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APNT > SEC Filings for APNT > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for APPLIED NANOTECH HOLDINGS, INC

Form 10-Q for APPLIED NANOTECH HOLDINGS, INC


8-May-2014

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management's discussion and analysis of certain significant factors that have affected the Company's financial position and operating results during the periods included in the accompanying consolidated financial statements.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements that we believe are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding our strategy, future operations, future expectations or future estimates, financial position and objectives of management. Those statements in this Form 10-Q containing the words "believes," "anticipates," "plans," "expects" and similar expressions constitute forward-looking statements, although not all forward-looking statements contain such identifying words. These forward-looking statements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating to our operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties.

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate and actual results may differ from those indicated by the forward-looking statements included in this Form 10-Q. In light of the significant uncertainties inherent in the forward-looking statements included in this Form 10-Q, you should not consider the inclusion of such information as a representation by us or anyone else that we will achieve such results. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

Three months ended March 31, 2014 and 2013

OVERVIEW

We are a nanotechnology company, primarily engaged in the development of technologies, based principally on our intellectual property. Historically, we have generated revenues by performing research services, licensing our technology, and selling products based on our technology. During all periods presented, substantially all of our revenues were earned as a result of reimbursed research expenditures. As more fully discussed in our Annual Report on Form 10-K for the year ended December 31, 2013, we expect to incur additional research and development expenses in 2014 to continue development of our technology. We are currently focused on obtaining sufficient revenue to cover our ongoing expenditures and achieving positive cash flow from operations. We are focused almost exclusively on our research contracts and have temporarily abandoned all commercialization efforts related to our technology. As such, there will be no significant product sales in the foreseeable future.

RECENT DEVELOPMENTS

On March 10, 2014, we entered into an agreement for a proposed business combination between the Company and NanoHolding, Inc., a privately held company with a leading market position for specialty optical coatings, cleaners, and nano-composite products. The specific mechanics of the proposed transaction are included in a current report on Form 8-K dated as of March 10, 2014 and the merger transaction is described in greater detail below, but the business combination, if approved by stockholders, will result in a combined entity with the Company and NanoHolding, Inc., operating under the name PEN, Inc.

The transaction is subject, among other things, to approval by the Company's stockholders, reaching agreement with the Company's convertible debt holders to convert their debt into equity in the combined entity or pay the debt, and raising bridge financing in the amount of up to $1.5 million to enable the Company to pay transaction expenses, retire debt, and operate until the business combination can be completed, if approved by stockholders.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

Merger Agreement

On March 10, 2014, the Company, together with its wholly owned direct subsidiaries PEN INC, a Delaware corporation ("PEN") and NanoMerger Sub Inc., ("Merger Sub") entered into an Agreement and Plan of Merger and Exchange (the "Merger Agreement") with NanoHolding Inc. ("Nano") and Carl Zeiss, Inc. ("Zeiss"), pursuant to which, subject to the terms and conditions of the Merger Agreement, the Company will merge with and into PEN and Nano will merge with and into Merger Sub and become a wholly-owned subsidiary of PEN (the "Merger"), immediately thereafter Zeiss will exchange its interest in Nano's subsidiary for stock in PEN. Nano's subsidiary Nanofilm Ltd. ("Nanofilm") is a private company with a leading market position for specialty optical coatings, cleaners and nano-composite products. Upon completion of the Merger, current stockholders of the Company. holders of certain debt convertible into the Company's common stock, and others with rights to acquire stock are expected to receive approximately 38% of PEN's outstanding common stock and stockholders of Nano and Zeiss are expected to receive approximately 62% of PEN's outstanding common stock as discussed below.

At the effective time of the Merger, each share of the Company's common stock issued and outstanding immediately prior to such time (other than shares owned by shareholders who have properly exercised and perfected their rights of dissent and appraisal under Texas law) will be automatically converted into the right to receive one share of PEN's Class A common stock. This conversion ratio is fixed and will not be adjusted for changes in the market value of Company common stock or Nano.

