|
|
|
|
|
2,147,825
|
|
|
|
2,133,698
|
|
Accumulated
depreciation and amortization
|
|
|
(1,162,594
|
)
|
|
|
(787,352
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
985,231
|
|
|
$
|
1,346,346
|
|
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
3. SELECTED
FINANCIAL STATEMENT CAPTIONS
(continued)
Accounts
payable and accrued expenses as of June 30, 2016 and 2015 consisted of the following:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Stock
cancellation liability (Note 6)
|
|
$
|
219,992
|
|
|
$
|
239,392
|
|
Accounts
payable
|
|
|
435,246
|
|
|
|
66,482
|
|
Other
accrued professional fees
|
|
|
109,854
|
|
|
|
22,666
|
|
Accrued
compensation and related expenses
|
|
|
721,905
|
|
|
|
87,581
|
|
Accrued
legal
|
|
|
3,063
|
|
|
|
-
|
|
Accrued
interest
|
|
|
237,313
|
|
|
|
4,817
|
|
Other
accrued expenses
|
|
|
30,785
|
|
|
|
4,644
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,758,158
|
|
|
$
|
425,582
|
|
4. NOTES
PAYABLE
Novus
On
June 19, 2014, the Company signed a loan and security agreement with Novus Capital Group that provides a loan in the amount of
$500,000. The loan accrues at an annual rate of 15.5%, has a term of thirty-six months, and monthly payments are $17,455. The
agreement includes a warrant to purchase 20,000 shares of common stock at an exercise price of $2.00 per share. The warrants were
valued at approximately $11,000, using the Black Scholes Merton option pricing model, and recorded as a discount to the note payable.
On
June 5, 2015, the Company signed a loan and security agreement with Novus Capital Group that provides a loan in the amount of
$127,500. The loan accrues interest at an annual rate of 15.5%, has a term of thirty-six months, and monthly payments are $4,451.
The agreement includes a warrant to purchase 2,555 shares of common stock at an exercise price of $2.00 per share that expires
June 30, 2020. The vested warrants were valued at approximately $2,000, using the Black Scholes Merton option pricing model, and
recorded as a discount to the note payable.
The
two loans with Novus Capital Group are secured by substantially all of the Company’s assets.
Bridge
Notes
On
July 28, 2015, the Company issued a promissory note for $60,000. The note was due October 12, 2015 and interest was set at $20,000.
On December 7, 2015, the note and interest were paid in full.
In
September 2015, the Company issued promissory notes totaling $350,000. The promissory notes bear interest at the rate of 10% per
thirty (30) day period and are due six months from the date of issuance. In connection with the promissory notes, the Company
also issued warrants exercisable at $3.00 per share and for a period of five (5) years. The number of warrants to be issued ranges
between 120% - 160% of the face value of the promissory note depending on repayment date. The warrants were valued at approximately
$87,000 using the Black Scholes Merton option pricing model, and recorded as a discount to the notes payable. In December 2015,
$150,000 in principal and related accrued interest were paid in cash. In December 2015, $200,000 in principal and $45,000 of related
accrued interest were converted to Series O-2 convertible notes payable. The Company accounted for the conversion as a debt extinguishment
and recorded a net loss of approximately $69,000 in the accompanying statements of operations. In total, 140,000 warrants were
issued and remain outstanding as of June 30, 2016.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
On
November 9, 2015, and February 25, 2016, the Company issued promissory notes totaling $100,000. The notes were due December 9,
2015 and March 25, 2016, respectively and bear interest at 10% per each 30 day period. The agreement includes a warrant to purchase
shares of common stock at 110% of the face value of the notes if the notes are repaid within 30 days, and an additional 10% of
the face value of the note for each month the note remains unpaid. The exercise price is $3.00 per share and the warrant expires
November 9, 2020. The warrants were valued at approximately $15,000 using the Black Scholes Merton option pricing model, and recorded
as a discount to the note payable. As of June 30, 2016, the note remains unpaid.
On
April 29, 2016, the Company issued a promissory note for $100,000. The note was due May 29, 2016 and interest was set at $25,000.
On June 10, 2016, the principal was paid. The interest remains accrued.
On
June 8, 2016, the Company issued promissory notes for cash totaling $500,000. The principal amount due on the notes was $587,500.
