Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheets
|
|
March 31,
|
|
|
|
|
|
|
2018
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2017
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
225,000
|
|
|
$
|
204,000
|
|
Prepaid expenses and other current assets
|
|
|
23,000
|
|
|
|
38,000
|
|
Total current assets
|
|
|
248,000
|
|
|
|
242,000
|
|
Property and equipment, net of accumulated depreciation of $59,000 and $51,000 at March 31, 2018 and December 31, 2017, respectively
|
|
|
38,000
|
|
|
|
46,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
288,000
|
|
|
$
|
290,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
915,000
|
|
|
$
|
852,000
|
|
Accounts payable and accrued expenses
|
|
|
763,000
|
|
|
|
748,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
37,000
|
|
|
|
31,000
|
|
Convertible debentures, net of discounts of $183,000 and $47,000 at March 31, 2018 and December 31, 2017, respectively
|
|
|
577,000
|
|
|
|
533,000
|
|
Total current liabilities
|
|
|
2,292,000
|
|
|
|
2,164,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 236,751,367 and 234,076,907 shares issued and outstanding
at March 31, 2018 and December 31, 2017, respectively
|
|
|
236,752
|
|
|
|
234,077
|
|
Additional paid-in capital
|
|
|
108,568,248
|
|
|
|
108,000,923
|
|
Accumulated deficit
|
|
|
(110,809,000
|
)
|
|
|
(110,109,000
|
)
|
Total stockholders’ deficit
|
|
|
(2,004,000
|
)
|
|
|
(1,874,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
288,000
|
|
|
$
|
290,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Operations, Unaudited
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
|
|
|
|
|
|
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
494,000
|
|
|
|
1,258,000
|
|
Research and development expenses
|
|
|
47,000
|
|
|
|
64,000
|
|
Loss before other income (expense)
|
|
|
(541,000
|
)
|
|
|
(1,272,000
|
)
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(159,000
|
)
|
|
|
(212,000
|
)
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
|
(700,000
|
)
|
|
|
(1,484,000
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
234,610,752
|
|
|
|
199,260,966
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the Three months Ended MARCH 31, 2018
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, January 1, 2018
|
|
|
234,076,907
|
|
|
$
|
234,077
|
|
|
$
|
108,000,923
|
|
|
$
|
(110,109,000
|
)
|
|
$
|
(1,874,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
1,345,710
|
|
|
|
1,346
|
|
|
|
69,654
|
|
|
|
|
|
|
|
71,000
|
|
Fair value of common stock issued on conversion of notes payable
|
|
|
1,278,750
|
|
|
|
1,279
|
|
|
|
97,721
|
|
|
|
|
|
|
|
99,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
|
|
|
|
|
|
|
|
245,000
|
|
|
|
|
|
|
|
245,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
|
|
|
|
|
|
|
|
143,000
|
|
|
|
|
|
|
|
143,000
|
|
Common stock issued for services
|
|
|
50,000
|
|
|
|
50
|
|
|
|
11,950
|
|
|
|
|
|
|
|
12,000
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(700,000
|
)
|
|
|
(700,000
|
)
|
Balance, March 31, 2018
|
|
|
236,751,367
|
|
|
$
|
236,752
|
|
|
$
|
108,568,248
|
|
|
$
|
(110,809,000
|
)
|
|
$
|
(2,004,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2018
|
|
|
2017
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(700,000
|
)
|
|
$
|
(1,484,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
143,000
|
|
|
|
235,000
|
|
Issuance of common stock for services
|
|
|
12,000
|
|
|
|
–
|
|
Amortization of debt discount and accrued interest
|
|
|
143,000
|
|
|
|
192,000
|
|
Depreciation and amortization
|
|
|
8,000
|
|
|
|
2,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
15,000
|
|
|
|
(5,000
|
)
|
Accounts payable and accrued expenses
|
|
|
15,000
|
|
|
|
141,000
|
|
Accounts payable – license agreements
|
|
|
63,000
|
|
|
|
66,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
6,000
|
|
|
|
662,000
|
|
Deposits and other current liabilities
|
|
|
–
|
|
|
|
20,000
|
|
Net cash used in operating activities
|
|
|
(295,000
|
)
|
|
|
(171,000
|
)
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of equipment
|
|
|
–
|
|
|
|
(19,000
|
)
|
Net cash used in investing activities
|
|
|
–
|
|
|
|
(19,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
245,000
|
|
|
|
201,000
|
|
Net proceeds from exercise of warrants and options
|
|
|
71,000
|
|
|
|
–
|
|
Net cash provided by financing activities
|
|
|
316,000
|
|
|
|
201,000
|
|
Net increase in cash
|
|
|
21,000
|
|
|
|
11,000
|
|
Cash, beginning of period
|
|
|
204,000
|
|
|
|
136,000
|
|
Cash, end of period
|
|
$
|
225,000
|
|
|
$
|
147,000
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
99,000
|
|
|
$
|
120,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
245,000
|
|
|
|
201,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
THREE MONTHS ENDED MARCH 31, 2018 AND
2017
|
1.
