ITEM 1. BUSINESS.
Unless otherwise stated or the context requires otherwise, references in this annual report on Form 10-K to “Carbon Sciences,” the “Company,” “we,” “us,” or “our” refer to Carbon Sciences, Inc.
Introduction
Although found in abundant supply at affordable prices in the United States and throughout the world, natural gas must be converted into liquid transportation fuels, such as diesel or gasoline, before it can be used in the existing transportation infrastructure. To meet this need, we are in the early stages of developing a small-scale natural gas-to-liquids (“GTL”) plant to produce diesel and other fuels (the “miniGTL plant” or the “Plant”). We anticipate that the miniGTL plant will be based on integrating and optimizing existing GTL technology components and processes into a modular diesel and other fuels production facility. We believe developing the Plant will require bringing together natural gas resource holders, engineering firms, and technology firms. Based on our internal economic analysis and conversations with prospective partners, we believe that the miniGTL, a modular Plant producing approximately 1,000 barrels per day of diesel and other fuels may be economically viable in the United States, given the low price and abundance of natural gas. We anticipate that a modular Plant would be mobile and could be moved from one gas field to another, amortizing the capital cost of the plant over several small gas fields, which are more plentiful than large gas fields.
We have also been developing a proprietary GTL catalyst technology, a dry reforming process that we believe can consume carbon dioxide (CO2) and natural gas to produce hydrogen (H2) and carbon monoxide (CO), an industry standard gas mixture commonly known as syngas. Syngas can then be processed into liquid fuels, such as gasoline and diesel, using commercially available technology, based on Fischer Tropsch and Methanol-to-Gasoline chemistry. The development work on this catalyst is based on a patented catalyst, for which we have an exclusive license from the University of Saskatchewan, Canada. The patented catalyst is a laboratory scale catalyst with over 2,000 hours of uninterrupted run time with high efficiency in converting natural gas and CO2 to syngas. Our research and development efforts have been based on developing a commercial form of this catalyst for use in industrial scale natural gas reforming processes. Our development activities have been primarily performed by outside catalyst development firms. Because the commercialization of an industrial grade natural gas reforming catalyst is a lengthy process that requires many iterative long-term and expensive testing programs, we have suspended our development efforts and are seeking a strategic partner for further funding and to help accelerate the commercial development of our catalyst. Without additional funding specifically devoted to this effort, we will not continue to develop our catalyst and may lose our exclusive license from the University of Saskatchewan, Canada.
To capitalize on what management believes to be the growing natural gas industry and the growing need for liquid transportation fuels, we have shifted our focus toward actual fuel production project development. We believe that by integrating commercially available GTL technology components in partnership with natural gas suppliers, we can develop a small scale GTL plant that can produce diesel and other fuels from natural gas that is cost competitive with traditional liquid fuels made from petroleum. Because natural gas is the cleanest of all fossil fuels, GTL diesel and gasoline are also cleaner and have smaller carbon footprints than their petroleum counterparts.
Market Opportunity
In the International Energy Outlook 2010 report, the United States Energy Information Administration (“EIA”) predicts that worldwide energy consumption will increase by 49% from 2007 to 2035. This increase translates to a requirement of over 114 million barrels of crude oil per day in 2035, up from 86 million barrels per day in 2007. The EIA reports that the biggest use of crude oil, making up nearly 80% of the increase, is in the production of liquid fuels for the transportation sector.
The 2010 World Energy Outlook report published by the International Energy Agency (“IEA”) stated that 2006 was the year that the world’s conventional oil production reached its peak of 70 million barrels per day.
In the World Energy Outlook 2011 report, the IEA postulates that the world is entering a “Golden Age of Gas.” Management believes that while the supply of world crude oil is declining, the global natural gas resource base is vast and widely dispersed geographically. The IEA estimates that conventional recoverable gas resources are equivalent to more than 120 years of current global consumption, while total recoverable resources could sustain today’s production for over 250 years.
Gas to Liquids Overview
Many natural gas proponents are proposing the use of compressed natural gas (“CNG”) or liquefied natural gas (“LNG”) for use in new trucks and other vehicles. We believe this is a step in the right direction, but new engines mean new and expensive infrastructure. We believe a better solution is the direct transformation of natural gas into gasoline, diesel and jet fuel for use in existing engines and fuel delivery infrastructure.
We believe there are four main reasons why natural gas should be the new feedstock for liquid fuels:
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Energy independence from petroleum;
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Resulting liquid fuels can be used directly in the existing infrastructure;
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Natural gas is abundant and affordable; and
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Reduction of greenhouse gas emissions.
Current industrial scale gas-to-liquids (“GTL”) technology, invented by German chemists Franz Fischer and Hans Tropsch in the 1920’s, can convert a gas mixture of hydrogen (H2) and carbon monoxide (CO) into liquid fuels without using petroleum. However, H2 and CO do not exist naturally and must be manufactured synthetically. There are a number of ways to make this synthesis gas, or syngas, but the most promising and scalable approach is the reforming of natural gas, which is primarily methane (CH4).
There are four (4) known processes to reform natural gas (methane) into syngas:
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Steam Reforming - Reacts steam with methane.
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Partial Oxidation - Reacts pure oxygen with methane.
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Autothermal Reforming - A combination of steam and partial oxidation reforming.
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Dry Reforming - Reacts carbon dioxide with methane, without steam or oxygen.
In our miniGTL plant, we intend to use a combination of existing and well known reforming processes - steam, partial oxidation, and/or autothermal. Dry reforming, which is what our proprietary catalyst does, will not be used in our first miniGTL plant.
Business Model
We are in the early stages of developing a small-scale natural gas-to-liquids (“GTL”) plant to produce diesel or gasoline (the “miniGTL plant” or the “Plant”). We anticipate that the miniGTL plant will be based on integrating and optimizing existing GTL technology components and processes into a modular diesel or gasoline production facility. We believe developing the Plant will require bringing together natural gas resource holders, engineering firms, and technology firms. Based on our internal economic analysis and conversations with prospective partners, we believe that the miniGTL, a modular Plant producing approximately 1,000 barrels per day of diesel or gasoline may be economically viable in the United States, given the low price and abundance of natural gas. We anticipate that a modular Plant would be mobile and could be moved from one gas field to another, amortizing the capital cost of the plant over several small gas fields, which are more plentiful than large gas fields.
Our plan is to act as the project developer, and then own and operate the miniGTL Plant. However, at any stage of this business process, we may choose to partner with other companies and or/sell our interest in the miniGTL Plant.
Marketing Strategy
We expect that our marketing strategy will include media and analyst communication, blogs, and selected trade show attendance. We intend to utilize appropriate opportunities to place our brand in general and industry specific publications, using press releases, white papers and authored articles and Internet publications.
Research and Development
At this time, we are not undertaking any research and development projects.
From time to time, we engage scientific advisors and part-time technical contractors, to help us develop our miniGTL plant. As a project developer, we plan to outsource as much of the development activity as possible.
Government Regulation
With respect to technology development and licensing activities, we do not intend to sell, manufacture, or produce any products. We are currently not subject to any government regulations that have a material effect on these operations. However, in the event that we successfully complete the development and then begin operating a miniGTL plant, we will be subject to a number of government regulations, including those administered by the Environmental Protection Agency and various states. Additionally, we are not aware of any pending legislation or regulations that would have a material effect on our operations.
Manufacturing and Distribution
With respect to technology development and licensing activities, we do not intend to manufacture and distribute any products. However, in the event that we successfully complete the development and begin operating a miniGTL plant, we will manufacture and distribute liquid transportation fuels, such as gasoline and diesel.
Intellectual Property
We have filed numerous patent applications with the United States Patent and Trademark Office (“USPTO”) in the course of our business history.
On December 23, 2010, we entered in to a license agreement (“License Agreement”) with the University of Saskatchewan (“UOS”), pursuant to which we have an exclusive, worldwide, sub-licensable, royalty-bearing right and license to make, have made, use, offer for sale, sell, reproduce, distribute, incorporate into other technology, or otherwise exploit certain patent-pending technology and relevant improvements from UOS, for a high performance catalyst for the dry reforming of methane with carbon dioxide for the production of synthesis gas. This License Agreement commenced on December 23, 2010, and will continue until the expiration date of the last of the licensed patents. In consideration for the grant of the patents, we are required to pay license fee of $20,000 a year for the term of the License Agreement. In addition, we are obligated to pay US $50,000 upon the first application of a licensed product in a pilot-scale or commercial facility and US $50,000 upon the first sale of a licensed product. We are also required to pay royalties ranging from 0.9% to 3.6% of the sales revenue from a customer that uses a tangible licensed product or system made by us. In the event that we sublicense the licensed patents, we must pay UOS sublicense compensation ranging from 6.25% to 12.5% of the sublicense fees that we receive. Under the License Agreement, we are also required to maintain general liability insurance with policy limits of no less than $2,000,000 during the term of the License Agreement and products liability insurance coverage with policy limits of no less than $5,000,000 to protect against our activities in relation to the license agreement.
The License Agreement may be terminated upon the party’s mutual consent or upon the expiration of six months after notice of termination to the UOS. In addition, the License Agreement may be terminated upon the occurrence of an event of default under the agreement.
The patent subject to the license agreement was issued by the USPTO on July 26, 2011 as patent No. 7,985,710.
Competition
The market for liquid fuel is large, as is the number of competitors providing technology to the fuel industry. For example, companies that offer fuel production technologies include UOP LLC (a Honeywell Company), Chevron Corp, Royal Dutch Shell plc, BP plc, and ExxonMobil Corp. Royal Dutch Shell and Sasol have profitably commercialized large scale, multi-billion dollar GTL plants. To our knowledge, there are currently no providers or operators of small scale GTL plants in the 1,000 - 2,000 barrel per day range. We see this as a lucrative market opportunity and we expect new entrants into the market. Many of these competitors may be more capitalized and may have more human resources than we do to develop a GTL project. However, since we are developing one profitable fuel production GTL plant at a time, competition may limit the availability of new opportunities but it does not change the economics of our project once it is up and running. In fact, the more competitive activity we see in the development of small scale GTL plants, the more it validates the vibrancy of our market.
Employees
As of March 24, 2014, we had one full-time employee. We have arrangements with various independent contractors and consultants to meet additional needs, including management, accounting, investor relations, research and development and other administrative functions.
ITEM 1A.
ITEM 1A. RISK FACTORS
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
We are in the early stages of development and have limited operating history on which you can base an investment decision.
We were formed in August 2006 and have been developing a new technology for commercial use. We have generated no revenues, have no real operating history upon which you can evaluate our business strategy or future prospects, and have negative working capital. As a result, our auditor issued an opinion in connection with our December 31, 2013 financial statements, which expressed substantial doubt about our ability to continue as a going concern unless we obtain additional financing. Our ability to generate such revenues will depend on whether we can successfully develop, commercialize and license our technology and make the transition from a development stage company to an operating company. We expect to continue to incur losses. In making your evaluation of our prospects, you should consider that we are a start-up business focused on a new technology, are designing solutions that have no proven market acceptance, and operate in a rapidly evolving industry. As a result, we may encounter many expenses, delays, problems and difficulties that we have not anticipated and for which we have not planned. There can be no assurance that at this time we will successfully commercialize our technology, operate profitably or that we will have adequate working capital to fund our operations or meet our obligations as they become due.
Our proposed operations are subject to all of the risks inherent in the initial expenses, challenges, complications and delays frequently encountered in connection with the formation of any new business. Investors should evaluate an investment in our company in light of the problems and uncertainties frequently encountered by companies attempting to develop markets for new products, services and technologies. Despite best efforts, we may never overcome these obstacles to achieve financial success. Our business is speculative and dependent upon the implementation of our business plan, as well as our ability to successfully complete the development of our technology or enter into licensing agreements with third parties on terms that will be commercially viable for us. There can be no assurance that our efforts will be successful or result in revenue or profit. There is no assurance that we will earn significant revenues or that our investors will not lose their entire investment.
If we are unable to effectively manage the transition from a development stage company to an operating company, our financial results will be negatively affected.
For the period from our inception, August 25, 2006, through December 31, 2013, we incurred an aggregate net loss, and had an accumulated deficit, of $14,449,332. For the years ended December 31, 2013 and 2012, we incurred net losses of $3,497,502 and $3,273,158. Our losses are expected to continue to increase for at least the next 48 months as we commence full-scale development of our technology. We believe we will require significant funding to make this transition. As we do make such transition, we expect our business to grow significantly in size and complexity. This growth is expected to place significant additional demands on our management, systems, internal controls and financial and operational resources. As a result, we will need to expend additional funds to hire additional qualified personnel, retain professionals to assist in developing appropriate control systems and expand our operating infrastructures. Our inability to secure additional resources, as and when needed, or manage our growth effectively, if and when it occurs, would significantly hinder our transition to an operating company, as well as diminish our prospects of generating revenues and, ultimately, achieving profitability.
