Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheets
|
|
March 31, 2019
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2018
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
924,000
|
|
|
$
|
1,153,000
|
|
Prepaid expenses and other current assets
|
|
|
490,000
|
|
|
|
34,000
|
|
Total current assets
|
|
|
1,414,000
|
|
|
|
1,187,000
|
|
Property and equipment, net of accumulated depreciation of $74,000 and $73,000 at March 31, 2019 and December 31, 2018, respectively
|
|
|
23,000
|
|
|
|
24,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
1,439,000
|
|
|
$
|
1,213,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
1,141,000
|
|
|
$
|
1,073,000
|
|
Accounts payable and accrued expenses
|
|
|
558,000
|
|
|
|
658,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
25,000
|
|
|
|
55,000
|
|
Convertible debentures, net of discounts of $221,000 and $1,100,000 at March 31, 2019 and December 31, 2018, respectively
|
|
|
704,000
|
|
|
|
909,000
|
|
Total current liabilities
|
|
|
2,428,000
|
|
|
|
2,695,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 294,805,488 and 256,123,515 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
|
|
|
294,805
|
|
|
|
256,123
|
|
Additional paid-in capital
|
|
|
114,166,195
|
|
|
|
111,429,877
|
|
Accumulated deficit
|
|
|
(115,450,000
|
)
|
|
|
(113,168,000
|
)
|
Total stockholders’ deficit
|
|
|
(989,000
|
)
|
|
|
(1,482,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
1,439,000
|
|
|
$
|
1,213,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Operations, Unaudited
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
478,000
|
|
|
|
494,000
|
|
Research and development expenses
|
|
|
151,000
|
|
|
|
47,000
|
|
Loss from operations
|
|
|
(629,000
|
)
|
|
|
(541,000
|
)
|
|
|
|
|
|
|
|
|
|
Other expense
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(1,653,000
|
)
|
|
|
(159,000
|
)
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
(2,282,000
|
)
|
|
$
|
(700,000
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.00
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
265,880,777
|
|
|
|
234,610,752
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the Three months Ended MARCH 31, 2019 and march 31, 2018
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, January 1, 2019
|
|
|
256,123,515
|
|
|
$
|
256,123
|
|
|
$
|
111,429,877
|
|
|
$
|
(113,168,000
|
)
|
|
$
|
(1,482,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
1,962,153
|
|
|
|
1,962
|
|
|
|
170,038
|
|
|
|
–
|
|
|
|
172,000
|
|
Fair value of common stock issued on conversion of notes payable
|
|
|
36,719,820
|
|
|
|
36,720
|
|
|
|
1,799,280
|
|
|
|
–
|
|
|
|
1,836,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
668,000
|
|
|
|
–
|
|
|
|
668,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
99,000
|
|
|
|
–
|
|
|
|
99,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(2,282,000
|
)
|
|
|
(2,282,000
|
)
|
Balance, March 31, 2019
|
|
|
294,805,488
|
|
|
$
|
294,805
|
|
|
$
|
114,166,195
|
|
|
$
|
(115,450,000
|
)
|
|
$
|
(989,000
|
)
|
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, January 1, 2018
|
|
|
234,076,907
|
|
|
$
|
234,077
|
|
|
$
|
108,000,923
|
|
|
$
|
(110,109,000
|
)
|
|
$
|
(1,874,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
1,345,710
|
|
|
|
1,346
|
|
|
|
69,654
|
|
|
|
–
|
|
|
|
71,000
|
|
Fair value of common stock issued on conversion of notes payable
|
|
|
1,278,750
|
|
|
|
1,279
|
|
|
|
97,721
|
|
|
|
–
|
|
|
|
99,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
245,000
|
|
|
|
–
|
|
|
|
245,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
143,000
|
|
|
|
–
|
|
|
|
143,000
|
|
Common stock issued for services
|
|
|
50,000
|
|
|
|
50
|
|
|
|
11,950
|
|
|
|
–
|
|
|
|
12,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
|
(700,000
|
)
|
|
|
(700,000
|
)
|
Balance, March 31, 2018
|
|
|
236,751,367
|
|
|
$
|
236,752
|
|
|
$
|
108,568,248
|
|
|
$
|
(110,809,000
|
)
|
|
$
|
(2,004,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2019
|
|
|
2018
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,282,000
|
)
|
|
$
|
(700,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
99,000
|
|
|
|
143,000
|
|
Issuance of common stock for services
|
|
|
–
|
|
|
|
12,000
|
|
Amortization of debt discount and accrued interest
|
|
|
1,632,000
|
|
|
|
143,000
|
|
Depreciation and amortization
|
|
|
1,000
|
|
|
|
8,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
(457,000
|
)
|
|
|
15,000
|
|
Accounts payable and accrued expenses
|
|
|
(100,000
|
)
|
|
|
15,000
|
|
Accounts payable – license agreements
|
|
|
68,000
|
|
|
|
63,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
(30,000
|
)
|
|
|
6,000
|
|
Net cash used in operating activities
|
|
|
