Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheet
|
|
March 31,
|
|
|
|
|
|
|
2016
|
|
|
December 31,
|
|
ASSETS
|
|
(unaudited)
|
|
|
2015
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
592,720
|
|
|
$
|
349,186
|
|
Prepaid expenses and other current assets
|
|
|
54,597
|
|
|
|
50,596
|
|
Total current assets
|
|
|
647,317
|
|
|
|
399,782
|
|
Property and equipment, net of accumulated depreciation of $27,302 and $60,242 at March 31, 2016 and December 31, 2015, respectively
|
|
|
16,532
|
|
|
|
21,798
|
|
Other assets
|
|
|
6,480
|
|
|
|
6,480
|
|
Total assets
|
|
$
|
670,329
|
|
|
$
|
428,060
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
636,876
|
|
|
$
|
590,001
|
|
Accounts payable and accrued expenses
|
|
|
226,832
|
|
|
|
207,334
|
|
Accrued expenses and accounts payable-related parties
|
|
|
174,603
|
|
|
|
190,750
|
|
Convertible debentures, net of discounts of $451,113 and $100,833 at March 31, 2016 and December 31, 2015, respectively
|
|
|
237,002
|
|
|
|
222,195
|
|
Total current liabilities
|
|
|
1,275,313
|
|
|
|
1,210,280
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 300,000,000 shares authorized 188,720,626 and 183,831,577 shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively
|
|
|
188,721
|
|
|
|
183,832
|
|
Additional paid-in capital
|
|
|
101,687,839
|
|
|
|
100,308,100
|
|
Accumulated deficit
|
|
|
(102,481,544
|
)
|
|
|
(101,274,152
|
)
|
Total stockholders’ deficit
|
|
|
(604,984
|
)
|
|
|
(782,220
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
670,329
|
|
|
$
|
428,060
|
|
See notes to condensed
consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Operations, Unaudited
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
635,402
|
|
|
|
855,452
|
|
Research and development expenses
|
|
|
74,935
|
|
|
|
272,777
|
|
Loss before other income (expense)
|
|
|
(710,337
|
)
|
|
|
(1,128,229
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
Other income
|
|
|
–
|
|
|
|
1,500
|
|
Interest and financing expense
|
|
|
(493,712
|
)
|
|
|
(47,608
|
)
|
Loss on disposition of equipment
|
|
|
(3,343
|
)
|
|
|
–
|
|
Net Loss
|
|
|
(1,207,392
|
)
|
|
|
(1,174,337
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
185,222,083
|
|
|
|
181,253,911
|
|
See notes to condensed
consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the Three months Ended MARCH 31, 2016
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, January 1, 2016
|
|
|
183,831,577
|
|
|
$
|
183,832
|
|
|
$
|
100,308,100
|
|
|
$
|
(101,274,152
|
)
|
|
$
|
(782,220
|
)
|
Common stock issued on conversion of notes payable
|
|
|
4,789,049
|
|
|
|
4,789
|
|
|
|
474,116
|
|
|
|
|
|
|
|
478,905
|
|
Fair value of stock issued for services
|
|
|
100,000
|
|
|
|
100
|
|
|
|
15,900
|
|
|
|
|
|
|
|
16,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
|
|
|
|
|
|
|
|
762,468
|
|
|
|
|
|
|
|
762,468
|
|
Fair value of options and warrants issued as compensation
|
|
|
|
|
|
|
|
|
|
|
127,255
|
|
|
|
|
|
|
|
127,255
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,207,392
|
)
|
|
|
(1,207,392
|
)
|
Balance, March 31, 2016 (unaudited)
|
|
|
188,720,626
|
|
|
$
|
188,721
|
|
|
$
|
101,687,839
|
|
|
$
|
(102,481,544
|
)
|
|
$
|
(604,984
|
)
|
See notes to condensed
consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2016
|
|
|
2015
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,207,392
|
)
|
|
$
|
(1,174,337
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
127,255
|
|
|
|
228,352
|
|
Issuance of common stock for services
|
|
|
16,000
|
|
|
|
–
|
|
Amortization of debt discount
|
|
|
488,435
|
|
|
|
47,608
|
|
Accrued interest expense
|
|
|
5,277
|
|
|
|
–
|
|
Loss on disposition of assets
|
|
|
3,343
|
|
|
|
–
|
|
Depreciation and amortization
|
|
|
1,923
|
|
|
|
3,213
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
(4,001
|
)
|
|
|
23,101
|
|
Accounts payable and accrued expenses
|
|
|
19,498
|
|
|
|
5,879
|
|
Accounts payable – license agreements
|
|
|
46,875
|
|
|
|
11,719
|
|
Accounts payable and accrued expenses – related parties
|
|
|
(16,147
|
)
|
|
|
(15,815
|
)
|
Net cash used in operating activities
|
|
|
(518,934
|
)
|
|
|
(870,280
|
)
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of equipment
|
|
|
–
|
|
|
|
(12,914
|
)
|
Net cash used in investing activities
|
|
|
–
|
|
|
|
(12,914
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
762,468
|
|
|
|
–
|
|
Net proceeds from exercise of warrants and options
|
|
|
–
|
|
|
|
50,000
|
|
Net cash provided by financing activities
|
|
|
762,468
|
|
|
|
50,000
|
|
Net increase (decrease) in cash
|
|
|
243,534
|
|
|
|
(833,194
|
)
|
Cash
, beginning of period
|
|
|
349,186
|
|
|
|
2,247,557
|
|
Cash
, end of period
|
|
$
|
592,720
|
|
|
$
|
1,414,363
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
–
|
|
|
$
|
–
|
|
Income Taxes
|
|
$
|
–
|
|
|
$
|
–
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Conversion of convertible debentures to common stock
|
|
$
|
478,905
|
|
|
$
|
52,800
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
762,468
|
|
|
|
–
|
|
See notes to condensed
consolidated financial statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
THREE MONTHS ENDED MARCH 31, 2016 AND
2015
|
1.
|
Description of Business
|
QS Energy, Inc. (“QS
Energy”, “Company”) (formerly known as Save the World Air, Inc.) was incorporated on February 18, 1998, as a
Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February
11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The Company’s common stock is quoted
under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact
sheet, logos and media articles are available at our corporate website,
www.qsenergy.com
.
