Digital Locations, Inc. - Annual Report: 2015 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

COMMISSION FILE NUMBER: 000-54817

(Name of registrant in its charter)

 (Address of principal executive offices) (Zip Code)

Issuer's telephone Number: (805) 456-7000

Securities registered under Section 12(b) of the Exchange Act: None.

Securities registered under Section 12(g) of the Exchange Act: Common Stock, $0.001 par value per share

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  o No  ☒

Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x No  ☐.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files.  Yes  x No  ☐.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  ☒.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the price at which the Company's common stock was sold as reported on the OTC-QB Market on June 30, 2015 was $3,296,503.

The number of shares of registrant's common stock outstanding, as of March 24, 2016 was 351,778,081.

TABLE OF CONTENTS

 

PART I

ITEM 1.  BUSINESS.

Unless otherwise stated or the context requires otherwise, references in this annual report on Form 10-K to "Carbon Sciences," the "Company," "we," "us," or "our" refer to Carbon Sciences, Inc.

Introduction

In December 2015, Carbon Sciences entered into a new Sponsored Research Agreement with the University of California at Santa Barbara ("UCSB") to develop a new graphene-based optical modulator, a critical fiber optics component needed to help unclog the existing bottlenecks and enable ultrafast communication in data centers for Cloud computing.  At this time, we do not see an opportunity to commercialize the research findings from our first UCSB Sponsored Research Agreement and are terminating our joint venture through Transphene, Inc., our 50% owned subsidiary, and expect to wind up and dissolve it in 2016.  In addition, on February 9, 2016, we announced a growth-by-acquisition strategy to extend our presence in the information technology ("IT") market. On March 7, 2016, we announced that Christopher S. Kelly joined the Company to serve as our Chief Executive Officer and help execute the growth-by-acquisition strategy.

Graphene is a naturally occurring sheet of pure carbon that is only one atom thick.  It is flexible, transparent, impermeable to moisture, strong, and highly conductive.  A Nobel Prize was awarded to the scientists who isolated graphene from graphite in 2010.  Experts believe that graphene is a versatile material that can enable new applications such as bendable touchscreen displays, rapid charge batteries, super-capacitors, low cost solar cells, extreme high-speed semiconductors, biosensors, as well as water purification.

After research and development of methods to produce low cost graphene, Carbon Sciences is currently focused on the research and development of graphene-based devices to enable ultrafast fiber optics communication in cloud computing infrastructure.

Moore's Law has enabled computers to process information at extreme high speeds. The speed of data movement between computers on the Internet, also referred to as the "Cloud," is, however, bottlenecked by fundamental limitations of today's fiber optics technology. By exploiting the natural optical and electrical properties of graphene, we hope to develop the next generation fiber optics components that are ultrafast, low power and low cost.

We believe high speed and low cost graphene-based components, such as optical modulators (for sending) and photodetectors (for receiving), has the potential to unclog the bottlenecks in the Cloud.  This advance would enable a global era of high-resolution video on demand, high fidelity music streaming, high volume e-commerce and many more Cloud-based services.

Our research program is expected to be secondary to the execution of our new growth-by-acquisition strategy.  We intend to focus the majority of our resources on acquiring, integrating, and expanding high quality businesses in the IT industry.  We believe that there is in excellent opportunity to consolidate profitable private companies engaged in the IT business on an accretive synergistic basis

Market Opportunity

Cloud computing allows application software and services to be delivered from large server farms in data centers over the Internet. Almost every web service we use today such as Netflix, Google and Amazon are all delivered from the Cloud. As more and more people use Cloud services, more and more data are created that need to be stored, transmitted and processed. This explosion of data requires larger and larger data centers – as big as one square mile. The size of current and future data centers is challenging the fundamental speed limits of today's cutting edge fiber optics technology.

 

According to a 2014 report by ACG Research, the growth of Cloud-based services in consumer and business applications during the past five years has been spectacular. By 2019, mobile network traffic is forecasted to increase tenfold. Fifty percent of this increase is expected to be in video services, and an additional 10% is expected to be in social networking applications. Over the same time, business Cloud computing services are expected to increase at a 40% average annual rate. By 2019 there are expected to be 60 percent more data centers in the world's major cities than there are today, and data center interconnect volumes are expected to increase by more than 400 percent.

We believe that graphene-based fiber optic components will be the next generation of devices to enable the transmission of large amounts of data, specifically between computer servers inside datacenters.

 

Business Model

We are in the early stages of researching and developing graphene-based technologies and devices. If successfully developed and commercialized, we plan to license our graphene manufacturing processes and device designs to other companies.

Research and Development

On June 18, 2014, we entered into a Sponsored Research Agreement ("SRA #1") with UCSB, pursuant to which UCSB performed research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #1 includes the development of a low-cost and scalable method to produce large-area graphene for transparent electrode applications.  The term of SRA #1 commenced on July 1, 2014 and expired on June 30, 2015.  The total cost to the Company was $387,730, which has been fully paid.  

After successfully producing high quality graphene under SRA #1, we determined that the best way to commercialize graphene was to focus on complete devices that use graphene.  Since February 2015, we have been engaged in researching commercial opportunities for graphene-based devices.  In June 2015, we announced a plan to develop high-speed graphene-based photonics devices, such as photodetectors and modulators, for fiber optics communication.

On December 15, 2015, we entered into another Sponsored Research Agreement ("SRA #2" and collectively with SRA #1, "SRAs") with UCSB, pursuant to which UCSB will perform research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #2 includes the development of a graphene based optical modulator for the high-speed transmission of digital data in fiber optic networks.  The term of SRA #2 commenced on January 1, 2016 and expires on June 30, 2016.  The total cost to the Company is $65,497.

For optical data to be transmitted through a fiber optic cable, light from a laser beam must be modulated, meaning changed or pulsed, to encode specific digital data.  Otherwise, a constant beam of light does not communicate anything. The faster the light beam can be modulated, the more data can be encoded and transmitted. One of the very important attributes of graphene is extreme high speed and tunable conductivity. Incidentally, changing the conductivity of graphene also changes its optical properties, which means light passing through it will also be changed accordingly to encode digital data.  It is these fundamental features of graphene that SRA #2 aims to exploit in developing an ultrafast, low cost, and low power, graphene-based optical modulator. 

Intellectual Property

We have filed numerous patent applications with the United States Patent and Trademark Office ("USPTO") in the course of our business history.  However, patent applications that are not related to the current business focus of graphene have all been abandoned.

We currently do not have any patent applications filed for graphene.  Our SRAs with UCSB give us the first right to review any new inventions arising out of the SRAs, and negotiate a license or option agreement for such inventions.

 

On January 5, 2015, Carbon Sciences formed Transphene, Inc., a Nevada corporation ("Transphene"), of which the Company owns 50% of the total issued and outstanding capital stock.  The remaining 50% is owned by Dr. Kaustav Banerjee ("Banerjee"), a director and Chief Technical Officer of Transphene.  Transphene was formed to commercialize any technology that the Company licensed from UCSB as a result of SRA #1.  In consideration for its interest in Transphene, the Company agreed to assign the intellectual property rights acquired by the Company from SRA #1 to Transphene.  At this time, the Company does not see an opportunity to commercialize the research findings of SRA #1.  As of the date of this report, the Company has not licensed any intellectual property from UCSB, and therefore has not assigned any intellectual property to Transphene.  The Company does not intend to continue Transphene, and expects to terminate, wind-up and dissolve the subsidiary in 2016.

 

Competition

Competition in the market for optical subsystems and components, such as photodetectors and optical modulators, are intense with large and well-capitalized companies.  For example, large companies include Avago Technologies, Finisar, JDS Uniphase, Oclaro, GigaOptix, and Sumitomo. However, we do not see these companies as direct competitors because our business model is licensing our graphene technologies to original equipment manufacturers like them.  To our knowledge, there are currently no commercially available graphene-based optical components on the market.  Most of our direct competitors for that potential business are in the research and development phase.

