Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheet
|
|
June 30,
|
|
|
|
|
|
|
2018
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2017
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
493,000
|
|
|
$
|
204,000
|
|
Prepaid expenses and other current assets
|
|
|
32,000
|
|
|
|
38,000
|
|
Total current assets
|
|
|
525,000
|
|
|
|
242,000
|
|
Property and equipment, net of accumulated depreciation of $68,000 and $51,000 at June 30, 2018 and December 31, 2017, respectively
|
|
|
29,000
|
|
|
|
46,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
556,000
|
|
|
$
|
290,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
974,000
|
|
|
$
|
852,000
|
|
Accounts payable and accrued expenses
|
|
|
735,000
|
|
|
|
748,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
43,000
|
|
|
|
31,000
|
|
Convertible debentures, net of discounts of $47,000 and $47,000 at June 30, 2018 and December 31, 2017, respectively
|
|
|
576,000
|
|
|
|
533,000
|
|
Total current liabilities
|
|
|
2,328,000
|
|
|
|
2,164,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 251,448,515 and 234,076,907 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively
|
|
|
251,448
|
|
|
|
234,077
|
|
Additional paid-in capital
|
|
|
109,543,552
|
|
|
|
108,000,923
|
|
Accumulated deficit
|
|
|
(111,567,000
|
)
|
|
|
(110,109,000
|
)
|
Total stockholders’ deficit
|
|
|
(1,772,000
|
)
|
|
|
(1,874,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
556,000
|
|
|
$
|
290,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Operations, Unaudited
|
|
Three months ended
|
|
|
Six months ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
50,000
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
462,000
|
|
|
|
580,000
|
|
|
|
956,000
|
|
|
|
1,838,000
|
|
Research and development expenses
|
|
|
48,000
|
|
|
|
56,000
|
|
|
|
95,000
|
|
|
|
120,000
|
|
Loss before other expense
|
|
|
(510,000
|
)
|
|
|
(636,000
|
)
|
|
|
(1,051,000
|
)
|
|
|
(1,908,000
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(248,000
|
)
|
|
|
(1,210,000
|
)
|
|
|
(407,000
|
)
|
|
|
(1,422,000
|
)
|
Net Loss
|
|
|
(758,000
|
)
|
|
|
(1,846,000
|
)
|
|
|
(1,458,000
|
)
|
|
|
(3,330,000
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.02
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
242,994,163
|
|
|
|
207,419,243
|
|
|
|
238,825,606
|
|
|
|
203,362,641
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the SIX months Ended JUNE 30, 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
|
|
|
12,697,483
|
|
|
|
12,697
|
|
|
|
634,303
|
|
|
|
|
|
|
|
647,000
|
|
Common stock issued on conversion of notes payable
|
|
|
4,624,125
|
|
|
|
4,624
|
|
|
|
332,376
|
|
|
|
|
|
|
|
337,000
|
|
Fair value of warrants and beneficial conversion feature of issued
convertible notes
|
|
|
|
|
|
|
|
|
|
|
319,000
|
|
|
|
|
|
|
|
319,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
|
|
|
|
|
|
|
|
245,000
|
|
|
|
|
|
|
|
245,000
|
|
Common stock issued for services
|
|
|
50,000
|
|
|
|
50
|
|
|
|
11,950
|
|
|
|
|
|
|
|
12,000
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,458,000
|
)
|
|
|
(1,458,000
|
)
|
Balance, June 30, 2018
|
|
|
251,448,515
|
|
|
$
|
251,448
|
|
|
$
|
109,543,552
|
|
|
$
|
(111,567,000
|
)
|
|
$
|
(1,772,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Six months ended
|
|
|
|
June 30
|
|
|
|
2018
|
|
|
2017
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,458,000
|
)
|
|
$
|
(3,330,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
245,000
|
|
|
|
535,000
|
|
Issuance of common stock for services
|
|
|
12,000
|
|
|
|
–
|
|
Amortization of debt discount and interest expense
|
|
|
381,000
|
|
|
|
1,402,000
|
|
Depreciation and amortization
|
|
|
17,000
|
|
|
|
4,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other assets
|
|
|
6,000
|
|
|
|
(8,000
|
)
|
Accounts payable and accrued expenses
|
|
|
(13,000
|
)
|
|
|
640,000
|
|
Accounts payable – license agreements
|
|
|
122,000
|
|
|
|
113,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
12,000
|
|
|
|
(116,000
|
)
|
Deposits and other current liabilities
|
|
|
–
|
|
|
|
(5,000
|
)
|
Net cash used in operating activities
|
|
|
(676,000
|
)
|
|
|
(765,000
|
)
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of equipment