QS Energy
develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving
the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual property
portfolio includes 47 domestic and international patents and patents pending, a substantial portion of which have been
developed in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple”).
QS Energy's primary technology is called Applied Oil Technology™ (AOT™), a commercial-grade crude oil
pipeline transportation flow-assurance product. AOT™ has been proven in U.S. Department of Energy tests to increase the
energy efficiency of oil pipeline pump stations. The AOT product has transitioned from the research and development stage to commercial production for testing by the midstream pipeline marketplace.
Basis of Presentation
The accompanying condensed
consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable
rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain
information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed
or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report
on Form 10-K for the fiscal year ended December 31, 2015 filed with the SEC. The condensed consolidated balance sheet as of December
31, 2015 included herein was derived from the audited consolidated financial statements as of that date, but does not include all
disclosures, including notes, required by GAAP.
In the opinion of management,
the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the
Company's financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained
herein are of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative
of fiscal year-end results.
|
2.
|
Summary of Significant Accounting Policies
|
Consolidation Policy
The accompanying consolidated
financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS
Energy Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.
Going Concern
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
during the three-months ended March 31, 2016, the Company incurred a net loss of $1,207,392, used cash in operations of $518,934
and had a stockholders’ deficit of $604,984 as of that date. These factors raise substantial doubt about the Company’s
ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s
ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
In addition, the Company's
independent registered public accounting firm, in its report on the Company's December 31, 2015 financial statements, has raised
substantial doubt about the Company's ability to continue as a going concern.
At March 31, 2016,
the Company had cash on hand in the amount of $592,720. Management estimates that the current funds on hand will be sufficient
to continue operations through July 2016. Management is currently seeking additional funds, primarily through the issuance of debt
and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with
the license and research and development agreements with Temple; costs associated with product development and commercialization
of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective
system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing
periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company
has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment
agreements, certain payments to a former officer and consulting fees, during the remainder of 2016 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of
debt financing or cause substantial dilution for our stockholders in case of equity financing.
Basic and Diluted Income
(loss) per share
Our computation of
earnings per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to
common stockholders divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects
the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income (loss)
of the Company as if they had been converted at the beginning of the periods presented, or issuance date, if later. In computing
diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the
proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive
effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise
price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per
share or decrease loss per share) are excluded from the calculation of diluted EPS.
Income (loss) per common
share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the
respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating
loss because all warrants and stock options outstanding are anti-dilutive. At March 31, 2016 and 2015, we excluded the outstanding
securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been
anti-dilutive.
|
|
March 31, 2016
|
|
|
March 31, 2015
|
|
Options
|
|
|
23,184,256
|
|
|
|
21,761,512
|
|
Warrants
|
|
|
8,885,242
|
|
|
|
5,392,087
|
|
Common stock issuable upon conversion of notes payable
|
|
|
3,370,400
|
|
|
|
–
|
|
Total
|
|
|
35,439,898
|
|
|
|
27,153,599
|
|
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board (FASB) whereas the value of the stock compensation
is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the
date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges
generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's stock option and warrant grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the stock options or warrants, and future dividends.
Compensation expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual
experience. The assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded
in future periods.
Estimates
The preparation of
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include
those related to assumptions used in valuing equity instruments issued for financing and services. Actual results could differ
from those estimates.
Fair Value of Financial
Instruments
Effective January 1,
2008, fair value measurements are determined by the Company's adoption of authoritative guidance issued by the FASB, with the exception
of the application of the statement to non-recurring, non-financial assets and liabilities as permitted. The adoption of the authoritative
guidance did not have a material impact on the Company's fair value measurements. Fair value is defined in the authoritative
guidance as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy
was established, which prioritizes the inputs used in measuring fair value into three broad levels as follows:
Level 1—Quoted
prices in active markets for identical assets or liabilities.
Level 2—Inputs,
other than the quoted prices in active markets, are observable either directly or indirectly.
Level 3—Unobservable
inputs based on the Company's assumptions.
The Company is required
to use of observable market data if such data is available without undue cost and effort.
The Company is required
to use observable market data if such data is available without undue cost and effort. At March 31, 2016, the carrying amounts
for cash, accounts payable, accrued expenses and convertible debentures approximate their fair value due to their short term nature.
Patent Costs
Patent costs consist
of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule
Heat products, all patent costs are expensed as incurred. During the three-month periods ended March 31, 2016 and 2015, patent
costs were $13,088 and $19,806, respectively, and were included as part of operating expenses in the accompanying consolidated
statements of operations.
Recent Accounting Pronouncements
In August 2014, the
FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which provides
guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires
management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year
of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial
doubt about the entity’s ability to continue as a going concern. The ASU applies to all entities and is effective for annual
periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted.
In May 2014, the Financial
Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers.
ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance
under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require
that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also
will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer
contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill
a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted
only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to
transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company
is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures.
In February 2016, the
FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset
and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective
for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective
transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning
of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company
is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.
Other recent accounting
pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants,
and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's
present or future consolidated financial statement presentation or disclosures.
|
3.
|
Certain Relationships and Related Transactions
|
As of March
31, 2016 and December 31, 2015, the Company had accrued expenses and accounts payable to related parties in the amount of $174,603
and $190,750, respectively. Included in these amounts at March 31, 2016 and December 31, 2015 were unpaid salaries due to our former
President and current member of the Company’s Board of Directors of $60,429 and $75,429, respectively. The Company agreed
to pay the former President $5,000 per month until the unpaid salary is fully settled. Also included in these amounts at March
31, 2016 and December 31, 2015 are accrued directors’ fees of $76,089.
|
4.
