UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2012

OR

For the transition period from ________________ to ________________

Commission file number 0-52993

GelTech Solutions, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (561) 427-6144

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  þ     No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  þ     No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o     No  þ

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. 

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

1

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

2

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED) 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

NOTE 1 – Organization and Basis of Presentation

Organization

GelTech Solutions, Inc. (“GelTech” or the “Company”) is a Delaware corporation organized in 2006.  GelTech is focused on marketing four products: (1) FireIce®, a water soluble fire retardant used to protect firefighters, structures and wildlands; (2) Soil₂O® 'Dust Control’, an application which is used for dust mitigation in the aggregate, road construction, mining, as well as, other industries that deal with daily dust control issues; (3) Soil₂O®, a product which reduces the use of water and is primarily marketed to golf courses and the agriculture market; and (4) FireIce® Home Defense Unit, a system for applying FireIce® to structures to protect them from wildfires. Additionally, GelTech owns a United States patent for a method to modify weather.

The corporate office is located in Jupiter, Florida.

Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements include the accounts of the Company and its two wholly owned subsidiaries: WeatherTech Innovations, Inc. and FireIce Gel, Inc. (formerly GelTech Innovations, Inc.). These unaudited condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (”SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by "GAAP" for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The information included in these unaudited condensed consolidated interim financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Conditions and Results of Operations contained in this report and the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2012 filed on September 28, 2012.

Inventories

Inventories as of December 31, 2012 consisted of raw materials and finished goods in the amounts of $158,670 and $417,335, respectively.

Fair Value of Financial Instruments and Fair Value Measurements

We measure our financial assets and liabilities in accordance with ASC 820 "Fair Value Measurements and Disclosures".  For certain of our financial instruments, including cash equivalents, accounts receivable, accounts payable, accrued expenses and line of credit, the carrying amounts approximate fair value due to their short maturities. The carrying amount of our convertible debt approximates the fair value because the interest rate on the convertible note does not vary materially from the market rate for similar debt instruments.

We adopted accounting guidance for fair value measurements of financial assets and liabilities and adopted the same guidance for non-financial assets and liabilities. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. This guidance does not apply to measurements related to share-based payments. This guidance discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

4

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

Level 2: Inputs other than quoted prices that are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3: Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use.

The Company had no financial or non-financial assets or liabilities measured at fair value and subject to this accounting standard as of December 31, 2012 or June 30, 2012.

Revenue Recognition

Revenue from sales of products is recognized when persuasive evidence of an arrangement exists, products have been shipped to the customer, economic risk of loss has passed to the customer, the price is fixed or determinable, collection is reasonably assured, and any future obligations of the Company are insignificant. Revenue is shown net of returns and allowances.

Products shipped from our third-party fulfillment companies or our Jupiter, Florida location are shipped FOB shipping point.  Normal terms are net 30 or net 60 days depending on the arrangement we have with the customer.  As such, revenue is recognized when product has been shipped from either the third-party fulfillment company or from the Jupiter, Florida location.

The Company follows the guidance of ASC 605-50-25, “Revenue Recognition, Customer Payments.” Accordingly, any incentives received from vendors are recognized as a reduction of the cost of goods sold. Promotional products or samples given to customers or potential customers are recognized as a cost of goods sold. Cash incentives provided to our customers are recognized as a reduction of the related sale price, and, therefore, are a reduction of sales.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management believes that the estimates utilized in preparing its consolidated financial statements are reasonable; however, actual results could differ materially from these estimates. Significant estimates for the three months and six months ended December 31, 2012 include the allowance for doubtful accounts, depreciation and amortization, valuation of inventories, valuation of options and warrants granted for services or settlements, valuation of common stock granted for services or debt conversion, valuation of debt discount related to the beneficial conversion feature of convertible notes, accruals for litigation losses and the valuation of deferred tax assets.

Net Earnings (Loss) per Share

The Company computes net earnings (loss) per share in accordance with ASC 260-10, “Earnings per Share.” ASC 260-10 requires presentation of both basic and diluted earnings per share (“EPS”) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period.  Diluted EPS excludes all dilutive potential common shares if their effect is anti-dilutive.  At December 31, 2012, there were stock appreciation rights to purchase 3,200,000 shares of the Company common stock, options to purchase 6,307,007 shares of the Company’s common stock, warrants to purchase 3,085,258 shares of the Company’s common stock, 800,000 restricted stock units and 2,894,782 shares of the Company’s common stock are reserved for convertible notes which may dilute future earnings per share.

5

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

Stock-Based Compensation

The Company accounts for employee stock-based compensation in accordance with ASC 718-10, “Share-Based Payment,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, restricted stock units, and employee stock purchases based on estimated fair values.

Determining Fair Value Under ASC 718-10

The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The Company’s determination of fair value using an option-pricing model is affected by the stock price as well as assumptions regarding the number of highly subjective variables.

The Company estimates volatility based upon the historical stock price of the Company and estimates the expected term for employee stock options using the simplified method for employees and directors and the contractual term for non-employees.  The risk free rate is determined based upon the prevailing rate of United States Treasury securities with similar maturities.

The fair values of stock option grants for the period from July 1, 2012 to December 31, 2012 were estimated using the following assumptions:

New Accounting Pronouncements

Accounting Standards Updates which were not effective until after December 31, 2012 are not expected to have a significant effect on the Company's consolidated financial position or results of operations.

NOTE 2 – Going Concern

These unaudited condensed consolidated financial statements have been prepared on a going concern basis, which implies the Company will continue to realize it assets and discharge its liabilities in the normal course of business.  As of December 31, 2012, the Company had a working capital deficit, an accumulated deficit and stockholders’ deficit of $1,339,923, $26,011,370 and $2,655,057, respectively, and incurred losses from operations of $3,211,484 for the six months ended December 31, 2012 and used cash from operations of $1,994,491 during the six months ended December 31, 2012.  In addition, the Company has not yet generated revenue sufficient to support ongoing operations. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern.

In January 2012, the Company signed a purchase agreement with Lincoln Park Capital Fund LLC which provided for the sale of up to an additional $4.9 million worth of common stock of the Company, in addition to the $100,000 purchased upon entering into the agreement. To date the Company has issued 2,336,569 shares of common stock in exchange for $1,420,003 under this agreement and has the ability to sell another $3.6 million under the agreement under certain circumstances.

Management believes that the actions presently being taken provide the opportunity for the Company to continue as a going concern.  Ultimately, the continuation of the Company as a going concern is dependent upon the ability of the Company to generated sufficient revenue to attain profitable operations. These unaudited condensed consolidated financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

6

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

NOTE 3 – Convertible and Non-Convertible Note Agreements

On May 29, 2009, the Company entered into a Credit Enhancement and Financing Security Agreement with the Company’s largest principal stockholder. In connection with this agreement the Company executed a Revolving Promissory Note which permitted the Company to borrow up to $2,500,000. Interest, at an annual rate of 5%, was due monthly on the 20th day of each month which commenced on July 20, 2009.  In May 2010, this agreement was extended for an additional one year period.

