NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Power Technologies, Inc. (hereinafter the Company) was incorporated in Delaware on August 26, 2004. The Company is primarily a holding company for its sole subsidiary, Q2Power Corp. Formerly, the Companys name was Anpath Group, Inc., and prior to that, Telecomm Sales Network, Inc.
The Company, through its subsidiary, Q2Power Corp. (the Subsidiary or Q2P), operates a renewable power company focused on the conversion of waste to energy and other valuable reuse products. Q2P plans to utilize proprietary technology and business models demonstrated in the solar and wind power industries to monetize waste energy resources such as methane, waste fuel and other organic waste. The operations of the Company are essentially those of the Subsidiary.
On November 12, 2015, the Company and its special purpose merger subsidiary completed a merger (the Merger) with Q2P. As a result of the Merger, all outstanding shares of Q2P were exchanged for 24,034,475 shares of the Companys common stock, which represented an exchange ratio of 0.34 shares of the Company for every one share of Q2P (the Exchange Ratio). In addition, the Company assumed both the Q2P 2014 Founders Stock Option Plan and the 2014 Employees Stock Option Plan (the Option Plans), and 1,095,480 options outstanding thereunder. Also pursuant to the Merger, the officers and directors of Q2P assumed control over the management and Board of Directors of the Company. Subsequent to the Merger, the Company officially changed its name to Q2Power Technologies, Inc.
On December 1, 2015, in connection with the Merger the Company also sold its prior operating subsidiary, EnviroSystems Inc. (ESI), to three former shareholders in exchange for a return of 470,560 shares of the Companys common stock. ESI assumed all debt, payables and a litigation judgment that was on its books as of the Merger date.
NOTE 2 BASIS OF PRESENTATION AND GOING CONCERN
The Company has incurred net losses of $3,536,021 and $1,612,093 for the years ended December 31, 2015 and 2014, respectively. The accumulated deficit since inception is $5,365,379, which is comprised of operating losses (which were paid in cash, stock for services and other equity instruments) and other expenses. The Company has a working capital deficit at December 31, 2015 of $2,439,947. These conditions raise substantial doubt about the Companys ability to continue as a going concern. There is no guarantee whether the Company will be able to generate enough revenue and/or raise capital sufficient to support its operations. The ability of the Company to continue as a going concern is dependent on managements plans which include implementation of its business model to generate revenue from power purchase agreements, product sales, and continuing to raise funds through debt or equity offerings. The Company will also likely continue to rely upon related-party debt or equity financing, which may not be available at the time required by the Company.
The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
U.S. Generally Accepted Accounting Principles (GAAP) requires the Company to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures during the period. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited to, those that relate to the realizable value of identifiable intangible assets and other long-lived assets, derivative liabilities, income taxes and contingencies. Actual results could differ from these estimates.
40
NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its Subsidiary. All significant inter-company transactions and balances have been eliminated in consolidation. References herein to the Company include the Company and its subsidiary, unless the context otherwise requires.
Cash
The Company considers all unrestricted cash, short-term deposits, and other investments with original maturities of no more than ninety days when acquired to be cash and cash equivalents for the purposes of the statement of cash flows. The Company maintains cash balances at two financial institutions, and has experienced no losses with respect to amounts on deposit.
At December 31, 2015 and 2014, cash held in banks totaled $1,012 and $265,374, respectively. As of December 31, 2014, restricted cash consists of funds held in escrow by an attorney in connection with the sale of common stock to investors. These funds were released to the Company in March 2015.
Revenue Recognition
Revenue will be recognized at the date of shipment of engines and systems, engine prototypes, engine designs or other deliverables to customers when a formal arrangement exists, the price is fixed or determinable, the delivery or milestone deliverable is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied will be recorded as deferred revenue. The Company will not allow its customers to return prototype products.
For the year ended December 31, 2015, the Company has recognized revenue of $20,000 related to two engineering services agreements with one customer, which were completed in the fourth quarter.
Research and Development
Research and development activities for product development are expensed as incurred. Costs for years ended December 31, 2015 and 2014 were $1,423,769 and $565,431, respectively.
Stock Based Compensation
The Company applies the fair value method of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718,
Share Based Payment
, in accounting for its stock based compensation. This standard states that compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. The Company values stock based compensation at the market price for the Companys common stock and other pertinent factors at the grant date.
The Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on the fair value of the equity instruments exchanged, in accordance with ASC 505-50,
Equity Based payments to Non-employees
. The Company measures the fair value of the equity instruments issued based on the market price of the Companys stock at the time services or goods are provided.