|
Description of Business
|
QS Energy, Inc. (“QS
Energy”, “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 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 properties include a portfolio
of 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. Engineered specifically
to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and
drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity
by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the
research and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption
by the midstream pipeline marketplace.
The Company commenced,
but has suspended for now, commercial development of a suite of products based around the Joule Heat technology. The Company began
fabrication of prototype equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter
of 2014. 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. In addition, the Company filed two additional provisional patents related to the technology’s method and apparatus.
In December 2015, we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial
development of the AOT Midstream. We currently plan to resume Joule Heat development in in the future depending on the availability
of sufficient capital and other resources.
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, 2017 filed with the SEC. The condensed consolidated balance sheet as of December
31, 2017 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, 2018, the Company incurred a net loss of $700,000, used cash in operations of $295,000
and had a stockholders’ deficit of $2,004,000 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, 2017 financial statements, has raised
substantial doubt about the Company's ability to continue as a going concern.
At March 31,
2018, the Company had cash on hand in the amount of $225,000. Management estimates that the current funds on hand will be
sufficient to continue operations through August 2018. 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 agreements with Temple; costs associated with product development and
commercialization of the AOT 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
2018 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, 2018 and 2017, 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,
2018
|
|
|
March 31,
2017
|
|
Options
|
|
|
37,301,300
|
|
|
|
29,974,256
|
|
Warrants
|
|
|
17,590,812
|
|
|
|
9,064,317
|
|
Common stock issuable upon conversion of notes payable
|
|
|
7,047,333
|
|
|
|
4,527,233
|
|
Total
|
|
|
61,939,445
|
|
|
|
43,565,806
|
|
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 accruals for potential liabilities, assumptions used in valuing equity instruments issued for financing and services
and realization of deferred tax assets, among others. Actual results could differ from those estimates.
Revenue Recognition
Policy
In September 2014,
the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09 (ASU No. 2014-09) regarding revenue recognition.
The new standard provides authoritative guidance clarifying the principles for recognizing revenue and developing a common revenue
standard for U.S. generally accepted accounting principles. The core principle of the guidance is that an entity should recognize
revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which
the entity expects to be entitled in the exchange for those goods or services. The ASU became effective January 1, 2018.
The Company’s
commercialization of our energy efficiency technologies that would assist in meeting increasing global energy demands, improving
the economics of oil extraction and transport, and reducing greenhouse gas emission have not yet reached the market and therefore;
have not generated considerable revenue. Due to the nature of the products leased by the Company and the stage of development in
which the products reside the adoption of the new standard has had no quantitative effect on the financial statements.