In February 2011, the Company renegotiated the Line of Credit Agreement with its largest principal stockholder (the Lender). As part of the renegotiation, the Company issued 892,857 shares of the Company’s common stock and five-year warrants to purchase 1,000,000 shares of the Company’s common stock at an exercise price of $1.25 per share in exchange for a $1,000,000 reduction in the principal amount of the Line of Credit. In addition, the remaining principal amount due under the line of credit of $1,497,483 was replaced by a five-year convertible note of the same amount, convertible at $1.12 per share (fair market value on transaction date based upon the quoted trading price) and bearing annual interest of 5%, due on the maturity date of the note (the “2011 Note”). As an inducement for the Lender to enter into the convertible note agreement, the Company granted the Lender five-year warrants to purchase 300,000 shares of the Company’s common stock at an exercise price of $1.75 per share. These warrants were exercised in September 2012 in exchange for $150,000 in connection with the Company’s offer to all warrant holders to exercise warrants at $0.50 per share instead of the exercise price negotiated on the date of the grant.

In December 2011, the Company received short term advances from its Chief Executive Officer, President and Chief Financial Officer in the amounts of $10,000, $29,380 and $50,000, respectively. The advances bear interest rates of 0.7%, 5.0% and 5.0%, respectively. In addition, as further inducement for the advance from the Chief Financial Officer, the Company approved the reduction in the exercise price of 150,000 options granted to the Chief Financial Officer from $1.95 to $0.60 per share. In connection with this repricing, the expense related to the vesting of these options was increased by $15,067 which will be recognized over the remaining service period.  Through December 31, 2012, the Company has made repayments to its President, Chief Executive Officer and Chief Financial Officer on the notes due these individuals in the amounts of $20,000, $9,839 and $35,000, respectively.  As of December 31, 2012, accrued interest related to these notes amounted to $3,318.

On March 9, 2012, the Company received $105,000 from third parties in exchange for six month convertible original issue discount notes in the amount of $107,625. The notes bear an annual interest rate of 5% and are convertible into the Company's common stock at the rate of $0.50 per share. In connection with the issuance of the notes, the Company recorded a loan discount related to the intrinsic value of the beneficial conversion feature in the amount of $84,562 which will be amortized to interest expense over the life of the notes.  In September 2012, the Company issued new one-year convertible original issue discount notes in the amount of $120,540, bearing annual interest of 12% and convertible at $0.50 per share in exchange for cancellation of the old notes.  This modification was not considered a debt extinguishment. In accordance with ASC 470, the Company will recognize a debt discount related to the change in fair value of the embedded conversion option in the amount of $35,138 which will be amortized to interest expense over the life of the convertible notes. For the six months ended December 31, 2012, the Company has recognized interest expense of $5,301 and $53,668, respectively, related to the amortization of the original issue discount and the beneficial conversion feature discount.

On March 10, 2012, the Company received $75,000 from a director in exchange for a six month convertible original issue discount note in the amount of $76,875. The note bears an annual interest rate of 5% and is convertible into the Company's common stock at the rate of $0.50 per share. In connection with the issuance of the note, the Company recorded a loan discount related to the intrinsic value of the beneficial conversion feature in the amount of $63,038 which will be amortized to interest expense over the life of the note. In September 2012, the Company issued a new one-year convertible original issue discount note in the amount of $86,100, bearing annual interest of 12% and convertible at $0.50 per share in exchange for cancellation of the old note.  This modification was not considered a debt extinguishment. In accordance with ASC 470, the Company will recognize a debt discount related to the change in fair value of the embedded conversion option in the amount of $24,971 which will be amortized to interest expense over the life of the convertible note. For the six months ended December 31, 2012, the Company has recognized interest expense of $3,527 and $31,839, respectively, related to the amortization of the original issue discount and the beneficial conversion feature discount.

7

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

On March 29, 2012, the Company received $250,000 from its  principal stockholder and accrued interest due this stockholder as of February 18, 2012 of $74,874 was paid by including the interest in a new six month convertible original issue discount note in the amount of $332,996. The note bears an annual interest rate of 5% and is convertible into the Company's common stock at the rate of $0.50 per share. In connection with the issuance of the note, the Company recorded a loan discount related to the intrinsic value of the beneficial conversion feature in the amount of $199,798 and an original issue discount of $8,121 which will be amortized to interest expense over the life of the note.  For the period from July 1, 2012 to September 28, 2012 the Company recognized interest expense of $3,972 and $97,703, respectively, related to the amortization of the original issue discount and the beneficial conversion feature discount.  On September 28, 2012, the holder elected to convert the note into common stock and was issued 665,992 shares of common stock by the Company.

In August 2012, the Company received $175,000 in exchange for six month convertible original issue discount notes in the amount of $179,375 with two accredited investors. The notes are convertible into common stock at $0.50 per share. The notes bear an annual interest rate of 5% and are convertible into the Company's common stock at the rate of $0.50 per share. In connection with the issuance of the notes, the Company recorded a loan discount related to the intrinsic value of the beneficial conversion feature in the amount of $106,600 and an original issue discount of $4,375 which will be amortized to interest expense over the life of the notes.  For the six months ended December 31, 2012, the Company has recognized interest expense of $3,475 and $85,368, respectively, related to the amortization of the original issue discount and the beneficial conversion feature discount.

On December 28, 2012, the Company received $250,000 from its principal stockholder in exchange for a one year convertible original issue discount note in the amount of $275,000 (the “2012 Note”). The note bears an annual interest rate of 10% and is convertible into the Company's common stock at the rate of $0.35 per share. In connection with the issuance of the note, the Company recorded a loan discount related to the intrinsic value of the beneficial conversion feature in the amount of $23,571 and an original issue discount of $25,000 which will be amortized to interest expense over the life of the note.  For the six months ended December 31, 2012, the Company has recognized interest expense of $412 and $389, respectively, related to the amortization of the original issue discount and the beneficial conversion feature discount.

NOTE 4 – Stockholders’ Equity

Preferred Stock

The Company has authorized 5,000,000 shares of preferred stock, par value $0.001 per share with such rights, preferences and limitation as may be set from time to time by resolution of the board of directors and the filing of a certificate of designation as required by Delaware General Corporation Law.

Common Stock

The issuances of common stock during the six months ended December 31, 2012 were as follows:

During the six months ended December 31, 2012, the Company has issued 1,333,820 shares of common stock in exchange for $810,003 in connection with the Purchase Agreement with Lincoln Park Capital.

In August 2012, the Company issued 256,000 shares of common stock in exchange for $128,000 in connection with private placement transactions with two accredited investors.

In September 2012, the Company issued 1,740,000 shares of common stock in exchange for $870,000 in connection with the exercise of 1,640,000 warrants and 100,000 options to purchase shares of the Company’s common stock related to an offer by the Company to reduce the exercise price to $0.50 per share. The original exercise prices of the warrants and options ranged from $1.25 to $1.75 per share. The cost of repricing warrants recognized by the Company amounted to $70,491 for the three months ended September 30, 2012. The cost represents the incremental increase in the fair value of the repriced warrants and options as compared to the original warrants and options granted, valued on the exercise date. The fair value of the warrants and options was determined using the Black-Scholes option pricing model.  In October 2012, the Company issued 80,000 shares of common in exchange for $40,000 in connection with the exercise of warrants at $0.50 per share.

