UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2015

 

 or

 

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

 

For the transition period from _______________________ to ___________________________

 

Commission File Number: 000-53913

 

QUANTUMSPHERE, INC.

(Exact name of registrant as specified in its charter)

 

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

 

714-545-6266

(Registrant’s telephone number, including area code)

 

 

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

 

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

 

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

 

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

 

Large accelerated filer	[  ]	.	Accelerated filer	[  ] .
Non-accelerated filer	[  ]	. (Do not check if a smaller reporting company)	Smaller reporting company	[X] .

 

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

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 16, 2015: 22,561,884

 

 

 

CAUTIONARY STATEMENT

 

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

 

 

TABLE OF CONTENTS

 

PART I

FINANCIAL INFORMATION

 

		Page
Item 1	Financial Statements	4
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4	Controls and Procedures	23
	PART II OTHER INFORMATION
Item 1	Legal Proceedings	24
Item 1A	Risk Factors	24
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3	Default upon Senior Securities	24
Item 4	Mine Safety Disclosures	24
Item 5	Other Information	24
Item 6	Exhibits	24
Signatures		25

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1 - FINANCIAL STATEMENTS

 

QUANTUMSPHERE, INC.

CONDENSED BALANCE SHEETS

 

		September 30, 2015				June 30, 2015
		(unaudited)
ASSETS
Current Assets
Cash		$	108,780			$	398,570
Inventory			65,668				65,668
Prepaid expenses and other current assets			594,914				39,081
Total current assets			769,362				503,319
Property and equipment, net			1,264,799				1,346,346
Patents, net			99,464				99,447
Other assets			24,578				24,578
Total assets		$	2,158,203			$	1,973,690
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current Liabilities
Accounts payable and accrued expenses		$	737,622			$	425,582
Notes payable, net of discount			546,595				197,639
Convertible notes payable, net of discount			170,000				42,500
Derivative liabilities			532,300				1,141,700
Total current liabilities			1,986,517				1,807,421
Notes Payable, long-term portion, net of discount			221,932				276,392
Total Liabilities			2,208,449				2,083,813
Stockholders’ Deficit
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, no shares issued or outstanding			–				–
Common stock, $0.001 par value, 500,000,000 shares authorized, 22,511,884 and 22,261,884 shares issued and outstanding as of September 30, 2015 and June 30, 2015, respectively			22,512				22,262
Additional paid-in capital			43,002,113				41,987,111
Accumulated deficit			(43,074,871	)			(42,119,496	)
Total stockholders’ deficit			(50,246	)			(110,123	)
Total liabilities and stockholders’ deficit		$	2,158,203			$	1,973,690

 

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

 

 

QUANTUMSPHERE, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended September 30,
		2015				2014
Net Sales		$	9,057			$	14,023
Cost of Sales			1,076				2,837
Gross Profit			7,981				11,186
Operating Expenses
Research and development			308,078				832,927
Selling, marketing and advertising			5,394				5,967
General and administrative			1,046,465				646,036
Total operating expenses			1,359.937				1,484,930
Loss from Operations			(1,351,956	)			(1,473,744	)
Other Expense
Interest expense, net			(65,253	)			(23,568	)
Interest expense – amortization of note discounts			(146,766	)			(939	)
Gain from change in fair value of derivative liabilities			609,400				-
Total other income (expense), net			397,381				(24,507	)
Loss Before Provision for Income Taxes			(954,575	)			(1,498,251	)
Provision for Income Taxes			800				-
Net Loss		$	(955,375	)		$	(1,498,251	)
Basic and Diluted Loss Per Common Share		$	(0.04	)		$	(0.07	)
Basic and Diluted Weighted-Average Common Shares Outstanding			22,391,232				21,455,597

 

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

 

 

QUANTUMSPHERE, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Three Months Ended September 30,
		2015				2014
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(955,375	)		$	(1,498,251	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			97,201				94,274
Stock based compensation expense			40,552				232,021
Gain from change in fair value of derivative liabilities			(609,400	)			-
Stock issued for services			402,128				-
Discount amortization on notes payable			146,766				939
Changes in operating assets and liabilities:
Accounts receivable			225				1,750
Prepaid expenses and other current assets			(45,641	)			(23,648	)
Accounts payable and accrued expenses			287,040				88,972
Net cash used in operating activities			(636,504	)			(1,103,943	)
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for development of patents			(1,545	)			(1,527	)
Purchase of property and equipment			(14,126	)			(167,775	)
Net cash used in investing activities			(15,671	)			(169,302	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuances of notes payable			410,000				-
Payments of notes payable			(47,615	)			(33,419	)
Common stock buy back			-				(61,418	)
Proceeds from exercise of common stock options			-				175,000
Net cash provided by financing activities			362,385				80,163
NET DECREASE IN CASH			(289,790	)			(1,193,082	)
CASH – beginning of period			398,570				2,702,889
CASH – end of period		$	108,780			$	1,509,807
ADDITIONAL CASH FLOW INFORMATION
Interest paid		$	20,535			$	23,618
Taxes paid		$	800			$	-