|
Property and Equipment
|
At March 31,
2016 and December 31, 2015, property and equipment consists of the following:
|
|
March 31, 2016 (unaudited)
|
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
Office equipment
|
|
$
|
28,040
|
|
|
$
|
65,051
|
|
Furniture and fixtures
|
|
|
2,880
|
|
|
|
4,075
|
|
Testing Equipment
|
|
|
12,914
|
|
|
|
12,914
|
|
Subtotal
|
|
|
43,834
|
|
|
|
82,040
|
|
Less accumulated depreciation
|
|
|
(27,302
|
)
|
|
|
(60,242
|
)
|
Total
|
|
$
|
16,532
|
|
|
$
|
21,798
|
|
Depreciation
expense for the three-month periods ended March 31, 2016 and 2015 was $1,923 and $3,213, respectively. During the period
ended March 31, 2016, the Company disposed of certain property and equipment with aggregate costs of $38,206 and accumulated
depreciation of $34,863 which resulted in a loss of $3,343.
|
|
March 31, 2016
(unaudited)
|
|
|
December 31
2015
|
|
Balance due on convertible notes
|
|
$
|
680,834
|
|
|
$
|
321,024
|
|
Accrued interest
|
|
|
7,281
|
|
|
|
2,004
|
|
Subtotal
|
|
|
688,115
|
|
|
|
323,028
|
|
Unamortized note discounts
|
|
|
(451,113
|
)
|
|
|
(100,833
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
237,002
|
|
|
$
|
222,195
|
|
During 2014
and 2015, the Company conducted a private placement and issued approximately $1 million of its unsecured convertible notes
for proceeds of $920,900 or an original issue discount (“OID”) of $85,490. The notes did not bear any
interest, however, the implied interest rate used was 10% since the notes were issued at 10% less than its face value, are
unsecured, and matured in twelve months from their issuance. The notes are convertible, at the option of the note holder,
into the Company’s common stock at a conversion price starting at $0.10 per share through $0.48 per share. In addition,
each note holder also received a warrant to purchase common stock equivalent to 25% of the number of shares the notes
are convertible into or a total of 1,942,704 shares of common stock. Each warrant is exercisable on a cash basis only at a
price starting at $0.10 through $0.48 per share, vested immediately upon issuance, and exercisable for one year from the date
of issuance.
As a result, the Company
recorded a note discount of $842,105 to account for the relative fair value of the warrants, the notes’ beneficial conversion
feature (“BCF”), and OID. The note discounts are being amortized over the life of the note or will be amortize in full
upon the conversion of the corresponding notes to common stock. At December 31, 2015, total outstanding notes payable amounted
to $321,024 and unamortized note discount was $100,833.
As reported in
our Form 8-K filed on April 25, 2016, in the three-month period ended March 31, 2016, the Company issued similar convertible
promissory notes in the aggregate of $838,715 for cash proceeds of $762,468 or a discount of $76,247. The notes do not bear
any interest; however, the implied interest rate used was 10% since the notes were issued at 10% less than its face value,
are unsecured, mature in twelve months from their issuance and convertible at $0.10 per share. In addition, the Company also
granted these note holders warrants to purchase 4,193,575 shares of the Company’ common stock. The warrants are fully
vested, exercisable at $0.10 per share and will expire in one year. As a result, the Company recorded a note discount of
$838,715 to account for the relative fair value of the warrants, the notes’ BCF and OID. The note discounts are being
amortized over the life of the note or will be amortize in full upon the conversion of the corresponding notes to common
stock.
During
the three-month period ended March 31, 2016, a total of $478,905 of notes payable were converted into 4,789,049
shares of common stock and amortized note discount of $488,435 was recorded as interest expense.
As of March 31, 2016,
total outstanding notes payable amounted to $680,834 and unamortized note discount of $451,113. Included in the Company’s
outstanding notes payable are three notes in the aggregate of $211,024 that had reached maturity without conversion as of March
31, 2016 and are currently due. As a result, the Company accrued interest of $7,281 pursuant to the terms of the note agreement.
|
6.
|
Research and Development
|
Research and development
costs consist of costs of construction, development and testing of the AOT and Joule Heat technologies with internal resources
and through the assistance of various third party entities. Costs incurred and expensed include fees such as testing fees, purchase
of test equipment, pipeline pumping equipment, crude oil tank batteries, viscometers, SCADA systems, computer equipment, payroll
and other related equipment and various logistical expenses for the purposes of evaluating and testing the Company’s AOT
and Joule Heat prototypes. In addition, research and development costs also include licensing fees and research and development
fees due to Temple University.
For the three-month
periods ended March 31, 2016 and 2015, our research and development expenses were $74,935 and $272,777 respectively.
AOT Product Development
and Testing
In 2014, the Company
entered into a lease agreement with Kinder Morgan Crude & Condensate, LLC for the manufacture and delivery of our AOT Prototype
Equipment. The AOT Prototype Equipment is currently undergoing testing in a Kinder Morgan facility. See Note 1 and 7 for further
discussion.
During the three-month
periods ended March 31, 2016 and 2015, the Company incurred total expenses of $27,860 and $28,892, respectively, in the manufacture,
delivery and testing of the AOT prototype equipment. These expenses have been reflected as part of Research and Development expenses
on the accompanying consolidated statements of operations.
Joule Heat Product Development
and Testing
On October 15, 2014,
the Company entered into a Joint Development Agreement with Newfield Pipeline Exploration Company (“Newfield”) to test
the effectiveness of the Company’s Joule Heat technology under operating conditions on Newfield’s oil pipeline. The
Company’s first Joule Heat prototype unit was delivered to Newfield in May 2015 for further testing. In December 2015, we
temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the
AOT Midstream.
During the three-month
periods ended March 31, 2016 and 2015, the Company incurred total expenses of $200 and $164,666, respectively, in the manufacture,
delivery and testing of the Joule Heat prototype equipment. These expenses have been reflected as part of Research and Development
expenses on the accompanying consolidated statement of operations.
Temple University Licensing
Agreement
On August 1, 2011,
the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License
Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated
with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology
to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the
territory licensed to the Company is worldwide and replace previously issued License Agreements.
Pursuant to the two
licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000;
(ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing
agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon.
Temple also agreed to defer $37,500 of the amount due if the Company agreed to fund at least $250,000 in research or development
of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon
the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing
agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights.
