Form 10-K for NATURALNANO, INC.
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31-Mar-2014
Annual Report
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Note Regarding Forward-Looking Statements
This annual report on Form 10-K and other reports that we file with the SEC contain statements that are considered forward-looking statements that involve risks and uncertainties. These include statements about our expectations, plans, objectives, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as "anticipate," "estimate," "plans," "potential," "projects," "continuing," "ongoing," "expects," "management believes," "we believe," "we intend" and similar expressions. Such forward looking statements include statements addressing operating performance, events or developments that the Company expects or anticipates will occur in the future, including statements relating to revenue realization, revenue growth, earnings, earnings per share, or similar projections. These statements estimates involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed for the reasons described in this report. You should not place undue reliance on these forward-looking statements.
You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors such as:
? the ability to raise capital to fund our operations until we generate adequate cash flow internally;
? the terms and timing of product sales and licensing agreements;
? our ability to enter into strategic partnering and joint development agreements;
? our ability to competitively market our controlled release and filled tube products;
? the successful implementation of research and development programs;
? our ability to attract and retain key personnel ;
? general market conditions.
Our actual results may differ materially from management's expectations. The following discussion and analysis should be read in conjunction with our financial statements included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue in the future, or that any conclusion reached herein will necessarily be indicative of actual operating performance in the future. Such discussion represents only the best present assessment of our management.
The forward-looking statements speak only as of the date on which they are made, and except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
General
NaturalNano (the "Company"), located in Rochester, New York, is engaged in the development and commercialization of material additives based on nanomaterials technology utilizing halloysite nanotubes (HNTs). The Company provides additives designed to improve the processing characteristics and mechanical properties of engineering thermoplastics and additives designed to optimize release of active agent such as vitamins and fragrance in cosmetics products. NaturalNano holds patents relating to the commercial use of HNTs in composite materials as well as specialized techniques used in the refinement and processing of HNTs and intermediaries that it ships to customers. HNT materials used as a surface treatment have also shown promise in medical research in stem cell collection and in trapping circulating cancer cells. The Company is also exploring surface treatments related to improved adhesion of protective coatings for polymer components used in several commercial applications.
NaturalNano is domiciled in the state of Nevada as a result of the merger with Cementitious Materials, Inc., ("CMI"), which was completed on November 29, 2005.
Liquidity
Going Concern - The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying consolidated financial statements, the Company incurred a net loss for 2013 of $892,139 and had negative working capital of $6,327,900 and a stockholders' deficiency of $6,571,265 at December 31, 2013. Since inception the Company's operations have been funded through a combination of convertible debt from private investors and from cash advances from its former parent and majority shareholder Technology Innovations, LLC. These factors, among others, indicate that the Company may not be able to continue as a going concern for a reasonable period of time. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations, to extend the terms of its existing obligations, to obtain additional financing and, ultimately, to attain successful operations.
As of December 31, 2013 the company owed $4,699,686 to lenders in the form of notes payable and accrued interest. Much of this debt is convertible into the Company's common stock at terms beneficial to the lenders compared to the market price of the Company's common stock (see Note 2). The Company continues to rely on these lenders to provide additional loans to cover Company expenses and to provide forbearance agreements extending the due dates of the various notes. As of December 31, 2013, the Company continued to require waivers for debt covenant violations and extensions of maturity dates. Refer to Note 2 for lenders waivers and maturity extensions received.
The Company's management and Board of Directors continue to actively assess the Company's operating structure with an objective to reduce ongoing expenses, increase sources of recurring revenue as well as seeking additional debt or equity financing. The Company will continually evaluate funding options including additional offerings of its securities to private and institutional investors and other credit facilities as they become available. There can be no assurance as to the availability or terms upon which such financing alternatives might be available.
