Indicate by check mark if the registrant is
a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
o
No
x
Indicate by check mark if the registrant is
not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
o
No
x
Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
x
No
o
Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes
x
No
o
Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained,
to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
x
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Act). Yes
o
No
x
The aggregate market
value of the voting and non-voting common equity held by non-affiliates (excluding voting shares held by officers and directors)
as of June 30, 2013, was $163,764,597.
The number of shares
of the Registrant’s Common Stock outstanding as of February 28, 2014, was 180,603,764
PART I
Forward-Looking Statements
This Annual Report
on Form 10-K contains forward-looking statements. These forward-looking statements include predictions and statements regarding
our future:
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·
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research and development expenses and efforts;
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·
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scientific and other third-party test results;
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·
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sales and marketing expenses and efforts;
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·
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liquidity and sufficiency of existing cash;
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·
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technology and products; and
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·
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the effect of recent accounting pronouncements on our financial condition and results of operations.
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You can identify these
and other forward-looking statements by the use of words such as “may,” “will,” “expects,”
“anticipates,” “believes,” “estimates,” “intends,” “project,” “potential,”
“forecast” “continues,” or the negative of such terms, or other comparable terminology, and also include
statements concerning plans, objectives, goals, strategies and future events or performance.
Our actual results
could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those
set forth below under the heading “Risk Factors.” We cannot assure you that we will achieve or accomplish our expectations,
beliefs or projections. All forward-looking statements included in this document are based on information available to us on the
date hereof. We assume no obligation to update any forward-looking statements.
Item 1. Business
The discussion of our
business is as of the date of filing this report, unless otherwise indicated.
Overview
Save the World Air,
Inc. (“STWA” or “Company” or “we” or “us” or “our”) is a development
stage Company that has not yet generated any significant revenues since our inception in February 1998. We have devoted the bulk
of our efforts to the completion of the design, and the commercial manufacturing of our production models, and testing of devices
and the promotion of our commercialized crude oil pipeline technology, services and products in the upstream and midstream energy
sector. We anticipate that these efforts will continue through 2014 and beyond.
Our expenses to date
have been funded primarily through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise
of stock purchase warrants and options. We raised capital in 2013 and will need to raise substantial additional capital in 2014,
and beyond, to fund our sales and marketing efforts, continuing research and development, and certain other expenses, until our
revenue base grows sufficiently.
The Company develops
and intends to commercialize energy efficiency technologies that assist in meeting increasing global energy demands, improving
the economics of oil extraction and transport, and reducing greenhouse gas emissions. Market conditions within the oil and gas
industry are favorable. As reported in the Short-Term Energy Outlook report issued by the U.S. Energy Information Administration,
U.S. crude oil production in August 2013 hit its highest monthly level in 24 years, creating significant pipeline capacity and
related logistical bottlenecks for both the upstream and midstream operator and supplier markets.
The Company's
intellectual property portfolio includes 47 domestic and international patents and patents pending, which have been developed
in conjunction with and exclusively licensed from Temple University. STWA's primary technology is called Applied Oil
Technology™ (AOT™), a commercial-grade crude oil pipeline transportation flow-assurance product. AOT™ has
been evaluated by Dr. Rongjia Tao, Ph.D, inventor of the underlying licensed technology in conjunction with the
U.S. Department of Energy to test potential benefits to oil pipeline networks. The AOT product has transitioned from the
research and development stage to initial commercial production for the midstream pipeline marketplace. The Company is
actively engaged in research and development related to the optimization and value engineering of our commercial midstream
pipeline AOT product and the development of complementary AOT product lines. Below is the current status of the AOT
development:
We operate in a
highly competitive industry. Many of our activities are subject to governmental regulation. We have
taken aggressive steps to comply with all governmental regulation(s) pertaining to our product(s), and have taken similar
measures to protect our intellectual property. See “Competition”, “Government Regulation and Environmental
Matters”
and “Intellectual Property”, below.
There are significant
risks associated with our business, our Company and our stock. See “Risk Factors,” below.
We are a development
stage Company that generated minimal revenues in 2006 and 2007. We did not generate any sales or revenues in 2008 up to 2013. Our
expenses to date have been funded primarily through the sale of common stock and issuance of convertible debt, as well as proceeds
from the exercise of stock purchase warrants and options. We raised capital in 2013 and will need to raise substantial additional
capital in 2014, and beyond, to fund our sales and marketing efforts, manufacturing efforts, continuing research and development,
and certain other expenses, until we generate revenue and such revenue grows sufficiently to cover such expenditures. See
“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” below.
Our Company was incorporated
on February 18, 1998, as a Nevada corporation, under the name Mandalay Capital Corporation. We changed our name to Save the
World Air, Inc. on February 11, 1999, following the acquisition of marketing and manufacturing rights of the ZEFS (legacy)
technologies. We have no plans to continue developing, testing or marketing our ZEFS technology. Our mailing address is 735 State
Street, Suite 500, Santa Barbara, California 93101. Our telephone number is (805) 845-3581. Our corporate website is
www.stwa.com
. Our
common stock is quoted under the symbol “ZERO” on the Over-the-Counter Bulletin Board.
Recent Developments
On August 1, 2013,
the Company entered into an Equipment Lease/Option to Purchase Agreement (“Agreement” or “Lease”) with
TransCanada Keystone Pipeline, L.P. by its agent TC Oil Pipeline Operations, Inc. (“TransCanada”), dated effective
as of July 17, 2013. In accordance with the terms and conditions of the Agreement, TransCanada has agreed to lease, install, maintain,
operate and test the effectiveness of the Company’s AOT technology and equipment on one of TransCanada’s operating
pipelines. Under terms of the Agreement the Company will deliver the Equipment to TransCanada to be installed and placed in operation
by TransCanada, at TransCanada’s expense, on a date estimated to be no later than March 1, 2014, as amended. The initial
term of the lease is six (6) months, with an option to extend the lease for an additional eighty-four (84) months. TransCanada
has an option to purchase equipment during the term of the lease. A copy of the Agreement was included as Exhibit 10.1 with the
Company’s Form 8-K filing with the SEC on August 2, 2013.
In July 2013, Mark
Stubbs was appointed as an independent member of the Board of Directors.
In July 2013, Greggory
Bigger was appointed President of the Company.
In August 2013, Don
Dickson was appointed as an independent member of the Board of Directors.
In October 2013, Greggory
Bigger was appointed as a non-independent member of the Board of Directors.
In November 2013, Greggory
Bigger was named Chief Executive Officer and Chairman of the Board (interim).
In November 2013, Cecil
Kyte voluntarily resigned as a Director, Chairman of the Board, a member of the Nominating and Corporate Governance Committee,
and Chief Executive Officer of the Company.
In December 2013, Company
stockholders approved an amendment to our articles of incorporation, increasing the number of our authorized shares of common stock
from 200 million to 300 million.
In December 2013, the
Company’s Board unanimously approved the reinstatement of 3,047,403 shares of common stock of the Company. The circumstances
related to such reinstatement are as follows: 3,047,403 shares of common stock of the Company were held in street (nominee) name
by Cede & Co. of the Depository Trust Co. (the “Cede Shares”). The Cede Shares were ordered cancelled by a federal
district court relating to litigation initiated by the Securities and Exchange Commission against the Company and its former CEO,
Jeffrey Mueller in 2001. Either before or after the court’s order (the timing of which is unknown to the Company), the Cede
Shares, at that time held directly or indirectly by Mueller, were placed with Cede & Co. in nominee name. In furtherance of
the court’s order, the physical certificates relating to the Cede Shares should have been returned to the Company’s
transfer agent (NATCO) for cancellation. This did not occur. Rather, Cede & Co. retained the stock certificates representing
the Cede Shares and continued to treat the Cede Shares as outstanding and free trading shares of the Company.
Notwithstanding the
foregoing, NATCO, in furtherance of then Company counsel’s instructions, cancelled the Cede Shares on the Company’s
books and records in 2005, and, in furtherance thereof, reduced the Company’s outstanding shares of common stock by 3,047,403.
Cede & Co. has requested, in effect, that, inasmuch as the Cede Shares continue to be within its system, the Cede Shares be
reinstated on the Company’s books and records and that the outstanding shares of the Company be increased by 3,047,403. Although
the Company believes Cede & Co.’s request is misplaced, particularly since it appears that Cede & Co. had prior notice
of the court’s order cancelling the Cede Shares, the Company has elected to avoid litigation with Cede & Co. and instead
has elected to reinstate the Cede Shares. Accordingly, 3,047,403 shares of the Company’s common stock has been added back
to the Company’s outstanding share count.
Our Business Strategy
STWA intends to acquire,
license, and develop new, novel technology from academia, and to develop the technology into commercially viable products for select
niche industries. Our current and primary product portfolio is dedicated to the crude oil production and transportation marketplace,
with a specifically-targeted product offering for enhancing the flow-assurance parameters of new and existing pipeline gathering
and transmission systems.
Our primary goal is
to provide the oil industry with a cost-effective method by which to increase the number of barrels of oil able to be transported
per day through the industry’s existing and newly built pipelines. We also seek to provide the oil industry with a way to
reduce emissions from operating equipment. We believe our goals are realizable via viscosity reduction using our AOT product.
There is currently
rapid growth within the petroleum industry and regulatory growth within governmental bodies worldwide. We believe, STWA’s
AOT system allows the petroleum industry to gain key value advantages boosting profit, while satisfying the needs of regulatory
bodies at the same time. We believe we can successfully provide valuable, simply installed, low maintenance, turn-key systems that
would provide benefits to the petroleum production, transportation and refinement industries.
Our business model
is to acquire and license intellectual properties which the Company believes hold potential for development to commercial application.
From there, the idea is developed into a test prototype series for validation that the idea is scalable to full-size from the laboratory,
and then developed further to a commercial-grade series of niche products for the intended market. The manufacturing of the commercial-grade
products is then conducted by third-party vendors and suppliers under contract(s) with the Company. These vendors are broken up
by product component subcategory, enabling multiple manufacturing capacity redundancies and safeguards to be utilized. In addition,
the strategy allows the Company to eliminate the prohibitively high capital expenditures such as costs of building, operating and
maintaining its own manufacturing facilities, ratings, personnel and licenses, thereby eliminating unnecessary capital intensity
and risk.
Our identified market
strategy is to continue meeting with oil and gas industry executives in the upstream, gathering, and midstream sectors from both
domestic and foreign companies. Our goal is to introduce our technology to oil and gas companies and to demonstrate potential value
for the purposes of negotiating commercial implementation of our AOT technology to their existing infrastructures.
Our strategy includes:
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1.
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Finalize manufacturing of our AOT Midstream commercial product line.
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2.
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Complete the multiple certification processes for our AOT Midstream commercial product line.
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3.
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Continue developments for implementation of our AOT Midstream product for commercial use.
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4.
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Gain clearance from customers’ procurement divisions for installation of AOT Midstream products
into their operations.
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5.
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Publish material events, collaborative arrangements, framework agreements and joint development
agreements.
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6.
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Co-Present with customers at various trade conferences in the United States.
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7.
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Continue to make inroads and meet with key strategic potential customers in the following geographic
regions:
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b.
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Williston, Bakken Basin, USA
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c.
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Niobrara, Denver-Julesberg Basin, USA
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8.
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Continue to make inroads and strategic alliances with additional supply chain and logistics support
to rapidly expand our production capacity beyond its current physical limitations, adding capacity, reach and stability with pre-approved
supply chain members that meet the criteria of the customers’ procurement divisions.
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9.
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Further develop two additional AOT product models beyond the AOT Midstream for reach into the upstream
and gathering energy production and transport sectors.
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10.
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Continue to develop collaboratively additional scientific and technical whitepaper reports, product
development enhancements, and additional products with our engineering support, consultants and relationships.
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Market Analysis Overview
The United States
energy sector is in a period of change and growth due to the invention and adoption of new oilfield drilling and completion
techniques. These new technological achievements, known as EOR Enhanced Oil Recovery Techniques (EOR), have reversed the
domestic United States' oilfield depletion trends, making this country extremely competitive in the global energy production
sector over the past five years. One of the many challenges to the sector is that the upstream growth is rapidly
overwhelming the midstream pipeline infrastructure's carrying capacity, leading to transportation and emissions problems.
STWA's Applied Oil Technology (AOT™) on-demand crude oil viscosity reduction flow assurance technology is
designed to assist with both of these issues facing the industry.
EOR Growth:
The advent of EOR beginning
predominantly in about 2007, has led to growth in the upstream sector. The Williston Basin and Bakken Formation in North
Dakota, for example, have benefitted from widespread adoption of the new techniques, enabling the once inactive field again to
become viable in the otherwise desolate region. The Bakken is considered by many within the industry as a key leading indicator
of future production as other areas begin the adoption process of the new downhole techniques. The rampant upstream growth
due to the EOR use has reversed the "Peak Oil" trend that was indicated decades ago, bringing the USA to the forefront
of gas and crude production. These new techniques allow for previously unattainable oil and gas reserves to become viable,
and have led to massive growth in the upstream production sector. With the EOR processes, many industry analysts predict
that the USA will be able to be energy independent within the next 5 to 10 years.
Midstream Challenges due
to EOR Growth:
The rampant and accelerating
growth does not come without its challenges however. One of the many issues facing the industry is the simple fact that the
accelerating growth in the upstream sector due to the adoption of the new and more effective recovery techniques has outstripped
the midstream transportation network of long distance transmission pipelines' carrying capacity. The midstream sector, which takes
the upstream product produced in the remote oilfields throughout the continent and brings it to market, hundreds to thousands of
miles away, was designed and built prior to the advent of the EOR technology. The problem is that there simply isn't enough
pipeline diameter and transport capacity to service the areas adopting the EOR techniques. This, in turn leads the upstream
producers to look to other means to bring their product to market. In regions such as the Williston Basin (Bakken), the lack
of pipeline carrying capacity has led to explosive growth in truck and train transportation, triggering many challenges for the
highway and rail systems throughout the domestic USA. The US Energy Information Administration states that truck and rail
petroleum transportation was up 38% in the first half of 2012 due to the lack of pipeline infrastructure.
New Regions Adopting EOR:
The EOR techniques
are being adopted in more regions than just the Williston / Bakken Formation at an accelerating rate. Our research is indicating
that like the Williston / Bakken, the adoption of the EOR techniques is now making old oilfields in the Rocky Mountains viable
for the first time in decades, and many notable upstream energy companies are seeing enormous benefits and growth in the areas.
Oilfields such as the Denver-Julesberg (D-J) Basin in northern Colorado / Southern Wyoming / Southern Nebraska, the Uinta-Piceance
Basin in Utah / Colorado, the Green River Basin, and a number of other fields in the Rockies are beginning to adopt the EOR techniques
that made the Williston / Bakken so successful. According to Midstream Business Magazine (Nov-Dec 2012 issue), the DJ Basin
production alone grew 30% last year, and analysts predict production to double by 2016. According to the office of the Governor'
Utah's Energy Landscape 2011 Department of Natural Resources Report, the number of oil and gas well completions in Utah averaged
879 per year over the past 7 years, a major increase over the 274 wells averaged throughout the 1990's.
The main problem the
new EOR adopting regions are facing is that their areas have an even greater lack of pipeline transport capacity leading out of
the areas, because the midstream pipeline infrastructure was designed decades before the advent of EOR made the regions viable.
The regions are extremely reliant on truck and train transport, because of the lack of midstream infrastructure servicing
the areas. We believe new technologies such as our AOT (Applied Oil Technology) are coming to the forefront of interest within
the commercial energy production and transport sector for its ability to increase the flow rates, improve the energy-efficiency,
and increase the margin of safety for the existing pipelines and new pipelines in development to service the areas.
Our Products and Technology
AOT Commercial Products
Beginning in the second
quarter of 2012, the Company began the design and engineering efforts required to transition from prototype testing to full-scale
commercial unit production. The Company established its supply chain, designs, drawings, engineering, certifications and specifications
to comply with the engineering audit processes as dictated by the Energy Industry regulation processes. The Company’s first
commercial prototype unit known as AOT™ Midstream, was completed in May 2013 to support the Company’s Pilot Program
installation efforts after successfully passing quality control according to accepted industry practices, and passing inspection
for various industry and regulatory certifications and inspections. The Company has been working in a collaborative engineering
environment with multiple Energy Industry companies to refine the AOT™ Midstream commercial design to comply with the stringent
standards and qualification processes as dictated by independent engineering audit groups and North American industry regulatory
bodies.
In July, 2013, the
Company began to design, engineer, and manufacture a commercial installation of the AOT™ Midstream system to be installed
to a major pipeline in the first quarter 2014. Manufacturing began in mid-2013 and continues into the first quarter 2014.
In August, 2013, the
Company began to design, engineer, and analyze additional commercial installation versions of the AOT™ technology suite to
identify, evaluate and address additional targets of opportunity within the energy production space. These efforts are intended
to yield a different embodiment of the device(s) for use in the production-side upstream market vertical, designed to increase
the efficiency and volume of the massive network of oil pipeline connecting production fields to midstream transport hubs. The
development processes continue at time of this document.
AOT Commercial Supply Chain
Beginning in 3
rd
Quarter 2010, the Company began the process of establishing its supply chain for fabrication of the commercial AOT devices in Casper,
Wyoming. The supply chain consists of multiple component suppliers and manufacturing companies engaged under Independent Contractor
Agreements according to their respective fields of expertise. The supply chain entities are chosen for their ability to work collaboratively
with STWA and for their existing relationships with current and potential future customers of the AOT systems. The external components
such as pressure vessels, inlet and outlet piping header systems, personnel and equipment shelters are manufactured under contract
with Power Service Inc. with offices in Casper, Wyoming, Green River, Wyoming, Salt Lake City, Utah, Denver, Colorado, Billings,
Montana, Dickinson, North Dakota and San Antonio, Texas. The AOT internal components such as gridpacks, electrical connections
and other machined parts are manufactured by Industrial Screen and Maintenance, with offices in Casper, Wyoming, and Grand Junction,
Colorado. All equipment is manufactured in the United States of America, using only approved raw materials and vendors for quality
control and import/export compliance purposes and meet the certifications and specifications as dictated by our customers and their
independent oversight and auditing authorities.
Other components such
as power systems, electrical junction boxes, cabling, hardware, switches, circuit breakers, computer equipment, sensors, SCADA/PLC,
software and other power and integration equipment are purchased as complete units from various suppliers with operations based
throughout North America. All component vendors are also required to meet or exceed the same specifications as the AOT parts manufacturers
to maintain compliance as dictated by our customers and their independent oversight and auditing authorities.
AOT Intellectual Property
Beginning in 1
st
Quarter 2012, the Company began its own independent audit process for the updating of its intellectual property portfolio. The
goal was to streamline unnecessary legacy items left over from prior management, consolidate efforts to countries and regions of
interest and retire items that were no longer valid or had been replaced with new intellectual property developments. The Company
internally audited its intellectual property portfolio throughout 2012, and in 1
st
Quarter 2013 retained the law firm
of Jones Walker LLP, with operations based in Houston, Texas and began consolidation and streamlining efforts to manage intellectual
properties. The Company applied for one new patent in 2
nd
Quarter 2013.
New Product Development
Pipeline networks in
the USA consume 77% of the electricity and 97% of the natural gas in the transportation sector. The scale of BTU emissions reduction
possible from hydraulic systems efficiency improvement worldwide is massive. By reducing viscosity, one can reduce the power required
to flow the fluid the same distance at the same rate, and directly reduce the amount of Carbon Dioxide emissions as a function
of the motor and electrical network efficiency. The impact of viscosity reduction for pipeline transportation systems is well-known.
Fluid viscosity plays an important role in the function of a hydraulics system, in that it is one of the main sources of internal
fluid friction that creates parasitic friction loss, which must be overcome by a pressure gradient from an area of high pressure
flowing to an area of low pressure. Reduction of friction enables the reduction of parasitic losses, thereby improving the efficiency
of the system as a whole. In large scale pipeline transportation systems, the generation of high pressure is achieved by the use
of fluid pumps. Fluid pumps increase the pressure of the system where they are located, thereby creating a pressure gradient between
their location and the next location down the pipeline. In the case of large scale pipeline networks, the reduction of friction
leads to the reduction of pressure required to overcome the same amount of distance, thereby reducing the power required to flow
a column of fluid the same distance. The reduction of power required to flow the fluid the same distance at the same rate directly
reduces the amount of Carbon Dioxide emissions as a function of the motor and electrical network efficiency. The efficiency of
systems can vary depending upon motive power source type, distance from power source, and many other factors which are outside
the scope of this statement. In short, provided that the system remains in the same flow condition as it started, (Laminar or Turbulent)
the reduction in viscosity leads to a reduction in power consumed per day.
We are currently working
on new intellectual properties which are a natural extension of the existing AOT mechanical apparatus. During our independent audit
of third-party laboratory equipment functionality, it was determined by Dr. Carl Meinhart, Ph.D. that the laboratory equipment
was generating significant heat during operation. Subsequent testing and analysis has confirmed this heat is created through a
process known as “Joule Heating”. Market research by STWA’s product development team has determined that this
highly efficient form of heat would likely be of significant value to the industry. The method of operation is that unlike traditional
electric heat methodologies, which use the electrical conductivity and resistance of a metallic substance to generate heat within
the metal, and then transfer that heat to a fluid via physical contact. The Joule Heat system uses the electrical resistance of
the fluid itself, thereby improving the efficiency of the system by the removal of parasitic losses. The heat system holds key
market advantages in that i) it is much more efficient than current electric-powered heat solutions (35±% vs 80±%);
and ii) it eliminates local emissions, a key advantage over current natural-gas based systems; and iii) it can be made in a small
enough form factor to expand the market into mobile applications such as truck and train transport systems. Management is currently
evaluating the market potential for such a product as a method of reengaging the Company’s diesel motor efficiency applications.
Provisional Patent Application
We filed a provisional
patent application with the United States Patent Office on December 6, 2013, titled “Joule Heating Apparatus and Method,
covering the “Joule Heating” process described above. We intend to file a regular (non-provisional) utility patent
application for this invention before the end of 2014.
The “Joule Heating”
process was developed by Bjorn Simundson and Dr. Carl Meinhart, both of whom assigned their process and invention to us.
Current Business Status
We are subject to non-disclosure
agreements with multi-national upstream and midstream energy production and transportation companies throughout the USA and overseas
for evaluation and analysis of our AOT products' value to their systems. The Company has non-disclosure agreements in place with
companies located on the following continents:
North America
Europe
Africa
Asia
Australia
Several of these companies
have elected to send crude oil samples to Temple University for official, independent laboratory viscosity reduction technology
testing.
AOT Target Market Segmentation
The Company’s
market segmentation can be broken into three main categories. Upstream Producers, Midstream Transporters and Downstream Refiners.
Each of the three market segments is comprised of multiple companies around the world. Some firms will receive greater benefit
from viscosity reduction than others.
The largest number
of potential customers, with the highest potential for benefit from viscosity reduction are the upstream companies, most notably
within the US borders. STWA is in discussions with upstream producers in Colorado, Wyoming, Utah, Texas, Alabama and Alberta, Canada
about our AOT technology. The upstream oil sector is also commonly known as the Exploration and Production (E&P) sector.
The second largest
number of potential customers, with the highest potential for benefit from viscosity reduction are the midstream companies, most
notably within the US borders. STWA is also in discussions with midstream transporters based in Alberta, Canada, Colorado, Wyoming,
Utah, Texas, Alabama, and Oklahoma, about our AOT The midstream sector involves the transportation by transmission or distribution
lines, for storage and marketing of the various oil and gas products produced by natural gas and crude oil processing plants and
by petroleum crude oil refineries.
The third largest number
of potential customers is the downstream market. These companies have not been identified as potential purchasers of our AOT products,
but are identified from benefitting greatly from the benefits of the upstream and midstream companies that provide them with the
material for refinement and should be considered as potential customers. The downstream sector commonly refers to the refining
of petroleum crude oil and the processing and purifying of raw natural gas, as well as the marketing and distribution of products
derived from crude oil and natural gas. The downstream sector reaches consumers through products such as gasoline or petrol, kerosene,
jet fuel, diesel oil, heating oil, fuel oils, lubricants, waxes, asphalt, natural gas, and liquified petroleum gas (LPG) as well
as hundreds of petrochemicals.
