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SHRINK NANOTECHNOLOGIES, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and related notes included in this Report and the "Forward Looking Statements" section in the forepart of this Report (see page ii above) and the "Risk Factors" set forth in our Annual Report filed on Form 10-K for the year ended December 31, 2010, as may be amended or updated from time to time. The statements contained in this Report that are not historic in nature, particularly those that utilize terminology such as "may," "will," "should," "expects," "anticipates," "estimates," "believes," or "plans" or comparable terminology are forward-looking statements based on current expectations and assumptions. No assurance can be made that any of our forward looking statements will materialize as planned. In addition, the below is not intended as a complete business description but rather, supplements and updates information which may be contained in our Annual Report or other reports filed from time to time. Various risks and uncertainties could cause actual results to differ materially from those expressed in forward-looking statements. For ease of reference we use certain defined terms as defined in "Use of Terms" on page iii above, in the forepart of this Report. Background General We are, with our subsidiaries, dedicated to commercializing biotechnology and other high technology intellectual property, know-how and related products, from universities and medium to large commercial businesses, that may be deployed as commercial products or licensing opportunities in the near (immediate to 2 years) and mid-term (2-4 years). We have also recently undertaken a program to seek to acquire small companies (or business segments of larger companies) with developed and ready-to-go-to-market products, strong intellectual property portfolios, management and operational infrastructure. Historically, we have primarily focused our resources in the life sciences market; however, we also have successfully acquired technologies in, for example, the semiconductor space. With all technologies we acquire and allocate our limited resources to, our objective is to develop products and intellectual property resources in order to generate cash flow, and ultimately, value for our shareholders. The Company has undergone, and continues to undergo, marked changes as we transition towards commercialization efforts and liquidate undesired assets. Our business currently consists of four operating units: Cell Culturing Products; Microfluidic Systems and Kits; Special Substrates; and Internal Development and Acquisitions. Our Cell Culturing Unit is dedicated to the commercialization of our stem cell culture platform known as StemDisc® and its related software, as well as NanoShrink® based tissue engineering substrates known for our Cell Align®. Our Microfluidic Systems and Kits business is seeking to market a unique and patented modular microfluidic system we exclusively licensed from Corning Incorporated, as well as a version of NanoShrink® (metal enhanced fluorescence) that will enable the low cost development of two dimensional microfluidic system prototypes. Our Special Substrates business is developing specialized versions of NanoShrink® substrates that have unique surface plasmon resonance capabilities and which may be integrated into existing market leading devices and systems. Our Internal Development and Acquisitions Unit is actively developing technologies that are a part of a development and commercialization program, as well as engaging in due diligence on technologies and businesses we are in the process of evaluating for acquisition purposes. Business Focus The Company intends to direct its focus, and expects to continue to allocate a material portion of its resources, towards (1) the commercialization and development of technologies in its four business units as discussed in greater depth in this Report, and (2) making acquisitions of life sciences companies and high technology companies and technology assets that either supplement or otherwise enhance the Company's core abilities and interests in the life sciences. Assets; Intellectual Property and Research Agreements Our assets include exclusive and non-exclusive patent rights, as more fully described in this Report and in our Annual Report, from agreements with third parties, as follows: · Our exclusive License Agreement with Corning, Inc. (the "Corning License Agreement") wherein the Company licensed the exclusive worldwide right to use and sublicense Corning's patent-pending Modular Microfluidic System and Method for Building Modular Microfluidic System. 14 -------------------------------------------------------------------------------- · Our two Sponsored Research Agreements with the University of California Regents on behalf of University of California, Irvine campus entered into in May 2010 (the "Biosensing Research Agreement"), and in September 2010 (the "EB Research Agreement"), and rights to acquire additional license rights funded by us under these agreements, (the "Sponsored Research Agreements"). Our assets also included, through June 3, 2011, the exclusive License Agreement (the "Chicago License Agreement") between our previously wholly-owned subsidiary BlackBox and the University of Chicago ("Chicago"), wherein BlackBox licensed the exclusive, worldwide right to use and sublicense Chicago's patent-pending Materials and Methods for the Preparation of Nanocomposites (a/k/a "electronic glue" chemistry) for fields of use other than thermoelectric applications. We have completed the sale of our BlackBox subsidiary along with this license to BlackBox Semiconductors, Inc., a Nevada corporation ("BlackBox Parent"). We also entered into other agreements, such as our agreement with the MF3 Consortium, accessing matching funds from MF3's relationship with DARPA. This agreement could provide us with research co-funding agreements as more fully provided below. Finally, we intend to commercialize our assets through relationships with third party manufacturers we contract with. No assurance can be made that the Company will have funds sufficient to further develop and license new technologies or to commercialize the ones we have. We may, from time-to-time and as a result of rights granted in one or more of our (or our subsidiary's) licensing agreements, take a license to inventions (and the related license to domestic and international patent application rights) which result from a sponsored research arrangement or private (non-academic sector) license agreement. Doing so may give Shrink the license rights, but will also trigger the payment of certain fees and various ongoing financial commitments, all of which have been negotiated and are disclosed in the license agreement as provided elsewhere in this Report. The Company regularly reviews its licenses and patents and, as technologies or inventions have been further commercially vetted or newer competing technologies are developed by others, management may determine using its reasonable business judgment, to not continue to support the development of a technology, and may therefore abandon its licensing rights and or intellectual property rights (if not otherwise