FORM 10-Q QUARTERLY REPORT DECEMBER 31, 2014

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

x. QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 31, 2014

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______________________  to  ___________________________

 

Commission File Number:  000-53913

 

QUANTUMSPHERE, INC.

(Exact name of registrant as specified in its charter)

 

Nevada	20-3925307
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2905 Tech Center Drive, Santa Ana, CA	92705
(Address of principal executive offices)	(Zip Code)

 

714-545-6266

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x . No ¨.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x . No ¨.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨. No x

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of February 16, 2015:  22,255,217

 

 

CAUTIONARY STATEMENT

 

All statements included or incorporated by reference in this Quarterly Report on Form 10-Q (this “Form 10-Q”), other than statements or characterizations of historical fact, are “forward-looking statements.” Examples of forward-looking statements include, but are not limited to, statements concerning projected sales, costs, expenses and gross margins; our accounting estimates, assumptions and judgments; the prospective demand for our products; the projected growth in our industry; the competitive nature of and anticipated growth in our industry; and our prospective needs for, and the availability of, additional capital. These forward-looking statements are based on our current expectations, estimates, approximations and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by such words as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are set forth in the “Risk Factors” section of our Transition Report on Form 10-KT filed on September 26, 2014, as updated through this Report, which could cause our financial results, including our net income or loss or growth in net income or loss to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. These forward-looking statements speak only as of the date of this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.

 

 

TABLE OF CONTENTS

 

		Page
PART I FINANCIAL INFORMATION
Item 1	Financial Statements		4
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3	Quantitative and Qualitative Disclosures About Market Risk		21
Item 4	Controls and Procedures		21
PART II OTHER INFORMATION
Item 1	Legal Proceedings		22
Item 1A	Risk Factors		22
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3	Default upon Senior Securities		22
Item 4	Mine Safety Disclosures		22
Item 5	Other Information		22
Item 6	Exhibits		22
Signatures

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1 - FINANCIAL STATEMENTS

 

QUANTUMSPHERE, INC.

CONDENSED BALANCE SHEETS

 

		December 31, 2014 (unaudited)				June 30, 2014
ASSETS
Current Assets
Cash		$	1,146,787			$	2,702,889
Accounts receivable			548				3,183
Prepaid expenses and other current assets			86,953				57,003
Total current assets			1,234,288				2,763,075
Property and equipment, net			1,524,772				1,533,588
Patents, net			113,915				112,299
Other assets			24,578				24,578
Total assets		$	2,897,553			$	4,433,540
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable and accrued expenses		$	385,961			$	501,051
Note payable, net of discount			149,346				130,786
Total current liabilities			535,307				631,837
Notes Payable, long-term portion, net of discount			273,414				358,245
Total Liabilities			808,721				990,082
Stockholders’ Equity
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued or outstanding			–				–
Common stock, $0.001 par value, 500,000,000 shares authorized, 22,255,217 and 21,385,217 shares issued and outstanding as of December 31, 2014 and June 30, 2014, respectively			22,255				21,385
Additional paid-in capital			41,583,278				40,232,630
Accumulated deficit			(39,516,701	)			(36,810,557	)
Total stockholders’ equity			2,088,832				3,443,458
Total liabilities and stockholders’ equity		$	2,897,553			$	4,433,540

 

The accompanying notes are an integral part of these financial statements.

 

 

QUANTUMSPHERE, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended December 31,								Six Months Ended December 31,
		2014				2013				2014				2013
Net Sales		$	11,881			$	71,271			$	25,904			$	156,288
Cost of Sales			2,830				25,351				5,667				53,279
Gross Profit			9,051				45,920				20,237				103,009
Operating Expenses
Research and development			599,744				290,909				1,432,671				532,682
Selling, marketing and advertising			5,788				25,175				11,755				26,395
General and administrative			607,824				558,947				1,253,860				936,129
Total operating expenses			1,213,356				875,031				2,698,286				1,495,206
Loss from Operations			(1,204,305	)			(829,111	)			(2,678,049	)			(1,392,197	)
Other Expense
Interest expense, net			(17,884	)			(124,984	)			(41,502	)			(193,682	)
Interest expense – amortization of note discounts			(939	)			-				(1,878	)			(86,471	)
Other income			15,235				-				15,285				-
Total other expense, net			(3,588	)			(124,984	)			(28,095	)			(280,153	)
Loss Before Provision for Income Taxes			(1,207,893	)			(954,095	)			(2,706,144	)			(1,672,350	)
Provision for Income Taxes			-				800				-				800
Net Loss		$	(1,207,893	)		$	(954,895	)		$	(2,706,144	)		$	(1,673,150	)
Basic and Diluted Loss Per Common Share		$	(0.05	)		$	(0.09	)		$	(0.12	)		$	(0.15	)
Basic and Diluted Weighted-Average Common Shares Outstanding			22,031,685				11,056,059				21,742,690				11,056,059

 

The accompanying notes are an integral part of these financial statements.

