ITEM
1 - FINANCIAL STATEMENTS
QUANTUMSPHERE,
INC.
CONDENSED
BALANCE SHEETS
|
|
March
31, 2017
|
|
|
June
30, 2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
2,001
|
|
|
$
|
180,805
|
|
Prepaid
expenses and other current assets
|
|
|
17,291
|
|
|
|
43,114
|
|
Total
current assets
|
|
|
19,292
|
|
|
|
223,919
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
723,355
|
|
|
|
985,231
|
|
Patents,
net
|
|
|
89,131
|
|
|
|
95,451
|
|
Other
assets
|
|
|
24,578
|
|
|
|
24,578
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
856,356
|
|
|
$
|
1,329,179
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
686,669
|
|
|
$
|
301,923
|
|
Accrued
expenses
|
|
|
2,074,096
|
|
|
|
1,456,235
|
|
Notes
payable, net of discount
|
|
|
487,765
|
|
|
|
686,525
|
|
Notes
payable, related party
|
|
|
-
|
|
|
|
108,762
|
|
Convertible
notes payable, net of discount
|
|
|
1,676,259
|
|
|
|
909,878
|
|
Convertible
notes payable, related party, net of discount
|
|
|
-
|
|
|
|
105,074
|
|
Derivative
liabilities
|
|
|
283,346
|
|
|
|
7,387
|
|
Total
current liabilities
|
|
|
5,208,135
|
|
|
|
3,575,784
|
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
5,208,135
|
|
|
|
3,575,784
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
Deficit
|
|
|
|
|
|
|
|
|
Undesignated
preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued or outstanding
|
|
|
–
|
|
|
|
–
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|
Common
stock, $0.001 par value, 500,000,000 shares authorized, 205,765,428 and 22,728,437 shares issued and outstanding as of March
31, 2017 and June 30, 2016, respectively
|
|
|
205,765
|
|
|
|
22,728
|
|
Additional
paid-in capital
|
|
|
44,807,625
|
|
|
|
44,209,388
|
|
Accumulated
deficit
|
|
|
(49,365,169
|
)
|
|
|
(46,478,721
|
)
|
Total
stockholders’ deficit
|
|
|
(4,351,779
|
)
|
|
|
(2,246,605
|
)
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ deficit
|
|
$
|
856,356
|
|
|
$
|
1,329,179
|
|
The
accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE,
INC.
CONDENSED
STATEMENTS OF OPERATIONS
(Unaudited)
|
|
Three
Months Ended March 31,
|
|
|
Nine
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net
Sales
|
|
$
|
174
|
|
|
$
|
14,656
|
|
|
$
|
29,443
|
|
|
$
|
44,828
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Sales
|
|
|
6
|
|
|
|
1,856
|
|
|
|
2,717
|
|
|
|
6,801
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Gross
Profit
|
|
|
168
|
|
|
|
12,800
|
|
|
|
26,726
|
|
|
|
38,027
|
|
|
|
|
|
|
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|
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|
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Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Research
and development
|
|
|
141,891
|
|
|
|
295,597
|
|
|
|
528,283
|
|
|
|
867,781
|
|
Selling,
marketing and advertising
|
|
|
-
|
|
|
|
5,205
|
|
|
|
2,203
|
|
|
|
22,029
|
|
General
and administrative
|
|
|
256,580
|
|
|
|
483,537
|
|
|
|
980,999
|
|
|
|
3,075,570
|
|
Total
operating expenses
|
|
|
398,471
|
|
|
|
784,339
|
|
|
|
1,511,485
|
|
|
|
3,965,380
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from Operations
|
|
|
(398,303
|
)
|
|
|
(771,539
|
)
|
|
|
(1,484,759
|
)
|
|
|
(3,927,353
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense, net
|
|
|
(165,301
|
)
|
|
|
(108,271
|
)
|
|
|
(550,021
|
)
|
|
|
(329,135
|
)
|
Interest
expense – amortization of note discounts
|
|
|
(59,902
|
)
|
|
|
(174,860
|
)
|
|
|
(1,153,248
|
)
|
|
|
(478,106
|
)
|
Change
in fair value of derivative liabilities
|
|
|
19,880
|
|
|
|
-
|
|
|
|
271,996
|
|
|
|
656,061
|
|
Gain
from disposal of assets
|
|
|
-
|
|
|
|
-
|
|
|
|
30,385
|
|
|
|
-
|
|
Gain
from debt extinguishment
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
161,667
|
|
Other
loss
|
|
|
-
|
|
|
|
(3,092
|
)
|
|
|
-
|
|
|
|
(3,042
|
)
|
Total
other income (expense), net
|
|
|
(205,323
|
)
|
|
|
(286,223
|
)
|
|
|
(1,400,888
|
)
|
|
|
7,445
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
Before Provision for Income Taxes
|
|
|
(603,626
|
)
|
|
|
(1,057,762
|
)
|
|
|
(2,885,647
|
)
|
|
|
(3,919,908
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
800
|
|
|
|
800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(603,626
|
)
|
|
$
|
(1,057,762
|
)
|
|
$
|
(2,886,447
|
)
|
|
$
|
(3,920,708
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and Diluted Loss Per Common Share
|
|
$
|
(0.01
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.17
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and Diluted Weighted-Average Common Shares Outstanding
|
|
|
114,667,100
|
|
|
|
22,653,184
|
|
|
|
53,043,407
|
|
|
|
22,538,793
|
|
The
accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE,
INC.