Common Stock Options
The Black-Scholes option pricing valuation method is used to determine fair value of these options consistent with ASC 718,
Share Based Payment.
Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields, expected term of the awards and risk-free interest rates.
41
Derivatives
Derivatives are recognized initially at fair value. Subsequent to initial recognition, derivatives are measured at fair value, and changes are therein generally recognized in profit or loss.
Software, Property and Equipment
Software, property and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives of the assets as follows:
|
|
|
| |
|
|
Years
|
|
Software
|
|
2
|
|
Furniture and equipment
|
|
7
|
|
Computers
|
|
5
|
|
Expenditures for maintenance and repairs are charged to operations as incurred.
Impairment of Long Lived Assets
The Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover the assets carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company has not recognized any impairment charges.
Income Taxes
Income taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, Income Taxes (ASC 740). 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 and operating loss and tax credit carry forwards. 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. Under ASC 740, the effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance is applied when in managements view it is more likely than not (50%) that such deferred tax will not be utilized.
In the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of December 31, 2015, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability to the taxing authorities. Interest and penalties related to the unrecognized tax benefits is recognized in the consolidated financial statements as a component of income taxes.
Basic and Diluted Loss Per Share
On July 22, 2015, the previous Board of Directors authorized that the Company effectuate a reverse split of its issued and outstanding Common Stock in the ratio of one (1) post-split share of Common Stock for every seven (7) shares of pre-split Common Stock, while retaining the current par value of $0.0001 per share, with appropriate adjustments being made in the additional paid-in capital and stated capital accounts of the Company, with all fractional shares that would otherwise result from such reverse split being rounded up to the nearest whole share. The reverse stock split has been retroactively adjusted throughout the consolidated financial statements.
Net loss per share is computed by dividing the net loss less preferred dividends by the weighted average number of common shares outstanding during the period. Diluted net loss per share is calculated by dividing the net loss less preferred dividends by the weighted average number of common shares outstanding during the period plus any potentially dilutive shares related to the issuance of stock options, shares issued from the conversion of convertible preferred stock and shares issued for the issuance of convertible debt. As of December 31, 2015, total
42
dilutive shares amounted to approximately 103,750 shares, consisting of potentially dilutive shares related to convertible debentures. There were no dilutive shares as of December 31, 2014.
Recent Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (ASU), No. 2014-09,
Revenue from Contracts with Customers
, to replace the existing revenue recognition criteria for contracts with customers and to establish the disclosure requirements for revenue from contracts with customers. The ASU is effective for interim and annual periods beginning after December 15, 2017. Adoption of the ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. The Company is currently assessing the future impact of the ASU on its financial statements.
In June 2014, the FASB issued ASU No. 2014-12,
CompensationStock Compensation (Topic 718)
or ASU 2014-12. ASU 2014-12 requires that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. The amendments in ASU 2014-12 are effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. The Company does not anticipate this ASU will have a material impact to the Companys financial position, results of operations or cash flows.
In August 2014, the FASB issued ASU No. 2014-15,
Presentation of Financial Statements Going Concern
, to provide guidance within GAAP requiring management to evaluate whether there is substantial doubt about an entitys ability to continue as a going concern and requiring related disclosures. The ASU is effective for annual periods ending after December 15, 2016. The Company is currently assessing the impact of the ASU on its financial statements.
In November 2015, the FASB issued ASU No. 2015-17,
Balance Sheet Classification of Deferred Assets
, requiring management to provide a classification of all deferred taxes as noncurrent assets or noncurrent liabilities. This ASU is effective for annual periods beginning after December 15, 2016. The Company does not anticipate this ASU will have a material impact to the Companys financial position, results of operations or cash flows.
In January 2016, the FASB issued ASU No. 2016-01,
Recognition and Measurement of Financial Assets and Financial Liabilities
, requiring management to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact of the ASU on its financial statements.
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842) (the Update)
, requiring management to recognize any right-to-use-asset and lease liability on the statement of financial position for those leases previously classified as operating leases. The criteria used to determine such classification is essentially the same as under the previous guidance, but it is more subjective. The lessee would classify the lease as a finance lease if certain criteria at lease commencement are met. This ASU is effective for fiscal years beginning after December 15, 2018. The Company is currently assessing the impact of the ASU on its financial statements.
In March 2016, the FASB issued ASU 2016-06,
Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (a consensus of the FASB Emerging Issues Task Force)
, which applies to all entities that are issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call (put) options, and requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One criterion is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact of the ASU on its financial statements.
In March 2016, the FASB issued ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
, which amends ASC Topic 718,
Compensation Stock Compensation
. The ASU includes provisions
43
intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements, including the income tax effects of share-based payments and accounting for forfeitures. This ASU is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. The Company is currently assessing the impact of the ASU on its financial statements.