|
|
|
–
|
|
|
|
(21,000
|
)
|
Net cash used in investing activities
|
|
|
–
|
|
|
|
(21,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
318,000
|
|
|
|
1,469,000
|
|
Net proceeds from exercise of warrants
|
|
|
647,000
|
|
|
|
61,000
|
|
Net cash provided by financing activities
|
|
|
965,000
|
|
|
|
1,530,000
|
|
Net increase (decrease) in cash
|
|
|
289,000
|
|
|
|
744,000
|
|
Cash, beginning of period
|
|
|
204,000
|
|
|
|
136,000
|
|
Cash, end of period
|
|
$
|
493,000
|
|
|
$
|
880,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
–
|
|
|
$
|
–
|
|
Income Taxes
|
|
$
|
1,600
|
|
|
$
|
1,600
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Conversion of convertible debentures to common stock
|
|
$
|
337,000
|
|
|
$
|
1,247,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
319,000
|
|
|
|
1,469,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
SIX MONTHS ENDED JUNE 30, 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 on the direct application of an electrical current
crude oil; a process known as Joule Heat. The Company built and tested its first Joule Heat unit in 2015. Though the test unit
was functional, changes to the prototype configuration will be required to determine commercial effectiveness of this technology.
In December 2015, we suspended Joule Heat development activities to focus Company resources on finalizing commercial development
of the AOT. We plan to resume Joule Heat development 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 six-months ended June 30, 2018, the Company incurred a net loss of $1,458,000, used cash in operations of $676,000 and
had a stockholders’ deficit of $1,772,000 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 June 30, 2018, the
Company had cash on hand in the amount of $493,000. Management estimates that the current funds on hand will be sufficient to continue
operations through November 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 June 30, 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.
|
|
June 30,
2018
|
|
|
June 30,
2017
|
|
Options
|
|
|
37,301,300
|
|
|
|
35,313,541
|
|
Warrants
|
|
|
5,006,355
|
|
|
|
21,507,270
|
|
Common stock issuable upon conversion of notes payable
|
|
|
5,287,502
|
|
|
|
9,968,933
|
|
Total
|
|
|
47,595,157
|
|
|
|
66,789,744
|
|
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.
Research and Development
Costs
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 six-month periods
ended June 30, 2018 and 2017 research and development costs were $95,000 and $120,000, respectively.
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 six-month periods ended June 30, 2018 and 2017, patent costs
were $12,000 and $24,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements
of operations. During the three-month periods ended June 30, 2018 and 2017, patent costs were $6,000 and $7,000, respectively,
and were included as part of operating expenses in the accompanying consolidated statements of operations.
Recent Accounting Pronouncements
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.
In July 2017, the FASB
issued Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II)
Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 allows companies
to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered
indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features
may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature
only when it is triggered, and the strike price has been adjusted downward. For equity-classified freestanding financial instruments,
an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders
in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions,
entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11
is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption
is permitted. The guidance in ASU 2017-11 is to be applied using a full or modified retrospective approach. The adoption of ASU
2017-11 is not currently expected to have any impact on the Company’s financial statement presentation or 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 Payables
|
Accrued Expenses
On April 1, 2017,
the Company executed a Separation Agreement and release effective with the Company’s former Chief Executive Officer (CEO).