We may not be able to finance the development of a miniGTL plant.
The cost of developing a miniGTL plant may require in excess of $100,000,000. We may not be able to attract sufficient interest from private equity partners and banks to complete the project. If we are not able to fund the cost of the miniGTL plant, we may be forced to scale back our plans to develop a miniGTL plant.
We may not be able to obtain sufficient quantities of natural gas at a reasonable cost to successfully to operate a miniGTL plant.
While natural gas is abundant in the United States at this time, we may not be able to contract for a sufficient quantity for the successful long-term operation of a miniGTL plant. Also, we have no assurance at this time that a long-term supply of natural gas can be obtained at cost that will allow us to successfully operate a miniGTL plant.
Changes in government regulations may delay or threaten the development and operation of a miniGTL plant.
In the event that we successfully complete the development and then begin operating a miniGTL plant, we will be subject to a number of government regulations, including those administered by the Environmental Protection Agency and various states. Changes in any of these government regulations may delay or threaten the development and operation of a miniGTL plant.
Sufficient customer acceptance for our technology may never develop or may take longer to develop than we anticipate, and as a result, our revenues and profits, if any, may be insufficient to fund our operations.
Sufficient markets may never develop for our technology, may develop more slowly than we anticipate or may develop with economics that are not favorable for us. The development of sufficient markets for our technology at favorable pricing may be affected by cost competitiveness of our technology, customer reluctance to try new technology and emergence of more competitive technologies. Because out technology has not yet been used to manufacture syngas or liquid fuels, potential customers may be skeptical about product stability, supply availability, quality control and our financial viability, which may prevent them from purchasing our technology or entering into long-term licensing agreements with us. We cannot estimate or predict whether a market for our technology will develop, whether sufficient demand for our technology will materialize at favorable prices, or whether satisfactory profit margins will be achieved. If such pricing levels are not achieved or sustained, or if our technologies and business approach to our markets do not achieve or sustain broad acceptance, our business, operating results and financial condition will be materially and adversely impacted.
The ability of our catalyst technology to be utilized on a commercially sustainable basis is unproven, and until we can develop and prove our technology, we likely will not be able to generate or sustain sufficient revenues to continue operating our business.
While producing syngas is not a new technology, our dry reforming catalyst is not currently suitable for commercial use and has never been utilized on a commercially sustainable basis. The tests that we have conducted to date with respect to our technology have been performed in a limited scale environment, and the same or similar results may not be obtainable at competitive costs on a large-scale commercial basis. While industrial processes exist to convert syngas into liquid fuels, we have not conducted end-to-end tests on the ability of our technology to produce liquid gas.
We have never utilized our technology under the conditions or in the volumes that will be required for us to be profitable and cannot predict all of the difficulties that may arise. Our technology requires further research, development, regulatory approvals, environmental permits, design and testing prior to commercialization. Accordingly, our technology may not perform successfully on a commercial basis and may never generate any meaningful revenues or profits.
We likely will not be able to generate significant revenues until we can successfully validate the performance of our technology with customers.
To date, we have generated no revenues. Revenue generation could be impacted by any of the following:
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delays in demonstrating the technological advantages or commercial viability of our proposed technology;
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delays in developing our technology; and
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inability to interest early adopter customers in our technology.
We may not be able to enter into agreements to license our technology at prices that will cover our costs. Potential customers may require lengthy or complex trials or long sampling periods before committing to license our technology.
The current credit and financial market conditions may exacerbate certain risks affecting our business.
Due to the continued disruption in the financial markets arising from the global recession and the slow pace of economic recovery, many of our potential customers are unable to access capital necessary to accommodate the use of our technology. Many are operating under austerity budgets that limit their ability to invest in infrastructure necessary to use alternative fuels and that make it significantly more difficult to take risks with new fuel sources. As a result, we may experience increased difficulties in convincing customers to adopt our technology as a viable alternative at this time.
We may not be able to generate revenues from licensing our technology.
Our business plan includes, as our main revenue stream, the collection of royalties through licensing our technology intellectual property portfolio that we currently have and will build in the course of our business. Companies to which we grant licenses may not be able to produce, market and sell enough products to pay us royalty fees or they may default on the payment of royalties. We may not be able to achieve profitable operations from collecting royalties from the licensing of our proprietary technology.
We do not maintain theft or casualty insurance, and only maintain modest liability and property insurance coverage and therefore we could incur losses as a result of an uninsured loss.
We cannot assure that we will not incur uninsured liabilities and losses as a result of the conduct of our business. Any such uninsured or insured loss or liability could have a material adverse effect on our results of operations.
If we lose key employees and consultants or are unable to attract or retain qualified personnel, our business could suffer.
Our success is highly dependent on our ability to attract and retain qualified scientific, engineering and management personnel. Competition for these qualified personnel is intense. We are highly dependent on our management and key consultants who have been critical to the development of our business. The loss of the services of key employees and key consultants could have a material adverse effect on our operations. We do not have an employment agreement with any employees. Accordingly, there can be no assurance that any employees will remain associated with us. The efforts of key employees will be critical to us as we continue to develop our technology and as we attempt to transition from a development stage company to a company with commercialized products and services. If we were to lose key employees or consultants, we may experience difficulties in competing effectively, developing our technology and implementing our business strategies.
The strategic relationships upon which we may rely are subject to change.
Our ability to successfully test our technology and identify and enter into commercial arrangements with licensees will depend on developing and maintaining close working relationships with industry participants. These relationships will need to change and evolve over time, as we enter different phases of development. Our strategic relationships most often are not yet reflected in definitive agreements, or the agreements we have do not cover all aspects of the relationship. Our success in this area also will depend on our ability to select and evaluate new strategic relationships and to consummate transactions. To test our technology, we will be dependent on strategic partners for the use or construction of demonstration systems. Our inability to identify suitable companies or enter into and maintain strategic relationships may affect our ability to commercialize our technology and impair our ability to grow. The terms of relationships with strategic partners may require us to incur expenses or undertake activities we would not otherwise be inclined to incur or undertake in order to maintain these relationships.
Failure to obtain the patents for our applications could prevent us from securing royalty payments in the future, if appropriate.
In addition to our license to the patented UOS catalyst, we may file new patent applications and build a global patent portfolio related to the methods of catalyst preparation, commercial form of the catalyst, application of the catalyst, process design and optimizations, in the normal course of our business. We cannot be certain that patents will be granted nor can we be certain that other companies will not file for patent protection for the similar technology before us. Even if we are granted patent protection for our technology, there is no assurance that we will be in a position to enforce our patent rights. Failure to be granted patent protection for our technology could result in greater competition or in limited royalty payments. This could result in inadequate revenue and cause us to cease operations.
We may never fully realize the value of our technology license agreement, which presently is the principal asset reflected on our balance sheet.
We may not be successful in realizing the expected benefits from our Exclusive License Agreement with the UOS. We intend to incorporate the licensed technology in our development of a high performance catalyst for the dry reforming of methane with carbon dioxide for the production of synthesis gas. To date, we have incurred approximately $1,246,000 in research and development costs separate from our license payments, and we will incur additional research and development costs to commercialize the catalyst and optimize the process.
If we do not obtain protection for our intellectual property rights, our competitors may be able to take advantage of our research and development efforts to develop competing technology.
Our success, competitive position and future revenues will depend in part on our ability to obtain and maintain patent protection for our methods, processes and other technologies, to preserve our trade secrets, to prevent third parties from infringing on our proprietary rights and to operate without infringing the proprietary rights of third parties.
We have yet to complete an infringement analysis and, even if such an analysis were available at the current time, we could not be certain that no infringement exists, particularly as our products have not yet been fully developed. We may need to acquire additional licenses from third parties in order to avoid infringement claims, and any required licenses may not be available to us on acceptable terms, or at all. To the extent infringement claims are made, we could incur substantial costs in the resulting litigation, and the existence of this type of litigation could impede the development of our business.
We anticipate filing patent applications both in the U.S. and in other countries, as appropriate. However, the patent process is subject to numerous risks and uncertainties, and there can be no assurance that we will be successful in protecting our technology by obtaining and defending patents. These risks and uncertainties include but are not limited to the following:
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Patents that may be issued or licensed may be challenged, invalidated, or circumvented, or otherwise may not provide any competitive advantage.
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Our competitors, many of which have substantially greater resources than us and many of which have made significant investments in competing technologies, may seek, or may already have obtained, patents that will limit, interfere with, or eliminate our ability to make, use, and sell our potential products either in the United States or in international markets.
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Countries other than the United States may have less restrictive patent laws than those upheld by United States courts, allowing foreign competitors the ability to exploit these laws to create, develop, and market competing products.
In addition to patents, we also intend to rely on trade secrets and proprietary know-how. Although we take measures to protect this information by entering into confidentiality and inventions agreements with our employees, scientific advisors, consultants, and collaborators, we cannot provide any assurances that these agreements will not be breached, that we will be able to protect ourselves from the harmful effects of disclosure if they are breached, or that our trade secrets will not otherwise become known or be independently discovered by competitors. If any of these events occurs, or we otherwise lose protection for our trade secrets or proprietary know-how, the value of this information may be greatly reduced.
Patent protection and other intellectual property protection are important to the success of our business and prospects, and there is a substantial risk that such protections will prove inadequate.
Intellectual property disputes could require us to spend time and money to address such disputes and could limit our intellectual property rights.
We may become subject to infringement claims or litigation arising out of patents and pending applications of competitors, or additional proceedings initiated by third parties or the United States Patent and Trademark Office, or PTO, to reexamine the patentability of our licensed patents. The defense and prosecution of intellectual property suits, PTO proceedings, and related legal and administrative proceedings are costly and time-consuming to pursue, and their outcome is uncertain. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and know-how, or to determine the enforceability, scope, and validity of the proprietary rights of others. An adverse determination in litigation or PTO proceedings to which we may become a party could subject us to significant liabilities, require us to obtain licenses from third parties, restrict or prevent us from selling our technology in certain markets, or invalidate or render unenforceable our licensed or owned patents. Although patent and intellectual property disputes might be settled through licensing or similar arrangements, the costs associated with such arrangements may be substantial and could include our paying large fixed payments and ongoing royalties. Furthermore, the necessary licenses may not be available on satisfactory terms or at all.
If we infringe the rights of third parties we could be prevented from licensing our technologies and forced to pay damages, and defend against litigation.
If our methods, processes and other technologies infringe the proprietary rights of other parties, we could incur substantial costs and we may have to do one or more of the following:
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obtain licenses, which may not be available on commercially reasonable terms, if at all;
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redesign our processes to avoid infringement;
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stop using the subject matter claimed in the patents held by others;
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pay damages; or
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defend litigation or administrative proceedings, which may be costly whether we win or lose, and which could result in a substantial diversion of our financial and management resources.
Any of these events could substantially harm our financial condition and operations.
Our technology may become ineffective or obsolete.
To be competitive in the industry, we may be required to continually enhance and update our technology. The costs of doing so may be substantial, and if we are unable to maintain the efficacy of our technology, our ability to compete may be impaired. In addition, interest in our technology may wane as alternative fuels and other energy sources gain market acceptance. If competitors develop, obtain or license technology that is superior to ours, we may lose our competitive edge which may have a material adverse effect on our business, financial condition, results of operations and prospects.
Competition resulting from advances in alternative fuels may reduce the demand for our technology.
Alternative fuels and other energy sources are continually under development. A wide array of entities, including automotive, industrial and power generation manufacturers, the federal government, academic institutions and small private concerns are seeking to develop alternative clean-power systems. These technologies include using fuel cells or clean-burning gaseous fuels that, like biodiesel, may address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns. Additionally, there is significant research and development being undertaken regarding the production of ethanol from cellulosic biomass, the production of methane from anaerobic digestors, and the production of electricity from wind and tidal energy systems, among other potential sources of renewable energy. If these alternative fuels continue to expand and gain broad acceptance, there may not be sufficient interest in our technology.
If we breach or default under our license agreement with the UOS, the licensor will have the right to terminate the license agreement, which termination may materially harm our business.
The success of our business will depend in part on the maintenance of our license agreement with UOS. Pursuant to the terms of the license agreement, we are required to pay UOS an additional $20,000 in cash per year until the expiration date of the last of the licensed patents. In addition, we are required to pay an aggregate of $100,000 if we hit certain commercialization milestones. The license agreement also provides that UOS may terminate the agreement if we file an assignment in bankruptcy or apply for reorganization or other similar proceedings. To the extent we default on any of the required payments or breach any other material provisions of the license agreement, UOS could terminate the agreement and pursue any remedy available to it in law or in equity, in which event we would lose our rights to commercialize our technology covered by the license, which loss may materially harm our business.