CONDENSED
STATEMENTS OF CASH FLOWS
(unaudited)
|
|
Nine
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,886,447
|
)
|
|
$
|
(3,920,708
|
)
|
Adjustments
to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
268,326
|
|
|
|
295,765
|
|
Stock
based compensation expense
|
|
|
37,687
|
|
|
|
461,524
|
|
Change
in fair value of derivative liabilities
|
|
|
(271,996
|
)
|
|
|
(656,061
|
)
|
Gain
from debt extinguishment
|
|
|
-
|
|
|
|
(161,667
|
)
|
Non-cash
interest added to debt principal
|
|
|
168,438
|
|
|
|
-
|
|
Stock
issued for services
|
|
|
110,500
|
|
|
|
1,059,005
|
|
Gain
on disposal of fixed assets
|
|
|
(30,385
|
)
|
|
|
-
|
|
Debt
discount amortization
|
|
|
1,153,248
|
|
|
|
478,106
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid
expenses and other current assets
|
|
|
25,823
|
|
|
|
(47,495
|
)
|
Accounts
payable
|
|
|
384,745
|
|
|
|
239,801
|
|
Accrued
expenses
|
|
|
675,323
|
|
|
|
995,401
|
|
Net
cash used in operating activities
|
|
|
(364,738
|
)
|
|
|
(1,256,329
|
)
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Payments
for development of patents
|
|
|
(130
|
)
|
|
|
(8,433
|
)
|
Purchase
of property and equipment
|
|
|
-
|
|
|
|
(14,126
|
)
|
Cash
received from disposal of equipment
|
|
|
30,385
|
|
|
|
-
|
|
Net
cash provided by (used in) investing activities
|
|
|
30,255
|
|
|
|
(22,559
|
)
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Proceeds
from issuances of convertible notes payable
|
|
|
116,000
|
|
|
|
625,000
|
|
Proceeds
from issuance of notes payable
|
|
|
76,000
|
|
|
|
585,000
|
|
Principal
payments of notes payable
|
|
|
(36,321
|
)
|
|
|
(307,099
|
)
|
Common
stock buy back
|
|
|
-
|
|
|
|
(19,400
|
)
|
Net
cash provided by financing activities
|
|
|
155,679
|
|
|
|
883,501
|
|
|
|
|
|
|
|
|
|
|
NET
DECREASE IN CASH
|
|
|
(178,804
|
)
|
|
|
(395,387
|
)
|
|
|
|
|
|
|
|
|
|
CASH
– beginning of period
|
|
|
180,805
|
|
|
|
398,570
|
|
|
|
|
|
|
|
|
|
|
CASH
– end of period
|
|
$
|
2,001
|
|
|
$
|
3,183
|
|
|
|
|
|
|
|
|
|
|
ADDITIONAL
CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$
|
11,910
|
|
|
$
|
133,318
|
|
Income
taxes paid
|
|
$
|
800
|
|
|
$
|
800
|
|
The
accompanying notes are an integral part of these financial statements.
SUPPLEMENTAL
SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
During
the nine months ended March 31, 2017, the Company entered into the following noncash transactions:
●
|
Issued
261,000 shares of common stock valued at approximately $111,000 in connection with services rendered.
|
|
|
●
|
Issued 182,776,134 shares of common stock for
the conversion of $627,701 in convertible notes payable and related accrued interest.
|
|
|
●
|
Derivative liability recorded
in connection with convertible debt in the amount of $547,955.
|
During
the nine months ended March 31, 2016, the Company entered into the following noncash transactions:
●
|
Issued
408,333 shares of common stock valued at approximately $1,327,000 in connection with services rendered.
|
|
|
●
|
Issued
624,488 warrants to purchase common stock with a relative fair value of approximately $403,000 in connection with the issuance
of notes payable.
|
|
|
●
|
Issued
66,667 warrants to purchase common stock with a relative fair value of approximately $80,000 in connection with services rendered.
|
|
|
●
|
Recorded
beneficial conversion feature of convertible notes payable of approximately $351,000
|
|
|
●
|
Converted
$710,000 of principal and approximately $72,000 of accrued interest to convertible notes payable
|
The
accompanying notes are an integral part of these financial statements.
QUANTUMSPHERE,
INC.
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2017
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 applications focused on the chemical
sector. The Company’s products are used on a stand-alone basis to improve efficiencies in the commercial production of ammonia.
The Company’s major activities to date have included capital formation, research and development, and marketing of its metallic
nanopowder products.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
accompanying unaudited condensed financial statements of the Company have been prepared in accordance with accounting principles
generally accepted in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission
(“SEC”) applicable to interim reports of companies filing as a smaller reporting company. These financial statements
should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual
Report on Form 10-K for the fiscal year ended June 30, 2016 filed with the SEC on October 13, 2016. In the opinion of management,
the accompanying condensed financial statements include all adjustments necessary in order to make the financial statements not
misleading. The results of operations for interim periods are not necessarily indicative of the results to be expected for the
full year or any other future period. Certain notes to the financial statements that would substantially duplicate the disclosures
contained in the audited financial statements for the most recent fiscal year as reported in the Company’s Annual Report
on Form 10-K have been omitted. The accompanying condensed balance sheet at June 30, 2016 has been derived from the audited balance
sheet at June 30, 2016 contained in such Form 10-K.
Going
Concern
The
accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has
incurred recurring losses from operations from inception and, at March 31, 2017, has $2,001 cash on hand and a working capital
deficit of $5,188,842. As of March 31, 2017, the Company had an accumulated deficit of approximately $49.4 million. In
addition, at March 31, 2017 the Company is in default on certain of its debt obligations as described in Note 3 below. As of the
date of this filing, the Company had $306 on hand.
The Company’s
activities will necessitate significant uses of working capital during and 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.
The Company engaged U.S. Capital Partners and Avalon Securities for a proposed issuance of up to $5.0 million of 8% Series A convertible
preferred stock. The Company completed the due diligence phase and both firms presented the offering to potential accredited investors.
At this time, potential accredited investors have indicated that they will await the issuance of a purchase order for the Company’s
nano iron from an ammonia plant before considering investing in the Company’s 8% Series A convertible preferred stock. On
February 2, 2017, the Company issued a convertible note for $68,000. On March 14, 2017, the Company issued a convertible note
for $48,000. Additionally, subsequent to March 31, 2017 to date, the Company has issued additional convertible notes payable in
the aggregate amount of $20,000. The Company is in immediate need of raising additional capital to fund its operations and is
actively pursuing additional debt financing needed to continue to fund operating activities. In addition, although a formal plan
has not been adopted to do so, the Company is exploring possible opportunities to sell certain of its assets pursuant to an asset
purchase agreement. In this regard, the Company has had preliminary discussions with multiple parties that have expressed an interest
in acquiring the Company’s assets. In addition, although a formal plan has not been adopted to do so, the Company is exploring
possible opportunities to merge a restructured Company with a non-public company. In this regard, the Company has had preliminary
discussions with a party that has expressed an interest in becoming a reporting company through a merger. There can be no assurances
additional financing will be obtained or that assets will be sold or that a merger will occur. Should the Company not be able
to obtain a purchase order, not be able to obtain additional equity or debt financing, not be able to sell assets, or not be able
to merge with another company, then the Company would have no alternative but to file bankruptcy. Based on these factors, management
has determined that there is substantial doubt regarding the Company’s ability to continue as a going concern within twelve
months of the issuance date of the interim financial statements for the period ended March 31, 2017. The financial statements
do not include any adjustments related to the recoverability and classification of asset carrying amounts or the amount and classification
of liabilities that might result should the Company be unable to continue as a going concern.