At the effective time of the Merger, each share of Nano stock issued and outstanding immediately prior to the effective time of the Merger (other than stock of holders who have properly exercised and perfected their rights of dissent and appraisal under Delaware law) will be converted into the right to receive PEN common stock. Zeiss will exchange its ownership in Nanofilm for PEN stock. Together the stockholders of Nano (other than dissenting holders) and Zeiss will own approximately 62% of PEN common stock. The exchange ratio depends on, among other things, the number of Company shares outstanding at the time of the Merger and exchange, but it will not be adjusted for changes in the market value of Company common stock, Nano common stock or the Zeiss interest in Nanofilm.

Under the Merger Agreement, shares of Nano's Class A common stock will be exchanged for shares of PEN's Class A common stock that entitle the holder to one vote per share. Shares of Nano's Class B common stock will be exchanged for shares of PEN's Class B common stock that entitle the holder to 100 votes per share. Scott Rickert, Ph.D. who will become the chief executive officer of PEN upon completion of the Merger, will own or control all of the shares of the Class B common stock. If Class B common stock is no longer controlled by the Rickert family, it automatically converts to Class A common stock. Each share of Class B common stock is also convertible into one share of Class A common stock at any time at the option of the holder. The Zeiss Class Z membership interest in Nanofilm will be exchanged for shares of PEN's Class Z common stock. The Class Z common stock holders will have no voting rights, but Zeiss, as the holder of the Class Z common stock will be entitled to nominate one person to the PEN board of directors. Class Z common stock has antidilutive rights that permit its holders to maintain their economic ownership percentage. If Class Z common stock is transferred out of the Zeiss control group, it automatically converts into Class A common stock and, if Zeiss sells more than half of the stock it acquires in the exchange, all the Class Z common stock converts into Class A common stock. In addition, each share of Class Z common stock is convertible into one share of Class A common stock at any time at the option of the holder.

Fully diluted Company common stock will be calculated immediately before the effective time of the merger of Nano with MergerSub and will include the sum of:
the number of the Company's shares outstanding, plus the total number of Company's shares reserved for issuance upon the exercise of any convertible instrument or right to receive the Company's common stock other than the options to purchase 5,908,000 shares which shall be excluded, but including any potential warrant exercise, plus the number of shares required for conversion of the Company's debt pursuant to the Convertible Debt Agreement Amendments described below, plus the number of the Company's shares of common stock issued or reserved pursuant to amended compensation agreements with its President and Chief Financial Officer, plus the number of shares of the Company's common stock issued or reserved for issuance pursuant to the Voting and Conversion Agreement described in the next paragraph and for the "merger fee" payable to the Special Committee of the Company's board of directors, and payment of accrued board fees for the Company's present and former directors.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

To induce Nano to enter into the Merger Agreement the Company has also entered into a Voting and Conversion Agreement with each of the Directors of the Company and Sichuan Anxian Yinhee Chemical and Construction Company. This agreement requires each of the parties to vote in favor of the approval of the Merger Agreement and conversion of accrued director's fees owed to the non-employee Directors of the Company into shares of PEN Class A common stock at the time of the Merger.

Subsequent to March 31, 2014, the Company has entered into Convertible Debt Agreement Amendments with all holders of the Company's convertible debt that was outstanding at February 28, 2014 and convertible at a fixed conversion price. The amendments extend the due date to August 15, 2014, and require these debt holders to convert the Company debt they hold at the time of the Merger into shares of PEN's Class A Common Stock at rates ranging from $0.05 to $0.10 per share. The shares issued upon conversion of this debt will count in the Fully Diluted shares of PEN common stock in calculating the shares to be received by stockholders of Nano and by Zeiss.

The boards of directors of the Company, PEN, MergerSub, and Nano have approved the Merger Agreement, and each board of directors has voted to recommend that stockholders adopt the Merger Agreement. Zeiss has also approved the Merger Agreement.