Employees

We currently have two full-time employees.  We have arrangements with various independent contractors and consultants to meet additional needs, including management, accounting, investor relations, research and development and other administrative functions.

RISKS RELATED TO OUR BUSINESS AND INDUSTRY

We were formed in August 2006 and have been developing a new technology for commercial use.  We have generated no revenues, have no real operating history upon which you can evaluate our business strategy or future prospects, and have negative working capital.  As a result, our auditor issued an opinion in connection with our December 31, 2014 financial statements, which expressed substantial doubt about our ability to continue as a going concern unless we obtain additional financing.  Our ability to generate such revenues will depend on whether we can successfully develop, commercialize and license our technology and make the transition from a development stage company to an operating company.  We expect to continue to incur losses.  In making your evaluation of our business, you should consider that we are a start-up business focused on a new technology, are designing solutions that have no proven market acceptance, and operate in a rapidly evolving industry.  As a result, we may encounter many expenses, delays, problems and difficulties that we have not anticipated and for which we have not planned. There can be no assurance that at this time we will successfully commercialize our technology, operate profitably or that we will have adequate working capital to fund our operations or meet our obligations as they become due.

There is no assurance that our new growth-by-acquisition strategy will be successful.

The commercial market for graphene is still very much in its infancy.  Sufficient markets may never develop for our technology, may develop more slowly than we anticipate or may develop with economics that are not favorable for us.  The development of sufficient markets for our technology at favorable pricing may be affected by cost competitiveness of our technology, customer reluctance to try new technology and emergence of more competitive technologies.  Because out technology has not yet been used, potential customers may be skeptical about product stability, supply availability, quality control and our financial viability, which may prevent them from purchasing our technology or entering into long-term licensing agreements with us.  We cannot estimate or predict whether a market for our technology will develop, whether sufficient demand for our technology will materialize at favorable prices, or whether satisfactory profit margins will be achieved.  If such pricing levels are not achieved or sustained, or if our technologies and business approach to our markets do not achieve or sustain broad acceptance, our business, operating results and financial condition will be materially and adversely impacted.

As previously discussed, the commercial market for graphene is still very much in its infancy.  The research and development that we have conducted to date with respect to our technology have been performed in a limited scale environment, and the same or similar results may not be obtainable at competitive costs on a large-scale commercial basis.

We have never utilized our technology under the conditions or in the volumes that will be required for us to be profitable and cannot predict all of the difficulties that may arise.  Our technology requires further research, development, regulatory approvals, environmental permits, design and testing prior to commercialization.  Accordingly, our technology may not perform successfully on a commercial basis and may never generate any meaningful revenues or profits.

To date, we have generated no revenues.  Revenue generation could be impacted by any of the following:

We may not be able to enter into agreements to license our technology at prices that will cover our costs.  Potential customers may require lengthy or complex trials or long sampling periods before committing to license our technology.

Due to the continued disruption in the financial markets arising from the global recession and the slow pace of economic recovery, many of our potential customers are unable to access capital necessary to accommodate the use of our technology.  Many are operating under austerity budgets that limit their ability to invest in infrastructure necessary to use alternative fuels and that make it significantly more difficult to take risks with new fuel sources.  As a result, we may experience increased difficulties in convincing customers to adopt our technology as a viable alternative at this time.

Our business plan includes, as our main revenue stream, the collection of royalties through licensing our technology intellectual property portfolio that we currently have and will build in the course of our business.  Companies to which we grant licenses may not be able to produce, market, and sell enough products to pay us royalty fees or they may default on the payment of royalties.  We may not be able to achieve profitable operations from collecting royalties from the licensing of our proprietary technology.

We cannot assure that we will not incur uninsured liabilities and losses as a result of the conduct of our business.  Any such uninsured or insured loss or liability could have a material adverse effect on our results of operations.

Our success is highly dependent on our ability to attract and retain qualified scientific, engineering, and management personnel.  Competition for these qualified personnel is intense.  We are highly dependent on our management and key consultants who have been critical to the development of our business.  The loss of the services of key employees and key consultants could have a material adverse effect on our operations.  We do not have an employment agreement with any employees.  Accordingly, there can be no assurance that any employees will remain associated with us.  The efforts of key employees will be critical to us as we continue to develop our technology and as we attempt to transition from a development stage company to a company with commercialized products and services.  If we were to lose key employees or consultants, we may experience difficulties in competing effectively, developing our technology and implementing our business strategies.

Our ability to successfully test our technology and identify and enter into commercial arrangements with licensees will depend on developing and maintaining close working relationships with industry participants.  These relationships will need to change and evolve over time, as we enter different phases of development.  Our strategic relationships most often are not yet reflected in definitive agreements, or the agreements we have do not cover all aspects of the relationship.  Our success in this area also will depend on our ability to select and evaluate new strategic relationships and to consummate transactions.  To test our technology, we will be dependent on strategic partners for the use or construction of demonstration systems.  Our inability to identify suitable companies or enter into and maintain strategic relationships may affect our ability to commercialize our technology and impair our ability to grow.  The terms of relationships with strategic partners may require us to incur expenses or undertake activities we would not otherwise be inclined to incur or undertake in order to maintain these relationships.

The commercial market for graphene is still very much in its infancy, but the rapidly growing number of graphene related patent applications suggests that intellectual property development is very competitive. Approximately 8,000 graphene-related patents have been filed, evidence of the huge investment and rich pipeline of products under development.  Additionally, the European Union has committed one billion Euros over a decade to research on graphene and other 2D materials, while the Korean and United Kingdom governments have each, respectively, committed at least $40 and £24 million in the past two years.

There is no guarantee that we are not overlapping other competitive innovations that have not been publicly disclosed.  We will not know for sure the value and protect-ability of our intellectual property until we file patents and prosecute them with patent offices globally.

Our success, competitive position, and future revenues will depend in part on our ability to obtain and maintain patent protection for our methods, processes, and other technologies, to preserve our trade secrets, to prevent third parties from infringing on our proprietary rights and to operate without infringing the proprietary rights of third parties.

We have yet to complete an infringement analysis and, even if such an analysis were available at the current time, we could not be certain that no infringement exists, particularly as our products have not yet been fully developed.  We may need to acquire additional licenses from third parties in order to avoid infringement claims, and any required licenses may not be available to us on acceptable terms, or at all.  To the extent infringement claims are made, we could incur substantial costs in the resulting litigation, and the existence of this type of litigation could impede the development of our business.

 

We anticipate filing patent applications both in the United States and in other countries, as appropriate.  However, the patent process is subject to numerous risks and uncertainties, and there can be no assurance that we will be successful in protecting our technology by obtaining and defending patents.  These risks and uncertainties include but are not limited to the following:

In addition to patents, we also intend to rely on trade secrets and proprietary know-how.  Although we take measures to protect this information by entering into confidentiality and inventions agreements with our employees, scientific advisors, consultants, and collaborators, we cannot provide any assurances that these agreements will not be breached, that we will be able to protect ourselves from the harmful effects of disclosure if they are breached, or that our trade secrets will not otherwise become known or be independently discovered by competitors.  If any of these events occurs, or we otherwise lose protection for our trade secrets or proprietary know-how, the value of this information may be greatly reduced.

Patent protection and other intellectual property protection are important to the success of our business and prospects, and there is a substantial risk that such protections will prove inadequate.