Use
of Estimates
The
accompanying financial statements are prepared in conformity with 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, fair value of derivative liabilities, 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 March 31, 2017 and June 30,
2016.
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 March 31, 2017 and June 30, 2016, inventory with cost values
of $65,668 and $65,668, respectively, were fully reserved.
Property
and Equipment
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.
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 March 31, 2017, ten patents have been issued and two patent applications 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.
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
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, accrued expenses, and debt. The
carrying amounts of such assets and liabilities approximate their respective fair values because of the short-term nature of these
items. The carrying amounts of the Company’s debt agreements approximate their fair values as interest approximates current
market rates for similar instruments. Derivative liabilities recorded in connection with convertible debt agreements are reported
at estimated fair value with changes in fair value reported in results of operations.
Other
than derivative liabilities referenced above, the Company did not have any assets or liabilities that are measured at fair value
on a recurring or nonrecurring basis during the nine months ended March 31, 2017 and the year ended June 30, 2016.
The
following details the fair value measurement within the fair value hierarchy of the Company’s financial assets and liabilities
at March 31, 2017.
|
|
Fair
Value Measurement
|
|
|
|
Total
Fair Value
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
$
|
283,346
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
283,346
|
|
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
|
|
There
were no transfers among Level 1, Level 2 and Level 3 during the nine months ended March 31, 2017 and the year ended June 30, 2016.
The
fair values of derivative liabilities were estimated using the Black-Scholes-Merton pricing model and the following assumptions
for the nine months ended March 31, 2017 and the year ended June 30, 2016:
|
|
March
31, 2017
|
|
|
June
30, 2016
|
|
|
|
|
|
|
|
|
Risk
free interest rate
|
|
|
0.4%
- 1.9
|
%
|
|
|
0.5%
- 1.0
|
%
|
Expected
term
|
|
|
0.25
- 5 years
|
|
|
|
1
- 5 years
|
|
Expected
volatility
|
|
|
80.5%
- 286.4
|
%
|
|
|
86.8%
- 131.7
|
%
|
Dividend
yield
|
|
|
-
|
|
|
|
-
|
|
The
change in fair value of the derivative liabilities during the nine months ended March 31, 2017 is summarized as follows:
Fair
value at June 30, 2016
|
|
|
7,387
|
|
Fair
value of new derivative liabilities
|
|
|
547,955
|
|
Change
in fair value, net
|
|
|
(271,996
|
)
|
|
|
|
|
|
Fair
value at March 31, 2017
|
|
$
|
283,346
|
|
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. Derivative liabilities are measured
at fair value using the Black-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 consolidated 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
nanocatalysts as well as end use applications for the nanocatalysts are expensed until the production process or applications
have been determined to be commercially viable. Research and development expenses on the accompanying Condensed Statements of
Operations include depreciation expenses of $83,016 and $253,042 for the three months and nine months ended March 31, 2017, respectively.
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 has determined that a full valuation
allowance against the Company’s net deferred tax assets is appropriate.
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 shares
underlying options, warrants, and convertible debt totaling 116,824,102 and 14,125,507, have been excluded
from the computations of diluted net loss per share because the effect would have been anti-dilutive for the three and nine months
ended March 31, 2017 and 2016, respectively.
Stock-Based
Compensation
The
Company measures all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocates the
related expense over the requisite service period. The expected volatility is based on the historical volatility of the Company’s
stock as determined by its private placement offerings and recent market activity. The expected life of the award is based on
the simplified method.
The
Company accounts for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of
the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.
Risks
and Uncertainties
The
Company faces risks and uncertainties relating to its ability to successfully implement and fulfill its strategy. Among other
things, these risks include the ability to obtain revenues; manage operations; competition; attract, retain and motivate qualified
personnel; maintain and develop new strategic relationships; and the ability to anticipate and adapt to the changing nanotechnology
market and any changes in government regulations.
Therefore,
the Company may be subject to the risks of delays in consummating contracts with customers and suppliers, raising sufficient capital
to achieve its objectives and other uncertainties, including financial, operational, technological, regulatory and other risks
associated with an emerging business, including the potential risks of business failure. Technology and manufacturing companies
with whom the Company is expected to compete, in general, are well capitalized. The Company is competing against entities with
the financial and intellectual resources and expressed intent of performing rapid technological innovation. The Company’s
resources are limited and must be allocated to focused objectives in order to succeed.
Subsequent
Events
The
Company has evaluated events subsequent to March 31, 2017 through the date that the accompanying condensed financial statements
were filed with the Securities and Exchange Commission for transactions and other events which may require adjustment or disclosure
in such financial statements
3.
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 vested warrants
were valued at approximately $11,000, using the Black Scholes Merton option pricing model, and recorded as a discount to the note
payable. As of March 31, 2017, $640 in unamortized discounts remain.
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,
beginning July 10, 2015. 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. As of March 31, 2017, $689 in unamortized discounts remain.
The
two loans with Novus Capital Group are secured by substantially all of the Company’s assets. The Company is currently in
default on payment of the two Novus Notes.
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 of the Company’s convertible notes payable. The Company accounted for the
conversion as a debt extinguishment and recorded a net loss of approximately $69,000 in the quarter ended December 31, 2015. In
total, 140,000 warrants were issued and remain outstanding as of March 31, 2017. As of March 31, 2017, the warrants discount was
fully amortized.
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 included a warrant to purchase
shares of common stock at 110% of the face value of the notes if the note is 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 March 31, 2017, the notes remain unpaid. The Company is currently in default on payment
of these notes. As of March 31, 2017, the warrants discount was fully amortized.
On
February 18, 2016, the Company issued a promissory note for $15,000 to a related party. The note was due August 18, 2016 and interest
is 10% per annum. The Company is currently in default on payment of the note.
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. As of March 31, 2017, the interest remains accrued.
On
September 16, 2016, the Company issued a promissory note for $25,000 to a related party. The note was due March 16, 2017 and interest
is 10% per annum. The Company is currently in default on payment of the note.