Consummation of the Merger is subject to certain conditions, including
(i) approval by the holders of at least a majority of the Company's common stock, (ii) payment or conversion of all Company debt that is convertible into its equity securities (exclusive of the any securities issued as part of Bridge Financing), and (iii) the absence of any law restraining, enjoining or prohibiting the Merger. Moreover, each party's obligation to consummate the Merger and the exchange is subject to certain other conditions including (a) the accuracy of the other parties' representations and warranties (subject to customary materiality qualifiers) and (b) the other parties' material compliance with its covenants and agreements contained in the Merger Agreement. The Merger Agreement also contains certain termination rights for both the Company and Nano, including if the Merger is not completed on or before July 31, 2014.

The foregoing summary of the Merger Agreement is not a complete description of all of the parties' rights and obligations under the Merger Agreement and is qualified in its entirety by reference to the Merger Agreement, a copy of which is filed as Exhibit 2.1 to the Current Report on Form 8-K dated as of March 10, 2014.

OUTLOOK

We expect our present cash balances, when combined with known and expected revenue sources, as well as funds currently being raised, and the proposed business combination discussed in the "Recent Developments" section above, to enable us to operate through the end of 2014. However, our cash on hand is only adequate to allow us to operate through the end of May 2014.We expect to raise additional funds through convertible notes during this time period which will extend that period further. If the proposed business combination is not approved by stockholders, or is not completed for some other reason, we will need financing to pay accrued liabilities, including transaction expenses. Our ability to raise capital will also be dependent, in part, on whether shareholders approve an increase in the authorized number of shares to permit us to raise equity, or convertible debt financing. We will be unable to meet our obligations to our debt holders, and we will be required to reach agreement with our existing convertible debt holders to further extend their notes, to convert those notes to equity, or raise additional funding to pay the notes in order to continue operations.

We have a plan to achieve positive cash flow from operations for 2014, prior to interest expense and expenses related to the business combination. Our plan anticipated a significant loss for the first quarter of 2014 and it anticipates a loss for the full year. A critical component of our plan is to maintain our research revenue at its current level, or above, and this will require the receipt of additional contracts. If we do not receive the expected revenue sources as quickly as anticipated by the plan, we likely will be required to cut expenses further, and to raise additional funding. Longer term, if the business combination does not occur, we will need financing to continue as a going concern. If we are unable to raise additional funding on commercially acceptable terms, we may be forced to drastically curtail activities or obtain funding on terms that are more unfavorable for the Company.

At the present time, there can be no assurance that we will achieve our plan for positive cash flow from operations in 2014, prior to interest expense and transaction costs, or that expected revenue sources will all occur as planned. The financing costs, including the beneficial conversion feature associated with the current round of convertible notes, and the costs related to the proposed business combination, preclude us from reaching profitability in 2014, unless a significant one-time event, such as an asset sale, were to occur.

It is not possible for us to achieve more than nominal profitability on an ongoing basis based solely on research revenues and our research activities are not capable of generating sufficient cash flow to enable us to commercialize our technology and sell products on a broad scale. Commercialization of our technology resulting in more than nominal product sales will require access to capital that is not currently available to us. We believe our proposed business combination will give us access to both the financial and human capital required to commercialize portions of our technology and increase revenues. We believe that we have the ability to continue to obtain funding, if necessary, to enable us to continue operations until we can consistently sustain ourselves on our own revenue.

Our plan is based on current development plans, current operating plans, the current regulatory environment, historical experience in the development of products and general economic conditions. Changes could occur which would cause certain assumptions on which this plan is based to be no longer valid. If adequate funds are not available from operations, or other sources of financing, we may have to further reduce research and development expenditures, or obtain funds through arrangements with other entities that may require us to relinquish rights to certain of our technologies or products. Such results could materially and adversely affect us.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

RECENT ACCOUNTING PRONOUNCEMENTS

There are no recent accounting pronouncements that we have not implemented that are expected to have a material impact on our financial statements.