 

 

QUANTUMSPHERE, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Six Months Ended December 31,
		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(2,706,144	)		$	(1,673,150	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			191,156				28,481
Stock based compensation expense			481,519				318,121
Change in warrants liabilities			-				(65,556	)
Discount amortization on note payable			1,878				152,027
Changes in operating assets and liabilities:
Accounts receivable			2,635				(4,133	)
Prepaid expenses and other current assets			(29,950	)			(2,599	)
Accounts payable and accrued expenses			(21,671	)			412,510
Net cash used in operating activities			(2,080,577	)			(834,299	)
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for development of patents			(4,035	)			(9,492	)
Purchase of property and equipment			(179,921	)			(70,368	)
Net cash used in investing activities			(183,956	)			(79,860	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuances of convertible notes payable			-				900,000
Principal payments of notes payable			(68,149	)			-
Common stock buy back			(93,420	)			-
Proceeds from exercise of common stock options			870,000				-
Net cash provided by financing activities			708,431				900,000
NET INCREASE (DECREASE) IN CASH			(1,556,102	)			(14,159	)
CASH – beginning of period			2,702,889				389,394
CASH – end of period		$	1,146,787			$	375,235
ADDITIONAL CASH FLOW INFORMATION
Interest paid		$	41,502			$	1,121
Income taxes paid		$	-			$	800

 

The accompanying notes are an integral part of these financial statements.

 

 

QUANTUMSPHERE, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

September 30, 2014

 

1. ORGANIZATION AND BUSINESS

 

QuantumSphere, Inc., formerly known as Way Cool Imports, Inc., was incorporated in the State of Nevada on December 1, 2005 (referred to as the “Company”). On April 22, 2014, the Company entered into an Agreement and Plan of Merger (“Merger”) with QuantumSphere, Inc., a California corporation (“QSI”), whereby, QSI would merge with Way Cool Merger Sub, Inc., a Nevada corporation (“Merger Sub”), a wholly-owned subsidiary of the Company. As a result of the Merger, QSI became a wholly-owned subsidiary of the Company, and the Company issued shares of the Company’s common stock to holders of QSI common stock at a rate of one-to-one.

 

The Merger was accounted for as a public shell reverse merger because post-Merger QSI’s shareholders own approximately 82% of the outstanding shares of the Company, QSI’s directors and officers now serve as the directors and officers of the Company, and the operations of QSI are the ongoing business of the Company. Prior to the merger, the Company had insignificant assets, liabilities, and operations. Therefore, the merger has been accounted for as a recapitalization of QSI, which resulted in QSI becoming a public company. All outstanding stock options and warrants are exercisable into shares of common stock of the legal parent entity.

 

Subsequent to the Merger, on April 25, 2014, the Company filed Articles of Merger with the Nevada Secretary of State for the purposes of effecting a short-form merger of QSI with and into the Company. The merger of the Company with QSI, its then wholly-owned subsidiary, is referred to as a short-form merger (the “Short-Form Merger”). As part of the Articles of Merger, the Company amended its Articles of Incorporation to change its name from “Way Cool Imports, Inc.” to “Quantumsphere, Inc.”

 

In June 2014, the Company elected to change its year end from December 31 to June 30.

 

Since commencing operations in 2003, QSI has developed a process to manufacture metallic nanopowders with end-use applications in the battery and chemicals sector. The Company’s products are used on a stand-alone basis, in the validation of Company’s nano-iron catalysts coated onto commercial iron catalysts used in the production of ammonia on a prospective basis, and research, development, and initial marketing of zinc-air battery products. The Company anticipates introducing zinc-air battery products on a commercial basis in the second calendar quarter of 2015  . The Company’s major activities to date have included capital formation, research and development, and marketing of its metallic nanopowder products.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited condensed financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and applicable sections of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary to make the financial statements not misleading have been included. The condensed balance sheet as of June 30, 2014 was derived from the audited financial statements filed in Form 10-KT on September 26, 2014. Operating results for the three and six months ended December 31, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2015. For further information, refer to our Transition Report on Form 10-KT for the year ended June 30, 2014 and our Form 8-K concerning the Merger filed on June 16, 2014, and as amended on July 7, 2014.

 

 

Use of Estimates

 

The accompanying financial statements are prepared in conformity with U.S. GAAP and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. The use of estimates may also affect the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include, among others, realization of capitalized assets, valuation of equity instruments, and deferred income tax asset valuation allowances. Actual results could differ from those estimates.