On
October 12, 2016, the Company issued a promissory note for $25,000. The note was due November 12, 2016 and interest is 10% per
annum. The Company is currently in default on payment of the note.
On
November 17, 2016, the Company issued a promissory note for $15,000 to a related party. The note is due May 17, 2017 and interest
is 10% per annum. As of the date of the filing of this 10-Q, the Company is in default on payment of the note.
On
January 18, 2017, the Company issued a promissory note for $8,000 to a related party. The note is due July 18, 2017 and interest
is 10% per annum.
On
January 20, 2017, the Company issued a promissory note for $3,000 to a related party. The note is due July 20, 2017 and interest
is 10% per annum.
Below
is a summary of notes payable at March 31, 2017.
Novus
notes
|
|
$
|
298,094
|
|
Promissory
notes
|
|
|
191,000
|
|
Total
notes payable at face value
|
|
|
489,094
|
|
Less
unamortized debt discounts
|
|
|
(1,329
|
)
|
Total
net notes payable
|
|
$
|
487,765
|
|
4.
CONVERTIBLE NOTES PAYABLE
Series
O-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 the Company’s Series O-2 Notes. All Series O-1 Notes
and the initial warrants were surrendered as part of the conversion. As of March 31, 2017, both the embedded conversion feature
and the warrants discount were fully amortized.
Series
O-2 Notes
In
October and November 2015, the Company issued convertible promissory notes (“Series O-2 Notes”) totaling $625,000.
In December 2015, the Company and note holders converted $245,000 principal and accrued interest of September 2015 bridge notes
and $537,058 principal and accrued interest of May 2015 Series O-1 notes into Series O-2 notes. 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 is amortizing the discount using the effective interest method over the term of the Series O-2 notes. All Series O-2 Notes
were outstanding as of March 31, 2017. The Company is currently in default on payment of these notes. As of March 31, 2017, both
the embedded conversion feature and the warrants discount were fully amortized.
Promissory
Notes
On
January 15, 2016, the Company issued a promissory note for $75,000. The note was due July 15, 2016 and interest was 10% per annum.
On June 8, 2016, the note was converted into a promissory note at the amount of $86,250 that bore interest at 5% per annum. The
new note is due October 8, 2016. Warrant agreement and security agreement are the same as the June 8, 2016 promissory notes listed
below. The Company is currently in default on payment of the note.
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. If the closing bid price of the
common stock is less than the above conversion price on the date following the conversion date on which the note holder actually
receives common shares, then the conversion price shall be deemed to have been retroactively adjusted, as of the conversion date,
to a price equal to 75% multiplied by the closing bid price of the common stock on the date the common stock is received, and
the Company shall issue additional shares based upon the difference between common stock initially issued and the shares due based
upon the revised number due. 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 were secured by all of the stock, options,
and warrants of the Company owned by Kevin Maloney and Gregory Hrncir. The Company is currently in default on payment of the promissory
notes. The amount of principal and accrued interest increased by 25% under Rights and Remedies. Upon an Event of Default in the
promissory notes agreements. As of March 31, 2017, $578,525 in promissory notes and $37,076 in related accrued interest have been
converted to 182,776,134 shares of common stock. $251,563 in remaining such notes were outstanding as of March 31, 2017. Due to
the notes becoming in default in October 2016, thus triggering the conversion feature, and the price protection feature of the
conversion feature, the embedded conversion features were considered to be derivative liabilities. As such, the Company recorded
a derivative liability and additional debt discount of $390,774, based on the estimated fair value of the derivative liability
on the debt default date. As of March 31, 2017, both the embedded conversion feature and the warrants discount were fully amortized.
On
February 2, 2017, the Company issued a promissory note for cash totaling $65,000. The principal amount due on the note was $68,000.
The note is due on November 5, 2017 and interest is 12% per annum. The default interest rate is 22% per annum. The note may be
converted into common stock at any time from 180 days after the date of the note until the latter of the maturity date or the
date of payment of the default amount. The conversion price of the note into common stock is 60% times the average of the 3 lowest
trading prices of the common stock during the 15 day trading period ending on the latest complete trading day prior to the conversion
date. The conversion feature of the note was valued at approximately $89,947 at the date that the note was issued using the Black-Scholes-Merton
pricing model and recorded as a discount to the note payable, considered a derivative liability. The derivative liability is revalued
at the end of each quarter.
On
March 14, 2017, the Company issued a promissory note for cash totaling $41,500. The principal amount due on the note was $48,000.
The note is due on December 30, 2017. The default interest rate is 22% per annum. The note may be converted into common stock
at any time from 180 days after the date of the note until the latter of the maturity date or the date of payment of the default
amount. The conversion price of the note into common stock is 60% times the average of the 3 lowest trading prices of the common
stock during the 10 day trading period ending on the latest complete trading day prior to the conversion date. The conversion
feature of the note was valued at approximately $67,234 at the date that the note was issued using the Black-Scholes-Merton pricing
model and recorded as a discount to the note payable, considered a derivative liability. The derivative liability is revalued
at the end of each quarter.
Below
is a summary of convertible notes payable at March 31, 2017.
Series
O-2 notes
|
|
$
|
1,407,058
|
|
June 2016
bridge notes
|
|
|
251,563
|
|
February 2017
promissory note
|
|
|
68,000
|
|
March 2017
promissory note
|
|
|
48,000
|
|
Total
convertible notes payable at face value
|
|
|
1,774,621
|
|
Less
unamortized debt discounts
|
|
|
(98,362
|
)
|
Total
net convertible notes payable
|
|
$
|
1,676,259
|
|
5.
STOCKHOLDERS’ EQUITY
Common
Stock
In
early April 2014, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and
repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse
split, the Company executed a 1 for 10,000 forward split. As of March 31, 2017, the Company had approximately $220,000 of accrued
liabilities associated with the share cancellation.
From
July 1, 2016 through March 31, 2017, 182,776,134 new shares of common stock were issued in the conversion of the June 2016 Promissory
Notes. As of March 31, 2017, 205,765,428 shares of common stock are outstanding.
Convertible
Preferred Stock
The
Company has authorized the issuance of 10,000,000 shares of convertible preferred stock with a $0.001 par value. As of March 31,
2017, no convertible preferred stock was outstanding.