As part of the agreement, the Company agreed to pay the former 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 2017 consolidated statements of operations. As of June 30, 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. The Company began deferring payments under the Separation Agreement in January 2018 and is currently
in arrears. The former CEO has made demands for all deferred payments and has proposed an amendment to the Separation Agreement
that contained terms and conditions that are unacceptable to the Company, and has threatened litigation to recover the deferred
payments, future payments due under the Separation Agreement, and damages. The Company has attempted to settle this matter with
the former CEO. This matter has not yet been resolved.
Accrued Expenses
and Accounts Payable – Related Parties
Accrued expense –
related parties consists of accrued salaries due to officers and fees due to members of the Board of Directors. As of June 30,
2018, and December 31, 2017, accrued expenses and accounts payable to related parties amounted to $43,000 and $31,000, respectively.
|
4.
|
Property and Equipment
|
At June 30, 2018 and
December 31, 2017, property and equipment consists of the following:
|
|
June 30,
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
|
|
|
(68,000
|
)
|
|
|
(51,000
|
)
|
Total
|
|
$
|
29,000
|
|
|
$
|
46,000
|
|
Depreciation expense
for the six-month periods ended June 30, 2018 and 2017 was $17,000 and $4,000, respectively. Depreciation expense for the three-month
periods ended June 30, 2018 and 2017 was $9,000 and $2,000, respectively.
|
|
June 30,
2018
(unaudited)
|
|
|
December 31
2017
|
|
Balance due on convertible notes
|
|
$
|
524,000
|
|
|
$
|
509,000
|
|
Accrued interest
|
|
|
99,000
|
|
|
|
71,000
|
|
Subtotal
|
|
|
623,000
|
|
|
|
580,000
|
|
Convertible note discount
|
|
|
(47,000
|
)
|
|
|
(47,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
576,000
|
|
|
$
|
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 six-month period ending June 30, 2018, the Company issued similar convertible promissory
notes in the aggregate of $350,000 for cash of $318,000 or a discount of $32,000. The notes do not bear any interest, however,
the implied interest rate used was 10% since the notes were issued at a price 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 2,189,688 shares of the Company’ common stock. The warrants are fully vested, exercisable at $0.08
per share and will expire in one year. Upon issuance, the Company recorded a note discount of $350,000 to account for the relative
fair value of the warrants, the notes’ BCF, and 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 period
ended June 30, 2018, a total of $336,000 notes payable was converted into 4,624,125 shares of common stock. In addition, note
discount of $381,000 was amortized to interest expense, and interest of $28,000 was accrued.
As of June 30, 2018,
total outstanding notes payable amounted to $524,000, accrued interest of $99,000 and unamortized note discount of $47,000 for
a net balance of $576,000. In addition, a total of eight notes amounting to $454,000 reached maturity and are past due. The Company
is currently in negotiations with the noteholders to settle the matured notes payable.
|
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 six-month periods
ended June 30, 2018 and 2017, our research and development expenses were $95,000 and $120,000 respectively. For the three-month
periods ended June 30, 2018 and 2017, our research and development expenses were $48,000 and $56,000, 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 six-month
periods ended June 30, 2018 and 2017, the Company incurred total expenses of $1,000 and $26,000, respectively, in the manufacture,
delivery and testing of the AOT prototype equipment. During the three-month periods ended June 30, 2018 and 2017, the Company incurred
total expenses of $1,000 and $9,000, respectively. 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 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 six-month period ended June 30, 2018 and 2017 pursuant to these two agreements amounted to $94,000 and $96,000, respectively.
Total expenses recognized during each three-month period ended June 30, 2018 and 2017 pursuant to these two agreements amounted
to $47,000 in each year. These expenses have been reflected in Research and Development expenses on the accompanying consolidated
statements of operations.
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 June 30, 2018,
and December 31, 2017, total unpaid fees due to Temple pursuant to these agreements amounted to $964,000 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 $68,000 are current, $405,000 are deferred until such time the Company achieves
a revenue milestone of $835,000 or upon termination of the licensing agreements and the remaining $491,000 are deemed past due.