8

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

In September 2012, our principal shareholder converted his $322,996 convertible original issue discount note which was due on September 28, 2012 into 665,992 shares of common stock.

Options and Stock Appreciation Rights to Purchase Common Stock

Stock-based compensation expense recognized under ASC 718-10 for the period July 1, 2012 to December 31, 2012 was $990,559 for stock options and stock appreciation rights granted to employees, directors and a consultant.  This expense is included in selling, general and administrative expenses in the unaudited condensed consolidated statements of operations.  Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period.  At December 31, 2012, the total compensation cost for stock options and stock appreciation rights not yet recognized was approximately $1,734, 037.  This cost will be recognized over the remaining vesting term of the options and stock appreciation rights of approximately three years.

Restricted Stock Units

The Company recognized stock-based compensation expense of $90,000 related to vested restricted stock units granted to the Company’s Executive Chairman.  Stock based compensation expense not yet recognized related to restricted stock units amounted to $270,000 at December 31, 2012.  This cost will be recognized over the remaining vesting term of the restricted stock units of approximately three years.

A summary of transactions for all employee stock options and stock appreciation rights for the six month periods ended December 31, 2012 and 2011 is as follows:

Employee Options and Stock Appreciation Rights

9

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

On September 1, 2011, ten-year options to purchase 150,000 shares of common stock at an exercise price of $1.95 share, which were contingently granted by the Company on June 3, 2011, were granted to its Chief Financial Officer, upon his transition from part time consultant to full-time employee. Of the options granted, 50,000 vested immediately and the remaining options vest semi-annually on December 31st and June 30th with the first vesting date being December 31, 2011, subject to continued employment. The options were valued using the Black-Scholes option pricing model using a volatility of 90.6% (derived from the historical market price of the Company’s common stock since it began trading in June 2008) an expected term of 6.5 years (using the simplified method) and a discount rate of 2.11%. The value of the options, $224,778, will be recorded as expense over the requisite service period.

On September 20, 2011, the Company granted ten-year options to purchase 175,000 shares of common stock at an exercise price of $0.81 share to each of its three original executive officers. The options vest semi-annually on December 31st and June 30th with the first vesting date being December 31, 2011, subject to continued employment. The options were valued using the Black-Scholes option pricing model using a volatility of 88.89% (derived from the historical market price of the Company’s common stock since it began trading in June 2008) an expected term of 6.5 years (using the simplified method) and a discount rate of 1.25%. The value of the options, $320,271, will be recorded as expense over the requisite service period.  These options replaced options to purchase the same number of shares at an exercise price of $1.00 per share which expired on September 15, 2011.

On September 21, 2012, the Company granted options to purchase 70,000 shares of the Company’s common stock at an exercise price of $0.63 per share to the father of the Company’s CEO and CTO in recognition of his service. Of the options granted, 35,000 vest immediately with the remainder vesting semi-annually each December 31 and June 30 over a three year period, subject to continued employment on the vesting date. The Company valued the options at $28,358 using the Black-Scholes option pricing model using a volatility of 90.09%, based upon the historical price of the Company’s common stock since June 2008, an estimated term of 4 years, using the Simplified Method and a discount rate of 0.53%.

On September 21, 2012, the Compensation Committee of the Board of Directors approved the granting of five-year options to purchase 265,000 shares of common stock at an exercise price of $0.60 per share to non-executive employees. The options vest 25% immediately with the remainder vesting annually over three years, subject to continued employment. The Company valued the options at $101,029 using the Black-Scholes option pricing model using a volatility of 89.93%, based upon the historical price of the Company’s common stock since June 2008, an estimated term of 4 years, using the Simplified Method and a discount rate of 0.53%. The resulting expense will be recognized 25% immediately and the remainder over the vesting period.

On November 14, 2012 , the Compensation Committee of the Board of Directors granted its Chief Executive Officer, Chief Financial Officer, Chief Technology Officer and President 800,000 each stock settled stock appreciation rights (“SARS”) of which (i) 200,000 vested immediately, (ii) 200,000 vest upon the Company generating $3,000,000 in revenue in any 12-month period, (iii) another 200,000 vest upon the Company generating $5,000,000 in revenue in any 12-month period and (iv) another 200,000 vest upon the Company generating $6,000,000 in revenue in any 12-month period. The SARs are exercisable at $0.45 per share over a 10-year period.  . The Company valued the SARS at $1,086,560 using the Black-Scholes option pricing model using a volatility of 89.67%, based upon the historical price of the Company’s common stock since June 2008, an estimated term of 6.5 years, using the Simplified Method and a discount rate of 0.93%.  The resulting expense will be recognized 25% immediately and the remainder over the vesting period.

The Company’s Chief Executive Officer, President and Chief Technology Officer agreed to cancel the 250,000 stock options granted to each of them in their prior employment agreements.

10

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

A summary of options issued to directors under the 2007 Plan and changes during the period from June 30, 2011 to December 31, 2011 and from June 30, 2012 to December 31, 2012 is as follows:

Options Issued to Directors

On July 1, 2011, the Company granted options to purchase 245,000 shares of the Company’s common stock to directors of the Company. The options have an exercise price of $1.75 per share, vest over one year and have a ten year term. The options were valued using the Black-Scholes model using a volatility of 89.65% (derived using the historical market price for the Company’s common stock since it began trading in June 2008), an expected term of 6.5 years (using the simplified method) and a discount rate of 2.35%. The value of the options, $311,001, will be recognized over the vesting term, one year.

On September 28, 2011, in connection with the resignation of a director, options to purchase 142,500 shares of common stock at a weighted average exercise price of $1.46 per share were forfeited.

On July 1, 2012, the Company issued options to purchase 230,000 shares of common stock to directors. The options have an exercise price of $0.91 per share, vest on June 30, 2013¸ subject to continuing service as a director and bear a ten year term. The options were valued using the Black-Scholes model using a volatility of 91.04% (derived using the historical market price for the Company’s common stock since it began trading in June 2008), an expected term of 5.5 years (using the simplified method) and a discount rate of 0.82%. The value of these options will be recognized as expense over the requisite service period.

On December 6, 2012, the Company issued options to purchase 5,000 shares of common stock to a director upon his appointment to the audit committee. The options have an exercise price of $0.36 per share, and vest over three years, subject to continued service and bear a ten year term. The options were valued using the Black-Scholes model using a volatility of 89.86% (derived using the historical market price for the Company’s common stock since it began trading in June 2008), an expected term of 6.5 years (using the simplified method) and a discount rate of 0.90%. The value of these options, $1,360, will be recognized as expense over the requisite service period.