 

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

 

 

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES

 

During the three months ended September 30, 2015, the Company entered into the following noncash transactions:

 

●	Issued 250,000 shares of common stock valued at $875,000 in connection with services rendered.
●	Issued 140,000 warrants to purchase common stock with a relative fair value of approximately $87,000 in connection with the issuance of notes payable.
●	Issued 30,000 warrants to purchase common stock with a relative fair value of approximately $13,000 in connection with services rendered.

 

During the three months ended September 30, 2014, the Company had no noncash transactions.

 

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

 

 

QUANTUMSPHERE, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

September 30, 2015

 

1. ORGANIZATION AND BUSINESS

 

QuantumSphere, Inc., (the “Company” or “QuantumSphere”) was organized under the laws of the State of Nevada on December 1, 2005. The Company has developed a process to manufacture metallic nanopowders with end-use application in the battery and chemical sectors. The Company’s products are used on a stand-alone basis, in the validation of Company nano-iron catalysts coated onto commercial iron catalysts used in the production of ammonia on a prospective basis, and research, development and initial marketing of zinc-air battery products. The Company’s major activities to date have included capital formation, research and development, and marketing of its metallic nanopowder products.

 

Dr. Douglas Carpenter, our Chief Technology Officer, had been on medical leave since November 4, 2014 due to a serious medical condition. Effective May 15, 2015, Dr. Carpenter transitioned to a consulting role with the Company and served on our Scientific Advisory Board. On August 5, 2015, Dr. Carpenter’s consulting role and position on our Scientific Advisory Board ended. We remain confident that the Company has all of the necessary resources to continue to handle Dr. Carpenter’s former duties. We do not believe this change will have a material effect on business operations. We anticipate undertaking a search for a new Chief Technology Officer in the future in conjunction with a significant expansion of our operations.

 

On May 5, 2015, the Company announced that commercial validation of its nano-iron catalyst had been achieved in a production-scale ammonia plant in China.

 

On May 27, 2015, the Company entered into a multi-year Joint Development Agreement with Swiss-based Casale, S.A. (Casale), a global leader in production technologies for ammonia, urea, melamine, methanol, syngas, nitrates and phosphates. Casale’s reactor production technologies are utilized in approximately 38 percent of global ammonia production and 39 percent of global methanol production. Casale and QSI have agreed to collaborate on commercial technologies for ammonia, methanol, and other industrial chemicals, which collectively account for several hundred billion USD of production annually. Casale also agreed to utilize QSI as its exclusive provider of nanocatalysts for its chemical synthesis processes during the term of the agreement due to QSI’s demonstrated increase in catalytic activity and patented high-volume manufacturing process. The first objective of the Joint Development Agreement is to validate and optimize QSI-Nano catalysts with Casale production reactor technologies. Following a successful validation phase, the second objective is to enter into a long-term agreement with Casale for the joint global distribution and sale of QSI-Nano catalysts with Casale reactor technologies to chemical plant owners and operators.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  

The accompanying unaudited condensed financial statements have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and applicable sections of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary to make the financial statements not misleading have been included. The condensed balance sheet as of June 30, 2015 was derived form the audited financial statements filed in Form 10-K on September 28, 2015. Operating results for the three months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending June 30, 2016. For further information, refer to our Annual Report on Form 10-K for the year ended June 30, 2015.

 

Use of Estimates

 

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

 

Revenue Recognition

 

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

 

 

Cash and Cash Equivalents

 

The Company considers demand deposits, U.S. treasury securities and highly-liquid debt investments purchased with original maturities of three months or less to be cash equivalents. The Company did not have any cash equivalents as of September 30, 2015 and June 30, 2015.

 

The Company maintains its cash in major banks. From time to time, the Company’s cash balances exceed the Federal Deposit Insurance Corporation limit. The Company has not experienced and does not anticipate any losses relating to these amounts.

