Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheet
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
279,000
|
|
|
$
|
204,000
|
|
Prepaid expenses and other current assets
|
|
|
38,000
|
|
|
|
38,000
|
|
Total current assets
|
|
|
317,000
|
|
|
|
242,000
|
|
Property and equipment, net of accumulated depreciation of $72,000 and $51,000 at September 30, 2018 and December 31, 2017, respectively
|
|
|
25,000
|
|
|
|
46,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
344,000
|
|
|
$
|
290,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
1,023,000
|
|
|
$
|
852,000
|
|
Accounts payable and accrued expenses
|
|
|
660,000
|
|
|
|
748,000
|
|
Accrued expenses
|
|
|
49,000
|
|
|
|
31,000
|
|
Convertible debentures, net of discounts of $99,000 and $47,000 at September 30, 2018 and December 31, 2017, respectively
|
|
|
626,000
|
|
|
|
533,000
|
|
Total current liabilities
|
|
|
2,358,000
|
|
|
|
2,164,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 254,198,515 and 234,076,907 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
|
|
|
254,198
|
|
|
|
234,077
|
|
Additional paid-in capital
|
|
|
109,979,802
|
|
|
|
108,000,923
|
|
Accumulated deficit
|
|
|
(112,248,000
|
)
|
|
|
(110,109,000
|
)
|
Total stockholders’ deficit
|
|
|
(2,014,000
|
)
|
|
|
(1,874,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
344,000
|
|
|
$
|
290,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated StatementS of Operations, Unaudited
|
|
Three months ended
|
|
|
Nine months ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
50,000
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
431,000
|
|
|
|
535,000
|
|
|
|
1,387,000
|
|
|
|
2,373,000
|
|
Research and development expenses
|
|
|
50,000
|
|
|
|
53,000
|
|
|
|
145,000
|
|
|
|
173,000
|
|
Loss before other expenses
|
|
|
(481,000
|
)
|
|
|
(588,000
|
)
|
|
|
(1,532,000
|
)
|
|
|
(2,496,000
|
)
|
Other income (expenses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(200,000
|
)
|
|
|
(227,000
|
)
|
|
|
(607,000
|
)
|
|
|
(1,649,000
|
)
|
Loss on disposition of equipment
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Net Loss
|
|
$
|
(681,000
|
)
|
|
|
(815,000
|
)
|
|
$
|
(2,139,000
|
)
|
|
|
(4,145,000
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.02
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
251,731,417
|
|
|
|
230,132,723
|
|
|
|
243,167,707
|
|
|
|
212,384,061
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the NINE months Ended SEPTEMBER 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
|
|
|
7,374,125
|
|
|
|
7,374
|
|
|
|
466,626
|
|
|
|
|
|
|
|
474,000
|
|
Fair value of warrants and beneficial conversion feature of issued
convertible notes
|
|
|
|
|
|
|
|
|
|
|
526,000
|
|
|
|
|
|
|
|
526,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
|
|
|
|
|
|
|
|
340,000
|
|
|
|
|
|
|
|
340,000
|
|
Common stock issued for services
|
|
|
50,000
|
|
|
|
50
|
|
|
|
11,950
|
|
|
|
|
|
|
|
12,000
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,139,000
|
)
|
|
|
(2,139,000
|
)
|
Balance, September 30, 2018
|
|
|
251,198,515
|
|
|
$
|
254,198
|
|
|
$
|
109,979,802
|
|
|
$
|
(112,248,000
|
)
|
|
$
|
(2,014,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Nine months ended
|
|
|
|
September 30
|
|
|
|
2018
|
|
|
2017
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,139,000
|
)
|
|
$
|
(4,145,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
340,000
|
|
|
|
653,000
|
|
Issuance of common stock for services
|
|
|
12,000
|
|
|
|
–
|
|
Amortization of debt discount and accrual of interest
|
|
|
567,000
|
|
|
|
1,667,000
|
|
Loss on disposition of assets
|
|
|
–
|
|
|
|
–
|
|
Depreciation and amortization
|
|
|
21,000
|
|
|
|
11,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other assets
|
|
|
–
|
|
|
|
(14,000
|
)
|
Accounts payable and accrued expenses
|
|
|
(88,000
|
)
|
|
|
549,000
|
|
Accounts payable – license agreements
|
|
|
171,000
|
|
|
|
10,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
18,000
|
|
|
|
(95,000
|
)
|
Deposits and other current liabilities