We may become subject to infringement claims or litigation arising out of patents and pending applications of competitors, or additional proceedings initiated by third parties or the United States Patent and Trademark Office ("PTO") to reexamine the patentability of our licensed patents.  The defense and prosecution of intellectual property suits, PTO proceedings, and related legal and administrative proceedings are costly and time-consuming to pursue, and their outcome is uncertain. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and know-how, or to determine the enforceability, scope, and validity of the proprietary rights of others.  An adverse determination in litigation or PTO proceedings to which we may become a party could subject us to significant liabilities, require us to obtain licenses from third parties, restrict or prevent us from selling our technology in certain markets, or invalidate or render unenforceable our licensed or owned patents.  Although patent and intellectual property disputes might be settled through licensing or similar arrangements, the costs associated with such arrangements may be substantial and could include our paying large fixed payments and ongoing royalties.  Furthermore, the necessary licenses may not be available on satisfactory terms or at all.

If our methods, processes and other technologies infringe the proprietary rights of other parties, we could incur substantial costs and we may have to do one or more of the following:

To be competitive in the industry, we may be required to continually enhance and update our technology.  The costs of doing so may be substantial, and if we are unable to maintain the efficacy of our technology, our ability to compete may be impaired.  In addition, interest in our technology may wane as alternative fuels and other energy sources gain market acceptance.  If competitors develop, obtain or license technology that is superior to ours, we may lose our competitive edge which may have a material adverse effect on our business, financial condition, results of operations and prospects.

We cannot assure that the market price for our common stock will remain at its current level and a decrease in the market price could result in substantial losses for investors.  The market price of our common stock may be significantly affected by one or more of the following factors:

Unless our common stock is listed on a national securities exchange, including the Nasdaq Capital Market or we have stockholders' equity of $5,000,000 or less and our common stock has a market price per share of less than $4.00, transactions in our common stock will be subject to the SEC's "penny stock" rules.  If our common stock remains subject to the "penny stock" rules promulgated under the Securities Exchange Act of 1934, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected.

In accordance with these rules, broker-dealers participating in transactions in low-priced securities must first deliver a risk disclosure document that describes the risks associated with such stocks, the broker-dealer's duties in selling the stock, the customer's rights and remedies and certain market and other information.  Furthermore, the broker-dealer must make a suitability determination approving the customer for low-priced stock transactions based on the customer's financial situation, investment experience and objectives.  Broker-dealers must also disclose these restrictions in writing to the customer, obtain specific written consent from the customer, and provide monthly account statements to the customer.  The effect of these restrictions will probably decrease the willingness of broker-dealers to make a market in our common stock, decrease liquidity of our common stock and increase transaction costs for sales and purchases of our common stock as compared to other securities.  Our management is aware of the abuses that have occurred historically in the penny stock market.

As a result, if our common stock becomes subject to the penny stock rules, the market price of our securities may be depressed, and you may find it more difficult to sell our securities.

Our internal control over financial reporting may have weaknesses and conditions that could require correction or remediation, the disclosure of which may have an adverse impact on the price of our common stock.  We are required to establish and maintain appropriate internal controls over financial reporting.  Failure to establish those controls, or any failure of those controls once established, could adversely affect our public disclosures regarding our business, prospects, financial condition or results of operations.

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require an annual assessment of internal controls over financial reporting, and for certain issuers an attestation of this assessment by the issuer's independent registered public accounting firm.  The standards that must be met for management to assess the internal controls over financial reporting as effective are evolving and complex, and require significant documentation, testing, and possible remediation to meet the detailed standards.  We expect to incur significant expenses and to devote resources to Section 404 compliance on an ongoing basis.  It is difficult for us to predict how long it will take or costly it will be to complete the assessment of the effectiveness of our internal control over financial reporting for each year and to remediate any deficiencies in our internal control over financial reporting. As a result, we may not be able to complete the assessment and remediation process on a timely basis.  In addition, management's assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors.  Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting or disclosure of management's assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.

Our Articles of Incorporation authorize our Company to issue up to 20,000,000 shares of blank check preferred stock.  Currently no preferred shares are issued; however, we can issue shares of our preferred stock in one or more series and can set the terms of the preferred stock without seeking any further approval from our common stockholders.  Any preferred stock that we issue may rank ahead of our common stock in terms of dividend priority or liquidation premiums and may have greater voting rights than our common stock.  In addition, such preferred stock may contain provisions allowing those shares to be converted into shares of common stock, which could dilute the value of common stock to current stockholders and could adversely affect the market price, if any, of our common stock.  In addition, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company.  Although we have no present intention to issue any shares of authorized preferred stock, there can be no assurance that we will not do so in the future.

From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 promulgated under the Securities Act, subject to certain limitations.  In general, pursuant to amended Rule 144, non-affiliate stockholders may sell freely after six months subject only to the current public information requirement.  Affiliates may sell after six months subject to the Rule 144 volume, manner of sale (for equity securities), current public information and notice requirements.  Of the 321,497,899 shares of our common stock outstanding as of December 31, 2015, approximately 317,409,000 shares are freely tradable without restriction, as of December 31, 2015.  Any substantial sales of our common stock pursuant to Rule 144 may have a material adverse effect on the market price of our common stock.

We do not currently anticipate paying cash dividends in the foreseeable future.  The payment of dividends on our common stock will depend on earnings, financial condition and other business and economic factors affecting it at such time as the board of directors may consider relevant.  Our current intention is to apply net earnings, if any, in the foreseeable future to increasing our capital base and development and marketing efforts.  There can be no assurance that we will ever have sufficient earnings to declare and pay dividends to the holders of our common stock, and in any event, a decision to declare and pay dividends is at the sole discretion of the our Board of Directors.  If we do not pay dividends, our common stock may be less valuable because a return on investment will only occur if its stock price appreciates.

 

Our principal office is located at 5511C Ekwill Street, Santa Barbara, California 93111.  We lease approximately 2,800 square feet.  We extended our lease for a period of five years, expiring on September 30, 2017.  The base rent for the period of October 1, 2012 to September 30, 2013 was $2,884 per month, and for the remaining period commencing on October 1, 2013 to September 30, 2017 the base rent is $2,971 per month.  We sublease approximately 1,400 square feet to a short-term subtenant, which reduces our occupancy expense to approximately 50% of our lease amount.

We are not currently a party to, nor is any of our property currently the subject of, any pending legal proceeding that will have a material adverse effect on our business.

Not applicable.

PART II

As of March __, 2016 there were 102 holders of record of our common stock.  This number does not include stockholders for whom shares were held in "nominee" or "street" name.

We have not declared or paid any cash dividends on our common stock and do not anticipate declaring or paying any cash dividends in the foreseeable future.  We currently expect to retain future earnings, if any, for the development of our business.

Our Articles of Incorporation, as amended, authorize the issuance of one billion shares of common stock, $.001 par value per share.  Holders of shares of common stock are entitled to one vote for each share on all matters to be voted on by the stockholders.  Holders of common stock have cumulative voting rights.  Holders of shares of common stock are entitled to share ratably in dividends, if any, as may be declared, from time to time by the Board of Directors in its discretion, from funds legally available therefor. In the event of a liquidation, dissolution, or winding up of our company, the holders of shares of common stock are entitled to share pro rata all assets remaining after payment in full of all liabilities.  Holders of common stock have no preemptive or other subscription rights, and there are no conversion rights or redemption or sinking fund provisions with respect to such shares.

As of March 24, 2016, our common stock was held by 102 stockholders of record, and we had 337,321,095 shares of common stock issued and outstanding.  We believe that the number of beneficial owners is substantially greater than the number of record holders because a significant portion of our outstanding common stock is held of record in broker street names for the benefit of individual investors.  The transfer agent of our common stock is Computershare Investor Services, 250 Royall Street, Canton, Massachusetts 02021.

EQUITY COMPENSATION PLAN INFORMATION

None.

Not applicable.

The following discussion and analysis should be read together with our financial statements and the related notes appearing elsewhere in this filing.  This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See "Forward-Looking Statements" for a discussion of the uncertainties, risks and assumptions associated with these statements.  Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under "Risk Factors" and elsewhere in this annual report.