 

Inventory

 

Inventory consists primarily of manufactured nano materials and is comprised of raw materials, labor and manufacturing overhead. Inventory is stated at the lower of cost, determined on a first-in, first-out basis, or market. The Company did not have an excess and obsolete reserve at September 30, 2015 and June 30, 2015. An inventory reserve is created when potentially slow-moving or obsolete inventories are identified in order to reflect the appropriate inventory value. Changes in economic conditions, production requirements, and lower than expected customer demand could result in additional obsolete or slow-moving inventory that cannot be sold or must be sold at reduced prices and could result in additional reserve provisions.

 

Property and Equipment

 

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

 

Patents

 

Costs incurred in applying for patents relating to the Company’s process for production of nanopowders have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of September 30, 2015, nine patents have been issued and three patents are pending approval. Amortization relating to issued patents was not significant during the periods presented. Additional significant costs may be required for the continued development of end-use applications for the Company’s technology. Patents costs are reviewed periodically as to if any patents are no longer being pursued and associated costs should be written off.

 

Impairment of Long-Lived Assets

 

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

 

 

Fair Value of Financial Instruments and Certain Other Assets and Liabilities

 

The Company follows the guidance of U.S. GAAP with respect to assets and liabilities that are measured at fair value. U.S. GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

●	Level 1: Observable inputs such as quoted prices in active markets;
●	Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
●	Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions

 

The Company’s financial instruments consist of cash, accounts receivable, accounts payable and accrued expenses and debt. The carrying amount approximates fair value because of the short-term nature of these items.

 

Other than derivative liabilities, the Company did not have any assets or liabilities that are measured at fair value on a recurring or nonrecurring basis during the three months ended September 30, 2015 and September 30, 2014.

 

Derivative Liabilities

 

A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage in hedging transactions. However, we have entered into certain financing transactions that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security. The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.

 

Research and Development Costs

 

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

 

 

Income Taxes

 

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

 

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

 

Loss Per Share

 

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

 

Potential common shares, consisting of options and warrants, totaling 12,923,761 and 12,271,327, have been excluded from the computations of diluted net loss per share because the effect would have been anti-dilutive for the three months ended September 30, 2015 and 2014, respectively.

 

Stock-Based Compensation

 

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

 

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

 

Reclassifications

 

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

 

Risks and Uncertainties

 

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

 

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

 

 

Recent Accounting Pronouncements

 

In July of 2015.the FASB issued ASU 2015-11, “Simplifying the measurement of Inventory (Inventory (Topic 330)).” Inventory Topic 330 currently requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. ASU 2015-11 simplifies the measurement of inventory such that inventory will be measured using the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 will be effective for the Company in the fiscal year beginning after December 16, 2016. The Company does not believe that this pronouncement will have an impact on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements-Going Concern (Subtopic 205-40).” This ASU provides guidance to determine when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. ASU 2014-15 will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. ASU 2014-15 will be effective for the Company beginning June 30, 2017. The Company does not believe that this pronouncement will have an impact on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which is the new comprehensive revenue recognition standard that will supersede all existing revenue recognition guidance under U.S. GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In July 2015, the FASB voted to defer the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. The Company is currently evaluating the impact of adopting this guidance.

 

Going Concern

 

The Company has experienced recurring losses from operations from inception and has limited working capital. As of September 30, 2015, the Company had an accumulated deficit of approximately $43.0 million. The Company’s activities will necessitate significant uses of working capital beyond the current quarter. Additionally, the Company’s capital requirements will depend on many factors, including the competitiveness of, and its success in commercializing, its products. The Company plans to continue financing its operations with cash received from financing activities. Management is currently working to raise additional capital from financing activities to sustain operations until the Company is able to generate sufficient cash flows from operations. There is no assurance that the Company will be able to raise sufficient capital to continue operations and, if available, on terms satisfactory to the Company.

 

3. NOTES PAYABLE

 

On June 19, 2014, the Company signed a loan and security agreement with Novus Capital Group that provides up to two loans, each in the amount of $500,000. The initial loan of $500,000 was funded on June 19, 2014. The Company did not meet the additional equity requirement for funding of the second loan of $500,000. The loans accrue at an annual rate of 15.5%, have a term of thirty-six months, and monthly payments on each loan are $17,455, beginning August 10, 2014 for the initial loan. The agreement includes a warrant to purchase 30,000 shares of common stock at an exercise price of $2.00 per share that expires July 1, 2019; 20,000 warrants vested upon the initial funding of $500,000, and 10,000 warrants were to vest upon the second funding of $500,000, but did not vest due to second $500,000 not funding as noted above. The initial vested warrants were valued at approximately $11,000, using the Black Scholes Merton option pricing model, and recorded as a discount to the note payable.