The past due amount of $491,000 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 six-month period ended June 30, 2018.
Temple University Sponsored
Research Agreement
From March 2012 through
August 2015, the 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 June 30, 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 June 30, 2018, the entire
$10,000 is deemed past due.
During the six months ended June 30,
2018, the Company issued 17,371,608 shares of its common stock as follows:
|
·
|
The Company issued 4,624,125 shares of
its common stock upon the conversion of $337,000 in convertible notes pursuant to the convertible notes conversion prices of $0.05
to $0.08 per share.
|
|
·
|
The Company issued 12,517,773 shares of
its common stock upon the exercise of warrants for proceeds of $634,000 at exercise prices of $0.05 to $0.08 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 directors, 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 June 30, 2018 was 5.4 years. Stock option activity for the period January
1, 2018 up to June 30, 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
|
)
|
|
|
–
|
|
|
Forfeited
|
|
|
|
–
|
|
|
|
–
|
|
|
June 30, 2018
|
|
|
|
37,301,300
|
|
|
$
|
0.22
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of June 30, 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
|
|
|
|
5.4
|
|
|
$
|
0.22
|
|
|
|
33,809,187
|
|
|
$
|
0.21
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
150,446
|
|
|
|
5.1
|
|
|
$
|
1.18
|
|
|
|
150,446
|
|
|
$
|
1.18
|
|
|
|
|
|
|
37,301,300
|
|
|
|
5.4
|
|
|
$
|
0.22
|
|
|
|
33,959,633
|
|
|
$
|
0.22
|
|
During the six-month
period ending June 30, 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 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 $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 six-month
periods ended June 30, 2018 and 2017, the Company recognized compensation costs based on the fair value of options that vested
of $245,000 and $535,000 respectively, which is included in Operating expenses in the Company’s statement of operations.
During the three-month periods ended June 30, 2018 and 2017, the Company recognized compensation costs based on the fair value
of options that vested of $102,000 and $300,000 respectively, which is included in Operating expenses in the Company’s statement
of operations.
At June 30, 2018, the
Company’s closing stock price was $0.12 per share. The aggregate intrinsic value of the options outstanding at June 30, 2018
was $520,000. Future unamortized compensation expense on the unvested outstanding options at June 30, 2018 is $209,000 to be recognized
through May 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 June 30, 2018.
|
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
|
January 1, 2018
|
|
|
|
17,622,437
|
|
|
$
|
0.09
|
|
|
Granted
|
|
|
|
2,189,688
|
|
|
|
0.08
|
|
|
Exercised
|
|
|
|
(12,517,773
|
)
|
|
|
0.05
|
|
|
Cancelled
|
|
|
|
(2,287,997
|
)
|
|
|
0.05
|
|
|
June 30, 2018
|
|
|
|
5,006,355
|
|
|
$
|
0.21
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of June 30, 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
|
|
|
|
5,006,355
|
|
|
|
2.1
|
|
|
$
|
0.21
|
|
|
|
4,956,355
|
|
|
$
|
0.21
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
5,006,355
|
|
|
|
2.1
|
|
|
$
|
0.21
|
|
|
|
4,956,355
|
|
|
$
|
0.21
|
|
In the six-month period
ending June 30, 2018, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 2,189,688 shares
of common stock with an exercise price of $0.08 per share, vesting immediately upon grant and expiring one year from the date of
grant (see Note 5).
During the six-month
period ended March 31, 2018, warrants to acquire 12,217,773 shares of common stock were exercised resulting in net proceeds to
the Company of $634,000.
At June 30, 2018, the
aggregate intrinsic value of the warrants outstanding was $77,000.
|
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 July 1 up to July
31, 2018, the Company issued convertible notes in aggregate of $228,000 in exchange for cash of $208,000. The notes are unsecured,
convertible into 4,565,000 shares of common stock of the Company at a conversion price of $0.05 per share and mature in one year.