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. 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. As of March 31, 2017, the total
shares authorized for issuance, were 7,500,000 shares of common stock. As of March 31, 2017 there were 1,620,523 shares of common
stock available for grant under the 2004 Plan.
No
stock options were granted for the nine months ended March 31, 2017. 280,000 stock options were granted to board members for the
nine months ended March 31, 2016. 413,724 options were forfeited for the nine months ended March 31, 2017.
During
the nine months ended March 31, 2017 and 2016, the company recognized stock based compensation expense of $37,687 and $461,524,
respectively, and as of March 31, 2017 there was unrecognized stock based compensation expense totaling $138,656, that is expected
to be recognized over the following nine months.
6.
RELATED PARTY TRANSACTIONS
From
July 2015 through March 31, 2017, Kevin Maloney, CEO of the Company, has provided short-term loans or paid expenses on behalf
of the Company totaling $139,046. As of March 31, 2017, $101,126 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 is the same as the September 2015 and February 2016 promissory notes with third parties). As of March 31, 2017, accrued interest
was $76,528. Kevin Maloney also provided a personal guarantee on a $59,882 balance on a Company credit card.
7.
CONCENTRATIONS
For
the three months ended March 31, 2017, 100% of net sales were to the United States. For the three months ended March 31, 2016,
64% of net sales were to South Korea and 26% of net sales were to the United States. For the three months ended March 31, 2017,
100% of net sales were to two customers. For the three months ended March 31, 2016, 76% of net sales were to two customers.
For
the nine months ended March 31, 2017, 79% of net sales were to the United States and 20% of net sales were to South Korea. For
the nine months ended March 31, 2016, 41% of net sales were to China, 27% of net sales were to South Korea, and 23% of net sales
were to the United States. For the nine months ended March 31, 2017, 81% of net sales were to four customers. For the nine
months ended March 31, 2016, 59% of net sales were to two customers.
8.
SUBSEQUENT EVENTS
On
May 12, 2017, QuantumSphere, Inc., a Nevada corporation (the “Registrant”), entered into a Settlement Agreement (the
“May 2017 Settlement Agreement”) for $701,015.78 with a certain accredited investor (the “Investor”),
dependent upon a court order approving the May 2017 Settlement Agreement. See the Company’s Form 8-K filed on May 31, 2017.
On
May 24, 2017, the Registrant entered into a Debt Purchase Agreement (the “May 2017 Debt Purchase Agreement”) with
a certain accredited investor (the “Investor”) pursuant to which the Registrant issued 10,000,000 shares of common
stock of the Registrant for the acquisition of $701,015.78 of the Registrant’s debt. See the Company’s Form 8-K filed
on May 31, 2017.
On May 23, 2017, the Registrant entered into
a Convertible Debt agreement for $20,000 from an existing creditor. See the Company’s Form 8-K filed on May
31, 2017.
On
May 23, 2017, the Registrant converted $1,127,408.20 in Series O-2 convertible notes principal and related accrued interest (67%
of the total of Series O-2 notes) into 1,127,410 shares of Registrant’s Series A preferred stock. Each share of preferred
stock has the voting rights of 254 common shares. The preferred shares in total represent approximately 58% of all voting common
shares. Three resolutions were presented to the Series A preferred shareholders and the Registrant is currently awaiting the voting
results. The first resolution is to approve the increase in authorized common shares from 500 million to 5.0 billion. The second
resolution is to approve the sale of up to ten reactors, peripheral production and lab testing equipment, and licensing of certain
QSI patents to Vivakor, Inc. The third resolution is to grant authority to the Registrant’s board to pursue a merger with,
sale to, or acquisition of another operating company. See the Company’s Form 8-K filed on May 31, 2017.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Forward
Looking Statements
This
Form 10-Q contains statements that must be deemed “forward-looking” statements under Section 27A of the Securities
Act, including, among other things, discussions as to our business strategies, expectations, market position and services, anticipated
revenues and performance, future operations, profitability, liquidity and capital resources. Words including, but not limited
to, “may,” “will,” “likely,” “should,” “could,” “expect,”
“plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,”
“potential,” “continue,” “seek,” or the negative of these terms or other comparable terminology.
Although we believe that the expectations reflected in such forward-looking statements are generally reasonable and reflect the
current views of our management, such statements are inherently uncertain, and we can give no assurance that such statements will
ultimately prove to be correct. Our operations are subject to a number of uncertainties and risks, many of which are outside our
control, and any one of which, or any combination of which, could materially adversely affect our results of operations. Important
factors, including, but not limited to, those discussed in the section titled “Risk Factors,” beginning on page 15
of our Form 10-K filed on October 13, 2016, 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 manufacturing and development 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. This validation has not
occurred as of the date of this filing. 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, continued to serve as directors of the Company. Francis Poli served as chairman of each of the board committees.
On
January 20, 2017, Francis Poli voluntarily resigned from the Board of Directors, effective immediately, and from his role as member
of the Company’s Audit, Compensation, Nominating, and Governance Committees. He has agreed to serve as a non-director advisor
to the Company. Kevin Maloney continues to serve as a director of the Company.
On
January 20, 2017, Gregory Hrncir voluntarily resigned as Chief Strategy Officer, General Counsel, and Secretary of the Company,
effective immediately. He has agreed to serve as an advisor to the Company.
GOING
CONCERN
The
accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has
incurred recurring losses from operations from inception and, at March 31, 2017, has $2,001 cash on hand and a working capital
deficit of $5,188,842. As of March 31, 2017, the Company had an accumulated deficit of approximately $49.4 million. In
addition, at March 31, 2017 the Company is in default on certain of its debt obligations as described in Note 3 below. As of the
date of this filing, the Company had $306 on hand.
The
Company’s activities will necessitate significant uses of working capital during and 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. The Company engaged U.S. Capital Partners and Avalon Securities for a proposed issuance of up to $5.0 million
of 8% Series A convertible preferred stock. The Company completed the due diligence phase and both firms presented the offering
to potential accredited investors. At this time, potential accredited investors have indicated that they will await the issuance
of a purchase order for the Company’s nano iron from an ammonia plant before considering investing in the Company’s
8% Series A convertible preferred stock. On February 2, 2017, the Company issued a convertible note for $68,000. On March 14,
2017, the Company issued a convertible note for $48,000. Additionally, subsequent to March 31, 2017 to date, the Company has issued
additional convertible notes payable in the aggregate amount of $20,000. The Company is in immediate need of raising additional
capital to fund its operations and is actively pursuing additional debt financing needed to continue to fund operating activities.