Concentration of Risk
The Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to be the two assets most likely to subject the Company to concentrations of credit risk. The Companys policy is to maintain its cash with high credit quality financial institutions to limit its risk of loss exposure.
The Company maintains cash accounts in two quality financial institutions. The Company has not experienced any losses in its bank accounts through December 31, 2015.
The Company purchases much of its machined parts through Precision CNC, a company that sub-leases office space to Q2P and owns a non-controlling interest in the Company. Further, one of the principals of Precision CNC is a Vice President of Q2P. Should Precision CNC no longer be able to provide such manufacturing services to the Company, it may prove difficult to find a suitable replacement in a timely and affordable manner, thus, the loss of this supplier could have a materially adverse impact on the Companys operations and financial position. For the years ended December 31, 2015 and 2014 the amounts paid to Precision CNC totaled $160,601 and $110,814, respectively, and consisted of rent and research and development expenses for machined parts.
NOTE 4 SOFTWARE, PROPERTY AND EQUIPMENT, NET
Software, property and equipment, net consists of the following:
|
|
|
|
| |
|
December 31,
2015
|
|
December 31,
2014
|
Software
|
$
|
83,735
|
|
$
|
24,671
|
Furniture and Computers
|
|
51,643
|
|
|
25,991
|
Shop Equipment
|
|
9,540
|
|
|
6,045
|
Total
|
|
144,918
|
|
|
56,707
|
Accumulated depreciation and amortization
|
|
44,184
|
|
|
4,318
|
Net software, property and equipment
|
$
|
100,734
|
|
$
|
52,389
|
At December 31, 2015 and 2014, the Company has software under capital leases with gross value of $24,671 and $24,671, respectively, net of accumulated depreciation and amortization of $15,419 and $3,084, respectively.
Depreciation and amortization expense for the years ended December 31, 2015 and 2014 was $39,866 and $4,318, respectively.
NOTE 5 CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
On July 28, 2014, Q2P (which at such time was called WHE Generation Corp., and renamed Q2Power Corp. on January 26, 2015) commenced operations as an independent company after receiving its initial round of seed funding and signing a formal separation agreement with Cyclone Power Technologies, Inc. (Cyclone). Cyclone had originally established Q2P as a wholly-owned Florida limited liability company (LLC) in 2010. In April 2014, in contemplation of its separation from Cyclone and initial funding, the Company redomiciled from Florida to Delaware and converted from an LLC to a corporation. In connection with this transaction, 1,132,268 membership interests in the LLC were exchanged for 1,924,855 shares in the Company. At December 31, 2014, Cyclone owned 17.63% in Q2P after dilution of its interest as a result of the separation, the Seed Round of funding, a Stock Repurchase Agreement, and the subsequent Series A Funding Round (a common stock offering). As of
44
December 31, 2015, Cyclone owned approximately 3% of Q2P after dilution of its interest as a result of the continuation of the Series A Round of funding and a Rights Offering in May 2015.
The separation agreement between Q2P and Cyclone provided for a formal division of certain assets, liabilities and contracts related to Q2Ps business, as well as establishing procedures for exchange of information, indemnification of liability, and releases and waivers for the principals moving forward.
As part of the separation from Cyclone, Q2P purchased for $175,000 certain licensing rights to use Cyclones patented technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2Ps waste heat and waste-to-power business. This agreement contains a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived from technology licensed from Cyclone. Also, as part of the separation from Cyclone, Q2P assumed a license agreement between Cyclone and Phoenix Power Group, which included deferred revenue of $250,000 from payments previously made to Cyclone for undelivered products. The net balances as of December 31, 2015 and 2014 for the Cyclone licensing rights were $113,021 and $156,771, respectively, and the net balances as of December 31, 2015 and 2014 for the Phoenix deferred revenue were $250,000 and $250,000, respectively, which are included as a component of deferred revenue on the consolidated balance sheets. Under the terms of the revised agreement with Phoenix Power Group, revenue associated with these deferrals will be recognized subject to the achievement of certain milestones, as follows: (1) on the completion of certain performance testing of the engine, deferred revenue of $150,000 will be recognized; and (2) on the delivery of the first 10 Generation 1 Engines, other deferred revenue will be recognized at a rate of $10,000 per delivered engine.
In connection with the separation from Cyclone, the Company also assumed a contract with Clean Carbon of Australia and a corresponding $10,064 prepayment for services or other value to be provided in the future. This deposit has been presented as deferred revenue on the December 31, 2015 and 2014 consolidated balance sheets.