Our current and potential competitors, some of whom have greater resources than we do, may develop products and technologies that may cause demand for, and the prices of, our products to decline.
While we are not aware of any direct competitors offering commercial dry reforming technology to produce liquid fuels from natural gas, our potential customers may choose to buy or build their own systems instead of licensing our technology. Furthermore, our competitors may combine with each other, and other companies may enter our markets by acquiring or entering into strategic relationships with our competitors. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the abilities of their products to address the needs of our prospective customers.
Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition and larger customer bases than we do. Our present or future competitors may be able to develop technology comparable or superior to those we offer, adapt more quickly than we do to new technologies, evolving industry trends and standards or customer requirements, or devote greater resources to the development, promotion and sale of their technology than we do. Accordingly, we may not be able to compete effectively in our markets, competition may intensify and future competition may harm our business.
RISKS RELATING TO OUR COMMON STOCK
Our common stock is subject to volatility.
We cannot assure that the market price for our common stock will remain at its current level and a decrease in the market price could result in substantial losses for investors. The market price of our common stock may be significantly affected by one or more of the following factors:
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announcements or press releases relating to the industry or to our own business or prospects;
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regulatory, legislative, or other developments affecting us or the industry generally;
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sales by holders of restricted securities pursuant to effective registration statements or exemptions from registration; and
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market conditions specific to biopharmaceutical companies, the healthcare industry and the stock market generally.
If our common stock remains subject to the SEC’s penny stock rules, broker-dealers may experience difficulty in completing customer transactions and trading activity in our securities may be adversely affected.
Unless our common stock is listed on a national securities exchange, including the Nasdaq Capital Market or we have stockholders’ equity of $5,000,000 or less and our common stock has a market price per share of less than $4.00, transactions in our common stock will be subject to the SEC’s “penny stock” rules. If our common stock remains subject to the “penny stock” rules promulgated under the Securities Exchange Act of 1934, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected.
In accordance with these rules, broker-dealers participating in transactions in low-priced securities must first deliver a risk disclosure document that describes the risks associated with such stocks, the broker-dealer's duties in selling the stock, the customer's rights and remedies and certain market and other information. Furthermore, the broker-dealer must make a suitability determination approving the customer for low-priced stock transactions based on the customer's financial situation, investment experience and objectives. Broker-dealers must also disclose these restrictions in writing to the customer, obtain specific written consent from the customer, and provide monthly account statements to the customer. The effect of these restrictions will probably decrease the willingness of broker-dealers to make a market in our common stock, decrease liquidity of our common stock and increase transaction costs for sales and purchases of our common stock as compared to other securities. Our management is aware of the abuses that have occurred historically in the penny stock market.
As a result, if our common stock becomes subject to the penny stock rules, the market price of our securities may be depressed, and you may find it more difficult to sell our securities.
If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
Our internal control over financial reporting may have weaknesses and conditions that could require correction or remediation, the disclosure of which may have an adverse impact on the price of our common stock. We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls once established, could adversely affect our public disclosures regarding our business, prospects, financial condition or results of operations.
Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require an annual assessment of internal controls over financial reporting, and for certain issuers an attestation of this assessment by the issuer’s independent registered public accounting firm. The standards that must be met for management to assess the internal controls over financial reporting as effective are evolving and complex, and require significant documentation, testing, and possible remediation to meet the detailed standards. We expect to incur significant expenses and to devote resources to Section 404 compliance on an ongoing basis. It is difficult for us to predict how long it will take or costly it will be to complete the assessment of the effectiveness of our internal control over financial reporting for each year and to remediate any deficiencies in our internal control over financial reporting. As a result, we may not be able to complete the assessment and remediation process on a timely basis. In addition, management’s assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting or disclosure of management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.
We are authorized to issue "blank check" preferred stock without stockholder approval, which could adversely impact the rights of holders of our common stock.
Our Articles of Incorporation authorize our Company to issue up to 20,000,000 shares of blank check preferred stock. Currently no preferred shares are issued; however, we can issue shares of our preferred stock in one or more series and can set the terms of the preferred stock without seeking any further approval from our common stockholders. Any preferred stock that we issue may rank ahead of our common stock in terms of dividend priority or liquidation premiums and may have greater voting rights than our common stock. In addition, such preferred stock may contain provisions allowing those shares to be converted into shares of common stock, which could dilute the value of common stock to current stockholders and could adversely affect the market price, if any, of our common stock. In addition, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. Although we have no present intention to issue any shares of authorized preferred stock, there can be no assurance that we will not do so in the future.
Shares eligible for future sale may adversely affect the market.
From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 promulgated under the Securities Act, subject to certain limitations. In general, pursuant to amended Rule 144, non-affiliate stockholders may sell freely after six months subject only to the current public information requirement. Affiliates may sell after six months subject to the Rule 144 volume, manner of sale (for equity securities), current public information and notice requirements. Of the 72,134,930 shares of our common stock outstanding as of December 31, 2013, approximately 70,475,900 shares are freely tradable without restriction, as of December 31, 2013. Any substantial sales of our common stock pursuant to Rule 144 may have a material adverse effect on the market price of our common stock.
We do not expect to pay dividends in the future and any return on investment may be limited to the value of our common stock.
We do not currently anticipate paying cash dividends in the foreseeable future. The payment of dividends on our common stock will depend on earnings, financial condition and other business and economic factors affecting it at such time as the board of directors may consider relevant. Our current intention is to apply net earnings, if any, in the foreseeable future to increasing our capital base and development and marketing efforts. There can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders of our common stock, and in any event, a decision to declare and pay dividends is at the sole discretion of the our Board of Directors. If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if its stock price appreciates.
ITEM 2.
ITEM 2. PROPERTIES.
Our principal office is located at 5511C Ekwill Street, Santa Barbara, California 93111. We lease approximately 2,800 square feet. We extended our lease for a period of five years, expiring on September 30, 2017. The base rent for the period of October 1, 2012 to September 30, 2013 was $2,884 per month, and for the remaining period commencing on October 1, 2013 to September 30, 2017 the base rent is $2,971 per month. We sublease approximately 1,400 square feet to a short-term subtenant, which reduces our occupancy expense to approximately 50% of our lease amount.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently a party to, nor is any of our property currently the subject of, any pending legal proceeding that will have a material adverse effect on our business.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock has been quoted on the OTC Bulletin Board under the symbol “CABN” since September 28, 2007. The following table provides, for the periods indicated, the range of high and low bid prices for our common stock. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. Where applicable, the prices set forth below give retroactive effect to our one-for-forty reverse stock split which was effected on May 9, 2011.
As of March 24, 2014 there were 108 holders of record of our common stock. This number does not include stockholders for whom shares were held in “nominee” or “street” name.
Dividend Policy
We have not declared or paid any cash dividends on our common stock and do not anticipate declaring or paying any cash dividends in the foreseeable future. We currently expect to retain future earnings, if any, for the development of our business.
Common Stock
Our Articles of Incorporation, as amended, authorize the issuance of 100,000,000 shares of common stock, $.001 par value per share. Holders of shares of common stock are entitled to one vote for each share on all matters to be voted on by the stockholders. Holders of common stock have cumulative voting rights. Holders of shares of common stock are entitled to share ratably in dividends, if any, as may be declared, from time to time by the Board of Directors in its discretion, from funds legally available therefor. In the event of a liquidation, dissolution, or winding up of our company, the holders of shares of common stock are entitled to share pro rata all assets remaining after payment in full of all liabilities. Holders of common stock have no preemptive or other subscription rights, and there are no conversion rights or redemption or sinking fund provisions with respect to such shares.
As of March 24, 2014, our common stock was held by 108 stockholders of record, and we had 109,856,687 shares of common stock issued and outstanding. We believe that the number of beneficial owners is substantially greater than the number of record holders because a significant portion of our outstanding common stock is held of record in broker street names for the benefit of individual investors. The transfer agent of our common stock is Computershare Investor Services, 250 Royall Street, Canton, MA 02021.
Equity Compensation Plan Information
The following table shows information with respect to each equity compensation plan under which our common stock is authorized for issuance as from inception (April 24, 2006) through December 31, 2013.
EQUITY COMPENSATION PLAN INFORMATION
(1) Consists of options to purchase a total of 14,100,000 common shares and warrants to purchase a total of 460,000 common shares.
During the fiscal year ended December 31, 2013, we granted a total of 28,000,000 restricted shares of our common stock to two of our consultants. Each 14,000,000 shares vest according to the following schedule of performance goals:
After a particular performance goal has been met, the restricted shares associated with that particular performance goal become eligible for vesting (the “Eligible Restricted Shares”). The Eligible Restricted Shares vest on a monthly basis, based on the following formula:
5% x Prior Monthly Trade Value
Monthly Number of Vested Shares = ------------------------------------------------------------
Fair Market Value of the Company’s Shares
For the purposes of this Agreement, the Monthly Trade Value of the Company’s Shares shall mean the aggregate sum of the Daily Trade Value in a calendar month. The Daily Trade Value is defined as the closing trade price of the Company’s Shares multiplied by the daily trade volume. For example, if the closing trade price was $1.00 and the daily trade volume on that day was 500,000 shares, then the Daily Trade Value for that day would be $500,000. If the Company’s common stock is no longer publicly traded, then the Board of Directors in good faith shall determine the Monthly Number of Vested Shares. If the Prior Monthly Trade Value is less than $50,000, then zero Eligible Restricted Shares shall vest for that month. The monthly vested Shares, if any, shall be issued to the Grantee within five (5) business days after the last day of each month. As of December 31, 2013, none of these shares have vested or been issued.
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
None.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read together with our financial statements and the related notes appearing elsewhere in this filing. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See “Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.
Our Company
Carbon Sciences is in the early stages of developing a complete small-scale natural gas-to-liquids (“GTL”) fuel production plant (the “miniGTL plant” or the “Plant”). We anticipate the miniGTL plant will be based on integrating and optimizing existing GTL technology components and processes into a modular diesel or gasoline production facility. We believe developing the Plant will require bringing together natural gas resource holders, engineering firms, and technology firms. Based on our internal economic analysis and conversations with prospective partners, we believe that the miniGTL A modular Plant producing approximately 1,000 barrels per day of diesel or gasoline may be economically viable in the United States, given the low price and abundance of natural gas. We anticipate that a modular Plant would be mobile and could be moved from one gas field to another, amortizing the capital cost of the plant over several small gas fields, which are more plentiful than large gas fields.
We have also been developing a proprietary GTL catalyst technology. The development work on this catalyst is based on a patented catalyst, for which we have an exclusive license from the University of Saskatchewan, Canada. The patented catalyst is a laboratory scale catalyst with over 2,000 hours of uninterrupted run time with high efficiency in converting natural gas and CO2 to syngas. Our research and development efforts have been based on developing a commercial form of this catalyst for use in industrial scale natural gas reforming processes. Our development activities have been primarily performed by outside catalyst development firms. Because the commercialization of an industrial grade natural gas reforming catalyst is a lengthy process that requires many iterative long-term and expensive testing programs, we have suspended our development efforts and are seeking a strategic partner for further funding and to help accelerate the commercial development of our catalyst. Without additional funding specifically devoted to this effort, we will not continue to develop our catalyst and may lose our exclusive license from the University of Saskatchewan, Canada.
We have not yet generated revenues. We currently have negative working capital and received an opinion from our independent auditors on our financial statements that expressed substantial doubt about our ability to continue as a going concern. The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business. The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital. Since our inception through December 31, 2013, the Company has obtained funds primarily from the issuance of common stock and debt. Management believes this funding will continue, and is continually seeking new investors. Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet our obligations as they become due, and will allow the development of our core of business. However, there can be no assurance that such financing will be available upon terms that are acceptable to us, if at all.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to impairment of property, plant and equipment, intangible assets, deferred tax assets and fair value computation using the Black Scholes option pricing model. We base our estimates on historical experience and on various other assumptions, such as the trading value of our common stock and estimated future undiscounted cash flows, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.
Use of Estimates
In accordance with GAAP, management utilizes estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These estimates and assumptions relate to recording net revenue, collectability of accounts receivable, useful lives and impairment of tangible and intangible assets, accruals, income taxes, inventory realization, stock-based compensation expense and other factors. Management believes it has exercised reasonable judgment in deriving these estimates. Consequently, a change in conditions could affect these estimates.