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1.
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Midstream operations are often included in the downstream category and considered to be a part
of the downstream sector.
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1.1.
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Upstream producer benefits from use of our AOT technology
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1.2.
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Increased flow rate capacities, especially in the fall through spring cold temperatures.
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1.3.
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Increased revenues via ability to unlock greater flow rates through bottleneck reduction.
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1.4.
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Decreased operational expenditure power required per barrel, saving power consumption, especially
of use with on-site remote power generators, resulting in lower localized emissions and power costs, in addition to reducing pass-through
power costs charged by midstream pipeline operator.
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1.5.
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Reduced trucking and/or train reliance to transport crude to market, leading to reduced operational
expenditure bringing product long distances to market.
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1.6.
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Supplemental to heat required with heavy content crude oil, reducing operational expenditure while
increasing safety and uptime. (Paraffin wax is a white or colorless soft solid that is derived from petroleum and consists of a
mixture of hydrocarbon molecules containing between twenty and forty carbon atoms.)
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1.7.
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Supplemental to diluent content required with heavy content crude oil, reducing operational expenditure
and infrastructure complications bringing diluent on-site and subsequent refining it out of the crude, increasing the value of
each barrel transported to refinery and reducing transport costs.
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1.8.
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Supplemental to polymeric friction reducers content required with high friction lines, reducing
operational expenditure and infrastructure complications bringing these friction reducers on-site and subsequent refining it out
of the crude, increasing the value of each barrel transported to refinery and reducing transport costs. Polymeric friction reducers
are a chemical drag reducing composition comprising of long-chain polymers used to reduce the turbulence loss and friction within
pipeline systems.
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1.9.
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Increased oilfield valuations via improved transport capacities.
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2.
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Midstream transporters benefits from use of our AOT technology:
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2.1.
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Increased revenues via higher flow rate capacities.
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2.2.
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Increased spot capacity revenues via committed and uncommitted flow increases.
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2.3.
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Decreased OPEX per barrel moved, enabling strategic advantages internally and lower transport costs.
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2.4.
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Decreased emissions per barrel opportunities for Environmental Protection Agency (EPA) and Department
of Transportation (DOT) governmental advantages.
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2.5.
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Decreased friction per mile, leading to reduced thermal build on “bullet” style transmission
lines.
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2.6.
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Decreased Reid Vapor Pressure (RVP) build at end of line collection tank batteries due to reduced
thermal build per mile, resulting in EPA compliance advantages.
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2.7.
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Decreased pressure loss per mile, leading to increased margins of safety and regulatory compliance
advantages via decreased pressure required to move product per mile.
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2.8.
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Increased flow flexibilities through the fall, winter and spring months, enabling more balanced
flow rates throughout the year in high temperature variance locations, leading to increased annual revenues and more stable flow
rate capacities throughout the year.
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3.
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Downstream refiners benefits from use of our AOT Technology:
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3.1.
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Reduced downstream collection tank RVP enables lower tank emissions due to reduced end of line
temperatures.
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3.2.
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Reduced RVP due to reduced diluent content secondary potential.
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3.3.
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Simplified refinement due to potential reduced diluent concentration.
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3.4.
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Simplified refinement due to potential reduced polymeric friction reducer concentration.
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3.5.
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Increased revenue potential due to greater concentration of high-value crude content.
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3.6.
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Increased refinement volume flexibility due to greater flow flexibility during the fall-winter-spring
months.
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3.7.
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Reduced truck and train delivery traffic, as greater volume moves through pipeline content, simplifying
down-line logistics for offloading.
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STWA Target Markets
STWA has separated
its market into specific groups to be addressed with slightly different strategies. The three markets within the petroleum industry
are Upstream Producers, Midstream Transporters, and Downstream Refiners. STWA seeks to pursue the first two of the three segments,
since we believe such segments would benefit the most from our AOT technology.
Upstream Producers.
Upstream Producers
are arguably the most motivated groups within the petroleum industry because they have the most to gain from additional flow throughput
capacity and also experience the most problems due to high viscosity crude oil, especially in the winter months.
This group, also known
as the “Wildcatter” group are the most open to new technology, typically have the fewest barriers to entry, and tend
to benefit financially the most from every additional barrel of their crude oil that they are able to transport. Upstream producers
physically move the most volume of product and make the most money of the three segments for every barrel of crude transport capacity.
They are the midstream transporter group’s customer and are the group that engages the transporter group in long-term contractual
shipping obligations (tariff-based transportation contracts) to move product from their fields to the refiners and markets downstream.
Producers make the
spot market price for every barrel delivered to refinery, minus the transport costs, tariffs, and marketing discounts associated
with bringing the product to market. A rough rule of thumb for this market is that the further away they are from the refinery,
the higher the transport costs to deliver the product. STWA’s AOT is of interest to upstream producers. This group would
benefit from our AOT technology by unlocking chokepoints from their field to the transmission line loading terminals due to viscosity
constraints. In addition, this group would also benefit from their midstream transporters implementing our AOT 2.0 transmission-line
series by its ability to increase the overall flow capacity of the pipelines transporting the product from the loading terminals
to market.
According to numerous
market research groups, the upstream producers are currently massively choked in the central United States because the pipelines
were designed to handle the recoverable capacity of crude oil prior to the advent of the Enhanced Oil Recovery Techniques rapidly
being put in place throughout the USA.
Midstream Transporters
Midstream transporters
transport the greatest volume of crude oil throughout the 400,000 miles of crude oil pipelines around the world (160,000+ miles
of crude pipelines are in the USA alone). We view them as a secondary market due to their tendency to be slower-moving and more
conservative than their upstream counterparts, as they are one of the highest-regulated industry segments in the world.
In general, a pipeline
transport operators’ business model is to charge a tariff to transport each barrel of oil through their pipeline. (The model
is similar in business description to that of a toll-road, bridge or ferry service.) They are of interest for our AOT technology
transmission-line series application in that the AOT viscosity reduction technology holds direct benefits to the midstream operators
via increased flow rate capacities, reduced [BTU] per ton-mile and large “Green Effort” public perception value.
The AOT Midstream’s
product value to this market segment is derived from the technology’s ability to reduce the friction loss per mile of the
crude oil as it passes through the hundreds, and sometimes thousands of miles of pipeline from the upstream producers, en route
to the downstream refineries
Midstream Gathering Transporters
A subset of the midstream
transporters sector is the gathering line operators. This group is sometimes a part of the upstream producers’ operations,
or part of the midstream transporter’s operations. It is classified in this discussion in the latter category. These pipelines
are the regional transportation lines that connect the upstream oilfields’ gathering lines to the midstream long distance
transporters’ main trunk lines. They are typically relatively short distance pipelines (20-100 miles) and have diameters
between 6” and 12”.
Downstream Refineries
The third market category
of the industry that can potentially benefit from our new viscosity reduction technology is the downstream refineries sector. The
benefits of the new viscosity reduction technology to this sector would be passed through from advantages realized in the up and
midstream sectors. We believe the advantages posed with the new technology hold potential for the downstream market sector in the
potential for reduced reliance on chemical based flow assurance additives, reduced friction thermal build on heavily turbulent
pipelines both leading to reduced Reid Vapor Pressures and subsequent evaporation mitigation practices and hardware requirements
as mandated by the United States Environmental Protection Agency.
Sales and Marketing
Beginning in 2
nd
Quarter 2012, the Company began to engage the sales and marketing processes associated with gaining early adopters of the AOT technology
to their assets in commercialized form. Since that time, the Company’s executive management team has been meeting with senior
level decision-makers and executives within energy industry companies based in North America, South America, Europe, Africa, Austral-Asia,
and Asia for evaluation and eventual deployment of AOT systems to Upstream and Midstream operations. During the year ended December
30, 2013, the Company entered into new non-disclosure agreements, increasing the number of multi-national companies with which
the Company is jointly evaluating the deployment of AOT™ technologies from five to seven. In addition, the Company has entered
into a regional relationship with newly formed North African energy equipment distributor Energy Tech Africa (ETA) to AOT™
technology available to oil producers in Africa and the Middle East and provide oil samples from several locations to test the
efficacy of AOT™ technology in South Sudan, Egypt and Qatar.
To support these efforts,
the Company developed a hydraulic analysis modeling tool to enable the Company to generate predictive analysis for the potential
benefits as generated by the AOT systems. Multiple samples of petroleum feed-stock and products were sent to the Company’s
technology development co-partner, Temple University for laboratory analysis and review. In addition to their technological benefits,
laboratory testing and hydraulic predictive analyses combine to provide an effective sales tool demonstrating the value proposition
of AOT systems and the cost benefits of leasing or purchasing AOT equipment.
Laboratory and Scientific Testing
Since 2010, the Company
has been working with the U.S. Department of Energy (US DOE) to test its technology at the Department of Energy’s Rocky Mountain
Oilfield Testing Center (RMOTC), near Casper, Wyoming. This third-party testing is to establish independently verified
data related to the Company’s technology as applied to commercial use in a controlled facility, using a commercial-scale
prototype of our AOT technology.
In 2010, a group led
by Dr. Rongjia Tao, Chairman, Department of Physics of Temple University conducted experiments, using the laboratory-scale Applied
Oil Technology apparatus at the National Institute of Standards and Technology (NIST) Center for Neutron Research (CNR). NIST
is an agency of the U.S. Department of Commerce, founded in 1901 in Gaithersburg, Maryland.
Laboratory testing
and confirmation of our AOT technology has been conducted by Dr. Rongjia Tao. Testing of the technology as applied to crude oil
extraction and transmission has been conducted at Temple University in their Physics Department, in addition to the US DOE, at
their Rocky Mountain Oilfield Testing Center, located on the Naval Petroleum Reserve #3 Teapot Dome Oilfield, north of Casper,
Wyoming.
Independent laboratory
testing was also conducted as a collaborative effort by Temple University and China Petroleum Pipeline Bureau in June 2012.
Competition
The oil transportation
industry is highly competitive. We are aware of only three currently available competitive technologies in widespread use for reducing
the viscosity of oil throughout the world. Many of our competitors have greater financial, research, marketing and staff
resources than we do. For instance, oil pipeline operators use heat, diluents such as naphtha and/or natural gasoline, and/or chemical
viscosity reduction additives, or chemical drag-reducing agents to improve flow in pipelines. Our research indicates
that these methods are either very energy-intensive, or costly to implement on a day to day basis. Management believes
that the Company’s AOT technology presents advantages over traditional methods, yet the industry’s willingness to experiment
with new technology may pose some challenges in acceptance.
We are not aware of
any other technology using uniform electrical field crude oil viscosity reduction technology which is designed to significantly
improve pipeline operation efficiency. Although we are unaware of any technologies that compete directly with our technologies,
there can be no assurance that any unknown existing or future technology will not be superior to products incorporating our AOT
technology. Major domestic and international manufacturers and distributors of pipeline flow-improvement chemical solutions
include Pemex, Petrotrin, Pluspetrol, Repsol, Glencore, Conoco-Philips, and Baker-Hughes. According to our research, heater skid
manufacturers are generally local to the oilfield and pipeline regions, and are comprised of a large number of relatively small
businesses in a fragmented industry. Major heater skid manufacturers are Parker, KW International, Thermotech Systems, LTD.
Government Regulation and Environmental
Matters
Our research and development
activities are not subject to any governmental regulations that would have a significant impact on our business and we believe
that we are in compliance with all applicable regulations that apply to our business as it is presently conducted. Our products,
as such, are not subject to certification or approval by the EPA or other governmental agencies domestically or internationally.
Depending upon whether we manufacture or license our products in the future and in which countries such products are manufactured
or sold, we may be subject to regulations, including environmental regulations, at such time.
Non-Disclosure Agreements
To further protect
our intellectual property, we have entered into agreements with certain employees and consultants, which limit access to, and disclosure
or use of, our technology. There can be no assurance, however, that the steps we have taken to deter misappropriation of our intellectual
property or third party development of our technology and/or processes will be adequate, that others will not independently develop
similar technologies and/or processes or that secrecy will not be breached. In addition, although management believes that our
technology has been independently developed and does not infringe on the proprietary rights of others, there can be no assurance
that our technology does not and will not so infringe or that third parties will not assert infringement claims against us in the
future. Management believes that the steps they have taken to date will provide some degree of protection; however, no assurance
can be given that this will be the case.
Employees
As of December 31,
2013, we had nine (9) full-time employees. As of such date, we also utilized the services of nineteen part-time consultants to
assist us with various matters, including engineering, investment relations, public relations, accounting and sales and
marketing. We intend to hire additional personnel to provide services when they are needed on a full-time basis. We recognize that
our efficiency largely depends, in part, on our ability to hire and retain additional qualified personnel as and when needed and
we have adopted procedures to assure our ability to do so.
Item 1A. Risk Factors
We have a history
of losses, and we cannot assure you that we will ever become or remain profitable. As a result, you may lose your entire investment.
We generated our first
revenues from operations in late 2006 and subsequently have not generated any revenues and we have incurred recurring net losses
every year since our inception in 1998. For the fiscal years ended December 31, 2013, 2012 and 2011, we had net losses of
$10,657,009, $13,092,387 and $10,856,547, respectively. To date, we have dedicated most of our financial resources to
research and development, general and administrative expenses and initial sales and marketing activities. We have funded all of
our activities through sales of our debt and equity securities for cash. We anticipate net losses and negative cash
flow to continue until such time as our products are brought to market in sufficient amounts to offset operating losses. Our ability
to achieve profitability is dependent upon our continuing research and development, product development, and sales and marketing
efforts, to deliver viable products and the Company’s ability to successfully bring them to market. Although our management
is optimistic that we will succeed in marketing products incorporating our AOT technology, there can be no assurance that we will
ever generate significant revenues or that any revenues that may be generated will be sufficient for us to become profitable or
thereafter maintain profitability. If we cannot generate sufficient revenues or become or remain profitable, we may have to cease
our operations and liquidate our business.
Our independent
auditors have expressed doubt about our ability to continue as a going concern, which may hinder our ability to obtain future financing.
In their report dated March
17, 2014, our independent auditors stated that our consolidated financial statements for the year ended December 31,
2013 were prepared assuming that we would continue as a going concern. Our ability to continue as a going concern is an issue raised
as a result of our recurring losses and accumulated deficit losses from operations since inception. We had an accumulated deficit
of $93,038,863 as of December 31, 2013. Our ability to continue as a going concern is subject to our ability to
obtain significant additional capital to fund our operations and to generate revenue from sales, of which there is no assurance.
The going concern qualification in the auditor’s report could materially limit our ability to raise additional capital. If
we fail to raise sufficient capital, we may have to liquidate our business and you may lose your investment.
Since we have not
yet begun to generate positive cash flow from operations, our ability to continue operations is dependent on our ability to either
begin to generate positive cash flow from operations or our ability to raise capital from outside sources.
We have not generated
positive cash flow from operations since our inception in February 1998 and have relied on external sources of capital to fund
operations. We had $4,137,068 in cash at December 31, 2013 and negative cash flow from operations of $5,912,368 for the year ended
December 31, 2013.
We currently do not
have credit facilities available with financial institutions or other third parties, and historically have relied upon best efforts
third-party funding. Though we have been successful at raising capital on a best efforts basis in the past, we can provide no assurance
that we will be successful in any future best-efforts financing endeavors. We will need to continue to rely upon financing from
external sources to fund our operations for the foreseeable future. If we are unable to raise sufficient capital from external
sources to fund our operations, we may need to curtail operations.
We will need substantial
additional capital to meet our operating needs, and we cannot be sure that additional financing will be available.
As of December 31,
2013 and thereafter, our expenses ran, and are expected to continue to run, at an approximate “cash burn rate” of
$
300,000
per month, which amount could increase during 2014. In order to fund our capital needs, we conducted
private offerings
of our securities in 2011 and 2012. While discussion regarding additional interim and permanent financings are being
actively conducted, management cannot predict with certainty that an equity line of credit will be available to provide adequate
funds, or any funds at all, or whether any additional interim or permanent financings will be available at all or, if it is
available, if it will be available on favorable terms. If we cannot obtain needed capital, our research and development, and sales
and marketing plans, business and financial condition and our ability to reduce losses and generate profits will be materially
and adversely affected.
Our business prospects
are difficult to predict because of our limited operating history, early stage of development and unproven business strategy. Since
our incorporation in 1998, we have been and continue to be involved in development of products using our technology, establishing
manufacturing and marketing of these products to consumers and industry partners. Although we believe our technology and products
in development have significant profit potential, we may not attain profitable operations and our management may not succeed in
realizing our business objectives.
If we are not able
to devote adequate resources to product development and commercialization, we may not be able to develop our products.
Our business strategy
is to develop, manufacture and market products incorporating our AOT technology. We also intend to develop, manufacture
and market products incorporating the technology. We believe that our revenue growth and profitability, if any, will substantially
depend upon our ability to raise additional necessary capital for research and development, complete development of our products
in development and successfully introduce and commercialize our products.
Certain of our products
are still under various stages of development. Because we have limited resources to devote to product development and commercialization,
any delay in the development of one product or reallocation of resources to product development efforts that prove unsuccessful
may delay or jeopardize the development of other product candidates. Although our management believes that it can finance our product
development through private placements and other capital sources, if we do not develop new products and bring them to market, our
ability to generate revenues will be adversely affected.
The commercial viability
of AOT technology remains largely unproven and we may not be able to attract customers.
Despite the fact that
we entered into a lease agreement with a major oil pipeline operator in August 2013 for the use of our AOT technology and have
executed several Non-Disclosure / Non-Competition Agreements with other potential customers the commercial viability of our devices
is not known at this time. If commercial opportunities are not realized from the use of products incorporating the AOT technology,
our ability to generate revenue would be adversely affected. There can be no assurances that we will be successful in
marketing our products, or that customers will ultimately purchase our products. Failure to have commercial success from the sale
of our products will significantly and negatively impact our financial condition. There can be no assurances that we will be successful
in
marketing our products, or that customers will ultimately purchase our products. Failure to have commercial
success from the sale of our products will significantly and negatively impact our financial condition.
If our products
and services do not gain market acceptance, it is unlikely that we will become profitable.
At this time, our technology
is commercially unproven, and the use of our technology by others is limited. The commercial success of our products will depend
upon the adoption of our technology by the oil industry. Market acceptance will depend on many factors, including:
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·
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the willingness and ability of consumers and industry partners to adopt new technologies;
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our ability to convince potential industry partners and consumers that our technology is an attractive
alternative to other technologies;
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our ability to manufacture products and provide services in sufficient quantities with acceptable
quality and at an acceptable cost; and,
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·
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our ability to place and service sufficient quantities of our products.
|
If our products do
not achieve a significant level of market acceptance, demand for our products will not develop as expected and it is unlikely that
we will become profitable.
We outsource and
rely on third parties for the manufacture of our products.
Our business model
calls for the outsourcing of the manufacture of our products in order to reduce our capital and infrastructure costs, capital expenditure
and personnel. Accordingly, we must enter into agreements with other companies that can assist us and provide certain capabilities
that we do not possess, and to increase our manufacturing capacity as necessary. We can provide no assurances that any such outsourcing
will be at commercially acceptable rates or profitable. Moreover, we do not have the required financial and human resources or
capability to manufacture, market and sell our products. Our business model calls for the outsourcing of the manufacture, and sales
and marketing of our products in order to reduce our capital and infrastructure costs as a means of potentially improving our financial
position and the profitability of our business. Accordingly, we must enter into agreements with other companies that can assist
us and provide certain capabilities that we do not possess. We may not be successful in entering into additional such alliances
on favorable terms or at all. Furthermore, any delay in entering into agreements could delay the development and commercialization
of our products and reduce their competitiveness even if they reach the market. Any such delay related to our existing or future
agreements could adversely affect our business.
If any party to
which we have outsourced certain functions fails to perform its obligations under agreements with us, the development and commercialization
of our products could be delayed or curtailed.
To the extent that
we rely on other companies to manufacture, sell or market our products, we will be dependent on the timeliness and effectiveness
of their efforts. If any of these parties do not perform its obligations in a timely and effective manner, the commercialization
of our products could be delayed or curtailed because we may not have sufficient financial resources or capabilities to continue
such development and commercialization on our own.
Any revenues that
we may earn in the future are unpredictable, and our operating results are likely to fluctuate from quarter to quarter.
We believe that our
future operating results will fluctuate due to a variety of factors, including delays in product development, market acceptance
of our new products, changes in the demand for and pricing of our products, competition and pricing pressure from competitive products,
manufacturing delays and expenses related to and the results of proceedings relating to our intellectual property.
A large portion of
our expenses, including expenses for our facilities, equipment and personnel, is relatively fixed and not subject to further significant
reduction. In addition, we expect our operating expenses will increase in 2014 as we continue our research and development
and increase our production and marketing activities, among other activities. Although we expect to generate revenues from sales
of our products, revenues may decline or not grow as anticipated and our operating results could be substantially harmed for a
particular fiscal period. Moreover, our operating results in some quarters may not meet the expectations of stock market analysts
and investors. In that case, our stock price most likely would decline.
Nondisclosure agreements
with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.
In order to protect
our proprietary technology and processes, we rely in part on nondisclosure agreements with our employees, licensing partners, consultants,
agents and other organizations to which we disclose our proprietary information. These agreements may not effectively prevent disclosure
of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information.
In addition, others may independently discover trade secrets and proprietary information, and in such cases we could not assert
any trade secret rights against such parties. Costly and time-consuming litigation could be necessary to enforce and determine
the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive
business position. Since we rely on trade secrets and nondisclosure agreements, in addition to patents, to protect some of our
intellectual property, there is a risk that third parties may obtain and improperly utilize our proprietary information to our
competitive disadvantage. We may not be able to detect unauthorized use or take appropriate and timely steps to enforce our intellectual
property rights.
The manufacture,
use or sale of our current and proposed products may infringe on the patent rights of others, and we may be forced to litigate
if an intellectual property dispute arises.
We have taken measures
to protect ourselves from infringing on the patent rights of others; however, if we infringe or are alleged to have infringed another
party’s patent rights, we may be required to seek a license, defend an infringement action or challenge the validity of the
patents in court. Patent litigation is costly and time consuming. We may not have sufficient resources to bring these actions to
a successful conclusion. In addition, if we do not obtain a license, do not successfully defend an infringement action or are unable
to have infringed patents declared invalid, we may incur substantial monetary damages ,encounter significant delays in marketing
our current and proposed product candidates, be unable to conduct or participate in the manufacture, use or sale of product, candidates
or methods of treatment requiring licenses, lose patent protection for our inventions and products; or find our patents are unenforceable,
invalid, or have a reduced scope of protection.
Parties making such
claims may be able to obtain injunctive relief that could effectively block our ability to further develop or commercialize our
current and proposed product candidates in the United States and abroad and could result in the award of substantial damages. Defense
of any lawsuit or failure to obtain any such license could substantially harm the company. Litigation, regardless of outcome, could
result in substantial cost to and a diversion of efforts by the Company to operate its business.
We may face
costly intellectual property disputes.
Our ability to
compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technologies and either
to operate without infringing the proprietary rights of others or to obtain rights to technology owned by third parties. Our pending
patent applications, specifically patent rights of the AOT technology and “Joule Heating” process may not result in
the issuance of any patents or any issued patents that will offer protection against competitors with similar technology. Patents
we have licensed for our technologies, and which we may receive, may be challenged, invalidated or circumvented in the future or
the rights created by those patents may not provide a competitive advantage. We also rely on trade secrets, technical know-how
and continuing invention to develop and maintain our competitive position. Others may independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to our trade secrets.
We may not be able
to attract or retain qualified senior personnel.
We believe we
are currently able to manage our current business with our existing management team. However, as we expand the scope of our operations,
we will need to obtain the full-time services of additional senior management and other personnel. Competition for highly-skilled
personnel is intense, and there can be no assurance that we will be able to attract or retain qualified senior personnel. Our failure
to do so could have an adverse effect on our ability to implement our business plan. As we add full-time senior personnel, our
overhead expenses for salaries and related items will increase compensation packages, these increases could be substantial.
If we lose our key
personnel or are unable to attract and retain additional personnel, we may be unable to achieve profitability.
