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FLXT > SEC Filings for FLXT > Form 10-K/A on 19-Dec-2013All Recent SEC Filings

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Form 10-K/A for FLEXPOINT SENSOR SYSTEMS INC


19-Dec-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

EXECUTIVE OVERVIEW

Flexpoint Sensor Systems, Inc. is a development stage company engaged principally in improving its unique sensor technology, expanding its suite of products, developing new sensor applications, obtaining financing and seeking long-term sustainable manufacturing contracts. Our operations have not yet commenced to a commercially sustainable level and include designing, engineering, manufacturing and selling sensor technology and products featuring our Bend Sensor® technology and equipment.

We emerged from Chapter 11 bankruptcy on February 24, 2004 and since that time we have leased a manufacturing facility, purchased necessary equipment to establish a production line, negotiated contracts, manufactured and improved our patented Bend Sensor® technology devices, developed additional applications for the technology and conducted testing on those devices and applications. When volumes dictate our goal will be to qualify our production line and facility as an ISO/TS 16949 production line and facility as it is required for manufacturing automotive and related parts. Until such time as we have sufficient volumes we have entered into an agreement with the Weber Group assist in meeting these qualifications now. The Walker Component Group, is a well-established manufacturing company with expertise and certifications, including ISO 9001:2008, ROHS and REACH certifications that will dramatically enhance Flexpoint's assembly infrastructure and assist to market products such as those that have been developed with HTK Engineering and Intertek. With numerous Fortune 100 clients, the Walker Group will add considerable experience, prestige, and confidence to every project that it enters into with Flexpoint. This agreement will increase the marketability of our products to automotive Tier 1 and major parts suppliers.

Finalizing long-term, constant revenue generating production contracts with our existing and other customers remains our greatest challenge because our on-going business is dependent on the types of revenues and cash flows generated by such contracts. Cash flow and cash requirement risks are closely tied to and are dependent upon our ability to attract significant long-term production contracts. We must continue to obtain funding to operate and expand our operations so that we can deliver our unique Bend Sensor® and Bend Sensor® related technologies and products to the market. Management believes that even though we are making positive strides forward with our business plan we will need to raise additional operating capital. Over the last year we have made significant progress within the automotive and other industry and based upon that progress we believe that over the next twelve months we will have signed various long-term contracts that should produce sufficient volumes to provide ongoing revenues streams to support our operations. In anticipation of manufacturing products for the automotive industry we have entered into a manufacturing agreement with the Weber Group which is already TS16949 certified manufacturer and will provided the needed certifications need for such contracts. As it becomes economically feasible we will begin the process to have our manufacturing facility certified as a TS 16949 manufacturer. However with the agreement with the Walker Group we do not anticipate the need for such certification in the near future.

As the world's economy is still unstable after the global meltdown in the financial industry most economies have seen some slow but steady growth. While all sectors of the economy have experienced difficult times, many including the automotive industry have seen some turn around in overall sales. Worldwide automakers are now faced with the challenge of providing a safer, more energy efficient, longer lasting product that consumers' can afford. This has required automakers to search new and innovative ways to lower the overall weight of the vehicle and to improve its fuel efficiencies, while lowering the cost. We continue to experience an increased interest regarding automotive and other potential applications for our sensor technology


because we meet this criteria. With its versatility, light weight single layer construction and the fact that it is currently being used in various safety devices the Bend Sensor® is positioned well to meet the challenges that the automobile industry is facing.

LIQUIDITY AND CAPITAL RESOURCES

Currently our revenue is primarily from design contract, testing and limited production services for prototypes and samples, and is not to a level to support our operations. However we believe based upon current orders and projected orders over the next twelve months that we could be producing sensors under long-term contracts that will help support our existing operations and potential future grow. However management recognizes such contracts usually go through a long negotiation process and there can be no guarantee that we will be successful in our negotiations or that such contracts will be sufficient to support our current operations in the near future.