 

 

On June 5, 2015, the Company signed a loan and security agreement with Novus Capital Group that provides an additional loan in the amount of $127,500. The loan accrues at an annual rate of 15.5%, has a term of thirty-six months, and monthly payments are $4,451, beginning July 10, 2015. The agreement includes a warrant to purchase 2,555 shares of common stock at an exercise price of $2.00 per share that expires June 30, 2020. The vested warrants were valued at approximately $1,745, using the Black-Scholes Merton option pricing model and recorded as a discount to the note payable.

 

The two loans with Novus Capital Group are secured by substantially all of the Company’s assets.

 

In September 2015, the Company issued promissory notes totaling $350,000. The promissory notes bear interest at the rate of 10% per thirty (30) day period. All outstanding principal and accrued interest under the promissory notes are to be paid no sooner than two months and no longer than six months following the date of issuance. In connection with the promissory notes, the Company also issued warrants exercisable at $3.00 per share and for a period of five (5) years. The number of warrants to be issued ranges between 120% - 160% of the face value of the promissory note depending on repayment date.

 

4. CONVERTIBLE NOTES PAYABLE

 

In May 2015, the Company issued convertible promissory notes (“Series O-1 Notes”) totaling $510,000. The Series O-1 Notes bear interest at the rate of 10% per annum, with a default rate of 18% per annum. The Series O-1 Notes will mature upon the earlier of (i) one year from the date of the issuance of the notes, or (ii) closing of an equity financing of Four Million Dollars or more (“Qualifying Equity Offering”). All outstanding principal and accrued interest under the Series O-1 Notes will be automatically converted into shares of common stock at the closing of a Qualifying Equity Offering based upon a fixed conversion price equal to the lesser of (i) a twenty percent (20.0%) discount to the price per share of common stock of the Qualifying Equity Offering, or (ii) a twenty percent (20.0%) discount to the closing bid price of the Company’s common stock on the Closing Date. Alternatively, the outstanding principal and accrued interest may be voluntarily converted, at the sole discretion of the Lender, at any time prior to the close of the Qualifying Equity Offering, in whole or in part, at a fixed conversion price per share equal to a twenty percent (20.0%) discount to the closing bid price of the Company’s common stock. In connection with the Series O-1 Notes, the Company also issued Warrants equal to 50% of the face value of the Series O-1 Notes based upon an exercise price equal to the lesser of (i) a twenty percent (20.0%) discount to the price per share of common stock of a Qualifying Equity Offering, or (ii) a twenty percent (20.0%) discount to the closing bid price of the Company’s common stock on the Closing Date. The Warrants shall be exercisable for a period of five (5) years. As a Qualifying Equity Offering has not yet occurred, the total number of warrants to be issued was not yet fixed. Due to the price protection features of the convertible note as well as the variable number of warrants that can be issued in connection with these notes, both the embedded conversion feature and the warrants were considered to be derivative liabilities. As such, the Company allocated the entire face amount of the notes as a debt discount and amortized the discount using the effective interest method. As of September 30, 2015, the unamortized discount on the notes was approximately $340,000. At June 30, 2015, the derivative liabilities were valued at $1,141,700. At September 30, 2015, the derivative liabilities were revalued at $532,300, resulting in a gain from the change in fair value of $609,400.

 

 

5. STOCKHOLDERS’ EQUITY

 

Common Stock

 

In early April 2014, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of September 30, 2015, the Company had approximately $239,000 of accrued liabilities associated with the share cancellation.

 

Stock Options

 

In 2004, the Company adopted the 2004 Stock Option and Incentive Plan (the “2004 Plan”) for directors, employees, consultants and other persons acting on behalf of the Company. Options granted under the 2004 Plan vest on the date of grant, over a fixed period of time, or upon the occurrence of certain events and are exercisable for up to ten years. As of September 30, 2015, the total shares authorized for issuance, were 7,500,000 shares of common stock. As of September 30, 2015, there were 1,158,647 shares of common stock available for grant under the 2004 Plan.