licensed) with respect to that technology, invention and the related license. The Company may, from time to time, abandon intellectual property rights which it formerly thought would be valuable or which may still have some value but would be too expensive to maintain. These same abandoned intellectual property rights may have been a part of a public announcement and even been a key part of the Company's operational strategy. Abandonment or an outright termination of a license to a particular invention may occur more often as Shrink acquires more IP rights, and the same inventions are commercially vetted. License or patent rights may also be abandoned based on no other reason other than limited capital or the Company's need to expend its capital on other vital needs. To the extent the Company abandons such non-critical IP rights, the Company may not file a specific abandonment notice. During late 2010, we terminated our research agreement with the UC Merced and the related license agreement with the UC Regents, as management felt that, given our limited funds, the costs of these agreements were cost prohibitive and were yielding unsuccessful results while viable alternative technologies were found elsewhere. As a result, we lost any patent license rights associated with these agreements. The Company has dissolved its Shrink Solar, LLC entity which had no revenues or assets. In March 2011, we entered into an agreement in principle to transfer our BlackBox Semiconductor, Inc. subsidiary (the "BlackBox Subsidiary") to a separate public company as the BlackBox business will require different management and commercial resources and relationships, as well as significant amounts of capital and time to commercialize products. On June 3, 2011, we finalized the agreement with BlackBox Semiconductor, Inc., f/k/a Visitrade, Inc., a Nevada corporation, a publicly traded company, (the "BlackBox Parent"), as purchaser, for the exchange of all of the shares of BlackBox Subsidiary from the Company (the "Share Exchange"). 15 -------------------------------------------------------------------------------- The material terms of the Share Exchange were: Shrink Nanotechnologies, Inc. issued 14,000,000 shares of restricted common stock to BlackBox Parent and 100% equity interest in BlackBox Subsidiary. In exchange, Shrink Nanotechnologies, Inc. will receive $75,000 cash payable prior to December 31, 2011, and 27,030,000 shares of BlackBox Parent, representing approximately 19.9% of BlackBox Parent's equity. The cash received from the transaction shall be used to recover costs Shrink Nanotechnologies, Inc. invested into BlackBox Subsidiary. Shares of BlackBox Parent will either be sold or spun off to shareholders in whole or in part pursuant to an effective registration statement, as may be determined by the board at a later date, if and when such shares become liquid. The primary asset of the BlackBox Subsidiary includes an exclusive License Agreement (the "Chicago License Agreement") with the University of Chicago, granting to BlackBox Subsidiary the exclusive, worldwide right to use and sublicense Chicago's patent-pending Materials and Methods for the Preparation of Nanocomposites (US PTO Application No. PCT/US10/32246, and provisional applications 61/214,434 and 61,264,790) and future patent applications filed by the University of Chicago based on certain other patentable technologies described in the Chicago License Agreement. Discussion of Business Strategy; Short Term Goals Although management constantly monitors market trends, as well as available capital and has in the past, and continues to, refine and re-prioritize the Company's goals, so as to attain commercialization as quickly as possible, the goals we will need to attain for our various businesses are currently: (1) commercialization of existing and newer versions of StemDisc®, Cell Align® and NanoShrink® products; (2) entering into a joint development agreement to commercialize the Corning microfluidic system; (3) joint development of certain materials from our Special Substrates business unit; and (4) entering into technologically accretive and synergistic acquisitions. We acquired our assets and rights by using a business model that has inexpensively allowed us to license technologies from two primary sources: (1) university laboratories, and (2) "secondary" technologies from very large industrial businesses. Traditionally and historically, university engineering labs have been used as commercial resources for venture capital organizations and other funding sources looking for high quality low cost technology. We have also recently undertaken a program to develop commercial relationships with larger, multi-national United States-based industrial companies in order to potentially work with their technologies and products which have been abandoned or "orphaned" for one or a number of reasons - primarily due to a limited market opportunity or limited funding at the time of abandonment. We are actively seeking to develop licensing agreements in this regard to provide the right to develop and market these "orphaned" technologies and product lines. In addition to our licensed technologies, we may develop technologies on our own as a result of our research or joint development activities. We also have developed a Science Advisory Board ("SAB"). Through the relationships with our SAB members, we have the exclusive right to certain intellectual property rights derived from their respective work for the Company. To date, we have not filed any applications to protect intellectual property rights derived from work provided to the Company by a member of the SAB. Nonetheless, much of the Company's scientific decision making process is guided in part by our SAB members. We also intend to review, and as such opportunities present themselves, seek to acquire synergistic assets and businesses, although these are not within the Company's primary initial focus as management believes that initial development, manufacturing and commercialization will be most economical through joint venture or third party OEM manufacturers we contract. Sponsored Research Agreements with UCI Sponsored Research Agreement with UC Regents (September 2010) As of September 22, 2010, Shrink entered into the EB Research Agreement with UC Regents on behalf of the Irvine Campus. The EB Research Agreement was for a term of three months, retroactively beginning August 1, through October 31, 2010. Although the term end date has passed, this agreement has not been terminated and work is ongoing with the project based on a good faith between the two parties. The EB Research Agreement was terminable by the Company or UCI subject to satisfying the appropriate notice requirements required under the agreement. 