ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF   OPERATIONS

 

Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" below, and elsewhere in this report, are not related to historical results, and are forward-looking statements.  Forward-looking statements present our expectations or forecasts of future events.  You can identify these statements by the fact that they do not relate strictly to historical or current facts.  These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements.  Forward-looking statements frequently are accompanied by such words such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue," or the negative of such terms or other words and terms of similar meaning.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or timeliness of such results.  Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such forward-looking statements.  We are under no duty to update any of the forward-looking statements contained herein after the date of this report.  Subsequent written and oral forward looking statements attributable to us or to persons acting in our behalf are expressly qualified in their entirety by the cautionary statements and risk factors set forth in our annual report on Form 10-K filed with the SEC on March 24, 2015, and in other reports filed by us with the SEC

You should read the following description of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and accompanying notes included in this report.

OVERVIEW

 

On June 18, 2014, we entered into a Sponsored Research Agreement ("SRA #1") with UCSB, pursuant to which UCSB performed research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #1 includes the development of a low-cost and scalable method to produce large-area graphene for transparent electrode applications.  The term of SRA #1 commenced on July 1, 2014 and expired on June 30, 2015.  The total cost to the Company was $387,730, which has been fully paid.  

On December 15, 2015, we entered into another Sponsored Research Agreement ("SRA #2") with UCSB, pursuant to which UCSB will perform research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #2 includes the development of a graphene based optical modulator for the high-speed transmission of digital data in fiber optic networks.  The term of SRA #2 commenced on January 1, 2016 and will expire on June 30, 2016.  The total cost to the Company is $65,497.

On February 9, 2016, we announced a growth-by-acquisition strategy to extend our presence in the information technology ("IT") market.  On March 7, 2016, we announced that Christopher S. Kelly joined the Company to serve as our Chief Executive Officer and help execute the growth-by-acquisition strategy.

 

In accordance with GAAP, management utilizes 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 as well as the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  These estimates and assumptions relate to recording net revenue, collectability of accounts receivable, useful lives and impairment of tangible and intangible assets, accruals, income taxes, inventory realization, stock-based compensation expense and other factors.  Management believes it has exercised reasonable judgment in deriving these estimates.  Consequently, a change in conditions could affect these estimates.

Fair Value of Financial Instruments

Disclosures about fair value of financial instruments, requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value.  As of March 31, 2016 and December 31, 2015, the amounts reported for cash, accrued interest and other expenses, and notes payable approximate the fair value because of their short maturities.

 

We adopted ASC Topic 820 (originally issued as SFAS 157, "Fair Value Measurements") as of January 1, 2008 for financial instruments measured at fair value on a recurring basis.  ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC Topic 820 established a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

 

• Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
• Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
• Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
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We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at March 31, 2016 and December 31, 2015:

Income Taxes

We account for income taxes using the asset and liability method.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Stock-Based Compensation

Stock-based compensation is measured at the grant date based on the value of the award granted using the Black-Scholes option pricing model, and recognized over the period in which the award vests.  For stock awards no longer expected to vest, any previously recognized stock compensation expense is reversed in the period of termination.  The stock-based compensation expense is included in general and administrative expenses.

Management reviewed new accounting pronouncements issued during the three months ended March 31, 2016 and through the date of filing this report, and believes no pronouncements are applicable to or would have a material impact on the condensed consolidated financial statements of the Company.

General and administrative expenses remained fairly constant in the three months ended March 31, 2016 compared to the three months ended March 31, 2015, increasing by $2,486 to $118,755 in the three months ended March 31, 2016 from 116,269 in the three months ended March 31, 2015.  The increase in general and administrative expenses in the current year is due primarily to increases in salary and other office expenses.

Research and development expenses decreased by $64,183 to $32,749 in the three months ended March 31, 2016 from $96,932 in the three months ended March 31, 2015.  The decrease in research and development expenses in the current year first quarter is due primarily to the decrease in amounts expensed related to SRA #1.

 

Depreciation and amortization expense increased by $41 to $93 in the three months ended March 31, 2016 from $52 in the three months ended March 31, 2015.   Our investment in property and equipment currently is not material to our operations, and substantially all of our property and equipment is fully depreciated at March 31, 2016.

As a result, we had a net loss of $1,800,851 and $21,252,740 in the three months ended March 31, 2016 and 2015, respectively.