In addition, although a formal plan has not been adopted to do so, the Company is exploring possible opportunities to sell its
assets pursuant to an asset purchase agreement. In this regard, the Company has had preliminary discussions with multiple parties
that have expressed an interest in acquiring the Company’s assets. In addition, although a formal plan has not been adopted
to do so, the Company is exploring possible opportunities to merge a restructured Company with a non-public company. In this regard,
the Company has had preliminary discussions with a party that has expressed an interest in becoming a reporting company through
a merger. There can be no assurances that additional financing will be obtained or that assets will be sold or that a merger will
occur and the financial statements do not include any adjustments to reflect the outcome of these uncertainties. Should the Company
not be able to obtain a purchase order, not be able to obtain additional equity or debt financing, not be able to sell assets,
or not be able to merge with another company, then the Company would have no alternative but to file bankruptcy. Based on these
factors, management has determined that there is substantial doubt regarding the Company’s ability to continue as a going
concern within twelve months of the issuance date of the interim financial statements for the period ended March 31, 2017. The
financial statements do not include any adjustments related to the recoverability and classification of asset carrying amounts
or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.
SMALLER
REPORTING COMPANY
To
the extent that we continue to qualify as a “smaller reporting 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; 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 a smaller reporting 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.
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 March
31, 2017 and June 30, 2016.
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 March
31, 2017.
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 March 31, 2017 and June 30, 2016, inventory
with cost values of $65,668 and $65,668, respectively, were fully reserved.
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 March 31, 2017, 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.
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.
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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Level
3
: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own
assumptions
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The
Company’s financial instruments consist of cash, accounts receivable, accounts payable, and accrued expenses. The carrying
amounts of such assets and liabilities approximate their respective fair values because of the short-term nature of these items.
The carrying amounts of the Company’s debt agreements approximate their fair values as interest approximates current market
rates for similar instruments. Derivative liabilities recorded in connection with convertible debt agreements are reported at
estimated fair value with changes in fair value reported in results of operations.
Other
than derivative liabilities referenced above, the Company did not have any assets or liabilities that are measured at fair value
on a recurring or nonrecurring basis during the nine months ended March 31, 2017 and the year ended June 30, 2016.
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. Derivative liabilities
are measured at fair value using the Black-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 consolidated 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. Research and development expenses on the accompanying
Condensed Statements of Operations include depreciation expenses of $83,016 and $253,042 for the three months and nine months
ended March 31, 2017, respectively.
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 has
determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.
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 shares
underlying options, warrants, and convertible debt totaling 116,824,102 and 14,125,507, have been excluded from
the computations of diluted net loss per share because the effect would have been anti-dilutive for the three and six months ended
March 31, 2017 and 2016.
Stock-Based
Compensation.
We measure all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocate
the related expense over the requisite service period. The expected volatility is based on the historical volatility of our stock
as determined by its private placement offerings, the expected life of the award is based on the simplified method. We account
for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services)
or the fair value of the equity instruments issued, whichever is more reliably measurable.
Results
of Operations
The
following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the three months
ended March 31, 2017 and 2016. This discussion and analysis should be read in conjunction with our financial statements appearing
elsewhere in this Form 10-Q. The following discussion contains forward-looking statements. Our actual results may differ significantly
from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed in the section titled “Risk Factors,’ beginning on page 15 of our Form 10-K
filed on October 13, 2016.
Three
Months Ended 31, 2017 Compared to Three Months Ended March 31, 2016
The
following discussions are based on the balance sheets as of March 31, 2017 and June 30, 2016 and statements of operations
for the three months ended March 31, 2017 and March 31, 2016, and notes thereto.
The
tables presented below, which compare QSI’s results of operations from one period to another, present the results for each
period and the change in those results from one period to another in dollars. The columns present the following:
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The
first two data columns in each table show the dollar results for each period presented.
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The
column entitled “Dollar variance” shows the change in results in dollars. This column 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. Conversely, when expenses increase from one period to the next, that change is shown as a negative.
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2017
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2016
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Dollar
variance favorable
(unfavorable)
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Net
Sales
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$
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174
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$
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14,656
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$
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(14,482
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)
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Cost
of Sales
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6
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1,856
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1,850
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Gross
Profit
|
|
|
168
|
|
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|
12,800
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(12,632
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)
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Operating
Expenses
|
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|
|
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Research
and development
|
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141,891
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295,597
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153,706
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Selling,
marketing and advertising
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-
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5,205
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5,205
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General
and administrative
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256,580
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483,537
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226,957
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Total
operating expenses
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398,471
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784,339
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385,868
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|
Loss
from Operations
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(398,303
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)
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(771,539
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)
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373,236
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|
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|
|
|
|
|
|
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|
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Other
Expense
|
|
|
|
|
|
|
|
|
|
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Interest
expense, net
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(165,301
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)
|
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(108,271
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)
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(57,030
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)
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Interest
expense – amortization of note discounts
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(59,902
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)
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(174,860
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)
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114,958
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Gain
from change in fair value of derivative liabilities
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19,880
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-
|
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19,880
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Other
income (loss)
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|
-
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(3,092
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)
|
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|
3,092
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Total
other income (expense), net
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(205,323
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)
|
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(286,223
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)
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80,900
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|
|
|
|
|
|
|
|
|
|
|
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|
Loss
Before Provision for Income Taxes
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|
|
(603,626
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)
|
|
|
(1,057,762
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)
|
|
|
454,136
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Net
Loss
|
|
$
|
(603,626
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)
|
|
$
|
(1,057,762
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)
|
|
$
|
454,136
|
|
Net
Sales.
Net sales decreased by $14,482 in the three months ended March 31, 2017 compared to the three months ended March 31,
2016, reflecting a decrease in sales of various nanomaterials and electrodes.
For
the three months ended March 31, 2017, 100% of net sales were to the United States. For the three months ended March 31, 2016,
64% of net sales were to South Korea and 26% of net sales were to the United States.
For
the three months ended March 31, 2017, 100% of net sales were to two customers. For the three months ended March 31, 2016, 76%
of net sales were to two customers.
Gross
Profit.