16 -------------------------------------------------------------------------------- The EB Research Agreement provided, among other things, that the Company sponsor specified research relating to the development of a complete system for culturing, imaging, and digitizing a large number of embryoid bodies (EBs) in custom-designed microfluidic devices, including developing protocols for staining and imaging EBs in 3-D. In addition, the research involved specifying and testing a suitable hardware/software platform for collecting images in a high-throughput setting. Regarding any inventions, discoveries or other commercially useful research products that may arise from research being conducted under the SRA, we will have a time-limited, first right to negotiate an exclusive license of such things with UCI. The Company's research sponsorship obligations require it to provide funding (which may be from the Company or other third parties) totaling up to $67,040 during the three month term of the EB Research Agreement. To date the Company has paid $5,000, and at June 30, 2011 owes $0 under this agreement. No assurance can be made that the Company will attain the funding necessary to fulfill its funding obligations under the SRA or, that the research performed will necessarily produce commercially viable new inventions. In addition, in the event that discoveries are made, no assurance can be made that the Company will be able to fund commercialization of these technologies or that it will exercise its right to an exclusive license of these products. Sponsored Research Agreement with UC Regents (May 2010) As of May 3, 2010, Shrink Parent entered into the Sponsored Research Agreement or, the "Biosensing Research Agreement", with UC Regents on behalf of UCI. The Biosensing Research Agreement is for a term of three years or such time as the research is completed, whichever is longer. The Biosensing Research Agreement may be terminated by the Company subject to satisfying appropriate notice requirements required under the agreement. The Biosensing Research Agreement provides, among other things, that the Company will sponsor specified research relating to development of (i) integrated, manufacturable, nanostructured substrates for biosensing and testing of new bioassays as well as assessing viability of other shrinkable materials, and (ii) stem cell tools that use shrinkable plastic microfluidic technologies, each as more fully provided in the Biosensing Research Agreement. The Biosensing Research Agreement provides that the Historically, we have spent far less than the amounts we are otherwise committed to under the UCI Biosensing SRA. We have exclusive access to license intellectual property from the Biosensing Research Agreement beginning from July 1, 2009 forward according to the terms of the Biosensing Research Agreement. Obligations under Biosensing Research Agreement The Company's research sponsorship obligations require it to provide funding (which may be from the Company or other third parties) totaling $632,051 during the three year term of the Biosensing Research Agreement. To date the Company has paid $20,000 to the UC Regents and owes additional sums under this agreement. The Company does not have any capital commitments to satisfy the required cash payments under this contract. Any funding amounts under the Biosensing Research Agreement are subject to adjustment down based on actual expenditures on the research. Additional IP that is subject to our license rights under the UCI Biosensing SRA includes both research performed under the specified work order of the UCI Biosensing SRA, as well as discoveries developed between July 2009 and May 3, 2010 by Dr. Michelle Khine that name Dr. Khine as primary inventor, and which are not under pre-existing obligations to third parties. We are also required to indemnify UC Regents and certain affiliates from losses and claims stemming from the agreement. The Biosensing Research Agreement provides that in the event that we desire to license Additional IP, if any is discovered, such license must be pursuant to license terms annexed to the Biosensing Research Agreement (the "UCI Biosensing License"). We are not required to pay an initial license issue fee, and the terms of the annual license fee is $5,000 for rights to each Additional IP license we acquire, with an overall license maintenance fee of $10,000 per annum commencing the fourth year after entry into the license (the "License Date"). In addition, we will be required to pay a fee of 30% of certain income generated from third party sublicenses of the Additional IP that are covered under the UCI Biosensing License, as well as royalty payments of: 2.5% of net sales where the first sale occurs within three years after the License Date; 4% of net sales where the first sale occurs between three and six years after the License Date; and 5% of net sales where the first sale occurs beyond six years after the License Date. In each case, the minimum earned royalty payment paid shall be $15,000 commencing the year of the first commercial sale of the Additional IP licensed, subject to increase, if and as we expand the UCI Biosensing License to include additional patents from time to time. With respect to any patent comprising the Additional IP, UC Regents reserves the right to utilize such intellectual property in connection for educational and research purposes, including research conducted for other sponsors. A copy of the UCI Biosensing SRA License is included as an annex to the Biosensing Research Agreement, filed as an exhibit to our public filings, and is incorporated by reference herein. 17 -------------------------------------------------------------------------------- Results of UCI Biosensing Research To Date To date, the Biosensing Research Agreement has led to two patent applications being filed with the USPTO. We do not have any commitments for financings or grants for this agreement and no assurance can be made that the Company will attain the funding necessary to fulfill our funding obligations under the Biosensing Research Agreement or, that the research performed will necessarily produce commercially viable new inventions. In addition, in the event that discoveries are made, no assurance can be made that the Company will be able to fund commercialization of these technologies or that it will exercise its right to an exclusive license of these products. License Agreement with University of Chicago - Sold Effective June 3, 2011, following the Share Exchange involving our BlackBox Subsidiary the License Agreement with the University of Chicago is no longer a part of our operations and business focus. Agreements Terminated in 2010 During 2010 the Company terminated certain agreements for economic reasons and because alternative resources were available. These terminated agreements include: Our original microfluidics research agreement with the University of California, Merced, originally entered into in May of 2009, and the underlying Exclusive License Agreement with the UC Regents, Merced, for Processes for Microfluidic Fabrication and Other Inventions. We no longer rely on these patents or intellectual property rights. Nonetheless, the Company still owns and maintains its rights to the ShrinkChip® related trademarks, which were not part of the terminated agreement. The Company will not be refunded its initial research and license fees paid (amounting to $90,985 and 495,500 shares issued to date), and the Company has certain additional further material liabilities under this agreement relating to patent filing legal prosecution costs or development fees of up to $234,000, which are subject to dispute. In addition, the Company is required to cover certain