Under the new guidance,
revenue is recognized when control of promised goods or services is transferred to our customers, in an amount that reflects the
consideration we expect to be entitled to in exchange for those leased products and ancillary services. The Company will review
its lease transactions to identify contractual rights, performance obligations, and transaction prices, including the allocation
of prices to separate performance obligations, if applicable. Revenue and costs of sales are recognized once products/services
are delivered to the customer’s control and performance obligations are satisfied.
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, 2018 and 2017, patent
costs were $6,000 and $16,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements
of operations.
Recent Accounting Pronouncements
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. 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
has determined that the adoption of ASU 2014-09 did not have a material impact on the Company’s financial statements.
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.
|
Accrued Expenses
and Accounts Payable
|
Accrued Expenses
On April 1, 2017, the
Company executed a separation agreement and release effective with the Company’s Chief Executive Officer (CEO). As part of
the agreement, the Company agreed to pay the CEO $580,000 in severance, payable in equal installment over 24 months. In addition,
the Company also agreed to continue paying certain expenses for the CEO for 24 months with an estimated cost of $44,000. As a result,
the Company accrued the entire $624,000 as of March 31, 2017 which was also reported as part of Operating expenses in the accompanying
consolidated statements of operations. As of March 31, 2018 and December 31, 2017, $377,000 and $390,000, respectively, was due
to our former CEO which was reported as part of Accrued expenses and accounts payable in the accompanying consolidated balance
sheet.
Accrued Expenses
and Accounts Payable – Related Parties
Accrued expense –
related parties consists accrued salaries of officers and fees due to members of the Board of Directors. As of March 31, 2018,
and December 31, 2017, accrued expenses and accounts payable to related parties amounted to $37,000 and $31,000,
respectively.
|
4.
|
Property and Equipment
|
At March 31, 2018 and
December 31, 2017, property and equipment consists of the following:
|
|
March 31,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Office equipment
|
|
$
|
30,000
|
|
|
$
|
30,000
|
|
Furniture and fixtures
|
|
|
5,000
|
|
|
|
5,000
|
|
Testing Equipment
|
|
|
37,000
|
|
|
|
37,000
|
|
Leasehold Improvements
|
|
|
25,000
|
|
|
|
25,000
|
|
Subtotal
|
|
|
97,000
|
|
|
|
97,000
|
|
Less accumulated depreciation
|
|
|
(59,000
|
)
|
|
|
(51,000
|
)
|
Total
|
|
$
|
38,000
|
|
|
$
|
46,000
|
|
Depreciation expense
for the three-month periods ended March 31, 2018 and 2017 was $8,000 and $2,000, respectively.
|
|
March 31,
2018
(unaudited)
|
|
|
December 31
2017
|
|
Balance due on convertible notes
|
|
$
|
680,000
|
|
|
$
|
509,000
|
|
Accrued interest
|
|
|
80,000
|
|
|
|
71,000
|
|
Subtotal
|
|
|
760,000
|
|
|
|
580,000
|
|
Convertible note discount
|
|
|
(183,000
|
)
|
|
|
(47,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
577,000
|
|
|
$
|
533,000
|
|
As in the prior years, the Company continues
to issue convertible notes in exchange for cash. The notes typically do not bear any interest, however, there is an implied interest
rate of 10% since the notes are typically issued at a 10% discount. The notes are unsecured, and usually mature twelve months from
issuance.
The notes are convertible at the option
of the note holder into the Company’s common stock at a conversion price stipulated in the conversion agreement. In addition,
the note holders received warrants to purchase shares of common stock that are fully vested and will expire in one year from the
date of issuance.
As a result, the Company records a note
discount to account for the relative fair value of the warrants, the notes’ beneficial conversion feature or BCF, and original
issue discount of 10% (OID). The note discounts are amortized over the term of the notes or amortized in full upon its conversion
to common stock. At December 31, 2017, total outstanding notes payable amounted to $509,000, accrued penalty interest of $71,000
and unamortized note discount of $47,000, or a net balance of $533,000.