   

Cautionary Statements

This Form 10-K contains financial projections and other "forward-looking statements," as that term is used in federal securities laws, about our financial condition, results of operations, and business.  These statements include, among others:

·	statements concerning the potential for benefits that we may experience from its business activities and certain transactions it contemplates or has completed; and

·

statements of our expectations, future plans and strategies, anticipated developments, and other matters that are not historical facts.  These statements may be made expressly in this Form 10-K.  You can find many of these statements by looking for words such as "believes," "expects," "anticipates," "estimates," or similar expressions used in this Form 10-K.  These forward-looking statements are subject to numerous assumptions, risks, and uncertainties that may cause the Company's actual results to be materially different from any future results expressed or implied by the Company in those statements. The most important facts that could prevent the Company from achieving its stated goals include, but are not limited to, the following:

(a)

volatility or decline of the Company's stock price;

(b)

potential fluctuation in quarterly results;

(c)

failure of the Company to earn revenues or profits;

(d)

inadequate capital to continue or expand its business, and inability to raise additional capital or financing to implement its business plans;

(e)

failure to further commercialize its technology or to make sales;

(f)

rapid and significant changes in markets;

(g)

litigation with or legal claims and allegations by outside parties;

(h)

insufficient revenues to cover operating costs;

(i)

aspects of the Company's business are not proprietary and in general the Company is subject to inherent competition;

(j)

further dilution of existing shareholders' ownership in Company; and

(k)

uncollectible accounts and the need to incur expenses to collect amounts owed to the Company.

There is no assurance that the Company will be profitable.  The Company may not be able to successfully develop, manage, or market its products and services.  The Company may not be able to attract or retain qualified executives and technology personnel.  The Company may not be able to obtain customers for its products or services.  The Company's products and services may become obsolete.  Government regulation may hinder the Company's business.  Additional dilution in outstanding stock ownership may be incurred due to the issuance of more shares, warrants and stock options, the exercise of outstanding warrants and stock options.

Because the statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the forward-looking statements.  The Company cautions you not to place undue reliance on the statements, which speak only as of the date of this Form 10-K. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that the Company or persons acting on its behalf may issue.  The Company does not undertake any obligation to review or confirm analysts' expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

The following discussion should be read in conjunction with our financial statements and notes to those statements.  In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties.

On June 18, 2014, we entered into a Sponsored Research Agreement ("SRA #1") with UCSB, pursuant to which UCSB performed research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #1 includes the development of a low-cost and scalable method to produce large-area graphene for transparent electrode applications.  The term of SRA #1 commenced on July 1, 2014 and expired on June 30, 2015.  The total cost to the Company was $387,730, which has been fully paid.  

On December 15, 2015, we entered into another Sponsored Research Agreement ("SRA #2") with UCSB, pursuant to which UCSB will perform research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #2 includes the development of a graphene based optical modulator for the high-speed transmission of digital data in fiber optic networks.  The term of SRA #2 commenced on January 1, 2016 and will expire on June 30, 2016.  The total cost to the Company is $65,497.

 

On February 9, 2016, we announced a growth-by-acquisition strategy to extend our presence in the information technology ("IT") market. On March 7, 2016, we announced that Christopher S. Kelly joined the Company to serve as our Chief Executive Officer and help execute the growth-by-acquisition strategy.

In accordance with GAAP, management utilizes estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  These estimates and assumptions relate to recording net revenue, collectability of accounts receivable, useful lives and impairment of tangible and intangible assets, accruals, income taxes, inventory realization, stock-based compensation expense and other factors.  Management believes it has exercised reasonable judgment in deriving these estimates.  Consequently, a change in conditions could affect these estimates.

Fair Value of Financial Instruments

Disclosures about fair value of financial instruments requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value.  As of December 31, 2015 and 2014, the amounts reported for cash, accrued interest, accrued expenses and other current liabilities, and notes payable approximate fair value because of their short maturities.

We adopted ASC Topic 820 (originally issued as SFAS 157, "Fair Value Measurements") as of January 1, 2008 for financial instruments measured as fair value on a recurring basis.  ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC Topic 820 established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements).  These tiers include:

 

·	Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;

·	Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and

·	Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

We measure certain financial instruments at fair value on a recurring basis.  Assets and liabilities measured at fair value on a recurring basis are as follows at December 31, 2015 and 2014:

We estimate the fair value of the derivative for the conversion feature of our convertible notes payable using the Black-Scholes pricing model at the inception of the debt, at the date of conversions to equity and at each reporting date, recording a derivative liability, debt discount and a gain or loss on change in derivative liability as applicable.  These estimates are based on multiple inputs, including the market price of our stock, interest rates, our stock price volatility, and variable conversion prices based on market prices as defined in the respective loan agreements.  These inputs are subject to significant changes from period to period; therefore, the estimated fair value of the derivative liability will fluctuate from period to period and the fluctuation may be material.

Income Taxes

We account for income taxes using the asset and liability method.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Stock-Based Compensation

Stock-based compensation is measured at the grant date based on the value of the award granted using the Black-Scholes option pricing model, and recognized over the period in which the award vests.  For stock awards no longer expected to vest, any previously recognized stock compensation expense is reversed in the period of termination.  The stock-based compensation expense is included in general and administrative expenses.

 

Management reviewed new accounting pronouncements issued during the year ended December 31, 2015 and through the date of filing this report, and believes no pronouncements are applicable to or would have a material impact on the financial statements of the Company.

General and administrative expenses decreased by $69,966 to $341,160 in the year ended December 31, 2015 from $411,126 in the year ended December 31, 2014.  The decrease in general and administrative expenses in the current year is due primarily to decreases in consulting and professional fees.

Research and development expenses increased by $105,000 to $298,865 in the year ended December 31, 2015 from $193,865 in the year ended December 31. 2014.  The increase in research and development expenses in the current year is due to the amortization of the payments made for SRA #1 and increased payments to consultants.

Depreciation and amortization expense decreased by $427 to $208 in the year ended December 31, 2015 from $635 in the year ended December 31, 2014.  Our investment in property and equipment currently is not material to our operations, and substantially all of our property and equipment is fully depreciated at December 31, 2015.

As a result, our net loss for the year ended December 31, 2015 was $5,218,161 compared to a net loss of $7,704,843 for the year ended December 31, 2014.

As of December 31, 2015, we had a working capital deficit of $15,031,642 compared to a working capital deficit of $10,518,191 as of December 31, 2014.  The increase in the working capital deficit was due primarily to the increase in our non-cash derivative liability.  Our cash balance at December 31, 2015 was $37,696.

During the year ended December 31, 2015, we used net cash of $534,751 in operating activities as a result of our net loss of $5,218,161, non-cash gain on settlement of debt of $5,660 and decrease in accounts payable of $20,535, partially offset by non-cash expenses totaling $4,490,501, a decrease in prepaid expenses of $68,586 and an increase in accrued expenses and other current liabilities of $150,518.

During the year ended December 31, 2014, we used net cash of $659,343 in operating activities as a result of our net loss of $7,704,843, non-cash gain on settlement of debt of $18,369, increase in prepaid expenses of $66,835 and decrease in accounts payable of $57,148, partially offset by non-cash expenses totaling $7,057,062, and an increase in accrued expenses and other current liabilities of $130,790.

We had no net cash provided by or used in investing activities during the years ended December 31, 2015 and 2014.

Net cash provided by financing activities during the year ended December 31, 2015 was $557,000, comprised of proceeds from convertible notes payable.

Net cash provided by financing activities during the year ended December 31, 2014 was $663,408, comprised of proceeds from convertible notes payable of $738,000, partially offset by repayment of convertible notes payable of $74,592.   Our capital needs have primarily been met from the proceeds of equity financings and investor loans, as we are currently have no revenues.