legal patent costs during the 90- day period after termination. Because the Company no longer is focusing on its solar segment, the Company also terminated its Strategic Marketing and Development Agreement (the "Marketing Agreement") with Inabata America Corporation. This agreement provided for the appointment of Inabata as the Company's non-exclusive representative for the purposes of marketing and promoting the Company's solar concentrator technology and ShrinkChip™ RPS solar products to third parties (the "Solar Products"). Critical Accounting Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The significant accounting policies that are believed to be the most critical to fully understanding and evaluating the reported financial results include recoverability of intangible assets, the recovery of deferred income tax assets and share-based compensation. Our intangible assets consist principally of intellectual properties such as trademarks. Shrink continues to make the required legal filings and uses of the trademarks, the trademarks have an indefinite life, therefore there is no amortization. The Company will re-evaluate its amortization practice once products related to these trademarks are put into full production. When our products are placed in full production we can better evaluate market demand for our technology. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or indicate that impairment exists. Once our intellectual property is placed into productive service, we expect to utilize a net present value of future cash flows analysis to calculate carrying value after an impairment determination. 18 -------------------------------------------------------------------------------- As part of the process of preparing our consolidated financial statements, we must estimate our actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheet. We must assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, a valuation allowance must be established. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, the impact will be included in the tax provision in the statement of operations. The Company strives to save liquid capital by paying for services or satisfying liabilities, whenever able, by issuance of stock and stock options to consultants and services providers. We also grant stock options, restricted stock units and restricted stock to directors and consultants under the Company's 2010 Equity Incentive Plan. We measure compensation cost for all stock-based awards at fair value on date of grant and recognize compensation over the requisite service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of our common stock on the date of grant. The determination of grant-date fair value for stock option awards is estimated using a Black-Scholes model, which includes variables such as the expected volatility of our share price, the anticipated exercise behavior of our employees, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense recognized for share-based payments. Such value is recognized as an expense over the requisite service period, net of estimated forfeitures, using the straight-line attribution method. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts are recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Recent Events Share Exchange BlackBox The discovery, funding and procurement of the Chicago License Agreement was initially funded by Noctua Fund, L.P., which is a creditor of the Company and affiliated with members of management, so as to provide the Company with the first opportunity to capitalize on this asset. The Company, after much research and negotiation, believed that it will take too long and require too much additional capital in a segment that is not currently within the Company's core business focus and therefore determined to transfer BlackBox to another entity affiliated with management, at a price and terms negotiated by independent members of the board of directors. We therefore entered into an agreement to transfer the business and Chicago License Agreement, with a separate public company. Shrink negotiated a sale price of $75,000, made a seed investment into BlackBox, and retained approximately 19.9% of the BlackBox parent company after the share exchange, among other benefits. The payment of the $75,000 is pending and is expected to be received prior to 2011 year end. LOI to Acquire Nanopoint and Termination of the Same We recently executed a binding letter of intent with Nanopoint, Inc., a Hawaii-based life sciences instrumentation business. This event was reported in a Form 8-K filed with the SEC on April 12, 2011. The transaction with Nanopoint, was subject to numerous closing conditions, and was to close by May 31, 2011, presuming all conditions, including a financing contingency, are met or waived. Following our due diligence, the transaction was terminated as of May 31, 2011. Corporate History and Structure We were incorporated in the state of Delaware on January 15, 2002 as Jupiter Processing, Inc. On January 13, 2005, the Company changed its name to Audiostocks, Inc. On May 14, 2009, the Parent company changed its name to Shrink Nanotechnologies, Inc. in anticipation of its acquisition of Shrink Technologies, Inc. On May 29, 2009, the Company entered into and completed a share exchange agreement with the former principals of Shrink Technologies, Inc., for the acquisition of Shrink. The exchange of shares with Shrink's owner has been accounted for as a reverse acquisition under the purchase method of accounting with the business of Shrink Technologies, Inc. as the surviving company for accounting and financial reporting purposes. As of December 31, 2010, Shrink determined that all future economic benefit will be derived from operations that existed as of that date, and all prior operating assets were fully impaired. 19 -------------------------------------------------------------------------------- Below is a chart of our organizational structure: [[Image Removed: [shrink10q063011002.jpg]]] The Company has negotiated a share exchange of our BlackBox business and will retain approximately 19.9% of the equity in the post-transaction business (pre dilution). Our common stock is quoted on the OTC Market under the symbol "INKN." Our principal operational offices are located at 4100 Calit2 Building, Irvine, CA 92697-2800. Our principal corporate contact is Mark L. Baum, Esq. who may be reached at (858)751-7374. Mr. Baum does not work on Shrink activities on a full time basis. Our main corporate website is www.shrinknano.com. Results of Operations for the Three and Six Months Ended June 30, 2011 and 2010 Revenue The Company, recorded $1,818 in revenues for the three and six months ended June 30, 2011, and no revenues, as compared to the same periods in 2010. The revenues recorded in 2011 are related to a service contract signed in May 2011. Shrink was due $10,000 at signing of the contract, which is being recognized throughout the length of the contract, and is eligible to receive future milestone payments of up to $40,000 due upon the delivery of specified services. Operating Expenses Shrink had total operating expenses of $431,461 for the six months ended June 30, 2011 as compared to $2,597,369 for the same period in 2011. For