 

Revenue Recognition

 

The Company recognizes revenue when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability is reasonably assured. The Company does not grant customers the right to return the products after such products have been accepted. Amounts billed for shipping and handling are recorded as a component of net sales and the cost incurred for freight is included as a component of operating expenses in the statements of operations.

 

Property and Equipment

 

Purchased property and equipment is stated at cost, less accumulated depreciation. Repairs and maintenance of equipment are charged to expense as incurred. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Gains or losses on dispositions of property and equipment are included in the results of operations when realized. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the shorter of terms of the leases or their estimated useful lives. Depreciation expense on assets acquired under capital leases is included in depreciation expense.

 

Patents

 

Costs incurred in applying for patents relating to the Company’s process for production of nanopowders have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of December 31, 2014, nine patents have been issued and three patents are pending approval. Amortization relating to issued patents was not significant during the periods presented. Additional significant costs may be required for the continued development of end-use applications for the Company’s technology.

 

Impairment of Long-Lived Assets

 

Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the assets with the estimated undiscounted future cash flows associated with them. Should the review indicate that an asset is not recoverable, the Company’s carrying value of the asset would be reduced by the estimated shortfall to fair value.

 

Research and Development Costs

 

Research and development costs are expensed as incurred. Costs incurred for research and development for new or improved processes to produce nanopowders as well as end use applications for the nanopowders are expensed until the production process or applications have been determined to be commercially viable. Costs incurred after the production process is viable and a working model of the equipment has been completed will be capitalized as long-lived assets.

 

 

Income Taxes

 

Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities.

 

The Company provides for tax contingencies, if any, for federal, state and local exposures relating to audit results, tax planning initiatives and compliance responsibilities. The development of these reserves requires judgments about tax issues, potential outcomes and timing. Although the outcome of such matters is uncertain, in management’s opinion adequate provisions for income taxes have been made for potential liabilities emanating from these reviews. If actual outcomes differ materially from these estimates, they could have a material impact on the Company’s results.

 

Loss Per Share

 

The Company calculates basic loss per share by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if such additional common shares had been issued and were dilutive.

 

Potential common shares, consisting of options and warrants, totaling 12,052,572 and 10,946,415, 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 December 31, 2014 and 2013, respectively.

 

Stock-Based Compensation

 

The Company measures all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocates the related expense over the requisite service period. The expected volatility is based on the historical volatility of the Company’s stock as determined by its private placement offerings, the expected life of the award is based on the simplified method.

 

The Company accounts for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.

 

Reclassifications

 

The Company has reclassified certain prior period amounts to conform with current year presentation, in particular with regard to enhanced allocation of research and development costs that were previously classified as cost of goods sold.

 

Risks and Uncertainties

 

The Company faces risks and uncertainties relating to its ability to successfully implement and fulfill its strategy. Among other things, these risks include the ability to obtain revenues; manage operations; competition; attract, retain and motivate qualified personnel; maintain and develop new strategic relationships; and the ability to anticipate and adapt to the changing nanotechnology market and any changes in government regulations.

 

Therefore, the Company may be subject to the risks of delays in consummating contracts with customers and suppliers, raising sufficient capital to achieve its objectives and other uncertainties, including financial, operational, technological, regulatory and other risks associated with an emerging business, including the potential risks of business failure. Technology and manufacturing companies with whom the Company is expected to compete, in general, are well capitalized. The Company is competing against entities with the financial and intellectual resources and expressed intent of performing rapid technological innovation. The Company’s resources are limited and must be allocated to focus objectives in order to succeed.

 

 

Going Concern

 

The Company has incurred recurring losses from operations from inception and has limited working capital. As of December 31, 2014, the Company had an accumulated deficit of approximately $39.5 million. The Company’s activities will necessitate significant uses of working capital beyond 2015. Additionally, the Company’s capital requirements will depend on many factors, including the success of its continued research and development efforts and the status of competitive products. The Company plans to continue financing its operations with cash received from financing activities. Management is currently attempting to raise additional capital from financing activities to sustain operations until the Company is able to generate sufficient cash flows from operations. There is no assurance that the Company will be able to raise sufficient capital to continue operations and, if available, on terms satisfactory to the Company.

 

3. NOTE PAYABLE

 

On June 19, 2014, the Company signed a loan and security agreement with Novus Capital Group that provides up to two loans, each in the amount of $500,000. The initial loan of $500,000 was funded on June 19, 2014. The second loan in the amount of $500,000 was to be funded upon: (a) the Company having secured additional equity financing of not less than $3,000,000 on or before December 31, 2014; (b) the monthly payments on the initial loan being made as agreed; and (c) the Company is not in default on any of its obligations with any of its creditors. The loans accrue at an annual rate of 15.5%, have a term of thirty-six months, and monthly payments on each loan are $17,455, beginning August 10, 2014 for the initial loan. The agreement includes a warrant to purchase 30,000 shares of common stock at an exercise price of $2.00 per share that expires July 1, 2019; 20,000 warrants vested upon the initial funding of $500,000, and 10,000 warrants vest upon the second funding of $500,000. The initial vested warrants were valued at approximately $11,000, using the Black Scholes Merton option pricing model, and recorded as a discount to the note payable. The Company did not meet the additional equity requirement for funding of the second loan of $500,000 as of December 31, 2014.