Total expenses recognized
during each three-month period ended March 31, 2016 and 2015 pursuant to these two agreements amounted to $46,875 and has been
reflected in Research and Development expenses on the accompanying consolidated statements of operations.
As of March 31, 2016
and December 31, 2015, total unpaid fees due to Temple pursuant to these agreements amounted to $507,500 and $460,625, respectively,
which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As
of March 31, 2016, $175,000 of the $507,500 payable has been deferred until the licensing agreements are terminated and $332,500
is deemed past due. The Company is currently in negotiations with Temple to settle this amount.
There were no revenues
generated from these two licenses during the three-month periods ended March 31, 2016 and 2015.
Temple University Sponsored
Research Agreement
On March 19,
2012, the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University
(“Temple”), whereby Temple, under the direction of Dr. Rongjia Tao, performed research related to the
Company’s AOT device (the “Project”), for the period April 1, 2012, through April 1, 2014. All rights
and title to intellectual property resulting from Temple’s work related to the Project were subjected to the
Exclusive License Agreements between Temple and the Company, dated August 1, 2011. In exchange
for Temple’s research efforts on the Project, the Company has agreed to pay Temple $500,000, payable in
quarterly installments of $62,500. The agreement expired in August 2015.
During the three-month
period ended March 31, 2015, the Company recognized a total expense of $32,344 pursuant to this agreement and such costs have been
reflected in Research and Development expenses on the accompanying consolidated statements of operations. There was no such cost
recorded during 2016 as a result of the expiration of the agreement in August 2015.
As of March 31, 2016
and December 31, 2015, total unpaid fees due to Temple pursuant to this agreement amounted to $129,376, which are included as part
of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As of March 31, 2016, the
entire $129,377 is deemed past due. The Company is currently in negotiations with Temple to settle this amount.
|
7.
|
Kinder Morgan Crude & Condensate, LLC Lease
|
On July 15, 2014, the
Company entered into an Equipment Lease/Option to Purchase Agreement (“Lease”) with Kinder Morgan Crude & Condensate,
LLC (“Kinder Morgan”). In accordance with the terms and conditions of the agreement, Kinder Morgan agreed to lease
and test the effectiveness of the Company’s AOT technology and equipment on one of Kinder Morgan’s operating pipelines.
Equipment provided under the Lease includes a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons
per minute.
The initial term (“Initial
Term”) of the Lease is four months, with an option to extend the Lease for up to a maximum of 84 months. During the Initial
Term, either the Company or Kinder Morgan may terminate the Agreement for any reason on 45 days’ written notice. Lease payments
shall be $20,000 per month; provided however, that in the event the Equipment is removed from service at its initial location during
the Initial Term, the monthly lease payments shall be reduced to $5,000 until the Equipment is placed back in service at its new
location, at which time the Lease payments shall resume at $20,000 per month. The agreement further provides that Kinder Morgan
shall have an option to purchase the Equipment during the term of the Lease for a fixed price of between $600,000 and $1,200,000,
depending upon the date of purchase.
The AOT equipment was
delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, the AOT equipment experienced technical
issues that needed further modifications. In February 2016, the AOT equipment was re-installed at Kinder Morgan’s facility.
The Company and Kinder Morgan are now working to finalize installation and acceptance of the equipment under the lease. See Item
2, Overview for further discussion.
During the three months
ended March 31, 2016, the Company issued 4,789,049 shares of its common stock upon the conversion of $478,905 in convertible notes
at $0.10 per share. In addition, the Company also issued 100,000 shares of common stock to a consultant for services rendered with
a fair value of $16,000 which is included as part of Operating Expenses in the attached consolidated statements of operations.
The shares were value at date of issuance.
|
9.
|
Stock Options and Warrants
|
The Company periodically
issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing
costs. Options vest and expire according to terms established at the grant date.
Options
Employee options vest
according to the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining
contractual life of employee and non-employee options outstanding at March 31, 2016 was 5.4 years. Stock option activity for
the period January 1, 2016 up to March 31, 2016, was as follows:
|
|
Options
|
|
|
Weighted Avg. Exercise
Price
|
|
January 1, 2016
|
|
|
21,535,148
|
|
|
$
|
0.30
|
|
Granted
|
|
|
1,710,527
|
|
|
|
0.19
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Forfeited
|
|
|
(61,419
|
)
|
|
|
1.46
|
|
March 31, 2016
|
|
|
23,184,256
|
|
|
$
|
0.29
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2016 were as
follows:
|
|
Outstanding Options
|
|
Exercisable Options
|
Option
Exercise Price
Per Share
|
|
Shares
|
|
|
Life
(Years)
|
|
Weighted
Average Exercise
Price
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
$ 0.21 - $ 0.99
|
|
|
23,033,810
|
|
|
5.4
|
|
$0.28
|
|
|
21,288,283
|
|
|
$0.29
|
$ 1.00 - $ 1.99
|
|
|
150,446
|
|
|
7.3
|
|
$1.18
|
|
|
150,446
|
|
|
$1.18
|
|
|
|
23,184,256
|
|
|
5.4
|
|
$0.29
|
|
|
21,438,729
|
|
|
$0.29
|
During the three-month
period ending March 31, 2016 the Company granted options to purchase 1,710,527 shares of common stock to members of the Company’s
Board of Directors. The options are exercisable at $0.19 per share, vest monthly over a twelve-month period, and expire ten years
from the date granted. Total fair value of these options at grant date was $273,683 using the Black-Scholes Option Pricing model
with the following assumptions: life of 5.5 years; risk free interest rate of 1.73%; volatility of 119% and dividend yield of 0%.
During the three month
periods ended March 31, 2016 and 2015, the Company recognized compensation costs based on the fair value of options that vested
of $99,595 and $207,425 respectively.
At March 31, 2016,
the Company’s closing stock price was $0.15 per share. As all outstanding options had an exercise price greater than $0.15
per share, the aggregate intrinsic value of the options outstanding at March 31, 2016 was $0. Future unamortized compensation
expense on the unvested outstanding options at March 31, 2016 is $207,815 to be recognized through December 2016.
Warrants
The following
table summarizes certain information about the Company’s stock purchase warrants activity for the period starting January
1, 2016 up to March 31, 2016.