During the three-month period ended March
31, 2018, the Company issued similar convertible promissory notes in the aggregate of $270,000 for cash of $245,000 or a discount
of $25,000. The notes do not bear any interest, however, the implied interest rate used was 10% since the notes were issued 10%
less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.08 per share. In
addition, the Company also granted these note holders warrants to purchase 1.7 million shares of the Company’ common stock.
The warrants are fully vested, exercisable at $0.08 per share and will expire in one year. As a result, the Company recorded a
note discount of $270,000 to account for the relative fair value of the warrants, the notes’ beneficial conversion feature
(BCF), and original issue discount (OID). The note discounts are being amortized over the term of the note or amortized in full
upon the conversion to common stock. During the three-month period ended March 31, 2018 notes payable of $99,000 were converted
into 1,278,750 shares of common stock.
As of March 31, 2018, total outstanding
notes payable amounted to $680,000, accrued interest of $80,000 and unamortized note discount of $183,000 for a net balance of
$577,000. A total of four notes in the aggregate of $399,000 have reached maturity and are past due.
|
6.
|
Research and Development
|
The Company constructs,
develops and tests the AOT technologies with internal resources and through the assistance of various third-party entities. Costs
incurred and expensed include fees such as license 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 prototypes.
Costs incurred
for research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also
expensed. Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established
commercial uses are also expensed.
For the three-month
periods ended March 31, 2018 and 2017, our research and development expenses were $47,000 and $64,000 respectively.
AOT Product Development
and Testing
The Company constructs,
develops and tests the AOT 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 prototypes.
During the three-month
periods ended March 31, 2017, the Company incurred total expenses of $17,000 in the manufacture, delivery and testing of the AOT
prototype equipment. The Company incurred similar expenses in the three-month period ended March 31, 2018. These expenses have
been reflected as part of Research and Development expenses on the accompanying consolidated statements 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 paid Temple a non-refundable license maintenance fee of $300,000 and agreed to pay (i)
annual maintenance fees of $187,500; (ii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing agreements;
and (iii) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon. The term of
the licenses commenced in August 2011 and will expire upon expiration of the patents. The agreements 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
fails to commercialize the patent rights.
As of December 31,
2016, total unpaid fees due to Temple pursuant to these agreements amounted to $726,000. In July 2017, the Company and Temple amended
the Second Temple License agreement. Pursuant to the amendment, the Company paid Temple $62,000 and Temple agreed to defer payment
of the remaining $135,000 in unpaid licensing fee until such time the Company generates revenues totaling $835,000 from the license.
In addition, the unpaid balance of $135,000 will accrue interest of 9% per annum. As of December 31, 2017, all amounts owed under
the Second Temple License agreement are either current or deferred under terms of the amendment.
Total expenses recognized
during each three-month period ended March 31, 2018 and 2017 pursuant to these two agreements amounted to $47,000 and has been
reflected in Research and Development expenses on the accompanying consolidated statements of operations. In the three-month periods
ended March 31, 2018 and 2017, the Company also recognized penalty interest on past-due balances of $16,000 and $20,000, respectively,
which is included as part of interest and financing expense in the accompanying statements of operations.
As of March 31, 2018,
and December 31, 2017, total unpaid fees due to Temple pursuant to these agreements amounted to $905,000 and $842,000, respectively,
which are included as part of Accounts payable – licensing agreements in the accompanying consolidated balance sheets. With
regards to the unpaid fees to Temple, a total of $52,000 are current, $392,000 are deferred until such time the Company achieves
a revenue milestone of $835,000 or upon termination of the licensing agreements and the remaining $461,000 are deemed past due.
The past due amount of $461,000 is owed pursuant to the First Temple License. The Company is currently in negotiations with Temple
to settle or cure the past due balance.
The Company generated
$50,000 in revenue from the viscosity reduction license during the three-month period ended March 31, 2017. This amount is not
sufficient to be subject to additional license fees under the license agreement. No revenues were earned from the two license agreements
during the three-month period ended March 2018.
