UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)

 QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2016
 
TRANSITION REPORT UNDER SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER: 000-54817

CARBON SCIENCES, INC.
(Name of registrant in its charter)

Nevada
 
20-5451302
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer Identification No.)
 
5511C Ekwill Street, Santa Barbara, California 93111
(Address of principal executive offices) (Zip Code)

Issuer's telephone Number: (805) 456-7000


Indicate by check mark whether the registrant (1) has filed all reports required 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    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      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 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
 
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    No 
 
The number of shares of registrant's common stock outstanding, as of May 16, 2016 was 35,177,808.


1


CARBON SCIENCES, INC. 
INDEX

 
   
3
 
4
 
5
 
6
23
29
29
30
30
30
30
31
31
31
31
35

 
PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARBON SCIENCES, INC.
 
Condensed Consolidated Balance Sheets
 
   
March 31,
2016
   
December 31,
2015
 
ASSETS
 
(Unaudited)
       
             
Current assets:
           
   Cash
 
$
23,107
   
$
37,696
 
   Prepaid expenses
   
22,052
     
2,007
 
   Total current assets
   
45,159
     
39,703
 
                 
Property and equipment, net
   
1,718
     
339
 
Total assets
 
$
46,877
   
$
40,042
 
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT
               
                 
Current liabilities:
               
   Accounts payable
 
$
154,410
   
$
139,735
 
   Accrued expenses and other current liabilities
   
5,315
     
4,611
 
   Accrued interest, notes payable
   
49,815
     
285,624
 
   Derivative liabilities
   
8,592,399
     
13,184,369
 
   Convertible notes payable
   
54,500
     
191,500
 
   Convertible notes payable, net of discount of $80,627 and
      $222,758, respectively
   
253,825
     
1,265,506
 
   Total current liabilities
   
9,110,264
     
15,071,345
 
                 
Long-term liabilities – Convertible notes payable, net of
               
    discount of 0 and $159,768, respectively
   
-
     
40,232
 
                 
Total liabilities
   
9,110,264
     
15,111,577
 
                 
Stockholders' deficit:
               
   Preferred stock, $0.001 par value; 20,000,000 shares authorized:
               
      Series A, 1,000 and 0 shares issued and outstanding, respectively
   
1
     
-
 
      Series B, 16,155 and 0 shares issued and outstanding, respectively
   
16
     
-
 
   Common stock, $0.001 par value; 1,000,000,000 shares
      authorized, 35,177,808 and 32,149,790 shares issued and
      outstanding, respectively
   
35,178
     
32,150
 
   Additional paid-in capital
   
20,074,605
     
12,268,651
 
   Accumulated deficit
   
(29,173,187
)
   
(27,372,336
)
   Total stockholders' deficit
   
(9,063,387
)
   
(15,071,535
)
Total liabilities and stockholders' deficit
 
$
46,877
   
$
40,042
 

See notes to condensed consolidated financial statements

CARBON SCIENCES, INC.
 
Condensed Consolidated Statements of Operations
 
(Unaudited)
 
   
Three Months Ended
March 31,
 
   
2016
   
2015
 
             
Revenue
 
$
-
   
$
-
 
                 
Operating Expenses:
               
   General and administrative
   
118,755
     
116,269
 
   Research and development
   
32,749
     
96,932
 
   Depreciation and amortization
   
93
     
52
 
                 
   Total operating expenses
   
151,597
     
213,253
 
                 
Loss from operations
   
(151,597
)
   
(213,253
)
                 
Other income (expense):
               
   Rental income
   
8,051
     
8,365
 
   (Loss) gain on settlement of debt
   
(39,005
)
   
2,600
 
   Loss on change in derivative liabilities
   
(1,149,505
)
   
(20,900,435
)
   Interest expense
   
(468,795
)
   
(150,017
)
                 
   Total other income (expense)
   
(1,649,254
)
   
(21,039,487
)
                 
Loss before income taxes
   
(1,800,851
)
   
(21,252,740
)
                 
Provision for income taxes
   
-
     
-
 
                 
Net loss
 
$
(1,800,851
)
 
$
(21,252,740
)
                 
                 
Net loss per common share, basic and diluted
 
$
(0.05
)
 
$
(0.82
)
                 
Weighted average number of common shares
   outstanding, basic and diluted
   
34,062,407
     
25,928,799
 
                 
See notes to condensed consolidated financial statements

 

CARBON SCIENCES, INC.
 
Condensed Consolidated Statements of Cash Flows
 
(Unaudited)
 
   
Three Months Ended
March 31,
 
   
2016
   
2015
 
             
Cash flows from operating activities:
           
   Net loss
 
$
(1,800,851
)
 
$
(21,252,740
)
   Adjustments to reconcile net loss to net cash
      used in operating activities:
               
      Depreciation and amortization
   
93
     
52
 
      Preferred stock issued for services
   
1
     
-
 
      (Gain) loss on settlement of debt
   
39,005
     
(2,600
)
      Amortization of debt discount and beneficial
         conversion feature recorded to interest expense
   
436,899
     
118,091
 
      Loss on change in derivative liabilities
   
1,149,505
     
20,900,435
 
      Stock compensation cost
   
-
     
8,400
 
   Changes in assets and liabilities:
               
      (Increase) decrease in prepaid expenses
   
(20,045
)
   
13,003
 
      Increase (decrease) in:
               
         Accounts payable
   
14,675
     
26,704
 
         Accrued expenses and other current liabilities
   
32,601
     
32,190
 
                 
   Net cash used in operating activities
   
(148,117
)
   
(156,465
)
                 
Cash flows from investing activities:
               
   Purchase of property and equipment
   
(1,472
)
   
-
 
                 
   Net cash used in investing activities
   
(1,472
)
   
-
 
                 
Cash flows from financing activities:
               
   Proceeds from convertible notes payable
   
135,000
     
152,000
 
                 
   Net cash provided by financing activities
   
135,000
     
152,000
 
                 
Net decrease in cash
   
(14,589
)
   
(4,465
)
Cash, beginning of period
   
37,696
     
15,447
 
                 
Cash, end of period
 
$
23,107
   
$
10,982
 
See notes to condensed consolidated financial statements
 
CARBON SCIENCES, INC.
Notes to Condensed Consolidated Financial Statements
Three Months Ended March 31, 2016
(Unaudited)

1.  BASIS OF PRESENTATION AND GOING CONCERN

Basis of Presentation
The accompanying unaudited condensed financial statements of Carbon Sciences, Inc. (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation have been included.  Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.  For further information refer to the consolidated financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2015.