Although most recently, proceeds received from the issuance of debt are sufficient to fund our current operating expenses, we will need to raise additional funds in the future to continue our operations and emerge from the development stage.  Therefore, our future operations are dependent on our ability to secure additional financing.  Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms.  However, the trading price of our common stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities.  Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, or experience unexpected cash requirements that would force us to seek alternative financing.  Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences, or privileges senior to those of existing holders of our common stock.  The inability to obtain additional capital may restrict our ability to grow and may reduce our ability to continue to conduct business operations.  If we are unable to obtain additional financing, we may have to curtail our marketing and development plans and possibly cease our operations.

We believe that we have assets to ensure that we can continue to operate without liquidation over the next twelve months, due to our current cash, and our experience in the past in being able to raise money from our investor base.  Therefore, we believe we have the ability to continue our operations for the foreseeable future and will be able to realize assets and discharge liabilities in the normal course of our operations.

The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business.  The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern.  The Company does not generate any revenue, and has negative cash flows from operations, which raises substantial doubt about the Company's ability to continue as a going concern.  The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital.  Since our inception through December 31, 2015, the Company has obtained funds primarily from the issuance of common stock and debt.  Management believes this funding will continue, and is continually seeking new investors.  Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet the Company's obligations as they become due, and will allow the development of its core of business.  However, we cannot assure that we will be successful in these endeavors.

 

 

All financial information required by this Item is attached hereto at the end of this report beginning on page F-1 and is hereby incorporated by reference.

Based on an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of December 31, 2015, our Chief Executive Officer and Acting Chief Financial Officer has concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.  Our Chief Executive Officer and Acting Chief Financial Officer also concluded that, as of December 31, 2015, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, to allow timely decisions regarding required disclosure.

We are responsible for establishing and maintaining adequate internal control over financial reporting in accordance with Exchange Act Rule 13a-15.  With the participation of our Chief Executive Officer and Acting Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2015 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013).  Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2015, based on those criteria.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

During the three months ended December 31, 2015, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

No Attestation Report by Independent Registered Accountant

PART III

The following table sets forth information about our executive officers and directors:

 

Name		Age		Position
Byron Elton		62		Chairman of the Board of Directors
William E. Beifuss, Jr.		70		Director, President, Acting Chief Financial Officer and Secretary
Christopher S. Kelly		35		Director and Chief Executive Officer

 

Directors serve until the next annual meeting and until their successors are elected and qualified.  The Directors of our company are elected by the vote of a majority in interest of the holders of the voting stock of our company and hold office until the expiration of the term for which he or she was elected and until a successor has been elected and qualified.

Officers are appointed to serve for one year until the meeting of the board of directors following the annual meeting of stockholders and until their successors have been elected and qualified.

The principal occupations for the past five years (and, in some instances, for prior years) of each of our executive officers and directors, followed by our key employees, are as follows:

Byron Elton — Chairman of the Board.  Mr. Elton has been a director of the Company since March 16, 2009.  He served as the President, Chief Operating Officer, acting Chief Financial Officer, and Secretary of the Company from January 5, 2009 to May 10, 2013. Mr. Elton is an experienced media and marketing professional with experience in crafting new business development strategies and building top-flight marketing organizations.  From January 2014 to the present, he has served as Executive Vice President of 451 Marketing, a fully integrated marketing and communications agency with offices in Boston, New York and Los Angeles.  From June 2013 to the present, he has served as a principal at PointClear Search, an executive search firm.  He previously served as Senior Vice President of Sales for Univision Online from 2007 to 2008.  Mr. Elton also served for eight years as an executive at AOL Media Networks from 2000 to 2007, where his assignments included Regional Vice President of Sales for AOL and Senior Vice President of E-Commerce for AOL Canada.  His broadcast media experience includes leading the ABC affiliate in Santa Barbara, California from 1995 to 2000 and the CBS affiliate in Monterrey, California, from 1998 to 1999, in addition to serving as President of the Alaskan Television Network from 1995 to 1999.  Mr. Elton's extensive senior level management experience specifically in new business development and partnership strategies made him qualified to serve on the Board of Directors.

 

William E. Beifuss, Jr. — Director, President, Secretary and Acting Chief Financial Officer.  Mr. Beifuss has been the President, acting Chief Financial Officer, Secretary, and a director of the Company since May 10, 2013. Mr. Beifuss also served as the Chief Executive Officer of the Company from May 10, 2013 to March 7, 2016.  Mr. Beifuss is a business executive and has served since February 2006 as the Chief Executive Officer of Cumorah Capital, Inc., a private investment company.  Mr. Beifuss served as Chairman of the Board of Warp 9, Inc. from December 2008 to January 2013.  From June 2010 to April 2012, Mr. Beifuss was the President of Warp 9.  He served as the interim Chief Financial Officer of Warp 9 from June 2011 to April 2012.  From April 1992 to January 2006, Mr. Beifuss was Chief Executive Officer of Coeur D'Alene French Baking Company.  He served as a unit committee chairman of Boy Scouts of America.

Christopher S. Kelly – Director and Chief Executive Officer.  Mr. Kelly was appointed to serve as the Chief Executive Officer and a director of the Company effective March 7, 2016.  Mr. Kelly is an experienced business executive with experience in the mergers and acquisitions field.  From September 2014 until joining the Company, Mr. Kelly served as Chief Operating Officer of Esperer Holdings/Butler America, a private equity acquisition and management company, where he managed all aspects of the purchase and transition of numerous private equity acquisitions in a broad variety of industries.  From July 2009 to September 2014, Mr. Kelly served as Vice President of Construction and Head of Business Development of MJB Construction, an oil and gas construction firm.  Mr. Kelly holds a Juris Doctor degree from University of Denver Sturm College of Law and a Bachelor of Arts Degree in History with a minor in Business Management from Brigham Young University.

There are no family relationships among our executive officers and directors.

Although we have not adopted a formal policy on whether the Chairman and Chief Executive Officer positions should be separate or combined, we have recently determined that it is in the best interests of the Company and its shareholders to separate these roles.

 

Our Board of Directors focuses on the most significant risks facing our company and our company's general risk management strategy, and also ensure that risks undertaken by our Company are consistent with the Board's appetite for risk.  While the Board oversees our company's risk management, management is responsible for day-to-day risk management processes.  We believe this division of responsibilities is the most effective approach for addressing the risks facing our company and that our Board leadership structure supports this approach.

Limitation of Liability and Indemnification of Officers and Directors

Under Nevada General Corporation Law and our articles of incorporation, our directors will have no personal liability to us or our stockholders for monetary damages incurred as the result of the breach or alleged breach by a director of his "duty of care."  This provision does not apply to the directors' (i) acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) acts or omissions that a director believes to be contrary to the best interests of the corporation or our shareholders or that involve the absence of good faith on the part of the director, (iii) approval of any transaction from which a director derives an improper personal benefit, (iv) acts or omissions that show a reckless disregard for the director's duty to the corporation or our shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the corporation or our shareholders, (v) acts or omissions that constituted an unexcused pattern of inattention that amounts to an abdication of the director's duty to the corporation or our shareholders, or (vi) approval of an unlawful dividend, distribution, stock repurchase or redemption.  This provision would generally absolve directors of personal liability for negligence in the performance of duties, including gross negligence.

The effect of this provision in our articles of incorporation is to eliminate the rights of Carbon Sciences and our stockholders (through stockholder's derivative suits on behalf of Carbon Sciences) to recover monetary damages against a director for breach of his fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior) except in the situations described in clauses (i) through (vi) above.  This provision does not limit nor eliminate the rights of Carbon Sciences or any stockholder to seek non-monetary relief such as an injunction or rescission in the event of a breach of a director's duty of care.  In addition, our Articles of Incorporation provide that if Nevada law is amended to authorize the future elimination or limitation of the liability of a director, then the liability of the directors will be eliminated or limited to the fullest extent permitted by the law, as amended.  Nevada General Corporation Law grants corporations the right to indemnify their directors, officers, employees and agents in accordance with applicable law.  Our bylaws provide for indemnification of such persons to the full extent allowable under applicable law.  These provisions will not alter the liability of the directors under federal securities laws.