In connection with these notes, the Company also issued warrants to purchase 2,282,500 shares of common stock of the Company at
an exercise price of $0.05 per share and expiring one year from the date of issuance. As a result, the Company will record a note
discount of $228,000 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.
Annual Meeting
of Shareholders
The Board, at its meeting on August 13, 2018, set the date for the Annual Meeting of Shareholders for
November 9, 2018, and set September 10, 2018, as the Record Date for the meeting.
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 June 30, 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 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 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 upstream and 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. 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 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 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 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.
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 is in the process of upgrading the laboratory-scale AOT device for planned deployment in 2018 to include temperature
control and is actively pursuing a pilot site to demonstrate AOT operations.
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 built and tested its first Joule Heat prototype in June 2015.
The system was operational; however, changes to the prototype configuration will be required to determine commercial effectiveness
of this unit. In December 2015, we suspended Joule Heat development activities to focus Company resources on finalizing commercial
development of the AOT.
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.
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.
The Company is actively
seeking deployments of its AOT technology intended to demonstrate and document AOT efficacy, operational benefits, and financial
impact. Primary activities are focused on AOT demonstration and joint development projects in the United States, South America
and Asia. These projects are designed to provide operating data and physical access to prospective customers to aid product commercialization
and future sales. We are currently working with a U.S.-based pipeline operator on a potential development agreement under which
we would operate an AOT midstream unit on a pipeline located in the southern United States delivering South American heavy crudes
to inland-land refineries. We are working towards finalizing a development agreement subject to the pipeline company’s engineering
review, targeting installation and operations in the fourth quarter 2018. We are also in discussions with an exploration and production
company regarding AOT operations on a West Coast heavy crude gathering line that relies heavily on diluent to achieve required
viscosity. This project is designed to demonstrate AOT for upstream and trucking applications, targeting operations in late 2018.
The Company is currently
pursuing AOT testing in several countries in South America related to upstream, midstream, barge, and tanker truck applications.
Oil samples from multiple clients for testing at Temple University have been delivered to a shipping facility in South America,
awaiting customs and shipping clearance. There is a vast amount of heavy oil in these countries and we believe the Ministers of
Hydrocarbons have standing orders to increase production and transportation capacity. We continue to work with an existing client
in Asia for an AOT installation; however, progress on this project has slowed from our original targets. A Company representative
is scheduled to meet with our Asian client in August 2018 to assess the project.
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 Operation for Six and Three-month
periods ended June 30, 2018 and 2017
|
I.
|
Six months ended June 30, 2018 and 2017
|
|
|
Six months ended
|
|
|
|
June 30
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
$
|
(50,000
|
)
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
956,000
|
|
|
|
1,838,000
|
|
|
|
(882,000
|
)
|
Research and development expenses
|
|
|
95,000
|
|
|
|
120,000
|
|
|
|
(25,000
|
)
|
Loss before other income (expense)
|
|
|
(1,015,000
|
)
|
|
|
(1,908,000
|
)
|
|
|
857,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(407,000
|
)
|
|
|
(1,422,000
|
)
|
|
|
1,015,000
|
|
Net Loss
|
|
$
|
(1,458,000
|
)
|
|
$
|
(3,330,000
|
)
|
|
$
|
1,872,000
|
|
During the six-month
period ended June 30, 2017, the Company recognized revenues of $50,000 pursuant to the completion of lease and testing agreement
of the Company’s AOT equipment. There were no such revenues in the comparable period in 2018.
Operating expenses
were $956,000 for the six-month period ended June 30, 2018, compared to $1,838,000 for the six-month period ended June 30, 2017,
a decrease of $882,000. This is due to decreases in non-cash expenses of $266,000 and in other expenses of $616,000. Specifically,
the decrease in non-cash expenses is attributable to a decrease in the fair value of options granted to directors and employees
of $290,000, offset by an increase in stock compensation expenses attributable to the fair value warrants and common stock granted
to consultants of $11,000. The decrease in other expense is attributable mostly to a severance package expense of $624,000 with
a former Chief Executive Officer in 2017.