|
|
|
–
|
|
|
|
(5,000
|
)
|
Net cash used in operating activities
|
|
|
(1,098,000
|
)
|
|
|
(1,369,000
|
)
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of equipment
|
|
|
–
|
|
|
|
(49,000
|
)
|
Net cash used in investing activities
|
|
|
–
|
|
|
|
(49,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common stock
|
|
|
–
|
|
|
|
38,000
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
526,000
|
|
|
|
1,469,000
|
|
Net proceeds from exercise of warrants
|
|
|
647,000
|
|
|
|
362,000
|
|
Net cash provided by financing activities
|
|
|
1,173,000
|
|
|
|
1,869,000
|
|
Net increase in cash
|
|
|
75,000
|
|
|
|
451,000
|
|
Cash, beginning of period
|
|
|
204,000
|
|
|
|
136,000
|
|
Cash, end of period
|
|
$
|
279,000
|
|
|
$
|
587,000
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
474,000
|
|
|
$
|
1,522,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
526,000
|
|
|
|
1,469,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
NINE MONTHS ENDED SEPTEMBER 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.
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 on April 2, 2018. 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 nine-months ended September 30, 2018, the Company incurred a net loss of $2,139,000, used cash in operations of $1,098,000
and had a stockholders’ deficit of $2,014,000 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 September 30, 2018,
the Company had cash on hand of $279,000. Management estimates that the current funds on hand will be sufficient to continue operations
through January 2019. 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 technology;
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, among other things, 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 September 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.
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Options
|
|
|
35,351,300
|
|
|
|
35,575,677
|
|
Warrants
|
|
|
7,288,855
|
|
|
|
17,420,770
|
|
Common stock issuable upon conversion of notes payable
|
|
|
7,204,552
|
|
|
|
4,957,333
|
|
Total
|
|
|
49,844,707
|
|
|
|
57,953,780
|
|
Estimates
The preparation of
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include
those related to assumptions used in valuing equity instruments issued for financing and for services, and reduction of deferred
tax assets. 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 nine-month
periods ended September 30, 2018 and 2017 research and development costs were $145,000 and $173,000, 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 nine-month periods ended September 30, 2018 and 2017, patent
costs were $27,000 and $38,000, respectively, and were included as part of operating expenses in the accompanying consolidated
statements of operations. During the three-month periods ended September 30, 2018 and 2017, patent costs were $15,000 and $14,000,
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.
|
Accounts Payable and Accrued Expenses – Related Parties
|
Accounts Payable
and 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 2017 consolidated statements of operations. As of September 30, 2018 and December 31, 2017, $357,000 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. The Company resumed making
payments of $10,000 per month in August 2018 but remains currently in arrears.
Accrued Expenses
– 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
September 30, 2018, and December 31, 2017, accrued expenses and accounts payable to related parties amounted to $49,000 and
$31,000, respectively.
|
4.
|
Property and Equipment
|
At September 30, 2018
and December 31, 2017, property and equipment consist of the following:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
(72,000
|
)
|
|
|
(51,000
|
)
|
Total
|
|
$
|
25,000
|
|
|
$
|
46,000
|
|
Depreciation expense
for the nine-month periods ended September 30, 2018 and 2017 was $21,000 and $11,000, respectively. Depreciation expense for the
three-month periods ended September 30, 2018 and 2017 was $4,000 and $6,000, respectively.