The licensing rights are amortized over its estimated useful life of 4 years. Amortization expense for the years ended December 31, 2015 and 2014 was $43,750 and $18,229, respectively.
NOTE 6 RELATED PARTY TRANSACTIONS
Expenses prepaid with common stock for the years ended December 31, 2015 and 2014 totaled $135,321 and $229,459, respectively. The balance at December 31, 2015 relates to stock issued to Greenblock Capital ("GBC") for future services with a remaining amount of $119,167, and shares purchased by the CEO and paid for through salary deductions with a remaining amount of $16,154. The balance at December 31, 2014 relates to stock issued to Precision CNC for future services.
The Company sub-leases approximately 2,500 square feet of assembly, warehouse and office space within the Precision CNC facility located at 1858 Cedar Hill Road in Lancaster, Ohio. The sublease provides for the Company to pay rent monthly in the amount of $2,500, which covers space and some utilities. Occupancy costs for the years ended December 31, 2015 and 2014 were $30,000 and $20,000, respectively. The sublease is month-to-month, however, Precision CNC must provide the Company 90 days notice to terminate. The Company also purchases much of its machined parts through Precision CNC. Precision CNC owns a non-controlling interest in the Company, and one of the principals of Precision CNC is a Vice President of Q2P. The Company also maintains an executive office in Florida, which is leased by GBC. The Company has no formal agreement for this space, but paid GBC $10,000 and $0 for the space for the years ended December 31, 2015 and 2014, respectively.
For the years ended December 31, 2015 and 2014, the amounts paid to Precision CNC totaled $160,601 and $110,814, respectively, and consisted of rent and research and development expenses for machined parts. Accounts payable and accrued expenses at December 31, 2015 and 2014 includes $31,048 and $33,281, respectively, to Precision CNC.
In September 2015, the Company received $10,000 from a member of the Board of Directors, who also serves as the Companys SEC counsel, in exchange for a promissory note to repay this amount plus $500 interest on demand but no earlier than October 1, 2015. This principal and interest were repaid in December 2015.
GBC loaned the Company $60,000 in 2015, which was repaid without interest in the same period. In connection with the Merger, GBC received 1,000,000 shares of unregistered common stock for
45
consulting services to be rendered in the amount of $260,000. The Companys (Anpaths) former director, Christopher J. Spencer, owns a majority interest in GBC, and our CEO is a Managing Director of GBC, although he has no equity or voting rights in GBC.
NOTE 7 INCOME TAXES
A reconciliation of the differences between the effective income tax rates and the statutory federal tax rates for the years ended December 31, 2015 and 2014 (computed by applying the U.S. Federal corporate tax rate of 34 percent to the loss before taxes) is as follows:
|
|
|
|
|
| |
|
2015
|
|
|
2014
|
Tax benefit at U.S. statutory rate
|
$
|
1,202,247
|
|
|
$
|
548,111
|
State taxes, net of federal benefit
|
|
--
|
|
|
|
--
|
Stock and stock based compensation
|
|
(350,942)
|
|
|
|
(196,730)
|
Net derivative expenses
|
|
(44,659)
|
|
|
|
--
|
Derivative expense
|
|
(4,587)
|
|
|
|
--
|
Other permanent differences
|
|
(1,213)
|
|
|
|
(757)
|
Increase in valuation allowance
|
|
(800,846)
|
|
|
|
(350,624)
|
|
$
|
--
|
|
|
$
|
--
|
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities for the years ended December 31, 2015 and 2014 consisted of the following:
|
|
|
|
|
|
| |
|
|
2015
|
|
|
2014
|
Net operating loss carry-forward
|
|
$
|
1,165,617
|
|
|
$
|
353,439
|
Deferred tax liabilities accrued salaries
|
|
|
(14,656)
|
|
|
|
(2,815)
|
Depreciation expense
|
|
|
509
|
|
|
|
--
|
Net deferred tax assets
|
|
|
1,151,470
|
|
|
|
350,624
|
Valuation allowance
|
|
|
(1,151,470)
|
|
|
|
(350,624)
|
Total net deferred tax asset
|
|
$
|
--
|
|
|
$
|
--
|
At December 31, 2015 and 2014, the Company had net deferred tax assets of $1,151,470 and $350,624 principally arising from net operating loss carry-forwards for income tax purposes. As management of the Company cannot determine that it is more likely than not that the Company will realize the benefit of the net deferred tax asset, a valuation allowance equal to the net deferred tax asset has been established at December 31, 2015 and 2014. At December 31, 2015, the Company has net operating loss carry forwards totaling $3,428,285, which will begin to expire in 2034.