Fair Value of Financial Instruments
Disclosures about fair value of financial instruments requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value. As of December 31, 2013, the amounts reported for cash, accrued interest, accrued expenses and other current liabilities, and notes payable approximate fair value because of their short maturities.
We adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) as of January 1, 2008 for financial instruments measured as fair value on a recurring basis. ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
●
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
●
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
●
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at December 31, 2013 and 2012:
Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Stock-Based Compensation
Stock-based compensation is measured at the grant date based on the value of the award granted using the Black-Scholes option pricing model, and recognized over the period in which the award vests. For stock awards no longer expected to vest, any previously recognized stock compensation expense is reversed in the period of termination. The stock-based compensation expense is included in general and administrative expenses.
Recently Issued Accounting Pronouncements
No new accounting pronouncements were issued during the year ended December 31, 2013 and through the date of filing this report that we believe are applicable or would have a material impact on our financial statements.
Results of Operations
Year ended December 31, 2013 compared to the year ended December 31, 2012
General and Administrative Expenses
General and administrative expenses decreased by $1,359,335 to $470,363 in the year ended December 31, 2013 from $1,829,698 in the year ended December 31, 2012. The decrease in general and administrative expenses in the current period is due primarily to the decrease in stock compensation expense, salaries, and related expenses and professional fees. We have decreased the number of employees compared to levels in the prior year.
Research and Development Expenses
Research and development expenses decreased by $139,267 to $439 in the year ended December 31, 2013 from $139,706 in the year ended December 31, 2012. We have decreased our outside consulting, lab fees and testing supplies in the current year.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased by $21,040 to $2,354 in the year ended December 31, 2013 from $23,394 in the year ended December 31, 2012. Our investment in property and equipment currently is not material to our operations, and substantially all of our property and equipment is fully depreciated at December 31, 2013.
Other Income (Expense)
Total other expense increased by $1,743,986 to $3,024,346 in the year ended December 31, 2013 from $1,280,360 in the year ended December 31, 2012. The increase in the current year is primarily the result of the loss on change in derivative liability of $2,267,693 related to our convertible debt and increased interest expense due to additional borrowings and amortization to interest expense of debt discount and beneficial conversion features for the convertible debt. The increase in other expense is partially offset by a decrease in debt incentive fees of $1,079,800 from the prior year.
Net Loss
As a result, our net loss for the year ended December 31, 2013 was $3,497,502, an increase of $224,344 from $3,273,158 for the year ended December 31, 2012.
Liquidity and Capital Resources
As of December 31, 2013, we had a working capital deficit of $3,765,272, compared to a working capital deficit of $1,131,145 as of December 31, 2012. The increase in the working capital deficit was due primarily to the non-cash derivative liability, plus an increase in convertible notes payable as a result of debt financing. Our cash balance at December 31, 2013 was $11,382.
During the year ended December 31, 2013, we used net cash of $256,055 in operating activities compared to net cash used in operating activities of $609,437 for the year ended December 31, 2012. The decrease of $353,382 in the use of cash for operating activities was primarily due to a decrease in operating expenses as above discussed. In addition, we incurred substantial non-cash expenses in 2013, including loss on change in derivative liability of $2,267,693, amortization of debt discount and beneficial conversion feature recorded to interest expense of $694,795, and stock compensation cost of $101,755.
Net cash used in investing activities, comprised of patent expenditures, was $200 and $19,146 for the years ended December 31, 2013 and 2012, respectively.
Net cash provided by financing activities during the year ended December 31, 2013 was $253,380, comprised of proceeds from debt financing, compared to $635,575 for the year ended December 31, 2012, comprised of proceeds from debt financing of $417,500 and net proceeds from the issuance of common stock of $253,075, partially offset by repayment of advances and notes payable of $35,000. Our capital needs have primarily been met from the proceeds of equity financings and investor loans, as we are currently in the development stage and have no revenues.
We do not have any material commitments for capital expenditures during the next twelve months. Although most recently, proceeds received from the issuance of debt are sufficient to fund our current operating expenses, we will need to raise additional funds in the future to continue our operations and emerge from the development stage. Therefore, our future operations are dependent on our ability to secure additional financing. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, or experience unexpected cash requirements that would force us to seek alternative financing. Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. The inability to obtain additional capital may restrict our ability to grow and may reduce our ability to continue to conduct business operations. If we are unable to obtain additional financing, we may have to curtail our marketing and development plans and possibly cease our operations.
We believe that we have assets to ensure that we can continue to operate without liquidation over the next twelve months, due to our current cash, and our experience in the past in being able to raise money from our investor base. Therefore, we believe we have the ability to continue our operations for the foreseeable future and will be able to realize assets and discharge liabilities in the normal course of our operations.
The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business. The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company does not generate any revenue, and has negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital. Since our inception through December 31, 2013, the Company has obtained funds primarily from the issuance of common stock and debt. Management believes this funding will continue, and is continually seeking new investors. Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet the Company’s obligations as they become due, and will allow the development of its core of business. However, we cannot assure that we will be successful in these endeavors.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
All financial information required by this Item is attached hereto at the end of this report beginning on page and is hereby incorporated by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Based on an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of December 31, 2013, our Chief Executive Officer and Acting Chief Financial Officer has concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us 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. Our Chief Executive Officer and Acting Chief Financial Officer also concluded that, as of December 31, 2013, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us 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 Acting Chief Financial Officer, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting in accordance with Exchange Act Rule 13a-15. With the participation of our Chief Executive Officer and Acting Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2013, based on those criteria. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
Changes in Internal Controls
During the three months ended December 31, 2013, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
No Attestation Report by Independent Registered Accountant
The annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.
The following table sets forth information about our executive officers and directors:
Directors serve until the next annual meeting and until their successors are elected and qualified. The Directors of our company are elected by the vote of a majority in interest of the holders of the voting stock of our company and hold office until the expiration of the term for which he or she was elected and until a successor has been elected and qualified.
A majority of the authorized number of directors constitutes a quorum of the Board for the transaction of business. The directors must be present at the meeting to constitute a quorum. However, any action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board individually or collectively consent in writing to the action.
Directors may receive compensation for their services and reimbursement for their expenses as shall be determined from time to time by resolution of the Board. Our directors currently do not receive monetary compensation for their service on the Board of Directors.
Officers are appointed to serve for one year until the meeting of the board of directors following the annual meeting of stockholders and until their successors have been elected and qualified.
The principal occupations for the past five years (and, in some instances, for prior years) of each of our executive officers and directors, followed by our key employees, are as follows:
Byron Elton - Chairman of the Board. Mr. Elton has been a director of the Company since March 16, 2009. He served as President and Chief Operating Officer of the Company from January 5, 2009 to May 10, 2013. Mr. Elton is an experienced media and marketing executive with a proven record in pioneering new business development strategies and building top-flight marketing organizations. He previously served as Senior Vice President of Sales for Univision Online from 2007 to 2008. Mr. Elton also served for eight years as an executive at AOL Media Networks from 2000 to 2007, where his assignments included Regional Vice President of Sales for AOL and Senior Vice President of E-Commerce for AOL Canada. His broadcast media experience includes leading the ABC affiliate in Santa Barbara, California from 1995 to 2000 and the CBS affiliate in Monterrey, California, from 1998 to 1999, in addition to serving as President of the Alaskan Television Network from 1995 to 1999. Mr. Elton’s extensive senior level management experience specifically in new business development and partnership strategies made him qualified to serve on the Board of Directors.
William Beifuss - President and Chief Executive Officer. Mr. Beifuss was appointed to serve as President and Chief Executive Officer of the Company effective May 10, 2013. He was appointed acting Chief Financial Officer of the Company effective May 10, 2013. Mr. Beifuss is a business executive and has served since February 2006 as the Chief Executive Officer of Cumorah Capital, Inc., a private investment company. Mr. Beifuss served as Chairman of the Board of Warp 9, Inc. from December 2008 to January 2013. From June 2010 to April 2012, Mr. Beifuss was the President of Warp 9. He served as the interim Chief Financial Officer of Warp 9 from June 2011 to April 2012. From April 1992 to January 2006, Mr. Beifuss was Chief Executive Officer of Coeur D'Alene French Baking Company. He served as a unit committee chairman of Boy Scouts of America.
Daniel Nethercott - Director. Mr. Nethercott has been a real estate professional for more than two decades. He is currently the President of Redfern Development and acts as the principal liaison to investors, partnerships and directing boards, both public and private. Before forming Redfern Development in 2004, he spent the majority of his career in executive management positions, including over 10 years as a Senior Vice President and Partner for the Grupe Company from 1995 to 2004, one of the largest commercial and residential developers in Northern California. His entrepreneurial experience also includes being a founding partner of NEKO Industries and an investor and founding board member of InMotx Robotics, a world leader in automated handling of natural products. Mr. Nethercott received his Bachelor of Arts degree in Finance from Brigham Young University prior to attending graduate school at the Arizona State University School of Business. Mr. Nethercott’s experience as board member and board consultant to technology companies combined with his executive management experience in strategic and financial planning made him qualified to serve on the Board of Directors.
On May 4, 2013, Lee Daniels resigned as a director of the Company, effective May 10, 2013.
Family Relationships
There are no family relationships among our executive officers and directors.
Board Leadership Structure and Role in Risk Oversight
Although we have not adopted a formal policy on whether the Chairman and Chief Executive Officer positions should be separate or combined, we have recently determined that it is in the best interests of the Company and its shareholders to separate these roles.
Our Board of Directors focuses on the most significant risks facing our company and our company’s general risk management strategy, and also ensure that risks undertaken by our Company are consistent with the Board’s appetite for risk. While the Board oversees our company’s risk management, management is responsible for day-to-day risk management processes. We believe this division of responsibilities is the most effective approach for addressing the risks facing our company and that our Board leadership structure supports this approach.
Limitation of Liability and Indemnification of Officers and Directors
Under Nevada General Corporation Law and our articles of incorporation, our directors will have no personal liability to us or our stockholders for monetary damages incurred as the result of the breach or alleged breach by a director of his “duty of care.” This provision does not apply to the directors’ (i) acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) acts or omissions that a director believes to be contrary to the best interests of the corporation or our shareholders or that involve the absence of good faith on the part of the director, (iii) approval of any transaction from which a director derives an improper personal benefit, (iv) acts or omissions that show a reckless disregard for the director’s duty to the corporation or our shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director’s duties, of a risk of serious injury to the corporation or our shareholders, (v) acts or omissions that constituted an unexcused pattern of inattention that amounts to an abdication of the director’s duty to the corporation or our shareholders, or (vi) approval of an unlawful dividend, distribution, stock repurchase or redemption. This provision would generally absolve directors of personal liability for negligence in the performance of duties, including gross negligence.
The effect of this provision in our articles of incorporation is to eliminate the rights of Carbon Sciences and our stockholders (through stockholder’s derivative suits on behalf of Carbon Sciences) to recover monetary damages against a director for breach of his fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior) except in the situations described in clauses (i) through (vi) above. This provision does not limit nor eliminate the rights of Carbon Sciences or any stockholder to seek non-monetary relief such as an injunction or rescission in the event of a breach of a director’s duty of care. In addition, our Articles of Incorporation provide that if Nevada law is amended to authorize the future elimination or limitation of the liability of a director, then the liability of the directors will be eliminated or limited to the fullest extent permitted by the law, as amended. Nevada General Corporation Law grants corporations the right to indemnify their directors, officers, employees and agents in accordance with applicable law. Our bylaws provide for indemnification of such persons to the full extent allowable under applicable law. These provisions will not alter the liability of the directors under federal securities laws.
We intend to enter into agreements to indemnify our directors and officers, in addition to the indemnification provided for in our bylaws. These agreements, among other things, indemnify our directors and officers for certain expenses (including attorneys’ fees), judgments, fines, and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of Carbon Sciences, arising out of such person’s services as a director or officer of Carbon Sciences, any subsidiary of Carbon Sciences or any other company or enterprise to which the person provides services at the request of Carbon Sciences. We believe that these provisions and agreements are necessary to attract and retain qualified directors and officers.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling Carbon Sciences pursuant to the foregoing provisions, Carbon Sciences has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Involvement in Certain Legal Proceedings
To our knowledge, during the past ten years, none of our directors, executive officers, promoters, control persons, or nominees has been:
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the subject of any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
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convicted in a criminal proceeding or is subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
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subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or any Federal or State authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities;
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found by a court of competent jurisdiction (in a civil action), the Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law.