The Company has experienced recurring losses from operations since its inception and continues to have a working capital deficiency and limited opportunities for additional capital infusion. The Company has experienced recurring defaults relating to the various provisions under its current debt obligations and is expected to require future forbearance and waivers relating to such provisions in the future. These negative financial conditions combined with delays experienced in product introduction and customer acceptance raises substantial doubt of the Company's ability to continue as a going concern.
Comparison of Liquidity and Capital Resources
for the years ended December 31, 2013 and 2012
Operating activities
Net cash used in operating activities in the years ended December 31, 2013 and 2012 was $190,525 and $129,572, respectively. The net loss generated in 2013 was $0.3 million lower than the prior period reflecting the Company's recognition of the $335,983 in stock based compensation expense from warrant grants in 2013. During 2012, the Company incurred a non-cash expense reflected as loss on modification of debt of $473,567 from forbearances received from Platinum, Platinum Advisors and Cape One.
Total non-cash adjustments to reconcile the net loss incurred to the cash used in operations aggregated $324,823 in 2013 and $784,723 in 2012. For the twelve months ended December 31, 2013 and 2012 the company recognized non-cash expenses of $0 and $44,451, respectively, for depreciation and amortization on fixed assets as all capital assets were fully depreciated in 2012. During 2013 and 2012, the Company recorded a loss on modification of debt of $30,000 and $473,567 related to consideration given to lenders in exchange for forbearance agreements. During 2013 and 2012, the Company reduced outstanding liabilities through negotiations with certain vendors resulting in a net gain on the forgiveness of debt of $19,654 and $4,679 in 2013 and 2012, respectively.
We expect that total operational spending in 2014 will be comparable to the 2013 levels, although we will continue to invest in product and commercialization efforts as our cash position and liquidity allow.
Investing activities
There was no net cash used in investing activities in the years ended December 31, 2013 or 2012, respectively.
Financing Activities
Net cash provided from financing activities in the years ended December 31, 2013 and 2012 was $184,365 and $134,000, respectively.
During 2013 the Company borrowed a total of $184,365 from Platinum and Alpha pursuant to the terms of the Senior Secured Promissory Note. These notes bear interest at the rate of 8% per annum and are now due and payable on June 30, 2014.
During 2013, the Company issued 138,500,000 shares of common stock to Alpha Capital Anstalt ("Alpha") in payment of $10,013 of converted Longview Special Finance debt obligations and $139,507 in interest obligations on the Senior Secured Convertible Notes. In accordance with the debt agreement and accompanying assignment, these shares were issued to Alpha using a conversion prices ranging from $.000375 and $.00195 per common share. Also during 2013, the Company issued 45,882,335 shares of common stock to Merit ("Merit") in payment of $28,981 in interest obligations on the Senior Secured Convertible Notes. In accordance with the debt agreement and accompanying assignment, these shares were issued to Merit using a conversion prices ranging from $.000375 and $.0009 per common share.
During 2013, the Company issued 64,000,000 shares of common stock to Cape One in payment of $9,900 of principal and $29,975 in interest obligations on the Senior Secured Convertible Notes. These shares were issued at prices ranging from $.0004 to $0.00825 per share in accordance with the debt agreement and the conversion rates in place at the time the conversions were made.
Results of Statement of Operations
For the years ended December 31, 2013 and 2012
Revenue and Gross Profit
During the twelve months ended December 31, 2013 and 2012, the Company recorded $147,362 and $136,611, respectively in revenue for products and samples. Gross margin from continuing operations of $117,749 and $ 125,638 reflects 80% and 92% of sales for these periods, respectively. The Company expects that it will experience significant variations in gross margins with its Nanotechnology products as it continues to introduce to market and develop new products and related applications. The Company expects that competitive pricing will be a continuing challenge as new products are developed and introduced and product acceptance and the Company's production reputation develops.