the three months ended June 30, 2011 Shrink had total operating expenses of $197,867 and $1,199,126, as compared to the same period in 2010. We expect operating expenses to continue to decrease as we look for new ways of conserving cash flow, focus in on our core business operations and invest further into those related research and development activities. General and Administrative Expenses. Our general and administration expenses decreased to $275,097 for the six months ended June 30, 2011, as compared to $2,347,269 for the same period in 2010 and $124,054 for the three months ended June 30, 2011, as compared to $1,051,277 for the same period in 2010. This decrease was mainly due to a significant reduction in consulting contracts the Company had engaged in during 2010 that were not renewed in 2011. In 2010, the Company switched its focus from developing and acquiring intellectual property, to the development of products derived from the intellectual property. As a result, the Company hired several consultants to help bring those products to a point of commercialization. With our products in final stages of testing we did not feel the need to renew these contracts and incur the additional fees. The costs of hiring these consultants were a significant part of the higher amount of general and administrative expenses in 2010. 20 -------------------------------------------------------------------------------- Professional Fees. Professional fees are generally related to public company reporting and governance expenses as well as costs related to our acquisitions. Our costs for professional fees increased slightly to $86,248 for the six months ended June 30, 2011, as compared to $84,663 for the same period ended in 2010 and decreased to $37,661 for the three months ended June 30, 2011, as compared to $56,044 for the three months ended June 30, 2010. The slight change was due to a reduction in legal costs during the three months ended June 30, 2011 and an increase in accounting fees for the six months ended June 30, 2011. Depreciation and Amortization. Our depreciation and amortization expenses decreased to $5,105 for the six months ended June 30, 2011, as compared to $32,296 for the same period ended in 2010 and $2,582 in the three months ended June 30, 2011, from $19,698 in the same period ended June 30, 2010. The decrease in depreciation and amortization expenses was mainly due to the impairment of our Stockvert assets occurring near the end of our fiscal year ended December 31, 2010 and the Share Exchange of our BlackBox subsidiary. Interest Expense. Interest expense decreased to $197,553 for the six months ended June 30, 2011, as compared to $276,757 for the same period ended in 2010 and $60,620 in the three months ended June 30, 2011 from $166,147 in 2010, primarily due to the decrease in convertible note issuances and the expense recognition of the subsequent debt discount accretion. We expect operating expenses to continue to decrease as we begin to weed out potential unnecessary costs, focus on our core technologies and their product development. We do not have capital commitments yet to cover any of our operating expenses. To date, our capital needs for Shrink have been funded by primarily through restricted stock issuances and private convertible debt financing. We have limited cash on hand, and to the extent we are able to negotiate with parties with whom we enter into business agreements with to accept stock in lieu of cash, these issuances could dilute the ownership of our shareholders. Discontinued Operations - BlackBox The Company, after much research and negotiation, believed that it will take too long and require too much additional capital in a segment that is not currently within the Company's core business focus and therefore determined to transfer our interest in BlackBox to another entity affiliated with management, at a price and terms negotiated by independent members of the board of directors. We therefore finalized an agreement on June 3, 2011 to transfer the business and Chicago License Agreement, with a separate public company. We do not currently incur material expenses related to BlackBox. No assurance can be made that we will be successful in monetizing any value from the BlackBox Parent shares received in the transaction or that said shares will exhibit liquidity. Because we no longer operate in this segment, management believes that extensive disclosure on this business is not material to an understanding of our core business and therefore meaningful to investors. Accordingly, the focus of this Report is on our ongoing Shrink related research and development business and business plans. Net Loss For the six months ended June 30, 2011, we had a net loss of $631,988 as compared to $2,874,126 for the same period ended in 2010 and $258,444 net loss for the three months ended June 30, 2011 as compared to a net loss of $1,365,273 for the period ended June 30, 2010. Management attributes the decrease in net loss mainly due to a significant reduction in consulting contracts the Company had engaged in during 2010 that were not renewed in 2011. In 2010, the Company switched its focus from developing and acquiring intellectual property, to the development of products derived from the intellectual property. As a result, the Company hired several consultants to help bring those products to a point of commercialization. With our products in final stages of testing we did not feel the need to renew these contracts and incur the additional fees. The costs of hiring these consultants were a significant part of the higher amount of general and administrative expenses in 2010. We anticipate continued losses relating to investment into our research and development activities relating to Shrink, and to our capital raising activities. We intend to fund our R&D activities, through potential government grants, partnerships and arrangements with universities (such as those that are in effect with the University of California Regents) and equity and debt financings. 21 -------------------------------------------------------------------------------- Liquidity and Capital Resources Our cash on hand at June 30, 2011, and December 31, 2010, was $845 and $2,131, respectively. The decrease in cash is primarily attributable to a decrease in financing commitments made during the six months ended June 30, 2011. Management has been primarily focused on product development and commercialization of products. As a result, management neglected to spend significant time, as compared to prior years, raising capital through the equity and debt financings. Given our current commitments and working capital, we cannot support our operations for the next 12 months without additional capital (See "Need for Additional Capital" below). Historically, our largest shareholders have provided operating capital, and therefore we are extremely reliant on their continued support. However, there can be no assurance that the same historical support will be made available going forward. The following table provides detailed information about our net cash flow for all financial statement periods presented in this Report. Cash Flow (All amounts in U.S. dollars) The Six months Ended June 30, 2011 2010 Net