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
January 1, 2016
|
|
|
4,411,667
|
|
|
$
|
0.31
|
|
Granted
|
|
|
4,593,575
|
|
|
|
0.11
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
Cancelled
|
|
|
(120,000
|
)
|
|
|
1.01
|
|
March 31, 2016
|
|
|
8,885,242
|
|
|
$
|
0.19
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2016 were
as follows:
|
|
Outstanding Warrants
|
|
|
Exercisable Warrants
|
|
Warrant Exercise Price Per Share
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Weighted
Average Exercise Price
|
|
|
Shares
|
|
|
Weighted
Average Exercise Price
|
|
$ 0.25 - $ 0.99
|
|
|
8,885,242
|
|
|
|
1.9
|
|
|
$
|
0.19
|
|
|
|
8,850,242
|
|
|
$
|
0.19
|
|
$ 1.00 - $ 1.99
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
8,885,242
|
|
|
|
1.9
|
|
|
$
|
0.19
|
|
|
|
8,850,242
|
|
|
$
|
0.19
|
|
In the three-month
period ending March 31, 2016, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 4,193,575
shares of common stock with an exercise price of $0.10 per share, vesting immediately upon grant and expiring one year from the
date of grant (see Note 5).
During the three-month
period ending March 31, 2016 the Company granted warrants to purchase 400,000 shares of common stock to consultants. The options
are exercisable starting at $0.12 per share to $0.18 per share, vested upon issuance, and expire one year from the date granted.
During the three periods
ended March 31, 2016 and 2015, the Company recognized compensation costs of $27,660 and $20,927, respectively, based on the fair
value of warrants that vested. Total fair value of these warrants at March 31, 2016 was computed using the Black-Scholes Option
Pricing model with the following assumptions: life of 1 year and 8 years; average stock price of $0.16 per share, average risk
free interest rate of 0.83%; average volatility of 110% and dividend yield of 0%.
At March 31, 2016,
the aggregate intrinsic value of the warrants outstanding was $256,679. Future unamortized compensation expense on the unvested
outstanding warrants at March 31, 2016 is approximately $475 to be recognized through April 2016.
|
10.
|
Contractual Obligations
|
The Company has certain
contractual commitments as of March 31, 2016 for future periods, including office leases, minimum guaranteed compensation payments
and other agreements as described in the following table and associated footnotes:
|
|
|
|
|
Research and
|
|
|
|
|
|
|
|
Year ending
|
|
Office
|
|
|
License
|
|
|
Compensation
|
|
|
Total
|
|
December 31,
|
|
Lease (1)
|
|
|
Agreements (2)
|
|
|
Agreements (3)
|
|
|
Obligations
|
|
2016
|
|
$
|
52,470
|
|
|
$
|
140,625
|
|
|
$
|
262,500
|
|
|
$
|
455,595
|
|
2017
|
|
|
69,960
|
|
|
|
187,500
|
|
|
|
305,429
|
|
|
|
562,889
|
|
2018
|
|
|
40,810
|
|
|
|
187,500
|
|
|
|
290,000
|
|
|
|
518,310
|
|
2019
|
|
|
–
|
|
|
|
187,500
|
|
|
|
54,375
|
|
|
|
241,875
|
|
2020
|
|
|
–
|
|
|
|
187,500
|
|
|
|
–
|
|
|
|
187,500
|
|
Total
|
|
$
|
163,240
|
|
|
$
|
890,625
|
|
|
$
|
912,304
|
|
|
$
|
1,966,169
|
|
________________________________
|
(1)
|
Consists of rent for the Company’s Santa Barbara Facility expiring on July 31, 2018.
|
|
(2)
|
Consists of license maintenance fees to Temple University in the amount of $187,500 paid annually
through the life of the underlying patents or until otherwise terminated by either party.
|
|
(3)
|
Consists of base salary and certain contractually-provided benefits, to i) an executive officer,
pursuant to an employment agreement at a base salary of $290,000 per year and, as amended by the Board on March 10, 2016, expires
on March 8, 2019; and ii) and a severance agreement of a former officer in the amount of $60,429.
|
|
11.
|
Commitments and Contingencies
|
There is no current
or pending litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the
normal course of business.
Increase in Outstanding
Shares
In April, 2016, the
Company issued a convertible note in the amount of $30,030 in exchange for cash of $27,300. This note is unsecured, convertible
into 300,300 shares in common stock of the Company at a conversion price of $0.10 per share and mature in one year. In connection
with this note, the Company also issued warrants to purchase 150,150 shares of common stock of the Company at an exercise price
of $0.10 per share and expiring one year from the date of issuance. As a result, the Company will record a note discount of $30,030
to account for the relative fair value of the warrants, the note’s beneficial conversion feature and original issue discount,
which will be amortized as interest expense over the life of the notes.
In April, 2016, Company
issued 3,546,400 shares of common stock upon conversion of previously issued convertible notes in aggregate value of $354,640.
Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations
The following discussion
and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial
Statements and supplementary data referred to in this Form 10-Q.
This discussion
contains forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning
future revenue sources and concentration, selling, general and administrative expenses, research and development expenses, capital
resources, additional financings and additional losses, are subject to risks and uncertainties, including, but not limited to,
those discussed elsewhere in this Form 10-Q, particularly in “Risk Factors,” that could cause actual results to differ
materially from those projected. Unless otherwise expressly indicated, the information set forth in this Form 10-Q is as of
March 31, 2016, and we undertake no duty to update this information.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) (formerly known as Save the
World Air, Inc.) develops and commercializes energy efficiency technologies that assist in meeting increasing global energy demands,
improving the economics of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual property
portfolio includes 47 domestic and international patents and patents pending, a substantial portion of which have been developed
in conjunction with and exclusively licensed from Temple University of Philadelphia, PA (“Temple” or “Temple
University”). For details of the licensing agreements with Temple University, see Financial Statements attached hereto, Note
6. QS Energy's primary technology is called Applied Oil Technology™ (AOT™), a commercial-grade crude oil pipeline
transportation flow-assurance product. AOT™ has been proven in U.S. Department of Energy tests to increase the energy efficiency
of oil pipeline pump stations. The AOT product has transitioned from the research and development stage to commercial production
for testing by the midstream pipeline marketplace.