Since emerging from bankruptcy and for the past twelve months we have relied on the proceeds of convertible loans from existing shareholder and private placements. In November 2008 we secured $300,000 of short-term financing from related parties. The notes were originally due on May 31, 2009 with an annual interest rate of 10% and secured by the Company's business assets, they also carried a conversion option for restricted common shares at $.25 per share. In May 2009 these notes were extended to May 31, 2010. During 2009 and through 2010 the same related parties have provided additional funding of $1,446,399 including accrued interest, under similar terms. In 2010 the Company also issued 7,590,663 in restricted common shares of stock to retire the $1,746,399 of outstanding convertible notes and associated accrued interest incurred over the past two years to fund operations.

During 2010 the Company issued 1,557,500 in restricted common shares of stock in lieu of cash and cancelled $347,731 in Company debt. The shares were issued to satisfy the Company's obligations for investor relations, legal fees, sales and marketing expense, and insurance expense associated with directors and officers insurance as well as its annual causality and liability insurance policies. The Company also issued 7,590,663 in restricted common shares of stock to retire the $1,746,399 of outstanding convertible notes and associated accrued interest incurred over the past two years used to fund operations.

In November 2010 we entered into an agreement with Maestro Investment LLC for a $500,000 line of credit secured by 1,666,667 of our restricted stock. The line of credit has a 10% interest rate and is due and payable no later than December 31, 2012. Maestro has the option to convert any outstanding amounts for the stock issued as collateral. During 2011 the Company used the line of credit to fund our operations. Due to the decline in the trading value of our stock, we agreed to issue an additional 833,333 in stock as additional collateral for the line of credit that is also held in escrow.

During 2011 the Company issued 431,750 in restricted common shares of stock in lieu of cash and cancelled $165,000 in Company debt. The shares were issued to satisfy the Company's obligations for investor relations and sales and marketing expenses.

During 2012 the Company issued 4,045,700 in restricted common shares of stock in lieu of cash and cancelled $501,622 in Company debt. The shares were issued to satisfy the Company's obligations for investor relations, sales and marketing expense and insurance expense associated with directors and officers insurance. The Company also issued 5,500,000 in restricted common shares of stock to retire $848,249 of the outstanding convertible notes and accrued interest, including the Maestro line of credit entered into in November 2010. Due to the difference between the market value of the shares issued and the stated conversion rate of the notes on the date of conversion the Company recognized a net gain on debt conversion of $371,021

Management believes that our current cash burn rate is approximately $50,000 per month and that proceeds from additional convertible notes and estimated revenues for engineering design and prototype products will be sufficient to fund the next twelve months of operations. Our auditors have expressed doubt about our ability to continue as a going concern and that we may not realize significant revenue or become profitable within the next twelve months. We will require additional financing to fund our short-term cash needs. We will have to rely on additional debt financing, loans from existing shareholders and private placements of common stock for additional funding. Based upon our current purchase orders and anticipated purchase orders over the next twelve months our projected revenues by the end of 2013 should be sufficient to cover our projected operations based on our current burn rate. However, we cannot assure you that we will be able to obtain short-term financing, or that sources of financing, if any, will continue to be available, and if available, that they will be on terms favorable to us. Nor is there any guarantee that the projected volume of purchase orders will meet the volumes that we anticipate.

We also expect that in the short term we may have to continue to issue common stock to pay for services and agreements rather than use our limited cash resources. Any issuance of common stock will likely be pursuant to exemptions provided by federal and state securities laws. The purchasers and manner of issuance will be determined according to our financial needs and the


available exemptions. We also note that if we issue more shares of our common stock our shareholders may experience dilution in the value per share of their common stock.

As we enter into new agreements, we must ensure that those agreements provide adequate funding for any pre-production research and development and manufacturing costs. If we are successful in establishing agreements with adequate initial funding, management believes that our operations for the long term will be funded by revenues, licensing fees and/or royalties related to these agreements. However, we have formalized only a few agreements during the past two years and there can be no assurance that the agreements will generate sufficient revenues or be profitable in the future or that a desired technological application will be successful enough to produce the volumes and profits necessary to fund our operations.

COMMITMENTS AND CONTINGENCIES

Our principal commitments at December 31, 2012 consist of our monthly lease and total current liabilities of $790,929, which includes $327,525 in convertible notes from existing shareholders and lines of credit. Our long term lease of our manufacturing facility expired as of December 31, 2011, and was later extended for three years. We are currently in our second year of the extended lease and are paying $7,950 per month. This amount will increase by $500 per month each year on the anniversary of the lease.

Our total current liabilities include accounts payable of $279,706 related to normal operating expenses, including health insurance, utilities, production supplies, legal expenses and travel expense. Accrued liabilities at December 31, 2012, were $183,698 and were related to payroll tax liabilities, tax expenses, investor relations consulting, and accrued Paid Time Off, a combination vacation-sick leave policy.

OFF-BALANCE SHEET ARRANGEMENTS

None.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates of particular significance in our financial statements include goodwill and the annual tests for impairment of goodwill and valuing stock option compensation.

Long-lived Assets: We annually test long-lived assets for impairment or when a triggering event occurs. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The analysis compared the present value of projected net cash flows for the remaining current year and next two years against the carrying value of the long-lived assets. Under similar analysis no impairment charge was taken during the twelve months ended December 31, 2012 and 2011 respectively. Impairment tests will be conducted on a regular basis and, should they indicate a carrying value in excess of fair value, additional charges may be required.

Goodwill: Because goodwill is not amortized, it is tested for impairment annually, or when a triggering event occurs. As described in ASU 2010-28 and ASU 2011-08, the Company has adopted the two step goodwill impairment analysis that includes quantitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as basis for determining whether it is necessary to perform the two-step goodwill impairment test. A fair-value-based test is applied at the overall Company level. The test compares the estimated fair value of the Company at the date of the analysis to the carrying value of its net assets. This test requires various judgments and estimates. The fair value of the Company is allocated to the Company's assets and liabilities based upon their fair values with the excess fair value allocated to goodwill. An impairment of goodwill is measured as the excess of the carrying amount of goodwill over the determined fair value.

The Company recorded goodwill of $5,356,414 upon emergence from bankruptcy in 2004. The valuation of goodwill was based upon an independent appraisal of the Company's intellectual properties and their unique properties with estimated applications in diverse multiple industries, including automotive, medical and industrial controls.

For the year ended December 31, 2011 the impairment test conducted in accordance with FASB ASC 350-20 resulted in an impairment of goodwill of $250,758. The analysis compared the carrying value of the Company's net assets to the estimated fair market value of the Company based upon the market value of the stock and the number of shares issued and outstanding,


including those held in escrow, at the close of the market on the valuation date. When considering the fair value of the Company the Company's carrying value of all its assets and liabilities are evaluated to determine their fair value. In this evaluation it was determined that the Company would recognize an impairment to goodwill.

For the year ended December 31, 2012, the Company valued our customer list valuation based upon the customer's estimated volume of sales over the next three to five years. In addition, the Company estimated the net present value of the projected cash flows of three automotive products from automotive companies over a five year period using a discount rate of 10%. However, the fair value of the Company's share price has continued to decline and many of the expected contracts have been delayed; therefore, under similar evaluation the Company recognized $208,747 in goodwill impairment as of December 31, 2012.

Stock options: We account for stock options under Statement of Financial Accounting Standards, Accounting Standards Codification Topic 718, Stock Compensation (formerly FASB Statement No. 123(R)), the pronouncement requires that recognition of the cost of employee services received in exchange for stock options and awards of equity instruments be based on the grant-date fair value of such options and awards and is recognized as an expense in operations over the period they vest. The fair value of the options we have granted is estimated at the date of grant using the Black-Scholes American option-pricing model.
Option pricing models require the input of highly sensitive assumptions, including expected stock volatility. Also, our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. Management believes the best input assumptions available were used to value the options and that the resulting option values are reasonable. For the years ended December 31, 2012 and 2011 we recognized $0 and $43,408, respectively, of stock-based compensation expense for our stock options and there is no additional unrecognized compensation cost related to employee stock options that will be recognized based upon the current grants issued.

RESULTS OF OPERATIONS

The following discussions are based on the consolidated operations of Flexpoint Sensor Systems, Inc. and its subsidiaries, Sensitron, and Flexpoint International, LLC and should be read in conjunction with our audited financial statements for the years ended December 31, 2012 and 2011. These financial statements are included in this report at Part II, Item 8, below.