As of March 31, 2016, we had a working capital deficit of $9,065,105 compared to a working capital deficit of $15,031,642 as of December 31, 2015.  The decrease in the working capital deficit was due primarily to the decrease in our non-cash derivative liabilities and the conversion of convertible debt to Series B preferred stock.  Our cash balance at March 31, 2016 was $23,107.

Series B Preferred Stock

Effective March 3, 2016, the Board of Directors of the Company authorized the issuance of 16,155 shares of Series B preferred stock having a face value of $1,615,500 to holders of convertible promissory notes in the aggregate principal amount of $1,615,362 payable by the Company (the "Prior Notes"), in exchange for the redemption and cancellation of the Prior Notes, including all outstanding principal of $1,615,362 and unpaid interest totaling $264,530.  See Note 3 to Notes to Condensed Consolidated Financial Statements for a detail discussion of the features of the Series B preferred stock.

 

The holders of the Series B preferred stock have the right, at any time, at their election, to convert all or part of the Share Value into shares of the Company's common stock. The conversion price is the lesser of (1) Fifty Percent (50%) of the lowest trade price of the Company's common stock recorded on any trade day after December 12, 2012 or (2) the lowest effective price per share granted to any person or entity to acquire shares of the Company's common stock, including the holders but excluding officers and directors of the Company.

On March 4, 2016, we entered into a convertible promissory note in the aggregate principal amount of $1,000,000 (the "March 2016 $1,000,000 CPN").  The lender may advance the Company consideration in such amounts as the lender may choose in its sole discretion.  The note is convertible into shares of our common stock at a price per share equal to the lesser of: $0.003; 50% of the lowest trade price of our common stock subsequent to the effective date of the note; or the lowest effective price per share granted to any person or entity (exclusive of our officers and directors) to acquire common stock subsequent to the effective date of the note.

We received proceeds of $25,000 on March 4, 2016, $27,000 on March 14, 2016 and $33,000 on March 17, 2016 pursuant to the March 4, 2016 $1,000,000 CPN.  The note matures, with respect to each advance, one year from the effective date of each advance.

During the three months ended March 31, 2016, we used net cash of $148,117 in operating activities as a result of our net loss of $1,800,851 and an increase in prepaid expenses of $20,045, partially offset by non-cash expenses totaling $1,625,503 and increases in accounts payable of $14,675 and accrued expenses and other current liabilities of $32,601.

During the three months ended March 31, 2015, we used net cash of $156,465 in operating activities as a result of our net loss of $21,252,740 and non-cash gain of $2,600, partially offset by non-cash expenses totaling $21,026,978, a decrease in prepaid expenses of $13,003 and increases in accounts payable of $26,704 and accrued expenses and other current liabilities of $32,190.

During the three months ended March 31, 2016, we used $1,472 in investing activities, comprised of the purchase of property and equipment.  We had no net cash provided by or used in investing activities during the three months ended March 31, 2015.

Net cash provided by financing activities during the three months ended March 31, 2016 and 2015 was $135,000 and $152,000, respectively, comprised of proceeds from convertible notes payable.

Our capital needs have primarily been met from the proceeds of equity financings and investor loans, as we are currently have no revenues.

Although most recently, proceeds received from the issuance of debt are sufficient to fund our current operating expenses, we will need to raise additional funds in the future to continue our operations and emerge from the development stage.  Therefore, our future operations are dependent on our ability to secure additional financing.  Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms.  However, the trading price of our common stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities.  Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, or experience unexpected cash requirements that would force us to seek alternative financing.  Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences, or privileges senior to those of existing holders of our common stock.  The inability to obtain additional capital may restrict our ability to grow and may reduce our ability to continue to conduct business operations.  If we are unable to obtain additional financing, we may have to curtail our marketing and development plans and possibly cease our operations.

 

We believe that we have assets to ensure that we can continue to operate without liquidation over the next twelve months, due to our current cash, and our experience in the past of being able to raise money from our investor base.  Therefore, we believe we have the ability to continue our operations for the foreseeable future and will be able to realize assets and discharge liabilities in the normal course of our operations.

The accompanying condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business.  The accompanying condensed consolidated financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern.  The Company does not generate any revenue, and has negative cash flows from operations, which raises substantial doubt about the Company's ability to continue as a going concern.  The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital.  Since our inception through March 31, 2016, the Company has obtained funds primarily from the issuance of common stock and debt.  Management believes this funding will continue, and is continually seeking new investors.  Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet the Company's obligations as they become due, and will allow the development of its core of business.  However, we cannot assure that we will be successful in these endeavors.