 

The fair value of stock options granted were estimated on their respective grant dates using the Black-Scholes-Merton option pricing model and the following assumptions for the three months ended September 30, 2015 and 2014:

 

		Three Months Ended September 30,
		2015				2014
Risk free interest rate			N/A				0.89	%
Expected term			N/A				5 years
Expected volatility			N/A				44.2	%
Dividend yield			N/A				–

 

Stock and Warrants for Services

 

In April 2015, the Company entered into a service agreement with a public relations firm. The agreement is for one year and calls for a monthly retainer and the issuance over months seven through twelve of 5,000 shares of common stock per month (a total of 30,000 shares of common stock) and the issuance of a total of 30,000 warrants to purchase common stock at $2.00 per share. The warrants may be exercised for a period of up to five years. The common stock was valued at the most recent market price at the date of the agreement and the fair value of the warrants was valued using the Black-Scholes Merton option pricing model; both are amortized over the length of the agreement. No shares have been issued as of September 30, 2015. 30,000 warrants have been issued as of September 30, 2015.

 

 

In July 2015, the Company entered into a service agreement with a market awareness firm. The agreement is for one year and calls for a monthly retainer and the issuance over the service period of 500,000 shares of common stock. The common stock was valued at the most recent market price at the date of the agreement and is amortized over the length of the agreement. 250,000 shares have been issued as of September 30, 2015.

 

In September 2015, the Company entered into a service agreement with a strategic advisory firm. The agreement is for one year and calls for a monthly retainer and the issuance over the service period of 100,000 shares of common stock and 50,000 warrants to purchase common stock at $1.30 per share. The warrants may be exercised through September 7, 2018. The common stock was valued at the most recent market price at the date of the agreement and the fair value of the warrants was valued using the Black-Scholes Merton option pricing model; both are amortized over the length of the agreement. No shares and no warrants have been issued as of September 30, 2015.

 

6. RELATED PARTY TRANSACTIONS

 

During the quarter ended September 30, 2015, Kevin Maloney, CEO of the Company, provided a short-term loan in the amount of $48,000. As of September 30, 2015, $9,267 had been repaid. The loan has no interest payments and is to be repaid upon the closing of the Company’s next financing.

 

7. CONCENTRATIONS

 

For the three months ended September 30, 2015, 48% of net sales were to the United States, 28% of net sales were to South Korea, 13% of net sales were to Japan, and 11% of net sales were to China. For the three months ended September 30, 2014, 51% of net sales were to South Korea, 24% of net sales were to Canada, and 14% of net sales were to the United States. For the three months ended September 30, 2015, 94% of net sales were to four customers. For the three months ended September 30, 2014, 69% of net sales were to two customers.

 

8. SUBSEQUENT EVENTS

 

In October 2015, the Company received $250,000 as part of the Series O-2 convertible promissory notes (“Series O-2 Notes”). The $250,000 investment will remain in a dedicated escrow account until such time as the Company receives $1,000,000 of investments in the Series O-2 notes offering, which amount shall include the outstanding principal and accrued interest of (a) the Series O-1 Notes and (b) the promissory notes issued in September 2015 that are exchanged, at sole discretion of the holders thereof, into Series O-2 notes. The Series O-2 Notes bear interest at the rate of 10% per annum, with a default rate of 18% per annum. The Series O-2 Notes will mature upon the earlier of (i) one year from the date of the issuance of the notes, or (ii) closing of an equity financing of Four Million Dollars or more (“Qualifying Equity Offering”). All outstanding principal and accrued interest under the Series O-2 Notes will be automatically converted into shares of common stock at the closing of a Qualifying Equity Offering based upon a fixed conversion price of $1.60 per share. Alternatively, the outstanding principal and accrued interest may be voluntarily converted, as the sole discretion of the Lender, at any time prior to the close of the Qualifying Equity Offering, in whole or in part, at a fixed conversion price of $1.60 per share. In connection with the Series O-2 Notes, the Company also issued Warrants equal to 100% of the face value of the Series O-2 Notes divided by $3.00 per share. The Warrants shall be exercisable for a period of five (5) years.

 

In November 2015, Kevin Maloney, CEO of the Company, provided a short-term loan in the amount of $50,000. The loan bears interest at the rate of 10% per thirty (30) day period. All outstanding principal and accrued interest under the loan are to be paid upon the closing of the Company’s next financing. In connection with the loan, the Company will issue warrants exercisable at $3.00 per share and for a period of five (5) years. The number of warrant to be issued ranges between 120% -160% of the face value of the loan depending on repayment date.