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance due convertible notes
|
|
$
|
614,000
|
|
|
$
|
509,000
|
|
Accrued interest
|
|
|
111,000
|
|
|
|
71,000
|
|
Subtotal
|
|
|
725,000
|
|
|
|
580,000
|
|
Unamortized note discounts
|
|
|
(99,000
|
)
|
|
|
(47,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
626,000
|
|
|
$
|
533,000
|
|
As in 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 nine-month period ending September 30, 2018, the Company issued similar convertible promissory
notes in the aggregate of $579,000 for cash of $526,000 or a discount of $53,000. 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 $0.05 to $0.08 per share. In addition, the Company also granted these
note holders warrants to purchase 4,472,188 shares of the Company’ common stock. The warrants are fully vested, exercisable
at $0.05 to $0.08 per share and will expire in one year. Upon issuance, the Company recorded a note discount of $579,000 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 nine-month
period ended September 30, 2018, a total of $474,000 notes payable was converted to 7,363,125 shares of common stock. In addition,
the note discount of $526,000 was amortized to interest expense, and interest of $41,000 was accrued.
As of September
30, 2018, total outstanding notes payable amounted to $614,000, accrued interest of $111,000 and unamortized note discount of
$99,000 for a net balance of $626,000 In addition, a total of eight outstanding notes amounting to $454,000 have reached maturity
and are past-due, and are now accruing interest at 10% per annum under terms of the notes.
|
6.
|
Research and Development
|
The Company constructs,
develops and tests the AOT technology 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.
For the nine-month
periods ended September 30, 2018 and 2017, our research and development expenses were $145,000 and $173,000 respectively. For the
three-month periods ended September 30, 2018 and 2017, our research and development expenses were $50,000 and $53,000, 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 nine-month
periods ended September 30, 2018 and 2017, the Company incurred total expenses of $5,000 and $30,000, respectively, in the manufacture,
delivery and testing of the AOT prototype equipment. During the three-month periods ended September 30, 2018 and 2017, the Company
incurred total expenses of $4,000 and $6,000, 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 nine-month period ended September 30, 2018 and 2017 pursuant to these two agreements amounted to $141,000 and $143,000,
respectively. Total expenses recognized during each three-month period ended September 30, 2018 and 2017 pursuant to these two
agreements amounted to $47,000. These expenses have been reflected in Research and Development expenses on the accompanying consolidated
statements of operations.
As of December 31,
2017, total unpaid fees due to Temple pursuant to these agreements amounted to $842,000. 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 September 30,
2018, and December 31, 2017, total unpaid fees due to Temple pursuant to these agreements amounted to $1,023,000 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 $83,000 are current, $417,000 are deferred until such time the Company
achieves a revenue milestone of $835,000 or upon termination of the licensing agreements and the remaining $523,000 are deemed
past due. The past due amount of $523,000 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 nine-month period ended September 30, 2017. This amount is not
sufficient to be subject to additional license fees under the license agreement.
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 September 30,
2018, and December 31, 2017, total unpaid fees due to Temple pursuant to the Research Agreement were $0 and $10,000, respectively,
which are included as part of Accounts payable – licensing agreements in the accompanying consolidated balance sheets.
During the nine months
ended September 30, 2018, the Company issued a total of 20,121,608 shares of its common stock as follows:
|
·
|
The Company issued 7,374,125 shares of
its common stock upon the conversion of $474,000 in convertible notes pursuant to the convertible notes at 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 September 30, 2018 was 5.4 years. Stock option activity for the period
January 1, 2018 up to September 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
|
)
|
|
|
0.07
|
|
|
Forfeited
|
|
|
|
(1,950,000
|
)
|
|
|
0.29
|
|
|
September 30, 2018
|
|
|
|
35,351,300
|
|
|
$
|
0.22
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of September 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
|
|
|
|
35,200,854
|
|
|
|
5.4
|
|
|
$
|
0.22
|
|
|
|
32,380,020
|
|
|
$
|
0.21
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
150,446
|
|
|
|
4.8
|
|
|
$
|
1.18
|
|
|
|
150,446
|
|
|
$
|
1.18
|
|
|
|
|
|
|
35,351,300
|
|
|
|
5.4
|
|
|
$
|
0.22
|
|
|
|
32,530,466
|
|
|
$
|
0.21
|
|
During the nine-month
period ending September 30, 2018, 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 nine-month
periods ended September 30, 2018 and 2017, the Company recognized total compensation costs based on the fair value of options that
vested of $340,000 and $653,000 respectively, which is included in Operating expenses in the Company’s statement of operations.