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the subject of, or a party to, any Federal or State judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of (a) any Federal or State securities or commodities law or regulation; (b) any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or (c) any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or
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the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Board Committees
Audit Committee. Our board of directors has appointed an audit committee. As of March 14, 2014, our audit committee is comprised of Daniel Nethercott. Mr. Nethercott qualifies as independent as defined in Rule 4200 of Nasdaq’s listing standards. Our audit committee is authorized to:
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appoint, compensate, and oversee the work of any registered public accounting firm employed by us;
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resolve any disagreements between management and the auditor regarding financial reporting;
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pre-approve all auditing and non-audit services;
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retain independent counsel, accountants, or others to advise the audit committee or assist in the conduct of an investigation;
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meet with our officers, external auditors, or outside counsel, as necessary; and
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oversee that management has established and maintained processes to assure our compliance with all applicable laws, regulations and corporate policy.
The audit committee held four meetings during fiscal year ended December 31, 2013.
Compensation Committee. Our compensation committee is comprised of Daniel Nethercott, and is authorized to:
●
discharge the responsibilities of the board of directors relating to compensation of the our directors, executive officers and key employees;
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assist the board of directors in establishing appropriate incentive compensation and equity-based plans and to administer such plans;
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oversee the annual process of evaluation of the performance of our management; and
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perform such other duties and responsibilities as enumerated in and consistent with compensation committee’s charter.
Nominating Committee. Our nominating committee is comprised of Daniel Nethercott and is authorized to:
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assist the board of directors by identifying qualified candidates for director nominees, and to recommend to the board of directors the director nominees for the next annual meeting of shareholders;
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lead the board of directors in its annual review of its performance;
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recommend to the board director nominees for each committee of the board of directors; and
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develop and recommend to the board of directors corporate governance guidelines applicable to us.
Report of the Audit Committee
Our audit committee has reviewed and discussed our audited financial statements for the fiscal year ended December 31, 2013 with senior management. The audit committee has also discussed with HJ Associates & Consultants, LLP, Certified Public Accountants, our independent auditors, the matters required to be discussed by the statement on Auditing Standards No. 61 (Communication with Audit Committees) and received the written disclosures and the letter from HJ required by Independence Standards Board Standard No. 1 (Independence Discussion with Audit Committees). The audit committee has discussed with HJ the independence of HJ as our auditors. Finally, in considering whether the independent auditors provision of non-audit services to us is compatible with the auditors’ independence for HJ, our audit committee has recommended to the board of directors that our audited financial statements be included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for filing with the United States Securities and Exchange Commission. Our audit committee did not submit a formal report regarding its findings.
AUDIT COMMITTEE
Daniel Nethercott
Notwithstanding anything to the contrary set forth in any of our previous or future filings under the United States Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate this report in future filings with the Securities and Exchange Commission, in whole or in part, the foregoing report shall not be deemed to be incorporated by reference into any such filing.
Indebtedness of Executive Officers
No executive officer, director or any member of these individuals' immediate families or any corporation or organization with whom any of these individuals is an affiliate is or has been indebted to us since the beginning of our last fiscal year.
Code of Ethics
We have adopted a Code of Ethics that applies to all of our directors, officers and employees. The text of the Code of Ethics has been posted on Carbon Science’s Internet website and can be viewed at www.carbonscience.com. A copy of the Code of Ethics has also been filed as an exhibit to our Annual Report for the year ending December 31, 2007, filed with the SEC on March 26, 2008, and incorporated herein by reference. Any waiver of the provisions of the Code of Ethics for executive officers and directors may be made only by the Audit Committee and, in the case of a waiver for members of the Audit Committee, by the Board of Directors. Any such waivers will be promptly disclosed to our shareholders.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company's directors, executive officers and persons who own more than 10% of the Company's stock (collectively, "Reporting Persons") to file with the SEC initial reports of ownership and changes in ownership of the Company's common stock. Reporting Persons are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file. To the Company's knowledge, based solely on its review of the copies of such reports received or written representations from certain Reporting Persons that no other reports were required, the Company believes that during its fiscal year ended December 31, 2013 all Reporting Persons timely complied with all applicable filing requirements.
Significant Consultants
In addition to the officers and directors identified above, we expect the following individuals to make significant contributions to our business:
Archie C. Smith III ("Trey") - Executive Vice President. Mr. Smith is a business executive with experience in the oil and gas industry. In 1999, he joined the Harold A. O'Neil Company and served as sales leader in the manufacturing sector, specializing in steel sales to large oil and gas OEM manufacturers, located in Fort Worth, Texas. Based in the epicenter of the Barnett Shale, Mr. Smith was well positioned to serve in the emerging technologies of horizontal drilling and modern hydraulic fracturing. He also specialized in supply chain solutions, value added manufacturing solutions, and materials management for companies such as Halliburton, Weir SPM, FTSI, Gardner Denver, FMC, Oil States and others. In 2013, Mr. Smith was appointed to serve as the President of Galtway Industries, a firm founded to provide supply chain solutions to existing and emerging technologies in the oil and gas industry. Mr. Smith graduated with honors and received his Bachelor of Business Administration degree from Stephen F. Austin State University, where he also received the SFA Outstanding General Business Graduate Award in 1999.
Kendall B. Carew - Vice President of Business Development. Mr. Carew has experience in upstream oil and gas operations, property development, and property transactions. In 2009, he founded a real estate investment/management firm specializing in student housing. In 2011, Mr. Carew joined Crimson Exploration, Inc., focusing on Eagle Ford Shale mineral purchasing. He recently completed an urban green space development on the Trinity River in Fort Worth, Texas. Mr. Carew received his Bachelor of Science degree in general studies, with emphasis in earth resources from Texas Christian University. He also earned a double minor in business and energy. Mr. Carew serves as a Board Member of Streams and Valleys and the Fort Worth Stock Show and Rodeo Committee.
James E. Leahy - GTL Project Advisor. In August 2013, we contracted with James E. Leahy as our GTL Project Advisor to assist us with planning and developing our first GTL plant. Mr. Leahy has extensive experience in process development, project management, and process plant technical support in the petrochemical and synthetic fuels industries. He received his Bachelor of Science in Chemical Engineering from Illinois Institute of Technology in 1969 and Master of Science in Chemical Engineering from University of Houston in 1973. Mr. Leahy joined Shell Chemical Company in 1969 as a process engineer. From 1974 to 1975 he worked as a process engineer for M.W. Kellogg Company. Mr. Leahy joined ARCO Chemical Company and served as Chief Process Engineer from 1976 to 1989, Engineering & Construction Manager from 1990 to 1997 and Project Manager from 1997 to 1999. From 2000 to 2007, he was Director, Special Projects at Syntroleum Corporation where he developed gas-to-liquids and coal-to-liquids processes. From 2008 to 2011, Mr. Leahy was Engineering Manager for Australian American Energy Company and managed various coal-to-liquids studies and projects. He is the holder of six patents in the field of synfuels.
Our consulting contract with Mr. Leahy, which expires in August 2014, requires us to pay him hourly consulting rates of $100 per hour for the first 40 hours per month and $150 per hour for any hours in excess of 40 hours per month.
Restricted Stock Awards
During the fiscal year ended December 31, 2013, we granted a total of 28,000,000 restricted shares of our common stock to Messrs. Smith and Carew. Each 14,000,000 shares vest according to the following schedule of performance goals:
After a particular performance goal has been met, the restricted shares associated with that particular performance goal become eligible for vesting (the “Eligible Restricted Shares”). The Eligible Restricted Shares vest on a monthly basis, based on the following formula:
5% x Prior Monthly Trade Value
Monthly Number of Vested Shares = ------------------------------------------------------------
Fair Market Value of the Company’s Shares
For the purposes of this Agreement, the Monthly Trade Value of the Company’s Shares shall mean the aggregate sum of the Daily Trade Value in a calendar month. The Daily Trade Value is defined as the closing trade price of the Company’s Shares multiplied by the daily trade volume. For example, if the closing trade price was $1.00 and the daily trade volume on that day was 500,000 shares, then the Daily Trade Value for that day would be $500,000. If the Company’s common stock is no longer publicly traded, then the Board of Directors in good faith shall determine the Monthly Number of Vested Shares. If the Prior Monthly Trade Value is less than $50,000, then zero Eligible Restricted Shares shall vest for that month. The monthly vested Shares, if any, shall be issued to the Grantee within five (5) business days after the last day of each month. As of December 31, 2013, none of these shares have vested and have been issued.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Compensation Discussion and Analysis
The following Compensation Discussion and Analysis describes the material elements of compensation for our executive officers identified in the Summary Compensation Table (“Named Executive Officers”), and executive officers that we may hire in the future. As more fully described below, our board of directors makes all decisions for the total direct compensation of our executive officers, including the Named Executive Officers. We do not have a compensation committee, so all decisions with respect to management compensation are made by the whole board.
Compensation Program Objectives and Rewards
Our compensation philosophy is based on the premise of attracting, retaining, and motivating exceptional leaders, setting high goals, working toward the common objectives of meeting the expectations of customers and stockholders, and rewarding outstanding performance. Following this philosophy, in determining executive compensation, we consider all relevant factors, such as the competition for talent, our desire to link pay with performance in the future, the use of equity to align executive interests with those of our stockholders, individual contributions, teamwork and performance, and each executive’s total compensation package. We strive to accomplish these objectives by compensating all executives with total compensation packages consisting of a combination of competitive base salary and incentive compensation.
While we have only hired one executive since inception because our business has not grown sufficiently to justify additional hires, we expect to grow and hire in the future. To date, we have not applied a formal compensation program to determine the compensation of the Named Executives Officers. In the future, as we and our management team expand, our board of directors expects to add independent members, form a compensation committee comprised of independent directors, and apply the compensation philosophy and policies described in this section of the Form 10-K.
The primary purpose of the compensation and benefits described below is to attract, retain, and motivate highly talented individuals when we do hire, who will engage in the behaviors necessary to enable us to succeed in our mission while upholding our values in a highly competitive marketplace. Different elements are designed to engender different behaviors, and the actual incentive amounts which may be awarded to each Named Executive Officer are subject to the annual review of the board of directors. The following is a brief description of the key elements of our planned executive compensation structure.
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Base salary and benefits are designed to attract and retain employees over time.
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Incentive compensation awards are designed to focus employees on the business objectives for a particular year.
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Equity incentive awards, such as stock options and non-vested stock, focus executives’ efforts on the behaviors within the recipients’ control that they believe are designed to ensure our long-term success as reflected in increases to our stock prices over a period of several years, growth in our profitability and other elements.
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Severance and change in control plans are designed to facilitate a company’s ability to attract and retain executives as we compete for talented employees in a marketplace where such protections are commonly offered. We currently have not given separation benefits to any of our Name Executive Officers.
Benchmarking
We have not yet adopted benchmarking but may do so in the future. When making compensation decisions, our board of directors may compare each element of compensation paid to our Named Executive Officers against a report showing comparable compensation metrics from a group that includes both publicly-traded and privately-held companies. Our board believes that while such peer group benchmarks are a point of reference for measurement, they are not necessarily a determining factor in setting executive compensation as each executive officer’s compensation relative to the benchmark varies based on scope of responsibility and time in the position. We have not yet formally established our peer group for this purpose.
The Elements of Carbon Sciences’ Compensation Program
Base Salary
Executive officer base salaries are based on job responsibilities and individual contribution. The board reviews the base salaries of our executive officers, including our Named Executive Officers, considering factors such as corporate progress toward achieving objectives (without reference to any specific performance-related targets) and individual performance experience and expertise. None of our Named Executive Officers have employment agreements with us. Additional factors reviewed by the board of directors in determining appropriate base salary levels and raises include subjective factors related to corporate and individual performance. For the year ended December 31, 2013, all executive officer base salary decisions were approved by the board of directors.
Our board of directors determines base salaries for the Named Executive Officers at the beginning of each fiscal year, and the board proposes new base salary amounts, if appropriate, based on its evaluation of individual performance and expected future contributions. We do not have a 401(k) Plan, but if we adopt one in the future, base salary would be the only element of compensation that would be used in determining the amount of contributions permitted under the 401(k) Plan.
Incentive Compensation Awards
The Named Executives have not been paid bonuses and our board of directors has not yet established a formal compensation policy for the determination of bonuses. If our revenue grows and bonuses become affordable and justifiable, we expect to use the following parameters in justifying and quantifying bonuses for our Named Executive Officers and other officers of Carbon Sciences: (1) the growth in our revenue, (2) the growth in our earnings before interest, taxes, depreciation and amortization, as adjusted (“EBITDA”), and (3) our stock price. The board has not adopted specific performance goals and target bonus amounts for any of our fiscal years, but may do so in the future.