Temple University Sponsored
Research Agreement
From March 2012 through
August 2015, the Company Temple University (“Temple”) provided research services at a fixed annual cost under a Sponsored
Research Agreement (“Research Agreement”). The Research Agreement expired in August 2015. Temple University continues
to perform laboratory tests on an as-needed basis, expenses are incurred on a per-test basis.
As of March 31, 2018,
and December 31, 2017, total unpaid fees due to Temple pursuant to the Research Agreement were $10,000, which are included as part
of Accounts payable – licensing agreements in the accompanying consolidated balance sheets. As of March 31, 2018, the entire
$10,000 is deemed past due.
During the three months
ended March 31, 2018, the Company issued 2,674,460 shares of its common stock as follows:
|
·
|
The Company issued 1,278,750 shares of its common stock upon the conversion of $99,000 in convertible notes pursuant to the convertible notes conversion prices of $0.08 per share.
|
|
·
|
The Company issued 1,166,000 shares of its common stock upon the exercise of warrants for proceeds of $58,000 at exercise prices of $0.05 per share.
|
|
·
|
The Company issued 179,710 shares of its common stock upon the exercise of options for proceeds of $13,000 at exercise prices of $0.07 per share.
|
|
·
|
The Company issued 50,000 shares of common stock in exchange for services in aggregate value of $12,000.
|
|
8.
|
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
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, 2018 was 5.7 years. Stock option activity for the period
January 1, 2018 up to March 31, 2018, was as follows:
|
|
|
Options
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
January 1, 2018
|
|
|
|
35,397,675
|
|
|
$
|
0.23
|
|
|
Granted
|
|
|
|
2,083,335
|
|
|
$
|
0.18
|
|
|
Exercised
|
|
|
|
(179,710
|
)
|
|
$
|
0.07
|
|
|
Forfeited
|
|
|
|
–
|
|
|
|
–
|
|
|
March 31, 2018
|
|
|
|
37,301,300
|
|
|
$
|
0.22
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2018 were as
follows:
|
|
Outstanding Options
|
|
Exercisable Options
|
Option
Exercise Price
Per Share
|
|
Shares
|
|
|
Life
(Years)
|
|
Weighted
Average Exercise
Price
|
|
Shares
|
|
|
Weighted
Average Exercise
Price
|
$ 0.05 - $ 0.99
|
|
|
37,150,854
|
|
|
5.7
|
|
$0.22
|
|
|
31,488,353
|
|
|
$0.22
|
$ 1.00 - $ 1.99
|
|
|
150,446
|
|
|
5.3
|
|
$1.18
|
|
|
150,446
|
|
|
$1.18
|
|
|
|
37,301,300
|
|
|
5.6
|
|
$0.22
|
|
|
31,638,799
|
|
|
$0.22
|
During the three-month
period ending March 31, 2018, and pursuant to the Company’s Board Compensation policy approved by the Board June 19, 2015,
the Company granted options to purchase 2,083,335 shares of common stock to members of the Company’s Board of Directors.
The options are exercisable at $0.18 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 $313,000 using the Black-Scholes Option Pricing model with the following assumptions:
life of 5 years; risk free interest rate of 1.7%; volatility of 118% and dividend yield of 0%.
During the three-month
periods ended March 31, 2018 and 2017, the Company recognized compensation costs based on the fair value of options that vested
of $143,000 and $231,000 respectively.
At March 31, 2018,
the Company’s closing stock price was $0.13 per share. The aggregate intrinsic value of the options outstanding at March
31, 2018 was $598,000. Future unamortized compensation expense on the unvested outstanding options at March 31, 2018 is approximately
$311,000 to be recognized through March 2019.