The notes are due October 8, 2016 and bear interest at 5% per annum. The agreements include warrants
to purchase shares of common stock at 150% of the face value of the notes with an exercise price equal to the price per share
of the Company’s next equity round of financing. In the event of default, the note holders may convert the notes and accrued
interest into shares of common stock at a price equal to 60% of the volume weighted average price of the common stock during
the 30 day consecutive trading day period immediately preceding the trading day that the Company receives a notice of conversion.
The warrants were valued at approximately $254,000 using the Black Scholes Merton option pricing model, and recorded as a discount
to the note payable, along with the original issue discount. Because the number of warrants was fixed, such instruments were not
considered derivative liabilities. The notes are secured by all of the stock, options, and warrants of the Company owned by Kevin
Maloney and Gregory
Hrncir. All such notes and accrued interest were outstanding as of June 30, 2016.
5. CONVERTIBLE
NOTES PAYABLE
Series
0-1 Notes
In
May 2015, the Company issued convertible promissory notes (“Series O-1 Notes”) totaling $510,000. The Series O-1 Notes
bear interest at the rate of 10% per annum. The Series O-1 Notes will mature upon the earlier of (i) one year from the date of
the issuance of the notes, or (ii) closing of an equity financing of Four Million Dollars or more (“Qualifying Equity Offering”).
The Series O-1 Notes were convertible and had certain price protection features based on the closing of a Qualifying Equity Offering
in the future. Additionally, the Company issued detachable warrants equal to 50% of the face value of the Series O-1 Notes based
on the closing of a Qualifying Equity Offering in the future. As a Qualifying Equity Offering has not yet occurred, the total
number of warrants to be issued was not yet fixed. Due to the price protection features of the convertible notes as well as the
variable number of warrants that can be issued in connection with these notes, both the embedded conversion feature and the warrants
were considered to be derivative liabilities. As such, the Company allocated the entire face amount of the notes as a debt discount
and amortized the discount using the effective interest method. In December 2015, all $510,000 in principal and approximately
$27,000 in accrued interest of the Series O-1 Notes were converted to Series O-2 Notes. All Series O-1 Notes and the initial warrants
were surrendered as part of the conversion.
Series
0-2 Notes
In
October and November 2015, the Company issued convertible promissory notes (“Series O-2 Notes”) totaling $625,000.
The notes bear interest at the rate of 10% per annum, with a default rate of 18% per annum. The Series O-2 Notes will mature upon
the earlier of (i) one year from the date of the issuance of the notes, or (ii) closing of an equity financing of Four Million
Dollars or more (Qualifying Equity Financing”). All outstanding principal and accrued interest under the Series O-2 Notes
will be automatically converted into shares of common stock at the closing of a Qualifying Equity Offering based upon a conversion
price equal to $1.60 per share. Alternatively, the outstanding principal and accrued interest may be voluntarily converted at
the sole discretion of the Lender, at any time prior to the close of the Qualifying Equity Offering, in whole or in part, at a
conversion price per share equal to $1.60 per share. In connection with the Series O-2 Notes, the Company also issued approximately
469,000 warrants exercisable at $3.00 per share, exercisable for a period of five (5) years. Both the Series O-2 Notes and warrants
also had certain price protection features based on the closing of a Qualifying Equity Offering in the future. Due to the price
protection features of the convertible notes as well as the variable number of warrants that can be issued in connection with
these notes, both the embedded conversion feature and the warrants were considered to be derivative liabilities. As such, the
Company allocated $727,841 as a debt discount and amortized the discount using the effective interest method. All Series O-2 Notes
were outstanding as of June 30, 2016.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
6. STOCKHOLDERS’
EQUITY (DEFICIT)
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 June 30, 2016, the Company had approximately $219,992 of accrued
liabilities associated with the share cancellation.
Convertible
Preferred Stock
The
Company has authorized the issuance of 10,000,000 shares of convertible preferred stock with a $0.001 par value.
Stock
Options
In
2004, the Company adopted the 2004 Stock Option and Incentive Plan (the “2004 Plan”) for directors, employees, consultants
and other persons acting on behalf of the Company, under which 4,000,000 shares of common stock were authorized for issuance.
Options
granted under the 2004 Plan vest on the date of grant, over a fixed period of time, or upon the occurrence of certain events and
are exercisable for up to ten years. In 2012, the shares authorized for issuance were increased to 6,000,000 shares of common
stock. In 2014, the shares authorized for issuance were increased to 7,500,000 shares of common stock. As of June 30, 2016, there
were 1,206,799 shares of common stock available for grant under the 2004 Plan.