FINANCIAL CONDITION AND LIQUIDITY

The Company has a history of net losses and negative cash flow from operations. We have had losses in each of the last three years, but we have a plan to achieve positive cashflow from operations for 2014, prior to interest expense and expenses associated with the business combination discussed in Note 6. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern, and do not included any adjustments that may be required if it were unable to continue as a going concern. Management and the Board believe that the actions taken to date in 2014 and currently being taken will allow the Company to achieve positive cashflow from operations for 2014, prior to interest expense and expenses associated with the business combination discussed in Note 6, and to achieve profitability in future years. These actions include both significant expense cuts and the business combination with NanoHolding as discussed above

Our cash position increased during the period from approximately $120,000 at December 31, 2013 to approximately $160,000 at March 31, 2014. This increase in cash is primarily the result of cash provided by financing activities raised through the issuance of convertible notes.

Our operating activities used approximately $10,000 of cash in the quarter ended March 31, 2014 (the "2014 Period"), as opposed to approximately $85,000 of cash provided by operating activities in the quarter ended March 31, 2013 (the "2013 Period"). The cash used in operating activities in the 2014 Period was the result of the net loss, offset by noncash expenses and working capital management. Working capital management included a focus on collecting and reducing accounts receivable, deferral or delay in payment of accounts payable, and receipt of customer payments in advance of work performed. The cash provided by operations in the 2013 Period was primarily the result of the net loss during the period, offset by non-cash expenditures and working capital management. In the 2013 Period, a $600,000 deposit related to a potential acquisition from 2012 was returned to us and was a significant source of working capital for us.

We would expect our cash used in, or provided by, operating activities to fluctuate in future quarters in 2014, depending on the timing of receipt of various items. The proceeds from current fundraising round of convertible notes discussed below are earmarked to increase working capital on our balance sheet by allowing for a reduction of accounts payable and accrued expenses, as well as to pay transaction expenses related to the proposed business combination. Each of these items will have a negative effect on cash flow from operations. We expect positive cash flow from operations in future quarters in 2014, but not in all quarters, depending on the timing of the receipt of funds from the convertible notes and timing of payment of expenses.

Our cash provided by financing activities was approximately$45,000 and $230,000 in the 2014 and 2013 Periods, respectively. In both periods, this was the result of issuing convertible notes payable to supplement our cash balance, partially offset by payments on capital leases and notes payable. We are currently in the process of raising up to $250,000 in additional convertible notes, and as a result cash provided by financing activities may increase in the second quarter.

We had no capital expenditures in either period, and we expect cash used in or provided by investing activities to remain at relatively insignificant levels for the balance of 2014.

Historically, the principal source of our liquidity has been funds received from exempt offerings of common stock and debt. While we expect to be able to obtain any funds needed for operations, we do not have the funds to meet the obligations to our debt holders and we will be required to reach agreement with our existing convertible debt holders to extend their notes, to convert those notes to equity, or raise additional funding to pay the notes in order to continue operations. We currently do not have the authorized shares available to either convert the notes currently outstanding, or to issue new equity. We intend to seek an increase in authorized shares at our next shareholder meeting, however if this is not approved, our financing alternatives will be limited. There can be no assurance that any financing alternatives can be arranged on commercially acceptable terms or that we will be successful in obtaining financing. If we are unable to achieve sufficient revenues to support our operations, we may be required to obtain funding on terms that are unfavorable to the Company. We believe that our success in reaching sustainable profitability will be dependent on our patent portfolio and upon the viability of products using our technology and their acceptance in the marketplace, as well as our ability to obtain additional debt or equity financings in the future, if needed.

We expect to continue to incur substantial expenses for research and development activities. Further, we believe that certain products that may be developed by us, or licensees of our technology, will not be available for commercial sale for a period of one to two years. Therefore, it is likely that the commercialization of our existing and proposed products will require additional capital in excess of our ability to raise funds. In addition, commercialization of our technology would require us to hire new executives with the skills and experience to develop and take products to market. Achievement of at least cash flow break-even would enable us to continue our research without seeking additional financing in the future.