Our Company was incorporated
on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save
the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The name change
was effected through a short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Additionally, QS Energy Pool,
Inc., a California corporation, was formed as a wholly-owned subsidiary of the Company on July 6, 2015 to serve as a vehicle for
the Company to explore, review and consider acquisition opportunities. The Company’s common stock is quoted under the symbol
“QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and
media articles are available at our corporate website,
www.qsenergy.com
.
In 2014, we reached
a major milestone in the Company’s evolution, generating revenues from our AOT technology for the first time since our inception
in February 1998. We continue to devote the bulk of our efforts to the promotion, design, testing and the commercial manufacturing
and operations of our crude oil pipeline products in the upstream and midstream energy sector. We anticipate that these efforts
will continue during 2016 and 2017.
Between 2011 and 2012,
the Company transitioned from prototype testing of its AOT technology at the U.S. Department of Energy Rocky Mountain Oilfield
Testing Center, Midwest, Wyoming, to the design and production of full-scale commercial prototype units. The Company worked in
a collaborative engineering environment with multiple energy industry companies to refine the AOT™ Midstream commercial design
to comply with the stringent standards and qualification processes as dictated by independent engineering audit groups and North
American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known as AOT™ Midstream,
was completed.
In 2013, the Company
entered into an Equipment Lease/Option to Purchase Agreement (“TransCanada Lease”) with TransCanada Keystone Pipeline,
L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada") which agreed to lease and test the effectiveness of
the Company’s AOT technology and equipment on one of TransCanada’s operating pipelines. As previously reported in our
10-K report filed with the SEC on March 16, 2015, in June 2014, the equipment was accepted by TransCanada and the lease commenced
and the first full test of the AOT equipment on the Keystone pipeline was performed in July 2014 by Dr. Rongjia Tao of Temple University,
with subsequent testing performed by an independent laboratory, ATS RheoSystems, a division of CANNON (“ATS”) in September
2014. Upon review of the July 2014 test results and preliminary report by Dr. Tao, QS Energy and TransCanada mutually agreed that
this initial test was flawed due to, among other factors, the short term nature of the test, the inability to isolate certain independent
pipeline operating factors such as fluctuations in upstream pump station pressures, and limitations of the AOT device to produce
a sufficient electric field to optimize viscosity reduction. Subsequent testing by ATS in September 2014 demonstrated viscosity
reductions of 8% to 23% depending on flow rates and crude oil types in transit. In its summary report, ATS concluded that i) data
indicated a decrease in viscosity of crude oil flowing through the TransCanada pipeline due to AOT treatment of the crude oil;
and ii) the power supply installed on our equipment would need to be increased to maximize reduction in viscosity and take full
advantage of the AOT technology. While more testing is required to establish the efficacy of our AOT technology, we are encouraged
by the findings of these field tests performed under commercial operating conditions. The TransCanada Lease was terminated by TransCanada,
effective October 15, 2014. Upon termination of the TransCanada Lease, all equipment was uninstalled, returned, inspected and configured
for re-deployment.
On July 15, 2014, the
Company entered into an Equipment Lease/Option to Purchase Agreement (“Kinder Morgan Lease”) with Kinder Morgan Crude
& Condensate, LLC (“Kinder Morgan”) under which Kinder Morgan agreed to lease and test the effectiveness of the
Company’s AOT technology and equipment on one of Kinder Morgan’s operating pipelines. Equipment provided under the
Lease includes a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons per minute. The equipment was
delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, during pre-start testing, low electrical
impedance was measured in the unit, indicating an electrical short. A replacement unit was installed May 2015. The second unit
also presented with low impedance when flooded with crude condensate from Kinder Morgan’s pipeline. Subsequent to design
modifications, a remanufactured AOT unit was installed and tested at Kinder Morgan’s pipeline facility in in August 2015.
Initial results were promising, with the unit operating generally as expected. However, voltage dropped as preliminary tests continued,
indicating decreased impedance within the AOT pressure vessel. QS Energy personnel and outside consultants performed a series of
troubleshooting assessments and determined that, despite modifications made to the AOT, conductive materials present in the crude
oil condensate continued to be the root cause of the decreased impedance. Based on these results, QS Energy and Kinder Morgan personnel
mutually agreed to hold on final acceptance of equipment under the lease and temporarily suspend in-field testing to provide time
to re-test crude oil condensate in a laboratory setting, and thoroughly review and test selected AOT component design and fabrication.
Subsequent analysis and testing led to changes in electrical insulation, inlet flow improvements and other component modifications.
These design changes were implemented and tested by Industrial Screen and Maintenance (ISM), one of QS Energy's supply chain partners
in Casper, Wyoming. Test performed by ISM at its Wyoming facility indicated significant improvements to system impedance and efficiency
of electric field generation.
In February 2016, the
modified AOT equipment was installed at Kinder Morgan’s facility. Pre-acceptance testing was performed in April 2016, culminating
in more than 24 hours of continuous operations. In-field viscosity measurements and pipeline data collected during this test indicate
the AOT equipment is operating as expected, resulting in reductions in viscosity and pipeline pressure equivalent to those measured
under laboratory conditions. QS Energy and Kinder Morgan are now working to finalize installation and acceptance of the equipment
under the lease.
Southern Research Institute
(SRI) was engaged by QS Energy in 2015 to investigate the root cause of the crude oil condensate impedance issue by replicating
conditions experienced in the field utilizing a laboratory-scaled version of the AOT and crude oil condensate samples provided
by Kinder Morgan. In addition, QS Energy retained an industry expert petroleum pipeline engineer to review the AOT design
and suggest design modifications to resolve the crude oil condensate impedance issue. This engineer has studied design details,
staff reports and forensic photographs of each relevant AOT installation and test. Based on these investigations, specific modifications
were proposed to resolve the impedance issue, and improve the overall efficiency of the AOT device, resulting in a new value-engineered
design of certain AOT internal components.