Equity Incentive Awards
In November 2011, our board adopted a stock option plan (the “2011 Plan”) under which 2,000,000 shares of common stock have been reserved for issuance. No stock option awards have yet been made to any of our Named Executives or other officers or employees of Carbon Sciences under the 2011 Plan. Our board has granted a total of 14,000,000 stock options to our current Chief Executive Officer and our former Chief Executive Officer outside of our 2011 Plan. These equity incentive awards, we believe, motivate our employees to work to improve our business and stock price performance, thereby further linking the interests of our senior management and our stockholders. The board considers several factors in determining whether awards are granted to an executive officer, including those previously described, as well as the executive’s position, his or her performance and responsibilities, and the amount of options or other awards, if any, currently held by the officer and their vesting schedule. Our policy prohibits backdating options or granting them retroactively.
Benefits and Prerequisites
At this stage of our business we have limited benefits and no prerequisites for our employees other than health insurance and vacation benefits that are generally comparable to those offered by other small private and public companies or as may be required by applicable state employment laws. We do not have a 401(k) Plan or any other retirement plan for our Named Executive Officers. We may adopt these plans and confer other fringe benefits for our executive officers in the future if our business grows sufficiently to enable us to afford them.
Separation and Change in Control Arrangements
We do not have any employment agreements with our Named Executive Officers or any other executive officer or employee of Carbon Sciences. None of them are eligible for specific benefits or payments if their employment or engagement terminates in a separation or if there is a change of control.
Executive Officer Compensation
The following table sets forth the annual compensation for years ended December 31, 2013 and 2012 to our Chief Executive Officer and our most highly compensated officers other than the Chief Executive Officer at December 31, 2013 whose total compensation exceeded $100,000, which we refer to as our named executive officers.
(1)
All other compensation consists of consulting fees paid.
(2)
Mr. Beifuss was appointed President and Chief Operating Officer effective May 10, 2013. On September 23, 2013, Mr. Beifuss was granted nonqualified stock options to purchase 12,000,000 shares of our common stock at an exercise price of $0.006 per share exercisable until September 23, 2020 in consideration for his services to us. These stock options vest 1/25th per month, commencing on October 23, 2013, on a monthly basis for as long as Mr. Beifuss is an employee or consultant of Carbon Sciences. The fair value of the stock option award to Mr. Beifuss was estimated using the Black-Scholes option pricing model. The estimated fair value was determined based on the market price of the Company’s stock on the date of grant.
(3)
On May 31, 2013, we entered into a convertible promissory note in exchange for services rendered by Mr. Beifuss in the amount of $15,000. Subsequently in 2013, Mr. Beifuss contributed the note to capital.
(4)
Mr. Elton was appointed President and Chief Operating Officer on January 5, 2009 and as Chief Executive Officer and Chairman on May 20, 2009. He resigned from these positions effective May 10, 2013 and serves as the Chairman of the Board. On September 23, 2013, Mr. Elton was granted nonqualified stock options to purchase 2,000,000 shares of our common stock at an exercise price of $0.006 per share exercisable until September 23, 2020 in consideration for his services to us. These stock options vest 1/25th per month, commencing on October 23, 2013, on a monthly basis for as long as Mr. Elton is an employee or consultant of Carbon Sciences. The fair value of the stock option awards to Mr. Elton were estimated using the Black-Scholes option pricing model. The estimated fair value was determined based on the market price of the Company’s stock on the date of each grant.
Employment Agreements
We have a written consulting agreement dated May 31, 2013 with William Beifuss, our Chief Executive Officer, President and Acting Chief Financial Officer, for the payment of monthly compensation of $5,000 per month beginning in June 2013. The agreement may be cancelled by either party with 30 days notice.
Grants of Equity Awards - Fiscal Year 2013
The following table provides information about grants of options to our Named Executive Officers in fiscal year 2013:
(1)
Options vest monthly over 25 months.
(2)
The fair value of the stock option awards was estimated using the Black-Scholes option pricing model. The estimated fair value was determined based on the market price of the Company’s stock on the date of grant.
Outstanding Equity Awards
The following table sets forth information with respect to grants of options to purchase our common stock to the named executive officers at December 31, 2013.
Outstanding Equity Awards at Fiscal Year-End
(1)
On September 23, 2013, Mr. Beifuss was granted nonqualified stock options to purchase 12,000,000 shares of our common stock at an exercise price of $0.006 per share exercisable until September 23, 2020 in consideration for his services to us. These stock options vest 1/25th per month, commencing on October 23, 2013, on a monthly basis for as long as Mr. Beifuss is an employee or consultant of Carbon Sciences.
(2)
On September 23, 2013, Mr. Elton was granted nonqualified stock options to purchase 2,000,000 shares of our common stock at an exercise price of $0.006 per share exercisable until September 23, 2020 in consideration for his services to us. These stock options vest 1/25th per month, commencing on October 23, 2013, on a monthly basis for as long as Mr. Elton is an employee or consultant of Carbon Sciences.
Option Exercises and Stock Vested
None of our executive officers exercised any stock options or acquired stock through vesting of an equity award during the fiscal year ended December 31, 2013.
Director Compensation
Non-employee directors may receive compensation for their services and reimbursement for their expenses as shall be determined from time to time by resolution of the Board.
For compensation paid to directors William Beifuss and Byron Elton, see Executive Compensation above. Our employee directors currently do not receive cash compensation for their service on the Board of Directors.
On June 4, 2013, Daniel Nethercott, a director, was issued a convertible promissory note in the amount of $25,000 in exchange for services. The maturity date of the note is June 4, 2016 and the note bears interest at a rate of 5% per annum. Mr. Nethercott has the right, at his election, to convert all or part of the outstanding and unpaid principal and accrued interest into shares of our common stock. The conversion price is the lesser of $0.035 per share or the closing price per share of our common stock on the trading day immediately preceding the date of conversion.
Stock Option and Other Long-term Incentive Plan
On November 2, 2011, our Board of Directors adopted the 2011 Equity Incentive Plan, or the 2011 Plan. Under the 2011 Plan, options may be granted which are intended to qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986,as amended, or the Code, or which are not intended to qualify as Incentive Stock Options thereunder. In addition, direct grants of stock or restricted stock may be awarded. There are 2,000,000 shares of common stock reserved for issuance under the 2011 Plan. A summary of the terms and provisions of the 2011 Plan are described below.
The primary purpose of the 2011 Plan is to attract and retain the best available personnel in order to promote the success of our business and to facilitate the ownership of our stock by employees and others who provide services to us. Under the 2011 Plan, options may be granted to employees, officers, directors or consultants of ours. The term of each option granted under the 2011 Plan will be contained in a stock option agreement between the optionee and us and such terms shall be determined by a committee of the board of directors consistent with the provisions of the 2011 Plan, including the following:
•
The purchase price of the common stock subject to each incentive stock option will not be less than the fair market value (as set forth in the 2011 Plan), or in the case of the grant of an incentive stock option to a principal stockholder, not less than 110% of fair market value of such common stock at the time such option is granted.
•
The dates on which each option (or portion thereof) will be exercisable and the conditions precedent to such exercise, if any, shall be fixed by the committee delegated by the board of directors, in its discretion, at the time such option is granted. Unless otherwise provided in the grant agreement, in the event of a change of control (as set forth in the Incentive Stock Plan), the committee delegated by the board may accelerate the vesting and exercisability of outstanding options all unvested shares shall immediately become vested;
•
Any option granted to an employee of ours will become exercisable over a period of no longer than five years. No option will in any event be exercisable after ten years from, and no Incentive Stock Option granted to a ten percent stockholder will become exercisable after the expiration of five years from, the date of the option;
•
No option will be transferable, except by will or the laws of descent and distribution, and any option may be exercised during the lifetime of the optionee only by such optionee. No option granted under the 2011 Plan will be subject to execution, attachment or other process;
•
In the event of any change in our outstanding common stock by reason of a stock split, stock dividend, combination or reclassification of shares, recapitalization, merger, or similar event, the board of directors or the committee delegated by the board may adjust proportionally (a) the number of shares of common stock (i) reserved under the 2011 Plan, (ii) available for Incentive Stock Options and Non-statutory Options and (iii) covered by outstanding stock awards or restricted stock purchase offers; (b) the exercise prices related to outstanding grants so that each optionee’s proportionate interest is maintained as immediately before such event; and (c) the appropriate fair market value and other price determinations for such grants. In the event of a corporate merger, consolidation, acquisition of property or stock, separation, reorganization or liquidation, the board of directors or the committee delegated by the board of directors will be authorized to issue or assume stock options, whether or not in a transaction to which Section 424(a) of the Code, applies, and other grants by means of substitution of new grant agreements for previously issued grants or an assumption of previously issued grants.
The board of directors may, insofar as permitted by law, from time to time, suspend or terminate the 2011 Plan or revise or amend it in any respect whatsoever, except that without the approval of our stockholders, no such revision or amendment will (i) increase the number of shares subject to the 2011 Plan, (ii) reduce the exercise price of outstanding options or effect repricing through cancellations and re-grants of new options, (iii) materially increase the benefits to participants, (iv) materially change the class of persons eligible to receive grants under the 2011 Plan; (v) decrease the exercise price of any grant to below 100% of the fair market value on the date of grant; or (vi) extend the term of any options beyond that provided in the 2011 Plan; provided, however, no such action will alter or impair the rights and obligations under any option, or stock award, or restricted stock purchase offer outstanding as of the date thereof without the written consent of the participant thereunder.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 24, 2014, the number of and percent of our common stock beneficially owned by:
•
each of our directors;
•
each of our named executive officers;
•
our directors and executive officers as a group, and persons or groups known by us to own beneficially 5% or more of our common stock:
Unless otherwise specified, we believe that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. The address for our executive officers and directors is the same as our address.
A person is deemed to be the beneficial owner of securities that can be acquired by him within 60 days of March 24, 2014 upon the exercise of options, warrants or convertible securities. Each beneficial owner's percentage ownership is determined by assuming that options, warrants or convertible securities that are held by him, but not those held by any other person, and which are exercisable within 60 days of March 14, 2014 have been exercised and converted.
(1)
Based upon 109,856,687 shares issued and outstanding as of March 14, 2014.
(2)
Includes 3,360,000 shares subject to stock options that are currently exercisable or exercisable within 60 days of March 14, 2014.
(3)
Includes 560,000 shares subject to stock options that are currently exercisable or exercisable within 60 days of March 14, 2014.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Certain Relationships and Related Transactions
On June 4, 2013, Daniel Nethercott, a director, was issued a convertible promissory note in the amount of $25,000 in exchange for services. The maturity date of the note is June 4, 2016 and the note bears interest at a rate of 5% per annum. Mr. Nethercott has the right, at his election, to convert all or part of the outstanding and unpaid principal and accrued interest into shares of our common stock. The conversion price is the lesser of $0.035 per share or the closing price per share of our common stock on the trading day immediately preceding the date of conversion. Accrued interest payable on the note was $719 at December 31, 2013.
On December 31, 2012, we entered into a convertible promissory note with Byron Elton, the Chairman of our Board of Directors and our former Chief Executive Officer, in exchange for services valued at $185,852. The maturity date of the note is December 31, 2014 and the note bears interest at a rate of 5% per annum. Mr. Elton has the right, at his election, to convert all or part of the outstanding and unpaid principal and accrued interest into shares of our common stock. The conversion price is the lesser of $0.20 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion. Accrued interest payable on the note was $9,293 at December 31, 2013.
On May 31, 2013, we entered into a convertible promissory note in exchange for services rendered by William Beifuss, our Chief Executive Officer and President, in the amount of $15,000. Subsequently in 2013, Mr. Beifuss contributed the note to capital and we decreased convertible notes payable and increased additional paid-in capital by $15,000.
In 2013, we increased additional paid-in capital and decreased accrued interest, notes payable by $7,175 to record the contribution of related party accrued interest to capital.
During the past three fiscal years, there have been no transactions other than those described above, and there are no currently proposed transactions in which the Company is a participant in which any related person has or will have a direct or indirect material interest which exceeds the lesser of $120,000 or one percent of the Company’s total assets at year end for the last two completed fiscal years.
Director Independence
Daniel Nethercott is independent as that term is defined in Rule 4200 of Nasdaq’s listing standards.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Audit Fees
The aggregate fees incurred by us to HJ & Associates, LLP during fiscal years 2013 and 2012 for the audits of our annual financial statements totaled $41,000 and $31,400, respectively.
Audit-Related Fees
We incurred no audit-related fees during 2013 and 2012 to HJ & Associates, LLP.
Tax Fees
We incurred fees of $941and $595 to HJ & Associates, LLP for tax compliance services for the years ended December 31, 2013 and December 31, 2012, respectively.
All Other Fees
There were no fees billed to us by HJ & Associates, LLP for services other than the services described above under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” during the years ended December 31, 2013 and 2012.