Warrants
The following table
summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2018
up to March 31, 2018.
|
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
|
January 1, 2018
|
|
|
|
17,622,437
|
|
|
$
|
0.09
|
|
|
Granted
|
|
|
|
1,684,375
|
|
|
|
0.08
|
|
|
Exercised
|
|
|
|
(1,166,000
|
)
|
|
|
0.05
|
|
|
Cancelled
|
|
|
|
(550,000
|
)
|
|
|
0.05
|
|
|
March 31, 2018
|
|
|
|
17,590,812
|
|
|
$
|
0.10
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2018 were
as follows:
|
|
Outstanding Warrants
|
|
|
Exercisable Warrants
|
|
Warrant Exercise Price Per Share
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Weighted
Average Exercise Price
|
|
|
Shares
|
|
|
Weighted
Average Exercise Price
|
|
$ 0.05 - $ 0.99
|
|
|
17,590,812
|
|
|
|
0.7
|
|
|
$
|
0.10
|
|
|
|
17,590,812
|
|
|
$
|
0.10
|
|
In the three-month
period ending March 31, 2018, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 1,684,375
shares of common stock with an exercise price of $.08 per share, vesting immediately upon grant and expiring one year from the
date of grant (see Note 5).
During the three-month
period ended March 31, 2018, warrants to acquire 1,345,710 shares of common stock were exercised resulting in net proceeds to the
Company of $71,000.
At March 31, 2018,
the aggregate intrinsic value of the warrants outstanding was $1,108,000.
|
9.
|
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.
Issuance of Convertible
Notes
From April 1, 2018
up to April 6, 2018, the Company issued convertible notes in aggregate of $81,000 in exchange for cash of $72,000. The notes are
unsecured, convertible into 1 million shares in common stock of the Company at a conversion price of $0.08 per share and mature
in one year. In connection with these notes, the Company also issued warrants to purchase 0.5 million shares of common stock of
the Company at an exercise price of $0.08 per share and expiring one year from the date of issuance. As a result, the Company will
record a note discount of $81,000 to account for the relative fair value of the warrants, the notes’ beneficial conversion
feature and original issue discount which will be amortized as interest expense over the life of the notes.
Conversion of
Convertible Notes
From April 1, 2018
up to May 14, 2018, Company issued 1,654,125 shares of common stock upon conversion of previously issued convertible notes in
aggregate value of $122,000.
Exercise of Warrants
From April 1, 2018
up to May 12, 2018, the Company issued 4,698,773 shares of common stock upon the exercise of previously issued warrants for aggregate
cash proceeds of $243,000.
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, and in the “Risk Factors” section filed with the SEC on April 2, 2018, 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, 2018, and we undertake no duty to update this information.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) 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 properties include a portfolio of 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. Engineered specifically to reduce
pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing
agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity by applying
a high intensity electrical field to crude oil feedstock while in transit. AOT technology delivers reductions in crude oil viscosity
and pipeline pressure loss as demonstrated in independent third-party tests performed by the U.S. Department of Energy, the PetroChina
Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™, at full-scale test facilities in the U.S. and China,
and under commercial operating conditions on one of North America’s largest high-volume crude oil pipelines. Prior testing
on a commercial crude oil condensate pipeline demonstrated high correlation between laboratory analysis and full-scale AOT operations
under commercial operating conditions with onsite measurements and data collected by the pipeline operator on its supervisory control
and data acquisition (“SCADA”) system. The AOT product has transitioned from laboratory testing and ongoing research
and development to initial production and continued testing in advance of our goal of seeking acceptance and adoption by the midstream
pipeline marketplace. 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 2018.
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 affected 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. To date, QS Energy Pool has not entered into any acquisition
transaction. In 2017, the Company ended acquisition activities and is considering dissolving QS Energy Pool in 2018 to reduce costs
associated with operating this subsidiary. 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.
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 (“RMOTC”), 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 commercial 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 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 put a 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. Tests 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 indicated
the AOT equipment operated as expected, resulting in viscosity reductions equivalent to those measured under laboratory conditions.
