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APNT > SEC Filings for APNT > Form 10-K on 1-Mar-2013All Recent SEC Filings

Show all filings for APPLIED NANOTECH HOLDINGS, INC

Form 10-K for APPLIED NANOTECH HOLDINGS, INC


1-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should assist in understanding our financial condition, liquidity, and capital resources as of December 31, 2012, and the results of operations for the years ended December 31, 2012, 2011 and 2010. The Notes to our Consolidated Financial Statements included later in this report contain detailed information that should also be read in conjunction with this discussion.

OVERVIEW

We are engaged in research, development, and the commercialization of products that we develop or improve using nanotechnology. We focus on four main areas - Nanosensors, nanomaterials, thermal management, and nanoelectronics. We also possess extensive intellectual property related to electron emission technology. Our technologies, as well as many of the potential applications, are still new and in the early stages of development. To date, our revenue has primarily consisted of development projects involving either the U.S. government or large multinational corporations. We have also received upfront payments related to royalty agreements. In 2011, we also begin receiving royalties from the first products commercialized using our technology, and began directly selling some of the products that we have developed.

OUTLOOK

We expect our total cash needs for 2013 to be approximately $5.3 million. We intend to fund those needs through revenue sources including sales, reimbursements for research, and license agreements. We anticipate increasing our revenue in 2013 over 2012 levels. We had approximately $330,000 of cash and cash equivalents on hand as of December 31, 2012. We have focused on cutting expenses and increasing revenue to achieve at least break even. We believe we will be able to cover our cash needs for 2013; however, we have very little cushion for any unexpected expenses, and we may have to raise debt or equity funds to cover any shortfalls.

We have a history of net operating losses, but in recent years we have been focusing on increasing our revenues and reaching profitability. We were profitable in 2010 based on a one-time event, a license agreement with Samsung that resulted in revenue of $2.5 million and an additional gain of approximately $1.0 million; however, we incurred losses in 2011 and 2012. We are targeting at least breakeven operations and positive cash flow for 2013. There can be no assurances that we will be profitable in 2013 or the future; however, we believe that based on our recent results, our revenue backlog, products expected to be introduced in 2013, and the status of discussions with potential additional revenue sources, that we will be able to at least reach breakeven in 2013. We expect to continue our concentrated research and development of our technology in 2013, although full commercial development of many of our technologies likely will require additional funds in the future.

Based on our plan, we believe that we can reach the point where we can sustain ourselves on our own revenue. Our plan is primarily dependent on raising funds through the licensing of our technology and through reimbursed research arrangements. Our current cash balances, when combined with expected revenues sources and other assets that can be converted to cash, are expected to be adequate to insure that we can maintain our operations at the present level. We believe that we have the ability to continue to secure short term funding, if it were needed, to enable us to continue operations until our plan can be completed if this plan takes longer than anticipated. Our auditors have included a going concern paragraph in their opinion on our financial statements, which could impact our ability to obtain financing, if needed. While we expect to operate achieve at least breakeven and generate positive cash flow from operations in 2013, we may need to raise additional debt or equity to maintain an operating cash cushion to cover temporary shortages.

Our plan is based on current development plans, current operating plans, the current regulatory environment, historical experience in the development of electronic products, and general economic conditions. Changes could occur which would cause certain assumptions on which this plan is based to be no longer valid. Our plan is primarily dependent upon increasing the level of revenues that we achieved in 2012. Although we do not expect funding our operations to be an insurmountable problem, if adequate funds are not available from operations, or additional sources of financing, we may have to eliminate, or reduce substantially, expenditures for research and development, testing of our products, or obtain funds through arrangements with other entities that may require us to relinquish rights to certain technologies or products. Such results could materially and adversely affect us.

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Critical Accounting Policies

Our significant accounting policies are summarized in the footnotes to our financial statements. Some of the most critical policies are also discussed below.

Stock based compensation - We routinely grant stock options to employees and others. We have granted options in the past and each year all employees have the opportunity to earn additional performance-based option awards. We account for these options using the fair value method of accounting.