 

4. STOCKHOLDERS’ EQUITY

 

Common Stock

 

In early April 2014, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of December 31, 2014, the Company had approximately $258,000 of accrued liabilities associated with the share cancellation.

 

Stock Options

 

During the six months ended December 31, 2014, 870,000 options were exercised at a price of $1.00 per share.

 

During the six months ended December 31, 2014, the Company issued to employees, officers, directors, advisory board and consultants options to purchase 520,000 shares of common stock, which are exercisable at a price of $2.00 per share.

 

The fair value of stock options granted were estimated on their respective grant dates using the Black-Scholes-Merton option pricing model and the following assumptions for the six months ended December 31, 2014 and 2013:

 

 

		Six Months Ended December 31,
		2014		2013
Risk free interest rate		1.14% - 1.75%		1.03% - 2.71%
Expected term		3 - 5 years		6 years
Expected volatility		51.8% - 52.1%		43.8% - 45.5%
Dividend yield		–		–

 

5. CONCENTRATIONS

 

For the three months ended December 31, 2014, 34% of net sales were to customers in Asia and 26% of net sales were to customers in Europe. For the three months ended December 31, 2013, 72% of net sales were to a customer in Israel. For the three months ended December 31, 2014, 70% of net sales were to four customers. For the three months ended December 31, 2013, 83% of net sales were to two customers.

 

For the six months ended December 31, 2014, 46% of net sales were to customers in Asia and 15% of net sales were to customers in Europe. For the six months ended December 31, 2013, 66% of net sales were to a customer in Israel and 17% of net sales were to customers in Asia. For the six months ended December 31, 2014, 48% of net sales were to three customers. For the six months ended December 31, 2013, 66% of net sales were to one customer.

 

6. SUBSEQUENT EVENTS

 

Dr. Douglas Carpenter, CTO of the Company, continues to be on a medical leave of absence that began on November 1, 2014. It is presently unknown how long Dr. Carpenter will be on leave, but Company management is confident that it has the necessary resources in place to handle all of Dr. Carpenter’s day-to-day duties and his absence will not have a material effect on the Company or its business operations.

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

 

Forward Looking Statements

 

This Form 10-Q contains statements that must be deemed “forward-looking” statements under Section 27A of the Securities Act, including, among other things, discussions as to our business strategies, expectations, market position and services, anticipated revenues and performance, future operations, profitability, liquidity and capital resources. Words including, but not limited to, “may,” “will,” “likely,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “continue,” “seek,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in such forward-looking statements are generally reasonable and reflect the current views of our management, such statements are inherently uncertain, and we can give no assurance that such statements will ultimately prove to be correct. Our operations are subject to a number of uncertainties and risks, many of which are outside our control, and any one of which, or any combination of which, could materially adversely affect our results of operations. Important factors, including, but not limited to, those discussed in the section titled “Risk Factors,” beginning on page 23 of our Transition Report on Form 10-KT filed on September 26, 2014, could cause actual results to differ materially from such statements. Therefore, you are cautioned not to place undue reliance on these forward-looking statements.

 

These forward-looking statements may relate to the following:

 

·

our future operating results and business prospects;

 

·

our ability to develop and market products that compete effectively in our targeted market segments;

 

·

Successful completion of large-scale commercial validation of our QSI- Nano ® iron catalysts;

 

·

market acceptance of our current and future products and the degree and nature of our competition;

 

·

our ability to meet customer demand;

 

·

our ability to protect and enforce our current and future intellectual property;

 

·

our ability to obtain sufficient funding to continue to pursue our business plan;

 

·

our ability to implement a long-term business strategy that will be profitable or generate sufficient cash flow;

 

·

our ability to manage our foreign manufacturing and development operations and international business risks;

 

·

the loss of any of our key members of management;

 

·

changes in our industry, interest rates or the general economy; and

 

·

changes in governmental regulations, tax rates and similar matters.

 

We believe that the expectations reflected in the forward-looking statements are reasonable. However, there may be events in the future that we are not able to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements, whether as a result of any new information, future events, or otherwise.