Pre-Approval Policies and Procedures of Audit and Non-Audit Services of Independent Registered Public Accounting Firm
The audit committee’s policy is to pre-approve, typically at the beginning of our fiscal year, all audit and non-audit services, other than de minimis non-audit services, to be provided by an independent registered public accounting firm. These services may include, among others, audit services, audit-related services, tax services and other services and such services are generally subject to a specific budget. The independent registered public accounting firm and management are required to periodically report to the full board of directors regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. As part of the board’s review, the board will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and approve or reject each service, taking into account whether the services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor’s independence from management. At audit committee meetings throughout the year, the auditor and management may present subsequent services for approval. Typically, these would be services such as due diligence for an acquisition, that would not have been known at the beginning of the year.
The audit committee has considered the provision of non-audit services provided by our independent registered public accounting firm to be compatible with maintaining their independence. The audit committee will continue to approve all audit and permissible non-audit services provided by our independent registered public accounting firm.
As of the date of this filing, our current policy is to not engage HJ & Associates, LLP to provide, among other things, bookkeeping services, appraisal or valuation services, or international audit services. The policy provides that we engage HJ & Associates, LLP to provide audit, tax compliance, and other assurance services, such as review of SEC reports or filings.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES.
EXHIBIT INDEX
*Filed herewith
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
SIGNATURE
TITLE
DATE
/s/ William Beifuss
William Beifuss
CHIEF EXECUTIVE OFFICER, PRESIDENT, AND ACTING CHIEF FINANCIAL OFFICER
March 31, 2014
/s/ Byron Elton
Byron Elton
CHAIRMAN OF THE BOARD OF DIRECTORS
March 31, 2014
/s/ Daniel Nethercott
DIRECTOR
March 31, 2014
Daniel Nethercott
CARBON SCIENCES, INC.
(A Development Stage Company)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Carbon Sciences, Inc.
(A Development Stage Company)
Santa Barbara, California
We have audited the accompanying balance sheets of Carbon Sciences, Inc. as of December 31, 2013 and 2012, and the related statements of operations, stockholders' deficit, and cash flows for the years then ended, and from inception on August 25, 2006 through December 31, 2013. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Carbon Sciences, Inc. as of December 31, 2013 and 2012, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As disclosed in Note 1 to the financial statements, the Company does not generate significant revenue, and has negative cash flows from operations. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/c/ HJ Associates & Consultants, LLP
HJ Associates & Consultants, LLP
Salt Lake City, Utah
March 31, 2014
CARBON SCIENCES, INC.
(A Development Stage Company)
BALANCE SHEETS
See notes to financial statements
See notes to financial statements
See notes to financial statements
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See notes to financial statements
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CARBON SCIENCES, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2013 AND 2012
1. ORGANIZATION AND LINE OF BUSINESS
Organizational History
The Company was incorporated in the State of Nevada on August 25, 2006 as Zingerang, Inc. On April 2, 2007, the Company changed its name to Carbon Sciences, Inc.
Overview of Business
The Company was initially in the business of offering real-time and interactive mobile communication services to businesses and consumers under the Zingerang trade name. The Company is now pursuing a new line of business. The Company is developing a technology to convert earth destroying carbon dioxide (CO2) into a useful form that will not contribute to green house gases. This technology is based on a patent filed by the Company and developed under the brand name GreenCarbon™ Technology. By eliminating harmful CO2 from human created sources, such as power plants and industrial factories, the technology will provide a partial solution to the problem of global warming. GreenCarbon™ Technology is initially targeted at electrical power plants. CO2 makes up nearly 80% of all greenhouse gases. More than a quarter of that CO2 comes from electrical power plants.
Going Concern
The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business. The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company does not generate any revenue, and has negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital. Since it’s inception through December 31, 2013, the Company has obtained funds primarily from the issuance of common stock and debt. Management believes this funding will continue, and is continually seeking new investors. Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet the Company’s obligations as they become due, and will allow the development of its core of business.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of significant accounting policies is presented to assist in understanding our financial statements. The financial statements and notes are representations of the Company’s management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.
Development Stage Activities and Operations
The Company is in the development stage of its operations and has had no revenues. A development stage activity is one in which all efforts are devoted substantially to establishing a new business and even if planned principal operations have commenced, revenues are insignificant.
Revenue Recognition
We will recognize revenue when services are performed, and at the time of shipment of products, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured. To date, we have had no revenues and are in the development stage.
Cash and Cash Equivalent
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Significant estimates made in preparing these financial statements include the estimate of useful lives of property and equipment, the deferred tax valuation allowance, and the fair value of stock options. Actual results could differ from those estimates.
Property and Equipment
Property and equipment are stated at cost, and are depreciated using the straight line method over the following estimated useful lives:
During the year ended December 31, 2012, we abandoned equipment in the amount of $155,837, and recognized a loss of $74,078. Depreciation expense for the years ended December 31, 2013 and 2012 was $2,354 and $23,394, respectively.
Patents and Impairment of Long-Lived Assets
Our intangible assets that have finite lives consist of patents, the cost of which is amortized over the estimated legal life of 15 years. During the year ended December 31, 2012, we reviewed the capitalized costs of patents for impairment and determined that due to known technological advances and economic conditions, the carrying amount exceeded its fair value. We adjusted the carrying amount of $89,731 to $1,584, and recognized an impairment loss of $88,147 during the year ended December 31, 2012. As of December 31, 2013 and 2012, no amortization has been expensed for the patents, since approval of the patents were pending.
Fair Value of Financial Instruments
Disclosures about fair value of financial instruments requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value. As of December 31, 2013, the amounts reported for cash, accrued interest, accrued expenses and other current liabilities, and notes payable approximate fair value because of their short maturities.
We adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) as of January 1, 2008 for financial instruments measured as fair value on a recurring basis. ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
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Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
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Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
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Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at December 31, 2013 and 2012:
Income (Loss) per Share Calculations
The computation of basic income (loss) per common share is based on the weighted average number of shares outstanding during each year.
The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year plus the common stock equivalents that would arise from the exercise of stock options and warrants outstanding, using the treasury stock method and the average market price per share during the year. Common stock equivalents are not included in the diluted loss per share calculation when their effect is anti-dilutive.
Since we had no dilutive effect of stock options and warrants for the years ended December 31, 2013 and 2012, our basic weighted average number of common shares outstanding is the same as our diluted weighted average number of common shares outstanding.
Income Taxes
We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Research and Development
Research and development costs are expensed as incurred. Total research and development costs were $439 and $139,706 for the years ended December 31, 2013 and 2012, respectively.
Advertising Costs
We expense the cost of advertising and promotional materials when incurred. We incurred no advertising costs for the years ended December 31, 2013 and 2012.
Stock-Based Compensation
Stock-based compensation is measured at the grant date based on the value of the award granted using the Black-Scholes option pricing model, and recognized over the period in which the award vests. For stock awards no longer expected to vest, any previously recognized stock compensation expense is reversed in the period of termination. The stock-based compensation expense is included in general and administrative expenses.
Comprehensive Loss
Comprehensive loss is the same as net loss for all years presented.
Reclassifications
Certain amounts in the prior years have been reclassified to conform to the current year presentation.
Recently Issued Accounting Pronouncements
No new accounting pronouncements were issued during the year ended December 31, 2013 and through the date of filing this report that we believe are applicable or would have a material impact on our financial statements.
3. CAPITAL STOCK
At December 31, 2013, the Company’s authorized stock consisted of 1,000,000,000 shares of common stock, with $0.001 par value. The Company is also authorized to issue 20,000,000 shares of preferred stock, with a par value of $0.001 per share. The rights, preferences, and privileges of the holders of the preferred stock will be determined by the Board of Directors prior to issuance of such shares.
During the year ended December 31, 2013, we issued a total of 59,965,470 shares of common stock at fair value in conversion of $219,934 of convertible promissory notes, plus accrued interest payable of $5,517. We recognized a loss of $33,277 on the conversion of the notes. We also issued a total of 592,780 shares of common stock pursuant to a price protection clause in a prior year agreement to issue shares for cash. These shares were recorded at par value.
During the year ended December 31, 2012, we issued a total of 1,982,113 shares of common stock: 474,721 shares for cash of $253,075; 423,943 for the cashless exercise of warrants recorded at par value; 192,857 shares at fair value for services valued at $166,000; 875,000 shares at fair value for an incentive fee valued at $1,079,800; and 15,592 shares at fair value for accounts payable of $15,705.
4. STOCK OPTIONS, WARRANTS AND RESTRICTED STOCK AWARDS
Stock Options
As of December 31, 2013, our Board of Directors granted a total of 14,100,000 non-qualified stock options to purchase 14,100,000 shares of common stock to our employees, officers and consultants. Stock-based compensation expense included in general and administrative expense was $101,755 and $691,814 for the years ended December 31, 2013 and 2012, respectively.
In September 2013, the Board of Directors granted a total of 14,000,000 non-qualified stock options to our former chief executive officer and our current chief executive officer to purchase a total of 14,000,000 shares at an exercise price of $0.006 per share. The options vest over a period of 25 months beginning in October 2013 and are exercisable for a period of seven years from the date of grant.
The estimated grant date fair value of these options was $0.005 per share, and the assumptions used in the Black-Scholes valuation model to determine this estimated fair value are as follows:
As of December 31, 2013, unrecognized stock-based compensation expense was approximately $65,000.
A summary of the Company’s stock option awards as of December 31, 2013, and changes during the years ended December 31, 2013 and 2012 is as follows:
The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on our closing stock price of $0.01 as of December 31, 2013, which would have been received by the holders of in-the-money options had the option holders exercised their options as of that date.
Warrants
As of December 31, 2013, the Company had 460,000 common stock purchase warrants outstanding, with an exercise price of $0.50 per share and expiring on various dates in 2017 and 2018.
Restricted Stock Awards
On September 12, 2013, two consultants were each granted restricted stock awards of 14,000,000 shares of our common stock. The shares vest upon reaching certain defined milestones related to our development and construction of a gas-to-liquid plant. Total compensation deferred at December 31, 2013 to be recognized as the shares vest, calculated using the closing market price of our common stock on the date of grant, was $137,200. No shares had vested at December 31, 2013.
5. NOTES PAYABLE
During the year ended December 31, 2013, the Company issued short-term promissory notes totaling $77,620, $11,000 for cash, $40,470 in payment of accounts payable and $26,150 issued for services. All of these notes were subsequently exchanged for convertible notes payable (Note 6) during the year ended December 31, 2013.
6. CONVERTIBLE NOTES PAYABLE
Institutional Lender
We entered into two securities purchase agreements on September 19, 2012 and December 12, 2012, for the issuance of two 8% convertible promissory notes in the aggregate principal amount of $75,000. The notes were convertible into shares of our common stock at a price equal to a variable conversion price of 58% multiplied by a defined market price, representing a discount of 42%. The market price was defined as the average of the lowest three (3) trading prices for our common stock during a ten trading day period ending on the latest complete trading day prior to the conversion date. Subsequently, during the year ended December 31, 2013 both notes were converted into shares of our common stock, extinguishing a total of $75,000 in principal and $3,000 in accrued interest.
We subsequently entered into two additional securities purchase agreements with the same lender on July 8, 2013 and September 16, 2013, for the issuance of two 8% promissory notes in the aggregate principal amount of $75,000. One note matures on April 10, 2014, and the other matures on June 18, 2014. The notes are convertible into shares of our common stock at a variable conversion price determined in the same manner as the first two notes described above. We recorded a debt discount of $75,000 related to the conversion feature of the notes, along with a derivative liability at inception. As of December 31, 2013, total amortization was recorded in the amount of $39,629, resulting in a remaining debt discount of $35,371 at December 31, 2013.
Securities Purchase Agreement - $299,212
On December 12, 2012, we exchanged certain promissory notes in the aggregate amount of $327,500 for convertible promissory notes. We entered into securities purchase agreements for the sale of 10% convertible promissory notes in the aggregate principal amount of $327,500, which were convertible into shares of our common stock at a conversion price equal to (a) the lesser of $0.54 per share or (b) 50% of the lowest trade price recorded on any trade date after the effective date, or (c) the lowest effective price per share granted to any person after the effective date. The notes were to mature one year from the effective date of the note. We recorded a debt discount of $327,500 related to the conversion feature of the note, along with a derivative liability at inception. During 2013, the principal sum of $62,000, plus accrued interest was transferred to another investor, and a total of $36,057 principal and $886 accrued interest were converted into shares of our common stock. During 2013, the aggregate debt discount balance as of December 31, 2012 of $312,740 was fully amortized to interest expense.