Our future success
is substantially dependent on the efforts of our senior management, particularly Gregg Bigger, our President, Chief Executive Officer
and Chief Financial Officer. The loss of the services of members of our senior management may significantly delay or prevent the
achievement of product development and other business objectives. Because of the scientific nature of our business, we depend substantially
on our ability to attract and retain qualified marketing, scientific and technical personnel, including consultants. There is intense
competition among specialized automotive companies for qualified personnel in the areas of our activities. If we lose the services
of, or do not successfully recruit key marketing, scientific and technical personnel, the growth of our business could be substantially
impaired. We do not maintain key man insurance for any of these individuals.
Currently, there
is only very limited trading in our stock, so you may be unable to sell your shares at or near the quoted bid prices if you need
to sell your shares.
The shares of our common
stock are thinly-traded on the OTC Bulletin Board, meaning that the number of persons interested in purchasing our common shares
at or near bid prices at any given time may be relatively small or non-existent. This situation is attributable to a number of
factors, including the fact that we are a small company engaged in a high risk business which is relatively unknown to stock analysts,
stock brokers, institutional investors and others in the investment community that can generate or influence daily trading volume
and valuation. Should we even come to the attention of such persons, they tend to be risk-averse and would be reluctant to follow
an unproven, early stage company such as ours or purchase or recommend the purchase of our shares until such time as we became
more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is
minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally
support continuous trading without negatively impacting our share price. We cannot provide any assurance that a broader or more
active public trading market for shares of our common stock will develop or be sustained. Due to these conditions, we
cannot give any assurance that shareholders will be able to sell their shares at or near bid prices or at all.
The market price
of our stock is volatile.
The market price for
our common stock has been volatile during the last year, ranging from a closing price of $0.80 on May 3, 2013 to a closing
price of $1.75 on August 3, 2013, and a closing price of $0.98 on February 28, 2014. Additionally, the price of our stock has been
both higher and lower than those amounts on an intra-day basis in the last year. Because our stock is thinly traded, its price
can change dramatically over short periods, even in a single day. The market price of our common stock could fluctuate widely in
response to many factors, including, developments with respect to patents or proprietary rights, announcements of technological
innovations by us or our competitors, announcements of new products or new contracts by us or our competitors, actual or anticipated
variations in our operating results due to the level of development expenses and other factors, changes in financial estimates
by securities analysts and whether any future earnings of ours meet or exceed such estimates, conditions and trends in our industry,
new accounting standards, general economic, political and market conditions and other factors.
Substantial sales
of common stock could cause our stock price to fall.
In the past year,
there have been times when average daily trading volume of our common stock has been extremely low, and there have been many
days in which no shares were traded at all. At other times, the average daily trading volume of our common stock has been
high. Nevertheless, the possibility that substantial amounts of common stock may be sold in the public market may adversely
affect prevailing market prices for our common stock and could impair a shareholder’s ability to sell our stock or our
ability to raise capital through the sale of our equity securities.
Potential
issuance of additional shares of our common stock could dilute existing stockholders.
We are authorized to
issue up to 300,000,000 shares of common stock. To the extent of such authorization, our Board of Directors has the ability, without
seeking stockholder approval, to issue additional shares of common stock in the future for such consideration as the Board of Directors
may consider sufficient. The issuance of additional common stock in the future will reduce the proportionate ownership and voting
power of shareholders.
We may not be successful
in identifying, making and integrating acquisitions.
A component of our
business strategy is to make selective acquisitions that will strengthen our core services or presence in selected markets. The
success of this strategy will depend, among other things, on our ability to identify suitable acquisition candidates, to negotiate
acceptable financial and other terms, to timely and successfully integrate acquired businesses or assets and to retain the key
personnel and the customer base of acquired businesses. Any future acquisitions could present a number of risks, including but
not limited to:
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incorrect assumptions regarding the future results of acquired operations or assets or expected
cost reductions or other synergies expected to be realized as a result of acquiring operations or assets;
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failure to integrate successfully the operations or management of any acquired operations or assets
in a timely manner;
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failure to retain or attract key employees; and
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diversion of management’s attention from existing operations or other priorities.
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If we are unable to
identify, make and successfully integrate acquired businesses, it could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
Our common stock
is subject to penny stock regulation, which may make it more difficult for us to raise capital.
Our common stock is
considered penny stock under SEC regulations. It is subject to rules that impose additional sales practice requirements on broker-dealers
who sell our securities. For example, broker-dealers must make a suitability determination for the purchaser, receive the purchaser’s
written consent to the transaction prior to sale, and make special disclosures regarding sales commissions, current stock
price quotations, recent price information and information on the limited market in penny stock. Because of these additional obligations,
some broker-dealers may not effect transactions in penny stocks, which may adversely affect the liquidity of our common stock and
shareholders’ ability to sell our common stock in the secondary market. This lack of liquidity may make it difficult for
us to raise capital in the future.
Item 1B. Unresolved Staff
Comments
None
Item 2. Properties
Our executive offices
are located at 735 State Street, Suite 500, Santa Barbara, California 93101. The Company also operated its ELEKTRA Research and
Development facility located at 235 Tennant Avenue, Morgan Hill, California 95037 until its closure in June 2013.
Total rent expense
under these leases in effect during the years ended December 31, 2013, 2012 and 2011, was $201,500, $210,635 and $138,840, respectively
which are included as part of Operating Expenses in the attached consolidated statements of operations. Remaining lease commitments
under the non-cancellable office lease at December 31, 2013 were $320,650 through the end of 2018. The following is a schedule
by years of future minimum rental payments required under the non-cancellable office leases as of December 31, 2013.
Year ending
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Non-cancellable
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December 31,
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Office Leases
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2014
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$
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69,960
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2015
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69,960
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2016
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69,960
|
|
2017
|
|
|
69,960
|
|
2018
|
|
|
40,810
|
|
Total
|
|
$
|
320,650
|
|
Beginning July
2013, the Company subleased a portion of the second floor office space under its Santa Barbara office lease on a
month-to-month basis. Total rents collected under these sublease agreements in the year ended December 31, 2013 were $11,085,
which were included as an offset to Operating Expenses in the attached consolidated statements of operations. The rent
expense, net of sublease rents collected for the year ended December 31, 2013 was $190,415.
Item 3. Legal Proceedings
There is no litigation
of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of business.
Item 4. Mine Safety
Disclosures.
None.
PART II
Item 5. Market
for Common Equity and Related Stockholder Matters
Through May 21,
2007, our common stock was traded on the Over the Counter Bulletin Board (the “OTCBB” under the symbol
“ZERO”. Effective May 22, 2007, our common stock was removed from the OTCBB and placed on the “Pink
Sheets”. Effective February 8, 2010, our common stock was reinstated and currently trades on the OTCBB. The
following table sets forth the high and low bid prices of the Company’s common stock for the quarters indicated as
quoted on the Pink Sheets or the OTCBB, as applicable, as reported by Yahoo Finance. These quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
First Quarter
|
|
$
|
1.13
|
|
|
$
|
0.77
|
|
|
$
|
0.68
|
|
|
$
|
0.30
|
|
|
$
|
0.64
|
|
|
$
|
0.25
|
|
Second Quarter
|
|
$
|
1.50
|
|
|
$
|
0.77
|
|
|
$
|
0.56
|
|
|
$
|
0.33
|
|
|
$
|
0.44
|
|
|
$
|
0.30
|
|
Third Quarter
|
|
$
|
1.88
|
|
|
$
|
1.05
|
|
|
$
|
1.89
|
|
|
$
|
0.42
|
|
|
$
|
0.37
|
|
|
$
|
0.18
|
|
Fourth Quarter
|
|
$
|
1.39
|
|
|
$
|
0.83
|
|
|
$
|
1.64
|
|
|
$
|
0.83
|
|
|
$
|
0.43
|
|
|
$
|
0.20
|
|
According to the records
of our transfer agent, we had approximately 1,145 stockholders of record of our
common stock at February 28, 2014.
The Company believes that the number of beneficial owners is substantially higher than this amount.
We do not pay a dividend
on our common stock and we currently intend to retain future cash flows to finance our operations and fund the growth of our business.
Any payment of future dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our
earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions in respect to the payment
of dividends and other factors that our Board of Directors deems relevant.
Stock Performance Graph
and Cumulative Total Return
The graph below shows
the cumulative total stockholder return assuming the investment of $100 on the date specified (and the reinvestment of dividends
thereafter) in each of STWA common stock (symbol ZERO), the NASDAQ Composite Total Returns, and the S&P Oil & Gas Equipment
& Services Index. The stock performance graph does not include STWA’s peer group because peer group information is represented
and included in the S&P Oil & Gas Equipment & Services Index. The comparisons in the graph below are based upon historical
data and are not indicative of, or intended to forecast, future performance of our common stock.
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 31, 2008 – December 31, 2013
|
|
12/2008
|
|
|
12/2009
|
|
|
12/2010
|
|
|
12/2011
|
|
|
12/2012
|
|
|
12/2013
|
|
Save the Wold Air, Inc.
|
|
100.00
|
|
|
137.50
|
|
|
135.00
|
|
|
92.50
|
|
|
245.00
|
|
|
267.50
|
|
NASDAQ Composite Total Returns
|
|
|
100.00
|
|
|
|
145.34
|
|
|
|
171.70
|
|
|
|
170.34
|
|
|
|
200.57
|
|
|
|
281.14
|
|
S&P 500 Oil & Gas Equipment & Services Index
|
|
|
100.00
|
|
|
|
159.79
|
|
|
|
222.56
|
|
|
|
196.56
|
|
|
|
196.57
|
|
|
|
256.81
|
|
Issuances of Unregistered
Securities in Current Fiscal Year
During the year ended
December 31, 2013, the Company issued an aggregate of 32,575,247 shares of its common stock as follows:
|
·
|
The Company issued 29,152,389 shares of its common stock upon exercise of options and warrants
at a price of $0.25 up to $0.98 with proceeds of $8,477,218, net of direct costs in the amount of $78,521 in commissions and foreign
exchange fees paid on warrants exercised by foreign (non-U.S.) investors. Furthermore, included in the exercise was issuance of
50,000 shares of common stock valued at $49,000 pursuant to an exercise of options and accounted for as partial settlement of unpaid
fees recorded in prior years. As a result, the aggregate net proceeds received amounted to $8,428,218.
|
|
●
|
The Company issued 50,000 shares of its common stock with a fair value of $49,000 or $0.98/share
to a consultant for service rendered. The shares were valued at market at the date of the agreement.
|
|
●
|
The Company issued 325,455 shares of its common stock with a fair value of $370,113 or $1.14/share
to Directors, Officers and Employees of the Company for service rendered. The shares were valued at market at the date of issuance.
|
|
●
|
In December 2013, the Company issued 3,047,403 shares of common stock with a fair value of $3,108,347
pursuant to a settlement with CEDE & Co. The shares were originally cancelled in November 2005 as a result of a court decision
against a former officer of the Company. At the time of the cancellation, the shares were held by a nominee, CEDE & Co. The
fair value of the shares issued was based upon the December 16, 2013 trading price of $1.02/share, the date of the Board approval
and was recorded as part of Operating Expenses in the accompanying Consolidated Statement of Operations.
|
The sales of the securities
described above were made in reliance on the exemptions from registration set forth in Section 4(2) of the Securities Act
of 1933, as amended (the “Act”), and/or Regulation S promulgated thereunder.
Item 6. Selected Financial
Data
The selected consolidated
financial data set forth below should be read in conjunction with our consolidated financial statements and related notes thereto
and management’s discussion and analysis included elsewhere in this Form 10-K annual report and in our annual reports
that have been filed for the prior years presented.
CONSOLIDATED STATEMENT
OF OPERATIONS
|
|
Year ended December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
Net sales
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Cost of goods sold
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Gross profit
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Operating expenses
|
|
|
11,883,975
|
|
|
|
7,187,170
|
|
|
|
6,698,181
|
|
|
|
4,220,631
|
|
|
|
3,042,465
|
|
Research and development expenses
|
|
|
2,011,486
|
|
|
|
963,184
|
|
|
|
1,318,783
|
|
|
|
500,982
|
|
|
|
428,139
|
|
Loss before other income (expense)
|
|
|
(13,895,461
|
)
|
|
|
(8,150,354
|
)
|
|
|
(8,016,964
|
)
|
|
|
(4,721,613
|
)
|
|
|
(3,470,604
|
)
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(260
|
)
|
|
|
(3,627,732
|
)
|
|
|
(5,084,253
|
)
|
|
|
(4,034,558
|
)
|
|
|
(1,603,500
|
)
|
Change in fair value of derivative liabilities
|
|
|
(220,614
|
)
|
|
|
(4,023,094
|
)
|
|
|
2,021,536
|
|
|
|
414,505
|
|
|
|
(307,840
|
)
|
Gain on extinguishment of derivative liabilities
|
|
|
3,441,752
|
|
|
|
2,445,095
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Costs of private placement
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(1,129,212
|
)
|
|
|
(511,503
|
)
|
Other income (expense)
|
|
|
18,374
|
|
|
|
264,498
|
|
|
|
223,934
|
|
|
|
(23,228
|
)
|
|
|
(300,703
|
)
|
Net loss before provision for income taxes
|
|
|
(10,656,209
|
)
|
|
|
(13,091,587
|
)
|
|
|
(10,855,747
|
)
|
|
|
(9,494,106
|
)
|
|
|
(6,194,150
|
)
|
Provision for income taxes
|
|
|
800
|
|
|
|
800
|
|
|
|
800
|
|
|
|
800
|
|
|
|
800
|
|
Net loss
|
|
$
|
(10,657,009
|
)
|
|
$
|
(13,092,387
|
)
|
|
$
|
(10,856,547
|
)
|
|
$
|
(9,494,906
|
)
|
|
$
|
(6,194,950
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.07
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.09
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
160,958,284
|
|
|
|
128,667,391
|
|
|
|
104,103,109
|
|
|
|
81,910,267
|
|
|
|
65,733,871
|
|
CONSOLIDATED BALANCE
SHEET
|
|
Year ending December 31,
|
|
Assets
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
|
|
Cash
|
|
$
|
4,137,068
|
|
|
$
|
1,601,791
|
|
|
$
|
617,797
|
|
|
$
|
101,645
|
|
|
$
|
33,611
|
|
Property and Equipment, net of accumulated depreciation
|
|
|
35,771
|
|
|
|
55,674
|
|
|
|
75,609
|
|
|
|
78,083
|
|
|
|
100,870
|
|
Other assets
|
|
|
62,760
|
|
|
|
50,462
|
|
|
|
88,237
|
|
|
|
37,445
|
|
|
|
27,473
|
|
Total assets
|
|
$
|
4,235,599
|
|
|
$
|
1,707,927
|
|
|
$
|
781,643
|
|
|
$
|
217,173
|
|
|
$
|
161,954
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
1,160,283
|
|
|
$
|
1,384,309
|
|
|
$
|
2,074,244
|
|
|
$
|
2,891,850
|
|
|
$
|
3,580,913
|
|
Convertible debentures, net-of-discount
|
|
|
–
|
|
|
|
–
|
|
|
|
169,542
|
|
|
|
76,947
|
|
|
|
485,650
|
|
Fair value of derivative liabilities
|
|
|
–
|
|
|
|
3,221,138
|
|
|
|
1,643,139
|
|
|
|
3,664,675
|
|
|
|
1,706,343
|
|
Total Liabilities
|
|
|
1,160,283
|
|
|
|
4,605,447
|
|
|
|
3,886,925
|
|
|
|
6,633,472
|
|
|
|
5,772,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity (deficiency)
|
|
|
3,075,316
|
|
|
|
(2,897,520
|
)
|
|
|
(3,105,282
|
)
|
|
|
(6,416,299
|
)
|
|
|
(5,610,952
|
)
|
Total liabilities and stockholders’ equity (deficiency)
|
|
$
|
4,235,599
|
|
|
$
|
1,707,927
|
|
|
$
|
781,643
|
|
|
$
|
217,173
|
|
|
$
|
161,954
|
|
Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operation
The following discussion
and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial
Statements and supplementary data referred to in Item 7 of this Form 10-K.
This discussion contains
forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue
sources and concentration, selling, general and administrative expenses, research and development expenses, capital resources,
additional financings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed
above in Item 1 and elsewhere in this Form 10-K, particularly in “Risk Factors,” that could cause actual results
to differ materially from those projected. Unless otherwise expressly indicated, the information set forth in this Form 10-K
is as of December 31, 2013, and we undertake no duty to update this information.
Overview
We are a development
stage company that has not yet generated any significant revenues since our inception in February 1998. We have devoted the bulk
of our efforts to the completion of the design, and the commercial manufacturing of our production models, and testing of devices
and the promotion of our commercialized crude oil pipeline products in the upstream and midstream energy sector. We anticipate
that these efforts will continue during 2014.
Our expenses to date
have been funded primarily through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise
of stock purchase warrants and options. We raised capital in 2013 and will need to raise substantial additional capital in 2014,
and possibly beyond, to fund our sales and marketing efforts, continuing research and development, and certain other expenses,
until our revenue base grows sufficiently.
Results of Operation
There were no revenues
and cost of sales for the fiscal year ended December 31, 2013, 2012 and 2011.
Operating Expense Comparison,
2013 and 2012
Operating expenses
were $11,883,975 for the fiscal year ended December 31, 2013, compared to $7,187,170 for the fiscal year ended December 31,
2012, an increase of $4,696,805. This increase is attributable to increases in non-cash expenses of $4,014,898 and cash expenses
of $681,967. Specifically, the increase in non-cash expenses is attributable to an a settlement paid through an issuance of stock
valued at $3,108,351 plus an increase in valuation of warrants and options given to employees and directors of $2,694,534 offset
by a decrease in depreciation and bad debts of $67,678 and a decrease in valuation of warrants and options given to consultants
of $1,720,308. The increase in cash expenses is attributable to an increase in salaries and benefits of $394,148, an increase in
travel expenses of $210,045 and an increase in general operating expenses of $82,320, offset by a decrease in professional and
consulting fees of $4,556.
Research and development
expenses were $2,011,486 for the fiscal year ended December 31, 2013, compared to $963,184 for the fiscal year ended December 31,
2012, an increase of $1,048,302. This increase is attributable to increases in product testing of $109,270 and product development
costs for the AOT prototype of $1,020,700 offset by a decrease in licensing and research fees of $81,668.
Other income was $3,493,125
for the fiscal year ended December 31, 2013, compared to $2,703,876 for the fiscal year ended December 31, 2012, an increase of
$789,249. This increase is attributable to an increase in the gain on extinguishment of derivative liabilities of $1,002,374, a
decrease income from forgiveness of debt of $239,429 and an increase in other miscellaneous income of $26,305.
Other expenses were
$254,674 for the fiscal year ended December 31, 2013, compared to $7,645,909 for the fiscal year ended December 31, 2012, a decrease
of $7,391,235. This decrease is attributable to a decrease in the fair value of derivative liabilities of $3,796,762, a decrease
in non-cash interest and financing expense of $3,626,623 and increase in other miscellaneous expenses of $32,150.
We had a net loss of
$10,657,009 or $0.07 loss per share for the fiscal year ended December 31, 2013 compared to a net loss of $13,092,387, or $0.10
loss per share for the fiscal year ended December 31, 2012.
Operating Expense Comparison,
2012 and 2011
Operating
expenses were $7,187,109 for the fiscal year ended December 31, 2012, compared to $6,698,181 for the fiscal year ended
December 31, 2011, an increase of $488,868. This increase is attributable to increases in non-cash expenses of $478,934 and
cash expenses of 9,934. Specifically, the increase in non-cash expenses is attributable to increases in valuation of common
stock and warrants given to consultants of $596,109, increase in depreciation and bad debts of $53,360, offset by a decrease
in valuation of warrants and options given to employees as compensation of $170,535. The increase in cash expenses is
attributable to increases in, salaries and benefits of $407,111, offset by decreases in consulting and professional fees of
$353,097 and travel expenses of $44,080.
Research and development
expenses were $963,184 for the fiscal year ended December 31, 2012, compared to $1,318,783 for the fiscal year ended December 31,
2011, a decrease of $355,599. This decrease is attributable to decreases in product testing, research and supplies of $335,313
and contract fees of $20,286.
Other expenses were
$4,941,233 for the fiscal year ended December 31, 2012, compared to $2,838,783 for the fiscal year ended December 31, 2011, an
increase of $2,102,450. This increase is attributable to increases in the fair value of derivative liabilities of $6,038,913,
a decrease in other income of $23,277, offset by a gain on extinguishment of derivative liabilities of $2,439,378, decrease in
non-cash interest and financing expense of $1,456,521 and increase in income from settlement of litigation and debt of $63,841.
We had a net loss of
$13,092,387 or $0.10 loss per share for the fiscal year ended December 31, 2012 compared to a net loss of $10,856,547, or $0.10
loss per share for the fiscal year ended December 31, 2011.
Liquidity and Capital Resources
General
We have incurred negative
cash flow from operations in the developmental stage since our inception in 1998. As of December 31, 2013, we had cash of
$4,137,068 and an accumulated deficit of $93.038,863. Our negative operating cash flow in 2013 was funded primarily through exercise
of stock purchase warrants and options.
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
the Company is a development stage company and had not generated any revenues from operations, had a net loss of $10,657,009 and
a negative cash flow from operations of $5,961,368 for the year ended December 31, 2013. These factors raise substantial
doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability
to raise additional funds and implement our business plan. The consolidated financial statements do not include any adjustments
that might be necessary if we are unable to continue as a going concern.
Summary
At December 31, 2013,
we had cash on hand in the amount of $4,137,068. We will need additional funds to operate our business, including without limitation
the expenses we will incur in connection with the license and research and development agreements with Temple University; costs
associated with product development and commercialization of the AOT and related technologies; costs to manufacture and ship our
products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs
of maintaining our status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual
property. In addition, as discussed below, we have substantial contractual commitments, including without limitation salaries to
our executive officers pursuant to employment agreements, certain severance payments to a former officer and consulting fees, during
the remainder of 2014 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Contractual Obligations
The Company has certain
contractual commitments for future periods, including office leases, minimum guaranteed compensation payments and other agreements
as described in the following table and associated footnotes:
|
|
|
|
|
Research and
|
|
|
|
|
|
|
|
Year ending
|
|
Office
|
|
|
License
|
|
|
Compensation
|
|
|
Total
|
|
December 31,
|
|
Lease (1)
|
|
|
Agreements (2)
|
|
|
Agreements (3)
|
|
|
Obligations
|
|
2014
|
|
$
|
69,960
|
|
|
$
|
316,796
|
|
|
$
|
656,250
|
|
|
$
|
1,043,006
|
|
2015
|
|
|
69,960
|
|
|
|
252,148
|
|
|
|
84,167
|
|
|
|
406,275
|
|
2016
|
|
|
69,960
|
|
|
|
187,500
|
|
|
|
60,000
|
|
|
|
317,460
|
|
2017
|
|
|
69,960
|
|
|
|
187,500
|
|
|
|
15,429
|
|
|
|
272,889
|
|
2018
|
|
|
40,810
|
|
|
|
187,500
|
|
|
|
–
|
|
|
|
228,310
|
|
Total
|
|
$
|
320,650
|
|
|
$
|
1,131,444
|
|
|
$
|
815,846
|
|
|
$
|
2,267,940
|
|
(1)
|
Consists
of rent for the Company’s Santa Barbara Facility expiring on July 31, 2018. (For description of this property, see Part
1, Item 2, “Properties”). Subsequent to the reporting period of this Form 10-K filing, effective as of February 1,
2014, the Company amended this lease, reducing rents to $5,860 per month.
|
(2)
|
Consists of license maintenance fees to Temple University in the amount of $187,500 paid annually
through the life of the underlying patents or until otherwise terminated by either party, and research fees paid to Temple University
in the amount of $32,324 paid quarterly through June 1, 2015.
|
(3)
|
Consists of base salary and certain contractually-provided benefits, to an executive officer, pursuant
to an employment agreement that expires on January 30, 2015 in the amount of $314,167 and two severance agreements of former officers
in the amount of $501,679.
|
Licensing Fees to Temple
University
For details of the
licensing agreements with Temple University, see Financial Statements attached hereto, note 6.