The Company is actively
seeking new deployments of its AOT technology. In August, 2015, QS Energy was invited to an offshore oil transfer platform in the
Gulf of Mexico. This offshore platform was assessed by QS Energy personnel for a potential deployment of the AOT viscosity reduction
technology as a solution for super-heavy crude oil flow assurance issues. Following the site visit, all parties executed non-disclosure
agreements in advance of detailed analysis and in anticipation of developing an onsite AOT testing program subject to laboratory
testing and case studies performed on oil samples to be provided by the offshore platform operator. In June 2015, the Company formed
a strategic alliance with Norrønt, AS (“Norrønt”), located in Oslo, Norway. Through its affiliation with
Norrønt, the Company is currently in the process of negotiating a collaboration agreement with three Norwegian based oil
companies as well as a potential research grant with the Norwegian Research Council. Under a strategic alliance formed in 2013,
Energy Tech Africa is actively marketing AOT technology in Africa and the Middle East. During the first and second quarters of
2015, oil samples from a Middle Eastern oil company were provided under non-disclosure agreement to Temple University for testing.
These tests demonstrated AOT viscosity reductions of 20% to 35% in a laboratory setting. Discussions with this Middle East oil
company are ongoing.
In 2014, the Company
began development of a new suite of products based around the new electrical heat system which reduces oil viscosity through a
process known as joule heat (“Joule Heat”). The Company is designing and optimizing the Joule Heat technology for the
upstream oil transportation market. The Company filed two provisional patents related to the technology’s method and apparatus
in the second quarter and fourth quarter of 2013, respectively. The first of the two provisional patents was finalized and submitted
to non-provisional status on April 29, 2014. The second of the two provisional patents was finalized and submitted to non-provisional
status at the end of the third quarter 2014.
In October 2014, QS
Energy entered into a Joint Development Agreement with Newfield Exploration Company (“Newfield”) to test a prototype
of QS Energy Joule Heat equipment, and combined Joule Heat and AOT technology, on a crude oil pipeline serving the Greater Monument
Butte oilfield located in the Uintah Basin of Utah. This test of the Joule Heat technology provides ideal conditions to demonstrate
efficiency and efficacy. The Uintah Basin is 5,000 to 10,000 feet above sea level with average low winter temperatures of 16ºF.
Crude oil pumped from the region is highly paraffinic with the consistency of shoe polish at room temperature. Uintah's black wax
crude must remain at a minimum of 95ºF and yellow wax above 115ºF and therefore requires a substantial amount of heat
to keep it above its high pour point. Operators in the upstream market often run at temperatures of 140ºF to 160ºF. Newfield,
like many other companies in the region, incurs significant operating expense in the form of fuel and power used to heat the waxy
crude and counter the cold climate conditions characteristic of Utah. The Company’s first Joule Heat prototype was installed
for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration
will be required to determine commercial effectiveness of this unit. During the third and fourth quarters of 2015, we worked with
Newfield and Dr. Carl Meinhart to modify the prototype configuration based on observed pipeline and Joule Heat operating factors.
In addition, QS Energy provided a scaled-down version of the Joule Heat unit for static and flow-through testing at SRI. Testing
performed by SRI in September 2015 on a laboratory-scale Joule Heat unit demonstrated the ability of the Joule Heat technology
to deliver temperature increases in the laboratory setting.
In 2015, the Company
worked in collaboration with Newfield, SRI, Dr. Carl Meinhart, and our manufacturing partner to design and build an AOT prototype
unit, for operations in the upstream crude oil pipeline market (“AOT Upstream”), specifically configured for pipeline
operating factors observed at Newfield’s Utah site. Our original plan was to retrofit an earlier prototype device previously
tested at RMOTC; however, after multiple site visits and discussions with Newfield, it was determined a new, smaller unit, specifically
optimized for Newfield operations would be more appropriate for this field test opportunity. We plan to jointly test the AOT Upstream
prototype unit under typical upstream commercial pipeline conditions on Newfield’s pipeline in conjunction with the previously
installed Joule Heat unit.
In December 2015, we
temporarily suspended Joule Heat and AOT Upstream development activities to focus Company resources on finalizing commercial development
of the AOT Midstream. Testing terminated at SRI and all prototype equipment was returned to the Company. We currently plan to resume
Joule Heat and AOT Upstream development in the fourth quarter of 2016 depending on the availability of sufficient capital and other
resources.
In July 2015, the Company
formed QS Energy Pool, Inc., a wholly owned subsidiary of QS Energy, Inc., for the sole purpose of taking advantage of asset acquisition
opportunities in the oil and gas operations market. QS Energy Pool is specifically targeting the acquisition of one or more operating
companies or properties with proven positive cash flow, providing operating income and bottom line revenue which are both accretive
to and synergistic with QS Energy, Inc.’s current operations. QS Energy has identified multiple attractive opportunities
to acquire producing oil and gas field operations. Our strategy is to acquire producing oil and gas fields with production profiles
of at least ten years, proven long-term development rights, and demonstrated positive cash flow at commodity prices as low as $25/barrel
of oil and $2.00/MCF of gas. Any such acquisitions would be subject on our ability to obtain acquisition financing under acceptable
terms and conditions. We can provide no assurances that such financing would be available to us.
Our expenses to date
have been funded primarily through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise
of stock purchase warrants and options. We will need to raise substantial additional capital through 2016, and beyond, to fund
our sales and marketing efforts, continuing research and development, and certain other expenses, until our revenue base grows
sufficiently.
There are significant
risks associated with our business, our Company and our stock. See “Risk Factors” in Part II, Item 1A below.
Results of Operations for Three months
ended March 31, 2016 and 2015
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2016
|
|
|
2015
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
635,402
|
|
|
|
855,452
|
|
|
|
(220,050
|
)
|
Research and development expenses
|
|
|
74,935
|
|
|
|
272,777
|
|
|
|
(197,842
|
)
|
Loss before other income (expense)
|
|
|
(710,337
|
)
|
|
|
(1,128,229
|
)
|
|
|
(417,892
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (loss)
|
|
|
–
|
|
|
|
1,500
|
|
|
|
(1,500
|
)
|
Interest and financing expense
|
|
|
(493,712
|
)
|
|
|
(47,608
|
)
|
|
|
(446,104
|
)
|
Loss on disposition of equipment
|
|
|
(3,343
|
)
|
|
|
–
|
|
|
|
(3,343
|
)
|
Net Loss
|
|
$
|
(1,207,392
|
)
|
|
$
|
(1,174,337
|
)
|
|
$
|
(125,270
|
)
|
The Company had no
revenues in the three month periods ended March 31, 2016 and 2015.