 

In November 2015, the Company received $50,000 for a promissory note. The note bears interest at the rate of 10% per thirty (30) day period and is for a thirty (30) day term. The Company will also issue 18,333 warrants exercisable at $3.00 per share and for a period of five (5) years.

 

 

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

 

Forward Looking Statements

 

This Form 10-Q contains statements that must be deemed “forward-looking” statements under Section 27A of the Securities Act, including, among other things, discussions as to our business strategies, expectations, market position and services, anticipated revenues and performance, future operations, profitability, liquidity and capital resources. Words including, but not limited to, “may,” “will,” “likely,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “continue,” “seek,” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in such forward-looking statements are generally reasonable and reflect the current views of our management, such statements are inherently uncertain, and we can give no assurance that such statements will ultimately prove to be correct. Our operations are subject to a number of uncertainties and risks, many of which are outside our control, and any one of which, or any combination of which, could materially adversely affect our results of operations. Important factors, including, but not limited to, those discussed in the section titled “Risk Factors,” beginning on page 16 of our Form 10-K filed on September 28, 2015, could cause actual results to differ materially from such statements. Therefore, you are cautioned not to place undue reliance on these forward-looking statements.

 

These forward-looking statements may relate to the following:

 

	●	our future operating results and business prospects;
	●	our ability to develop and market products that compete effectively in our targeted market segments;
	●	market acceptance of our current and future products and the degree and nature of our competition;
	●	our ability to meet customer demand;
	●	our ability to protect and enforce our current and future intellectual property;
	●	our ability to obtain sufficient funding to continue to pursue our business plan;
	●	our ability to implement a long-term business strategy that will be profitable or generate sufficient cash flow;
	●	our ability to manage our foreign manufacturing and development operations and international business risks;
	●	the loss of any of our key members of management;
	●	changes in our industry, interest rates or the general economy; and
	●	changes in governmental regulations, tax rates and similar matters.

 

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

 

 

Overview

 

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

 

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

 

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

 

Dr. Douglas Carpenter, our Chief Technology Officer, had been on medical leave since November 4, 2014 due to a serious medical condition. Effective May 15, 2015, Dr. Carpenter transitioned to a consulting role with the Company and served on our Scientific Advisory Board. On August 5, 2015, Dr. Carpenter’s consulting role and position on our Scientific Advisory Board ended. We remain confident that under current operations the Company has the necessary resources to continue to handle Dr. Carpenter’s former duties. We do not believe this change will have a material effect on business operations. We anticipate undertaking a search for a new Chief Technology Officer upon significant expansion of our operations in the future.

  

On May 5, 2015, the Company announced that commercial validation of its nano-iron catalyst had been achieved in a production-scale ammonia plant in China.

 

On May 27, 2015, the Company entered into a multi-year Joint Development Agreement with Swiss-based Casale, S.A. (Casale), a global leader in production technologies for ammonia, urea, melamine, methanol, syngas, nitrates and phosphates. Casale’s reactor production technologies are utilized in approximately 38 percent of global ammonia production and 39 percent of global methanol production. Casale and QSI have agreed to collaborate on commercial technologies for ammonia, methanol, and other industrial chemicals, which collectively account for several hundred billion USD of production annually. Casale also agreed to utilize QSI as its exclusive provider of nanocatalysts for its chemical synthesis processes during the term of the agreement due to QSI’s demonstrated increase in catalytic activity and patented high-volume manufacturing process. The first objective of the Joint Development Agreement is to validate and optimize QSI-Nano catalysts with Casale production reactor technologies. Following a successful validation phase, the second objective is to enter into a long-term agreement with Casale for the joint global distribution and sale of QSI-Nano catalysts with Casale reactor technologies to chemical plant owners and operators.

 

 

Emerging Growth Company

 

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

 

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

 

	●	Only two years of audited consolidated financial statements in addition to any required unaudited interim financial statements with correspondingly reduced “Management’s Discussion and Analysis of Financial Condition and Results of Operations” disclosure;
	●	Reduced disclosure about our executive compensation arrangements;
	●	No requirement that we hold non-binding advisory votes on executive compensation or golden parachute arrangements; and
	●	Exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting.

 

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

 

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

 

Critical Accounting Policies and Estimates

 

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

 

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

 

 

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

 

Patents. Costs incurred in applying for patents relating to our process for production of nanomaterials have been capitalized. Patents are amortized to reflect the pattern of economic benefits consumed, on a straight-line basis, over the estimated periods benefited. As of September 30, 2015, nine patents have been issued and three patents are pending approval. Additional significant costs may be required for the continued development of end-use applications for our technology.