Supervisory Control And Data Acquisition (“SCADA”) pipeline operating data collected by Kinder Morgan during this test
indicated a pipeline pressure drop reduction consistent with expectations. Kinder Morgan provided the Company with a number of
additional crude oil samples which were tested in the laboratory for future test correlation and operational planning purposes.
Based on final analysis of in-field test results, SCADA operating data and subsequent analysis of crude oil samples at Temple University,
Kinder Morgan and QS Energy are considering moving the AOT test facility to a different, higher-volume pipeline location. The Kinder
Morgan Lease is currently in suspension and lease payments have not yet commenced.
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 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, subject to non-disclosure agreements
executed by all parties, laboratory testing was performed on crude oil samples provided by the operator, which demonstrated significant
AOT viscosity reductions. Detailed hydraulic analysis based on laboratory results and pipeline operating parameters was presented
to the operator demonstrating potential benefits of AOT technology within the operator’s specified infrastructure. Based
on this analysis, the Company prepared a preliminary configuration for AOT units optimized for the operator’s high-volume,
space-constrained operations. Company engineers and supply chain partners presented an optimized configuration and production budget.
Discussions continue with this operator regarding an onsite pilot test deployment of the proposed AOT configuration, targeting
project planning in 2018 and potential deployment in 2019.
In 2017, the Company
shifted its business development efforts to the development of one or more pilot projects intended to demonstrate and document
AOT efficacy, operational benefits, and financial impact. The Company is working with prospective customers on potential pilot
project sites in three primary markets: U.S., South America, and Asia. Each of these prospects operates heavy crude oil pipelines.
The Company’s short-term goal is to have at least one pilot project operational in 2018 with the intention of converting
from pilot operations to revenue-generating commercial operations and future commercial AOT deployment. Company’s efforts
are tightly focused on executing its pilot program strategy and conversations continue with prospective customers in the Gulf Coast,
Canada, and the Middle East.
During the third quarter
2016, the Company developed a new onsite testing program to demonstrate AOT viscosity reduction at prospective customer sites.
This program utilized a fully functional laboratory-scale AOT device designed and developed by the Company and tested at the Southern
Research Institute. Under this program, Company engineers set up a temporary lab at the customer’s site to test a full range
of crude oils. Fees charged for providing this service were dependent on scope of services, crude oil sample to be tested, and
onsite time requirements. In the fourth quarter 2016, the Company entered a contract to provide these onsite testing services to
a North American oil producer and pipeline operator over a one-week period in early 2017 at a fixed price of $50,000. This test
was performed in January 2017; data analysis and final report was completed in March 2017. Test results demonstrated viscosity
reduction under limited laboratory conditions. The test equipment was not capable of controlling temperature as required to simulate
operating conditions. The oil producer has requested access to a full-scale pilot facility and operating data when available. The
Company plans to upgrade the laboratory-scale AOT device in 2018 to include temperature control and is actively pursuing a pilot
site to demonstrate AOT operations.
In July 2017, the Company
filed for trademark protection for the word “eDiluent” in advance of rolling out a new marketing and revenue strategy
based on the concept of using AOT to reduce pipeline dependence upon diluent to reduce viscosity of crude oils. A primary function
of AOT is to reduce viscosity by means of its solid-state electronics technology; in essence providing an electronic form of diluent,
or “eDiluent”. The Company plans to market and sell a value-added service under the name eDiluent, designed to be upsold
by the Company’s midstream pipeline customers in an effort to provide the Company with long-term recurring revenues.
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 plans on 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”). 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.
During the third quarter
2017, the Company built a dedicated laboratory space at its Tomball Texas facility, and now has the capability to perform onsite
testing utilizing our laboratory-scale AOT device, among other equipment. Development of an AOT unit for use in crude oil upstream
and gathering operations was restarted in September 2017 utilizing resources at the Tomball facility, and the Company plans to
resume Joule Heat development in the future depending on the availability of sufficient capital and other resources. Also, during
the third quarter 2017, the Company built an outdoor facility at its Tomball Texas facility for onsite storage of AOT inventory
and other large equipment. The Tomball facility is owned by the Company’s CEO as described in our Form 10-K filed with the
SEC on April 2, 2018.