There may be substantial fluctuations in our results of operations. We currently are focused almost solely on research activities and are unable to undertake any commercialization activities without raising additional capital and hiring additional staff and executive talent. Given the extensive costs associated with product commercialization, it is unlikely that we can commercialize our technology without a substantial capital raise, or achieve sustained profitability for an extended period of time.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

RESULTS OF OPERATIONS

Our net loss for the 2014 Period was approximately $450,000, substantially down from the net loss of approximately $1.375 million for the 2013 Period. Our loss from operations also decreased by approximately 50% from the 2013 Period to the 2014 Period - from approximately $665,000 to approximately $345,000. The reasons for the decreased loss are discussed in more detail below.

Our revenues for the quarter ended March 31, 2014, totaled approximately $880,000, compared to approximately $950,000 for the same quarter in 2013. The revenues in both periods were substantially all the result of reimbursed research expenditures. The majority of the revenues in both periods came from government sources, which is included in government contract revenue in the statement of operations. The decrease related to reductions in royalties and product sales, while total research revenues remained relatively consistent from period to period. The royalties decreased because the royalties in the 2013 Period were from Yonex, and Yonex made a one-time lump sum payment later in 2013 to buy out the remainder of their license. As such there will be no more royalties from Yonex. Product sales decreased because we eliminated our sales force later in 2013 and are no longer focusing on product sales. Product sales will remain at negligible levels for the balance of 2014.

At the present stage of our development, significant conclusions cannot be drawn by comparing revenues from period to period; however, we would expect the quarterly revenue for the balance of 2014 to increase slightly above the first quarter level in the majority of quarters. Our plan calls for targeted revenues of $4.2 million for 2014. Our current business strategy is built on generating revenue through research contracts and keeping costs down to a level to attain positive cash flow from operations. Our revenues will not increase significantly without commercialization of our technology, which will require capital in excess of that currently available to us.

We had a research revenue backlog of approximately $2.8 million as of both March 31, 2014 and 2013. Our ability to perform continued research, or fulfill our backlog, should not require significant additional personnel; however, we do plan to increase this backlog throughout 2014 and an increase in revenue levels may require additional personnel. We expect our revenue backlog to continue to support our expected revenue levels.

We incurred research and development expenses of approximately $625,000 for the 2014 Period, a decrease from the approximately $875,000 incurred in the 2013 Period. This decrease in research expenses is a direct result of our cost cutting initiatives and elimination of almost all unfunded research activities. We expect research and development expenditures to remain near the current level for the balance of 2014; however, significant new revenue producing research programs beyond those already identified could cause research and development expenditures to increase further.

Our selling, general, and administrative expenses decreased from approximately $750,000 for the 2013 Period to approximately $600,000 for the 2014 Period. The 2014 amount includes approximately $175,000 of expenses related to the proposed business combination. Without those expenses, the selling general and administration expenses would have been approximately $425,000. This decrease in selling, general, and administrative expenses was primarily the result of our cost cutting efforts, which included a reduction in the number of administrative personnel, a reduction in salary rates, a reduction in patent expenses, and a reduction in travel and other expenses. Significant additional cuts were made in March 2014, so excluding transaction costs, the quarterly selling general and administrative expenses should decline further in future quarters as the effect of those cuts are realized over an entire quarter. The actual amount of decrease is dependent on the amount of transaction costs incurred related to the proposed business combination. We expect significant additional transaction related costs in the second, and possibly third, quarters of 2014.

Our interest income is insignificant in both periods. Historically, our interest income results from the investment of excess funds in short term interest bearing instruments, primarily certificates of deposit, commercial paper, and money market funds. We expect our interest income to remain at insignificant levels for the balance of 2014 as a result of limited investible funds and the current interest rate environment.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

Our interest expense, which is primarily the result of our convertible notes payable, decreased significantly from the 2013 Period to the 2014 Period. This interest expense includes both the stated interest rate on the debt and the amortization of the discount associated with the beneficial conversion feature of the notes. The interest expense decreased because of several factors including new notes issued with beneficial conversion features issued in the 2013 Period, original issue discount on new notes issued in the 2013 Period, and expense associated with induced conversions (lowering the conversion price to induce conversion) in the 2013 Period. We issued only a small amount of debt in . . .

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