For the year ended Variance
December 31, Increase
Revenue, Cost of Goods, and Gross Profit 2013 2012 (decrease)
Halloysite based products, revenue $ 147,362 $ 136,611 $ 10,751
Halloysite based products, cost of goods 29,613 10,973 (18,640 )
Gross Margin $ 117,749 $ 125,638 $ (7,889 )
Gross Margin % 80 % 92 %
Operating Expenses
Management continues to actively assess the Company's operating structure for the purpose of controlling expenses across all categories of the business. Such evaluations will continue with the intent to invest in research and development programs and product development in 2014 as our cash position and liquidity allows. No assurance can be given that future investment or debt financing will develop thereby resulting in improved cash inflow or liquidity for the Company.
Total research and development expenses decreased by $59,173 to $55,927 in the year ended December 31, 2013. The Company did not incur outside consulting services for research in 2013 and spent $3,407 less on patent maintenance filings than 2012. Consulting services were reduced in 2013 as product formulations developed in 2012 continue to be used in current sales with fewer new formulations requested by customers. There was no depreciation expense in 2013 as all laboratory assets were fully depreciated during 2012.
For the year ended Variance
December 31, Increase
Research and Development 2013 2012 (decrease)
Salaries and benefits $ 11,841 $ - $ 11,841
Patent Costs 3,334 6,741 (3,407 )
Consulting Services - 21,088 (21,088 )
Rents & Utilities 39,349 33,117 6,232
Depreciation - 44,451 (44,451 )
All other 1,403 9,703 (8,300 )
$ 55,927 $ 115,100 $ (59,173 )
Total general and administrative expense for the year ended December 31, 2013 was $680,928 as compared to $368,334 for the year ended December 31, 2012.
Salaries and benefits increased 3% in 2013 over costs incurred in 2012 and professional services increased by 14% to $73,987. During the first and fourth quarters of 2013, the Company granted a total of 114,000,000 warrants to certain consultants, the Company's CEO and the Company's board member. These warrants grant the right to purchase one share of common stock at an exercise price of $0.0014 per share. The warrants were fully vested as of the grant date and contain a cashless exercise provision. The fair value of the warrants on the date of grant was determined using the Black-Scholes model and was measured on the various dates of grant at $324,525. An expected volatility assumption of 289% has been used based on the volatility of the Company's stock price utilizing a look-back basis and the risk-free interest rate of 1.37% to 1.88% % and was derived from the U.S. treasury yields on the dates of grant. The market price of the Company's common stock on the grant dates ranged from $0.0014 to $0.0039 per share. The expiration date used in the valuation model aligns with the warrant life of five and ten years as indicated in the agreements. The dividend yield was assumed to be zero. On January 3, 2011, Mr. Jim Wemett, the Company's CEO, was awarded 882,353 warrant shares, each warrant share grants the right to purchase one share of common stock, at an exercise price of $0.01 per warrant share. The warrants vest over three years, expire January 3, 2016 and contain a cashless exercise provision. The 2011 warrant grant results in expense of $11,626 annual expense over the vesting period.
For the year ended Variance
December 31, increase
General and Administrative 2013 2012 (decrease)
Salary & Benefits $ 196,975 $ 191,758 $ 5,217
Legal and Professional Fees 73,987 64,652 9,335
Consulting Services - 34,437 (34,437 )
Insurance 5,375 3,935 1,440
Shareholder and Board 42,216 47,293 (5,077 )
Travel and Entertainment 14,322 8,917 5,405
All other 12,071 5,716 6,355
General and administrative excluding stock
based compensation $ 344,946 $ 356,708 $ (11,762 )
Stock based compensation related to warrants $ 335,982 $ 11,626 $ 324,356
Total general and administrative $ 680,928 $ 368,334 $ 312,594
Management continues to actively assess the Company's operating structure for the purpose of controlling expenses across all categories of the business. We expect that spending for general and administrative expenses will continue to be controlled in 2014, although investments in marketing and sales will be a priority if the Company's cash and liquidity position improves. No assurance can be given that future investment or debt financing will develop thereby resulting in improved cash inflow or liquidity for the Company.