 

 

Overview

 

QuantumSphere, Inc. was incorporated in the State of Nevada on December 1, 2005 and formerly known as Way Cool Imports, Inc. (“WYCC”). On April 22, 2014, WYCC entered into the Merger Agreement with QuantumSphere, Inc., a California corporation (“QSI”), whereby, QSI would merge with Way Cool Merger Sub, Inc., a Nevada corporation and wholly-owned subsidiary of WYCC. On April 22, 2014, the parties consummated the merger and QSI became a wholly-owned subsidiary of WYCC. As part of the merger, WYCC issued 17,185,217 shares of common stock to QSI shareholders, options to purchase 5,942,078 shares of common stock, and warrants to purchase 9,883,233 shares of common stock. The merger was considered a public shell reverse merger and, accordingly, accounted for as a recapitalization of QSI.

 

Subsequent to the merger, on April 25, 2014, WYCC filed Articles of Merger with the Nevada Secretary of State for the purposes of effecting a short-form merger of WYCC with and into QSI. The merger of WYCC with QSI, its wholly-owned subsidiary, is referred to as a short-form merger and did not require the approval of WYCC’s stockholders. As part of the Articles of Merger, WYCC amended its Articles of Incorporation to change its name from “Way Cool Imports, Inc.” to “QuantumSphere, Inc.” The Articles of Merger were effective upon filing.

 

On June 23, 2014, we reported our decision to change our fiscal year end to June 30 from a fiscal year ending on December 31. This action created a “transition period” (as defined), which is the six month period ended June 30, 2014. Under the SEC’s reporting rules, a registrant is required to file a separate transition report for transition periods that cover a period of six months or greater. Rule 13a-10 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), requires registrants that have a transition period of six months or greater to file audited financial statements for that transition period on the form appropriate for annual reports of the registrant. Accordingly, our audited statement of operations and cash flows for the six month transition period ended June 30, 2014 were filed on Form 10-KT on September 26, 2014.

 

Emerging Growth Company

 

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). We will remain an emerging growth company until the earlier of the following: (1) the last day of the fiscal year following the fifth anniversary of the date of the first sale of our common stock pursuant to an effective registration statement under the Securities Act of 1933, as amended (the “Securities Act”); (2) the last day of the fiscal year where we have total annual gross revenues of at least $1.0 billion; (3) the date on which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeded $700.0 million as of the prior June 30; and (4) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

 

As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that may otherwise be applicable to public companies. These provisions include:

 

·

Only two years of audited consolidated financial statements in addition to any required unaudited interim financial statements with correspondingly reduced “Management’s Discussion and Analysis of Financial Condition and Results of Operations” disclosure;

 

·

Reduced disclosure about our executive compensation arrangements;

 

·

No requirement that we hold non-binding advisory votes on executive compensation or golden parachute arrangements; and

 

 

·

Exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting.

 

We have taken advantage of some of these reduced burdens and may continue to do so for so long as we remain an emerging growth company, and thus the information we provide stockholders may be different from what you might receive from other public companies in which you hold shares.

 

To the extent that we continue to qualify as a “smaller reporting company,” as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), after we cease to qualify as an emerging growth company, certain of the exemptions available to us as an emerging growth company may continue to be available to us as a smaller reporting company, including: (1) not being required to comply with the auditor attestation requirements of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002; (2) scaled executive compensation disclosures; and (3) the requirement to provide only two years of audited financial statements, instead of three years.

 

Critical Accounting Policies and Estimates

 

Use of Estimates. We make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. The use of estimates may also affect the reported amounts of revenues and expenses during the reporting periods. Significant estimates made by management include, among others, realization of capitalized assets, valuation of equity instruments, and deferred income tax valuation allowances. Actual results could differ from those estimates.

 

Revenue Recognition. We recognize revenue when all four of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured. We do not grant customers the right to return the products after such products have been accepted. Amounts billed for shipping and handling are recorded as a component of net sales and the cost incurred for freight is included as a component of operating expenses in the statements of operations.

 

Property and Equipment. Purchased property and equipment is stated at cost, less accumulated depreciation. Repairs and maintenance of equipment are charged to expense as incurred. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Gains or losses on dispositions of property and equipment are included in the results of operations when realized. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to seven years. Leasehold improvements are amortized over the shorter of terms of the leases or their estimated useful lives. Depreciation expense on assets acquired under capital leases is included in depreciation expense.

 

Patents. Costs incurred in applying for patents relating to our process for production of nanomaterials have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of December 31, 2014, nine patents have been issued and three patents are pending approval. Additional significant costs may be required for the continued development of end-use applications for our technology.

 

Impairment of Long-Lived Assets. Long-lived assets and intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We evaluate potential impairment by comparing the carrying amount of the assets with the estimated undiscounted future cash flows associated with them. Should the review indicate that an asset is not recoverable, our carrying value of the asset would be reduced by the estimated shortfall to fair value.

 

 

Income Taxes. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each period end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period, if any, and the change during the period in deferred tax assets and liabilities.