Critical Accounting Policies and Estimates
Our discussion and
analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going
basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical
experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates.
The methods, estimates
and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report
in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies
that are both most important to the portrayal of a company’s financial condition and results of operations and those that
require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about
matters that are inherently uncertain at the time of estimation. For a more detailed discussion of the accounting policies of the
Company, see Note 2 of the Notes to the Consolidated Financial Statements, “Summary of Significant Accounting Policies”.
We believe the following
critical accounting policies, among others, require significant judgments and estimates used in the preparation of our consolidated
financial statements.
The preparation of
consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note
2 to Notes to Consolidated Financial Statements. Actual results could differ from those estimates.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's common stock option grant is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation
expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The
assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.
Accounting for Derivatives
The Company evaluates
all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially
recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated
statements of operations. For stock-based derivative financial instruments, the Company uses probability weighted
average series Black-Scholes Option Pricing models to value the derivative instruments at inception and on subsequent valuation
dates.
The classification
of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the
end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current
based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet
date.
The Company had derivative
liabilities up to January 2013 relating to adjustments on the exercise price of warrants issued in 2009 and 2010 in conjunction
with the Company’s convertible note offering. These warrants were exercised to common stock or expired in January 2013 thus
eliminating the derivate liabilities.
Research and Development
Costs
Costs incurred for
research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed.
Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial
uses are also expensed.
For the years ended
December 31, 2013, 2012 and 2011, and for the period from inception to December 31, 2013, research and development costs incurred
were $2,011,486, $963,184, $1,318,783 and $10,681,167, respectively.
Recent Accounting Pronouncements
In February 2013, the
Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-04. This update clarifies how entities
measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed
at the reporting date. This guidance is effective for fiscal years beginning after December 15, 2013 and interim reporting periods
thereafter. This update is not expected to have an impact on the Company’s financial position or results of operations
In April 2013, the
FASB issued ASU 2013-07 to clarify when it is appropriate to apply the liquidation basis of accounting. Additionally, the update
provides guidance for recognition and measurement of assets and liabilities and requirements for financial statements prepared
using the liquidation basis of accounting. Under the amendment, entities are required to prepare their financial statements under
the liquidation basis of accounting when a liquidation becomes imminent. This guidance is effective for annual reporting periods
beginning after December 15, 2013, and interim reporting periods thereafter. This update is not expected to have an impact on the
Company’s financial position or results of operations.
In July 2013, the FASB
issued ASU 2013-11 which provides guidance relating to the financial statement presentation of unrecognized tax benefits. The update
provides that a liability related to an unrecognized tax benefit would be presented as a reduction of a deferred tax asset for
a net operating loss carryforward, a similar tax loss or a tax credit carryforward, if such settlement is required or expected
in the event the uncertain tax position is disallowed. This update does not require any new recurring disclosures and is effective
for public entities for fiscal years beginning after December 15, 2013, and interim reporting periods thereafter. This update is
not expected to have an impact on the Company’s financial position or results of operations.
Other recent accounting
pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants,
and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's
present or future consolidated financial statements.
Item 7A. Quantitative and
Qualitative Disclosure About Market Risk
We issue from time
to time fixed rate discounted convertible notes. Our convertible notes and our equity securities are exposed to risk as set forth
above, in Item 1A, “Risk Factors.” Please also see Item 7, above, “Management’s Discussion and Analysis
of Financial Condition and Results of Operations.”
Item 8. Financial
Statements and Supplementary Data
Our consolidated financial
statements as of and for the years ended December 31, 2013, 2012 and 2011 are presented in a separate section of this report following
Item 15 and begin with the index on page F-1.
Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
1. Disclosure Controls
and Procedures
The Company's management,
with the participation of the Company's chief executive officer and chief financial officer, evaluated, as of December 31, 2013,
the effectiveness of the Company's disclosure controls and procedures, which were designed to be effective at the reasonable assurance
level. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and
management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based
on the evaluation of the Company's disclosure controls and procedures as of December 31, 2013, management, the chief executive
officer and the chief financial officer concluded that the Company's disclosure controls and procedures were effective at the reasonable
assurance level at that date.
2. Internal Control
over Financial Reporting
|
(a)
|
Management's Annual Report on Internal Control over Financial Reporting
|
Our management is responsible
for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial
reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision
of, the company's principal executive and principal financial officers and effected by the company's board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures
that:
Pertain to
the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets
of the company;
Provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and
Provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that
could have a material effect on the financial statements.
Save the Word Air,
Inc.'s internal control system is designed to provide reasonable assurance to the Company's management and Board regarding the
preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed,
have inherent limitations which may not prevent or detect misstatements. Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed
the effectiveness of Save the Word Air, Inc.' internal controls over financial reporting as of December 31, 2013. In making this
assessment, it used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission ("COSO") (1992 framework). Based on our assessment, we conclude that, as of December 31, 2013,
the Company has maintained effective internal control over financial reporting based on those criteria.
Our independent
registered public accounting firm, Weinberg & Company, P.A., has audited the Consolidated Financial Statements and has
issued an attestation report on Save the Word Air, Inc.'s internal controls over financial reporting as of December 31, 2013
as stated in its reports which are included herein.
|
(b)
|
Changes in Internal Control over Financial Reporting
|
No change in the Company's
internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the fourth quarter ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
Item 9B. Other Information
Accrued Expense, Accelerated
Vesting and Termination of Options at Separation
On November 15, 2013,
Cecil Kyte voluntarily resigned as a Director, Chairman of the Board, a member of the Nominating and Corporate Governance Committee,
and CEO. Subject to terms of Mr. Kyte’s separation agreement, Kyte will receive severance pay equal to one-year’s salary
($350,000) paid in 24 equal installments ($14,853), subject to all applicable tax withholdings, beginning November 30, 2013 through
November 15, 2014. The Company recognized an expense of $350,000 for severance pay plus $14,315 in deferred payroll taxes. As of
December 31, 2013, the Company had paid $44,559 of the severance pay and $997 of deferred payroll taxes. The severance pay balance
of $305,441 and deferred payroll tax balance of $13,318 as of December 31, 2013 are reported liabilities in Company’s balance
sheet as Accrued Expense and Accounts Payable – Related Parties.
At the time of separation,
Mr. Kyte held unvested options which had been issued in January 2011 to purchase 10,560,000 shares of common stock at $0.25 per
share, of which 3,520,000 shares were due to vest in January 2014. The remaining 7,040,000 shares were due to fully vest by January
2016. Under terms of the separation agreement, the Company accelerated vesting as of the date of separation on the 3,520,000 shares
due to vest in January 2014. The remaining options to purchase 7,040,000 shares terminated as of separation. Under Financial Accounting
Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, employee stock options which are subject to accelerated
vesting at termination are treated as a Type III modification. As such, the Company recognized an expense related to the accelerated
vesting in the amount of $3,809,325.
Mr. Kyte held additional
unvested options which had been issued as board compensation in September 2013 to purchase 21,009 shares of common stock at $1.19
per share. These options terminated as of the date of his separation.
Reinstated Shares
In December 2013, the
Company’s Board unanimously approved the reinstatement of 3,047,403 shares of common stock of the Company. The circumstances
related to the reinstatement are as follows: 3,047,403 shares of common stock of the Company were held in street (nominee) name
by Cede & Co. of the Depository Trust Co. (the “Cede Shares”). The Cede Shares were ordered cancelled by a federal
district court relating to litigation initiated by the Securities and Exchange Commission against the Company and its former CEO,
Jeffrey Mueller in 2001. Either before or after the court’s order (the timing of which is unknown to the Company), the Cede
Shares, at that time held directly or indirectly by Mueller, were placed with Cede & Co. in nominee name. In furtherance of
the court’s order, the physical certificates relating to the Cede Shares should have been returned to the Company’s
transfer agent (NATCO) for cancellation. This did not occur. Rather, Cede & Co. retained the stock certificates representing
the Cede Shares and continued to treat the Cede Shares as outstanding and free trading shares of the Company.
Notwithstanding the
foregoing, NATCO, in furtherance of then Company counsel’s instructions, cancelled the Cede Shares on the Company’s
books and records in 2005, and, in furtherance thereof, reduced the Company’s outstanding shares of common stock by 3,047,403.
Cede & Co. has requested, in effect, that, inasmuch as the Cede Shares continue to be within its system, the Cede Shares be
reinstated on the Company’s books and records and that the outstanding shares of the Company be increased by 3,047,403. Although
the Company believes Cede & Co.’s request is misplaced, particularly since it appears that Cede & Co. had prior notice
of the court’s order cancelling the Cede Shares, the Company has elected to avoid litigation with Cede & Co. and instead
has elected to reinstate the Cede Shares. Accordingly, 3,047,403 shares of the Company’s common stock has been added back
to the Company’s outstanding share count.
PART III
Item 10. Directors,
Executive Officers and Corporate Governance
Composition of Board of Directors
Our bylaws
provide that the Board shall consist of between one and eight directors, as determined by the Board from time to time. The
Board consisted of six (6) members elected by the holders of the common stock at the Company’s Meeting of Shareholders
on December 16, 2013. Our directors are elected by our stockholders at each annual meeting of stockholders and will
serve until their successors are elected and qualified, or until their earlier resignation or removal. Officers are appointed
by our Board of Directors and their terms of office are, except to the extent governed by an employment contract, at the
discretion of our Board of Directors. There are no family relationships among any of our current directors or our executive
officers.
The following constitutes
the Board of Directors as of December 31, 2013:
Name
|
|
Age
|
|
Position
|
|
Director Since
|
Greggory Bigger
|
|
46
|
|
Chief Executive Officer, Chief Financial Officer and Chairman, Director (Non-Independent)
|
|
2013
|
Charles R. Blum (1) (2) (3)
|
|
75
|
|
Director (Non-Independent)
|
|
2007
|
Donald Dickson
|
|
57
|
|
Director (Independent)
|
|
2013
|
Nathan Shelton (1) (2) (3)
|
|
64
|
|
Director (Independent)
|
|
2007
|
Mark Stubbs (1)(2)
|
|
42
|
|
Director (Independent)
|
|
2013
|
Ryan Zinke
|
|
53
|
|
Director (Independent)
|
|
2012
|
(1) Member
of the Audit Committee
(2) Member
of the Compensation Committee
(3) Member
of the Nominating and Corporate Governance Committee
Biographical Information
Regarding Directors
Greggory Bigger,
President, CEO and CFO
(Non-Independent Director) was appointed to the Board of Directors on September 16, 2013. Gregg Bigger
was most recently Founding Partner of Rocfin Advisors, a Strategic Management Consulting Company providing advice and direction
to a variety of clients including companies in the energy, clean tech, and emerging technology markets. Prior, Mr. Bigger was Founder
and Board Member of The Bank of Santa Barbara. Earlier in his career Mr. Bigger held a variety of key management and leadership
positions including U.S. Trust as a Vice-President in the Private Client Group, and First Republic Bank as a Vice President and
Manager in the Private Banking Group. Mr. Bigger also served in the United States Marine Corps' Special Operations in Amphibious
Warfare and Cliff Assault.
Charles R. Blum
(Non-Independent Director) was appointed on July 25, 2007 to the Board of directors and engaged as the President and Chief Executive
Officer of the Company. In January 2010, Mr. Blum resigned as Chief Executive Officer of the Company, and thereafter resigned as
President of the Company. Mr. Blum spent 22 years as the President/CEO of the Specialty Equipment Market Association
(SEMA). SEMA is a trade group representing 6500 business members who are actively engaged in the manufacture and distribution
of automotive parts and accessories. SEMA produces the world’s largest automotive aftermarket Trade Show which is held annually
in Las Vegas, Nevada. Mr. Blum led the association as its members grew from a handful of small entrepreneurial companies into an
industry membership that sells over 31 billion dollars of product at the retail level annually. Mr. Blum has a proven record of
accomplishment as a senior executive and brings a broad knowledge of the automotive aftermarket to the Company. Mr.
Blum attended Rutgers University.
Nathan Shelton
(Independent Director) has served as a director since February 12, 2007. Mr. Shelton has a long and distinguished career with a
number of diverse successful companies primarily related to the automotive industry, holding prominent positions. In
1987 he joined K&N Engineering as President and part owner and built the company into an industry leader. In 2002
he sold his interest in K&N Engineering and founded S&S Marketing, which is engaged in the automotive aftermarket parts
rep business, which he currently operates. Mr. Shelton is the recipient of numerous industry related prestigious awards, and in
1992, Specialty Equipment Market Association (SEMA) invited him to join its board of directors, which includes serving in capacity
as its Chairman from 2002 to 2004. In 2007 he was elected to the SEMA “Hall of Fame”. Mr. Shelton
served honorably in the United States Seabees from 1968 to 1972. He attended Chaffey Junior College.
Mark Stubbs
(Independent Director) was appointed to the Board of Directors and Chairman of the Audit Committee on July 3, 2013. Mr. Stubbs
currently serves as Chief Financial Officer for London Stock Exchange listed BBA Aviation's Aftermarket Services Division, a leading
global aviation services and aftermarket support provider. Prior to joining BBA in 2012, Mr. Stubbs served as Chief Financial Officer
and Interim Chief Executive Officer for CallWave, Inc., which was then a NASDAQ-listed company and a global provider of enhanced
telecommunications software and services. From 2005 to 2006, Mr. Stubbs was Chief Financial Officer of Sound ID, a privately held
consumer electronics company. Prior to Sound ID, Mr. Stubbs held a number of executive positions including Vice President Global
Supply Chain and Vice President and Managing Director EMEA (Europe, Middle East and Africa) at Somera, Inc., which at the time
was a NASDAQ-listed company and a leading global provider of telecommunications infrastructure and services. Previously, Mr. Stubbs
held a number of financial management positions at Kinko's Inc., which has since been acquired by NYSE-listed FedEx. Mr. Stubbs
earned a BA in Finance and MBA from Cal Poly San Luis Obispo and is a Certified Public Account (CPA).
Ryan Zinke.
(Independent Director) On December 7, 2012, former State of Montana Senator Ryan Zinke, age 51, was appointed to serve as a member
of our Board. Ryan Zinke, former state senator from Montana, began his distinguished military career as a graduate of Officer Candidate
School and SEAL training (class 136). He was then assigned to SEAL Team ONE in Coronado, Calif. where he led counter-insurgency
and contingency operations in the Persian Gulf and the Pacific theater of operations. From 1990-93 and again from 1996-99, he was
selected to SEAL TEAM SIX where he was a Team Leader, Ground Force Commander, Task Force Commander and Current Operations Officer
in support of National Command Authority missions. He retired from active duty 2008 after serving 23 years as a US Navy SEAL. Sen.
Zinke is CEO of two business development firms that specialize in advanced technology with clients to include Raytheon, Northrop-Grumman,
General Dynamics, Sierra Nevada, Unmanned Systems Inc., and Katmai among others. Sen. Zinke attended the University of Oregon on
an athletic scholarship and graduated with a B.S. in Geology. Sen. Zinke is a Disabled Veteran and holds a MBA in Finance and a
Master’s of Science in Global Leadership from the University of San Diego.
Don Dickson
(Independent Director), appointed to Board of Directors on August 6, 2013, currently serves as Chief Executive Officer for Advanced
Pipeline Services (APS). APS was established for the purpose of providing a full range of services to the oil and gas industry.
Core business areas are in new construction of pipeline and facilities, horizontal directional drilling and pipeline integrity/rehabilitation.
Prior to APS, Mr. Dickson worked for Kinder Morgan in their natural gas operations, retiring after twenty-six years. During his
time at Kinder Morgan served in different engineering capacities including as Director of Operations on two major pipeline projects,
the 42” (REX) Rockies Mountain Express through the state of Illinois, and the 42” (MEP) Midcontinent Express Pipeline
through the state of Louisiana. He also was Director of Operations with Tetra Resources completing various onshore and offshore
oil and gas wells and a Senior Engineer with Halliburton Services. Mr. Dickson earned his B.S. in Engineering from Oklahoma State
University.
Executive Officers
The following table
sets forth certain information regarding our executive officers as of December 31, 2013:
|
Name
|
|
Age
|
|
Position
|
|
|
Greggory M. Bigger
|
|
46
|
|
Chief Executive Officer, Chief Financial Officer and
President
|
|
For the biography of
Greggory Bigger, please see above under “Biographical Information Regarding Directors.”
CORPORATE GOVERNANCE
We maintain a corporate
governance page on our corporate website at
www.stwa.com
, which includes information regarding the Company’s corporate
governance practices. Our codes of business conduct and ethics, Board committee charters and certain other corporate governance
documents and policies and code of business conduct are posted on our website. In addition, we will provide a copy of any of these
documents without charge to any stockholder upon written request made to Corporate Secretary, Save the World Air, Inc., 735 State
Street, Suite 500, Santa Barbara, California 93101. The information on our website is not, and shall not be deemed to
be, a part of this form 10-K or incorporated by reference into this or any other filing we make with the Securities and Exchange
Commission (the “SEC”).
Board of Directors
Director Independence
Our Board of Directors
as of December 31, 2013 consisted of six (6) members. As of that date, the Board has affirmatively determined that Mr.
Dickson, Mr. Shelton, Mr. Stubbs and Mr. Zinke are independent directors. Mr. Bigger, our President, Chief Executive
Officer, and Chief Financial Officer and Mr. Blum, former Chief Executive Officer, are not considered independent.
Meetings of the Board
The Board held eight
(8) meetings in 2013. A majority of the members attended all 8 board meetings held in 2013. The Board has held one meeting in 2014.
A majority of our directors
attended the Company’s 2013 Annual Shareholder’s Meeting. Because our Board holds one of its regular meetings in conjunction
with our Annual Meeting of shareholders, we anticipate that all of the members of the Board will be present for the 2014 Annual
Shareholder’s Meeting.
Communications with the
Board
The following procedures
have been established by the Board in order to facilitate communications between our stockholders and the Board:
|
|
Stockholders may send correspondence, which should indicate that the sender is a stockholder, to the Board or to any individual director, by mail to Corporate Secretary, Save the World Air, Inc. 735 State Street, Suite 500, Santa Barbara, California, 93101 or by e-mail to info@stwa.com.
|
|
|
Our Secretary will be responsible for the first review and logging of this correspondence and will forward the communication to the director or directors to whom it is addressed unless it is a type of correspondence which the Board has identified as correspondence which may be retained in our files and not sent to directors. The Board has authorized the Secretary to retain and not send to directors communications that: (a) are advertising or promotional in nature (offering goods or services), (b) solely relate to complaints by customers with respect to ordinary course of business customer service and satisfaction issues or (c) clearly are unrelated to our business, industry, management or Board or committee matters. These types of communications will be logged and filed but not circulated to directors. Except as set forth in the preceding sentence, the Secretary will not screen communications sent to directors.
|
|
|
The log of stockholder correspondence will be available to members of the Board for inspection. At least once each year, the Secretary will provide to the Board a summary of the communications received from stockholders, including the communications not sent to directors in accordance with the procedures set forth above.
|
Our shareholders may
also communicate directly with the non-management directors, individually or as a group, by mail c/o Corporate Secretary,
Save the World Air, Inc., 735 State Street, Suite 500, Santa Barbara, California 93101 or by e-mail to
info@stwa.com.
The Audit
Committee has established procedures, as outlined in the Company’s policy for
“
Procedures for Accounting
and Auditing Matters
”,
for the receipt, retention and treatment of complaints regarding questionable accounting,
internal controls, and financial improprieties or auditing matters. Any of the Company’s employees may confidentially
communicate concerns about any of these matters by calling our toll-free number, +1 (877) USA-STWA, (+1 (877) 872-7892).
Upon receipt of a complaint or concern, a determination will be made whether it pertains to accounting, internal controls or
auditing matters and if it does, it will be handled in accordance with the procedures established by the Audit
Committee.
Committees of the Board
The Board has a standing
Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee. Each of these committees operates under
a written charter. Copies of these charters, and other corporate governance documents, are available on our website,
www.stwa.com
In addition, we will provide a copy of any of these documents without charge to any stockholder upon written request made to Corporate
Secretary, Save the World Air Inc., 735 State Street, Suite 500, Santa Barbara, California 93101.
The composition, functions
and general responsibilities of each committee are summarized below.
Audit Committee
The Audit Committee
currently consists of Mr. Stubbs (chairperson), Mr. Blum and Mr. Shelton. The Board has determined that Mr. Stubbs and Mr. Shelton
are considered independent under rules of the SEC. The Audit Committee held a total of six (6) meetings during 2013,
each attended by a majority of Audit Committee members. The Audit Committee has met once during 2014 as of the date of this report.
The Audit Committee
operates under a written charter. The Audit Committee’s duties include responsibility for reviewing our accounting practices
and audit procedures. In addition, the Audit Committee has responsibility for reviewing complaints about, and investigating allegations
of, financial impropriety or misconduct. The Audit Committee works closely with management and our independent auditors. The Audit
Committee also meets with our independent auditors on a quarterly basis, following completion of their quarterly reviews and annual
audit, to review the results of their work. The Audit Committee also meets with our independent auditors to approve the annual
scope of the audit services to be performed.
As part of its responsibility,
the Audit Committee is responsible for engaging our independent auditor, as well as pre-approving audit and non-audit services
performed by our independent auditor in order to assure that the provision of such services does not impair the independent auditor’s
independence.
See “Audit Committee
Report” below, which provides further details of many of the duties and responsibilities of the Audit Committee.
Compensation Committee
The Compensation Committee
consists of Mr. Blum (chairperson), Mr. Stubbs and Mr. Shelton. The Board has determined that Mr. Stubbs and Mr. Shelton are
independent The Compensation Committee held no meetings during 2013 and has not met during 2014 as of the date of this report.
The Compensation Committee
administers the Company’s executive compensation program. The Compensation Committee has the authority to review and determine
the salaries and bonuses of the executive officers of the Company, including the Chief Executive Officer and the other executive
officers named in the Summary Compensation Table (the “Named Executive Officers”) appearing elsewhere in this 10-K,
and to establish the general compensation policies for such individuals. The Compensation Committee also has the sole and exclusive
authority to make discretionary option grants to all of the Company’s employees under the Company’s 2004 Stock Option
Plan (the “2004 Plan”).
The Compensation Committee
operates under a written charter. The charter reflects these various responsibilities, and the Committee is charged with periodically
reviewing the charter. In addition, the Committee has the authority to engage the services of outside advisors, experts and others,
including independent compensation consultants who do not advise the Company, to assist the Committee.
See “Compensation
Committee Report” below, which provides further details of many of the duties and responsibilities of the Compensation Committee.
Nominating and Governance
Committee
The Nominating and
Corporate Governance Committee consists of Mr. Shelton (chairperson) and Mr. Blum. The Board believes that Mr. Shelton
meet independent requirements under rules of the SEC. The Nominating and Corporate Governance Committee held no meetings
during 2013 and has not met during 2014 as of the date of this report.
The Nominating and
Corporate Governance Committee operates under a written charter. The Nominating and Corporate Governance Committee has the primary
responsibility for overseeing the Company’s corporate governance compliance practices, as well as supervising the affairs
of the Company as they relate to the nomination of directors. The principal ongoing functions of the Nominating and Corporate Governance
Committee include developing criteria for selecting new directors, establishing and monitoring procedures for the receipt and consideration
of director nominations by stockholders and others, considering and examining director candidates, developing and recommending
corporate governance principles for the Company and monitoring the Company’s compliance with these principles and establishing
and monitoring procedures for the receipt of stockholder communications directed to the Board.
The Nominating and
Corporate Governance Committee is also responsible for conducting an annual evaluation of the Board to determine whether the Board
and its committees are functioning effectively. In performing this evaluation, the Nominating and Corporate Governance Committee
receives comments from all directors and reports annually to the Board with the results of this evaluation.
See “Nominating
and Governance Committee Report” below, which provides further details of many of the duties and responsibilities of the
Nominating and Governance Committee.
AUDIT COMMITTEE REPORT
The Audit Committee
is currently composed of three (3) directors, Mr. Stubbs (Chairperson), Mr. Charles R. Blum and Mr. Shelton. The Board has determined
that Mr. Stubbs and Mr. Shelton are considered independent within the rules of the SEC. The duties and responsibilities of a member
of the Audit Committee are in addition to his duties as a member of the Board.