During the three-month periods ended September 30, 2018 and 2017, the Company recognized compensation costs based on the fair value
of options that vested of $95,000 and $117,000 respectively, which is included in Operating expenses in the Company’s statement
of operations.
During the period ended
September 30, 2018, the Company issued 179,710 shares of common stock upon exercise of stock options which resulted in proceeds
of $13,000.
At September 30, 2018,
the Company’s closing stock price was $0.08 per share. The aggregate intrinsic value of the options outstanding at September
30, 2018 was $208,036. Future unamortized compensation expense on the unvested outstanding options at September 30, 2018 is $114,127
to be recognized through June 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 September 30, 2018.
|
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
|
January 1, 2018
|
|
|
|
17,622,437
|
|
|
$
|
0.09
|
|
|
Granted
|
|
|
|
4,472,188
|
|
|
|
0.06
|
|
|
Exercised
|
|
|
|
(12,517,773
|
)
|
|
|
0.05
|
|
|
Cancelled
|
|
|
|
(2,287,997
|
)
|
|
|
0.05
|
|
|
September 30, 2018
|
|
|
|
7,288,855
|
|
|
$
|
0.16
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of September 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
|
|
|
|
7,288,855
|
|
|
|
1.5
|
|
|
$
|
0.16
|
|
|
|
7,288,855
|
|
|
$
|
0.16
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
7,288,855
|
|
|
|
1.5
|
|
|
$
|
0.16
|
|
|
|
7,288,855
|
|
|
$
|
0.16
|
|
In the nine-month period
ending September 30, 2018, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 4,472,188 shares
of common stock with an exercise price of $.05 to $0.08 per share, vesting immediately upon grant and expiring one year from the
date of grant (see Note 5).
During the nine-month
period ended September 30, 2018, warrants to acquire 12,517,773 shares of common stock were exercised resulting in net proceeds
to the Company of $634,000.
During the nine-month
periods ended September 30, 2018 and 2017, the Company recognized compensation costs of $0 and $1,000, respectively, based on the
fair value of warrants previously issued for services that vested during the period, which is included in Operating expenses in
the Company’s statement of operations. During the three-month periods ended September 30, 2018 and 2017, the Company recognized
compensation costs of $0 and $2,000, respectively, based on the fair value of warrants that vested, which is included in Operating
expenses in the Company’s statement of operations.
At September 30, 2018,
the aggregate intrinsic value of the warrants outstanding was $68,000.
|
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.
Conversion of
Convertible Notes
Between October 1,
2018 and November 14, 2018, the Company issued 1,925,000 shares of common stock upon conversion of previously issued convertible
notes in aggregate value of $104,500.
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 in our form 10-K 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 September 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. However, the Company will still consider entering into potential beneficial acquisitions. The Company is considering
dissolving QS Energy Pool 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 suspended 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. Although
discussions continue, an alternate location has not been identified. 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. We plan to resume Joule Heat development in the future depending on the availability of sufficient capital
and other resources.
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 United States delivering multiple heavy crudes. In August,
these efforts culminated in the execution of a non-bindingMemorandum of Understanding (“MOU”) detailing the project’s
general scope, timeline and terms. Since that time, we have been working diligently with the operator to complete engineering reviews,
select a project location, and finalize a detailed statement of work which we anticipate will be the foundation for final definitive
agreements. Although final project terms may vary from those described in the current statement of work, we and the operator have
a general understanding that, subject to the execution of a definitive agreement, the demonstration project will operate under
an initial term of 36 months, targeting installation in December 2018 – January 2019. QS Energy and the pipeline operator
would have dual ownership of all data collected. Importantly, AOT-related data would not be as tightly restricted as it has been
in the past, and access to the demonstration site would be made available to prospective QS Energy customers. QS Energy would provide
and retain ownership of all AOT equipment at no cost to the operator and pay AOT-related installation and operating costs through
the term of the project. The project would be subject to early termination by either party after 6 months of operations. At the
end of the initial term, the operator would have the option to extend the project or either purchase equipment or lease equipment
under terms to be mutually agreed upon.
