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

[August 12, 2014]

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

(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" below, and elsewhere in this report, are not related to historical results, and are forward-looking statements. Forward-looking statements present our expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements frequently are accompanied by such words such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue," or the negative of such terms or other words and terms of similar meaning. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or timeliness of such results. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such forward-looking statements. We are under no duty to update any of the forward-looking statements contained herein after the date of this report. Subsequent written and oral forward looking statements attributable to us or to persons acting in our behalf are expressly qualified in their entirety by the cautionary statements and risk factors set forth in our annual report on Form 10-K filed with the SEC on March 31, 2014, and in other reports filed by us with the SEC You should read the following description of our financial condition and results of operations in conjunction with the financial statements and accompanying notes included in this report.


OVERVIEW Carbon Sciences, Inc. ("Carbon Sciences," "we," "us," "our," or the "Company") 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 a miniGTL 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.

16-------------------------------------------------------------------------------- Index 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 June 30, 2014, 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.

On June 18, 2014, the Company entered into a Sponsored Research Agreement (the "SRA") with the University of California, Santa Barbara campus ("University"), pursuant to which the University will perform research work for the mutual benefit of the University and the Company. The purpose of the SRA includes the development of a low-cost and scalable method to produce large-area graphene for transparent electrode applications. The term of the SRA commenced on July 1, 2014 and will expire on June 30, 2015. The total cost to the Company will not exceed $387,730, as determined on a cost-reimbursement basis. Payment of the total cost is payable in installments as follows: $200,000 on or before July 1, 2014 (payment made in July 2014) $62,577 on October 1, 2014 $62,577 on January 1, 2015 $62,576 on April 1, 2015 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.

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.

17-------------------------------------------------------------------------------- Index 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 June 30, 2014 and 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 June 30, 2014 and December 31, 2013: Total Level 1 Level 2 Level 3 June 30, 2014: Derivative liability $ 1,252,357 $ - $ - $ 1,252,357 Convertible notes payable, net 553,741 - - 553,741 Long-term convertible notes payable, net 41,745 - - 41,745 Total liabilities measured at fair value $ 1,847,843 $ - $ - $ 1,847,843 December 31, 2013: Derivative liability $ 2,811,962 $ - $ - $ 2,811,962 Convertible notes payable, net of discount 492,904 - - 492,904 Total liabilities measured at fair value $ 3,304,866 $ - $ - $ 3,304,866 18-------------------------------------------------------------------------------- Index 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 six months ended June 30, 2014 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 - THREE MONTHS ENDED JUNE 30, 2014 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2013 General and Administrative Expenses General and administrative expenses decreased by $39,889 to $81,704 in the three months ended June 30, 2014 from $121,593 in the three months ended June 30, 2013. The decrease in general and administrative expenses in the current period is due primarily to a decrease in stock option compensation expense, salaries, and related expenses.

Research and Development During the three months ended June 30, 2014 and 2013, we did not undertake any research and development projects and, accordingly, we eliminated our outside consulting, lab fees, and testing supplies. As a result, research and development expenses were $0 and $(2,000) in the three months ended June 30, 2014 and 2013, respectively.

Depreciation and Amortization Expense Depreciation and amortization expense decreased by $629 to $235 in three months ended June 30, 2014 from $864 in the three months ended June 30, 2013. 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 June 30, 2014.

19-------------------------------------------------------------------------------- Index Other Income (Expense) Total other income was $396,478 in the three months ended June 30, 2014, compared to other expense of $431,640 in the three months ended June 30, 2013. The increase in other income in the current year is primarily the result of the gain on change in derivative liability of $495,027 related to our convertible debt and decreased interest expense due to debt conversions and decreased amortization to interest expense of debt discount and beneficial conversion features for the convertible debt. Interest expense decreased to $108,445 in the three months ended June 30, 2014 from $182,907 in the three months ended June 30, 2013. We also recognized a gain on settlement of debt of $5,396 in the three months ended June 30, 2014 resulting from the conversion of debt to equity, compared to a loss on settlement of debt of $27,536 in the three months ended June 30, 2013. We recognized a gain on forgiveness of debt of $20,000 in the three months ended June 30, 2013 and had no such gain in the three months ended June 30, 2014.