 

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

 

Derivative Liabilities. A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, we do not invest in separable financial derivatives or engage in hedging transactions. However, we have entered into certain financing transactions that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. We may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security. The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.

  

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

 

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

 

Results of Operations

 

The following sets forth a discussion and analysis of the financial condition and results of operations of QSI for the three months ended September 30, 2015 and 2014. This discussion and analysis should be read in conjunction with our financial statements appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors,” beginning on page 16 of our Form 10-K filed on September 28, 2015.

 

Three Months Ended September 30, 2015 Compared to Three Months Ended September 30, 2014

 

The following discussions are based on the consolidated balance sheets as of September 30, 2015 and June 30, 2015 and statements of operations for the three months ended September 30, 2015 and September 30, 2014 and notes thereto.

 

 

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

 

	●	The first two data columns in each table show the dollar results for each period presented.
	●	The column entitled “Dollar variance” shows the change in results in dollars. This column show favorable changes as positive and unfavorable changes as negative. For example, when net sales increase from one period to the next, that change is shown as a positive number. Conversely, when expenses increase from one period to the next, that change is shown as a negative.

 

		2015				2014				Dollar variance favorable (unfavorable)
Net Sales		$	9,057			$	14,023			$	(4,966	)
Cost of Sales			1,076				2,837				1,761
Gross Profit			7,981				11,186				(3,205	)
Operating Expenses
Research and development			308,078				832,927				524,849
Selling, marketing and advertising			5,394				5,967				573
General and administrative			1,046,465				646,036				(400,429	)
Total operating expenses			1,359,937				1,484,930				124,993
Loss from Operations			(1,351,956	)			(1,473,744	)			121,788
Other Expense
Interest expense, net			(65,253	)			(23,568	)			(41,685	)
Interest expense – amortization of note discounts			(146,766	)			(939	)			(145,827	)
Gain from change in fair value of derivative liabilities			609,400				-				609,400
Total other income (expense), net			397,381				(24,507	)			421,888
Loss Before Provision for Income Taxes			(954,575	)			(1,498,251	)			543,676
Provision for Income Taxes			800				-				(800	)
Net Loss		$	(955,375	)		$	(1,498,251	)		$	542,876

 

 

Net Sales. Net sales decreased by $4,966 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014, reflecting a decrease in sales of various nanomaterials and electrodes.

 

For the three months ended September 30, 2015, 48% of net sales were to the United States, 28% of net sales were to South Korea, 13% of net sales were to Japan, and 11% of net sales were to China. For the three months ended September 30, 2014, 51% of net sales were to South Korea, 24% of net sales were to Canada, and 14% of net sales were to the United States.

 

For the three months ended September 30, 2015, 94% of net sales were to four customers. For the three months ended September 30, 2014, 69% of net sales were to two customers.

 

Gross Profit. Gross profit decreased by $3,205 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The decrease resulted from decrease of $4,966 in sales and $344,074 less allocation of nano iron production costs to research and development, offset by decreases of $154,752 in manufacturing salaries and related expenses, $84,286 in production materials, $83,196 in utilities, and $23,601 in miscellaneous expenses.

 

Research and Development. Research and development expenses decreased by $524,849 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The decrease resulted from decreases of $306,775 in production of nano iron for commercial validation purposes, $130,208 in salaries and related expenses due to less employees, $37,299 in ammonia research, $36,029 in production materials, and $15,000 in outside consultants, offset by an increase of $462 in miscellaneous expenses. In the three months ended September 30, 2014, nano iron was produced to be placed in use in an ammonia plant in China to verify prior laboratory results and thus was considered to still be part of research & development. The nano iron provided was not considered a sale as no income was received for it.

 

Selling, Marketing and Advertising Expenses. Selling, marketing and advertising expenses decreased by $573 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The decrease resulted from decreases of $2,860 in marketing expense and $1,002 in miscellaneous expenses, offset by an increase of $3,289 in outside consultants

 

General and Administrative Expenses. General and administrative expenses increased by $400,429 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The increase resulted from an increase of $576,574 in consultants and outside services (primarily for investor relations), offset by decreases of $61,567 in payroll and related expenses (primarily stock compensation expense), $39,456 in legal expense, $33,510 in board members compensation (primarily stock compensation expense), $18,892 in business insurance, $12,260 in audit expense, $9,809 in travel related expenses, and $651 in miscellaneous expenses.