Research and development
expenses were $95,000 for the six-month period ended June 30, 2018, compared to $120,000 for the six-month period ended June 30,
2017, a decrease of $25,000. This decrease is attributable to decreases in prototype product development costs of $22,000, and
in product testing, research, patents and other costs of $3,000.
Other income and expense
were $407,000 expense for the six-month period ended June 30, 2018, compared to $1,422,000 expense for the six-month period ended
June 30, 2017, a net decrease in other expenses of $1,015,000. This decrease is attributable to a decrease in non-cash other expenses
of $1,015,000. 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 $1,023,000, offset by an increase in other non-cash
interest of $8,000.
The Company had a net
loss of $1,458,000, or $0.01 per share, for the six-month period ended June 30, 2018, compared to a net loss of $3,330,000, or
$0.02 per share, for the six-month period ended June 30, 2017.
|
II.
|
Three months ended June 30, 2018 and 2017
|
|
|
Three months ended
|
|
|
|
June 30
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
462,000
|
|
|
|
580,000
|
|
|
|
(118,000
|
)
|
Research and development expenses
|
|
|
48,000
|
|
|
|
56,000
|
|
|
|
(8,000
|
)
|
Loss before other income (expense)
|
|
|
(510,000
|
)
|
|
|
(636,000
|
)
|
|
|
(126,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(248,000
|
)
|
|
|
(1,210,000
|
)
|
|
|
962,000
|
|
Net Loss
|
|
$
|
(758,000
|
)
|
|
$
|
(1,846,000
|
)
|
|
$
|
836,000
|
|
The Company had no
revenues in the three month-periods ended June 30, 2018 and 2017.
Operating expenses
were $462,000 for the three-month period ended June 30, 2018, compared to $580,000 for the three-month period ended June 30, 2017,
a decrease of $118,000. This is due to a decrease in non-cash expenses of $191,000, and an increase in cash expenses of $73,000.
Specifically, the decrease in non-cash expenses are attributable to an increase in depreciation of $7,000, offset by a decrease
in stock compensation expenses attributable to the fair value of options granted to directors and employees of $198,000. The increase
in cash expense is attributable to decreases in office expenses of $9,000, and legal and accounting expenses of $33,000, offset
by increases in consulting fees of $3,000, corporate expenses of $37,000, insurance expenses of $8,000, salaries and benefits of
$60,000, and other expenses of $7,000.
Research and development
expenses were $48,000 for the three-month period ended June 30, 2018, compared to $56,000 for the three-month period ended June
30, 2017, a decrease of $8,000. This decrease is attributable to decreases in prototype product development costs of $8,000.
Other income and expense
were $248,000 expense for the three-month period ended June 30, 2018, compared to $1,210,000 expense for the three-month period
ended June 30, 2017, a net decrease in other expenses of $962,000. This decrease is attributable to a crease in non-cash other
expenses of $962,000. 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 $1,114,000, offset by an increase in
other non-cash interest of $12,000.
The Company had a net
loss of $758,000, or $0.00 per share, for the three-month period ended June 30, 2018, compared to a net loss of $1,846,000, or
$0.01 per share, for the three-month period ended June 30, 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 $1,772,000 as of June 30, 2018. Our negative operating cash flow for the periods ended June 30, 2018 was funded primarily
through issuance of convertible notes and the exercise of options and warrants.
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 $1,458,000 and a negative cash flow from operations of $676,000 for the six-month
period ended June 30, 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
June 30, 2018, we received cash totaling $965,000 from issuance of our convertible notes payable and exercise of warrants, and
used cash in operations of $676,000. At June 30, 2018, we had cash on hand in the amount of $493,000. 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, as amended; 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 included in this report, 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 six-months ended June 30, 2018, the Company incurred a net loss of $1,458,000, used
cash in operations of $676,000 and had a stockholders’ deficit of $1,772,000 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 June 30, 2018, the
Company had cash on hand in the amount of $493,000. Management estimates that the current funds on hand will be sufficient to continue
operations through November 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 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 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.