cash used in operating activities $ (149,683) $ (426,932) Net cash used in investing activities (1,853) (39,845) Net cash provided by financing activities 150,250 535,000 Net Increase (Decrease) in Cash and Cash Equivalents (1,286) 68,223 Cash and Cash Equivalent at Beginning of the Year 2,131 58,539 Cash and Cash Equivalent at End of the Year $ 845 $ 126,762 In early May, 2010, through our entry into a Consortium Agreement with Micro/Nano Fluidics Fundamentals Focus MF3 Center, as led by the University of California at Irvine, our research qualified to receive matched funding from Defense Advanced Research Projects Agency, as described above. Under the policies of the consortium agreement the Company's funded research projects are eligible to receive matched funding on a dollar-for-dollar basis, for each dollar we invest in certain qualifying projects. Since we are dependent on our ability to raise additional capital for our research, no assurance can be made that we will be able to utilize this funding source. Even if we do raise additional capital, no assurance can be made that we will dedicate it towards those same research projects that qualify for DARPA matching funds. Our expectations are based on certain assumptions concerning the anticipated costs associated with any new projects. These assumptions concern future events and circumstances that our officers believe to be significant to our operations and upon which our working capital requirements will depend. Some assumptions will invariably not materialize and some unanticipated events and circumstances occurring subsequent to the date of this Report. A portion of our research is being conducted by the University of California, through grants. We will continue to seek to fund our capital requirements over the next 12 to 24 months from the additional sale of our securities; however, it is possible that we will be unable to obtain sufficient additional capital through the sale of our securities as needed. As part of the Company's business plan and when feasible, it regularly elects to pay consulting and professional fees in stock, as opposed to cash, so as to preserve capital. In particular, between April and July 2010, the Company issued an aggregate of 1,602,197 shares of restricted common stock to five consultants and professional service providers for services rendered, some of which covers services rendered through mid 2010. The Company recognizes, however, that share issuances are highly dilutive to investors and existing shareholders and, not all service providers are willing to accept share compensation in lieu of cash. Accordingly, the Company is required to expend funds regularly for services. The amount and timing of our future capital requirements will depend upon many factors, including the level of cash needed to continue our research program, fulfill our obligations under license agreements, or fund initial production efforts. We intend to retain future earnings, if any, to retire any existing debt, finance the expansion of our business and any necessary capital expenditures, and for general corporate purposes. The Company estimates that it will cost approximately $6,000,000 in deficit cash flows through 2014 until sustained potential profitability, and that substantial additional costs will be incurred in order to commercialize its Shrink related technologies. The Company is not aware as to how much, if any, of these funds will be obtainable from private parties, government grants and/or offset by joint venturing development of our products. 22 -------------------------------------------------------------------------------- Operating Activities Net cash used in operating activities was $149,683 for the six months ended June 30, 2011, as compared to $426,932 used in operating activities during the same six month period in 2010. The decrease in net cash used in operating activities was mainly due to management minimizing certain administrative expenses and rent costs, lengthening our accounts payable policy and eliminating any expenses that no longer focused on our core technologies. Investing Activities Net cash used in investing activities for the six months ended June 30, 2011 was $1,853 as compared to $39,845 net cash used in investing activities during the six months ended June 30, 2010. The decrease in net cash used in investing activities was mainly due to the termination of our license agreement with the Regents representing the University of California - Merced campus and the BlackBox Share Exchange. Financing Activities Net cash provided by financing activities for the six months ended June 30, 2011 was $150,250 as compared to June 30, 2010 which was $535,000. The decrease of net cash provided by financing activities was mainly attributable to financing efforts made by management during the first six months of 2010 in order to obtain certain assets, maintain current business operations and research and development activities. During the six months ended June 30, 2011, the Company issued a 14% $60,000 convertible note payable to Noctua Fund, LP, an affiliate, which is convertible at $.17 per share, in exchange the Company received $60,000 cash. The Company also received cash in the amount of $70,000, to purchase 411,764 shares of the Company's restricted common stock. To date, a material portion of our operations, and of the operations of our Shrink subsidiary, have been funded by certain members of management and Noctua Fund, LP, which is an affiliate of Messrs. Baum and Panther, our current directors. Specifically, and without limitation, Noctua Fund, LP loaned the Company over $238,000, as represented by the 14% convertible promissory notes, convertible at $.04 per share; and the above mentioned $60,000 14% convertible promissory note, convertible at $.17 per share, to fund operations. Interest to date on the notes exceeds $66,600 and all of the foregoing notes to Noctua are in default. During the six months ended June 30, 2010, the Company raised $535,000 through Convertible Note and Series A Warrant financing. To date, the Company has raised a total of $635,000 through Convertible Note and Series A Warrant financing beginning in November 2009 through April 2010. Further, we have raised an additional $117,000 through a Convertible Note and Series B Warrant financing in November 2010, with gross proceeds to the Company of $752,000. The Company has issued over 6,406,900 shares as a result of conversions of some of these notes and their accrued interest totaling $639,993 (or principal balances of $575,000 and accrued interest amounts of $64,993). Currently, approximately $177,000 is outstanding under these notes, which accrues interest at 12% and started becoming due commencing mid February 2011. Our expectations are based on certain assumptions concerning the anticipated costs associated with any new projects. These assumptions concern future events and circumstances that our officers believe to be significant to our operations and upon which our working capital requirements will depend. Some assumptions will invariably not materialize and some unanticipated events and circumstances occurring subsequent to the date of this Report. A portion of our research is being conducted by the University of California. We will continue to seek to fund our capital requirements over the next 12 months from the additional sale of our securities; however, it is possible that we will be unable to obtain sufficient additional capital through the sale of our securities as needed. The amount and timing of our future capital requirements will depend upon many factors, including the level of funding received by us anticipated private placements of our common stock and the level of funding obtained through other financing sources, and the timing of such funding. We intend to retain any future earnings to retire any existing debt, finance the expansion of our business and any necessary capital expenditures, and for general corporate purposes. The Company estimates that it will cost approximately $6,000,000 in deficit cash flows until sustained potential profitability, and that substantial additional costs will be incurred in order to commercialize its Shrink related technologies. 