The Audit Committee
operates under a written charter, which is available on the Company’s website. The Board and the Audit Committee believe
that the Audit Committee charter complies with the current standards set forth in SEC regulations. There may be further action
by the SEC during the current year on several matters that affect all audit committees. The Board and the Audit Committee continue
to follow closely further developments by the SEC in the area of the functions of audit committees, particularly as it relates
to internal controls for non-accelerated filers, and will make additional changes to the Audit Committee charter and the policies
of the Audit Committee as required or advisable as a result of these new rules and regulations. The Audit Committee met six (6)
times during 2013 and each was attended by a majority of committee members. The Audit Committee has met once during 2014 as of
the date of this report.
The Audit Committee’s
primary duties and responsibilities are to:
|
·
|
engage the Company’s independent auditor;
|
|
·
|
monitor the independent auditor’s independence, qualifications and performance;
|
|
·
|
pre-approve all audit and non-audit services;
|
Management is responsible
for the Company’s internal controls and the financial reporting process. The Company’s independent auditor is responsible
for performing an independent audit of the Company’s financial statements in accordance with the standards of the Public
Company Accounting Oversight Board and issuing a report thereon. The Audit Committee’s responsibility is to monitor and oversee
these processes.
In February 2012, the
Company began the process of designing and implementing various financial controls from within our finance department under the
supervision of the Company’s Chief Executive Officer and Chief Financial Officer. Furthermore, the Company also hired an
outside consultant to further enhance these internal controls, policies and procedures. On March 19, 2013, the Company’s
Board of Directors approved and began the implementation of these internal controls, policies and procedures. In June 2013, the
Company began the process of designing and implementing additional internal controls based on a continuous process of assessment
and improvement under which board and management financial reporting objectives were defined and implemented, policies and procedures
were tested for effectiveness and deficiencies were identified and remediated. On December 16, 2013, the Board of Directors approved
a revised Internal Controls Policy based on policy refinements and improvements implemented under this assessment process. Additional
controls and policies designed and implemented in second and third quarters of 2013 have been tested and identified deficiencies
have been remediated. The Internal Controls Policy and Sarbanes-Oxley 302 matrix approved by the Board of Directors on March 19,
2013, as revised and approved by the board on December 16, 2013, have been implemented and are functioning as planned.
Our management evaluated,
with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-
15(e)
under the Securities Exchange Act of 1934 (the “Exchange Act”) were effective as of September 30, 2013 and continue
to be effective as of the date of this report.
Our Chief Executive
Officer, Chief Financial Officer and Controller conducted an assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2013 based on the framework in Internal Control – Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our internal controls over financial reporting (as defined in Rules 13a-
15(e)
under the Securities Exchange Act of 1934 (the “Exchange Act”) were effective as of December 31 2013.
With respect to the
Company’s independent auditors, the Audit Committee, among other things, discussed with Weinberg & Co., P.A., matters
relating to its independence, including the written disclosures made to the Audit Committee as required by the Independence Standards
Board Standard No. 1 (Independence Discussions with Audit Committees). The Audit Committee also reviewed and approved the
audit and non-audit fees of that firm.
On the basis of these
reviews and discussions, the Audit Committee (i) appointed Weinberg & Co., P.A. as the independent registered public
accounting firm for the 2013 fiscal year and (ii) recommended to the Board that the Board approve the inclusion of the Company’s
audited financial statements in the 10-K for filing with the SEC.
|
Respectfully submitted:
|
|
|
|
Mark Stubbs (Chairman)
|
COMPENSATION COMMITTEE REPORT
The Compensation Committee
has furnished this report on executive compensation for the 2013 fiscal year.
The Compensation Committee
administers the Company’s executive compensation program. The Compensation Committee has the authority to review and determine
the salaries and bonuses of the executive officers of the Company, including the Chief Executive Officer and the other executive
officers named in the Summary Compensation Table (the “Named Executive Officers”) appearing elsewhere in this 10-K,
and to establish the general compensation policies for such individuals. The Compensation Committee also has the sole and exclusive
authority to make discretionary option grants to all of the Company’s employees under the Company’s 2004 Stock Option
Plan (the “2004 Plan”).
The Compensation Committee
currently consists of Mr. Blum (chairperson), Mr. Stubbs and Mr. Shelton. The Board believes that Messrs. Stubbs and Shelton
are independent. None of our executive officers served on the compensation committee of another entity or on any other
committee of the board of directors of another entity performing similar functions during 2013. The Compensation Committee held
no meetings during 2013 and has not met during 2014 as of the date of this report.
The Compensation Committee
operates under a written charter. The charter reflects these various responsibilities, and the Committee is charged with periodically
reviewing the charter. In addition, the Committee has the authority to engage the services of outside advisors, experts and others,
including independent compensation consultants who do not advise the Company, to assist the Committee.
The Compensation Committee
believes that the compensation programs for the Company’s executive officers should reflect the Company’s performance
and the value created for the Company’s stockholders. In addition, the compensation programs should support the short-term
and long-term strategic goals and values of the Company, reward individual contribution to the Company’s success and align
the interests of the Company’s officers with the interests of its stockholders. The committee believes that the Company’s
success depends upon its ability to attract and retain qualified executives through the competitive compensation packages it offers
to such individuals.
The principal factors
that were taken into account in establishing each executive officer’s compensation package for the 2013 fiscal year are described
below. However, the Compensation Committee may in its discretion apply entirely different factors, such as different measures of
financial performance, for future fiscal years. Moreover, all of the Company’s Named Executive Officers have entered into
employment agreements with the Company and many components of each such person’s compensation are set by such agreements.
Equity-Based Compensation.
The Committee believes in linking long-term incentives to an increase in stock value. Accordingly, it awards stock options under
the 2004 Plan with an exercise price equal to the fair market value of the underlying stock on the date of grant that vest and
become exercisable over time. The Committee believes that these options encourage employees to continue to use their best efforts
and to remain in the Company’s employment. Options granted to executive officers under the 2004 Plan generally vest and become
exercisable in annual 25% increments over a four-year period after grant.
The Committee relies
substantially on management of the Company to make specific recommendations regarding which individuals should receive option grants
and the amounts of such grants.
The Company grants
stock options to executive officers with a cumulative option price of up to $100,000 as incentive stock options and the remainder
as non-qualified stock options, both with an exercise price equal to the fair market value of the Company’s common stock
on the date of grant. Accordingly, those stock options will have value only if the market price of the Company’s common
stock increases after that date. In determining the size of stock option grants to executive officers, the Committee bases its
decisions on such considerations as similar awards to individuals holding comparable positions in our comparative groups, company
performance and individual performance, as well as the allocation of overall share usage attributed to executive officers.
Compliance with Code
Section 162(m). Section 162(m) of the Code disallows a tax deduction to publicly-held companies for compensation paid
to certain of their executive officers, to the extent that compensation exceeds $1 million per covered officer in any fiscal
year. The limitation applies only to compensation which is not considered to be performance based. Non-performance based compensation
paid to the Company’s executive officers for the 2013 fiscal year did not exceed the $1 million limit per officer, and
the Compensation Committee does not anticipate that the non-performance based compensation to be paid to the Company’s executive
officers for the 2014 fiscal year will exceed that limit. Because it is unlikely that the cash compensation payable to any of the
Company’s executive officers in the foreseeable future will approach the $1 million limit, the Compensation Committee
has decided at this time not to take any action to limit or restructure the elements of cash compensation payable to the Company’s
executive officers. The Compensation Committee will reconsider this decision should the individual cash non-performance based compensation
of any executive officer ever approach the $1 million level.
The Board did not modify
any action or recommendation made by the Compensation Committee with respect to executive compensation for the 2013 fiscal year.
It is the opinion of the Compensation Committee that the executive compensation policies and plans provide the necessary total
remuneration program to properly align the Company’s performance and the interests of the Company’s stockholders through
the use of competitive and equitable executive compensation in a balanced and reasonable manner, for both the short and long term.
|
Respectfully submitted by:
|
|
|
|
Charles Blum, Chairman
|
NOMINATING AND CORPORATE GOVERNANCE
COMMITTEE REPORT
The Nominating and
Corporate Governance Committee currently consists of Mr.. Shelton (chairperson) and Mr. Blum. The Board believes that Mr. Shelton
meet independent requirements under rules of the SEC. The Nominating and Corporate Governance Committee held no meetings
during 2013 and has not met during 2014 as of the date of this report.
The Nominating and
Corporate Governance Committee operates under a written charter. The Nominating and Corporate Governance Committee has the primary
responsibility for overseeing the Company’s corporate governance compliance practices, as well as supervising the affairs
of the Company as they relate to the nomination of directors. The principal ongoing functions of the Nominating and Corporate Governance
Committee include developing criteria for selecting new directors, establishing and monitoring procedures for the receipt and consideration
of director nominations by stockholders and others, considering and examining director candidates, developing and recommending
corporate governance principles for the Company and monitoring the Company’s compliance with these principles and establishing
and monitoring procedures for the receipt of stockholder communications directed to the Board.
The Nominating and
Corporate Governance Committee is also responsible for conducting an annual evaluation of the Board to determine whether the Board
and its committees are functioning effectively. In performing this evaluation, the Nominating and Corporate Governance Committee
receives comments from all directors and reports annually to the Board with the results of this evaluation.
Director Nominations
The Nominating and
Corporate Governance Committee seeks out appropriate candidates to serve as directors of the Company, and the Nominating and Corporate
Governance Committee interviews and examines director candidates and makes recommendations to the Board regarding candidate selection.
In considering candidates to serve as director, the Nominating and Corporate Governance Committee evaluates various minimum individual
qualifications, including strength of character, maturity of judgment, relevant technical skills or financial acumen, diversity
of viewpoint and industry knowledge, as well as the extent to which the candidate would fill a present need on the Board.
The Nominating and
Corporate Governance Committee will consider, without commitment, stockholder nominations for director. Nominations for director
submitted to this committee by stockholders are evaluated according to the Company’s overall needs and the nominee’s
knowledge, experience and background. A nominating stockholder must give appropriate notice to the Company of the nomination not
less than 90 days prior to the first anniversary of the preceding year’s annual meeting. In the event that the date
of the annual meeting is advanced by more than 30 days or delayed by more than 60 days from the anniversary date of the
preceding year’s annual meeting, the notice by the stockholder must be delivered not later than the close of business on
the later of the 60th day prior to such annual meeting or the tenth day following the day on which public announcement of the date
of such annual meeting is first made.
The stockholders’
notice shall set forth, as to:
|
·
|
each person whom the stockholder proposes to nominate for election as a director:
|
|
·
|
the name, age, business address and residence address of such person,
|
|
·
|
the principal occupation or employment of the person,
|
|
·
|
the class and number of shares of the Company which are beneficially owned by such person, if any, and
|
|
·
|
any other information relating to such person which is required to be disclosed in solicitations for proxies for election of directors pursuant to Regulation 14A under the Exchange Act and the rules hereunder; and the stockholder giving the notice
|
|
·
|
the name and record address of the stockholder and the class and number of shares of the Company which are beneficially owned by the stockholder,
|
|
·
|
a description of all arrangements or understandings between such stockholder and each proposed nominee and any other person or persons (including their names) pursuant to which nomination(s) are to be made by such stockholder,
|
|
·
|
a representation that such stockholder intends to appear in person or by proxy at the meeting to nominate the persons named in its notice,
|
|
·
|
any other information relating to such person which is required to be disclosed in solicitations for proxies for election of directors pursuant to Regulation 14A under the Exchange Act and the rules thereunder.
|
The notice must be
accompanied by a written consent of the proposed nominee to be named as a director.
We have
adopted codes of business conduct and ethics for our directors, officers and employees, which we believe meet requirements of
a code of ethics. You can access the Company’s Code of Business Conduct and Ethics and our Code of Ethics for
Senior Executives and Financial Officers on the Corporate Governance page of the Company’s website at
www.stwa.com
.
Any shareholder who so requests may obtain a printed copy of the Code of Conduct by submitting a request to the
Company’s Corporate Secretary.
|
Respectfully submitted by:
|
|
|
|
Nathan Shelton, Chairman
|
Item 11. Executive Compensation
EXECUTIVE COMPENSATION DISCUSSION AND
ANALYSIS
The following table
sets forth certain information regarding the compensation earned during the last three fiscal years by the Named Executive Officers:
Summary Compensation Table
|
|
Long-Term Compensation Awards
|
|
Name and Principal Position
|
|
Fiscal
Year
|
|
Annual
Compensation
Salary ($)
|
|
|
Restricted
Stock
Awards
($)
|
|
|
Securities
Underlying
Options
(#)
|
|
|
Full Value
of Options
($)
|
|
|
All
Other
Compensation
($)
|
|
|
Total
($)
|
|
Cecil Bond Kyte (1)(3)(4)(5)
|
|
2013
|
|
$
|
350,000
|
|
|
$
|
–
|
|
|
|
–
|
|
|
$
|
–
|
|
|
$
|
100,000
|
|
|
$
|
450,000
|
|
Chief Executive Officer
|
|
2012
|
|
$
|
300,000
|
|
|
$
|
–
|
|
|
|
–
|
|
|
$
|
–
|
|
|
$
|
216,978
|
|
|
$
|
516,978
|
|
|
|
2011
|
|
$
|
208,333
|
|
|
$
|
–
|
|
|
|
17,600,000
|
|
|
$
|
6,834,231
|
|
|
$
|
87,838
|
|
|
$
|
7,130,402
|
|
|
|
2010
|
|
$
|
200,000
|
|
|
$
|
–
|
|
|
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
200,000
|
|
Greggory Bigger (2)(3)(5)
|
|
2013
|
|
$
|
290,000
|
|
|
$
|
109,000
|
|
|
|
–
|
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
$
|
449,000
|
|
President,
Chief Executive Officer and
Chief Financial Officer
|
|
2012
|
|
$
|
172,500
|
|
|
$
|
–
|
|
|
|
4,000,000
|
|
|
$
|
1,207,193
|
|
|
$
|
31,567
|
|
|
$
|
204,067
|
|
____________
(1)
|
Mr. Kyte was appointed Chief Executive Officer in January 2009. In 2010, Mr. Kyte earned
and was paid $200,000. On December 1, 2011, Mr. Kyte’s salary was increased to $300,000 per year. In addition,
Mr. Kyte received $33,333 in accrued back pay and on December 8, 2011 he received a bonus of $54,505. In connection
with the Amendment to Mr. Kyte’s Employment Agreement dated March 1, 2011, Mr. Kyte received options for 17,600,000 shares
of common stock exercisable at $0.25 per share, and, options for 181,118 shares of common stock previously granted, were cancelled.
Of the 17,600,000 options, 3,520,000 vested on January 30, 2012. 3,520,000 vest on each succeeding date and year. On December 1,
2011 the Board approved Amendment Number 2 to Mr. Kyte’s Employment Agreement and increased his salary to $300,000 per year.
During the year 2012, Mr. Kyte received a bonus of $87,838. Effective September 1, 2013, the Board approved Amendment Number 3
to Mr. Kyte’s Employment Agreement, increasing his salary to $350,000 per year. During the year 2013, Mr. Kyte received a
bonus of $100,000. Mr. Kyte’s employment terminated on November 15, 2013. Under terms of his Separation Agreement, Mr. Kyte
will receive severance payments totaling $350,000 paid semi-monthly through November 15, 2014.
|
(2)
|
On February 1, 2012, Mr. Bigger was appointed Chief Financial Officer. During 2012, Mr. Bigger
was paid $172,500 plus signing and performance bonuses totaling $31,567. In addition, Mr. Bigger received options for 4,000,000
exercisable at $0.25 per share, vesting over four years. Of the 4,000,000 options, 500,000 vested on February 1, 2012, 500,000
vested on February 1 2013, 1,000,000 vest on February 1, 2014 and 1,000,000 vest on February 1, 2015.
|
(3)
|
The number and value of vested restricted stock based upon the closing market price of the common
stock at December 31, 2013 of $1.07 were as follows: Mr. Kyte’s 10,569,000 vested shares at an execution price of $0.25 are
valued at $8,659,2000, and Mr. Bigger’s, 1,500,000 vested shares at a execution price of $0.25 are valued at $1,230,000.
|
(4)
|
In connection with Mr. Kyte’s separation from the Company, Mr. Kyte have agreed that Mr.
Kyte’s Employment Agreement, dated January 30, 2009, and the three (3) amendments thereto, dated March 1, 2011, December
1, 2011 and September 1, 2013, respectively, shall be terminated and be of no further force or effect. In exchange, the Company
has agreed to pay Mr. Kyte an amount equal to $350,000, representing his salary for one (1) year, less withholding taxes, in twelve
(12) equal monthly installments, commencing November 15, 2013. The Company has also agreed to reimburse Mr. Kyte for his health
insurance premiums for a twelve (12) month period, also commencing November 15, 2013. Mr. Kyte will retain his vested Company stock
options and warrants, but all unvested Company stock options and warrants shall be terminated and of no further force or effect,
except that 3,520,000 option shares previously granted to Mr. Kyte, and scheduled to vest on January 30, 2014, shall be deemed
vested as of November 15, 2013. The Company shall also pay Mr. Kyte the sum of $25,000, less all applicable tax withholdings, on
November 15, 2013, representing payment for Mr. Kyte’s accrued vacation and sick days.
|
(5)
|
In addition to executive compensation provided in this table, Mr. Kyte and Mr. Bigger each
received compensation as members of the Company’s Board of Directors as detailed in the section titled Director
Compensation below.
|
OPTION GRANTS IN LAST FISCAL YEAR
None.
AGGREGATED OPTION EXERCISES IN LAST
FISCAL YEAR AND YEAR-END OPTION VALUES
No options were exercised
by any of the Named Executive Officers during the 2013 fiscal year. The following table sets forth the number of shares of our
common stock subject to exercisable and unexercisable stock options which the Named Executive Officers held at the end of the 2013
fiscal year. As of November 15, 2013, under terms of his Separation Agreement, Mr. Kyte is no longer considered a Named Executive
Officer.
|
|
Shares
|
|
|
Value
|
|
|
Number of Securities
Underlying Unexercised
Options at
Fiscal Year-End (#)
|
|
|
Value of Unexercised
In-the-Money Options ($)(1)
|
|
|
|
Acquired on
|
|
|
Realized
|
|
|
|
|
|
|
|
Name
|
|
Exercise (#)
|
|
|
($)
|
|
|
Exercisable
|
|
|
Unexercisable
|
|
|
Exercisable
|
|
|
Unexercisable
|
|
Cecil Bond Kyte
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
10,560,000
|
|
|
|
–
|
|
|
$
|
8,659,200
|
|
|
$
|
–
|
|
Greggory Bigger
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
1,000,000
|
|
|
|
3,000,000
|
|
|
$
|
820,000
|
|
|
$
|
2,460,000
|
|
____________
(1) Market
value of our common stock at fiscal year-end minus the exercise price. The closing price of our common stock on December 31,
2013 the last trading day of the year was $1.07 per share.
EQUITY COMPENSATION PLAN INFORMATION
FOR 2013
The following table
sets forth information regarding outstanding options and shares reserved for future issuance under our equity compensation plans
as of December 31, 2013:
Plan Category
|
|
Number of Securities
to be Issued upon
Exercise of
Outstanding Options,
Warrants and Rights
|
|
|
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
|
|
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in the
First Column)
|
|
|
|
|
|
|
|
|
|
|
Equity compensation plans approved by security holders
|
|
|
3,549,908
|
|
|
$0.40
|
|
|
2,201,759
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity compensation plans not approved by security holders
|
|
|
16,760,000
|
|
|
$0.26
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
20,309,908
|
|
|
$0.28
|
|
|
–
|
|
Employment Agreements
Agreement with Cecil
Bond Kyte
.
On January 30, 2009, (the “Effective Date”), the Company entered into an employment agreement
with Cecil Bond Kyte, pursuant to which he serves as our Chief Executive Officer. The initial term of the agreement
became effective on January 30, 2009 and expires on January 30, 2010 and renews automatically for addition one-year periods unless
either party has given notice of non-extension prior to October 30, 2010. The agreement provides for a base compensation
of $200,000 per year. Mr. Kyte is eligible to participate in the Company’s incentive and benefit plans, including
eligibility to receive grants of stock options under the 2004 plan.
Mr. Kyte shall be eligible
to receive an annual cash bonus in an amount equal to 2% of the Company’s net profit, if any, for its most recently completed
fiscal year, computed in accordance with generally accepted accounting principles applied consistently with prior periods. The
bonus shall be payable, if at all, on the anniversary date of employment each year of the term; provided that no bonus shall be
paid if the Executive is not, on such payment date, in the employ of the Company.
Mr. Kyte shall also
receive an option (the “Option”) to purchase a number of shares (the “Option Shares”) of the Company’s
common stock equal to the result of (A) 100,000 divided by (B) the closing price per share of the Company’s Common Stock
on the first anniversary of the Effective Date. The Option shall be an incentive stock option, shall be exercisable
at the closing price per share on the first anniversary of the Effective Date, shall be exercisable for ten years from the date
of grant and shall vest on the second anniversary of the Effective Date.
Amendment To Kyte Employment
Agreement
On March 1, 2011, the
Board of Directors of the Company approved an amendment (the “Amendment”) to the Kyte employment agreement. The
Company and Kyte have agreed to an amendment of the Employment Agreement, providing for non-cash performance compensation in the
form of nonqualified stock options. Mr. Kyte has agreed to continue to serve in the role of CEO of the Company through
at least January 29, 2016.
The Board determined
to grant Mr. Kyte nonqualified stock options to acquire shares of common stock of the Company under the following terms and conditions:
Stock Option Grant
(“Grant”) of 17,600,000 Shares at an Exercise Price of $0.25 per share exercisable for 10 years, which will expire
on January 30, 2021. (See Note 9 of the Company’s Financial Statement.)
Twenty percent (20%)
of the Option shall vest on the first anniversary of the Effective Date (i.e. January 30, 2011); twenty percent (20%) on the second
anniversary of the Effective Date; twenty percent (20%) on the third anniversary of the Effective Date; twenty percent (20%) on
the fourth anniversary of the Effective Date; and, twenty percent (20%) on the fifth anniversary of the Effective Date;
Amendment #2 to Kyte Employment
Agreement
The Second Amendment
to Kyte’s Employment Agreement was made and entered into by and between the Company and Mr. Kyte effective as of December
1, 2011. Compensation for Mr. Kyte was increased to a base salary of $300,000.
Amendment #3 to Kyte Employment
Agreement
The Third Amendment
to the Kyte Employment Agreement was made and entered into by and between the Company and Mr. Kyte effective as of September 1,
2013. Annual Base Salary for Mr. Kyte was increased to $350,000. Mr. Kyte is also eligible to receive an annual cash bonus, within
the discretion of the Company’s Board. In exercising its discretion, the Board shall consider, among other things, the Company’s:
(a) revenue; (b) earnings; (c) contracts; (d) cash position; (e) liquidity; (f) customers; (g) NASDAQ or other exchange listings;
(h) market capitalization; (i) general financial condition; and (j) achievement of goals set forth in management’s yearly
budgets, plans and projections. Any award of bonus shall be paid no later than forty-five (45) days following the filing of the
Company’s Form 10-K with the SEC. Mr. Kyte is also entitled to receive paid vacation of six (6) weeks per year.
Additionally, in the
event any person, including all affiliates of such person, directly or indirectly, becomes the beneficial owner of 50% or more
of the combined voting power of the Company’s outstanding shares, and otherwise on a Change of Control event as defined in
Mr. Kyte’s Employment Agreement, Mr. Kyte’s Employment Agreement and all amendments thereto shall be terminated whereupon
Mr. Kyte shall be paid an amount equal to four (4) times his annual Base Salary as in effect on the date of the Change of Control
event, and all of Mr. Kyte’s unvested stock options and warrants shall immediately vest effective on the date of the Change
of Control event.
Additionally, if Mr.
