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TMCNet:  CARBON SCIENCES, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

[March 31, 2014]

CARBON SCIENCES, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

(Edgar Glimpses Via Acquire Media NewsEdge) 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 prospectus.


Our Company Carbon Sciences is in the early stages of developing a complete small-scale natural gas-to-liquids ("GTL") fuel production plant (the "miniGTL plant" or the "Plant"). We anticipate the miniGTL plant will be based on integrating and optimizing existing GTL technology components and processes into a modular diesel or gasoline production facility. We believe developing the Plant will require bringing together natural gas resource holders, engineering firms, and technology firms. Based on our internal economic analysis and conversations with prospective partners, we believe that the miniGTL A modular Plant producing approximately 1,000 barrels per day of diesel or gasoline may be economically viable in the United States, given the low price and abundance of natural gas. We anticipate that a modular Plant would be mobile and could be moved from one gas field to another, amortizing the capital cost of the plant over several small gas fields, which are more plentiful than large gas fields.

We have also been developing a proprietary GTL catalyst technology. The development work on this catalyst is based on a patented catalyst, for which we have an exclusive license from the University of Saskatchewan, Canada. The patented catalyst is a laboratory scale catalyst with over 2,000 hours of uninterrupted run time with high efficiency in converting natural gas and CO2 to syngas. Our research and development efforts have been based on developing a commercial form of this catalyst for use in industrial scale natural gas reforming processes. Our development activities have been primarily performed by outside catalyst development firms. Because the commercialization of an industrial grade natural gas reforming catalyst is a lengthy process that requires many iterative long-term and expensive testing programs, we have suspended our development efforts and are seeking a strategic partner for further funding and to help accelerate the commercial development of our catalyst. Without additional funding specifically devoted to this effort, we will not continue to develop our catalyst and may lose our exclusive license from the University of Saskatchewan, Canada.

We have not yet generated revenues. We currently have negative working capital and received an opinion from our independent auditors on our financial statements that expressed substantial doubt about our ability to continue as a going concern. 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 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, 2013, 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 our obligations as they become due, and will allow the development of our core of business. However, there can be no assurance that such financing will be available upon terms that are acceptable to us, if at all.

Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to impairment of property, plant and equipment, intangible assets, deferred tax assets and fair value computation using the Black Scholes option pricing model. We base our estimates on historical experience and on various other assumptions, such as the trading value of our common stock and estimated future undiscounted cash flows, that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions; however, we believe that our estimates, including those for the above-described items, are reasonable.

18-------------------------------------------------------------------------------- Table of Contents Use of Estimates 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, 2013, 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, 2013 and 2012: Total Level 1 Level 2 Level 3 December 31, 2013: Derivative liability $ 2,811,962 $ - $ - $ 2,811,962 Convertible notes payable 492,904 - - 492,904 Total liabilities measured at fair value $ 3,304,866 $ - $ - $ 3,304,866 19-------------------------------------------------------------------------------- Table of Contents December 31, 2012: Derivative liability $ 753,971 $ - $ - $ 753,971 Convertible notes payable 86,182 - - 86,182 Total liabilities measured at fair value $ 840,153 $ - $ - $ 840,153 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.

Recently Issued Accounting Pronouncements No new accounting pronouncements were issued during the year ended December 31, 2013 and through the date of filing this report that we believe are applicable or would have a material impact on our financial statements.

Results of Operations Year ended December 31, 2013 compared to the year ended December 31, 2012 General and Administrative Expenses General and administrative expenses decreased by $1,359,335 to $470,363 in the year ended December 31, 2013 from $1,829,698 in the year ended December 31, 2012. The decrease in general and administrative expenses in the current period is due primarily to the decrease in stock compensation expense, salaries, and related expenses and professional fees. We have decreased the number of employees compared to levels in the prior year.

Research and Development Expenses Research and development expenses decreased by $139,267 to $439 in the year ended December 31, 2013 from $139,706 in the year ended December 31, 2012. We have decreased our outside consulting, lab fees and testing supplies in the current year.

Depreciation and Amortization Expense Depreciation and amortization expense decreased by $21,040 to $2,354 in the year ended December 31, 2013 from $23,394 in the year ended December 31, 2012. 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, 2013.

20-------------------------------------------------------------------------------- Table of Contents Other Income (Expense) Total other expense increased by $1,743,986 to $3,024,346 in the year ended December 31, 2013 from $1,280,360 in the year ended December 31, 2012. The increase in the current year is primarily the result of the loss on change in derivative liability of $2,267,693 related to our convertible debt and increased interest expense due to additional borrowings and amortization to interest expense of debt discount and beneficial conversion features for the convertible debt. The increase in other expense is partially offset by a decrease in debt incentive fees of $1,079,800 from the prior year.

Net Loss As a result, our net loss for the year ended December 31, 2013 was $3,497,502, an increase of $224,344 from $3,273,158 for the year ended December 31, 2012.

Liquidity and Capital Resources As of December 31, 2013, we had a working capital deficit of $3,765,272, compared to a working capital deficit of $1,131,145 as of December 31, 2012. The increase in the working capital deficit was due primarily to the non-cash derivative liability, plus an increase in convertible notes payable as a result of debt financing. Our cash balance at December 31, 2013 was $11,382.

During the year ended December 31, 2013, we used net cash of $256,055 in operating activities compared to net cash used in operating activities of $609,437 for the year ended December 31, 2012. The decrease of $353,382 in the use of cash for operating activities was primarily due to a decrease in operating expenses as above discussed. In addition, we incurred substantial non-cash expenses in 2013, including loss on change in derivative liability of $2,267,693, amortization of debt discount and beneficial conversion feature recorded to interest expense of $694,795, and stock compensation cost of $101,755.

Net cash used in investing activities, comprised of patent expenditures, was $200 and $19,146 for the years ended December 31, 2013 and 2012, respectively.

Net cash provided by financing activities during the year ended December 31, 2013 was $253,380, comprised of proceeds from debt financing, compared to $635,575 for the year ended December 31, 2012, comprised of proceeds from debt financing of $417,500 and net proceeds from the issuance of common stock of $253,075, partially offset by repayment of advances and notes payable of $35,000. Our capital needs have primarily been met from the proceeds of equity financings and investor loans, as we are currently in the development stage and have no revenues.

We do not have any material commitments for capital expenditures during the next twelve months. 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.

21-------------------------------------------------------------------------------- Table of Contents 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 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 our inception through December 31, 2013, 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.

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