 

Stock-Based Compensation. We measure all employee stock-based compensation awards using the Black-Scholes-Merton valuation model and allocate the related expense over the requisite service period. The expected volatility is based on the historical volatility of our stock as determined by its private placement offerings, the expected life of the award is based on the simplified method. We account for nonemployee stock-based transactions using the fair value of the consideration received (i.e. the value of the goods or services) or the fair value of the equity instruments issued, whichever is more reliably measurable.

 

Results of Operations

 

The following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the three and six months ended December 31, 2014 and 2013. This discussion and analysis should be read in conjunction with our financial statements appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors,” beginning on page 23 of our Form 10-KT filed on September 26, 2014.

 

Three Months Ended December 31, 2014 Compared to Three Months Ended December 31, 2013

 

The following discussions are based on the consolidated balance sheets as of December 31, 2014 and June 30, 2014 and statements of operations for the three months ended December 31, 2014 and December 31, 2013 and notes thereto.

 

The tables presented below, which compare QSI’s results of operations from one period to another, present the results for each period and the change in those results from one period to another in dollars. The columns present the following:

 

·

The first two data columns in each table show the dollar results for each period presented.

 

·

The column entitled “Dollar variance” shows the change in results in dollars. This column 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.

 

 

		Three Months Ended December 31,								Dollar variance favorable
		2014				2013				(unfavorable)
Net Sales		$	11,881			$	71,271			$	(59,390	)
Cost of Sales			2,830				25,351				22,521
Gross Profit			9,051				45,920				(36,869	)
Operating Expenses
Research and development			599,744				290,909				(308,835	)
Selling, marketing and advertising			5,788				25,175				19,387
General and administrative			607,824				558,947				(48,877	)
Total operating expenses			1,213,356				875,031				(338,325	)
Loss from Operations			(1,204,305	)			(829,111	)			(375,194	)
Other Expense
Interest expense, net			(17,884	)			(124,984	)			107,100
Interest expense – amortization of note discounts			(939	)			-				(939	)
Other income			15,235				-				15,235
Total other expense, net			(3,588	)			(124,984	)			121,396
Loss Before Provision for Income Taxes			(1,207,893	)			(954,095	)			(253,798	)
Provision for Income Taxes			-				800				800
Net Loss		$	(1,207,893	)		$	(954,895	)		$	(252,998	)

 

 

Net Sales. Net sales decreased by $59,390 in the three months ended December 31, 2014 compared to the three months ended December 31, 2013, primarily reflecting a decrease in sales of silver-palladium to one customer.

 

For the three months ended December 31, 2014 and 2013, 70% and 83% of net sales were to four and two customers, respectively.

 

For the three months ended December 31, 2014, 34% of net sales were to customers in Asia and 26% of net sales were to customers in Europe. For the three months ended December 31, 2013, 72% of net sales were to a customer in Israel.

 

Gross Profit.  Gross profit decreased by $36,869 in the three months ended December 31, 2014 compared to the three months ended December 31, 2013. The decrease resulted from a decrease of $59,390 in net sales offset by a related decrease of $22,521 in cost of sales.

 

Research and Development. Research and development expenses increased by $308,835 in the three months ended December 31, 2014 compared to the three months ended December 31, 2013. The increase resulted from increases of $373,379 in production of nano iron for commercial validation purposes and $11,874 in research on the MetAir® Ranger battery, offset by a decrease of $75,906 in nano metals research and $512 in miscellaneous expenses. Nano iron produced and placed in use in an ammonia plant in China to verify prior laboratory results was classified as research & development.

 

Selling, Marketing and Advertising Expenses.  Selling, marketing and advertising expenses decreased by $19,387 in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The decrease resulted from decreases of $21,066 in marketing expense offset by increases of $1,679 in miscellaneous expenses.

 

General and Administrative Expenses. General and administrative expenses increased by $48,877 in December 31, 2014 compared to the three months ended December 31, 2013. The increase resulted from $202,818 in board members compensation ($173,478 related to stock-based compensation), $40,656 in business insurance, and $13,350 in audit/review expense, offset by $177,629 less legal expense ($190,609 in 2013 was for the reverse merger), $20,245 in payroll and related expenses, and $10,073 in miscellaneous expenses.

 

Interest Expense. Interest expense decreased by $107,100 in the three months ended December 31, 2014 compared to the three months ended December 31, 2013. The decrease resulted from the conversion to common stock in April 2014 of $2,667,500 in convertible notes payable at December 31, 2013, offset by a new note payable of $431,850 at December 31, 2014.

 

Other Income. Other income increased by $15,235 in the three months ended December 31, 2014 compared to the three months ended December 31, 2013. This was the result of refunds of prior years’ personal property taxes.