11

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

A summary of options issued to non-employees under the 2007 Plan and changes during the six month periods from June 30, 2011 to December 31, 2011 and from June 30, 2012 to December 31, 2012 is as follows:

Non-Employee, Non-Director Options

In September 2012, the Company issued 100,000 shares of common stock in exchange for $50,000 in connection with the exercise of 100,000 options to purchase shares of the Company’s common stock related to an offer by the Company to reduce the exercise price to $0.50 per share. The original exercise price of the options was $1.25 per share. The Company recognized a loss resulting from the reduction of the exercise price of the options exercised in the amount of $391 representing the difference in the fair market value of the repriced options as compared to the fair market value of the original options on the exercise date. The fair market value of the options was determined using the Black-Scholes options pricing model.

Warrants to Purchase Common Stock

The Company accounts for warrants issued for services in accordance with ASC 505-50-30-2 Equity Based Payments to Non-Employees.  As such, the Company calculates the fair value of the warrants granted using the Black-Scholes option pricing model and records the fair value to either prepaid expense or expense based upon the terms of the underlying contract for services.  In applying the Black-Scholes method, the Company calculates volatility based upon the historical market price of the Company’s common stock, utilizes discount rates obtained from the Federal Reserve Statistical Release for treasury instruments of the same duration and expected term as the contractual term of the warrants.

Warrants issued in connection with the sale of shares of common stock are treated as part of the equity transaction and are recorded in stockholders’ equity or liabilities in accordance with the guidance at ASC 480-10-25.

12

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

A summary of warrants issued for settlements and changes during the periods July 1, 2011 to December 31, 2011 and from July 1, 2012 to December 31, 2012 is as follows:

Warrants Issued as Settlements

On September 21, 2012, the Board of Directors granted five year warrants to purchase 350,000 shares of the Company’s common stock at an exercise price of $0.63 per share to a director in recognition of his exemplary five years of service to the Company. The warrants vested immediately. The Company valued the warrants at $115,883 using the Black-Scholes option pricing model using a volatility of 90.09%, based upon the historical price of the Company’s common stock since June 2008, an estimated term of 2.5 years, using the Simplified Method and a discount rate of 0.32%.

13

GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

A summary of warrants issued for cash and changes during the periods June 30, 2011 to December 31, 2011 and from June 30, 2012 to December 31, 2012 is as follows:

Warrants issued for cash or services

On September 21, 2012, the Board of Directors granted five year warrants to purchase 50,000 shares of the Company’s common stock at an exercise price of $0.63 per share to the Company’s Investor Relations firm in recognition of their performance over the past year. The warrants vested immediately. The Company valued the warrants at $21,787 using the Black-Scholes option pricing model using a volatility of 90.09%, based upon the historical price of the Company’s common stock since June 2008, an estimated term of 5 years, the term of the warrants, and a discount rate of 0.70%.

During the six months ended December 31, 2012, the Company issued 1,820,000 shares of common stock in exchange for $910,000 in connection with the exercise of 1,820,000 warrants to purchase shares of the Company’s common stock related to an offer by the Company to reduce the exercise price to $0.50 per share. The original exercise prices of the warrants ranged from $1.25 to $1.75 per share. The cost of repricing warrants recognized by the Company amounted to $70,491 for the six months ended December 31, 2012.  The cost represents the incremental increase in the fair value of the repriced warrants as compared to the original warrants granted, valued on the exercise date.  The fair value of the warrants was determined using the Black-Scholes option pricing model.

During December 2012, warrants to purchase 320,000 shares of the Company’s common stock at an exercise price of $1.60 per share expired unexercised.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

NOTE 5 – Commitments and Contingencies

The Company leases office and warehouse space located in Jupiter, Florida under a month-to-month lease and leases space in an industrial yard in Irvine, California under a one year lease which commenced in June 2011.

Rent expense for the six months ended December 31, 2012 and 2011 was $53,479 and $67,312, respectively.

In March 2011, the Compensation Committee approved new employment terms for each of the Company’s three executive officers.  The Executives will receive a base salary of $150,000 per year with the Committee having the authority to increase the Executive’s base salary for the succeeding 12-month period with the increase based on profitability, positive cash flow or such other factors as the Committee deems important. 

Effective September 1, 2011, the Compensation Committee approved an Employment Agreement with the Company's Chief Financial Officer (CFO).  The CFO will receive a base salary of $146,000 per year with the Committee having the authority to increase the CFO’s base salary for the succeeding 12-month period with the increase based on profitability, positive cash flow or such other factors as the Committee deems important. In addition, the CFO received options as previously described in Note 4.

On November 14, 2012, the Company approved new employment agreements for the Company’s Chief Executive Officer, President, Chief Technology Officer and Chief Financial Officer. The employment agreements each provide for base salaries of $150,000 and 800,000 stock settled stock appreciation rights (“SARS”) of which (i) 200,000 vested immediately, (ii) 200,000 vest upon the Company generating $3,000,000 in revenue in any 12-month period, (iii) another 200,000 vest upon the Company generating $5,000,000 in revenue in any 12-month period and (iv) another 200,000 vest upon the Company generating $6,000,000 in revenue in any 12-month period. The SARs are exercisable at $0.45 per share over a 10-year period. The Company’s Chief Executive Officer, President and Chief Technology Officer agreed to cancel the 250,000 stock options granted to each of them in their prior employment agreements. These executives’ base salary will increase to: (i) $170,000 upon the Company generating $3,000,000 in revenue in any 12-month period, (ii) $190,000 upon the Company generating $5,000,000 in any 12-month period and (iii) $200,000 upon the Company generating $6,000,000 in any 12-month period.

Additionally, the Company approved an employment agreement for the Company’s Executive Chairman. The Executive Chairman receives a base salary of $200,000 per year and was granted 800,000 restricted stock units vesting on identical terms as the SARs. All of the five senior executives receive a monthly car allowance of $600 per month. The Compensation Committee will also have the discretion to award each of the executives a bonus based upon job performance, revenue growth or any other factors determined by the Compensation Committee. Each of the employment agreements was effective as of October 1, 2012 and is for a four-year term.

The Company was sued by a former employee on June 23, 2008, alleging breach of a consulting agreement and an employment agreement entered into in May and June 2007, respectively.  In addition, the plaintiff seeks to recover certain of his  personal property, which was used or stored in the Company’s offices, and alleges the Company invaded his privacy by looking at his personal computer (which was used in the Company’s business) in the Company’s offices. A jury trial was held for the lawsuit in July 2012. At the conclusion of the trial, the plaintiff was awarded $200,000 under his invasion of privacy and fraudulent misrepresentation claim, $5,000 on the trespass claim, $841,000 on the breach of consulting agreement claim and $200,000 against the Company’s CEO on a claim of civil theft, which by law results in an award of $600,000 for the plaintiff. The Company’s board of directors approved the indemnification of the Company’s CEO for the $600,000. The Company filed a post trial motion for Judgment Notwithstanding Verdict, New Trial and Remittitur, requesting that the judge set aside or reduce the amounts of the jury verdict.