We intend to enter into agreements to indemnify our directors and officers, in addition to the indemnification provided for in our bylaws.  These agreements, among other things, indemnify our directors and officers for certain expenses (including attorneys' fees), judgments, fines, and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of Carbon Sciences, arising out of such person's services as a director or officer of Carbon Sciences, any subsidiary of Carbon Sciences or any other company or enterprise to which the person provides services at the request of Carbon Sciences.  We believe that these provisions and agreements are necessary to attract and retain qualified directors and officers.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling Carbon Sciences pursuant to the foregoing provisions, Carbon Sciences has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

To our knowledge, during the past ten years, none of our directors, executive officers, promoters, control persons, or nominees has been:

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Board Committees

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Indebtedness of Executive Officers

Code of Ethics

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Section 16(a) Beneficial Ownership Reporting Compliance

ITEM 11.  EXECUTIVE COMPENSATION.

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Employment Agreements

Grants of Equity Awards – Fiscal Year 2015

 

Outstanding Equity Awards

The following table sets forth information with respect to grants of options to purchase our common stock to our Named Executive Officer at December 31, 2015.

 

Director Compensation

Non-employee directors may receive compensation for their services and reimbursement for their expenses as shall be determined from time to time by resolution of the Board.

No director compensation was paid to our non-employee directors during the fiscal year ended December 31, 2015.  Our employee directors currently do not receive cash compensation for their service on the Board of Directors.

On June 4, 2013, Daniel Nethercott, a former director who resigned, effective January 3, 2015, was issued a convertible promissory note in the amount of $25,000 in exchange for services.  The maturity date of the note is June 4, 2016 and the note bears interest at a rate of 5% per annum.  Mr. Nethercott has the right, at his election, to convert all or part of the outstanding and unpaid principal and accrued interest into shares of our common stock.  The conversion price is the lesser of $0.035 per share or the closing price per share of our common stock on the trading day immediately preceding the date of conversion.

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Stock Option and Other Long-Term Incentive Plan

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ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

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ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

Certain Relationships and Related Transactions

On June 4, 2013, Daniel Nethercott, a former director who resigned effective January 3, 2015, was issued a convertible promissory note in the amount of $25,000 in exchange for services.  The maturity date of the note is June 4, 2016 and the note bears interest at a rate of 5% per annum.  Mr. Nethercott has the right, at his election, to convert all or part of the outstanding and unpaid principal and accrued interest into shares of our common stock.  The conversion price is the lesser of $0.035 per share or the closing price per share of our common stock on the trading day immediately preceding the date of conversion.  Accrued interest payable on the note was $3,219 at December 31, 2015.

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Mr. Kelly agrees in connection with any registration of the Company's securities that, upon the request of the Company or the underwriters managing any public offering of the Company's securities, Mr. Kelly will not sell or otherwise dispose of any securities received from the conversion of the Series B Preferred Stock, without the prior written consent of the Company or such underwriters, as the case may be, for such period of time (not to exceed one hundred eighty (180) days) after the effective date of such registration requested by such underwriters and subject to all restrictions as the Company or the underwriters may specify.

During the past three fiscal years, there have been no transactions other than those described above, and there are no currently proposed transactions in which the Company is a participant in which any related person has or will have a direct or indirect material interest which exceeds the lesser of $120,000 or one percent of the Company's total assets at year end for the last two completed fiscal years.

Director Independence

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES.

Audit Fees

The aggregate fees billable to us by Liggett & Webb P.A. in 2016 for the audit of our 2015 annual financial statements will total approximately $30,000.

Audit-Related Fees

Tax Fees

All Other Fees

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As of the date of this filing, our current policy is to not engage Liggett & Webb P.A. to provide, among other things, bookkeeping services, appraisal or valuation services, or international audit services.  The policy provides that we engage Liggett & Webb P.A. to provide audit, tax compliance, and other assurance services, such as review of SEC reports or filings.

ITEM 15.  EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES.

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*Filed herewith

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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

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To the Board of Directors and Shareholders

Carbon Sciences, Inc.

Santa Clarita, California

 

We have audited the accompanying consolidated balance sheet of Carbon Sciences, Inc. ("the Company") as of December 31, 2015, and the related consolidated statement of operations, shareholders' deficit, and cash flow for the year then ended.  These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based upon our audit.

  

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Carbon Sciences, Inc. as of December 31, 2015, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in Note 1 to the consolidated financial statements, the Company does not generate revenue and has negative cash flows from operations.  This raises substantial doubt about the Company's ability to continue as a going concern.  Management's plans in regard to these matters are also described in Note 1.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

March 24, 2016

New York, New York

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1.  ORGANIZATION AND LINE OF BUSINESS

Carbon Sciences, Inc. (the "Company") was incorporated in the State of Nevada on August 25, 2006 as Zingerang, Inc.  On April 2, 2007, the Company changed its name to Carbon Sciences, Inc.

The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities, and commitments in the normal course of business.  The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern.  The Company does not generate any revenue, and has negative cash flows from operations, which raise substantial doubt about the Company's ability to continue as a going concern.  The ability of the Company to continue as a going concern is dependent upon, among other things, raising additional capital.  Since its inception through December 31, 2015, the Company has obtained funds primarily from the issuance of common stock and debt.  Management believes this funding will continue, and is continually seeking new investors.  Management believes the existing shareholders and lenders and prospective new investors will provide the additional cash needed to meet the Company's obligations as they become due, and will allow the development of its core of business.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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During the years ended December 31, 2015 and 2014, the Company had the following activity in its derivative liability account:

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At December 31, 2015, the Company's authorized stock consisted of 1,000,000,000 shares of common stock, with a par value of $0.001 per share.  The Company is also authorized to issue 20,000,000 shares of preferred stock, with a par value of $0.001 per share.  The rights, preferences, and privileges of the holders of the preferred stock will be determined by the Board of Directors prior to issuance of such shares.

During the year ended December 31, 2015, the Company issued a total of 80,311,720 shares of common stock at fair value in conversion of $29,200 of convertible promissory notes, accrued interest payable of $6,940 and derivative liability of $691,907.  We recognized a gain of $5,660 on the conversion of the notes.

 

During the year ended December 31, 2014, we issued a total of 169,051,249 shares of common stock at fair value.  We issued 163,051,249 shares in conversion of $230,385 of convertible promissory notes, accrued interest payable of $9,987, derivative liability of $602,576 and reduction of debt discount of $47,639. We recognized a gain of $18,369 on the conversion of the notes.  We also issued a total of 6,000,000 shares of common stock for accrued consulting services of $49,623 pursuant to a restricted stock grant.

4.  STOCK OPTIONS, WARRANTS AND RESTRICTED STOCK AWARDS

In September 2013, the Board of Directors granted a total of 14,000,000 non-qualified stock options to a former Chief Executive Officer and our current President to purchase a total of 14,000,000 shares at an exercise price of $0.006 per share.  The options vest over a period of 25 months beginning in October 2013 and are exercisable for a period of seven years from the date of grant.  As of December 31, 2015, we had no unrecognized stock-based compensation expense.

As of December 31, 2015, the Company had a total of 14,100,000 non-qualified stock options outstanding to purchase 14,100,000 shares of common stock to our employees, officers, and consultants.  Stock-based compensation expense included in general and administrative expense was $28,000 and $36,825 for the years ended December 31, 2015 and 2014, respectively.

A summary of the Company's stock option awards as of December 31, 2015, and changes during the years ended December 31, 2015 and 2014 are as follows:

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on our closing stock price of $0.004 as of December 31, 2015, which would have been received by the holders of in-the-money options had the option holders exercised their options as of that date.