Interest and Other Income (expense)
Other expense for the year ended December 31, 2013 was $272,969 as compared $854,694 for the year ended December 31, 2012.
In June 2008, the FASB finalized ASC 815, formerly Emerging Issues Task Force 07-05, "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock," which was adopted by the Company effective January 1, 2009. During the twelve months ended December 31, 2013 and 2012, the Company recognized a loss of $6,517 and $4,074 respectively relating to the changes in fair market value for these derivative liabilities.
In 2013, the Company recorded an expense of $30,000 in connection with debt modifications related to forbearance agreements signed during the year as opposed to $473,567 for debt modifications in 2012. These losses from debt modification were netted against gains on forgiveness of debt in each year of $19,654 and $4,769, respectively. The Company entered into various agreements with certain vendors to settle accounts payable that were outstanding for amounts less than the liability that was recorded in the accompanying balance sheet. These vendor concessions have been treated as gains in the period that the underlying agreements were reached. During 2013, the Company released $70,000 of deferred income from a prior year where management considered all conditions to income recognition had been met related to a research project from an interested party. This research was not extended beyond Phase I.
Interest expense includes the interest on the senior and subordinated convertible and non-convertible promissory notes.
Inflation
Although our operations are influenced by general economic conditions, we do not believe that inflation had a material effect on our results of operations during 2013 or 2012.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial condition, financial statements, revenues or expenses.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. Our actual results may differ from these estimates.
We believe, that of the significant accounting policies described in the notes to our consolidated financial statements, the following policies involve a greater degree of judgment and complexity and accordingly; these policies are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition
Revenue is generated from the delivery of Pleximer? and sample products specifically formulated for customer applications. The Company earns and recognizes such revenue when the shipment of the sample products has occurred, title transfers, no further performance obligation exists, and when collection is reasonably assured.
Deferred Taxes
Deferred tax assets and liabilities are determined based on temporary differences between income and expenses reported for financial reporting and tax reporting. ASC 740 requires that a valuation allowance be established when management determines that it is more likely than not that all or a portion of a deferred tax asset will not be realized. The Company evaluates the realizability of its net deferred tax assets on an annual basis and any additional valuation allowances are provided or released, as necessary. Since the Company has had cumulative losses in recent years, the accounting guidance suggests that it should not look to future earnings to support the realizability of the net deferred tax asset.
As of the years ended December 31, 2013 and 2012, the Company has recorded a valuation allowance to reduce its gross deferred tax assets to zero in accordance with ASC 740.
The Company believes that the accounting estimates related to deferred tax valuation allowances are "critical accounting estimates" because: (1) the need for valuation allowance is highly susceptible to change from period to period due to changes in deferred tax asset and deferred tax liability balances, (2) the need for valuation allowance is susceptible to actual operating results and
(3) changes in the tax valuation allowance can have a material impact on the tax provisions/benefit in the consolidated statements of operations and on deferred income taxes in the consolidated balance sheets.
Share-based compensation
Compensation expense related to stock-based payments is recorded over the requisite service period based on the grant date fair value of the awards. The Company uses the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of assumptions which determines the fair value of stock-based awards, including the option's expected term and the price volatility of the underlying stock.
The Company's policy for equity instruments issued to consultants and vendors in exchange for goods and services as follows: The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which the commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor's performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is based on the fair value of the services or the award, whichever is more readily determinable and is recognized over the term of the consulting agreement.
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair market value and then is revalued at each reporting date, with changes in fair value reported in the consolidated statement of operations. For stock based derivative financial instruments, the Company estimated the total enterprise value based upon trending the firm value from December 2006 to December 2013 and considering industry and Company specific factors including the changes in forward estimated revenues and market factors. Once the enterprise value was determined an option pricing model was used to allocate the enterprise value to the individual derivative securities in the Company's capital structure. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.