Operating expenses
were $635,402 for the three-month period ended March 31, 2016, compared to $855,452 for the three-month period ended March 31,
2015, a decrease of $220,050. This is due to decreases in non-cash expenses of $86,386, and in cash expenses of $133,664. Specifically,
the decrease in non-cash expenses are attributable to decreases in depreciation of $1,289 and stock compensation expenses attributable
to options granted to directors and employees of $107,830, offset by increases in stock compensation expenses attributable to warrants
granted to consultants of $22,733. The decrease in cash expense is attributable to decreases in salaries and benefits of $58,971,
legal and accounting of $43,675, travel and related expenses of $36,119, and other expenses of $22,910, offset by increases in
consulting fees of $10,470, rents of $1,661, corporate expenses of $10,483, and insurance of $5,397.
Research and development
expenses were $74,395 for the three-month period ended March 31, 2016, compared to $272,777 for the three-month period ended March
31, 2015, a decrease of $197,842. This decrease is attributable to decreases in prototype product development costs of $149,998,
and product testing, research, patents and other costs of $47,844.
Other income and expense
were $497,055 expense for the three-month period ended March 31, 2016, compared to $46,108 expense for the three-month period ended
March 31, 2015, a net increase in other expenses of $450,947. This increase is attributable to an increase in non-cash other expenses
of $446,104 and an increase in cash expenses of $4,843. The increase in non-cash other expense is due to an increase in expense
attributable to interest, beneficial conversion factors and warrants associated with convertible notes issued in the amount of
$446,104. The decrease in other cash income is due to a decrease in income from sale fixed assets in the amount of $1,500, and
an increase in loss on the disposition of assets in the amount of $3,343.
The Company had a net
loss of $1,207,392, or $0.01 per share, for the three-month period ended March 31, 2016, compared to a net loss of $1,174,337,
or $0.01 per share, for the three-month period ended March 31, 2015.
Liquidity and Capital Resources
General
As reflected in the
accompanying condensed consolidated financial statements, the Company has not yet generated significant revenues and has incurred
recurring net losses. We have incurred negative cash flow from operations since our inception in 1998 and an accumulated deficit
of $102,481,544 as of March 31, 2016. Our negative operating cash flow in 2015 and the first three months of 2016 was funded primarily
through issuance of convertible notes and the exercise of stock purchase warrants and options for cash.
The accompanying
condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of
assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed
consolidated financial statements, the Company had a net loss of $1,207,392 and a negative cash flow from operations of $518,934
for the three-month period ended March 31, 2016. These factors raise substantial doubt about our ability to continue as a
going concern.
In addition, the Company’s
independent registered public accounting firm, in its report on the Company’s December 31, 2015 financial statements, has
raised substantial doubt about the Company’s ability to continue as a going concern. Our ability to continue as a going concern
is dependent upon our ability to raise additional funds and implement our business plan. The consolidated financial statements
do not include any adjustments that might be necessary if we are unable to continue as a going concern.
Summary
During the period ended
March 31, 2016, we received cash totaling $762,468 from issuance of our convertible notes payable and used cash in operations of
$518,934. At March 31, 2016, we had cash on hand in the amount of $592,720. We will need additional funds to operate our business,
including without limitation the expenses we will incur in connection with the license and research and development agreements
with Temple University; costs associated with product development and commercialization of the AOT and related technologies; costs
to manufacture and ship our products; costs to design and implement an effective system of internal controls and disclosure controls
and procedures; costs of maintaining our status as a public company by filing periodic reports with the SEC and costs required
to protect our intellectual property. In addition, as discussed above, we have substantial contractual commitments, including without
limitation salaries to our executive officers pursuant to employment agreements, certain severance payments to a former officer
and consulting fees, during the remainder of 2016 and beyond.
No assurance
can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the
Company.
Licensing Fees to Temple
University
For details of the
licensing agreements with Temple University, see Financial Statements attached hereto, Note 6 (Research and Development).
Critical Accounting Policies and Estimates
Our discussion and
analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going
basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical
experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates.
The methods, estimates
and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report
in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies
that are both most important to the portrayal of a company’s financial condition and results of operations and those that
require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about
matters that are inherently uncertain at the time of estimation. For a more detailed discussion of the accounting policies of the
Company, see Note 1 of the Notes to the Condensed Consolidated Financial Statements, “Summary of Significant Accounting Policies”.
We believe the
following critical accounting policies, among others, require significant judgments and estimates used in the preparation of our
consolidated financial statements.
Estimates
The preparation
of consolidated financial statements in conformity with generally accepted accounting principles requires management to make 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 and the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note
1 to Notes to the Condensed Consolidated Financial Statements. Actual results could differ from those estimates.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value
of the Company's common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain
assumptions related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends.
Compensation expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual
experience. The assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded
in future periods.
Going Concern
The accompanying
consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying
consolidated financial statements, during the three-months ended March 31, 2016, the Company incurred a net loss of
$1,207,392, used cash in operations of $518,934 and had a stockholders’ deficit of $604,984 as of that date. These
factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company
to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its
business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to
continue as a going concern.
At March 31, 2016,
the Company had cash on hand in the amount of $592,720. Management estimates that the current funds on hand will be sufficient
to continue operations through July 2016. Management is currently seeking additional funds, primarily through the issuance of debt
and equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with
the license and research and development agreements with Temple; costs associated with product development and commercialization
of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective
system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing
periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company
has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment
agreements, certain payments to a former officer and consulting fees, during the remainder of 2016 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of
debt financing or cause substantial dilution for our stockholders in case of equity financing.
Recent Accounting Polices
See Footnote 2 in the
accompanying financial statements for a discussion of recent accounting policies.