As of December 31, 2015, the Company had 460,000 common stock purchase warrants outstanding, with an exercise price of $0.50 per share and expiring on various dates in 2017 and 2018.

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On September 12, 2013 and as amended on October 24, 2013, two consultants were each granted restricted stock awards for 14,000,000 shares of our common stock (the "RSAs").  The shares were to vest upon reaching certain defined milestones related to our development and construction of a gas-to-liquid plant.

During the year ended December 31, 2014, 3,000,000 shares vested for each of the two consultants and we recognized total compensation expense of $49,623.  We have discontinued our development of the gas-to-liquid plant involving the consultants.  Therefore, there will be no further vesting of shares and recognition of compensation expense under RSAs.

5.  CONVERTIBLE PROMISSORY NOTES PAYABLE

On July 8, 2013, September 16, 2013 and January 6, 2014, we entered into securities purchase agreements with an institutional lender for the issuance of three 8% promissory notes in the aggregate principal amounts of $42,500, $32,500 and $63,000, respectively.  The notes are convertible into shares of our common stock at a price equal to a variable conversion price of $58% multiplied by a defined market price, representing a discount of 42%.  The market price is defined as the average of the lowest three trading prices for our common stock during a ten trading day period ending on the latest complete trading day prior to the conversion date.

During the year ended December 31, 2014, the July 8, 2013 note was fully converted into shares of our common stock, extinguishing a total of $42,500 in principal and $1,700 in accrued interest.  During the year ended December 31, 2014, amortization of debt discount was recorded to interest expense in the amount of $15,399.

During the year ended December 31, 2014, the September 16, 2013 note was fully converted into shares of our common stock, extinguishing a total of $32,500 in principal and $1,300 in accrued interest.  During the year ended December 31, 2014, amortization of debt discount was recorded to interest expense in the amount of $19,973.

During the year ended December 31, 2014, the January 6, 2014 note was partially converted into shares of our common stock, extinguishing a total of $16,325 in principal.  We paid in cash the remaining $46,675 in principal and $18,325 in accrued interest and early payment penalties.

We recorded a debt discount of $63,000 related to the conversion feature of the January 6, 2014 note, along with a derivative liability at inception.  During the year ended December 31, 2014, amortization of the debt discount was recorded to interest expense in the amount of $63,000.

On December 12, 2012, we exchanged certain promissory notes in the aggregate amount of $327,500 for convertible promissory notes.  We entered into 10% convertible promissory note agreements in the aggregate principal amount of $327,500, which were convertible into shares of our common stock at a conversion price equal to (a) the lesser of $0.54 per share or (b) 50% of the lowest trade price recorded on any trade date after the effective date, or (c) the lowest effective price per share granted to any person after the effective date.  The notes were to mature one year from the effective date of the note.  We recorded a debt discount of $327,500 related to the conversion feature of the notes, which has been fully amortized to interest expense, along with a derivative liability at inception.  During 2013, the principal sum of $62,000, plus accrued interest was transferred to another investor.

 

Effective October 24, 2013, the remaining principal balance of the notes discussed in the preceding paragraph totaling $291,443 and accrued interest of $7,769 were combined in a new 10% convertible promissory note in the aggregate amount of $299,212, which originally matured on October 24, 2014.  The new note is convertible into shares of our common stock at a conversion price equal to (a) the lesser of $0.006 per share or (b) 50% of the lowest trade price recorded on any trade date after the effective date, or (c) the lowest effective price per share granted to any person through the issuance of securities after the effective date.  After conversions to our common stock during 2013 and 2014, the note had a principal balance of $233,012 payable at December 31, 2014.  During the year ended December 31, 2015, a total of $29,200 principal and $6,940 accrued interest were converted into shares of our common stock, resulting in a principal balance of $203,812 payable at September 30, 2015.  The maturity date of the note was extended to June 30, 2016.

On December 31, 2012, we entered into convertible promissory notes with three individuals in exchange for services rendered in the aggregate amount of $244,452, including $185,852 with the Chairman of our Board of Directors and our former Chief Executive Officer.  We entered into convertible promissory note agreements for the sale of 5% convertible promissory notes in the principal amount of $244,452, which are convertible into shares of our common stock at a conversion price equal to the lesser of $0.20 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  One of the notes with a principal balance of $25,980 at December 31, 2015 matured on December 31, 2014 and is currently in default.  The other two notes mature on December 31, 2016.  We recorded a debt discount of $237,742 related to the conversion feature of the notes, which has been fully amortized to interest expense, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, total amortization was recorded to interest expense in the amounts of $0 and $120,958, respectively.

During 2013, we received total proceeds of $40,000 pursuant to a convertible promissory note in the aggregate principal amount of $100,000.  The note is convertible into shares of our common stock at a price equal to a variable conversion price of the lesser of $0.09 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The note was to mature one year from its effective date.  The maturity date has been extended to June 30, 2016.  We recorded a debt discount of $40,000, which has been fully amortized to interest expense.

On March 14, 2013, we entered into a 5% convertible promissory note in the principal amount of $29,500, which is convertible into shares of our common stock at a conversion price equal to the lesser of $0.15 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  The note matured two years from its effective date, or March 14, 2015, and is currently in default.

On May 29, 2013, we exchanged $97,000 in demand promissory notes for a 10% convertible promissory note in the aggregate principal amount of $97,000.  The note is convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.028 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The maturity date of the note was extended to June 30, 2016.  We recorded a debt discount of $97,000, which has been fully amortized to interest expense.

On June 4, 2013, we entered into a 5% convertible promissory note with a former member of our Board of Directors in exchange for services rendered in the amount of $25,000.  The note is convertible into shares of common stock of the Company at a conversion price equal to the lesser of $0.035 per share or the closing price per share of common stock recorded on the trading day immediately preceding the date of conversion.  The note matures three years from its effective date, or June 4, 2016.

 

On September 6, 2013, we exchanged a $5,000 promissory note for a 10% convertible promissory note in the aggregate principal amount of $5,000.  The note is convertible into shares of our common stock at a price equal to a conversion price of the lesser of $0.0042 per share or fifty percent (50%) of the lowest trade price recorded after the effective date.  The note matures on June 30, 2016.  We recorded a debt discount of $2,536, which has been fully amortized to interest expense, along with a derivative liability at inception. During the years ended December 31, 2015 and 2014, total amortization was recorded to interest expense in the amounts of $0 and $1,459, respectively.

On October 8, 2012, we entered into to a 10% convertible promissory note in the aggregate principal amount of $250,000.  The note is convertible into shares of common stock of the Company at a price equal to the lesser of $0.006 or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion.  The maturity dates of the notes were extended to June 30, 2016.

The lender previously advanced a total of $11,000 in August and September 2013 that was transferred to this promissory note.  We recorded a debt discount of $11,000, which has been fully amortized to interest expense, along with a derivative liability upon transfer.  During the years ended December 31, 2015 and 2014, amortization of debt discount to interest expense was $0 and $5,863, respectively.

On October 21, 2013, we received additional proceeds of $22,000 on this promissory note.  We recorded a debt discount of $22,000, which has been fully amortized to interest expense, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount to interest expense was $0 and $13,418, respectively.

On November 22, 2013, we received additional proceeds of $25,000 on this promissory note agreement.  We recorded a debt discount of $25,000, which has been fully amortized to interest expense, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount to interest expense was $0 and $19,613, respectively.

On April 18, 2014, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "April 2014 $500,000 CPN").  The advance amounts received are at the lender's discretion.  The notes are convertible into shares of our common stock at a price per share equal to the lesser of: $0.003; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The note matures, with respect to each advance, eighteen months from the effective date of each advance.