Preparation for this
demonstration project started several months ago when we entered into a master services contract with the pipeline operator, initiating
the operator’s vendor qualification process, a process which began with a review of our operating procedures and records
and was finalized earlier this month with the expansion of our insurance coverages to meet the operator’s standard requirements.
Upon execution of the MOU in August, we selected an AOT unit from inventory for inspection and quality assurance testing, after
which we sent the AOT to one of our supply-chain partners for some minor system improvements. Equipment preparation, hydro testing
and final quality assurance should be completed in November, on schedule for delivery to the demonstration site for installation
in December-January.
Crude oil samples provided
by the pipeline operator have been tested at Temple University, indicating AOT could significantly reduce viscosity of the heavy
crudes typically transported through this pipeline. Analysis of the selected pipeline location and configuration indicates the
proposed location has excellent characteristics for demonstration purposes. If successful at the proposed location, acquisition
and installation of additional AOT’s may be required for the operator to fully realize and optimize AOT benefits along the
full length of the selected pipeline.
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 have been shipped from South America for testing at Temple University. 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. In August 2018, we were informed by our Asian client the project would be suspended and reassessed in
2019 subject to budget and project approval requirements imposed by new management. In August 2018, we were approached by a prospective
customer in northwest Asia and have been invited to meet with senior management to make presentations and provide a proposal to
install AOTs on a new 2,000 km pipeline. 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. Ongoing communications are continuing with energy companies in Europe
and the Middle East.
Our expenses to date
have been funded 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 we are able to achieve a revenue
base.
There are significant
risks associated with our business, our Company and our stock. See “Risk Factors,” below.
Results of Operation for Nine and Three-month
periods ended September 30, 2018 and 2017
|
|
Nine months ended September 30, 2018 and 2017
|
|
|
Nine months ended
|
|
|
|
September 30
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
$
|
(50,000
|
)
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
1,387,000
|
|
|
|
2,373,000
|
|
|
|
(986,000
|
)
|
Research and development expenses
|
|
|
145,000
|
|
|
|
173,000
|
|
|
|
(28,000
|
)
|
Loss before other income (expense)
|
|
|
(1,532,000
|
)
|
|
|
(2,496,000
|
)
|
|
|
964,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Interest and financing expense
|
|
|
(607,000
|
)
|
|
|
(1,649,000
|
)
|
|
|
1,042,000
|
|
Loss on disposition of equipment
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Net Loss
|
|
$
|
(2,139,000
|
)
|
|
$
|
(4,145,000
|
)
|
|
$
|
2,006,000
|
|
During the nine-month
period ended September 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 was no similar transaction during the period ended September 30, 2018.
Operating expenses
were $1,387,000 for the nine-month period ended September 30, 2018, compared to $2,373,000 for the nine-month period ended September
30, 2017, a decrease of $989,000. This is due to decreases in non-cash expenses of $290,000, and in cash expenses of $696,000.
Specifically, the decrease in non-cash expenses are attributable to increases in depreciation of $11,000 and stock compensation
expenses attributable to the fair value of warrants and common stock issued to consultants of $11,000, offset by a decrease in
the fair value of options granted to directors and employees of $312,000. The decrease in cash expenses is attributable to increases
in insurance expenses of $10,000, and salaries and benefits of $78,000, offset by decreases in consulting expenses of $21,000,
corporate expenses of $6,000, office expenses of $30,000, legal and accounting expenses of $75,000, travel expenses of $26,000,
other expenses of $2,000, and a decrease to severance package expense of $624,000.
Research and development
expenses were $145,000 for the nine-month period ended September 30, 2018, compared to $173,000 for the nine-month period ended
September 30, 2017, a decrease of $28,000 This decrease is attributable to decreases in product testing, research, patents and
other costs of $25,000, and prototype product development costs of $3,000
Other income and expense
were a net expense of $607,000 for the nine-month period ended September 30, 2018, compared to a net expense of $1,041,000 for
the nine-month period ended September 30, 2017, a net decrease in other expenses of $1,041,000. This decrease is attributable to
a decrease in non-cash other expenses of $1,041,000. 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 $1,041,000.