Gross profit decreased by $12,632 in the three months ended March 31, 2017 compared to the three months ended March
31, 2016. The decrease resulted from a decrease of $14,482 in sales and decreases in costs of sales of $64,621 in manufacturing
salaries and related expenses, $5,764 in depreciation, $5,599 in miscellaneous expenses, and $4,077 in utilities, offset by $78,211
less allocation of nano iron analysis costs to research and development.
Research
and Development.
Research and development expenses decreased by $153,706 in the three months ended March 31, 2017 compared
to the three months ended March 31, 2016. The decrease resulted from decreases of $78,211 in nano iron analysis costs, $69,273
in salaries and related expenses due to less employees, and $6,222 in miscellaneous expenses.
Selling,
Marketing and Advertising Expenses.
Selling, marketing and advertising expenses decreased by $5,205 in the three months ended
March 31, 2017 compared to the three months ended March 31, 2016. The decrease resulted from decreases of $4,541 in outside consultants
and $664 in miscellaneous expenses.
General
and Administrative Expenses.
General and administrative expenses decreased by $226,957 in the three months ended March 31,
2017 compared to the three months ended March 31, 2016. The decrease resulted from decreases of $92,061 payroll and related expenses,
$39,999 in board members compensation (primarily less board members in the three months ended March 31, 2017), $38,456 less in
consultants and outside services (primarily for investor relations), $37,768 less in business insurance, $11,186 less in legal
expense, $9,620 less in audit expenses, and $3,333 less in travel related expenses, offset by $4,705 more public filing expenses
and $761 more in miscellaneous expenses.
Interest
Expense.
Interest expense increased by $57,030 in the three months ended March 31, 2017 compared to the three months ended
March 31, 2016. The increase resulted from the addition of notes payable in February, April, June 2016, September 2016, November
2016, and January 2017.
Interest
Expense – Amortization of Note Discounts.
Debt discount amortization decreased by $114,958 in the three months ended
March 31, 2017 compared to the three months ended March 31, 2016. $166,074 was due to $166,074 of Series O-2 Notes amortization
in the three months ended March 31, 2016 compared to $0 in the three months ended March 31, 2017, as the discounts were fully
amortized in November 2016. $7,703 was due to $7,703 in miscellaneous discount amortizations in the three months ended March 31,
2016 compared to $0 in the three months ended March 31, 2017, as the discounts were fully amortized in March 2016. Those were
offset by $58,819 in discount amortization on convertible notes payable added in February and March 2017. These were non-cash
entries.
Gain
from change in Fair Value of Derivative Liabilities.
Gain from change in fair value of derivative liabilities increased by
$19,880 in the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The increase was due to revaluation
of the derivative liabilities of the Series O-2 notes and the June 2016 bridge notes at March 31, 2017.
Nine
Months Ended March 31, 2017 Compared to Nine Months Ended March 31, 2016
The
following discussions are based on the balance sheets as of March 31, 2017 and June 30, 2016 and statements of operations for
the nine months ended March 31, 2017 and March 31, 2016 and notes thereto.
The
tables presented below, which compare our results of operations from one period to another, present the results for each period
and the change in those results from one period to another in dollars. The columns present the following:
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●
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The
first two data columns in each table show the dollar results for each period presented.
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●
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The
column entitled “Dollar variance” shows the change in results in dollars. This column 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. Conversely, when expenses increase from one period to the next, that change is shown as a negative.
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Dollar
variance
|
|
|
|
Nine
Months Ended March 31,
|
|
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favorable
|
|
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|
2017
|
|
|
2016
|
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(unfavorable)
|
|
|
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|
|
|
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Net
Sales
|
|
$
|
29,443
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|
|
$
|
44,828
|
|
|
$
|
(15,385
|
)
|
|
|
|
|
|
|
|
|
|
|
|
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|
Cost
of Sales
|
|
|
2,717
|
|
|
|
6,801
|
|
|
|
4,084
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
26,726
|
|
|
|
38,027
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|
|
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(11,301
|
)
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|
|
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|
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Operating
Expenses
|
|
|
|
|
|
|
|
|
|
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Research
and development
|
|
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528,283
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|
|
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867,781
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|
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339,498
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Selling,
marketing and advertising
|
|
|
2,203
|
|
|
|
22,029
|
|
|
|
19,826
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General
and administrative
|
|
|
980,999
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|
|
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3,075,570
|
|
|
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2,094,571
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Total
operating expenses
|
|
|
1,511,485
|
|
|
|
3,965,380
|
|
|
|
2,453,895
|
|
|
|
|
|
|
|
|
|
|
|
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Loss
from Operations
|
|
|
(1,484,759
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)
|
|
|
(3,927,353
|
)
|
|
|
2,442,594
|
|
|
|
|
|
|
|
|
|
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Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
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Interest
expense, net
|
|
|
(550,021
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)
|
|
|
(329,135
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)
|
|
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(220,886
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)
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Interest
expense – amortization of note discounts
|
|
|
(1,153,248
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)
|
|
|
(478,106
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)
|
|
|
(675,142
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)
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Gain
from change in fair value of derivative liabilities
|
|
|
271,996
|
|
|
|
656,061
|
|
|
|
(384,065
|
)
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Gain
from disposal of assets
|
|
|
30,385
|
|
|
|
-
|
|
|
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30,385
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Gain
from debt extinguishment
|
|
|
-
|
|
|
|
161,667
|
|
|
|
(161,667
|
)
|
Other
income (loss)
|
|
|
-
|
|
|
|
(3,042
|
)
|
|
|
3,042
|
|
Total
other income (expense), net
|
|
|
(1,400,888
|
)
|
|
|
7,445
|
|
|
|
(1,408,333
|
)
|
|
|
|
|
|
|
|
|
|
|
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Loss
Before Provision for Income Taxes
|
|
|
(2,885,647
|
)
|
|
|
(3,919,908
|
)
|
|
|
1,034,261
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for Income Taxes
|
|
|
800
|
|
|
|
800
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(2,886,447
|
)
|
|
$
|
(3,920,708
|
)
|
|
$
|
1,034,261
|
|
Net
Sales.
Net sales decreased by $15,385 in the nine months ended March 31, 2017 compared to the nine months ended March 31,
2016 reflecting a decrease in sales of various nanomaterials and electrodes.
For
the nine months ended March 31, 2017, 79% of net sales were to the United States and 20% of net sales were to South Korea. For
the nine months ended March 31, 2017, 41% of net sales were to China, 27% of net sales were to South Korea, and 23% of net sales
were to the United States.