On April 18, 2014, we received proceeds of $60,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $60,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $31,861 and $28,139, respectively.  At December 31, 2015, the debt discount has been fully amortized to interest expense.

 

On May 20, 2014, we received proceeds of $45,000 pursuant to the April 2014 $500,000 SPA.  We recorded a debt discount of $45,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $26,557 and $18,443, respectively.  At December 31, 2015, the debt discount has been fully amortized to interest expense.

On June 30, 2014, we received proceeds of $200,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $200,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $132,847 and $67,153, respectively.  At December 31, 2015, the debt discount has been fully amortized to interest expense.

On July 18, 2014, we received proceeds of $25,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $16,621 and $7,559, respectively, resulting in a remaining discount of $820 at December 31, 2015.

On August 6, 2014, we received proceeds of $65,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $43,215 and $17,404, respectively, resulting in a remaining discount of $4,381 at December 31, 2015.

On August 18, 2014, we received proceeds of $25,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $16,621 and $6,148, respectively, resulting in a remaining discount of $2,231 at December 31, 2015.

On September 9, 2014, we received proceeds of $56,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $56,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $37,367 and $11,569, respectively, resulting in a remaining discount of $7,064 at December 31, 2015.

On October 8, 2014, we received proceeds of $24,000 pursuant to the April 2014 $500,000 CPN.  We recorded a debt discount of $24,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $15,985 and $3,679, respectively, resulting in a remaining discount of $4,336 at December 31, 2015.

On October 1, 2014, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "October 2014 $500,000 CPN").  The advance amounts received are at the lender's discretion.  The note is convertible into shares of our common stock at a price per share equal to the lesser of: $0.003; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The notes mature eighteen months from the effective date of each advance.

On October 1, 2014, we received proceeds of $65,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $43,294 and $10,794, respectively, resulting in a remaining discount of $10,912 at December 31, 2015.

 

On November 7, 2014, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $20,018 and $2,962, respectively, resulting in a remaining discount of $7,020 at December 31, 2015.

On December 9, 2014, we received proceeds of $25,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the years ended December 31, 2015 and 2014, amortization of debt discount was recorded to interest expense in the amount of $16,651 and $1,004, respectively, resulting in a remaining discount of $7,345 at December 31, 2015.

On January 14, 2015, we received proceeds of $92,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $92,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $59,035, resulting in a remaining discount of $32,965 at December 31, 2015.

On February 10, 2015, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $17,770, resulting in a remaining discount of $12,230 at December 31, 2015.

On March 16, 2015, we received proceeds of $30,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $30,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $15,818, resulting in a remaining discount of $14,182 at December 31, 2015.

On April 17, 2015, we received proceeds of $45,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $45,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $21,148, resulting in a remaining discount of $23,852 at December 31, 2015.

On May 5, 2015, we received proceeds of $65,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $28,364, resulting in a remaining discount of $36,636 at December 31, 2015.

On May 11, 2015, we received proceeds of $40,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $40,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $17,018, resulting in a remaining discount of $22,982 at December 31, 2015.

On June 22, 2015, we received proceeds of $35,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $35,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $12,240, resulting in a remaining discount of $22,760 at December 31, 2015.

 

On June 23, 2015, we received proceeds of $20,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $20,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $6,958, resulting in a remaining discount of $13,042 at December 31, 2015.

On July 9, 2015, we received proceeds of $23,000 pursuant to the October 2014 $500,000 CPN.  We recorded a debt discount of $23,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $7,318, resulting in a remaining discount of $15,682 at December 31, 2015.

On July 13, 2015, we entered into a 10% convertible promissory note with an aggregate principal amount of $500,000 (the "July 2015 $500,000 CPN").  The advance amounts received are at the lender's discretion.  The note is convertible into shares of our common stock at a price per share equal to the lesser of: $0.003; or 50% of the lowest trade price subsequent to the effective date of the note and prior to the conversion; or the lowest effective price per share granted to any person or entity to acquire common stock subsequent to the effective date of the note.  The note, with respect to each advance matures eighteen months from the effective date of each advance.

On July 13, 2015, we received proceeds of $12,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $12,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $3,731, resulting in a remaining discount of $8,269 at December 31, 2015.

On August 7, 2015, we received proceeds of $65,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $65,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $17,255, resulting in a remaining discount of $47,745 at December 31, 2015.

On September 10, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $5,119, resulting in a remaining discount of $19,881 at December 31, 2015.

On October 13, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $3,611, resulting in a remaining discount of $21,389 at December 31, 2015.

On November 13, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $2,194, resulting in a remaining discount of $22,806 at December 31, 2015.

 

On December 9, 2015, we received proceeds of $25,000 pursuant to the July 2015 $500,000 CPN.  We recorded a debt discount of $25,000 related to the conversion feature of the note, along with a derivative liability at inception.  During the year ended December 31, 2015, amortization of debt discount was recorded to interest expense in the amount of $1,005, resulting in a remaining discount of $23,995 at December 31, 2015.

We evaluated the financing transactions in accordance with ASC Topic 815, Derivatives and Hedging, and determined that the conversion features of the convertible promissory notes were not afforded the exemption for conventional convertible instruments due to their variable conversion rate. The notes have no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification.  The Company elected to recognize the notes under paragraph 815-15-25-4, whereby, there would be a separation into a host contract and derivative instrument. The Company elected to initially and subsequently measure the note in its entirety at fair value, with changes in fair value recognized in earnings. The Company recorded a derivative liability representing the imputed interest associated with the embedded derivative. The derivative liability is adjusted periodically according to the stock price fluctuations.

For purpose of determining the fair market value of the derivative liability, we used the Black Scholes option valuation model.  The significant assumptions used in the Black Scholes valuation of the derivative liability at December 31, 2015 and 2014 are as follows:

 

The value of the derivative liability balance at December 31, 2015 and 2014 was $13,184,369 and $9,476,605, respectively.  These assumptions are subject to significant changes and market fluctuations from period to period; therefore, the estimated fair value of the derivative liability will fluctuate from period to period and the fluctuation may be material.  Based on the assumptions used to estimate the fair value of the derivative liability at December 31, 2015 and assuming all lenders convert the notes payable at the December 31, 2015 conversion prices, the Company would have insufficient authorized shares of common stock to complete the debt conversions.

6.  RESEARCH AGREEMENTS AND FORMATION OF SUBSIDIARY

On June 18, 2014, we entered into a Sponsored Research Agreement ("SRA #1") with UCSB, pursuant to which UCSB performed research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #1 included the development of a low-cost and scalable method to produce large-area graphene for transparent electrode applications.  The term of SRA #1 commenced on July 1, 2014 and expired on June 30, 2015.  The total cost to the Company was $387,730, which has been fully paid.  The Company amortized the SRA #1 payments over the life of the contract.  Research and development expenses included $193,865 related to the SRA #1 for each of the years ended December 31, 2015 and 2014.

On December 15, 2015, we entered into another Sponsored Research Agreement ("SRA #2") with UCSB, pursuant to which UCSB will perform research work for the mutual benefit of UCSB and the Company.  The purpose of SRA #2 includes the development of a graphene based optical modulator for the high-speed transmission of digital data in fiber optic networks.  The term of SRA #2 will commence on January 1, 2016 and expire on June 30, 2016.  The total cost to the Company is $65,497.

 

7.  SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION

During the years ended December 31, 2015 and 2014, we paid no amounts for income taxes.

During the years ended December 31, 2015 and 2014, we paid interest of $0 and $18,983, respectively.

During the year ended December 31, 2015, the Company had the following non-cash investing and financing activities:

During the year ended December 31, 2014, the Company had the following non-cash investing and financing activities:

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8.  INCOME TAXES

A reconciliation of the income tax provision (benefit) that would result from applying a combined U.S. federal and state rate of 43% to loss before income taxes with the provision (benefit) for income taxes presented in the financial statements is as follows: