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ZERO > SEC Filings for ZERO > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for SAVE THE WORLD AIR INC

Form 10-K for SAVE THE WORLD AIR INC


17-Mar-2014

Annual Report


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.

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