Kyte is terminated by the Company without cause or if he resigns for “good reason,” he shall be paid an amount equal
to three (3) times his annual Base Salary as in effect on the date of the termination, payable, at the discretion of the Company,
in one lump sum or in equal monthly installments during a term not to exceed thirty-six (36) months, less applicable withholding
taxes. Additionally, all of Mr. Kyte’s unvested options and warrants shall vest to the same extent as he would have become
vested if he had remained employed by the Company for an additional three (3) years. “Good Reason” is defined to mean
any reduction in Mr. Kyte’s then current annual Base Salary of ten percent (10%) or more, or relocation of the Company’s
principal executive office to a location more than twenty-five (25) miles outside of Santa Barbara, California, or a substantial
change in Mr. Kyte’s then current duties and responsibilities.
Additionally, in the
event of Mr. Kyte’s termination for Cause, Mr. Kyte shall be entitled to receive only his Base Salary accrued through the
date of such termination, and nothing more, and all of Mr. Kyte’s unvested options and warrants shall be canceled.
Additionally, the Board
awarded Mr. Kyte a discretionary cash bonus of $100,000 effective June 11, 2013.
The Board, with Mr.
Kyte’s consent, has determined to freeze Mr. Kyte’s salary at its current level for the balance of the calendar year
2013, and for the calendar year 2014, and will not grant Mr. Kyte any bonus or grants of stock, options or warrants, or any other
compensation for the balance of calendar year 2013, and for calendar year 2014.
Kyte Separation Agreement
Effective November
15, 2013, Cecil Bond Kyte voluntarily resigned as a director, chairman of the board, a member of the Nominating and Corporate Governance
Committee, and chief executive officer of the Company. Mr. Kyte has also voluntarily elected to withdraw as a nominee for election
as a director of the Company at the Company’s 2013 Annual Meeting of Stockholders to be held on December 16, 2013.
In connection with
Mr. Kyte’s resignation, the Company and Mr. Kyte have agreed that Mr. Kyte’s Employment Agreement, dated January 30,
2009, and the three (3) amendments thereto, dated March 1, 2011, December 1, 2011 and September 1, 2013, respectively, shall be
terminated and be of no further force or effect. In exchange, the Company has agreed to pay Mr. Kyte an amount equal to $350,000,
representing his salary for one (1) year, less withholding taxes, in twelve (12) equal monthly installments, commencing November
15, 2013. The Company has also agreed to reimburse Mr. Kyte for his health insurance premiums for a twelve (12) month period, also
commencing November 15, 2013. Mr. Kyte will retain his vested Company stock options and warrants, but all unvested Company stock
options and warrants shall be terminated and of no further force or effect, except that 3,520,000 option shares previously granted
to Mr. Kyte, and scheduled to vest on January 30, 2014, shall be deemed vested as of November 15, 2013. The Company shall also
pay Mr. Kyte the sum of $25,000, less all applicable tax withholdings, on November 15, 2013, representing payment for Mr. Kyte’s
accrued vacation and sick days.
Employment Agreement with
Greggory M. Bigger
On February 1,
2012, the Company entered into an employment agreement with Greggory M. Bigger, pursuant to which he agreed to serve as the
Company’s Chief Financial Officer. The initial term of the agreement commenced February 1, 2012, and
continues for one (1) year. Thereafter, the agreement is renewable for successive one (1) year periods, unless either party
gives written notice of non-renewal, no later than sixty (60) days prior to the renewal date. The agreement
provides for the payment of a one-time acceptance bonus of $10,000. Base salary under the agreement is $10,000 per
month, plus an automobile allowance of $900 per month and other benefits generally available to senior employees of the
Company. In addition, the Company also granted Mr. Bigger an option to purchase 4,000,000 shares of common stock at
$0.25/share (See Note 9 of the Company’s Financial Statement). The options were granted on February 1, 2012 and will
expire ten years from date of grant. The options vest subject to Mr. Bigger’s continued employment over a period of
four years, with 500,000 shares vesting immediately upon grant, 500,000 shares vesting on February 1, 2013, and three
tranches of 1,000,000 shares each vesting on February 1, 2014, 2015 and 2016. On April 30, 2012, the Company raised Mr.
Bigger’s salary to $15,000 per month for his extraordinary leadership and loyalty. On September 1, 2012, his salary was
increased to $20,000 per month for accepting the position of President of the Company in addition to being the
Chief Financial Officer.
Amendment #1 to Bigger Employment
Agreement
Effective September
1, 2013, Mr. Bigger’s Employment Agreement, in recognition of his additional responsibilities as President of the Company,
was amended, as follows:
(i) Annual Base Salary
for Mr. Bigger was increased to $290,000. Mr. Bigger is also eligible to receive an annual cash bonus, within the discretion of
the Company’s Board. In exercising its discretion, the Board shall consider, among other things, the Company’s: (a) revenue;
(b) earnings; (c) contracts; (d) cash position; (e) liquidity; (f) customers; (g) NASDAQ or other exchange listings;
(h) market capitalization; (i) general financial condition; and (j) achievement of goals set forth in management’s yearly
budgets, plans and projections. Any award of bonus shall be paid no later than forty-five (45) days following the filing of the
Company’s Form 10-K.
(ii) Additionally,
in the event any person, including all affiliates of such person, directly or indirectly, becomes the beneficial owner of 50% or
more of the combined voting power of the Company’s outstanding shares, and otherwise on a Change of Control event as defined
in Mr. Bigger’s Employment Agreement, Mr. Bigger’s Employment Agreement and all amendments thereto shall be terminated
whereupon Mr. Bigger shall be paid an amount equal to two (2) times his annual Base Salary as in effect on the date of the Change
of Control event, and all of Mr Bigger’s unvested stock options and warrants shall immediately vest effective on the date
of the Change of Control event.
(iii) Additionally,
if Mr. Bigger is terminated by the Company without cause or if he resigns for “good reason,” he shall be paid an amount
equal to three (3) times his annual Base Salary as in effect on the date of the termination, payable, at the discretion of the
Company, in one lump sum or in equal monthly installments during a term not to exceed thirty-six (36) months, less applicable withholding
taxes. Additionally, all of Mr. Bigger’s unvested options and warrants shall vest to the same extent as he would have become
vested if he had remained employed by the Company for an additional three (3) years. “Good Reason” shall be defined
to mean any reduction in Mr. Bigger’s then current annual Base Salary of ten percent (10%) or more, or relocation of the
Company’s principal executive office to a location more than twenty-five (25) miles outside of Santa Barbara, California,
or a substantial change in Mr. Bigger’s then current duties and responsibilities.
(iv) Additionally,
in the event of Mr. Bigger’s termination for Cause, Mr. Bigger shall be entitled to receive only his Base Salary accrued
through the date of such termination, and nothing more, and all of Mr. Bigger’s unvested options and warrants shall be canceled.
Director Compensation
The table below summarizes
the compensation paid by the Company to its non-employee directors for the fiscal year ended December 31, 2013.
Name
|
|
Fees earned or paid in cash (1)
($)
|
|
|
Stock Awards (2)
($)
|
|
|
Option Awards (3)
($)
|
|
|
Non-Equity Incentive Plan Compensation
($)
|
|
|
Change in Pension Value and Nonqualified Deferred Compensation Earnings
($)
|
|
|
All Other Compensation
($)
|
|
|
Total
($)
|
|
Charles Blum (4)
|
|
$
|
3,000
|
|
|
$
|
25,000
|
|
|
$
|
21,779
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
49,779
|
|
Donald Dickson (5)
|
|
|
–
|
|
|
|
25,000
|
|
|
|
21,834
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
46,834
|
|
Nathan Shelton (6)
|
|
|
3,000
|
|
|
|
25,000
|
|
|
|
21,836
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
49,836
|
|
Mark Stubbs (7)
|
|
|
3,000
|
|
|
|
25,000
|
|
|
|
45,189
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
73,189
|
|
Ryan Zinke (8)
|
|
|
–
|
|
|
|
25,000
|
|
|
|
21,836
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
46,836
|
|
|
(1)
|
Effective July 1, 2013, the Board approved a compensation plan which includes a $500 monthly fee
paid to any member of the Board of Directors who serves on a Board Committee.
|
|
(2)
|
Effective July 1, 2013, the Board approved a compensation plan which includes a grant of stock
valued at $25,000 awarded annually to each member of the Board.
|
|
(3)
|
Effective July 1, 2013, the Board approved a compensation plan which includes an annual grant of
options to purchase a number of shares of common stock equal to $25,000 divided by the per share closing price on the date of grant
with an exercise price equal to the stock closing price on the date of grant, a one year vesting period and an expiration date
10 years from the date of grant. Also effective July 1, 2013, the Board approved an annual grant of options to purchase 25,000
shares of common stock at a price equal to the stock’s closing price on the date of grant, vesting immediately and expiring
10 years from the date of grant as compensation to the chairman of the Board’s Audit Committee.
|
|
(4)
|
Mr. Blum serves as chairman of the Compensation Committee and as a member of the Audit Committee
and the Governance and Nominating Committee. As a member of a Board Committee, Mr. Blum received compensation in the amount of
$500 per month for the six month period of July 1, 2013 through December 31, 2013. On September 16, 2013, Mr. Blum received a grant
to purchase 21,009 shares of common stock valued at $21,779 using Black-Scholes Option Pricing. The options are exercisable at
$1.19/share, vest over a period of one year and expire ten years from the date of grant. During the year ended December 31, 2013,
the Company recognized compensation costs of $7,259 based on the fair value of Mr. Blum’s options that vested and $3,000
for Mr. Blum’s Board Committee fees.
|
|
(5)
|
On August 6, 2013, Mr. Dickson received a grant to purchase 14,620 shares of common stock valued
at $21,834 using Black-Scholes Option Pricing. The options are exercisable at $1.71/share, vest over a period of one year and expire
ten years from the date of grant. During the year ended December 31, 2013, the Company recognized compensation costs of $9,094
based on the fair value of options that vested.
|
|
(6)
|
Mr. Shelton serves as chairman of the Governance and Nominating Committee and as a member of the
Audit Committee and the Compensation Committee. As a member of a Board Committee, Mr. Shelton received compensation in the amount
of $500 per month for the six month period of July 1, 2013 through December 31, 2013. On July 3, 2013, Mr. Shelton received a grant
to purchase 22,936 shares of common stock valued at $21,779 using Black-Scholes Option Pricing. The options are exercisable at
$1.19/share, vest over a period of one year and expire ten years from the date of grant. During the year ended December 31, 2013,
the Company recognized compensation costs of $7,259 based on the fair value of Mr. Shelton’s options that vested and $3,000
for Mr. Shelton’s Board Committee fees.
|
|
(7)
|
Mr. Stubbs serves as chairman of the Audit Committee and as a member of the Compensation Committee.
As a member of a Board Committee, Mr. Stubbs received compensation in the amount of $500 per month for the six month period of
July 1, 2013 through December 31, 2013. On July 3, 2013, Mr. Stubbs received a grant to purchase 22,936 shares of common stock
valued at $21,836 using Black-Scholes Option Pricing. The options are exercisable at $1.09/share, vest over a period of one year
and expire ten years from the date of grant. As chairman of the Audit Committee, Mr. Stubbs received an additional grant of options
on July 3. 2013 to purchase 25,000 shares of common stock valued at $23,252 using Black-Scholes Option Pricing. These options are
exercisable at $1.09/share, vested immediately upon grant and expire ten years from the date of grant. During the year ended December
31, 2013, the Company recognized compensation costs of $34,269 based on the fair value of Mr. Stubb’s options that vested
and $3,000 for Mr. Stubb’s Board Committee fees.
|
|
(8)
|
On July 3, 2013, Mr. Zinke received a grant to purchase 22,936 shares of common stock valued at
$21,779 using Black-Scholes Option Pricing. The options are exercisable at $1.19/share, vest over a period of one year and expire
ten years from the date of grant. During the year ended December 31, 2013, the Company recognized compensation costs of $7,259
based on the fair value of options that vested.
|
Two employee
directors received compensation for service on the Company’s Board of Directors. On September 16, 2013, Mr. Cecil Kyte
and Mr. Greggory Bigger each received a grant of 21,009 shares of common stock valued at $1.19/share for an aggregate value
of $25,000 and a grant to purchase 21,009 shares of common stock valued at $21,779 using the Black-Scholes Option Pricing model.
The options are exercisable at $1.19/share, vest over a period of one year and expire ten years from the date of grant. Mr.
Kyte forfeited these options upon his separation from the Company on November 15, 2013. During the year ended December 31,
2013, the Company recognized compensation costs of $7,259 based on the fair value of Mr. Bigger’s options that vested.
Mr. Kyte received $1,500 for service on Board Committees in the year ending December 31. 2013.
Subsequent to the reporting
period of this Form 10-K filing, effective as of January 1, 2014, the Company’s Board of Directors adopted a resolution to
suspend compensation to the Board of Directors under the Company’s current compensation plan. The Board intends to adopt
a new equity-based compensation plan in the future, specifically excluding any direct grants of common stock and excluding any
compensation to employee directors.
Item 12
.
Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table
sets forth certain information regarding the beneficial ownership of our common stock as of December 31, 2013.
|
·
|
each person, or group of affiliated persons, known by us to be the beneficial owner of more than
5% of the outstanding shares of our common stock;
|
|
·
|
the Company’s Chief Executive Officer, who also holds the positions of Chief Financial Officer
and President, is the only person serving as a Named Executive as of December 31, 2013 whose total annual salary and bonus exceeded
$100,000, for services rendered in all capacities to the Company (such individuals are hereafter referred to as the “Named
Executive Officers”); and all of our directors and executive officers serving as a group.
|
Name and Address of Beneficial Owner (1)
|
|
Number of Shares of
Common Stock Beneficially Owned (2)
|
|
|
Percentage of
Shares Beneficially
Owned (2)
|
|
Named Executive Officers and Director
|
|
|
|
|
|
|
|
|
Bigger, Greggory – Chief Executive Officer,
Chief Financial Officer, President, Director (3)
|
|
|
2,121,009
|
|
|
|
1.20%
|
|
Charles R. Blum – Director (4)
|
|
|
1,965,021
|
|
|
|
1.11%
|
|
Dickson, Donald
|
|
|
14,620
|
|
|
|
0.01%
|
|
Shelton, Nathan – Director (5)
|
|
|
327,521
|
|
|
|
0.19%
|
|
Stubbs, Mark – Director
|
|
|
22,936
|
|
|
|
0.01%
|
|
Ryan Zinke – Director
|
|
|
22,936
|
|
|
|
0.01%
|
|
All directors and executive officers as a group (6)
|
|
|
4,474,043
|
|
|
|
2.81%
|
|
____________
|
(1)
|
Unless otherwise indicated, the address of each listed person is c/o Save the World Air, Inc.,
735 State Street, Suite 500, Santa Barbara, California 93101.
|
|
(2)
|
Percentage of beneficial ownership is based upon 176,242,817 shares of the Company’s common
stock outstanding as of December 31, 2013. Beneficial ownership is determined in accordance with the rules of the SEC and
generally includes voting or investment power with respect to securities. Shares of common stock subject to options and warrants
currently exercisable or convertible, or exercisable or convertible within 60 days, are deemed outstanding for determining the
number of shares beneficially owned and for computing the percentage ownership of the person holding such options, but are not
deemed outstanding for computing the percentage ownership of any other person. Except as indicated by footnote, and subject to
community property laws where applicable, the persons named in the table have sole voting and investment power with respect to
all shares of common stock shown as beneficially owned by them.
|
|
(3)
|
Includes options to purchase 2,000,000 shares of the Company’s common stock exercisable within 60 days of December 31, 2013.
|
|
|
|
|
(4)
|
Includes options to purchase 1,588,679 shares of the Company’s common stock exercisable within 60 days of December 31, 2013.
|
|
|
|
|
(5)
|
Includes options to purchase 304,585 shares of the Company’s common stock exercisable within 60 days of December 31, 2013.
|
|
|
|
|
(6)
|
Effective November 15, 2013, Mr. Cecil Bond Kyte resigned as Chief Executive Officer and as a member of the Board of Directors. Mr. Kyte held a beneficial ownership in 14,970,206 shares of common stock, including options to purchase 11,660,000 shares of the Company’s common stock exercisable within 60 days of December 31, 2013. Including Mr. Kyte as a Named Executive Officer would increase the beneficial ownership of all directors and executive officers as a group to 19,444,249 shares which equals 11.30% of common stock
|
Item 13.
Certain
Relationships and Related Transactions, and Director Independence
Accrued Expenses and Accounts
Payable - Related Parties
As of December
31, 2013 and December 31, 2012, the Company had accounts payable to related parties in the amount of $85,869 and $65,192, respectively.
These amounts are unpaid Directors Fees and unpaid Company expenses incurred by Officers and Directors.
As of December
31, 2013 and December 31, 2012, the Company accrued the unpaid salaries, unused vacation and the corresponding payroll taxes of
Officers in the aggregate of $576,159 and $468,086, respectively. Included in these accruals are the unpaid salaries of the former
Chief Executive Officer (CEO) of the Company of $306,250 and $0, respectively pursuant to November 2013 settlement agreement, former
President and current member of the Company’s Board of Directors of $195,429 and $255,429, respectively and the former Chief
Financial Officer (CFO) of the Company of $0 and $155,000 respectively. The Company agreed to a monthly payment of $5,000 up to
$29,167 to these Officers until their unpaid salaries are fully settled.
Bonus Paid to Officers
General and
administrative expenses for the year ended December 31, 2013 include a cash bonus in the aggregate of $259,000 paid to
Officers including a grant of common stock valued at $109,000. There were no such bonuses in during the year ended December 31, 2012
and 2011.
Consulting Fees Paid to
Related Party
During the year ended
December 31, 2013 the Company incurred consulting fees of $60,000 to a consulting firm controlled by a member of our Board of Directors.
Director Independence
The Company believes
Mr. Dickson, Mr. Shelton, Mr. Stubbs and Mr. Zinke are independent, and Mr. Bigger and Mr. Blum are non-independent.
Item 14. Principal Accounting
Fees and Services
The Audit Committee
has selected Weinberg & Company, P.A. to audit our financial statements for the fiscal year ended December 31, 2013.
Weinberg &
Company, P.A. was first appointed in fiscal year 2003, and has audited our financial statements for fiscal years 2002 through 2013.
Audit and Other Fees
The following table
summarizes the fees charged by Weinberg & Company, P.A. for certain services rendered to the Company during 2013, 2012
and 2011.
|
|
Amount
|
|
|
|
Fiscal
|
|
|
Fiscal
|
|
|
Fiscal
|
|
Type of Fee
|
|
Year 2013
|
|
|
Year 2012
|
|
|
Year 2011
|
|
Audit(1)
|
|
$
|
126,662
|
|
|
$
|
121,340
|
|
|
$
|
83,162
|
|
Audit Related(2)
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Taxes (3)
|
|
|
6,675
|
|
|
|
6,430
|
|
|
|
7,693
|
|
All Other (4)
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Total
|
|
$
|
133,337
|
|
|
$
|
127,770
|
|
|
$
|
90,855
|
|
1)
|
This category consists of fees for the audit of our annual financial statements
included in the Company’s annual report on Form 10-K and review of the financial statements included in the
Company’s quarterly reports on Form 10-Q. This category also includes advice on audit and accounting matters that
arose during, or as a result of, the audit or the review of interim financial statements, statutory audits required by
non-U.S. jurisdictions and the preparation of an annual “management letter” on internal control matters.
|
2)
|
Represents services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for those fiscal years, aggregate fees charged for assurance and related services that are reasonably related to the performance of the audit and are not reported as audit fees. These services include consultations regarding Sarbanes-Oxley Act requirements, various SEC filings and the implementation of new accounting requirements.
|
3)
|
Represents aggregate fees charged for professional services for tax compliance and preparation, tax consulting and advice, and tax planning.
|
4)
|
Represents aggregate fees charged for products and services other than those services previously reported.
|
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2013, 2012 AND 2011
AND FOR THE PERIOD
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2013
1. Description of
Business
Description of Business
Save The World Air,
Inc. (“STWA”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name
Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. The Company’s
common stock is quoted under the symbol “ZERO” on the Over-the-Counter Bulletin Board. More information including the
Company’s fact sheet, logos and media articles are available at our corporate website,
www.stwa.com
.
Save The World Air,
Inc. develops and intends to commercialize energy efficiency technologies that assist in meeting increasing global energy demands,
improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual property
portfolio includes 47 domestic and international patents and patents pending, which have been developed in conjunction with and
exclusively licensed from Temple University of Philadelphia, PA (“Temple”). STWA's technology is called Applied Oil
Technology™ (AOT™), a commercial-grade crude oil pipeline transportation flow-assurance product. AOT™ has been
proven in U.S. Department of Energy tests to increase the energy efficiency of oil pipeline pump stations. The AOT product has
transitioned from the research and development stage to initial commercial production for the midstream pipeline marketplace.
Consolidation Policy
The accompanying consolidated
financial statements of Save the World Air, Inc. and Subsidiary include the accounts of Save the World Air, Inc. (the Parent) and
its wholly owned subsidiary STWA Asia Pte. Limited, incorporated on January 17, 2006. Intercompany transactions and
balances have been eliminated in consolidation.
Reclassification
Certain financial results
in prior years of Research and Development Expenses and Operating Expenses have been reclassified to conform to the current year
presentation. Such reclassification did not change the reported net loss during those periods.
In presenting the Company’s
statement of operations for the twelve-month periods ended December 31, 2012 and 2011, the Company reclassified certain salary
and consulting expenses in the aggregate of $270,000 and $188,500 respectively that were previously reflected as operating expenses
to research and development expenses.
In presenting the Company’s
statement of operations from inception to December 31, 2013, the Company reclassified certain salary and consulting expenses in
the aggregate $531,500 previously reflected as operating expenses to research and development expenses.
2. Summary of Significant
Accounting Policies
Development Stage Enterprise
The Company is a development
stage enterprise. Losses accumulated since the inception of the Company have been considered as part of the Company’s
development stage activities.
The Company’s
focus is on product development and marketing of proprietary devices that are designed to improve the operational parameters of
petrochemical pipeline transport systems and has not yet generated meaningful revenues. The Company is currently transitioning
from the product development cycle to the commercial manufacturing and sales cycle. Expenses have been funded through
the sale of shares of common stock for cash, issuance of convertible notes for cash and the proceeds from exercise of options and
warrants. The Company has taken actions to secure the intellectual property rights to the proprietary technologies and
is the worldwide exclusive licensee for the intellectual property the Company co-developed with its intellectual property partner,
Temple.
Going Concern
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
the Company is in a development stage and has not generated any revenues from operations, and had a net loss of $10,657,009 and
a negative cash flow from operations of $5,912,368 for the year ended December 31, 2013. These factors 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 the Company’s ability to raise additional funds and implement its business plan. The financial statements
do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
At December 31, 2013,
the Company had cash on hand in the amount of $4,137,068. Management expects that the current funds on hand will be sufficient
to continue operations through December 2014. Management is currently seeking additional funds, primarily through the issuance
of debt and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection
with the license and research and development agreements with Temple; costs associated with product development and commercialization
of the AOT technology; costs to manufacture and ship the products; costs to design and implement an effective system of internal
controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports
with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company has substantial
contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain
severance payments to former officers and consulting fees, during the remainder of 2014 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of
debt financing or cause substantial dilution for our stock holders, in case or equity financing.
Revenue Recognition Policy
The Company recognizes
revenue based upon meeting the following criteria. Persuasive evidence of an arrangement exists; Delivery has occurred or services
rendered; The seller’s price to the buyer is fixed or determinable; and Collectability is reasonably assured.
The Company co-develops
with, and licenses from, its intellectual property as a joint-agreement with Temple. The Company’s business model
is to contract with suppliers and manufacturers of oilfield equipment to sell into the oilfield pipeline market. The Company negotiates
an initial contract with the customer fixing the terms of the sale and then receive a letter of credit or full payment in advance
of shipment. Upon shipment, the Company will recognize the revenue associated with the sale of the products to the customer.
Property and Equipment and
Depreciation
Property and equipment
are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and improvements that extend the useful lives of property
and equipment are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. Leasehold improvements
are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.
Impairment of Long-lived
Assets
Our long-lived assets,
such as property and equipment, are reviewed for impairment at least annually, or when events and circumstances indicate that depreciable
or amortizable long lived assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount of those assets. When specific assets are determined to be unrecoverable, the cost basis of the asset
is reduced to reflect the current value.
We use various assumptions
in determining the current fair value of these assets, including future expected cash flows and discount rates, as well as other
fair value measures. Our impairment loss calculations require us to apply judgment in estimating future cash flows, including forecasting
useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows.
If actual results are
not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed
to future impairment losses that could be material to our results. Based upon management’s annual review, no impairments
were recorded for the years ended December 31, 2013 and 2012.
Loss per Share
Basic loss per share
is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during
the period. Diluted loss per share reflects the potential dilution, using the treasury stock method that could occur if securities
or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock
that then shared in the loss of the Company. In computing diluted loss per share, the treasury stock method assumes that outstanding
options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period.
Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common
stock during the period exceeds the exercise price of the options and warrants.
For the years ended
December 31, 2013, 2012 and 2011, the dilutive impact of outstanding stock options of 20,309,908, 27,278,098 and 24,067,892;
outstanding warrants of 11,763,966, 42,205,507, and 49,106,280 and notes convertible into -0-, -0- and 6,836,016 shares of our
common stock respectively, have been excluded because their impact on the loss per share is anti-dilutive.
Income Taxes
Income taxes are recognized
for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets are recognized for the
future tax consequences of transactions that have been recognized in the Company’s consolidated financial statements or tax
returns. A valuation allowance is provided when it is more likely than not that some portion or entire deferred tax asset will
not be realized.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's stock options and warrants grant is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the stock options or warrants, and future dividends.
Compensation expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual
experience. The assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded
in future periods.
Accounting for Derivatives
The Company evaluates
all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially
recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated
statements of operations. For stock-based derivative financial instruments, the Company uses probability weighted
average series Black-Scholes Option Pricing models to value the derivative instruments at inception and on subsequent valuation
dates.
The classification
of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the
end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current
based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet
date.
The Company had derivative
liabilities up to January 2013 relating to adjustments on the exercise price of warrants issued in 2009 and 2010 in conjunction
with the Company’s convertible note offering. These warrants were exercised to common stock or expired in January 2013 thus
eliminating the derivate liabilities.
Business and Credit Concentrations
Company’s cash
balances in financial institutions at times may exceed federally insured limits. As of December 31, 2013 and 2012, before
adjustments for outstanding checks and deposits in transit, the Company had $4,143,367 and $1,616,639, respectively, on deposit
with two banks. The deposits are federally insured up to $250,000 at each bank.
Estimates
The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Certain significant estimates were made in connection with preparing the Company’s financial statements. This
includes certain inputs to the Black-Scholes Option Pricing model used to value options and warrants to purchase stock and
derivative liabilities. Actual results could differ from those estimates.
Fair Value of Financial
Instruments
Effective January 1,
2008, fair value measurements are determined by the Company's adoption of authoritative guidance issued by the FASB, with the exception
of the application of the statement to non-recurring, non-financial assets and liabilities as permitted. The adoption of the authoritative
guidance did not have a material impact on the Company's fair value measurements. Fair value is defined in the authoritative
guidance as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy
was established, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
Level 1—Quoted
prices in active markets for identical assets or liabilities.
Level 2—Inputs,
other than the quoted prices in active markets, are observable either directly or indirectly.
Level 3—Unobservable
inputs based on the Company's assumptions.
The Company is required
to use of observable market data if such data is available without undue cost and effort.
The following table
presents certain investments and liabilities of the Company’s financial assets measured and recorded at fair value on the
Company’s consolidated balance sheets on a recurring basis and their level within the fair value hierarchy as of December
31, 2013 and 2012.
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Fair value of Derivative Liability, December 31, 2013
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Fair value of Derivative Liability, December 31, 2012
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
3,221,138
|
|
|
$
|
3,221,138
|
|
Research and Development
Costs
Costs incurred for
research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed.
Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial
uses are also expensed.
For the years ended
December 31, 2013, 2012 and 2011, and for the period from inception to December 31, 2013, research and development costs incurred
were $2,011,486, $963,184, $1,318,783 and $10,681,167, respectively.
Recent Accounting Pronouncements
In February 2013, the
Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-04. This update clarifies how entities
measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed
at the reporting date. This guidance is effective for fiscal years beginning after December 15, 2013 and interim reporting periods
thereafter. This update is not expected to have an impact on the Company’s financial position or results of operations
In April 2013, the
FASB issued ASU 2013-07 to clarify when it is appropriate to apply the liquidation basis of accounting. Additionally, the update
provides guidance for recognition and measurement of assets and liabilities and requirements for financial statements prepared
using the liquidation basis of accounting. Under the amendment, entities are required to prepare their financial statements under
the liquidation basis of accounting when a liquidation becomes imminent. This guidance is effective for annual reporting periods
beginning after December 15, 2013, and interim reporting periods thereafter. This update is not expected to have an impact on the
Company’s financial position or results of operations.
In July 2013, the FASB
issued ASU 2013-11 which provides guidance relating to the financial statement presentation of unrecognized tax benefits. The update
provides that a liability related to an unrecognized tax benefit would be presented as a reduction of a deferred tax asset for
a net operating loss carryforward, a similar tax loss or a tax credit carryforward, if such settlement is required or expected
in the event the uncertain tax position is disallowed. This update does not require any new recurring disclosures and is effective
for public entities for fiscal years beginning after December 15, 2013, and interim reporting periods thereafter. This update is
not expected to have an impact on the Company’s financial position or results of operations.
Other recent accounting
pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants,
and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's
present or future consolidated financial statements.
3. Certain Relationships
and Related Transactions
Accrued Expenses and Accounts
Payable - Related Parties
As of December 31,
2013 and December 31, 2012, the Company had accounts payable to related parties in the amount of $85,869 and $65,192, respectively.
These amounts are unpaid Directors Fees and unpaid Company expenses incurred by Officers and Directors.
As of December 31,
2013 and December 31, 2012, the Company accrued the unpaid salaries, unused vacation and the corresponding payroll taxes of Officers
in the aggregate of $576,159 and $468,086, respectively. Included in these accruals are the unpaid salaries of the former Chief
Executive Officer (CEO) of the Company of $306,250 and $0, respectively pursuant to November 2013 settlement agreement, former
President and current member of the Company’s Board of Directors of $195,429 and $255,429, respectively and the former Chief
Financial Officer (CFO) of the Company of $0 and $155,000 respectively. The Company agreed to monthly payments ranging from $5,000
up to $29,167 to these Officers until their unpaid salaries are fully settled.
Bonus Paid to Officers
General
and administrative expenses for the year ended December 31, 2013 include a cash bonus in the aggregate of $259,000 including
a grant of common stock valued at $109,000. There were no such cash bonuses in 2012 or 2011.
Consulting Fees Paid to
Related Party
During the year
ended December 31, 2013 the Company incurred consulting fees of $60,000 to a consulting firm controlled by a member of our
Board of Directors. There were no such costs in 2012 or 2011.
4. Property and Equipment
At December 31,
2013 and 2012, property and equipment consists of the following:
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
Office equipment
|
|
$
|
65,051
|
|
|
$
|
91,288
|
|
Furniture and fixtures
|
|
|
4,075
|
|
|
|
16,128
|
|
Machinery and equipment
|
|
|
–
|
|
|
|
49,986
|
|
Testing equipment
|
|
|
–
|
|
|
|
147,312
|
|
Subtotal
|
|
|
69,126
|
|
|
|
304,714
|
|
Less accumulated depreciation
|
|
|
(33,355
|
)
|
|
|
(249,040
|
)
|
Total
|
|
$
|
35,771
|
|
|
$
|
55,674
|
|
Depreciation expense
for the years ended December 31, 2013, 2012 and 2011 was $15,399, $36,077 and $34,717, respectively. Depreciation expense for
the period from inception (February 18, 1998) through December 31, 2012 was $546,375.
|
5.
|
Convertible Notes and Warrants
|
2011
In 2011, the Company
issued its convertible notes in the aggregate of $6,232,979 for a total cash consideration of $5,360,070, original issue discount
of $566,634 and conversion of $306,275 of accounts payable. The notes do not bear any interest, however, the Company used an implied
interest rate of 10%, are unsecured, will mature in one year and convertible to 24,931,916 shares of common stock at a conversion
price of $0.25 per share. Furthermore, each of the investors in the offerings received, for no additional consideration, warrants
to purchase a total of 24,931,916 shares of common stock. Each warrant is exercisable on a cash basis only at a price of $0.30
per share, and is exercisable immediately upon issuance and will expire within two (2) years from the date of issuance.
The aggregate relative
fair value of the warrants issued in the 2011 offerings were valued at $2,970,311 using the Black-Scholes Option Pricing model
with the following average assumptions: risk-free interest rate of 0.28%; dividend yield of 0%; volatility rate of 118% based upon
the Company’s historical stock price; and an expected life of two years (statutory term). The Company also determined that
the notes contained a beneficial conversion feature of $2,696,034 since the market price of the Company’s common stock were
higher than the conversion price of the notes when they were issued. The value of the 2011 Offering Warrants, the beneficial
conversion feature and the original issue discount in the aggregate of $6,232,979 was considered as debt discount and was amortized
over the term of the notes or in full upon the conversion of the corresponding notes. During the year ended December 31, 2011,
the Company converted $4,512,519 of these notes to 18,050,076 shares of common stock and amortized to interest expense $4,682,061
of the corresponding note discount. As of December 31, 2011, total outstanding balance of these notes amounted to $1,720,460 and
the unamortized note discount amounted to $1,550,918.
During the year ended
December 31, 2012, the remaining note balance of $1,720,460 was converted to 6,881,840 shares of common stock and the Company amortized
to interest expense $1,550,918 of the remaining note discount. As such, there was no balance due to this note as of December 31,
2012.
2012
In 2012, the Company
issued its convertible notes in the aggregate of $2,069,174 for total cash consideration of $1,835,840, resulting in an original
issue discount of $180,963 and conversion of $52,371 of accounts payable. The notes do not bear any interest, however, the Company
used an implied interest rate of 10%, are unsecured, will mature in one year and convertible to 7,423,316 shares of common stock
at a conversion price of $0.25 up to $0.40 per share. Furthermore, each of the investors in the offerings received, for no additional
consideration, warrants to purchase a total of 7,423,316 shares of common stock. Each warrant is exercisable on a cash basis only
at a price of $0.30 up to $0.40 per share, and is exercisable immediately upon issuance and will expire within two (2) to three
(3) years from the date of issuance.
The aggregate relative
fair value of the warrants issued in the 2012 offerings were valued at $839,131 using the Black-Scholes Option Pricing model
with the following average assumptions: risk-free interest rate of 0.26%; dividend yield of 0%; volatility rate of 111% based upon
the Company’s historical stock price; and an expected life of two to three years (statutory term). The Company also determined
that the notes contained a beneficial conversion feature of $1,049,080 since the market price of the Company’s common stock
were higher than the conversion price of the notes when they were issued. The value of the 2012 Offering Warrants, the beneficial
conversion feature and the original issue discount in the aggregate of $2,069,174 was considered as debt discount and was amortized
as interest over the term of the notes or in full upon the conversion of the corresponding notes.
During the year ended
December 31, 2012, the Company converted $2,069,174 of these notes to 7,423,316 shares of common stock and the Company amortized
to interest expense $2,069,174 of the corresponding note discount. As such, there was no balance due to this note as of December
31, 2012.
6. Research and Development
AOT Testing
In 2011, the Company
conducted research and development of its AOT technology prototypes in a testing facility in Midwest, Wyoming, located at the U.S.
Department of Energy Rocky Mountain Oilfield Testing Center, Naval Petroleum Reserve #3 (US DOE). The Company constructs the AOT
technology prototypes through the assistance of various third party entities, located in Casper, Wyoming. Costs incurred and expensed
includes fees charged by the US DOE, purchase of test equipment, pipeline pumping equipment, crude oil tank batteries, viscometers,
SCADA systems, computer equipment and other related equipment and various logistical expenses for the purposes of evaluating and
testing its AOT prototypes.
In 2012, the Company
began the design and engineering efforts required to transition from prototype testing to full-scale commercial unit production.
The Company has been working in a collaborative engineering environment with multiple Energy Industry companies to refine the AOT™
Midstream commercial design to comply with the stringent standards and qualification processes as dictated by independent engineering
audit groups and North American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known
as AOT™ Midstream serial number 000001, was completed.
In the fourth quarter
of 2013, the Company began development of a new joule heat system which uses the electrical resistance of the fluid itself, thereby
improving the efficiency of the system by the removal of parasitic losses.
Total expenses incurred
during the years ended December 31, 2013, 2012 and 2011 on AOT testing amounted to $690,890, $588,584 and $923,497, respectively,
and has been reflected as part of Research and Development expenses on the accompanying consolidated statement of operations.
AOT Prototype
On August 1, 2013,
the Company entered into an Equipment Lease/Option to Purchase Agreement ("Agreement" or "Lease") with TransCanada
Keystone Pipeline, L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada"), whereby, TransCanada has agreed
to lease, install, maintain, operate and test the effectiveness of the Company's AOT technology and equipment (the "Equipment")
on one of TransCanada's operating pipelines by the second quarter of 2014. The initial term of the lease is six (6) months at a
rate of $60,000/month, with an option to extend the lease for an additional eighty-four (84) months. TransCanada has an option
to purchase equipment during the term of the lease for approximately $4.3 million. The Company will account for this lease as an
operating lease if accepted by TransCanada.
The Company began manufacturing
equipment for delivery to TransCanada in the third quarter of 2013. Total expenses incurred during the year ended December 31,
2013 amounted to $1,029,143 and has been reflected as part of Research and Development expenses on the accompanying consolidated
statement of operations. The Company expects to utilize an additional $200,000 in completion of this prototype in the first quarter
of 2014.
Temple University Licensing
Agreement
On August 1, 2011,
the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License
Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated
with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology
to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the
territory licensed to the Company is worldwide and replace previously issued License Agreements.
Pursuant to the two
licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000;
(ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing
agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon.
Temple also agreed to cancel $37,500 of the amount due if the Company agrees to fund at least $250,000 in research or development
of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon
the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing
agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights..
Total expenses recognized
during the year ended December 31, 2013, 2012 and 2011 pursuant to these two agreements amounted to $187,500, $187,500 and $395,286,
respectively, and has been reflected in Research and Development expenses on the accompanying consolidated statement of operations.
As of December
31, 2013 and 2012, total unpaid fees due to Temple pursuant to these agreements amounted to $153,125 and $128,350,
respectively, which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated
balance sheets.
As of December 31,
2013, 2012 and 2011, there were no revenues generated from these two licenses.
Temple University Sponsored
Research Agreement
On March 19,
2012, the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University
(“Temple”), whereby Temple, under the direction of Dr. Rongjia Tao, will perform ongoing research related to the
Company’s AOT device (the “Project”), for the period April 1, 2012, through April 1, 2014. All
rights and title to intellectual property resulting from Temple’s work related to the Project shall be subject to
the Exclusive License Agreements between Temple and the Company, dated August 1, 2011. In exchange
for Temple’s research efforts on the Project, the Company has agreed to pay Temple $500,000, payable in
quarterly installments of $62,500.
In August 2013, the
Company and Temple amended the Research Agreement. Under the amended agreement, parties agreed that total cost for Phase 1 of the
agreement expenses incurred in prior periods was $241,408, of which, $187,500 was already recognized in prior year and total cost
for Phase 2 of the agreement was $258,592 payable beginning September 1, 2013 in eight quarterly installments of $32,324.
During the years ended
December 31, 2013 and 2012, the Company recognized a total of $118,556 and $187,500,
respectively, pursuant to this agreement and has been reflected
in Research and Development expenses on the accompanying consolidated statement of operations. There were no such costs in 2011.
As of December 31,
2013 and 2012, total unpaid fees due to Temple pursuant to this agreement amounted to $32,325 and $187,500,
respectively, which are included as
part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets.
7. Derivative Liability
In June 2010, the FASB
issued authoritative guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock.
Under the authoritative guidance, effective January 1, 2010, instruments which do not have fixed settlement provisions are deemed
to be derivative instruments. The FASB’s guidance requires the fair value of these liabilities be re-measured at the end
of every reporting period.
In 2009 and 2010, in
connection with certain convertible note offerings, the Company granted an aggregate of 8,522,500 warrants, exercisable at $0.30
per share which contains exercise prices that may fluctuate based on the occurrence of future offerings or events. As a result,
these warrants were not considered indexed to the Company’s own stock. The Company characterized the fair value of these
warrants as derivative liabilities upon issuance and re-measured every reporting period with the change in value reported in the
accompanying statement of operations.
During the year ended
December 31, 2011, the Company recorded a gain of $2,021,536 due to the change in the fair value of the derivative liability. As
of December 31, 2011, a total fair value of the derivative liability amounted to $1,643,139 representing 8,322,500 warrants that
are still outstanding.
During the year ended
December 31, 2012, the Company recorded a loss of $4,023,094 due to the change in the fair value of the derivatives. Furthermore,
the Company recognized a gain of $2,445,095 due to the extinguishment of the derivative liabilities resulting from the expiration
of 220,000 warrants and exercise of 3,690,000 warrants to shares of common stock. At December 31, 2012, the Company determined
the fair value of these derivative liabilities to be $3,221,138 representing 4,412,500 warrants that are still outstanding.
From January 1 up to
15, 2013, 4,112,500 warrants were exercised and the remaining 300,000 warrants expired unexercised at which time the warrants had
a fair value of $3,441,752, which resulted in a loss of $220,614 due to the change in the fair value of the derivative liability.
As a result of the exercise and expiration of these warrants, the Company recorded a gain of $3,441,752 due to the
extinguishment of the corresponding derivative liability.
The derivative liabilities
were valued using a probability weighted average series of Black-Scholes Option Pricing models as a valuation technique, which
approximates the Monte Carlo and other binominal valuation techniques with the following assumptions:
|
|
Fair Value of Warrants
|
|
|
|
January 15,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Risk-free interest rate
|
|
|
0.12%
|
|
|
|
0.02%
|
|
|
|
0.02%
|
|
Expected volatility
|
|
|
92%
|
|
|
|
165%
|
|
|
|
165%
|
|
Expected life (in years)
|
|
|
0.75 - 1.00
|
|
|
|
0.04
|
|
|
|
0.04
|
|
Expected dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
|
|
0%
|
|
Fair Value:
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 Summer Warrants
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
332,998
|
|
2009 Wellfleet Warrants
|
|
|
–
|
|
|
|
–
|
|
|
|
17,807
|
|
2009 Fall Warrants
|
|
|
3,441,752
|
|
|
|
3,221,138
|
|
|
|
1,292,334
|
|
Total Fair Value
|
|
$
|
3,441,752
|
|
|
$
|
3,221,138
|
|
|
$
|
1,643,139
|
|
The risk-free interest
rate is based on the yield available on U.S. Treasury securities. The Company estimates volatility based on the historical
volatility of its common stock. The expected life warrants are based on the expiration date of the related warrants. The
expected dividend yield was based on the fact that the Company has not paid dividends to stockholders in the past nor is it expected
to pay any dividends in the foreseeable future.
8. Common Stock Transactions
2013
In December 2013, the
Company’s stockholders agreed to increase the authorized shares of common stock of the Company from 200,000,000 to 300,000,000.
During the year ended December 31, 2013, the Company issued an aggregate of 32,575,247 shares of its common stock as follows:
|
·
|
The Company issued 29,152,389 shares of its common stock upon exercise of options and warrants
at a price of $0.25 up to $0.98 with proceeds of $8,477,218, net of direct costs in the amount of $78,521 in commissions and foreign
exchange fees paid on warrants exercised by foreign (non-U.S.) investors. Furthermore, included in the exercise was issuance of
50,000 shares of common stock valued at $49,000 pursuant to an exercise of options and accounted for as partial settlement of unpaid
fees recorded in prior years. As a result, the aggregate net proceeds received amounted to $8,428,218.
|
|
●
|
The Company issued 50,000 shares of its common stock with a fair value of $49,000 or $0.98/share
to a consultant for service rendered. The shares were valued at market at the date of the agreement.
|
|
●
|
The Company issued 325,455 shares of its common stock with a fair value of $370,113 or $1.14/share
to Directors, Officers and Employees of the Company for service rendered. The shares were valued at market at the date of issuance.
|
|
●
|
In December 2013, the Company issued 3,047,403 shares of common stock with a fair value of $3,108,347
pursuant to a settlement with CEDE & Co (see Note 12).
|
2012
During the year ended
December 31, 2012, the Company issued an aggregate of 29,394,100 shares of its common stock as follows:
|
●
|
The Company issued 14,305,156 shares of its common stock in exchange for conversion of $3,789,634
of Convertible Notes pursuant to the convertible notes conversion prices of $0.25 up to $0.40 per share.
|
|
●
|
The Company issued 11,787,277 shares of its common stock for exercise of warrants at an average
price of $0.28 and valued at $3,317,181.
|
|
●
|
The Company issued 2,525,000 shares of our common stock for services valued in the aggregate at
$1,228,250. We valued the shares at market prices at the date of the agreements ranging from $0.30 to $1.07 per share.
|
|
●
|
The Company issued 776,667 shares of its common stock upon exercise of options valued at $0.27
up to $0.30 per share with an aggregate value of $364,700.
|
2011
During the year ended
December 31, 2011 the Company issued an aggregate of 22,820,276 shares of its common stock as follows:
|
●
|
The Company issued 19,861,478 shares of its common stock in exchange for conversion of $4,965,370
of Convertible Notes pursuant to the convertible notes conversion prices of $0.25 per share.
|
|
●
|
The Company issued 81,020 shares of its common stock for cashless exercise of warrants.
|
|
●
|
The Company issued 2,800,000 shares of its common stock for services valued in the aggregate at
$862,000. The Company valued the shares at the trading price at the date of the agreements ranging from $0.25 up to $0.60 per share.
|
|
●
|
The Company issued 77,778 shares of its common stock for exercised options valued at $0.27 per
share or $21,000.
|
9. Stock Options and
Warrants
The Company periodically
issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing
costs. Options vest and expire according to terms established at the grant date.
Options
The Company currently
issues stock options to employees, directors and consultants under its 2004 Stock Option Plan (the Plan). The Company could issue
options under the Plan to acquire up to 7,000,000 shares of common stock as amended in May 2006.
From the Plan’s
inception in 2004 up to December 31, 2013, the Company granted options to purchase 9,091,815 shares under the Plan, of which 4,293,574
shares were subsequently cancelled or forfeited and made available for grants under the Plan. As of December 31, 2013, 2,201,759
shares were available to be granted under the Plan.
From the Company’s
inception in February 1998 up to December 31, 2013, a total of 37,050,000 shares were granted outside of the Plan, of which, 17,430,000
shares were subsequently cancelled or forfeited. During the year ended December 31, 2013, there were no shares granted outside
the Plan while 7,040,000 shares granted outside the Plan in 2011 were cancelled. During the year ended December 31, 2012, 4,000,000
shares were granted outside the Plan.
Employee options
vest according to the terms of the specific grant and expire from 5 to 10 years from date of grant. Non-employee option
grants have vested upon issuance and up to 2 years from the date of grant. The weighted-average, remaining contractual life
of employee and Non-employee options outstanding at December 31, 2013 was 7.1 years. Stock option activity for the
period January 1, 2011 to December 31, 2013, was as follows:
|
|
Weighted Avg.
Options
|
|
|
Weighted Avg.