Net Loss As a result, we reported net income for the three months ended June 30, 2014 of $314,539, compared to a net loss of $552,097 for the three months ended June 30, 2013.

RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2014 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2013 General and Administrative Expenses General and administrative expenses decreased by $23,758 to $253,454 in the six months ended June 30, 2014 from $277,212 in the six months ended June 30, 2013. The decrease in general and administrative expenses in the current period is due primarily to a decrease in stock option compensation expense, salaries, and related expenses, partially offset by an increase in stock compensation to two consultants.

Research and Development During the six months ended June 30, 2014 and 2013, we did not undertake any research and development projects and, accordingly, we eliminated our outside consulting, lab fees, and testing supplies. As a result, research and development expenses were $0 and $439 in the six months ended June 30, 2014 and 2013, respectively.

Depreciation and Amortization Expense Depreciation and amortization expense decreased by $1,214 to $514 in six months ended June 30, 2014 from $1,728 in the six months ended June 30, 2013. 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 June 30, 2014.

Other Income (Expense) Total other income was $1,441,116 in the six months ended June 30, 2014, compared to other expense of $585,616 in the six months ended June 30, 2013. The increase in other income in the current year is primarily the result of the gain on change in derivative liability of $1,654,390 related to our convertible debt and decreased interest expense due to debt conversions and decreased amortization to interest expense of debt discount and beneficial conversion features for the convertible debt. Interest expense decreased to $243,886 in the six months ended June 30, 2014 from $347,684 in the six months ended June 30, 2013. We also recognized a gain on settlement of debt of $20,112 in the six months ended June 30, 2014 resulting from the conversion of debt to equity, compared to a loss on settlement of debt of $27,536 in the six months ended June 30, 2013. We recognized a gain on forgiveness of debt of $20,000 in the six months ended June 30, 2013 and had no such gain in the six months ended June 30, 2014.

20-------------------------------------------------------------------------------- Index Net Loss As a result, we reported net income for the six months ended June 30, 2014 of $1,187,148, compared to a net loss of $864,995 for the six months ended June 30, 2013.

Liquidity and Capital Resources As of June 30, 2014, we had a working capital deficit of $2,059,559, compared to a working capital deficit of $3,765,272 as of December 31, 2013. The decrease in the working capital deficit was due primarily to the decrease in our non-cash derivative liability. Our cash balance at June 30, 2014 was $215,071, $200,000 of which was paid in July on our Sponsored Research Agreement.

During the six months ended June 30, 2014, we used net cash of $219,311 in operating activities as a result of our net income of $1,187,148, non-cash expenses totaling $223,372, and increases in accrued expenses and other current liabilities of $80,839, reduced by gain on settlement of debt of $20,112, gain on change of derivative liability of $1,654,390, and increase in prepaid expenses of $12,562 and decrease in accounts payable of $23,606.

By comparison, during the six months ended June 30, 2013, we used net cash of $101,858 in operating activities as a result of our net loss of $864,995, gain on forgiveness of debt of $20,000, and increase in prepaid expenses of $354, partially offset by non-cash expenses totaling $725,265, and increases in accounts payable of $34,111 and accrued expenses and other current liabilities of $24,115.

We had no net cash provided by or used in investing activities in the six months ended June 30, 2014. Net cash used in investing activities, comprised of patent expenditures, was $200 in the six months ended June 30, 2013.

Net cash provided by financing activities during the six months ended June 30, 2014 and 2013 was $423,000 and $95,380, respectively, comprised of proceeds from convertible notes payable. 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.

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-------------------------------------------------------------------------------- Index 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 June 30, 2014, 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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