 

Interest Expense. Interest expense increased by $41,685 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The increase resulted from the addition of notes payable in May, June, July, and September 2015.

 

Interest Expense – Amortization of Note Discounts. Debt discount amortization increased by $145,827 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The increase resulted primarily from debt discount amortization of $127,500 on the May 2015 notes and $18,183 on the September 2015 notes. These were non-cash entries.

 

Gain from Change in Fair Value of Derivative Liabilities. Gain from change in fair value of derivative liabilities increased by $609,400 in the three months ended September 30, 2015 compared to the three months ended September 30, 2014. The derivative liabilities relate to the convertible notes issued in May 2015 and thus there was no valuation for the three months ended September 30, 2014. The gain was the result of a decrease in the market value of our stock from June 30, 2015 which resulted in the reduction of the fair value. This was a non-cash entry.

 

 

Liquidity and Capital Resources

 

As of September 30, 2015, we had current assets of $769,362, including $108,780 in cash and cash equivalents.

 

Cash decreased $289,790 from $398,570 at June 30, 2015 to $108,780 at September 30, 2015. Net cash used in operating activities of $636,504 in the three months ended September 30, 2015 included $955,375 operating loss, $45,641 increase in prepaid expenses, and $609,400 non-cash gain from change in fair value of derivative liabilities, offset by non-cash expenses of $402,128 for stock issued for services, $146,766 for discount amortization on notes payable, $97,201 for depreciation and amortization, and $40,552 for stock based compensation, and $287,040 increase for accounts payable and accrued expenses, and $225 decrease in accounts receivable. $1,103,943 in cash was used in operating activities for the three months ended September 30, 2014.

 

$15,671 of cash was used in investing activities in the three months ended September 30, 2015. $14,126 of cash was used for the purchase of property and equipment and $1,545 of cash was used for the development of patents. $169,302 of cash was used in investing activities in the three months ended September 30, 2014.

 

$362,385 in cash was provided by financing activities in the three months ended September 30, 2015. $410,000 was provided by the issuance of notes payable, offset by $47,615 principal payments on notes payable. $80,163 in cash was provided by financing activities in the three months ended September 30, 2014.

 

Immediately prior to the consummation of the Merger, the Company executed a 10,000 for 1 reverse split. As a result of the reverse split, the Company cancelled and repurchased fractional shares comprising approximately 585,000 shares of common stock for $2.00 per share. Shortly after the reverse split, the Company executed a 1 for 10,000 forward split. As of September 30, 2015, the Company had approximately $239,000 of accrued liabilities associated with the share cancellation.

 

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

 

Other Commitments and Contingencies

 

Our commitments and contingencies as of September 30, 2015 consisted of our lease agreement for our principal corporate offices located in Santa Ana, California and leased equipment. Accordingly, the following table only summarizes our minimum lease payments for the next five years and thereafter:

 

Year Ending September 30,		Amount
2016		$	106,253
2017			44,049
Total		$	150,302

 

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

 

 

OFF BALANCE SHEET ARRANGEMENTS

 

We do not have any off-balance sheet arrangements.

 

Inflation

 

We do not believe that the current levels of inflation in the United States have had a significant impact on our operations. If current levels of inflation hold steady, we do not believe future operations will be negatively impacted.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not required by smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures.

 

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls as of the end of the period covered by this report, September 30, 2015. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer, Mr. Kevin Maloney, and Chief Financial Officer, Mr. Stephen Gillings, (the “Certifying Officers”). Based upon that evaluation, our Certifying Officers concluded that as of the end of the period covered by this report, our disclosure controls and procedures are effective in timely alerting management to material information relating to us and required to be included in our periodic filings with the Securities and Exchange Commission (the “Commission”).

 

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

 

Changes in Internal Control over Financial Reporting.

 

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

 

 

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

ITEM 1A. RISK FACTORS

 

Not Applicable.

 

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

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable.

 

ITEM 5. OTHER INFORMATION.

 

None

 

ITEM 6. EXHIBITS

 

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

 

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

  

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

 

 

SIGNATURES

 

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

 

QUANTUMSPHERE, INC.

 

Date: November 16, 2015

 

By:	/s/ Kevin Maloney
	Kevin Maloney, Chief Executive Officer

 

By:	/s/ Stephen Gillings
	Stephen Gillings, Chief Financial Officer