During
the year ended June 30, 2016, the Company issued to employees, officers, directors, advisory board and consultants options to
purchase 540,000 shares of common stock, which are exercisable at a weighted average price of $1.32 per share.
During
the year ended June 30, 2015, 870,000 options were exercised at a price of $1.00 per share and 6,667 options were exercised at
a price of $1.50 per share.
During
the year ended June 30, 2015, the Company issued to employees, officers, directors, advisory board and consultants options to
purchase 570,000 shares of common stock, which are exercisable at a price of $2.00 per share (the “2015 Options”).
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
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 years ended June 30, 2016 and 2015:
|
|
|
2016
|
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
Risk
free interest rate
|
|
|
1.0%
- 1.7
|
%
|
|
|
0.9%
- 1.8
|
%
|
Expected
term
|
|
|
3
- 6 years
|
|
|
|
3
- 6 years
|
|
Expected
volatility
|
|
|
62.3%
- 84.9
|
%
|
|
|
44.2%
- 52.1
|
%
|
Dividend
yield
|
|
|
–
|
|
|
|
–
|
|
Stock
compensation expense related to options was $511,000 and $729,000 for the years ended June 30, 2016 and June 30, 2015, respectively.
Unrecognized compensation costs related to non-vested stock options was $149,000 as of June 30, 2016. The related cost is expected
to be recognized over the remaining weighted-average vesting period of 0.7 years.
A
summary of the status of the Company’s options granted is as follows:
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
|
Average
Remaining Contractual Term (Years)
|
|
Outstanding
– June 30, 2014
|
|
|
6,088,078
|
|
|
$
|
1.48
|
|
|
|
6.3
|
|
Granted
|
|
|
570,000
|
|
|
$
|
2.00
|
|
|
|
|
|
Exercised
|
|
|
(876,667
|
)
|
|
$
|
1.00
|
|
|
|
|
|
Forfeited
or expired
|
|
|
(214,584
|
)
|
|
$
|
1.74
|
|
|
|
|
|
Outstanding
– June 30, 2015
|
|
|
5,566,827
|
|
|
$
|
1.53
|
|
|
|
6.0
|
|
Granted
|
|
|
540,000
|
|
|
$
|
1.32
|
|
|
|
|
|
Forfeited
or expired
|
|
|
(690,793
|
)
|
|
$
|
1.51
|
|
|
|
|
|
Outstanding
– June 30, 2016
|
|
|
5,416,034
|
|
|
$
|
1.49
|
|
|
|
5.5
|
|
Exercisable:
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30, 2015
|
|
|
4,774,101
|
|
|
$
|
1.52
|
|
|
|
5.5
|
|
June
30, 2016
|
|
|
5,036,448
|
|
|
$
|
1.50
|
|
|
|
5.2
|
|
A
summary of the status of the Company’s nonvested options and changes are presented below:
|
|
Shares
|
|
|
Weighted-Average
Grant-Date
Fair
Value
|
|
Nonvested
– June 30, 2014
|
|
|
1,448,905
|
|
|
$
|
0.67
|
|
Granted
|
|
|
570,000
|
|
|
$
|
0.59
|
|
Forfeited
or expired
|
|
|
(103,195
|
)
|
|
$
|
0.62
|
|
Vested
|
|
|
(1,122,984
|
)
|
|
$
|
0.61
|
|
Nonvested
– June 30, 2015
|
|
|
792,726
|
|
|
$
|
0.71
|
|
Granted
|
|
|
540,000
|
|
|
$
|
0.77
|
|
Vested
|
|
|
(817,296
|
)
|
|
$
|
0.75
|
|
Forfeited
or expired
|
|
|
(135,844
|
)
|
|
$
|
0.79
|
|
Nonvested
– June 30, 2016
|
|
|
379,586
|
|
|
$
|
0.67
|
|
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
The
aggregate intrinsic value of vested and exercisable stock options was approximately $0 and $9,839,000 as of June 30, 2016 and
2015, respectively.
Warrants
From
April 2015 through September 2015, the Company entered into one-year service agreements with firms to provide public relations,
market awareness, and strategic advisory services. Each agreement called for a monthly cash retainer and shares of common stock.
The shares were valued at the most recent market price at the date of each agreement and are amortized over the length of each
agreement. In addition, agreements called for warrants to purchase common stock for periods from three to five years at exercise
prices of $1.30 to $2.00 per share. The fair value of the warrants were valued using the Black-Scholes Merton option pricing model
and are to be amortized over the length of each agreement. As of June 30, 2016, 433,220 shares and 106,667 warrants have been
issued.
In
October 2015, the Company entered into a service agreement with an investor relations firm. The agreement is to conclude during
the calendar fourth quarter of 2015 and provides for the issuance of 33,333 shares of common stock. The common stock was valued
at the most recent market price at the date of the agreement. 33,333 shares have been issued as of June 30, 2016. The Company
has recorded related expense when service was performed.
During
the year ended December 31, 2013, the Company issued warrants to purchase 500,000 shares of common stock, exercisable for a period
of seven years at $1.30 per share, to a member of management subject to satisfaction of certain vesting conditions and are exercisable
for up to seven years. 125,000 vested immediately and the balance vest 125,000 each upon certain milestones being met. As of June
30, 2016, vesting milestones have been met for 250,000 additional warrants (125,000 for achieving $3.0 million additional equity,
125,000 upon commercial validation of nano iron in China). 125,000 were forfeited upon the departure of the member in early 2016.
The
fair value of warrants granted were estimated on their respective grant dates using the Black-Scholes-Merton option pricing model
and the following assumptions for the years ended June 30, 2016 and 2015:
|
|
|
2016
|
|
2015
|
|
Risk
free interest rate
|
|
|
0.85% - 1.71
|
%
|
|
1.8
|
%
|
Expected
term
|
|
|
5 years
|
|
|
5
years
|
|
Expected
volatility
|
|
|
57.5% - 76.6
|
%
|
|
44.9
|
%
|
Dividend
yield
|
|
|
-
|
|
|
–
|
|
Stock
compensation expense related to warrants was $0 and $144,000 for the years ended June 30, 2016 and 2015, respectively. Unrecognized
compensation costs related to non-vested warrants was approximately $310,000 as of June 30, 2016. The related cost is expected
to be recognized over the remaining weighted-average vesting period of 4.9 years.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
Warrants
(continued)
A
summary of the status of all warrants granted is as follows:
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
|
Average
Remaining Contractual Term (Years)
|
|
Outstanding
– June 30, 2014
|
|
|
12,958,802
|
|
|
$
|
1.73
|
|
|
|
3.8
|
|
Granted
|
|
|
321,305
|
|
|
$
|
1.60
|
|
|
|
|
|
Forfeited
|
|
|
(1,507,480
|
)
|
|
$
|
3.97
|
|
|
|
|
|
Outstanding
– June 30, 2015
|
|
|
11,772,627
|
|
|
$
|
1.44
|
|
|
|
3.2
|
|
Granted
|
|
|
1,735,479
|
|
|
$
|
1.34
|
|
|
|
|
|
Forfeited
|
|
|
(643,750
|
)
|
|
$
|
1.51
|
|
|
|
|
|
Outstanding
– June 30, 2016
|
|
|
12,864,356
|
|
|
$
|
1.39
|
|
|
|
2.5
|
|
Exercisable:
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30, 2015
|
|
|
8,147,627
|
|
|
$
|
1.41
|
|
|
|
2.9
|
|
June
30, 2016
|
|
|
11,853,731
|
|
|
$
|
1.49
|
|
|
|
2.3
|
|
A
summary of the status of the Company’s nonvested warrants granted in exchange for services or under compensation arrangements
is presented below:
|
|
Shares
|
|
|
Weighted-Average
Grant-Date
Fair
Value
|
|
Nonvested
– June 30, 2014
|
|
|
3,968,332
|
|
|
$
|
0.71
|
|
Granted
|
|
|
321,305
|
|
|
$
|
1.07
|
|
Forfeited
|
|
|
(10,000
|
)
|
|
$
|
0.58
|
|
Vested
|
|
|
(654,637
|
)
|
|
$
|
0.56
|
|
Nonvested
– June 30, 2015
|
|
|
3,625,000
|
|
|
$
|
0.72
|
|
Granted
|
|
|
1,735,479
|
|
|
$
|
0.55
|
|
Forfeited
|
|
|
(125,000
|
)
|
|
$
|
0.62
|
|
Vested
|
|
|
(4,224,854
|
)
|
|
$
|
0.76
|
|
Nonvested
– June 30, 2016
|
|
|
1,010,625
|
|
|
$
|
0.31
|
|
The
aggregate intrinsic value of vested and exercisable warrants was approximately $0 and $15,740,000 as of June 30, 2016 and 2015,
respectively.