In January 2015, we formed Transphene, Inc. ("Transphene") to hold 50% ownership in the technology developed through a research agreement (Note 9).  Through March 31, 2016, the Company has not licensed any intellectual property from UCSB and therefore has not assigned any intellectual property to Transphene.  There have been no financial transactions in Transphene and no impact on our condensed consolidated financial statements.  All future inter-company transactions will be eliminated in consolidation.

Going Concern
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 raise substantial doubt about the Company's ability to continue as a going concern.  The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital.  Since its 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.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of the Company are disclosed in Note 2 to the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K.  The following summary of significant accounting policies of the Company is presented to assist in understanding the Company's interim financial statements.  The financial statements and notes are representations of the Company's management, which is responsible for their integrity and objectivity.  These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.

Income (Loss) per Share Calculations

Basic net income or loss per common share (Basic EPS) is computed by dividing net income or loss by the weighted average number of common shares outstanding.  Diluted net income or loss per common share (Diluted EPS) is computed by dividing net income or loss by the sum of the weighted average number of common shares outstanding and the dilutive potential common share equivalents then outstanding.  Potential dilutive common share equivalents consist of shares issuable upon the exercise of outstanding stock options and warrants to acquire common stock using the treasury stock method and the average market price per share during the period.
 

Since we had no dilutive effect of stock options and warrants for the three months ended March 31, 2016 and 2015, our basic weighted average number of common shares outstanding is the same as our diluted weighted average number of common shares outstanding.  The Company has excluded 1,410,000 common shares for exercisable options, 46,000 common shares for exercisable common stock purchase warrants, approximately 23,452,000 common shares issuable upon exercise of convertible notes payable and approximately 359,000,000 common shares upon exercise of convertible Series B preferred stock for the three months ended March 31, 2016.  The Company has excluded 1,018,000 common shares for exercisable options, 46,000 common shares for exercisable common stock purchase warrants and approximately 261,202,000 common shares issuable upon exercise of convertible notes payable for the three months ended March 31, 2015.

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.
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:


   
Total
   
Level 1
   
Level 2
   
Level 3
 
March 31, 2016:
                       
   Derivative liabilities
 
$
8,592,399
   
$
-
   
$
-
   
$
8,592,399
 
                                 
   Total liabilities measured at fair value
 
$
8,592,399
   
$
-
   
$
-
   
$
8,592,399
 
                                 
December 31, 2015:
                               
   Derivative liabilities
 
$
13,184,369
   
$
-
   
$
-
   
$
13,184,369
 
                                 
   Total liabilities measured at fair value
 
$
13,184,369
   
$
-
   
$
-
   
$
13,184,369
 
 
During the three months ended March 31, 2016, the Company had the following activity in its derivative liabilities:

   
Convertible Notes
   
Series B
       
   
Payable
   
Preferred Stock
   
Total
 
                   
Derivative liability at December 31, 2015
 
$
13,184,369
   
$
-
   
$
13,184,369
 
Addition to liability for new debt/shares issued
   
135,000
     
3,908,211
     
4,043,211
 
Elimination of liability on conversion to common shares
   
(33,756
)
   
-
     
(33,756
)
Elimination of liability on conversion to preferred shares
   
(9,750,930
)
   
-
     
(9,750,930
)
Change in fair value
   
(1,567,094
)
   
2,716,599
     
1,149,505
 
                         
Derivative liability at March 31, 2016
 
$
1,967,589
   
$
6,624,810
   
$
8,592,399
 

 
Derivative Liabilities

We have identified the conversion features of our convertible notes payable and our Series B preferred stock as derivatives.  We estimate the fair value of the derivatives associated with our convertible notes payable using the Black-Scholes pricing model and estimate the fair value of the derivatives associated with our Series B preferred stock using a multinomial lattice model based on projections of various potential future outcomes.  We estimate the fair value of the derivative liabilities at the inception of the financial instruments, at the date of conversions to equity and at each reporting date, recording a derivative liability, debt discount, additional paid-in capital and a gain or loss on change in derivative liabilities as applicable.  These estimates are based on multiple inputs, including the market price of our stock, interest rates, our stock price volatility, variable conversion prices based on market prices as defined in the respective agreements and probabilities of certain outcomes based on management projections.  These inputs are subject to significant changes from period to period and to management's judgment; therefore, the estimated fair value of the derivative liabilities will fluctuate from period to period, and the fluctuation may be material.

Recently Issued Accounting Pronouncements

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 consolidated financial statements of the Company.

Reclassifications

Certain amounts in the condensed consolidated financial statements for the three months ended March 31, 2015 have been reclassified to conform to the presentation for the three months ended March 31, 2016.

3.  CAPITAL STOCK

At March 31, 2016, the Company's authorized stock consisted of 1,000,000,000 shares of common stock, with a par value of $0.001 per share.  The Company is also authorized to issue 20,000,000 shares of preferred stock, with a par value of $0.001 per share.  The rights, preferences and privileges of the holders of the preferred stock will be determined by the Board of Directors prior to issuance of such shares.

Series A Preferred Stock

On February 12, 2016, the Board of Directors of the Company authorized the issuance of 1,000 shares of Series A Preferred Stock at par value of $0.001 per share to the Company's President and director, William E. Beifuss, Jr., for services rendered.
 

On February 12, 2016, the Company filed a Certificate of Designation for its Series A Preferred Stock the "Series A Certificate") with the Secretary of State of Nevada designating 1,000 shares of its authorized preferred stock as Series A Preferred Stock.  The shares of Series A Preferred Stock have a par value of $0.001 per share. The Series A Preferred Shares do not have a dividend rate or liquidation preference and are not convertible into shares of common stock.
 
For so long as any shares of the Series A Preferred Stock remain issued and outstanding, the holders thereof, voting separately as a class, shall have the right, on or after February 12, 2016, to vote in an amount equal to 51% of the total vote (representing a super majority voting power) with respect to any proposal relating to (a) increasing the authorized share capital of the Company, and (b) effecting any reverse stock split of the Company's issued and outstanding shares of capital stock.  Such vote shall be determined by the holder(s) of a majority of the then issued and outstanding shares of Series A Preferred Stock.  For example, if there are 10,000 shares of the Company's common stock issued and outstanding at the time of such shareholder vote, the holders of the Series A Preferred Stock, voting separately as a class, will have the right to vote an aggregate of 10,408 shares, out of a total number of 20,408 shares voting.  

The shares of the Series A Preferred Stock shall be automatically redeemed by the Company at their par value on the first to occur of the following: (i) a date ninety (90) days after the effective date of the Series A Certificate, (ii) on the date that Mr. Beifuss ceases, for any reason, to serve as officer, director or consultant of the Company, or (iii) on the date that the Company's shares of common stock first trade on any national securities exchange provided that the listing rules of any such exchange prohibit preferential voting rights of a class of securities of the Company, or listing on any such national securities exchange is conditioned upon the elimination of the preferential voting rights of the Series A Preferred Stock set forth in Series A Certificate.