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 2018, 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,” below.
Results of Operations for Three months
ended March 31, 2018 and 2017
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
$
|
(50,000
|
)
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
494,000
|
|
|
|
1,258,000
|
|
|
|
(764,000
|
)
|
Research and development expenses
|
|
|
47,000
|
|
|
|
64,000
|
|
|
|
(17,000
|
)
|
Loss before other income (expense)
|
|
|
(541,000
|
)
|
|
|
(1,272,000
|
)
|
|
|
731,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(159,000
|
)
|
|
|
(212,000
|
)
|
|
|
53,000
|
|
Net Loss
|
|
$
|
(700,000
|
)
|
|
$
|
(1,484,000
|
)
|
|
$
|
784,000
|
|
During the period ended
March 31, 2017, the Company recognized revenues of $50,000 pursuant to the completion of a lease and testing agreement of the Company’s
AOT equipment. The Company recognized no revenues during the period ended March 31, 2017.
Operating expenses
were $494,000 for the three-month period ended March 31, 2018, compared to $1,258,000 for the three-month period ended March 31,
2017, a decrease of $764,000. This is due to decreases in non-cash expenses of $75,000, and in cash expenses of $689,000. Specifically,
the decrease in non-cash expenses are attributable to increases in common stock and warrants issued as compensation for services
of $11,000, and depreciation of $8,000, offset by a decrease in stock compensation expense attributable to options granted to employees
and directors of $92,000. The decrease in cash expense is attributable to decreases in severance expenses of $624,000, salaries
and benefits of $11,000, consulting fees of $11,000, corporate and office expenses of 8,000, legal and accounting fees of $31,000,
and patent expenses of $11,000, offset by increases in rent and utilities of $3,000, and other expenses of $4,000.
Research and development
expenses were $47,000 for the three-month period ended March 31, 2018, compared to $64,000 for the three-month period ended March
31, 2017, a decrease of $17,000. This decrease is attributable a decrease in prototype product development costs of $17,000.
Other income and expense
were $159,000 expense for the three-month period ended March 31, 2018, compared to $212,000 expense for the three-month period
ended March 31, 2017, a net decrease in other expenses of $53,000. This decrease is attributable to a decrease in non-cash other
expenses of $53,000. The decrease in non-cash other expense is due to decreases in expense attributable to interest, beneficial
conversion factors and warrants associated with convertible notes issued in the amount of $49,000, and other non-cash interest
of $4,000.
The Company had a net
loss of $700,000, or $0.00 per share, for the three-month period ended March 31, 2018, compared to a net loss of $1,484,000, or
$0.01 per share, for the three-month period ended March 31, 2017.
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 a stockholders’
deficit of $2,004,000 as of March 31, 2018. Our negative operating cash flow for the periods ended March 31, 2018 was funded primarily
through issuance of convertible notes and execution of options and warrants to purchase common stock.
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 $700,000 and a negative cash flow from operations of $295,000 for the three-month
period ended March 31, 2018. 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, 2017 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, 2018, we received cash totaling $316,000 from issuance of our convertible notes payable and exercise of options and warrants
to purchase common stock and used cash in operations of $295,000. At March 31, 2018, we had cash on hand in the amount of $225,000.
We will need additional funds to operate our business, including without limitation the expenses we will incur in connection with
the license 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 2018 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, 2018, the Company incurred a net loss of $700,000, used cash in operations of $295,000
and had a stockholders’ deficit of $2,004,000 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, 2018,
the Company had cash on hand in the amount of $225,000. Management estimates that the current funds on hand will be sufficient
to continue operations through August 2018. 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 agreements with Temple; costs associated with product development and commercialization of the AOT 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 2018 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.