7.
RELATED PARTY TRANSACTIONS
From
July 2015 through June 2016, Kevin Maloney, CEO of the Company, has provided short-term loans or paid expenses on behalf of the
Company totaling $128,629. As of June 30, 2016, $88,239 has been repaid. The loans/expense payments are similar to a revolving
line of credit. Payment in full is to be made upon a financing of $1 million or more and interest is 10% per month (interest rate
the same as the September 2015, November 2015, and February 2016 promissory notes with third parties).
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
8. INCOME
TAXES
For
the years ended June 30, 2016 and 2015, the provision for income taxes consists entirely of state income taxes.
The
following is a reconciliation of the provision for income taxes computed at the statutory federal rate of 34% to the net provision
for income taxes for the years ended June 30, 2016 and 2015.
|
|
2016
|
|
|
2015
|
|
Benefit
at statutory rate (34%)
|
|
$
|
(1,482,000
|
)
|
|
$
|
(1,805,000
|
)
|
State
tax benefit, net of federal tax benefit
|
|
|
(284,000
|
)
|
|
|
(224,000
|
)
|
Stock
based compensation and other
|
|
|
515,000
|
|
|
|
378,000
|
|
Change
in value of warrant liability
|
|
|
(687,000
|
)
|
|
|
153,000
|
|
Change
in valuation allowance
|
|
|
1,938,800
|
|
|
|
1,498,800
|
|
Net
provision for income taxes
|
|
$
|
800
|
|
|
$
|
800
|
|
Significant
components of deferred tax assets and liabilities at June 30, 2016 and June 30, 2015 consist of tax net operating loss carryforwards
offset by full valuation allowances on deferred tax assets. Management believes that, based on a number of factors, including
the available objective evidence it is more likely than not that deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences
become deductible.
As
of June 30, 2016 and June 30, 2015, the Company’s deferred tax assets were primarily comprised of net operating losses totaling
approximately $13,128,000 and $11,483,000, respectively. As of June 30, 2016, the Company had federal and state tax net operating
loss carryforwards of approximately $33,348,000 and $30,968,000, respectively. If unused, the federal and state net operating
losses begin to expire in 2026 and 2016, respectively. Utilization of the net operating loss carryforwards may be subject to a
substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future, as
required by Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions. The Company has
not completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes
since the Company’s formation due to the complexity and cost associated with such a study, and the fact that there may be
additional such ownership changes in the future.
The
Company does not believe it has any uncertain income tax positions that could materially affect its financial statements. The
Company’s federal and state income tax returns remain open to agency examination for the standard statute length of time
after filing.
9. COMMITMENTS
AND CONTINGENCIES
The
Company has noncancelable operating lease commitments for equipment through December 2016 and real property through February 2017.
Rent expense under operating leases is recognized on the straight-line basis over the term of the leases. Rent expense for the
years ended June 30, 2016 and June 30, 2015 were approximately $106,000 and $105,000, respectively.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
10. CONCENTRATIONS
For
the year ended June 30, 2016, 39% of net sales were to China, 26% of net sales were to the United States, and 26% of net sales
were to South Korea. For the year ended June 30, 2015, 36% of net sales were to South Korea and 13% of net sales were to Canada.
For the year ended June 30, 2016, 57% of net sales were to two customers. For the year ended June 30, 2015, 30% of net sales were
to one customer. No other significant customers or foreign sales were noted during the years ended June 30, 2016 and 2015.
11.
SIGNIFICANT FOURTH QUARTER ADJUSTMENTS
During
the fourth quarter of 2016, several adjustments were recorded that related primarily to the recognition of derivative liabilities
associated with financings throughout the year. The net impact of these adjustments was a increase of approximately $196,000 in
net loss for the year, a decrease of approximately $664,000 in additional paid-in capital, and an increase of approximately $860,000
in derivative liabilities.
QUANTUMSPHERE,
INC.
NOTES
TO FINANCIAL STATEMENTS
For
the Years Ended June 30, 2016 and 2015
12. SUBSEQUENT
EVENTS (UNAUDITED)
On
October 9, 2016, the Company was in default of $673,750 in promissory notes and $11,259 in related interest. The Company is currently
in discussion with the note holders in regards to extension of the date of payments.