23 -------------------------------------------------------------------------------- Trends We anticipate that, for the foreseeable future, our ability to attain conventional bank or secured financing for our products will be difficult as a result of our limited fungible assets and banking constraints that limit commercial loans available to weaker balance sheet companies like Shrink. We are a cash-deprived company and must secure cash in order to operate going forward. Capital raising activities will likely be dilutive to our shareholders. Historically, our largest shareholders have provided operating capital, and therefore we are extremely reliant on their continued support. However, there can be no assurance that the same historical support will be made available going forward. Contractual Obligations The Company (on its own or through its subsidiary) was a party to a license agreement with the UC Regents and sponsored research agreements with the UC Regents and more recently, Corning Agreement mentioned above and incorporated herein, as well as to its Strategic Marketing Agreement described above and incorporated by reference herein. The Company does not have all of the funds necessary to fund these agreements or to commercialize its products and no assurance can be made that it will raise the capital necessary to do so. The Company also enters into agreements with science consultants and professional service providers calling for payment by issuance of stock in lieu of cash, where able. Some of these agreements call for cash payments at hourly rates as well, if and as needed and with prior consent of the Company. The Company has not yet, approved hourly cash payments to consultants, but intends on doing so if and as our cash availability increases. Sublease with Business Consulting Group Unlimited, Inc. - Terminated The Company subleased space from Business Consulting Group Unlimited, Inc., an entity owned by Panther and Baum, pursuant to which the Company leased approximately 3,000 square feet of office and administrative space, as well as use of, among other things, internet, postage, copy machines, electricity, furniture, fixtures etc. at a rate of $6,000 per month. The lease with Business Consulting Group Unlimited, Inc. expired April 30, 2010, and continued as a month to month tenancy thereafter. The lease agreement was terminated on January 31, 2011. As of June 30, 2011, $7,333 was owed to Business Consulting Group Unlimited, Inc. and during the six months ended June 30, 2011, $16,667 had been paid to Business Consulting Group Unlimited, Inc. This liability is recorded as due to related parties on our balance sheets. Operating Agreement and Services with BCGU, LLC On May 29, 2009, the Company signed an operating agreement with BCGU, LLC, an entity indirectly controlled by James B. Panther, and Mark L. Baum, Esq., who are two of our directors and majority control persons, for a fee of $6,000 per month. During October 2009, the Company amended the Operating Agreement with BCGU, LLC. The amended Operating Agreement ("the "Amended Operating Agreement") allows us to retain certain day-to-day administrative services and management in consideration of a monthly fee of $30,000 per month. The Amended Operating Agreement also included a $270,000 signature bonus. Effective as of January 31, 2011, we entered into the Second Amended Operating Agreement (the "Second Amended Operating Agreement") with BCGU, LLC which amended the terms of the previously existing First Amended Operating Agreement among the parties, entered into on October 1, 2009. The Amended Operating Agreement provides for a term ending in October 1, of 2012 and provides for services to be provided that include day to day management, provision of bookkeeping and accounting personnel and administrative support staff as well as record keeping and accounting maintenance, in exchange for a new and lesser fee of $20,000 per month. The Company was indebted to BCGU under the old agreement, in the amount of $615,000 which continues to be due and payable as of the date of the Second Amended Operating Agreement. There is an option within the Second Amended Operating Agreement that allows BCGU, LLC to convert outstanding payables related to the Operating Agreements into a convertible note. On April 6, 2011, BCGU, LLC exercised its right to memorialize its debt in note form. As a result the Company issued BCGU, LLC a 4% convertible promissory note with a principal balance of $675,000 (representing all unpaid accrued fees beginning in May 2009 through April 2011 under this agreement), that is convertible at $.06 per share and matures on April 6, 2012. For the six months ended June 30, 2011, $121,000 had been paid to BCGU, LLC under the operating agreement and there was $40,000 owed to BCGU, LLC at June 30, 2011 (excluding amounts due under the 4% convertible note). This liability is recorded as due to related parties on our balance sheets. Because BCGU, LLC is (i) substantially managing the affairs of the company, (ii) is familiar with the affairs of the Company and its strategic direction, (iii) is receiving minimal cash compensation for its efforts and is deferring most payments, the Company believes that the transactions are no less favorable to the Company than would otherwise be available from independent third parties. The Company has incurred debt and obligations to entities directly owned by or otherwise controlled by two of our founders, Mark L. Baum and James B. Panther, in order to fund its operations, as discussed above and elsewhere in this report. The notes and related obligations to these founders are disclosed throughout this Report, particularly in the Risk Factors section of this report. 