Additionally, the Company is prohibited from adopting any amendments to the Company's Bylaws, Articles of Incorporation, as amended, making any changes to the Series A Certificate, or effecting any reclassification of the Series A Preferred Stock, without the affirmative vote of at least 66-2/3% of the outstanding shares of Series A Preferred Stock. However, the Company may, by any means authorized by law and without any vote of the holders of shares of Series A Preferred Stock, make technical, corrective, administrative or similar changes to the Series A Certificate  that do not, individually or in the aggregate, adversely affect the rights or preferences of the holders of shares of Series A Preferred Stock.

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, which has been accruing at 10% per annum.  At the date of conversion, the Prior Notes and accrued interest payable consisted of the following:

         
Accrued
 
Effective Date
 
Principal
   
Interest
 
             
December 12, 2012
 
$
198,912
   
$
71,929
 
February 22, 2013
   
34,450
     
9,607
 
May 29, 2013
   
97,000
     
27,461
 
October 7, 2013
   
58,000
     
13,609
 
April 18, 2014
   
500,000
     
82,677
 
October 1, 2014
   
500,000
     
50,749
 
July 13, 2015
   
227,000
     
8,498
 
                 
Total
 
$
1,615,362
   
$
264,530
 

 
 
On March 2, 2016, the Company filed a Certificate of Designation for its Series B Preferred Stock (the "Series B Certificate") with the Secretary of State of Nevada designating 30,000 shares of its authorized preferred stock as Series B Preferred Stock. The shares of Series B Preferred Stock have a par value of $0.001 per share.

The total face value of this entire series is three million dollars ($3,000,000). Each share of Series B Preferred Stock has a stated face value of One Hundred Dollars ($100) ("Share Value"), and is convertible into shares of fully paid and non-assessable shares of common stock ("Common Stock") of the Company.

The holders of outstanding shares of the Series B Preferred Stock (the "Holders") are entitled to receive dividends pari passu with the holders of Common Stock, except upon a liquidation, dissolution and winding up of the Company, in which case the Series B Preferred Stock has a preference.  Such dividends will be paid equally to all outstanding shares of Series B Preferred Stock and Common Stock, on an as-if-converted basis with respect to the Series B Preferred Stock.  The Holders may elect to use the most favorable conversion price for the purpose of determining the as-if-converted number of shares.

In the event of any liquidation, dissolution or winding up of the Company, either voluntary or involuntary, the Holder of each outstanding share of the Series B Preferred Stock shall be entitled to receive, out of the assets of the Company available for distribution to its shareholders upon such liquidation, whether such assets are capital or surplus of any nature, an amount equal to one hundred dollars ($100) for each such share of the Series B Preferred Stock (as adjusted for any combinations, consolidations, stock distributions, stock splits or stock dividends with respect to such shares), plus all dividends, if any, declared and unpaid thereon as of the date of such distribution, before any payment is made or any assets distributed to the holders of the Common Stock.  After such payment, the remaining assets of the Company will be distributed to the holders of Common Stock.

If the assets to be distributed to the Holders of the Series B Preferred Stock are insufficient to permit the receipt by such Holders of the full preferential amounts, then all of such assets will be distributed among such Holders ratably in accordance with the number of such shares then held by each such Holder.

The sale of all or substantially all of the Company's assets, any consolidation or merger of the Company with or into any other entity or person, or any other corporate reorganization, in which the stockholders of the Company immediately prior to such consolidation, merger or reorganization, own less than fifty percent (50%) of the Company's voting power immediately after such consolidation, merger or reorganization, or any transaction or series of related transactions to which the Company is a party in which in excess of fifty percent (50%) of the Company's voting power is transferred, excluding any consolidation or merger effected exclusively to change the domicile of the Company, is deemed to be a liquidation, dissolution or winding up.

The Series B Preferred Stock is convertible into Common Stock.

The Holder has the right, at any time, at its election, to convert all or part of the Share Value into shares of Common Stock. The conversion price is the lesser of (1) Fifty Percent (50%) of the lowest trade price of 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, including the Holder but excluding officers and directors of the Company, to acquire Common Stock, or adjusted, whether by operation of purchase price adjustment, settlement agreements, exchange agreements, reset provision, floating conversion or otherwise, any outstanding warrant, option or other right to acquire Common Stock or outstanding Common Stock equivalents (the "Conversion Price").

The conversion formula is as follows: The number of shares receivable upon conversion equals the Share Value divided by the Conversion Price. A conversion notice (the "Conversion Notice") may be delivered to Company by any method of Holder's choice (including but not limited to email, facsimile, mail, overnight courier, or personal delivery), and all conversions will be cashless and not require further payment from the Holder. If no objection is delivered from the Company to the Holder, with respect to any variable or calculation reflected in the Conversion Notice, within 24 hours of delivery of the Conversion Notice, the Company will thereafter be deemed to have irrevocably confirmed and ratified such notice of conversion and waived any objection. The Company will deliver the shares of Common Stock from any conversion to the Holder (in any name directed by the Holder) within three (3) business days of Conversion Notice delivery. If the Company is participating in the Depository Trust Company ("DTC") Fast Automated Securities Transfer ("FAST") program, then upon request of the Holder and provided that the shares to be issued are eligible for transfer under Rule 144 of the Securities Act of 1933, as amended (the "Securities Act"), or are effectively registered under the Securities Act, the Company will cause its transfer agent to electronically issue the Common Stock issuable upon conversion to the Holder through the DTC Direct Registration System ("DRS"). If the Company is not participating in the DTC FAST program, then the Company agrees in good faith to apply and cause the approval for participation in the DTC FAST program.
 

The Conversion Price is subject to equitable adjustments for stock splits, stock dividends or rights offerings by the Company relating to the Company's securities or the securities of any subsidiary of the Company, combinations, recapitalization, reclassifications, extraordinary distributions and similar events. No fractional shares of the Common Stock shall be issuable upon the conversion of shares of the Series B Preferred Stock and the Company shall pay the cash equivalent of any fractional share upon such conversion.

If the Company fails to deliver shares in accordance with the required time frame, then for each conversion, a penalty of $1,500 per day will be assessed for each day after the third business day (inclusive of the day of the conversion) until share delivery is made.  Such penalty may be converted into Common Stock at the Conversion Price or payable in cash, at the sole option of the Holder (under the Holder's and the Company's expectations that any penalty amounts shall tack back to the original date of the issuance of Series B Preferred Stock, consistent with applicable securities laws).

In no event will the Holder be entitled to convert any Series B Preferred Stock, such that upon conversion the sum of (1) the number of shares of Common Stock beneficially owned by the Holder and its affiliates (other than shares of Common Stock which may be deemed beneficially owned through the ownership of the unconverted portion of this Series B Preferred Stock or the unexercised or unconverted portion of any other security of the Company subject to a limitation on conversion or exercise analogous to these limitations), and (2) the number of shares of Common Stock issuable upon the conversion of Series B Preferred Stock, would result in beneficial ownership by the Holder and its affiliates of more than 4.99% of the outstanding shares of Common Stock.  The limitations on conversion may be waived by the Holder upon, at the election of the Holder, not less than 61 days prior notice to the Company, and the provisions of the conversion limitation shall continue to apply until such 61st day (or such later date, as determined by the Holder, as may be specified in such notice of waiver).

Except as required by law, the Holders of Series B Preferred Stock are not entitled to vote, as a separate class or otherwise, on any matter presented to the stockholders of the Company for their action or consideration at any meeting of stockholders of the Company (or by written consent of stockholders in lieu of meeting).  Each Holder of outstanding shares of Series B Preferred Stock will be entitled, on the same basis as holders of Common Stock, to receive notice of such action or meeting.

So long as any shares of the Series B Preferred Stock remain outstanding, the Company will not, without first obtaining the approval (by vote or written consent, as provided by law) of the holders of at least a majority of the then outstanding shares of Series B Preferred Stock voting together as one class: (a) alter or change the rights, preferences or privileges of the shares of the Series B Preferred Stock so as to affect materially and adversely such shares; or (b) create any new class of shares having preference over the Series B Preferred Stock.
 

The Holder has the right, at its sole discretion, to elect a fixed conversion price for the Series B Preferred Stock.  The Fixed Conversion Price may not be lower than the Conversion Price.  The Company will not, by amendment of its Certificate of Incorporation, bylaws or through any reorganization, transfer of assets, consolidation, merger, scheme of arrangement, dissolution, issue or sale of securities, or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Series B Certificate, and will at all times carry out all the provisions of the Series B Certificate.

Common Stock

On April 20, 2016, the Company affected a one-for-ten reverse stock split of its authorized, issued and outstanding shares of Common Stock.  See Note 10.  The Company has given retroactive affect for the reverse stock split in all periods presented in the accompanying condensed consolidated financial statements.

Also in April 2016, the Company's Articles of Incorporation were amended to increase the number of authorized common shares from 100,000,000 to 2,000,000,000 shares.  See Note 10.

During the three months ended March 31, 2016, the Company issued a total of 3,028,018 shares of common stock at fair value in conversion of $10,450 of convertible promissory notes and accrued interest payable of $3,176.  In connection with the debt conversion, the Company increased common stock by $3,028 and additional paid-in capital by $83,359, reduced derivative liabilities by $33,756 and recognized a loss of $39,005 on conversion of the notes.
 
4.  STOCK OPTIONS AND WARRANTS

Stock Options

As of March 31, 2016, the Board of Directors of the Company had granted non-qualified stock options exercisable for a total of 1,410,000 shares of common stock to its employees, officers, and consultants.   Stock-based compensation cost 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, which is generally 25 months.  Stock-based compensation expense included in general and administrative expense was $$0 and $8,400 for the three months ended March 31, 2016 and 2015, respectively.  As of March 31, 2016, we had no unrecognized stock-based compensation expense.

A summary of the Company's stock option awards as of March 31, 2016, and changes during the three months then ended is as follows:


   



Shares
   

Weighted
Average
Exercise Price
   
Weighted Average
Remaining
Contract Term
(Years)
   

Aggregate
Intrinsic
Value
 
                         
Outstanding at December 31, 2015
   
1,410,000
   
$
0.19
             
Granted
   
-
   
$
-
             
Exercised
   
-
   
$
-
             
Forfeited or expired
   
-
   
$
-
             
                             
Outstanding and exercisable
 at March 31, 2016
   

1,410,000
   
$
0.19
     

4.47
   
$
49,000
 


The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the closing price of our common stock of $0.095 as of March 31, 2016, which would have been received by the holders of in-the-money options had the option holders exercised their options as of that date.

Warrants

As of March 31, 2016 and December 31, 2015, the Company had 46,000 common stock purchase warrants outstanding, with an exercise price of $5.00 per share and expiring on various dates in 2017 and 2018.

5.  CONVERTIBLE NOTES PAYABLE

Convertible Promissory Note - $299,212

Effective October 24, 2013, the remaining principal balance of the certain notes payable totaling $291,443 and accrued interest of $7,769 were combined in a new 10% convertible promissory note in the aggregate amount of $299,212.  The new note was convertible into shares of our common stock at a conversion price equal to (a) the lesser of $0.06 per share or (b) 50% of the lowest trade price recorded on any trade date after the effective date, or (c) the lowest effective price per share granted to any person through the issuance of securities after the effective date.  After conversions to our common stock during 2013 and 2014, and the three months ended March 31, 2016, the note had a principal balance of $198,912.  This principal balance and related accrued payable of $71,929 were converted into shares of Series B preferred stock on March 3, 2016.

Convertible Promissory Notes - Services of $244,452

On December 31, 2012, we entered into convertible promissory notes with three individuals in exchange for services rendered in the aggregate amount of $244,452, including $185,852 with the Chairman of our Board of Directors and our former Chief Executive Officer.  We entered into securities purchase agreements for the sale of 5% convertible promissory notes in the principal amount of $244,452, which are convertible into shares of our common stock at a conversion price equal to the lesser of $2.00 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  One of the notes with a principal balance of $25,980 at September 30, 2015 matured on December 31, 2014 and is currently in default.  The other two notes mature on December 31, 2016.  We recorded a debt discount of $237,742 related to the conversion feature of the notes, which has been fully amortized to interest expense, along with a derivative liability at inception.
 

Convertible Promissory Note - $100,000

During 2013, we received total proceeds of $40,000 pursuant to a securities purchase agreement for the sale of 10% convertible promissory notes in the aggregate principal amount of $100,000.  The notes are convertible into shares of our common stock at a price equal to a variable conversion price of the lesser of $0.90 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The notes were to mature one year from their effective date.  The maturity dates were extended to June 30, 2016.  We recorded a debt discount of $40,000 related to the beneficial conversion feature of the notes, which has been fully amortized to interest expense.  During the three months ended March 31, 2016, $5,550 principal and $1,660 accrued interest payable were converted into shares of common stock and the remaining principal of $34,450 and accrued interest payable of $9,607 were converted into shares of Series B preferred stock.

Convertible Promissory Note – Accounts Payable of $29,500

On March 14, 2013, we entered into a 5% convertible promissory note in the principal amount of $29,500, which is convertible into shares of our common stock at a conversion price equal to the lesser of $1.50 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  The note matured two years from its effective date, or March 14, 2015, and is currently in default.

Convertible Promissory Note – $97,000

On May 29, 2013, we exchanged $97,000 in demand promissory notes for a 10% convertible promissory note in the aggregate principal amount of $97,000.  The note was convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.28 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The maturity date of the note was extended to June 30, 2016.  We recorded a debt discount of $97,000 related to the beneficial conversion feature of the note, which has been fully amortized to interest expense.  The principal balance of $97,000 and accrued interest payable of $27,461 were converted into shares of Series B preferred stock on March 3, 2016.

Convertible Promissory Note – Services of $25,000

On June 4, 2013, we entered into a 5% convertible promissory note with a former member of our Board of Directors in exchange for services rendered in the amount of $25,000.  The note is convertible into shares of common stock of the Company at a conversion price equal to the lesser of $0.35 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  The note matures three years from its effective date, or June 4, 2016.

Convertible Promissory Note – $5,000 Exchanged Note

On September 6, 2013, we exchanged a $5,000 promissory note for a 10% convertible promissory note in the aggregate principal amount of $5,000.  The note is convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.042 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The note matures on June 30, 2016.  We recorded a debt discount of $2,536, which has been fully amortized to interest expense, along with a derivative liability at inception.

Convertible Promissory Note – $250,000

On October 8, 2012, we entered into to a 10% convertible promissory note in the aggregate principal amount of $250,000.  The note is convertible into shares of common stock of the Company at a price equal to the lesser of $0.06 or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion.  The maturity dates of the notes were extended to June 30, 2016.
 

The lender previously advanced a total of $11,000 in August and September 2013 that was transferred to this promissory note.  We recorded a debt discount of $11,000, which has been fully amortized to interest expense, along with a derivative liability upon transfer.

On October 21, 2013, we received additional proceeds of $22,000 on this promissory note.  We recorded a debt discount of $22,000, which has been fully amortized to interest expense, along with a derivative liability at inception.

On November 22, 2013, we received additional proceeds of $25,000 on this promissory note agreement.  We recorded a debt discount of $25,000, which has been fully amortized to interest expense, along with a derivative liability at inception.

The total principal balance of $58,000 and total accrued interest payable of $13,609 were converted into shares of Series B preferred stock on March 3, 2016.

April 2014 Convertible Promissory Note – $500,000

On April 18, 2014, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "April 2014 $500,000 CPN").  The advance amounts received were at the lender's discretion.  The notes were convertible into shares of our common stock at a price per share equal to the lesser of: $0.03; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The note matured, with respect to each advance, eighteen months from the effective date of each advance.

On April 18, 2014, we received proceeds of $60,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $60,000 related to the conversion feature of the note, along with a derivative liability at inception.  The debt discount was fully amortized to interest expense.

On May 20, 2014, we received proceeds of $45,000 pursuant to the April 2014 $500,000 SPA.  We recorded a debt discount of $45,000 related to the conversion feature of the note, along with a derivative liability at inception.  The debt discount was fully amortized to interest expense.

On June 30, 2014, we received proceeds of $200,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $200,000 related to the conversion feature of the note, along with a derivative liability at inception. The debt discount has been fully amortized to interest expense.

On July 18, 2014, we received proceeds of $25,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $820.

On August 6, 2014, we received proceeds of $65,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $4,381.

On August 18, 2014, we received proceeds of $25,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,231.
 

On September 9, 2014, we received proceeds of $56,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $56,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $7,064.

On October 8, 2014, we received proceeds of $24,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $24,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,759.

The total principal balance of $500,000 and total accrued interest payable of $82,677 were converted into shares of Series B preferred stock on March 3, 2016.

October 2014 Convertible Promissory Note – $500,000

On October 1, 2014, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "October 2014 $500,000 CPN").  The advance amounts received were at the lender's discretion.  The note was convertible into shares of our common stock at a price per share equal to the lesser of: $0.03; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The note was to mature, with respect to each advance, eighteen months from the effective date of each advance.

On October 1, 2014, we received proceeds of $65,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $7,473.

On November 7, 2014, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $3,455.

On December 9, 2014, we received proceeds of $25,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,874.

On January 14, 2015, we received proceeds of $92,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $92,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $10,596.

On February 10, 2015, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $3,455.

On March 16, 2015, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $3,436.
 

On April 17, 2015, we received proceeds of $45,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $45,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $5,164.

On May 5, 2015, we received proceeds of $65,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $7,445.

On May 11, 2015, we received proceeds of $40,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $40,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $4,582.

On June 22, 2015, we received proceeds of $35,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $35,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $4,016.

On June 23, 2015, we received proceeds of $20,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $20,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,295.

On July 9, 2015, we received proceeds of $23,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $23,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,635.

The total principal balance of $500,000 and total accrued interest payable of $50,748 were converted into shares of Series B preferred stock on March 3, 2016.

July 2015 Convertible Promissory Note – $500,000

On July 13, 2015, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "July 2015 $500,000 CPN").  The advance amounts received were at the lender's discretion.  The note was convertible into shares of our common stock at a price per share equal to the lesser of: $0.03; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The note was to mature, with respect to each advance, eighteen months from the effective date of each advance.

On July 13, 2015, we received proceeds of $12,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $12,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $1,375.

On August 7, 2015, we received proceeds of $65,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $7,445.
 

On September 10, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,879.

On October 13, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,879.

On November 13, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,879.

On December 9, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,879.

On January 14, 2016, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $2,239.

On February 9, 2016, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $1,051.

The total principal balance of $227,000 and total accrued interest payable of $8,498 were converted into shares of Series B preferred stock on March 3, 2016.

March 2016 Convertible Promissory Note – $500,000

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: $0.03; 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.  The note matures, with respect to each advance, one year from the effective date of each advance.

On March 4, 2016, we received proceeds of $25,000 pursuant to the March 4, 2016 $1,000,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $1,849.

On March 14, 2016, we received proceeds of $27,000 pursuant to the March 4, 2016 $1,000,000 CPN.  We recorded a debt discount of $27,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $1,258.
 

On March 17, 2016, we received proceeds of $33,000 pursuant to the March 4, 2016 $1,000,000 CPN.  We recorded a debt discount of $33,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the three months ended March 31, 2016, amortization of debt discount was recorded to interest expense in the amount of $1,266.

The total loss on settlement of debt related to the conversion of notes payable into shares of our common stock was $39,005 for the three months ended March 31, 2016.  The total gain on settlement of debt related to the conversion of notes payable into shares of our common stock was $2,600 for the three months ended March 31, 2015.

6.  DERIVATIVE LIABILITIES

The fair value of the Company's derivative liabilities is estimated at the issuance date and is revalued at each subsequent reporting date.   For purpose of estimating the fair value of the derivative liability associated with our convertible notes payable, we used the Black Scholes option valuation model.  The significant assumptions used in the Black Scholes valuation of the derivative liability at March 31, 2016 are as follows:

       
Stock price on the valuation date
 
$
0.095
 
Conversion price for the debt
 
$
0.0045 - $0.095
 
Dividend yield
   
0.00
%
Years to maturity
   
.75 – 1.00
 
Risk free rate
   
.49% - .59
%
Expected volatility
   
117.14% - 122.13
%

The value of the derivative liability associated with our convertible notes payable at March 31, 2016 and December 31, 2015 was estimated at $1,967,589 and $13,184,369, respectively.  These inputs are subject to significant changes and market fluctuations from period to period; therefore, the estimated fair value of the derivative liability will fluctuate from period to period and the fluctuation may be material.

For purpose of estimating the fair value of the derivative liability associated with our Series B preferred stock, we used a multinomial lattice model based on projections of various potential future outcomes.  The significant assumptions used in the valuation of the derivative liability at March 31, 2016 are as follows:

Conversion to stock
 
Monthly
 
Stock price on the valuation date
 
$
0.095
 
Conversion price
 
$
0.0045
 
Years to maturity
   
20.0
 
Expected volatility
   
270.9 – 272.6
%

The value of the derivative liability associated with our Series B convertible stock at March 31, 2016 was estimated at $6,624,810.  These inputs are subject to significant changes from period to period and to management's judgment; therefore, the estimated fair value of the derivative liability will fluctuate from period to period, and the fluctuation may be material.

 
7.  SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION

During the three months ended March 31, 2016 and 2015, the Company paid no amounts for income taxes.

During the three months ended March 31, 2016 and 2014, the Company paid no amounts for interest.

During the three months ended March 31, 2016, the Company had the following non-cash investing and financing activities:

The Company issued a total of 3,028,018 shares of common stock in conversion of $10,450 in convertible notes payable, plus $3,176 of accrued interest payable, increasing common stock by $3,028, increasing additional paid-in capital by $83,359, decreasing derivative liabilities by $33,756 and recording a loss on settlement of debt of $39,005.

The Company increased debt discount and derivative liabilities by $135,000 for the issuance of new convertible debt.

The Company issued a total of 16,155 shares of Series B preferred stock in conversion of $1,615,362 in convertible notes payable, plus $264,530 of accrued interest payable, increasing Series B preferred stock by $16, increasing additional paid-in capital by $11,630,806 and decreasing derivative liabilities by $9,750,930.

The Company increased derivative liabilities and decreased additional paid-in capital by $3,908,211 for derivative liabilities associated with the issuance of Series B preferred stock.

During the three months ended March 31, 2015, the Company had the following non-cash investing and financing activities:

The Company issued a total of 3,816,767 shares of common stock in conversion of $14,100 in convertible notes payable, plus $3,074 of accrued interest payable, increasing common stock by $3,817, increasing additional paid-in capital by $326,083, decreasing derivative liabilities by $315,326 and recording a gain on settlement of debt of $2,600.

The Company increased debt discount and derivative liabilities by $152,000 for the issuance of new convertible debt.


8.  RELATED PARTY TRANSACTIONS

See Note 3 for discussion of the issuance of 1,000 shares of Series A Preferred Stock to the Company's President and director, William E. Beifuss, Jr., for services rendered.

See Note 5 for discussion of convertible notes payable to related parties, including multiple lenders who are also shareholders of the Company.

On December 12, 2012, we entered into a convertible note with the Chairman of our Board of Directors and our former Chief Executive Officer in exchange for services valued at $185,852.  The principal balance of this related party note was $185,852 as of March 31, 2016 and December 31, 2015, with accrued interest payable of $30,195 and $27,878 as of March 31, 2016 and December 31, 2015, respectively.

On June 4, 2013, we entered into a convertible note with a member of our Board of Directors in exchange for services valued at $25,000.  As of March 31, 2016 and December 31, 2015, the principal balance of this related party note was $25,000, with accrued interest payable of $3,531 and $3,219 as of March 31, 2016 and December 31, 2015, respectively.

9.  RESEARCH AGREEMENTS AND FORMATION OF SUBSIDIARY

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 included 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.  The Company amortized the SRA #1 payments over the life of the contract.

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 will commence on January 1, 2016 and expire on June 30, 2016.  The total cost to the Company is $65,497.

On January 5, 2015, the Company formed Transphene, Inc., a Nevada corporation ("Transphene"), of which the Company owns 50% of the total issued and outstanding capital stock.  The remaining 50% is owned by Dr. Kaustav Banerjee ("Banerjee"), a director and Chief Technical Officer of Transphene.  Transphene is formed to commercialize any technology that the Company licenses out of SRA #1. In consideration for its interest in Transphene, the Company assigned to Transphene the intellectual property rights acquired by the Company from SRA #1.  The Company and Banerjee also entered into a Shareholders' Agreement pursuant to which the Company and Banerjee agreed to (i) vote their shares to elect Mr. William E. Beifuss, Jr., President and Chief Executive Officer of the Company, and Banerjee as the directors of Transphene and (ii) not sell or transfer shares until the selling shareholder first offers its shares to the other shareholder.  Through December 31, 2015, the Company has not licensed any intellectual property from UCSB and therefore has not assigned any intellectual property to Transphene.  There have been no financial transactions in Transphene and no impact on our consolidated financial statements. At this time, the Company does not see an opportunity to commercialize the research findings from SRA #1.  The Company does not intend to continue Transphene, and expects to terminate, wind-up and dissolve the subsidiary in 2016.  Any future inter-company transactions will be eliminated in consolidation.  


10.  SUBSEQUENT EVENTS

Management has evaluated subsequent events according to the requirements of ASC TOPIC 855, and has reported the following:

We received an advance under the March 4, 2016 CPN of $90,000 on April 11, 2016.

In April 2016, the Company amended its articles of incorporation to reduce the number of authorized shares of common stock from 1,000,000,000 to 100,000,000 and to affect a one-for-ten reverse stock split of its outstanding common stock.

On April 29, 2016, our Board of Directors and the holder of a majority of the total issued and outstanding voting stock of the Company authorized and approved an amendment to the Company's articles of incorporation in order to increase the number of authorized shares of common stock from 100,000,000 to 2,000,000,000.  The amendment will be recorded upon satisfaction by the Company of all applicable filing and notification requirements of the United States Securities and Exchange Commission.


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
 
Effective September 16, 2014, Carbon Sciences, Inc. ("Carbon Sciences," "we," "us," "our," or the "Company") determined to change the focus of its business from developing a technology to convert natural gas into liquid fuel to developing graphene-based technologies and devices. If successfully developed and commercialized, we plan to license our graphene technology to other companies.   The technology, which we are developing in conjunction with the University of California, Santa Barbara ("UCSB"), is intended to commercialize a new graphene-based optical modulator, a critical fiber optics component needed to help unclog the existing bottlenecks and enable ultrafast communication in data centers for Cloud computing.

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.
 

We have not yet generated revenues.  We currently have negative working capital and received an opinion from our independent auditors on our consolidated financial statements that expressed substantial doubt about our ability to continue as a going concern.  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 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 our obligations as they become due, and will allow the development of our core of business.  However, there can be no assurance that such financing will be available upon terms that are acceptable to us, if at all.

Critical Accounting Policies

Our significant accounting policies are disclosed in Note 2 to the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K.   Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP.  The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  On an ongoing basis, we evaluate our estimates, including those related to impairment of property, plant and equipment, intangible assets, deferred tax assets and fair value computations using the Black Scholes and other option pricing models.  We base our estimates on historical experience and on various other assumptions, such as the trading value of our common stock and estimated future undiscounted cash flows, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.

Use of Estimates

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.

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:

   
Total
   
Level 1
   
Level 2
   
Level 3
 
March 31, 2016:
                       
   Derivative liabilities
 
$
8,592,399
   
$
-
   
$
-
   
$
8,592,399
 
                                 
   Total liabilities measured at fair value
 
$
8,592,399
   
$
-
   
$
-
   
$
8,592,399
 
                                 
December 31, 2015:
                               
   Derivative liabilities
 
$
13,184,369
   
$
-
   
$
-
   
$
13,184,369
 
                                 
   Total liabilities measured at fair value
 
$
13,184,369
   
$
-
   
$
-
   
$
13,184,369
 

Derivative Liabilities

We have identified the conversion features of our convertible notes payable and our Series B preferred stock as derivatives.  We estimate the fair value of the derivatives associated with our convertible notes payable using the Black-Scholes pricing model and estimate the fair value of the derivatives associated with our Series B preferred stock using a multinomial lattice model based on projections of various potential future outcomes.  We estimate the fair value of the derivative liabilities at the inception of the financial instruments, at the date of conversions to equity and at each reporting date, recording a derivative liability, debt discount, additional paid-in capital and a gain or loss on change in derivative liabilities as applicable.  These estimates are based on multiple inputs, including the market price of our stock, interest rates, our stock price volatility, variable conversion prices based on market prices as defined in the respective agreements and probabilities of certain outcomes based on management projections.  These inputs are subject to significant changes from period to period and to management's judgment; therefore, the estimated fair value of the derivative liabilities will fluctuate from period to period, and the fluctuation may be material.
 

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.

Recently Issued Accounting Pronouncements

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.

Results of Operations

General and Administrative Expenses

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

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

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.

Other Income (Expense)

Total other expense was $1,649,254 and $21,039,487 for the three months ended March 31, 2016 and 2015, respectively.

  We reported a loss on change in derivative liabilities of $1,149,505 and $20,900,435 in the three months ended March 31, 2016 and 2015, respectively.  We estimate the fair value of the derivatives associated with our convertible notes payable using the Black-Scholes pricing model and estimate the fair value of the derivatives associated with our Series B preferred stock using a multinomial lattice model based on projections of various potential future outcomes.  These estimates are based on multiple inputs, including the market price of our stock, interest rates, our stock price volatility, variable conversion prices based on market prices as defined in the respective agreements and probabilities of certain outcomes based on management projections.  These inputs are subject to significant changes from period to period and to management's judgment; therefore, the estimated fair value of the derivative liabilities will fluctuate from period to period, and the fluctuation may be material.

Our interest expense increased by $318,778 to $468,795 for the three months ended March 31, 2016 from $150,017 for the three months ended March 31, 2015.  The increase is the result of interest on new debt incurred to finance our operations, including the amortization of related debt discount.

We also recognized a loss on settlement of debt resulting from the conversion of debt to equity of $39,005 for the three months ended March 31, 2016, compared to a gain on settlement of debt of $2,600 for the three months ended March 31, 2015.

We have also reported rental income from the sublease of our office space that is not material to our operations.

Net Loss

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.

Liquidity and Capital Resources

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.

March 2016 Convertible Promissory Note – $500,000

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.

Cash Flows from Operating, Investing and Financing Activities

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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.
 
ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer that it files under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive officer and principal financial officers, or persons performing similar functions as appropriate to allow timely decisions regarding required disclosure. The Company's president and chief financial officer is responsible for establishing and maintaining disclosure controls and procedures for the Company.
 

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our president and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act).  Based upon this evaluation, our president and chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (i) recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and (ii) accumulated and communicated to our management, including our president and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, (as defined in Rule 13a-15(f) under the Exchange Act).  The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes of accounting principles generally accepted in the United States.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. Furthermore, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to change in conditions, or the degree of compliance with the policies or procedures may deteriorate.  After evaluating the Company's internal controls over financial reporting, the Company's chief executive officer and chief financial officer concluded that the internal controls over financial reporting are effective as of March 31, 2016.

Changes in Internal Control Over Financial Reporting

There was no change to our internal controls or in other factors that could affect these controls during the three month period ended March 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not a party to any pending legal proceeding, nor is our property the subject of a pending legal proceeding, that is not in the ordinary course of business or otherwise material to the financial condition of our business.  None of our directors, officers or affiliates is involved in a proceeding adverse to our business or has a material interest adverse to our business.

ITEM 1A.  RISK FACTORS
 
There are no material changes from the risk factors previously disclosed in our annual report on Form 10-K filed March 24, 2016.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the three months ended March 31, 2016, the Company issued a total of 3,028,018 shares of common stock in conversion of $10,450 of convertible promissory notes and accrued interest payable of $3,176.  These shares were issued pursuant to Rule 506(b) of Regulation D of the Securities Act of 1933, as amended (the "Act").
 

On February 12, 2016, the Company issued of 1,000 shares of Series A Preferred Stock, valued at $1 to the Company's President and director, William E. Beifuss, Jr., for services.  The securities were offered and sold pursuant to an exemption from the registration requirements under Section 4(2) of the Securities Act, as amended (the "Securities Act") and Rule 506 of Regulation D promulgated thereunder since, among other things, the transactions did not involve a public offering and the securities were acquired for investment purposes only and not with a view to or for sale in connection with any distribution of them.

Effective March 3, 2016, the Company issued a total 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.  The securities were offered and sold pursuant to an exemption from the registration requirements under Section 4(2) of the Securities Act, as amended (the "Securities Act") and Rule 506 of Regulation D promulgated thereunder since, among other things, the transactions did not involve a public offering and the securities were acquired for investment purposes only and not with a view to or for sale in connection with any distribution of them.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

As further discussed in Note 5 to our condensed consolidated financial statements, as of March 31, 2016, we were in default on two convertible notes payable totaling $55,480.  We are currently in discussions with the lenders and anticipate we will successfully negotiate extensions of the maturity date of the notes.
 
ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable.

ITEM 5. OTHER INFORMATION
 
None
 
ITEM 6. EXHIBITS
 
3.1
Articles of Incorporation of Carbon Sciences, Inc. filed with the Nevada Secretary of State on August 25, 2007. (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007).
   
3.2
Articles of Amendment of Articles of Incorporation of Carbon Sciences, Inc. filed with the Nevada Secretary of State on April 9, 2007 (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007).
   
3.3
Certificate of Amendment to Articles of Incorporation, filed with the Nevada Secretary of State on May 9, 2011 (Incorporated by reference to the Company's Current Report on Form 8-K filed on May 16, 2011).
 
 
 
   
3.4
Certificate of Amendment to Articles of Incorporation, filed with the Nevada Secretary of State on August 1, 2011 (Incorporated by reference to the Company's Current Report on Form 8-K filed on August 4, 2011).
   
3.5
Certificate of Designation for Series A Preferred Stock, filed with the Nevada Secretary of State on February 12, 2016 (Incorporated by reference to the Company's Current Report on Form 8-K filed on March 4, 2016).
   
3.6
Certificate of Designation for Series B Preferred Stock, filed with the Nevada Secretary of State on March 2, 2016 (Incorporated by reference to the Company's Current Report on Form 8-K filed on February 17, 2014).
   
3.7*
Certificate of Correction, filed with the Nevada Secretary of State on April 1, 2016.
   
3.8*
Certificate of Change, filed with the Nevada Secretary of State on April 14, 2016.
   
3.9
Bylaws of Carbon Sciences, Inc. (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007).
   
4.3
Form of Warrant issued in connection with Stock Purchase Agreement entered into between the Company and the Purchasers, signatory thereto. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.1
Lease agreement with Ekwill Street, L.P. (as amended). (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.2
Exclusive License Agreement between Carbon Sciences, Inc. and the University of Saskatchewan dated December 23, 2010. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.3
Consulting Agreement dated as of March 30, 2011 between Carbon Sciences, Inc. and Emerging Fuels, Technology, Inc. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.4
Form of Stock Purchase Agreement entered into between the Company and the Purchasers, signatory thereto. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.5
Stock Option Agreement between Carbon Sciences, Inc. and Byron Elton. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
 
 
 
   
10.6
Carbon Sciences, Inc. 2011 Equity Incentive Plan. (Incorporated by reference to the Company's Registration Statement on S-1 filed on November 7, 2011)
   
10.7
Consulting Agreement between Carbon Sciences, Inc. and Howard Fong, dated December 8, 2011. (Incorporated by reference to the Company's Registration Statement on S-1 filed on January 9, 2012)
   
10.8
Form of Subscription Agreement dated as of September 18, 2006 (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007)
   
10.9
Form of Subscription Agreement dated as of October 2, 2006 (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007)
   
10.10
Form of Subscription Agreement dated as of March 1, 2007 (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007)
   
10.11
Form of Subscription Agreement dated as of April 16, 2007 (Incorporated by reference to the Company's Registration Statement on Form SB-2 filed on July 27, 2007)
   
10.12
Consulting Agreement between Carbon Sciences, Inc. and William Beifuss, dated May 31, 2013 (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2013 filed on March 31, 2014)
   
10.13
Shareholders' Agreement of Transphene, Inc., dated January 5, 2015 (Incorporated by reference to the Company's  Current Report on Form 8-K filed  on January 8, 2015)
   
14.1
Code of Ethics (Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2007 filed on March 26, 2008).
   
31.1*
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2*
Certification of the Acting Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1*
Certification of the Chief Executive Officer furnished pursuant to Section 1350 of Chapter 63 of 18 U.S.C. as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2*
Certification of the acting Chief Financial Officer furnished pursuant to Section 1350 of Chapter 63 of 18 U.S.C. as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
EX-101.INS
XBRL INSTANCE DOCUMENT
 
 
EX-101.SCH
XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
 
 
EX-101.CAL
XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
 
 
EX-101.DEF
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
   
 
EX-101.LAB
XBRL TAXONOMY EXTENSION LABELS LINKBASE
   
 
EX-101.PRE
XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE



*Filed herewith



SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Santa Barbara, State of California, on May 16, 2016.

 
CARBON SCIENCES, INC.
 
 
 
 
By:
/s/ William Beifuss
 
 
 
President (Principal Executive Officer ) and Acting Chief Financial Officer
(Principal Financial/Accounting Officer)
 
35

EXHIBIT 3.7
 

 
 

EXHIBIT 3.8
 
 

 
 

EXHIBIT 31.1
CERTIFICATION

I, William Beifuss, certify that:

1.           I have reviewed this quarterly report on Form 10-Q of Carbon Sciences, Inc. for the quarter ended March 31, 2016;
 
2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.           The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a.           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b.           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c.           Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d.           Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
 
5.           The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
a.           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
 
b.           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

May 16, 2016

/s/ William Beifuss
William Beifuss
President
(Principal Executive Officer)
 


EXHIBIT 31.2
CERTIFICATION

I, William Beifuss, certify that:

1.           I have reviewed this quarterly report on Form 10-Q of Carbon Sciences, Inc. for the quarter ended March 31, 2016;
 
2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.           The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a.           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b.           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c.           Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d.           Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
 
5.           The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
 
a.           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
 
b.           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

May 16, 2016

/s/ William Beifuss
William Beifuss
Acing Chief Financial Officer
(Principal Financial/Accounting Officer)
 


                                                                                                                                         EXHIBIT 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Carbon Sciences, Inc. (the "Company") on Form 10-Q for the quarter ended March 31, 2016 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William Beifuss, President of the Company, certify, pursuant to 18 U.S.C. section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.


March 16, 2016
/s/ William Beifuss
 
 
William Beifuss
 
President
 
(Principal Executive Officer)
 



EXHIBIT 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Carbon Sciences, Inc. (the "Company") on Form 10-Q for the quarter ended March 31, 2016 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William Beifuss, Acting Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.


May 16, 2016
/s/ William Beifuss
 
 
William Beifuss
 
Acting Chief Financial Officer
 
(Principal Financial/ Accounting Officer)