Other -As a matter of policy, we review our major assets for impairment. Our major operating assets are accounts receivable, and property and equipment. We depreciate our property and equipment over their estimated useful lives. We did not identify any impaired items in 2010, 2011 or 2012. We have not experienced significant bad debt expense, and we do not believe that we need an allowance for doubtful accounts for any exposure to loss in our December 31, 2012 accounts receivable.

LIQUIDITY AND CAPITAL RESOURCES

Our cash balance decreased significantly during the year - from approximately $3.1 million at December 31, 2011 to approximately $330,000 at December 31, 2012. Our working capital also decreased significantly, primarily as a result of our decrease in cash. Our current liabilities remained relatively constant, but a decrease in the current portion of long-term debt was offset by significant increases in accounts payable and accrued expenses as a result of cash conservation programs and working capital management.

The principal source of our liquidity has historically been from funds received from exempt offerings of our common stock. We received $2.5 million and $200,000 in 2011 and 2010, respectively, from issuance of our stock in private placements. We also issued convertible notes payable with a face amount of $935,700 and $1,946,000 in 2012 and 2010, respectively. These notes are convertible into common stock, and $549,200 of these notes have been converted as of December 31, 2012. We expect the majority of the remaining notes to be converted into common stock in 2013 and 2014. We did receive proceeds of approximately $50,000, and $4,000 from the exercise of stock options by current and former employees in 2011 and 2010, respectively.

We believe that our current cash level, when combined with our backlog, expected revenue, and the expected refund of a deposit reflected in prepaid expenses, is sufficient for us to operate at least through the end of 2013; however, our cash on hand as of the date of this filing only allows us to operate through the end of March, 2013. We expect to at least breakeven in 2013, and if that occurs, we will generate positive cash flow from operations and have no need to raise funding solely to continue operations. We have cut costs significantly, and if revenue sources do not materialize as quickly as we expect, we intend to cut expenses further to a level to enable us to continue operations, and may have to seek debt or equity funding to fill any gap.

Since December 31, 2012, we have received approximately $200,000 in additional convertible debt, and in the event that we were to need additional funds in the future, beyond the amount that we have on hand and those that we expect to receive as revenues or from other sources, we may seek to sell additional debt or equity securities. While we expect to be able to obtain any funds needed for operations, there is no assurance that any financing alternatives can be arranged on commercially acceptable terms. We believe that our success in maintaining profitability will be dependent upon the viability of products using our technology and their acceptance in the marketplace.

The primary factor that drives our cash provided by, or used in, operations is net income or loss. We had net operating losses in both 2012 and 2011 and therefore had cash used in operations in both of those years. We had net income in 2010 and therefore had cash provided by operations in that year. Factors affecting net income or loss are discussed in the Results of Operations section below. In 2012, because of our reduced cash position, a substantial portion of the net loss was offset by management of working capital items, including reduction of accounts receivable, increase in accounts payable, and deferral of officer, employee, and board compensation resulting in an increase in accrued expenses. The cash used in operations in 2011 relative to the net loss in that period is a much more normal relationship between the net loss and cash used in operations. We plan to generate positive cash flow from operations again in 2013, based primarily on achieving at least break-even operations and continued working capital management.

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Cash used in investing activities was the result of the purchase of capital assets in all years. We would expect minimal cash to be used in investing activities in 2013. No material commitments exist as of December 31, 2012, for future purchases of capital assets.

Our contractual obligations as of December 31, 2012 consist of notes payable (including interest), operating leases, and capital leases. The notes payable are convertible into common stock at rates of $0.16 to $0.25 per share (including one in the amount of $110,000 convertible at a discount of 30% to market at the time of conversion) and many likely will be converted before their due dates in 2013 and 2014. A summary of our obligations at December 31, 2012 is as follows:

Total 2013 2014 2015 2016 2017 Capital leases $72,290 $61,632 $10,658 - - - Operating leases $369,115 $270,968 $64,619 $18,288 $15,240 - Convertible notes payable $2,925,880 $950,436 1,975,444 - - -

This table reflects the lease of our current facility through its expiration in February 2014. At that time, we may move to a less costly facility, or reduce our space at our present location. We would expect to sign a new lease prior to February 2014. We believe that we will have the cash available to meet our cash requirements for fiscal 2013, and we believe that many of the notes due in 2013 and 2014, including both principal and interest, will be converted to common stock rather than paid in cash.