                           SUMMARY OF OPERATING RESULTS

                                           For the year ended   For the year ended
                                           December 31, 2012    December 31, 2011
 Engineering, contract and testing revenue  $         47,546     $          72,378
 Total operating costs and expenses               (1,421,028)          (1,655,371)
 Net other income (expense)                           323,082             (33,564)
 Net loss                                         (1,050,400)          (1,616,557)
 Basic and diluted loss per common share               (0.03)               (0.04)

Our revenue for the 2012 and 2011 years was primarily from design and development engineering, prototype products and sample products. Revenue from research and development engineering and prototype product contracts is recognized as the services are provided and accepted by the customer. Revenue from contracts to license technology to others is deferred until all conditions under the contract are met and then the sale is recognized as licensing royalty revenue over the remaining term of the contract. Revenue from the sale of a product is recorded at the time of shipment to the customer. Management anticipates that revenue will increase as we continue to provide engineering services and our customers continue to order more frequently and in larger quantities.

Total operating costs and expenses decreased in 2012 when compared to 2011 by $234,343. The decrease is primarily due to lower administrative and marketing expense and lower recognition of goodwill impairment during the year. Net loss decreased by $576,227 due to the recognition of a gain on the conversion of notes payable. The gain on the note conversion is due to the difference between the contractual conversion rate and the fair value of the stock issued at the date of conversion. Administrative and marketing expenses decreased to $845,843 for 2012 compared to $1,017,156 in 2011, the decrease is primarily due to decrease in legal fees related to the litigation with R&D Company. The cost of revenue and amortization of patents and proprietary technology expense remained relatively the same.


Total other income (expense) for the year ending December 31, 2012 was income of $323,082 compared to an expense of $33,564 in 2011. The difference is due the recognition of a $371,021 gain on the conversation of the full Maestro $500,000 line of credit including the accrued interest and partial conversions of other lines of credit for, for 5,500,000 of restricted shares of stock. The gain represents the difference between the conversion rate per share stated on the lines of credit and the fair market values of the shares at the dates of conversion.

As we continued to mature as a manufacturing company our engineering design and production revenues increased as a percent of our total revenue during 2012. As we expand and sell our existing suite of products and as we grow the relationship with our customers we expect this trend to continue in the future. We are not able to guarantee that our operating losses will be reduced in the short term.

The chart below presents a summary of our consolidated balance sheets at December 31, 2012 and 2011.

                       SUMMARY OF BALANCE SHEET INFORMATION
                                            Year ended            Year ended
                                         December 31, 2012     December 31, 2011
  Cash and cash equivalents              $         42,024      $           7,294
  Total current assets                             76,020                48,904
  Total assets                                  5,598,750             5,967,705

  Total liabilities                               790,929             1,088,334
  Deficit accumulated during the              (19,447,820)          (18,397,420)
  development stage
  Total stockholders' equity             $      4,807,821     $       5,967,705

Cash and cash equivalents increased in 2012 compared to 2011 by $34,730. The increase is the result of additional funding from convertible notes to fund operations and cost cutting measures during 2012. Until our revenue increases, our cash and assets will decrease as we fund our operations. As we expand our customer base and product offerings we will need to raise additional operating capital during the first three quarters 2013. It is expected that this will be accomplished by issuing stock, securing additional loans from related parties and existing shareholders, or through the licensing of our technology. We anticipate needing to raise approximately $750,000 in funding to support our existing operations and our anticipated growth during the last half of 2013.

Our non-current assets decreased by $389,234 at December 31, 2012 compared to 2011 due to the depreciation, amortization and impairment associated with our long-lived assets. These assets include, after adjustments, property and equipment valued at $135,639, patents and proprietary technology of $480,511, goodwill of $4,896,917, and deposits of $16,500 for the leased facility and patents.

Accrued liabilities decreased at December 31, 2012 by $93,158 when compared to December 31, 2011. The decrease is primarily due to the issuance of restricted stock to pay for services related to legal, insurance and investor relations expenses in 2012 that was not done in 2011. Total liabilities decreased by $297,405 at December 31, 2012, as a result of decrease in accrued liabilities and the issuance of stock to retire the convertible notes to Maestro and others during 2012

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