Exercise Price
|
|
Options, January 1, 2011
|
|
|
4,837,488
|
|
|
$
|
0.52
|
|
Options granted
|
|
|
19,800,000
|
|
|
|
0.26
|
|
Options exercised
|
|
|
(77,778
|
)
|
|
|
0.27
|
|
Options forfeited
|
|
|
(310,000
|
)
|
|
|
0.76
|
|
Options cancelled
|
|
|
(181,818
|
)
|
|
|
0.55
|
|
Options, December 31, 2011
|
|
|
24,067,892
|
|
|
$
|
0.30
|
|
Options granted
|
|
|
4,858,000
|
|
|
|
0.30
|
|
Options exercised
|
|
|
(776,667
|
)
|
|
|
0.47
|
|
Options forfeited
|
|
|
(871,127
|
)
|
|
|
0.98
|
|
Options, December 31, 2012
|
|
|
27,278,098
|
|
|
$
|
0.27
|
|
Options granted
|
|
|
207,819
|
|
|
|
1.17
|
|
Options exercised
|
|
|
(115,000
|
)
|
|
|
0.60
|
|
Options forfeited
|
|
|
(7,061,009
|
)
|
|
|
0.25
|
|
Options, December 31, 2013
|
|
|
20,309,908
|
|
|
$
|
0.28
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest under the Plan as of December 31,
2013 were as follows:
|
|
Outstanding Options
|
|
Exercisable Options
|
Option
Exercise Price
Per Share
|
|
Shares
|
|
|
Life
(Years)
|
|
Weighted
Average Exercise
Price
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
$ 0.21 - $ 0.99
|
|
|
20,041,679
|
|
|
7.1
|
|
$0.27
|
|
|
17,041,679
|
|
|
$0.27
|
$ 1.00 - $ 1.99
|
|
|
268,229
|
|
|
6.1
|
|
$1.22
|
|
|
124,601
|
|
|
$1.27
|
|
|
|
20,309,908
|
|
|
|
|
$0.28
|
|
|
17,166,280
|
|
|
$0.28
|
As of December 31,
2013 the market price of the Company’s stock was $1.07 per share. At December 31, 2013 the aggregate intrinsic value
of the options outstanding was $16,060,907. Future unamortized compensation expense on the unvested outstanding options at December
31, 2013 is approximately $705,500.
2013
|
·
|
From April up to September 2013, options to acquire 115,000 shares of common stock were exercised
resulting in net proceeds of $19,500. Included in the exercise was issuance of 50,000 shares of common stock valued at $49,000
pursuant to an exercise of options and accounted for as partial settlement of a liability recorded in prior years.
|
|
·
|
In July 2013, the Company issued options to purchase 36,364 shares of common stock to consultants
with an estimated fair value of approximately $25,000 using the Black-Scholes Option Pricing model. The options are exercisable
at $1.10/share, vest over a period of one year and expire in two years from the date of grant. During the year ended December 31,
2013, the Company recognized compensation costs of $16,000 based on the fair value of options that vested.
|
|
·
|
From July up to September 2013, the Company issued options to purchase 171,455 shares of common
stock to employees, officers and members of the Board of Directors with a fair value of approximately $176,000 using the Black-Scholes
Option Pricing model. The options are exercisable at $1.09/share up to $1.71/share, vest over a period of one year and expire in
ten years from the date of grant. During the year ended December 31, 2013, the Company recognized compensation costs of $85,157
based on the fair value of options that vested.
|
|
·
|
In November 2013, pursuant to separation agreement with an Officer of the Company, the Company
cancelled unvested option to purchase 7,040,000 shares of common stock at $0.25 and modified the vesting period of unvested option
to purchase 3,520,000 shares of common stock at $0.25, both granted 2011 (see Note 13).
|
|
·
|
During year ended December 31, 2013, the Company amortized $403,127 of compensation cost based
on the vesting of the options granted to employees, directors and consultants in prior years.
|
2012
|
·
|
On February 1, 2012, the Company issued 4,000,000 options to its Chief Financial Officer, valued
at $1,207,193 using Black-Scholes Option Pricing model. The options have an exercise price of $0.25 per share, vest over a four
year period, and expire ten years from date of grant. Twelve and a half percent vested immediately, twelve and a half percent will
vest on the first anniversary date, and twenty-five percent will vest on the following three anniversary dates. During the year
ended December 31, 2012, the Company recognized compensation costs of $289,223 based upon its vesting.
|
|
·
|
On May 18, 2012, the Company issued 850,000 options to its employees, valued at $242,963 using
Black-Scholes Option Pricing model. The options have an exercise price of $0.30 per share, vesting immediately, and expire ten
years from date of grant.
|
|
·
|
On October 1, 2012, the Company issued 8,000 options to its employees, valued at $5,851 using Black-Scholes
Option Pricing model. The options have an exercise price of $0.83 per share, vesting immediately, and expire ten years from date
of grant.
|
|
·
|
During year ended December 31, 2012, the Company amortized $1,366,846 of compensation cost based
on the vesting of the options granted to employees, directors and consultants in prior years
|
2011
|
·
|
In March 2011, the Company granted 17,600,000 options to the Company’s Chairman and Chief
Executive Officer with a fair value of $6,834,231 using the Black-Scholes Option Pricing model. The options have an exercise price
of $0.25 per share, vest over a five year period, and expire ten years from date of grant. Twenty percent of the options shall
vest on each of the first five anniversary dates. In the event of a change of control of the Company, all unvested options shall
vest on the date of the change of control. During the year ended December 31, 2011, the Company amortized $1,252,942 of compensation
cost based on the vesting of the options.
|
|
·
|
During the year ended December 31, 2011, the Company granted 2,200,000 options to certain of
its director and officers. The options have an exercise price of $0.30 per share, vest immediately and expire ten years from
date of grant. The options were valued at $541,134 or $0.25 per share using the Black-Scholes Option Pricing model and were
expensed at the time of grant.
|
|
·
|
During the year ended December 31, 2011, the Company recognized amortization expense of $8,058
based upon its vesting of options granted to an employee in prior years.
|
Black-Scholes Option Pricing
During the years ended
December 31, 2013, 2012 and 2011, the Company used the following average assumptions in its calculation using the Black-Scholes
Option Pricing model:
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Expected life (years)
|
|
|
1.5 – 5.5
|
|
|
|
5.0 – 7.0
|
|
|
|
6
|
|
Risk free interest rate
|
|
|
0.34 – 1.65%
|
|
|
|
0.62 – 1.27%
|
|
|
|
1.95%
|
|
Volatility
|
|
|
127 – 130%
|
|
|
|
125 – 140%
|
|
|
|
141.97%
|
|
Expected dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
|
|
0%
|
|
The weighted average
fair value for options granted in 2013, 2012 and 2011 were $0.96, $0.30 and $0.37, respectively.
Warrants
The following table
summarizes certain information about the Company’s stock purchase warrants.
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
Warrants outstanding, January 1, 2011
|
|
|
22,979,068
|
|
|
$0.52
|
Warrants granted
|
|
|
29,781,916
|
|
|
0.30
|
Warrants exercised
|
|
|
(224,000
|
)
|
|
0.47
|
Warrants cancelled
|
|
|
(3,430,704
|
)
|
|
0.56
|
Warrants outstanding, December 31, 2011
|
|
|
49,106,280
|
|
|
$0.32
|
Warrants granted
|
|
|
9,273,316
|
|
|
0.31
|
Warrants exercised
|
|
|
(12,039,846
|
)
|
|
0.29
|
Warrants cancelled
|
|
|
(4,134,243
|
)
|
|
0.49
|
Warrants outstanding, December 31, 2012
|
|
|
42,205,507
|
|
|
$0.31
|
Warrants granted
|
|
|
150,000
|
|
|
0.31
|
Warrants exercised
|
|
|
(29,037,389
|
)
|
|
0.29
|
Warrants cancelled
|
|
|
(1,554,152
|
)
|
|
0.49
|
Warrants outstanding, December 31, 2013
|
|
|
11,763,966
|
|
|
$0.31
|
At December 31, 2013
the price of the Company’s common stock was $1.07 per share and the aggregate intrinsic value of the warrants outstanding
was $8,585,149. Future unamortized compensation expense on the unvested outstanding warrants at December 31, 2013 is approximately
$162,500.
|
|
|
Outstanding Warrants
|
|
Exercisable Warrants
|
Warrant
Exercise Price Per Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
Weighted
Average Exercise
Price
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
$ 0.30 - $ 0.99
|
|
|
|
11,263,966
|
|
|
2.7
|
|
$0.31
|
|
|
10,380,632
|
|
|
$0.31
|
$ 1.00 - $ 1.99
|
|
|
|
500,000
|
|
|
0.5
|
|
$1.00
|
|
|
500,000
|
|
|
$1.00
|
|
|
|
|
|
11,763,966
|
|
|
|
|
$0.34
|
|
|
10,880,632
|
|
|
$0.34
|
2013
|
·
|
In March 2013, pursuant to a settlement of debt agreement, the Company granted a consultant a warrant
to purchase 150,000 shares of its common stock with an exercise price of $0.30 per share, vesting immediately and expiring in two
years from grant date. The fair value of the warrant amounted to $129,622 using the Black-Scholes Option Pricing model with the
following average assumptions: risk-free interest rate of 0.26%; dividend yield of 0%; volatility of 132%; and an expected life
of two years. The fair value of the warrant of $129,622 was recorded as part of Settlement of litigation and debt in the accompanying
Consolidated Statement of Operations.
|
|
·
|
During the year ended December 31, 2013, warrants to acquire 29,307,389 shares of common stock
were exercised resulting in proceeds of $8,408,718, net of direct costs incurred of $78,521.
|
|
·
|
During year ended December 31, 2013, the Company recorded $84,694 of compensation cost based on
the vesting of the warrants granted to a consultant in 2011 using the Black-Scholes Option Pricing model with the following average
assumptions: risk-free interest rate of 2.21%; dividend yield of 0%; volatility of 129%; and an expected life of 8 years. Unamortized
compensation expense on the unvested outstanding options at December 31, 2013 is approximately $8,600.
|
|
·
|
During year ended December 31, 2013, the Company amortized $97,242 of compensation cost based on
the vesting of the warrants granted to employees, directors and consultants in prior years.
|
2012
|
·
|
During the year ended December 31, 2012, the Company granted warrants to consultants to purchase
1,850,000 shares of its common stock. The warrants have an exercise price of $0.30 per share, fully vested and will expire in two
to three years from grant date. Total fair value of the warrant amounted to $517,777 using the Black-Scholes Option Pricing model
with the following average assumptions: risk-free interest rate of 0.23% to 0.39%; dividend yield of 0%; volatility of 111%; and
an expected life of three years.
|
|
·
|
During the year ended December 31, 2012, the Company granted 7,423,316 warrants to acquire share
of its common stock in connection of its issuance of convertible notes. The warrants have an average exercise price of $0.29 per
share, fully vested, and will expire in two to three years from date of grant.
|
|
·
|
During the year ended December 31, 2012, the Company recognized amortization expense of $289,513
based upon its vesting of warrants granted in prior years.
|
2011
|
·
|
In August 2011, the Company granted a warrant to an employee to purchase 2,000,000 shares of its
common stock pursuant to an employment agreement. The warrant is exercisable at $0.30/share, vests over five years and will expire
in ten years from grant date. Total fair value of the warrant was determined to be $486,202 at the date of grant using a Black-Scholes
Option Pricing model with the following assumptions: risk-free interest rate of 2.05%; dividend yield of 0%; volatility of 126%;
and an expected life of seven years. During the year ended December 31, 2011, the Company recognized amortization expense of $69,457
based upon vesting of the warrants.
|
|
·
|
In December 2011, the Company granted a warrant to an employee to purchase 1,000,000 shares of
its common stock pursuant to a separation agreement. The warrant is exercisable at $0.30/share, vest immediately and will expire
in ten years from grant date. Total fair value of the warrant was determined to be $369,370 at the date of grant using a Black-Scholes
Option Pricing model with the following assumptions: risk-free interest rate of 1.89%; dividend yield of 0%; volatility of 196%;
and an expected life of ten years. During the year ended December 31, 2011, the Company recognized the full value of the warrant.
|
|
·
|
During the year ended December 31, 2011, the Company granted warrants to consultants to purchase
1,850,000 shares of its common stock. The warrants have an average exercise price of $0.31/share, vests over a period up to three
years and will expire in one to ten years from grant date. Total fair value of the warrant amounted to $463,898 using the Black-Scholes
Option Pricing model with the following average assumptions: risk-free interest rate of 0.71%; dividend yield of 0%; volatility
of 136%; and an expected life of four years. During the year ended December 31, 2011, the Company recognized amortization expense
of $411,888 based upon vesting of the warrants.
|
|
·
|
During the year ended December 31, 2011, the Company granted issued 24,931,916 warrants to acquire
shares of its common stock in connection of its issuance of convertible notes. The warrant is exercisable at $0.25/share, fully
vested, and will expire in two years for date of grant.
|
10. Commitments and
contingencies
There are no current
or pending litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the
normal course of business.
Leases
On August 1, 2013,
the Company terminated its previous lease, and entered into a new non-cancellable lease with a 5-year term, expiring July 31, 2018
at a monthly rent of $13,075.
Total rent expense
during the years ended December 31, 2013, 2012 and 2011, was $201,500, $210,635 and $138,840, respectively, which are included as
part of Operating Expenses in the attached consolidated statements of operations. The following is a schedule by years of future
minimum rental payments required under the non-cancellable office lease as of December 31, 2013.
Remaining Lease Commitments by Year
|
2014
|
|
$
|
69,960
|
|
2015
|
|
|
69,960
|
|
2016
|
|
|
69,960
|
|
2017
|
|
|
69,960
|
|
2018
|
|
|
40,810
|
|
Total
|
|
$
|
320,650
|
|
Beginning
July 2013, the Company subleased a portion of its office space under the Santa Barbara office lease on a month-to-month
basis. Total rents collected under these sublease agreements in the year ended December 31, 2013 were $11,085, which were
included as an offset to Operating Expenses in the attached consolidated statements of operations. The rent expense net of
sublease rents collected for the year ended December 31, 2013 was $190,415.
11. Income Taxes
The Company did not
record an income tax provision for 2013, 2012 and 2011, other than $800 for the minimum state tax provision. A reconciliation of
income taxes with the amounts computed at the statutory federal rate follows:
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
2011
|
|
Computed tax provision (benefit) at federal statutory rate (34%)
|
|
$
|
(1,993,000
|
)
|
|
$
|
(1,434,000
|
)
|
|
$
|
(1,175,000
|
)
|
State income taxes, net of federal benefit
|
|
|
(518,000
|
)
|
|
|
(373,000
|
)
|
|
|
(305,000
|
)
|
Permanent items
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
Valuation allowance
|
|
|
2,511,800
|
|
|
|
1,807,800
|
|
|
|
1,480,800
|
|
Income tax provision
|
|
$
|
800
|
|
|
$
|
800
|
|
|
$
|
800
|
|
The deferred tax assets
and deferred tax liabilities recorded on the balance sheet are as follows:
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Net operating loss carry forwards
|
|
|
18,400,000
|
|
|
|
15,900,000
|
|
Valuation allowance
|
|
|
(18,400,000
|
)
|
|
|
(15,900,000
|
)
|
Total deferred taxes net of valuation allowance
|
|
$
|
–
|
|
|
$
|
–
|
|
As of December 31,
2013, the Company had net operating losses available for carry forward for federal tax purposes of approximately $44 million expiring
beginning in 2019. These carry forward benefits may be subject to annual limitations due to the ownership change limitations imposed
by the Internal Revenue Code and similar state provisions. The annual limitation, if imposed, may result in the expiration of net
operating losses before utilization.
As of December 31,
2013, the Company recorded valuation allowance of $18,400,000 for its deferred tax assets the Company believes that such assets
did not meet the more likely than not criteria to be recoverable through projected future profitable operations in the foreseeable
future
Effective January 1,
2007, the Company adopted FASB guidance that addresses the determination of whether tax benefits claimed or expected to be claimed
on a tax return should be recorded in the financial statements. Under this guidance, the Company may recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from
such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement. The FASB also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting
in interim periods and requires increased disclosures. As of December 31, 2013, 2012 and 2011, the Company does not have a liability
for unrecognized tax benefits.
The Company files income
tax returns in the U.S. federal jurisdiction and the state of California. The Company is subject to U.S. federal or state income
tax examinations by tax authorities for years after 2009. During the periods open to examination, the Company has net operating
loss and tax credit carry forwards for U.S. federal and state tax purposes that have attributes from closed periods. Since these
net operating losses and tax credit carry forwards may be utilized in future periods, they remain subject to examination. The Company’s
policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of December 31, 2013, the Company
has no accrued interest or penalties related to uncertain tax positions. The Company believes that it has not taken any uncertain
tax positions that would impact its consolidated financial statements as of December 31, 2013, 2012 or 2011.
12. Settlement
with CEDE & Co.
In December 2013, the
Company’s Board unanimously approved the reinstatement of 3,047,403 shares of common stock of the Company. The circumstances
related to the reinstatement are as follows: 3,047,403 shares of common stock of the Company were held in street (nominee) name
by Cede & Co. of the Depository Trust Co. (the “Cede Shares”). The Cede Shares were ordered cancelled by a federal
district court relating to litigation initiated by the Securities and Exchange Commission against the Company and its former CEO,
Jeffrey Mueller in 2001. Either before or after the court’s order (the timing of which is unknown to the Company), the Cede
Shares, at that time held directly or indirectly by Mueller, were placed with Cede & Co. in nominee name. In furtherance of
the court’s order, the physical certificates relating to the Cede Shares should have been returned to the Company’s
transfer agent (NATCO) for cancellation. This did not occur. Rather, Cede & Co. retained the stock certificates representing
the Cede Shares and continued to treat the Cede Shares as outstanding and free trading shares of the Company.
Notwithstanding the
foregoing, NATCO, in furtherance of then Company counsel’s instructions, cancelled the Cede Shares on the Company’s
books and records in 2005, and, in furtherance thereof, reduced the Company’s outstanding shares of common stock by 3,047,403.
Cede & Co. has requested, in effect, that, inasmuch as the Cede Shares continue to be within its system, the Cede Shares be
reinstated on the Company’s books and records and that the outstanding shares of the Company be increased by 3,047,403. Although
the Company believes Cede & Co.’s request is misplaced, particularly since it appears that Cede & Co. had prior notice
of the court’s order cancelling the Cede Shares, the Company has elected to avoid litigation with Cede & Co. and instead
has elected to reinstate the Cede Shares. Accordingly, 3,047,403 shares of the Company’s common stock has been added back
to the Company’s outstanding share count.
As a result, the Company
recorded the fair value of the reinstated shares of $3,108,347 as part of Operating Expenses in 2013 in the accompanying consolidated
Statement of Operations. The fair value of the shares was determined based on the trading price of the Company’s shares on
December 16, 2013, the date of the Company’s Board of Directors approved such reinstatement.
13. Settlement
with Former Officer
On November 15, 2013,
Cecil Kyte voluntarily resigned as a Director, Chairman of the Board, a member of the Nominating and Corporate Governance Committee,
and CEO. Subject to terms of Mr. Kyte’s separation agreement, Kyte will receive severance pay equal to one-year’s salary
($350,000) paid in 24 equal installments ($14,853), subject to all applicable tax withholdings, beginning November 30, 2013 through
November 15, 2014. The Company recognized an expense of $350,000 for severance pay plus $14,315 in deferred payroll taxes. As of
December 31, 2013, the Company had paid $44,559 of the severance pay and $997 of deferred payroll taxes. The severance pay balance
of $305,441 and deferred payroll tax balance of $13,318 as of December 31, 2013 are reported liabilities in Company’s balance
sheet as Accrued Expense and Accounts Payable – Related Parties.
At the time of separation,
Mr. Kyte held unvested options which had been issued in January 2011 to purchase 10,560,000 shares of common stock at $0.25 per
share, of which 3,520,000 shares were due to vest in January 2014. The remaining 7,040,000 shares were due to fully vest by January
2016. Under terms of the separation agreement, the Company accelerated vesting as of the date of separation on the 3,520,000 shares
due to vest in January 2014. The remaining options to purchase 7,040,000 shares terminated as of separation. Under Financial Accounting
Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, employee stock options which are subject to accelerated
vesting at termination are treated as a Type III modification. As such, the Company recognized an expense related to the accelerated
vesting in the amount of $3,809,325 the fair value of which was determined using a Black-Scholes Option Pricing model with the
following: risk-free interest rate of 2.06%; dividend yield of 0%; volatility of 130%; and an expected life of 7 years. Previously
recorded compensation recorded in 2013 related to the original vesting schedule of the 3,520,000 options was reversed, and the
total of $3,809,325 is recorded in Operating Expenses in the accompanying consolidated Statement of Operations for 2013.
Mr. Kyte held additional
unvested options which had been issued as board compensation in September 2013 to purchase 21,009 shares of common stock at $1.19
per share. These options terminated as of the date of his separation.
14. Quarterly
Information (unaudited)
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
Year Ended December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Gross profit
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Net income (loss)
|
|
$
|
1,582,800
|
|
|
$
|
(1,920,950
|
)
|
|
$
|
(1,445,125
|
)
|
|
$
|
(8,873,734
|
)
|
Basic income per share (1)
|
|
$
|
0.01
|
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.07
|
)
|
Diluted income per share (1)
|
|
$
|
0.01
|
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.07
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
|
Second
|
|
|
|
Third
|
|
|
|
Fourth
|
|
|
|
|
Quarter
|
|
|
|
Quarter
|
|
|
|
Quarter
|
|
|
|
Quarter
|
|
Year Ended December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Gross profit
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Net loss
|
|
$
|
(5,470,350
|
)
|
|
$
|
(1,397,598
|
)
|
|
$
|
(4,670,704
|
)
|
|
$
|
(1,553,735
|
)
|
Basic income per share (1)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.06
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.10
|
)
|
Diluted income per share (1)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.06
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.10
|
)
|
(1) Per share data
was computed independently for each of the quarters presented. Therefore, the sum of the quarterly per share information may not
equal the annual income per share.
15. Contractual
Obligations
The Company has certain
contractual commitments for future periods, including office leases, minimum guaranteed compensation payments and other agreements
as described in the following table and associated footnotes:
|
|
|
|
|
Research and
|
|
|
|
|
|
|
|
Year ending
|
|
Office
|
|
|
License
|
|
|
Compensation
|
|
|
Total
|
|
December 31,
|
|
Lease (1)
|
|
|
Agreements (2)
|
|
|
Agreements (3)
|
|
|
Obligations
|
|
2014
|
|
$
|
69,960
|
|
|
$
|
316,796
|
|
|
$
|
656,250
|
|
|
$
|
1,043,006
|
|
2015
|
|
|
69,960
|
|
|
|
252,148
|
|
|
|
84,167
|
|
|
|
406,275
|
|
2016
|
|
|
69,960
|
|
|
|
187,500
|
|
|
|
60,000
|
|
|
|
317,460
|
|
2017
|
|
|
69,960
|
|
|
|
187,500
|
|
|
|
15,429
|
|
|
|
272,889
|
|
2018
|
|
|
40,810
|
|
|
|
187,500
|
|
|
|
–
|
|
|
|
228,310
|
|
Total
|
|
$
|
320,650
|
|
|
$
|
1,131,444
|
|
|
$
|
815,846
|
|
|
$
|
2,267,940
|
|
__________
(1)
|
Consists
of rent for the Company’s Santa Barbara Facility expiring on July 31, 2018. (For description of this property, see Part 1,
Item 2, “Properties”). Subsequent to the reporting period of this Form 10-K filing, effective as of February 1, 2014,
the Company amended this lease, reducing rents to $5,860 per month.
|
(2)
|
Consists of license maintenance fees to Temple University in the amount of $187,500 paid annually
through the life of the underlying patents or until otherwise terminated by either party, and research fees paid to Temple University
in the amount of $32,324 paid quarterly through June 1, 2015.
|
(3)
|
Consists of base salary and certain contractually-provided benefits, to an executive officer, pursuant
to an employment agreement that expires on January 30, 2015 in the amount of $314,167 and two severance agreements of former officers
in the amount of $501,679.
|
16. Subsequent
Events
Increase in Outstanding
Shares
From January 1, 2013
up to February 28, 2014, the Company issued an aggregate of 4,360,947 shares of its common stock upon exercise of warrants to purchase
4,340,947 shares of its common stock and 20,000 shares of its common stock upon exercise of options for aggregate proceeds of $1,308,284.
Leases
On February 1, 2014,
the Company amended its lease of office space in Santa Barbara, California, in order to reduce the leased area as well as the monthly
lease from $13,750 per month to $5,830 per month.
Board Compensation
Effective January 1,
2014, the Company’s Board of Directors adopted a resolution to suspend compensation to the Board of Directors under the Company’s
current compensation plan. The Board intends to adopt a new equity-based compensation plan in the future, specifically excluding
any direct grants of common stock.