RESULTS OF OPERATIONS

Business Segments.We operate with a single reportable business segment.

Revenues.Following is a summary of key revenue categories for the three years covered by this report.

                                           2012            2011            2010
       Government Revenues              $ 1,733,728     $ 2,956,717     $ 2,920,030
       Other Contract Research          $   309,274     $ 1,102,428     $ 1,137,370
       Upfront License Fees             $   750,000     $ 1,500,000     $ 1,250,000
       Product Royalties                $   433,453     $   499,638     $         -
       Product Sales                    $   228,200     $   186,267     $    83,979
       Other Revenues                   $   138,713     $   242,411     $   152,416
       Total Core Revenues              $ 3,593,368     $ 6,487,461     $ 5,543,795
       Noncore Revenues                 $         -     $         -     $ 2,500,000
       Total Revenues                   $ 3,593,368     $ 6,487,461     $ 8,043,795

       Revenue backlog at December 31   $ 2,929,000     $ 2,268,000     $ 3,361,000

Our total revenue decreased significantly from 2011 to 2012, after increasing from 2010 to 2011 in our core areas. The main reason for the increase from 2010 to 2011 was the product introduction by Yonex which generated approximately $500,000 of product royalties in 2011, as compared to no royalties in 2010, plus increased upfront royalties in 2011.

Our revenues decreased in 2012 as a result of several factors. In the government revenue area, we had an extraordinary $1.6 million contract that spanned 2010 and 2011, resulting in increased government revenues in those years. In addition, we focused on product sales in 2012. This focus diverted resources from government contracts and proposals for new contracts. We were unable to generate product sales as quickly as we expected and we lost research revenue as a result of this reallocation of resources. We have pulled back on our product sales effort and are moving more slowly in that area. We are now focusing our rebuilding our core, bread and butter, research efforts and expect government contract revenues to increase to approximately $2.6 million in 2013. This same product sale focus negatively impacted our private contract research. In addition, we had a couple of large contracts that were completed in early 2012 that were not replaced. As a result of our increased focus in this area, we expect our private contract research to exceed $2.0 million in 2013.

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Our royalty revenue - both upfront payments and product royalties decreased from 2011 to 2012, primarily as a result of our decreased focus on licensing. The upfront payments were all from YHCC in both 2011 and 2012, and the product royalties were all from Yonex in both years. We expect both of our upfront payments and product royalties to increase in 2013.

The revenue backlog as of December 31, 2012 results from several government programs and private contracts. The majority of these programs are currently in progress and generating revenue, with the remainder related to contracts awarded, but not yet started. The overwhelming majority of this backlog will be converted into revenue in 2013. The revenue backlog at December 31, 2010 was higher than normal for us because we had a Phase III commercialization project related to our solar inks in progress that started in late 2010. That project has been completed, and our backlog has returned to a more historically normal level. We also have some highly likely contracts that have not yet been finalized, and therefore, are not included in the backlog numbers as of December 31, 2012. In addition, Yonex has products in the market that are generating royalty revenue for us and will continue to do so in 2013, and we expect to sign additional licenses that will generate upfront payments, and possibly royalties, in 2013.

We expect revenue to be higher in 2013 than in 2012. We are targeting minimum revenues in 2013 of $7.0 million, an increase of approximately 100% over 2012. Of that, $2.9 million is already committed and in process, and we have specifically identified, and are working on, opportunities that would make up the majority of the remaining $4.1 million needed to achieve $7.0 million in revenue in 2013. There is no guarantee that these revenues will be obtained; however, we think this target is reasonable. Revenues could increase above these levels as a result of unanticipated royalty agreements or additional research revenues, but there is no assurance that this will occur, or that even the targeted minimum of $7.0 million in revenue will be achieved. We are currently pursuing opportunities in several areas that could result in additional revenue in 2013.

Cost of sales.Because we do not ship significant amounts of products or provide homogenous services, we do not incur costs of sales in the traditional sense. We do keep track of our costs on individual projects, but because there is a wide variation in cost percentages, presenting cost of sales information is not meaningful. Government sponsored research has nominal or no gross margins and is primarily just a reimbursement of costs. In some cases we charge nominal amounts for projects that have much higher costs because we are proving a concept that will be helpful to us in other areas, or are seeking a significantly larger follow up contract with the customer. In other instances we may perform research contracts that have significant positive margins because we are able to capitalize on work that we have done and knowledge that we have gained in the past. At the present stage of our development, it is more meaningful to look at total research and development costs in conjunction with revenues than to look at solely internally funded research projects and the cost of research associated with revenue producing contracts. We have, however, broken out some of our costs in the R&D discussion below.

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Research and development. Following is a summary of research and development expenditures for the past three years.

                                                2012            2011            2010
 Direct Materials - Funded Projects              405,014       1,016,803         580,854
 Direct Materials - Internal Projects            422,675         486,836         667,318
 Direct Subcontractors - Funded Projects         321,332         236,826         364,702
 Direct Subcontractors - Internal Projects             -          18,813           3,200
 Direct Labor  - Funded Projects                 734,263       1,030,037         675,659
 Direct Labor - Internal Projects                552,330         398,569         508,383
 Overhead Labor                                  296,450         339,343         294,439
 Benefits                                        634,037         768,727         700,962
 Facilities and supplies                         937,894       1,006,203         746,523
 Other Overhead                                  167,213         215,780         174,323
 Total Research and development              $ 4,471,208     $ 5,517,937     $ 4,716,363

Our research and development spending varies with revenue, as a significant portion of our spending is on funded programs. Our spending on internal projects in 2012 was largely in support of potential product sales - working with potential customers, tailoring our technology to products, and providing samples, as well as continued refinement of our licensed products, as opposed to new research. Subcontractors are usually involved in specific projects and the amount spent on subcontractors depends on the type of contracts that we have in process at any particular time.

Our labor and benefits in the research and development area also varies with the amount of revenue. Our labor devoted to internal projects in 2012 was, like material, largely in support of potential product sales and continued refinement of licensed technologies.

We expect to continue to incur substantial expenses in support of additional research and development activities related to the commercial development of our technologies. We expect to incur approximately 10% less research and development related expenditures in 2013 than those incurred in 2012, as we cut back on spending on internal projects and focus on funded projects. We may, however, incur more research and development expense in 2013 than presently expected. We are pursuing numerous opportunities for research contracts and depending upon the nature of the contracts signed, we may require more research materials than expected, or we may require additional personnel. If research revenue does not materialize as expected at the present time, we would likely reduce research expenditures accordingly.

Selling, general, and administrative. Following are some key components of selling, general, and administrative expense:

                                                 2012            2011            2010
 Labor and benefits                           $ 1,525,923     $ 1,162,202     $ 1,174,596
 Board of Director costs                      $   180,038     $   180,153     $    43,679
 Professional fees                            $   876,964     $   474,764     $   299,776
 Patent expense                               $   629,985     $   744,658     $   393,217
 Trade shows and conferences                  $    83,734     $   134,695     $   123,193
 Patent license commission                    $         -               -         460,938
 Other S, G, & A                              $   503,652     $   475,922     $   409,277
 Total selling, general, and administrative   $ 3,800,296     $ 3,172,394     $ 2,904,676

The most significant cost in selling, general and administrative expense is labor and benefits. After remaining relatively constant in 2010 and 2011, we experienced an increase in 2012. This increase was almost entirely related to new hires, and spending, in the sales and marketing area, as we focused on product sales. We would expect labor and benefits to decrease in 2013 from the 2012 level, as we have cut back on our sales and marketing efforts.

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Board of Director costs were similar in 2012 and 2011, but significantly higher than 2010, as a result of the new Board compensation package adopted at the end of 2010.

We also spend a significant amount on patents. Our patent expense decreased from approximately $745,000 in 2011 to approximately $630,000 in 2012 as we did an extensive review of our portfolio and discontinued maintenance payments on old patents that we considered to no longer have value to us. Our patent expense was lower than normal in 2010, when reached a favorable resolution on a fee dispute with our previous patent firm that resulted in us paying less than the amount previously billed. We expect patent expense to remain at similar levels in 2013 as it was in 2012, although we are continuing to review our patent portfolio and will eliminate or sell any patents we no longer consider useful to us as part of our core strategy.

In 2010, we retained a patent broker to represent us in auctioning a portion of our electron emission patent portfolio. This broker also represented us in the transaction with Samsung Electronics. The portion of the fee allocated to the license portion of the Samsung agreement was $460,938 and is included in selling general and administrative expense. No such fees were incurred in 2011 or 2012.

We expect total selling, general, and administrative expenses to be approximately $2.6 million in 2013, as we focus on keeping costs low to match our revenue levels. If revenues increase above anticipated levels, or other unanticipated transactions occur, our selling, general and administrative expenses could increase above expected levels.

Gain on sale of intellectual property and other assets.

In 2010, we had a gain related to the sale of intellectual property. We entered into a transaction with Samsung Electronics Co., Ltd whereby we sold 29 patents (11 U.S. and 18 foreign counterparts) and licensed approximately 150 additional patents in exchange for a one-time payment of $3.75 million. The proceeds of $3.75 million were allocated between the patents sold and the patents licensed. A total of $2.5 million was allocated to the license and recorded as license revenue. A total of $1.25 million was allocated to the patents sold. The gain of $1,019,531 represents the sale proceeds of $1.25 million reduced by a pro rata share of the expenses related to a patent broker associated with the transaction. The balance of the gain came from the sale of miscellaneous items.

Other income.Following is a summary of other income for the last three fiscal years.

                                             2012           2011           2010
       Interest expense associated with
       capital leases                     $  (11,025 )   $   (6,274 )   $   (5,764 )
       Interest expense associated with
       notes payable                      $ (187,797 )   $ (135,879 )   $ (144,953 )
       Interest expense associated
       notes payable discount             $ (253,779 )   $ (241,939 )   $ (270,987 )
       Interest income                    $    1,587     $   16,714     $    2,031
       Miscellaneous income               $        -     $        -     $    4,707

Our convertible notes bear interest at a rate of 8%. In addition, the value of the conversion feature was recorded as a discount at the time of issuance and is being amortized to expense over the life of the notes. We expect approximately $200,000 of interest expense on notes in 2013, as well as roughly $180,000 of additional discount amortization in 2013.

Our interest income is earned as a result of the investment of excess cash balances. Our interest income is negligible in all years, and we expect it to be negligible in 2013.

Provision for taxes.In 2010, we paid $618,750 of Korean taxes that were withheld related to the previously described transaction with Samsung. No such taxes were paid in 2011 or 2012. These Korean taxes are available to offset U.S. income taxes in the future. As a result of net operating loss carry forwards and credits available, we have no liability for U.S. income taxes in any year and expect no such liability in 2013, or the near future.

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Overview

The largest single component of cost that we incur is payroll related expense. Excluding the cost related to stock based compensation, we incurred payroll related expense of approximately $3.2 million in 2010, $3.3 million in 2011, and $3.6 million in 2012. The increase in 2012 was primarily related to increased spending in the sales and marketing area. We expect payroll related expense in 2013 to decrease to approximately $3.3 million, as a result of our cost reduction efforts. We expect our spending rate for 2013, excluding any revenue, to average approximately $575,000 per month. Based on this, we believe we can reach breakeven at a revenue level of $7.0 million, but there is no assurance that this will occur, or that we will achieve that level of revenue. We are, however, targeting minimum revenues of $7.0 million in 2013. The monthly spending rate of $575,000 includes approximately $100,000 per month of non-cash expenses, resulting in a cash spending rate, excluding any revenue of approximately $475,000 per month on average.

We expect expenditures will increase if additional revenue producing projects, beyond those expected, are obtained. This expenditure level is based on anticipated revenue levels. If these revenue levels are not attained, we will not incur many of these expenses, and our expense level will also be lower than anticipated.

SEASONALITY AND INFLATION

Applied Nanotech Holdings' business is not seasonal in nature. Management believes that Applied Nanotech Holdings' operations have not been affected by inflation.

ACCOUNTING PRONOUNCEMENTS

There are no recently issued accounting pronouncements which have not been implemented in our financial statements that would have a material impact on our financial statements.

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