24 -------------------------------------------------------------------------------- Agreements for Consulting Services The Company strives to save liquid capital by paying for services or satisfying liabilities, whenever able, by issuance of stock to consultants, services providers and consultants. The issuance of restricted stock in lieu of cash payment sometimes requires that the company pay a premium for such services. Management believes, nonetheless, that given credit crisis, and difficulty in raising capital for R&D companies such as our own, that the benefits of issuing restricted stock for services outweigh the downside in that it leaves cash available to satisfy debts with vendors where able. Below is a list material agreements entered into with consultants for services, all of which consultants are independent parties. In January 2011, pursuant our 2010 Stock Incentive Plan, the Company issued 750,000 shares valued at $95,625 to Heiner Dreismann, a member of our Board of Directors, for services rendered and as an incentive to remain on the board with the Company. As a result of the Mr. Dreismann's issuance there are 24,250,000 remaining shares authorized for issuance pursuant to the 2010 Stock Incentive Plan. In February 2011, the Company issued 140,000 shares valued at $16,330 for payment of professional services provided during the year ended December 31, 2010 and thru February 2011. In April 2011, the Company issued 40,000 shares valued at $3,740 for payment of professional services provided during the months of March and April. In April 2011, the Company issued 102,041 shares valued at $10,000 for payment for consulting services and due diligence research related to certain biotech and biomedical businesses during the month April. In June 2011, the Company issued 14,000,000 shares as part of the BlackBox Share Exchange (see Note 2 in the Notes to the Consolidated Financial Statements.) and recorded an equity subscription receivable in amount of $75,000. In July 2011, the Company issued 411,764 shares in exchange for $70,000 received in March 2011. In July 2011, the Company issued 99,999 shares valued at $7,470 for payment of professional services provided during the months of May, June and July. In August 2011, the Company issued 218,003 shares valued at $18,000 for payment to a consultant for research and development services provided during the months of February through July. Some of the agreements under which these shares were issued were not originally committed to writing and were entered into based on an oral agreement between the independent contractor(s) and a company representative and subsequently memorialized. These shares are cancellable based on performance of said independent contractor. The foregoing agreements do not require us to make further issuances (except for the issuances for professional services which continue insofar as such persons continue to provide services and agree to accept shares in lieu of cash payment. The foregoing are the material terms of the foregoing agreements, copies of which, to the extent material, are annexed as exhibits to this Report. All stock issuances are subject to Board approval. In addition, any transactions with affiliates or management, such as the BlackBox Share Exchange as well as any operating agreement or other agreement with affiliates, are subject to approval by the disinterested (unconflicted) board members. Recent Accounting Pronouncements We are not aware of any additional pronouncements that materially affect our financial position or results of operations. Properties The Company subleased space from Business Consulting Group Unlimited, Inc., an entity owned by two of our directors, James B. Panther, and Mark L. Baum, Esq. pursuant to which the Company leases approximately 3,000 square feet of office and administrative space, as well as use of, among other things, internet, postage, copy machines, electricity, furniture, fixtures etc. at a rate of $6,000 per month. The lease with Business Consulting Group Unlimited, Inc. was terminated during this past quarter, as of January 31, 2011. 25 -------------------------------------------------------------------------------- In September 2010, we entered into a lease for laboratory space with the University of California, Irvine (UCI) TechPortal™ technology facilitator center, which lease commenced November 1, 2010. The lease provides approximately 150 square feet of laboratory space and certain equipment and shared office space that will be used for our UCI developed patents under the UCI Biosensing SRA. The lease is for a minimum of six (6) months and may be extended for another 24 months and may be extended thereafter by the discretion of the parties, and provides for rent of $5,400 per year with each party required to bear the costs of their own insurance and related expenses. We did not effectively commence utilizing this space until November 2010, and in January, 2011 we moved our corporate headquarters to this location. The Company is currently occupying the space on a month-to-month basis. The foregoing are the material terms of our lease with the UCI Tech Portal, a copy of which is attached as an Exhibit to our Current Report Form 8-K, Filed November 1, 2010, the provisions of which are incorporated by reference herein. On August 1, 2011, Shrink commenced a new lease for 700 square feet of office space. The term of the lease is through March of 2012. The cost of the lease is $1,500 per month including electricity costs. Hedging and Derivative Activities As at June 30, 2011, and, at June 30, 2010, we have not entered into any type of hedging or interest rate swap transaction. We do not have any foreign operations or research activities, and, management believes, we do not have exposure to financial product risks. Need for Additional Capital As indicated above, management does not believe that the Company has sufficient capital to sustain its operations beyond 12 months or commercializing its technologies without raising additional capital. We presently do not have any available credit, bank financing or other external sources of liquidity. Accordingly, we expect that we will require additional funding through additional equity and/or debt financings. However, there can be no assurance that any additional financing will become available to us, and if available, on terms acceptable to us. The conversion of our outstanding notes and exercise of our outstanding warrants into shares of common stock would have a dilutive effect on our common stock, which would in turn reduce our ability to raise additional funds on favorable terms. In addition, the subsequent sale on the open market of any shares of common stock issued upon conversion of our outstanding notes and exercise of our outstanding warrants could impact our stock price which would in turn reduce our ability to raise additional funds on favorable terms. Any financing, if available, may involve restrictive covenants that may impact our ability to conduct our business or raise additional funds on acceptable terms. If we are unable to raise additional capital when required or on acceptable terms, we may have to delay, scale back or discontinue our expansion plans. In the event we are unable to raise additional capital we will not be able to sustain any growth or continue to operate. Effects of Inflation Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor the price change and continually maintain effective cost control in operations. Off Balance Sheet Arrangements We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities. Seasonality Our operating results and operating cash flows historically have not been subject to seasonal variations. This pattern may change, however, as a result of new market opportunities or new product introductions. |