Effective October 24, 2013, the remaining principal balance of the notes discussed in the preceding paragraph totaling $291,443 and accrued interest of $7,769 were combined in a new 10% convertible promissory note in the aggregate amount of $299,212, which matures on October 24, 2014. The new note is convertible into shares of our common stock at a conversion price equal to (a) the lesser of $0.006 per share or (b) 50% of the lowest trade price recorded on any trade date after the effective date, or (c) the lowest effective price per share granted to any person after the effective date. A total of $16,750 principal and $1,631 accrued interest were subsequently converted into shares of our common stock, resulting in a principal balance of $282,462 payable at December 31, 2013.
Securities Purchase Agreements - Services of $244,452
On December 31, 2012, we entered into convertible promissory notes with three individuals in exchange for services rendered in the aggregate amount of $244,452, including $185,852 with the Chairman of our Board of Directors and our former Chief Executive Officer. We entered into securities purchase agreements for the sale of 5% convertible promissory notes in the principal amount of $244,452, which are convertible into shares of our common stock at a conversion price equal to the lesser of $0.20 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion. The notes mature two years from their effective dates, or December 31, 2014. We recorded a debt discount of $237,742 related to the conversion feature of the notes, along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $118,993, resulting in a remaining debt discount of $120,958 at December 31, 2013.
Securities Purchase Agreement - $100,000
During 2013, we received total proceeds of $40,000 pursuant to a securities purchase agreement for the sale of 10% convertible promissory notes in the aggregate principal amount of $100,000. The notes are convertible into shares of our common stock at a price equal to a variable conversion price of the lesser of $0.09 per share or fifty percent (50%) of the lowest trade price recorded after the effective date. The notes were to mature one year from their effective date. We recorded a debt discount of $40,000 related to the beneficial conversion feature of the notes. During 2013, total amortization was recorded in the amount of $31,151, resulting in a remaining discount of $8,849 at December 31, 2013.
Securities Purchase Agreement - $335,000
On October 8, 2012, we received proceeds of $75,000 pursuant to a securities purchase agreement for the sale of 10% convertible promissory notes in aggregate principal amount of $335,000 with a 10% Original Issue Discount (OID) of $35,000. The principal amount of $83,750 outstanding on the note as of December 31, 2012 included the payment of $75,000 plus the unamortized original issue discount of $8,750. We recorded a debt discount of $54,843 related to the conversion feature of the note and $8,750 related to the original issue discount, along with a derivative liability at inception. During 2013, the principal sum of $80,844 was converted into shares of our common stock. The remaining principal balance of $2,906 was transferred to and included in a new note payable to this lender. During 2013, the balance of the debt discount at December 31, 2012 of $43,283 was fully amortized to interest expense.
On February 27, 2013, we received additional proceeds of $25,000 on this securities purchase agreement, with an original issue discount of $4,313 for total principal owed of $29,313. We recorded a debt discount of $25,403 related to the conversion feature of the note and the original issue discount, along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $23,266, resulting in a remaining discount of $2,137 at December 31, 2013. If the notes are repaid before 90 days, the interest rate will be zero percent (0%), otherwise a one-time interest rate of five percent (5%) will be applied to the principal sums outstanding. As of December 31, 2013, all interest was owed. The notes are convertible into shares of common stock of the Company at a price equal to the lesser of $0.72 or 70% of the lowest trade price in the 25 trading days prior to the conversion. The notes mature one year from the effective date of each advance.
On December 10, 2013, we received additional proceeds of $25,000 on this securities purchase agreement, with an original issue discount of $4,312 and the transfer of $2,137 principal and $4,957 accrued interest for total principal owed of $36,406. We recorded a debt discount of $29,312 related to the conversion feature of the note and the original issue discount, along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $1,686, resulting in a remaining discount of $27,626 at December 31, 2013.
During 2013, a total of $11,284 principal was converted into shares of our common stock.
Securities Purchase Agreement - Accounts Payable of $29,500
On March 14, 2013, we entered into a convertible promissory note in exchange for accounts payable in the amount of $29,500. We entered into securities purchase agreements for the sale of a 5% convertible promissory note in the principal amount of $29,500, which is convertible into shares of our common stock at a conversion price equal to the lesser of $0.15 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion. The note matures two years from its effective date, or March 14, 2015.
Securities Purchase Agreement - $97,000
On May 29, 2013, we exchanged $97,000 in demand promissory notes for convertible promissory notes pursuant to a securities purchase agreement for the sale of a 10% convertible promissory note in the aggregate principal amount of $97,000. The notes are convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.028 per share or fifty percent (50%) of the lowest trade price recorded after the effective date. The note matures six months from the effective date. We recorded a debt discount of $97,000 related to the beneficial conversion feature of the note. During 2013, the debt discount of $97,000 was fully amortized to interest expense.
Securities Purchase Agreement - Services of $25,000
On June 4, 2013, we entered into a convertible promissory note with a member of our Board of Directors in exchange for services rendered in the amount of $25,000. We entered into securities purchase agreements for the sale of a 5% convertible promissory note in the principal amount of $25,000, which is convertible into shares of common stock of the Company at a conversion price equal to the lesser of $0.035 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion. The note matures three years from its effective date, or June 4, 2016.
Securities Purchase Agreement - Chief Executive Officer Services of $15,000
On May 31, 2013, we entered into a convertible promissory note in exchange for services rendered by our Chief Executive Officer in the amount of $15,000. We entered into securities purchase agreements for the sale of a 5% convertible promissory note in the principal amount of $15,000, which is convertible into shares of our common stock at a conversion price equal to the lesser of $0.04 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion. The note was to mature two years from its effective date. Subsequently in 2013, the Chief Executive Officer contributed the note to capital.
Securities Purchase Agreement - $5,000 Exchanged Note
On September 6, 2013, we exchanged a $5,000 promissory note for a convertible promissory note pursuant to a securities purchase agreement for the sale of a 10% convertible promissory note in the aggregate principal amount of $5,000. The note is convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.0042 per share or fifty percent (50%) of the lowest trade price recorded after the effective date. The note matures on June 30, 2014. We recorded a debt discount of $2,536 related to the beneficial conversion feature of the note, along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $1,077, resulting in a remaining discount of $1,459 at December 31, 2013.
Securities Purchase Agreement - $250,000
On October 8, 2012, we entered into to a securities purchase agreement for the sale of 10% convertible promissory notes in aggregate principal amount of $250,000. The notes are convertible into shares of common stock of the Company at a price equal to the lesser of $0.006 or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion. The notes mature six months from the effective date of each advance.
The lender previously advanced a total of $11,000 in August and September 2013 that was transferred to this agreement. We recorded a debt discount of $11,000 along with a derivative liability upon transfer. During 2013, total amortization was recorded in the amount of $5,137, resulting in a remaining discount of $5,863 at December 31, 2013.
On October 21, 2013, we received additional proceeds of $22,000 on this securities purchase agreement. We recorded a debt discount of $22,000 along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $8,582, resulting in a remaining discount of $13,418 at December 31, 2013.
On November 22, 2013, we received additional proceeds of $25,000 on this securities purchase agreement. We recorded a debt discount of $25,000 along with a derivative liability at inception. During 2013, total amortization was recorded in the amount of $5,387, resulting in a remaining discount of $19,613 at December 31, 2013.
For purpose of determining the fair market value of the derivative liability, we used the Black Scholes option valuation model. The significant assumptions used in the Black Scholes valuation of the derivative liability at December 31, 2013 are as follows:
The value of the derivative liability balance at December 31, 2013 was $2,811,962.
The total loss on settlement of debt related to the conversion of notes payable into shares of our common stock was $25,195 for the year ended December 31, 2013.
7. SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION
During the years ended December 31, 2013 and 2012, we paid no amounts for income taxes.
During the years ended December 31, 2013 and 2012, we paid interest of $4,333 and $6,208, respectively.
During the year ended December 31, 2013, we had the following non-cash investing and financing activities:
We issued a total of 59,965,470 shares of common stock in conversion of $219,934 in convertible notes payable, plus $5,517 of accrued interest payable, increasing common stock by $59,965, increasing additional paid-in capital by $540,325, decreasing debt discount by $55,942 and decreasing derivative liability by $430,781.
We exchanged notes payable of $82,620 for convertible notes payable.
We issued 592,780 shares of common stock pursuant to a price protection clause in a prior year agreement to issue shares for cash, increasing common stock and decreasing additional paid-in capital by $593.
We increased additional paid-in capital and decreased accrued interest, notes payable by $7,175 to record the contribution of related party accrued interest to capital.
We increased additional paid-in capital and beneficial conversion feature by $138,951 for the beneficial conversion feature related to new notes and decreased additional paid-in capital by $15,571, increased derivative liability by $6,585 and decreased debt discount by $8,986.
We issued convertible notes payable for accounts payable of $29,500.
We issued notes payable for accounts payable of $40,470.
We decreased convertible notes payable and increased additional paid-in capital by $15,000 for the note contributed to capital.
We decreased accrued interest payable and increased convertible notes payable by $11,955.
During the year ended December 2012, we had the following non-cash investing and financing activities:
We issued 15,592 shares of common stock for payment of accounts payable of $15,705, increasing common stock by $15 and increasing additional paid-in capital by $15,690.
We issued 423,943 shares of common stock through a cashless exercise of warrants, increasing common stock by $424 and decreasing additional paid-in capital by $424.
8. INCOME TAXES
A reconciliation of the income tax provision (benefit) that would result from applying a combined U.S. federal and state rate of 43% to loss before income taxes with the provision (benefit) for income taxes presented in the financial statements is as follows:
Deferred tax assets (liabilities) are comprised of the following:
The ultimate realization of our deferred tax assets is dependent, in part, upon the tax laws in effect, our future earnings, and other events. As of December 31, 2013, we recorded a valuation allowance of $3,311,400 against net current deferred tax. In recording the valuation allowance, we were unable to conclude that it is more likely than not that our deferred tax assets will be realized.
As of December 31, 2013, we had a net operating loss carryforward available to offset future taxable income of approximately $7,453,000, which begins to expire at dates that have not been determined. If substantial changes in the Company’s ownership should occur, there would be an annual limitation of the amount of the net operating loss carryforward that could be utilized.
We perform a review of our material tax positions in accordance with recognition and measurement standards established by authoritative accounting literature, which requires a company to determine whether it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. If the more-likely-than-not threshold is met, a company must measure the tax position to determine the amount to recognize in the financial statements. Based upon our review and evaluation, during the years ended December 31, 2013 and 2012, we concluded the Company had no unrecognized tax benefit that would affect its effective tax rate if recognized.
We file income tax returns in the U.S. federal jurisdiction and in the state of California. With few exceptions, we are no longer subject to U.S. federal, state or local income tax examinations by tax authorities for years before 2011.
We classify any interest and penalties arising from the underpayment of income taxes in our statements of operations and comprehensive loss in other income (expense). As of December 31, 2013 and 2012, we had no accrued interest or penalties related to uncertain tax positions.
9. RELATED PARTY TRANSACTIONS
See Notes 5 and 6 for discussion of notes payable and convertible notes payable with related parties, including many lenders who are also shareholders of the Company.
On December 12, 2012, we entered into a convertible note with the Chairman of our Board of Directors and our former Chief Executive Officer in exchange for services valued at $185,852. The principal balance of this related party note was $185,852 as of December 31, 2013 and 2012, with accrued interest payable of $9,293 as of December 31, 2013.
On June 4, 2013, we entered into a convertible note with a member of our Board of Directors in exchange for services valued at $25,000. As of December 31, 2013, the principal balance of this related party note was $25,000, with accrued interest payable of $719.
On May 31, 2013, we entered into a convertible promissory note in exchange for services rendered by our Chief Executive Officer in the amount of $15,000. Subsequently in 2013, the Chief Executive Officer contributed the note to capital and we decreased convertible notes payable and increased additional paid-in capital by $15,000.
In 2013, we increased additional paid-in capital and decreased accrued interest, notes payable by $7,175 to record the contribution of related party accrued interest to capital.
10. OPERATING LEASE
We extended our facility lease for a period of five years, expiring on September 30, 2017. The base rent for the period of October 1, 2012 to September 30, 2013 is $2,884 per month, and for the remaining period commencing on October 1, 2013 to September 30, 2017 the base rent will be $2,971 per month. Rent expense for the years ended December 31, 2013 and 2012 was $53,045 and $46,089, respectively.
11. SUBSEQUENT EVENTS
Management has evaluated subsequent events according to the requirements of ASC TOPIC 855, and has reported the following:
Subsequent to December 31, 2013, we issued lenders a total of 37,721,757 shares of our common stock in conversion of debt principal of $85,672 and accrued interest of $4,966.
We received proceeds of $63,000 in January 2014 and $30,000 in February 2014 from convertible promissory notes payable.