For
the nine months ended March 31, 2017, 81% of net sales were to four customers. For the nine months ended March 31, 2016, 59% of
net sales were to two customers.
Gross
Profit.
Gross profit decreased by $11,301 in the nine months ended March 31, 2017 compared to the nine months ended March
31, 2016. The decrease resulted from decreases in sales of $15,385 and $205,195 in cost of sales allocation to Research and Development
for ammonia research, offset by decreases in cost of sales of $152,076 in salaries and related expenses, $19,764 in depreciation,
$18,749 in utilities, $11,053 in repairs and maintenance, $4,835 in cost of sales materials, and $2,802 in miscellaneous expenses.
Research
and Development.
Research and development expenses decreased by $339,498 in the nine months ended March 31, 2017 compared
to the nine months ended March 31, 2016. The decrease resulted from decreases of $205,195 in ammonia research, $121,852 in salaries
and related expenses due to less employees, $15,175 in research and development expenses, offset by an increase of $2,724 in miscellaneous
expenses.
Selling,
Marketing and Advertising Expenses.
Selling, marketing and advertising expenses decreased by $19,826 in the nine months ended
March 31, 2017 compared to the nine months ended March 31, 2106. The decrease resulted from a decrease of $9,615 in marketing
and advertising, $8,661 in outside consultants, and $1,550 less miscellaneous expenses.
General
and Administrative Expenses.
General and administrative expenses decreased by $2,094,571 in the nine months ended March 31,
2017 compared to the nine months ended March 31, 2016. The decrease resulted from decreases of $1,218,026 in consultants and outside
services (primarily for investor relations, of which $995,173 was the market value of stock and fair value of warrants issued),
$435,910 in board members compensation (primarily annual stock options issuance expense to the board in 2016 and less board members
in 2017), $228,054 in payroll and related expenses (due to two less employees in 2017 and less stock options issuance expense
in 2017), $67,639 in business insurance, $60,432 in travel related expenses, $36,638 in audit expense, $30,689 in legal, $6,861
in dues and subscriptions, $6,656 in miscellaneous expenses, $5,535 in public filing expenses, and $5,041 in repairs and maintenance,
offset by an increase of $6,910 in fees.
Interest
Expense.
Interest expense increased by $220,886 in the nine months ended March 31, 2017 compared to the nine months ended
March 31, 2016. The increase resulted from the addition of notes payable in September, October, and November 2015, June 2016,
September 2016, November 2016, and January 2017.
Interest
Expense – Amortization of Note Discounts.
Debt discount amortization increased by $675,142 in the nine months ended
March 31, 2017 compared to the nine months ended March 31, 2016. $225,549 of the increase resulted from debt discount amortization
on the September 2015 bridge notes, on the October/November/December 2015 Series O-2 Notes, and on the June 2016 bridge notes.
$390,774 of the increase was due to the June 2016 bridge notes becoming convertible in October 2016 due to default. $58,819 of
the increase was due to the addition of February and March 2017 convertible notes. These were non-cash entries.
Gain
from Change in Fair Value of Derivative Liabilities.
Gain from change in fair value of derivative liabilities decreased by
$384,065 in the nine months ended March 31, 2017 compared to the nine months ended March 31, 2016. The March 2016 gain of $656,061
was the result of the elimination of the derivative liabilities on the Series O-1 notes, as the Series O-1 notes were all converted
to Series O-2 notes in December 2015 that did not have derivative liabilities. $271,515 of the March 31, 2017 gain was due to
revaluation of the derivative liabilities of the June 2016 bridge notes at December 31, 2016 and March 31, 2017.
Gain
from Disposal of Assets.
Gain from disposal of assets increased by $30,385 in the nine months ended March 31, 2017 compared
to the nine months ended March 31, 2016. Several fully depreciated assets were sold.
Gain
from Debt Extinguishment.
Gain on debt extinguishment decreased by $161,667 in the nine months ended March 31, 2017 compared
to the nine months ended March 31, 2016. The gain in the nine months ended March 31, 2016 was the result of the elimination of
the derivative liabilities as the Series O-1 notes were all converted to Series O-2 notes in December 2015 that did not have derivative
liabilities.
Liquidity
and Capital Resources
As
of March 31, 2017, we had cash of $2,001, current assets of $19,292, and a working capital deficit of $5,188,842.
Cash
decreased $178,804 from $180,805 at June 30, 2016 to $2,001 at March 31, 2017. Net cash used in operating activities of $364,738
in the nine months ended March 31, 2017 included $2,886,447 operating loss, $271,996 non-cash gain from change in fair value of
derivative liabilities, and $30,385 gain on disposal of fixed assets, offset by $675,323 increase in accrued expenses, $384,745
increase in accounts payable, $25,823 decrease in prepaid expenses and other current assets, and noncash items of $1,153,248 in
discount amortization on notes payable, $268,326 in depreciation and amortization, $168,438 increase in notes payable due to default
,
$110,500 in stock issued for services, and $37,687 stock based compensation. $1,256,329 in cash was used in operating activities
for the nine months ended March 31, 2016.
$30,255 in cash was provided by investing
activities in the nine months ended March 31, 2017. $30,385 was received in disposal of equipment, offset by $130 used
for patents. $22,559 of cash was used in investing activities in the nine months ended March 31, 2016.
$155,679
in cash was provided by financing activities in the nine months ended March 31, 2017. $116,000 was provided by the issuance of
convertible notes payable and $76,000 was provided by the issuance of notes payable, offset by $36,321 principal payments on notes
payable. $883,501 in cash was provided by financing activities in the nine months ended March 31, 2016.
Immediately
prior to the consummation of the April 22, 2014 merger with Way Cool Imports, Inc., 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 March 31, 2017, 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.
The
Company currently has very little cash on hand, has a significant working capital deficit, and is in immediate need of raising
additional capital to fund operations. These factors raise substantial doubt regarding the Company’s ability to continue
to operate as a going concern within the twelve month period of the issuance date of the interim financial statements for the
period ended March 31, 2017. See the section “Going Concern” under “Item 2 Management’s Discussion and
Analysis of Financial Condition and Results of Operations.”
OFF
BALANCE SHEET ARRANGEMENTS
We
do not have any off-balance sheet arrangements.