Based upon the verdicts, the Company recorded a litigation accrual of $1,646,000 as of June 30, 2012. In November 2012, the insurance carrier paid the plaintiff $200,000 in settlement of the invasion of privacy and fraudulent misrepresentation awards. As a result, the Company reduced the amounts accrued for these awards resulting in other income of $200,000 for the period ended December 31, 2012. See Note 8.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

NOTE 6 – Related Party Transactions

In addition to the Chief Executive Officer (CEO) and the Chief Technology Officer (CTO) the following related parties are employed at GelTech:

We believe all of these salaries are at or are below the going rate of what such services would cost on the open market.

The Company has employment arrangements with its executive officers which are described under Note 5.

The Company has entered into a series of credit facilities with its principal stockholder as more fully described in Note 3.  Additionally, the Company was provided a loan of $250,000 in December 2012 by its principal stockholder.  See Note 3.

The Company issued short term notes payable to its President, Chief Executive Officer and Chief Financial Officer as more fully described in Note 3.

In September 2012, the Company granted options to purchase 70,000 shares of the Company’s common stock to the father of the Company’s Chief Executive Officer and Chief Technology Officer as more fully described in Note 4.

In September 2012, the Company granted warrants to purchase 350,000 shares of the Company’s common stock to a director as more fully described in Note 4.

NOTE 7 – Concentrations

The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through December 31, 2012.  As of December 31, 2012, there were no cash equivalent balances held in depository accounts that are not insured.

At December 31, 2012, three customers accounted for 41.7%, 33.4% and 11.9%, respectively, of accounts receivable.

For the six months ended December 31, 2012 four customers accounted for approximately 18.5%, 15.6%, 12.8% and 11.1% of sales.

During the six  months ended December 31, 2012 all sales resulted from two products, FireIce® and Soil₂O™ which made up 87.5% and 12.5%, respectively, of total sales.  Of the FireIce® sales, 84.0% related to sales of FireIce product and 16.0% related to sales of the FireIce Home Defense units.  Of the Soil₂O™ sales, 72.5% related to traditional sales of Soil₂O® and 27.5% related to Soil₂O® Dust Control.

Three vendors accounted for 37.2%, 19.2% and 10.0% of the Company’s approximately $88,000 of raw material and packaging purchases during the six months ended December 31, 2012.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2012 AND 2011

(Unaudited)

NOTE 8 – Subsequent Events

In January 2013, the Company borrowed $250,000 from Michael Reger, its principal shareholder. In connection with this loan, the Company consolidated all of the outstanding notes held by the principal shareholder and issued him a $1,997,483 7.5% note convertible at $0.35 per share due February 18, 2016 (the “2013 Note”) and the principal shareholder cancelled his 2011 Note and the 2012 Note.  The 2013 Note bears an annual interest rate of 7.5% with interest to be paid annually.  In connection with the new note the Company issued 210,226 shares of common stock in payment of accrued interest of $73,579 owed under the 2011 Note and the 2012 Note.  See Note 3 above.

In January 2013, the court ruled on the Company’s post-trial motions in the Hopkins litigation dismissing the $200,000 verdict (which was subject to triple damages) against Mr. Cordani and reducing the $841,000 breach of the consulting agreement award to $500,000.  Previously, the Company’s insurance carrier paid the plaintiff $200,000 which leaves the Company liable for the $5,000 trespass award and the $500,000 breach of consulting agreement award. The Company filed motions seeking a new trial on damages. The Company received a favorable ruling on these motions and has 30 days to elect to accept the reduced award or file for a new trial. The Company intends to file for a new trial.

Effective February 8, 2013, the Company’s President and Director resigned from the Company to pursue other opportunities.  In connection with his separation, the Company agreed to pay the President $150,000 plus COBRA payments over 14 months.  In addition, the Company agreed to issue the former President ten year fully vested options to purchase 112,500 shares of the Company’s common stock at an exercise price of $0.39 per share, subject to a lockup agreement for the option shares and the other shares he currently owns.  In addition, vested options and stock appreciation rights to purchase 1,137,500 shares of the Company’s common stock at exercise prices from $0.45 to $1.22 per share, previously issued to the President, were cancelled.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

ITEM 2. 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements in “Management’s Discussion and Analysis and of Financial Condition and Results of Operations” are forward-looking statements that involve risks and uncertainties. Words such as may, will, should, would, anticipates, expects, intends, plans, believes, seeks, estimates and similar expressions identify such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. We assume no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements.

Overview

GelTech Solutions, Inc. markets four products: (1) FireIce®, a water soluble fire retardant used to protect firefighters, structures and wildlands; (2) Soil₂O® ‘Dust Control’, our new application which is used for dust mitigation in the aggregate, road construction, mining, as well as, other industries that deal with daily dust control issues (3) Soil₂O®, a product which reduces the use of water and is primarily marketed to golf courses, commercial landscapers and the agriculture market; and (4) FireIce® Home Defense Unit, a system for applying FireIce® to structures to protect them from wildfires.  Our financial statements have been prepared on a going concern basis, and we need to generate sufficient material revenues to support the ongoing business of the Company.

FireIce® has been included on the United States Forest Service (the "Forest Service") Qualified Products List (the “QPL List”) since March 2011.  Inclusion on the QPL List qualifies our product for use to fight brush and wildfires on State and National Park lands.  In May 2012, the Company received four blanket purchase agreements from the Forest Service which provide the framework for federal and state agencies to use FirecIce® from the air and on the ground to fight wildland fires.  To date, we have we have been deployed aerially by the Bureau of Indian Affairs on a few wildfires in New Mexico and have been used on a very limited basis by the Forest Service to fight fires aerially in Washington.

FireIce® has many applications in the municipal and urban firefighting arena.  FireIce® has demonstrated the ability to be much more effective than water in extinguishing car fires.  In addition, we are currently working with municipal departments on other land and marine based municipal applications.

Although sales of our Soil₂O® ‘Dust Control’ and our Soil₂O® agricultural product applications were down during the three months ended December 31, 2012, we continue to believe there are substantial markets for these products given the heightened federal regulations for mitigating airborne particulate matter and in light of the severe drought conditions experienced by many parts of the United States in 2012.

We have found that sales of our FireIce® HDU units are greatest when wildfires are imminent.  The efficacy of the retardant ability of FireIce® was demonstrated in January 2012 when two homes were protected by firefighters from a fast moving grass fire in Montana by applying FireIce® to the homes and surrounding foliage.