The Company had a net
loss of $2,139,000, or $0.01 per share, for the nine-month period ended September 30, 2018, compared to a net loss of $4,145,000,
or $0.02 per share, for the nine-month period ended September 30, 2017.
Three months ended September 30, 2018
and 2017
|
|
Three months ended
|
|
|
|
September 30
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
431,000
|
|
|
|
535,000
|
|
|
|
(104,000
|
)
|
Research and development expenses
|
|
|
50,000
|
|
|
|
53,000
|
|
|
|
(3,000
|
)
|
Loss before other income (expense)
|
|
|
(481,000
|
)
|
|
|
(588,000
|
)
|
|
|
107,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Interest and financing expense
|
|
|
(200,000
|
)
|
|
|
(227,000
|
)
|
|
|
(27,000
|
)
|
Net Loss
|
|
$
|
(681,000
|
)
|
|
$
|
(815,000
|
)
|
|
$
|
134,000
|
|
The Company had no
revenues in the three month-periods ended September 30, 2018 and 2017.
Operating expenses
were $431,000 for the three-month period ended September 30, 2018, compared to $535,000 for the three-month period ended September
30, 2017, a decrease of $104,000. This is due to decreases in non-cash expenses of $22,000 and in cash expenses of $79,000. Specifically,
the decrease in non-cash expenses are attributable to decreases in depreciation of $3,000 and stock compensation expenses attributable
to the fair value of options granted to directors and employees of $22,000. The decrease in cash expenses is attributable to an
increase salaries and benefits of $29,000, offset by decreases in consulting expenses of $13,000, corporate expenses of $39,000,
freight expenses of $9,000, office expenses of $16,000, legal and accounting expenses of $11,000, travel expenses of $19,000, and
other expenses of $1,000.
Research and development
expenses were $50,000 for the three-month period ended September 30, 2018, compared to $53,000 for the nine-month period ended
September 30, 2017, a decrease of $3,000. This decrease is attributable to decreases in prototype product development costs of
$3,000.
Other income and expense
were $200,000 expense for the three-month period ended September 30, 2018, compared to $227,000 expense for the three-month period
ended September 30, 2017, a net decrease in other expenses of $27,000. This decrease is attributable to a decrease in non-cash
other expenses of $27,000. The decrease in non-cash other expense is due to an increase in expense attributable to interest, beneficial
conversion features and warrants associated with convertible notes issued in the amount of $77,000, offset by a decrease in other
non-cash interest of $50,000.
The Company had a net
loss of $681,000, or $0.00 per share, for the three-month period ended September 30, 2018, compared to a net loss of $815,000,
or $0.00 per share, for the three-month period ended September 30, 2017.
Liquidity and Capital Resources
General
As reflected in the
accompanying condensed consolidated financial statements, the Company has not yet generated significant or ongoing 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 $112,248,000 as of September 30, 2018. Our negative operating cash flow for the periods ended September 30, 2018 was
funded 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 $2,139,000 and a negative cash flow from operations of $1,098,000 for the nine-month
period ended September 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
September 30, 2018, we received cash totaling $1,173,000 from issuance of our convertible notes payable, exercise of options and
warrants, and used cash in operations of $1,098,000 At September 30, 2018, we had cash on hand in the amount of $279,000. 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, as amended; costs associated with product development and commercialization of the AOT and related
technologies; costs to manufacture and ship our products; costs to maintain an effective system of internal controls and disclosure
controls and procedures; costs of maintaining our status as a public company by, among other things, 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 2 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
2 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 nine-months ended September 30, 2018, the Company incurred a net loss of $2,139,000 used cash in operations of $1,098,000
and had a stockholders’ deficit of $112,248,000 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 September 30, 2018,
the Company had cash on hand in the amount of $279,000 Management estimates that the current funds on hand will be sufficient to
continue operations through January 2019. 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.