 

Six Months Ended December 31, 2014 Compared to Six Months Ended December 31, 2013

 

The following discussions are based on the consolidated balance sheets as of December 31, 2014 and June 30, 2014 and statements of operations for the six months ended December 31, 2014 and December 31, 2013 and notes thereto.

 

The tables presented below, which compare QSI’s results of operations from one period to another, present the results for each period and the change in those results from one period to another in dollars. The columns present the following:

 

·

The first two data columns in each table show the dollar results for each period presented.

 

 

·

The column entitled “Dollar variance” shows the change in results in dollars. This column 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.

 

		Six Months ended December 31,								Dollar variance favorable
		2014				2013				(unfavorable)
Net Sales		$	25,904			$	156,288			$	(130,384	)
Cost of Sales			5,667				53,279				47,612
Gross Profit			20,237				103,009				(82,772	)
Operating Expenses
Research and development			1,432,671				532,682				(899,989	)
Selling, marketing and advertising			11,755				26,395				14,640
General and administrative			1,253,860				936,129				(317,731	)
Total operating expenses			2,698,286				1,495,206				(1,203,080	)
Loss from Operations			(2,678,049	)			(1,392,197	)			(1,285,852	)
Other Expense
Interest expense, net			(41,502	)			(193,682	)			152,180
Interest expense – amortization of note discounts			(1,878	)			(86,471	)			84,593
Other income			15,285								15,285
Total other expense, net			(28,095	)			(280,153	)			252,058
Loss Before Provision for Income Taxes			(2,706,144	)			(1,672,350	)			(1,033,794	)
Provision for Income Taxes			-				800				800
Net Loss		$	(2,706,144	)		$	(1,673,150	)		$	(1,032,994	)

 

 

Net Sales. Net sales decreased by $130,384 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013, primarily reflecting a decrease in sales of silver-palladium to one customer and in addition a decrease in sales of various nanomaterials and electrodes.

 

For the six months ended December 31, 2014 and 2013, 48% and 66% of net sales were to three and one customers, respectively.

 

For the six months ended December 31, 2014, 46% of net sales were to customers in Asia and 15% of net sales were to customers in Europe. For the six months ended December 21, 2013, 66% of net sales were to a customer in Israel and 17% of net sales were to customers in Asia.

 

Gross Profit.  Gross profit decreased by $82,772 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The decreased resulted from a decrease of $130,384 in net sales offset by a related decrease of $47,612 in cost of sales.

 

Research and Development. Research and development expenses increased by $899,989 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The increase resulted from increases of $918,827 in production of nano iron for commercial validation purposes, $80,354 in salaries and related expenses due to more employees, $10,626 in research on the MetAir® Ranger battery, and $23,580 in miscellaneous expenses, offset by a decrease of $133,398 in nano metals research. Nano iron produced and placed in use in an ammonia plant in China to verify prior laboratory results was classified as research & development.

 

Selling, Marketing and Advertising Expenses.  Selling, marketing and advertising expenses decreased by $14,640 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The decrease resulted from a decrease of $19,018 in marketing expense offset by an increase of $4,378 in miscellaneous expenses.

 

General and Administrative Expenses. General and administrative expenses increased by $317,731 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The increase resulted from $285,889 in board members compensation ($222,402 related to stock-based compensation), $83,230 in business insurance, $65,990 in audit/review expense, and $16,627 in miscellaneous expenses, offset by $134,005 less legal expenses ($190,609 in 2013 was for the reverse merger, $46,888 in 2014 was for public reporting matters).

 

Interest Expense. Interest expense decreased by $152,180 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The decrease resulted from the conversion to common stock in April 2014 of $2,667,500 in convertible notes payable at December 31, 2013, offset by a new note payable of $431,850 at December 31, 2014.

 

Interest Expense – Amortization of Note Discounts. Debt discount amortization decreased by $84,593 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. The decrease resulted from the conversion to common stock in April 2014 of $2,667,500 in convertible notes payable at December 31, 2013, offset by a new note payable of $431,850 at December 31, 2014.

 

Other Income. Other income increased by $15,285 in the six months ended December 31, 2014 compared to the six months ended December 31, 2013. $15,235 was the result of refunds of prior years’ personal property taxes.

 

Liquidity and Capital Resources

 

As of December 31, 2014, we had current assets of $1,234,288, including $1,146,787 in cash.

 

 

Cash decreased $1,556,102 from $2,702,889 at June 30, 2014 to $1,146,787 at December 31, 2014. Net cash used in operating activities of $2,080,577 in the six months ended December 31, 2014 included $2,706,144 operating loss, $29,950 increase in prepaid expenses, and $21,671 decrease in accounts payable and accrued expenses, offset by non-cash expenses of $481,519 for stock based compensation, $191,156 for depreciation and amortization, and $2,635 decrease in accounts receivable and $1,878 for discounts on notes payable. $834,299 in cash was used in operating activities for the six months ended December 31, 2013.