International sales of FireIce® and Soil₂O® are expected to continue as our Australian Distributor has been successful in obtaining government approvals of Soil₂O® for use in landscaping applications.  Shipments under our Chinese distribution agreement have been delayed indefinitely pending resolution of the trademark registration of FireIce by the Company’s prior distributor in China or registration of FireGel as a new trademark.  The Company has been advised by its Chinese counsel that any sales of FireIce by the Company or its new distributor in China would be deemed an infringement on the prior distributor’s trademark and therefore no shipments under our new distributor agreement will begin until this is resolved or we register an alternative trademark and receive approval to sell in China using that trademark.  The Company has filed an administrative proceeding in China seeking to cancel a third party’s registration of FireIce, and the resolution of this proceeding may not be resolved until as late as October 2013.  Even if the FireIce registration is cancelled, the Company has been advised that it could take as many as 18 months for the Company to re-register the FireIce trademark.  In December 2012, the Company filed a trademark application for FireGel in China.  We have been advised by legal counsel that the trademark review process generally takes five months.  If the application is accepted, the Company would be allowed to sell FireIce under the FireGel name within 12 months after acceptance.  The Company is working with Chinese counsel and the new distributor to determine the fastest method to begin selling FireIce in China.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

RESULTS OF OPERATIONS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2012 COMPARED TO THE SIX MONTHS ENDED DECEMBER 31, 2011.

Sales

For the six months ended December 31, 2012, we had sales of $121,903 as compared to sales of $262,953 for the six months ended December 31, 2011, a decrease of $141,050 or 53.6%.  Sales of product during the six months ended December 31, 2012 consisted of $15,201 for Soil₂O® and $106,702 for FireIce® and related products. Of the Soil₂O® sales, $4,187 related to the new dust control application and $11,014 related to traditional Soil₂O® applications. FireIce® sales consisted of $89,578 product sales and $17,124 related to sales of HDU related products.  Sales of product during the six months ended December 31, 2011 consisted of $144,878 for Soil2O™ and $118,075 for FireIce® and related products.  Sales of Soil₂O®"Dust Control" were negatively impacted during the three months ended December 31, 2012 by the rainy season in the Southwestern US where we are currently focusing our efforts. We are preparing for a resumption of Soil₂O® Dust Control sales as we move out of the rainy season. FireIce® sales during the six months ended December 31, 2012 were primarily attributable to municipalities and commercial customers.

Cost of Goods Sold

Cost of goods sold was $49,578 for the six months ended December 31, 2012 as compared to a cost of goods sold of $114,421 for the six months ended December 31, 2011. The decrease was the direct result of the decrease in sales.  Cost of sales as a percentage of sales was 40.7% for the six months ended December 31, 2012 as compared to 43.5% for the six months ended December 31, 2011. We expect future cost of sales as a percentage of sales will be consistent with the cost of sales percentage for the six months ended December 31, 2012.

Selling, General and Administrative Expenses

Selling, General and Administrative expenses were $3,076,098 for the six months ended December 31, 2012 as compared to $2,626,410 for the six months ended December 31, 2011. The increase in fiscal 2013 expenses resulted from (1) an increase in salaries and employee benefits of $28,254 related to the employment  a full time CFO during the six month period in fiscal 2013 versus a four month period in fiscal 2012 as well as the new employment of our Executive Chairman effective October 1, 2012; (2) an increase in non-cash stock option expense of $404,227 related to option, stock appreciation rights and restricted stock unit grants to executive officers and directors in fiscal 2013; and (3) an increase in professional fees of $133,051 related to ongoing litigation with a former employee and a former distributor.  These increases were partially offset by decreases in investor relations expense of $64,072 and sales and marketing expense of 35,999.

Research and Development Expenses

R&D expenses were $23,731 for the six months ended December 31, 2012 as compared to $49,975 for the six months ended December 31, 2011. The fiscal 2012 expenses relate to research of potential product enhancements for FireIce® and additional testing of our Soil₂O®"Dust Control" product.

Loss from Operations

Loss from operations was $3,027,504 for the six months ended December 31, 2012 as compared to $2,527,853 for the six months ended December 31, 2011. The decrease in the loss resulted from the lower gross profit resulting from the decrease in sales which were partially offset by the higher operating expenses as described above.

Interest Income

Interest income was $565 for the six months ended December 31, 2012 as compared to $463 for the six months ended December 31, 2011. The amounts are reflective of the cash balances on hand and the prevailing interest rates during the respective six month periods.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

Loss on Settlement

Loss on settlement of $301,500 during the six months ended December 31, 2011 resulted from the issuance of 441,176 shares of the Company's common stock to a director in settlement of amounts due the director by the Company's predecessor company plus a payment of $1,500 to a former shareholder of the predecessor company.

Reduction of Accrual for Losses from Litigation

In November 2012, the Company recognized other income of $200,000 resulting from the reduction of the accrual for losses from litigation related to a lawsuit filed by a former employee.  The reduction was recorded to reflect insurance payments made to the plaintiff in settlement of the invasion of privacy and fraudulent misrepresentation awards.

Cost of Repricing of Warrants to Induce Exercise

The Company recognized a cost of repricing warrants of $70,491 for the six months ended December 31, 2012 related to the reduction of the exercise price of warrants to purchase 1,820,000 shares of common stock with exercise prices from $1.25 to $1.75 per share to $0.50 per share.   The Company recognized a cost of repricing warrants of $5,834 for the six months ended December 31, 2011 related to the reduction of the exercise price of warrants to purchase 130,000 shares of common stock with an exercise price of $1.50 per share to $0.50 per share.

Interest Expense

Interest expense was $314,054 for the six months ended December 31, 2012 as compared to $38,487 for the six months ended December 31, 2011. The higher expense during the six months ended December 31, 2012 resulted from the amortization of debt discounts resulting from the beneficial conversion features of convertible debt related to convertible debt financings. Amortization of these costs was $274,426 for the six months ended December 31, 2012.

Net Loss

Net loss was $3,211,484 for the six months ended December 31, 2012 as compared to $2,873,211 for the six months ended December 31, 2011. The lower net loss resulted primarily from the reversal of accrual for losses from litigation which were partially offset by higher operating expenses, higher interest expense and lower gross profit.  Net loss per common share was $0.12 for the six months ended December 31, 2012 as compared to $0.13 for the six months ended December 31, 2011. The weighted average number of shares outstanding for the six months ended December 31, 2012 and 2011 were 27,387,133 and 22,152,375, respectively.

FOR THE THREE MONTHS ENDED DECEMBER 31, 2012 COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 2011.

Sales

For the three months ended December 31, 2012, we had sales of $37,453 as compared to sale of $84,551 for the three months ended December 31, 2011, a decrease of $47,098 or 55.74%. Sales of product during the three months ended December 31, 2012 consisted of $4,634 for Soil₂O® and $32,729 for FireIce® and related products. Of the Soil₂O® sales, $4,187 related to the new dust control application and $447 related to traditional Soil₂O® applications.  FireIce® sales consisted of $32,323 product sales and $406 related to sales of HDU related products.  Sales of product during the three months ended December 31, 2011 consisted of $5,593 for Soil2O™ and $78,958 for FireIce® and related products.  Sales of Soil₂O® "Dust Control" are negatively affected during the rainy season in the Southwestern US where we are currently focusing our efforts. We are preparing for a resumption of Soil₂O® Dust Control sales as we move out of the rainy season.  The higher FireIce® sales for the three months ended December 31, 2011 were primarily attributable to the initial sales to our Australian distributor.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

Cost of Goods Sold

Cost of goods sold was $13,499 for the three months ended December 31, 2012 as compared to a cost of goods sold of $39,181 for the three months ended December 31, 2011. The decrease was the direct result of the decrease in sales. Cost of sales as a percentage of sales was 36% for the three months ended December 31, 2012 as compared to 46% for the three months ended December 31, 2011. The lower cost of sales percentage in fiscal 2012 relates to the sales mix. During the three months ended December 31, 2011 the Company sold a greater number of FireIce® HDU units which have a lower gross margin. We expect future cost of sales as a percentage of sales will be consistent with the fiscal year to date cost of sales percentage for the six months ended December 31, 2012.