 

$183,956 of cash was used in investing activities in the six months ended December 31, 2014. $179,921 of cash was used for the purchase of property and equipment and $4,035 of cash was used for the development of patents. $79,860 of cash was used in investing activities in the six months ended December 31, 2013.

 

$708,431 in cash was provided by financing activities in the six months ended December 31, 2014. $870,000 was provided by the exercise of stock options, offset by $93,420 common stock buy backs and $68,149 principal payments on a note payable. $900,000 in cash was provided by financing activities in the six months ended 31, 2013.

 

Immediately prior to the consummation of the Merger, the Company completed a private placement of 1,267,000 units consisting of 1,267,000 shares of common stock and warrants to purchase 633,500 shares of common stock for $2,534,000 in cash and converted all of its debt obligations totaling $6,642,500 and $574,281 in related interest expense into 5,447,194 shares of common stock and warrants to purchase 1,805,645 shares of common stock. Upon consummation of the Merger, the Company did not have any outstanding debt instruments. The Company incurred a $500,000 note payable in June 2014.

 

Immediately prior to the consummation of the Merger, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of December 31, 2014, the Company had approximately $258,000 of accrued liabilities associated with the share cancellation.

 

The Company estimates that, as of the date of this filing, its current cash will be depleted by the end of April 2015. The Company is currently seeking sources of additional funding, either in the form of debt or equity. In the event additional funding is not obtained in time, we plan to take measures to reduce our operating expenses, such as general and administrative, research and development, and selling, marketing and advertising. These measures may delay or adversely affect the commercial validation of our QSI- Nano ® iron catalysts and/or the commercialization of our metal-air batteries.

 

We monitor our financial resources on an ongoing basis and may adjust planned business activities and operations as needed to ensure that we have sufficient operating capital. We evaluate our capital needs, and the availability and cost of capital on an ongoing basis and expect to seek capital when and on such terms as deemed appropriate based upon an assessment of then-current liquidity, capital needs, and the availability and cost of capital. Given our stage of operations, we do not expect that bank or other institutional debt financing will be available. We expect that any capital we raise will be through the issuance of equity securities, warrants or similar securities. We believe that we will be able to obtain financing when and as needed, but may be required to pay a high price for capital.

 

Other Commitments and Contingencies

 

Our commitments and contingencies as of December 31, 2014 consisted of our lease agreement for our principal corporate offices located in Santa Ana, California and leased equipment. Accordingly, the following table only summarizes our minimum lease payments for the next five years and thereafter:

 

Year Ending December 31,		Amount
2015		$	104,012
2016			107,006
2017			17,172
Total		$	228,190

 

 

The above minimum lease payments include a new lease for our principal corporate offices that was signed in March 2014. The lease period is from March 2014 through February 2017.

 

OFF BALANCE SHEET ARRANGEMENTS

 

We do not have any off-balance sheet arrangements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not required by smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures.

 

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls as of the end of the period covered by this report, December 31, 2014. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer, Mr. Kevin Maloney, and Chief Financial Officer, Mr. Stephen Gillings, (the “Certifying Officers”). Based upon that evaluation, our Certifying Officers concluded that as of the end of the period covered by this report, our disclosure controls and procedures are effective in timely alerting management to material information relating to us and required to be included in our periodic filings with the Securities and Exchange Commission (the “Commission”).

 

Our officers further concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the issuer in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms and are also effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow time for decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting.

 

There were no changes in the Company's internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

ITEM 1A. RISK FACTORS

 

Not Applicable.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable.

 

ITEM 5. OTHER INFORMATION.

 

None

 

ITEM 6. EXHIBITS

 

Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-K.

 

Exhibit No.		Title of Document		Location
31		Certification of the Principal Executive Officer/ Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		Attached
32		Certification of the Principal Executive Officer/ Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*		Attached
101.INS		XBRL Instance Document		Attached
101.SCH		XBRL Taxonomy Extension Schema Document		Attached
101.CAL		XBRL Taxonomy Calculation Linkbase Document		Attached
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document		Attached
101.LAB		XBRL Taxonomy Label Linkbase Document		Attached
101.PRE		XBRL Taxonomy Presentation Linkbase Document		Attached

 

 

The Exhibit attached to this Form 10-Q shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act") or otherwise subject to liability under that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act, except as expressly set forth by specific reference in such filing.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

QUANTUMSPHERE, INC.
Date:  February 16, 2015
By:	/s/Kevin Maloney
Kevin Maloney, Chief Executive Officer
By:	/s/Stephen Gillings
Stephen Gillings, Chief Financial Officer