Selling, General and Administrative Expenses

Selling, General and Administrative expenses were $1,526,616 for the three months ended December 31, 2012 as compared to $1,123,204 for the three months ended December 31, 2011. The increase in fiscal 2013 expenses resulted from (1) an increase in non-cash expenses of $263,608 related to option, stock appreciation rights and restricted stock unit grants to directors and executive officers in fiscal 2013; (2) an increase in professional fees of $164,829 due to ongoing litigation with a former employee and a former distributor; (3) an increase in salaries and employee benefits of $63,355 resulting from the hiring of a new executive chairman; and (4) an increase in sales and marketing due to a new focus on search engine optimization to increase internet traffic to our website.  These increases were partially offset by decreases in investor relations and facilities costs of $46,060 and $13,785, respectively.

Research and Development Expenses

R&D expenses were $6,423 for the three months ended December 31, 2012 as compared to $7,726 for the three months ended December 31, 2011. The fiscal 2013 expenses relate to research of potential product enhancements for FireIce®.

Loss from Operations

Loss from operations was $1,509,085 for the three months ended December 31, 2012 as compared to $1,085,560 for the three months ended December 31, 2011. The increase in the loss resulted from the higher operating expenses plus the lower gross profit resulting from the reduction in sales.

Interest Income

Interest income was $514 for the three months ended December 31, 2012 as compared to $57 for the three months ended December 31, 2011. The amounts are reflective of the cash balances on hand and the prevailing interest rates during the respective three month periods.

Reduction of Accrual for Losses from Litigation

In November 2012, the Company recognized other income of $200,000 resulting from the reduction of the accrual for losses from litigation related to a lawsuit filed by a former employee.  The reduction was recorded to reflect insurance payments made to the plaintiff in settlement of the invasion of privacy and fraudulent misrepresentation awards.

Loss on Settlement

Loss on settlement of $300,000 during the three months ended December 31, 2011 resulted from the issuance of 441,176 shares of the Company's common stock to a director in settlement of amounts due the director by the Company's predecessor company.

Cost of Repricing of Warrants to Induce Exercise

The Company recognized a cost of repricing warrants of $5,834 for the three months ended December 31, 2011 related to the reduction of the exercise price of warrants to purchase 130,000 shares of common stock with an exercise price of $1.50 per share to $0.50 per share.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

Interest Expense

Interest expense was $97,226 for the three months ended December 31, 2012 as compared to $19,328 for the three months ended December 31, 2011. The higher expense during the three months ended December 31, 2012 resulted from the amortization of debt discounts resulting from the beneficial conversion features of convertible debt related to convertible debt financings. Amortization of these costs was $77,629 for the three months ended December 31, 2012.

Net Loss

Net loss was $1,405,797 for the three months ended December 31, 2012 as compared to $1,410,665 for the three months ended December 31, 2011. The lower net loss resulted primarily from the reversal of accrual for losses from litigation which were partially offset by the higher operating expenses, higher interest expense and the lower gross profit. Net loss per common share was $0.05 for the three months ended December 31, 2012 as compared to $0.06 for the three months ended December 31, 2011. The weighted average number of shares outstanding for the three months ended December 31, 2012 and 2011 were 28,877,700 and 22,204,124, respectively.

LIQUIDITY AND CAPITAL RESOURCES

For the six months ended December 31, 2012, the Company used net cash of $1,994,491 in operating activities as compared to net cash used in operating activities of $2,054,789 for the six months ended December 31, 2011.  Net cash used during the six months ended December 31, 2012 resulted primarily from the net loss of $3,211,484, recognition of the reversal of losses from litigation of $200,000, a decrease in accrued expenses of $4,542, a decrease in accounts payable of $32,669 and an increase in inventory of $29,665 which were partially offset by non-cash stock based compensation of $990,559, amortization of convertible note discounts of $274,426, vesting of restricted stock units of $90,0000, loss on repricing of warrants of $70,491  and depreciation of $25,346. Net cash used during the six months ended December 31, 2011 resulted primarily from the net loss of $2,873,211, a decrease in accrued expenses of $103,756, a decrease in accounts payable of $32,734 and an increase in inventory of $178,007 which were partially offset by non-cash stock based compensation of $676,332, non-cash amortization of stock based prepaid consulting of $42,500, non-cash stock issued for settlement of $300,000 and depreciation of $25,519.

Cash flows used in investing activities for the six months ended December 31, 2012 amounted to $3,285 as compared to $26,922 for the six months ended December 31, 2011. The cash flows used in investing activity for the six months ended December 31, 2012 related to purchases of computer equipment for the corporate office. The cash flows used in investing activity for the six months ended December 31, 2011 related to purchases of equipment used with our mobile mixing truck and additional computer and office equipment for the corporate office.

Cash flows from financing activities for the six months ended December 31, 2012 were $2,194,131 as compared to $217,815 for the six months ended December 31, 2011.  During the six months ended December 31, 2012, the Company received $910,000 from the exercise of options to purchase 1,820,000 shares of common stock at an exercise price of $0.50 per share, $128,000 from two accredited investors in exchange for 156,000 shares of common stock in connection with a private placement, $810,003 in exchange for 1,333,820 shares of common stock in connection with the stock purchase agreement with Lincoln Park Capital Fund LLC (“LPC”), $175,000 in exchange for six-month convertible notes with two accredited investors and $250,000 from the Company’s principal stockholder in exchange for a one year convertible original issue discount note.  The amounts received were used to make repayments on notes payable to related parties of $59,839 and to make payments on insurance premium finance contracts of $19,033. During the six months ended December 31, 2011, the Company received $50,000 proceeds from the sale of common stock, $33,335 from the exercise of options to purchase 35,000 shares of common stock at exercise prices from $0.667 to $1.00 per share by a director, $65,000 from the exercise of 130,000 warrants at $0.50 per share and $89,380 in loan proceeds from related parties and used those funds to repay $19,900 of insurance premium financing.

As of the filing date of this report, we have $152,500 in available cash. Although we do not anticipate the need to purchase any additional material capital assets in order to carry out our business, it may be necessary for us to purchase additional mobile mixing trucks and support vehicles in the future, depending on demand. As previously disclosed, in January 2012, the Company signed a $5 million purchase agreement with LPC and filed registration statement related to the transaction covering the shares that may be issued to LPC under the purchase agreement. Provided that the registration statement is current, the Company has the right, in its sole discretion, over a 30-month period to sell shares of common stock to LPC in amounts between $30,000 and $500,000 per sale, depending on certain conditions as set forth in the purchase

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

agreement, up to $4.9 million. To date, the Company has issued 2,336,569 shares of common stock in exchange for $1,420,003 under the purchase agreement and has the ability to sell another $3.6 million under the purchase agreement.  The price at which the Company may sell shares to LPC is subject to a floor of $0.35 per share.  The Company believes the LPC purchase agreement could provide the Company with a sufficient amount of working capital for the next 12 months; however the Company must file an amendment to its registration statement and update it before it can sell any common stock.  The Company has continued to meet with additional potential investors to explore other financing alternatives.

In September and October 2012, the Company issued 1,820,000 shares of common stock in exchange for $910,000 in connection with the exercise of 1,820,000 warrants (including 1,200,000 warrants held by our principal shareholder) related to an offer by the Company to reduce the exercise prices of the warrants to $0.50 per share. Additionally, in September 2012, our principal shareholder converted his $322,996 convertible original issue discount note which was due on September 28, 2012 into 665,992 shares of common stock.

In December 2012, in consideration for a $250,000 loan, the Company issued its principal shareholder a $275,000 one-year 10% original issue discount note convertible at $0.35 per share (the “2012 Note”).  The 2012 Note was amended to: (i) reduce the interest to 7.5% and (ii) extend the due date to December 31, 2016.  In February 2013, the Company borrowed $250,000 from its principal shareholder.  In connection with this loan, the Company consolidated all of the outstanding notes held by the principal shareholder and issued him a $1,997,482.95 note convertible at $0.35 per share due December 31, 2016 (the “2013 Note”) and the principal shareholder cancelled his $1.4 million note and the 2012 Note.  The 2013 Note bears an annual interest rate of 7.5% with interest to be paid annually in cash or common stock at $0.35 per share at the principal shareholder’s option.

Ultimately, if the Company is unable to generate substantial cash flows from sales of its products or complete financings, the Company may not be able to remain operational.  As a result of the recent court ruling in the Hopkins’ matter (see page 25, “Item 1. Legal Proceedings), the Company does not have an imminent need for liquidity to fund a bond requirement. However, in the event that Mr. Hopkins is awarded a substantial award in the new trial, the Company may not have the money to secure an appeal bond.  There can be no assurance that we will complete any financing or otherwise be able to meet our working capital needs.

Related Person Transactions

For information on related party transactions and their financial impact, see Note 6 and Note 8 to the Unaudited Condensed Consolidated Financial Statements.

Principal Accounting Estimates

In response to the SEC’s financial reporting release, FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, the Company has selected its most subjective accounting estimation processes for purposes of explaining the methodology used in calculating the estimate, in addition to the inherent uncertainties pertaining to the estimate and the possible effects on the Company’s financial condition. The accounting estimates are discussed below. This estimate involves certain assumptions that if incorrect could create a material adverse impact on the Company’s results of operations and financial condition.

Revenue Recognition

Under ASC 605-15-25 we recognize sales of our products when each of the following has occurred:

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

Stock-Based Compensation

Under ASC 718-10 we recognize an expense for the fair value of our outstanding stock options as they vest, whether held by employees or others.

We estimate the fair value of each stock option and warrant at the grant date using the Black-Scholes option pricing model based upon certain assumptions which are contained in Note 1 to the Unaudited Condensed Consolidated Financial Statements contained herein. The Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because our stock options and warrants have characteristics different from those of traded options, and because changes in the subjective input of assumptions can materially affect the fair value estimate, in our management’s opinion, the existing models may not necessarily provide a reliable single measure of the fair value of such stock options.

RECENT ACCOUNTING PRONOUNCEMENTS

For information on recent accounting pronouncements, see Note 1 to the Unaudited Condensed Consolidated Financial Statements.

Cautionary Note Regarding Forward-Looking Statements

This report contains forward-looking statements including our liquidity and anticipated capital asset requirements, the substantial markets for our products including Soil₂O® “Dust Control” and expected increase in sales of our products internationally. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects” and similar references to future periods.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions.  Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict.  Our actual results may differ materially from those contemplated by the forward-looking statements.  We caution you therefore against relying on any of these forward-looking statements.  They are neither statements of historical fact nor guarantees or assurances of future performance. Important factors that could cause actual results to differ materially from those in the forward-looking statements include global and domestic economic conditions, budgetary pressures facing state and local governments, our failure to receive or the potential delay of anticipated orders for our products, failure to receive acceptance of FireIce® by State and Local governments, failure to resolve our trademark issue in China, and an adverse result in the Hopkin’s litigation.

Further information on our risk factors is contained in our filings with the SEC, including the Form 10-K for the fiscal year ended June 30, 2012.  Any forward-looking statement made by us speaks only as of the date on which it is made.  Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them.  We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

ITEM 3. 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable to smaller reporting companies

ITEM 4. 

CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures.  Our management carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial Officer, required by Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”) of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on their evaluation, our management has concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting.  There were no changes in our internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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GELTECH SOLUTIONS, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

ITEM 1. 

LEGAL PROCEEDINGS.

As previously disclosed, David Hopkins, a former employee, obtained a jury verdict in July 2012 against the Company for $1,046,000 and against Mr. Michael Cordani, the Company’s Chief Executive Officer, for $200,000.  In January, 2013 the court ruled on the defendant’s post-trial motions dismissing the $200,000 claim against Mr. Cordani and reducing the $841,000 verdict to $500,000.  In November 2012, the Company’s insurance carrier paid the plaintiff $200,000 which leaves the Company liable for the $5,000 trespass award and the $500,000 breach of consulting agreement award. The Company has filed another post trial motion seeking a new trial on damages relating to the $500,000 verdict.  The Company’s motion for a new trial on damages was granted in February 2013.

ITEM 1A.

RISK FACTORS.

Not applicable to smaller reporting companies.

ITEM 2. 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

In addition to those unregistered securities previously disclosed in reports filed with the Securities and Exchange Commission, or the SEC, we have sold securities without registration under the Securities Act of 1933, or the Securities Act, as described below.

————————

ITEM 3. 

DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4. 

MINE SAFETY DISCLOSURES.

Not Applicable

ITEM 5. 

OTHER INFORMATION.

On February 8, 2013, Joseph Ingarra resigned as a director and President of the Company in order to pursue other interests.  In connection with his resignation, the Company agreed to pay Mr. Ingarra 12 months of severance at the same rate as his current base salary, or $150,000, (plus COBRA reimbursement) payable in accordance with the Company’s standard payroll practices with the first 10 months paid each month and the last two months paid once a month (in one-half of the monthly rate installments) for four months.  The severance was in lieu of the approximately 45 months due under his Employment Agreement under certain circumstances.  Additionally, the Company granted Mr. Ingarra 112,500 fully-vested stock options exercisable at $0.39 per share, subject to a lockup agreement for the option shares and the other shares he currently owns.  All other stock options and stock appreciation rights previously granted to Mr. Ingarra have been cancelled.

ITEM 6. 

EXHIBITS.

The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-Q.

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