(1,069,000
|
)
|
|
|
(295,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
668,000
|
|
|
|
245,000
|
|
Net proceeds from exercise of warrants and options
|
|
|
172,000
|
|
|
|
71,000
|
|
Net cash provided by financing activities
|
|
|
840,000
|
|
|
|
316,000
|
|
Net increase (decrease) in cash
|
|
|
(229,000
|
)
|
|
|
21,000
|
|
Cash, beginning of period
|
|
|
1,153,000
|
|
|
|
204,000
|
|
Cash, end of period
|
|
$
|
924,000
|
|
|
$
|
225,000
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
–
|
|
|
$
|
–
|
|
Income Taxes
|
|
$
|
–
|
|
|
$
|
–
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Conversion of convertible debentures to common stock
|
|
$
|
1,836,000
|
|
|
$
|
99,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
668,000
|
|
|
|
245,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
THREE MONTHS ENDED MARCH 31, 2019 AND
2018
|
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, 2018 filed with the SEC. The condensed consolidated balance sheet as of December
31, 2018 included herein was derived from the audited consolidated financial statements as of that date, but does not include all
disclosures, including notes, required by GAAP.
In the opinion of management,
the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the
Company's financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained
herein are of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative
of fiscal year-end results.
|
2.
|
Summary of Significant Accounting Policies
|
Consolidation Policy
The accompanying consolidated
financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS
Energy Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.
Going Concern
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
during the three-months ended March 31, 2019, the Company incurred a net loss of $2,282,000, used cash in operations of $1,069,000
and had a stockholders’ deficit of $989,000 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, 2018 financial statements, has raised
substantial doubt about the Company's ability to continue as a going concern.
At March 31, 2019,
the Company had cash on hand in the amount of $924,000. Management estimates that the current funds on hand will be sufficient
to continue operations through September 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 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 2019 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of
debt financing or cause substantial dilution for our stockholders in case of equity financing.
Basic and Diluted Income
(loss) per share
Our computation of
earnings per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to
common stockholders divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects
the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income (loss)
of the Company as if they had been converted at the beginning of the periods presented, or issuance date, if later. In computing
diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the
proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive
effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise
price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per
share or decrease loss per share) are excluded from the calculation of diluted EPS.
Income (loss) per common
share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the
respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating
loss because all warrants and stock options outstanding are anti-dilutive. At March 31, 2019 and 2019, we excluded the outstanding
securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been
anti-dilutive.
|
|
March 31,
2019
|
|
|
March 31,
2018
|
|
Options
|
|
|
39,711,022
|
|
|
|
37,301,300
|
|
Warrants
|
|
|
26,102,430
|
|
|
|
17,590,812
|
|
Common stock issuable upon conversion of notes payable
|
|
|
11,058,950
|
|
|
|
7,047,333
|
|
Total
|
|
|
76,872,402
|
|
|
|
61,939,445
|
|
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
Under its business
plan, the Company anticipates the leasing of its primary technology. The Company will recognize lease revenue ratably over the
life of the lease upon commencement of the lease. Revenue on future product sales will be recognized in accordance with Accounting
Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition
standard that supersedes nearly all existing revenue recognition guidance under current U.S. GAAP and replaces it with a principle-based
approach or determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred
goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing
and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments
and assets recognized from costs incurred to obtain or fulfill a contract.
Research and Development
Costs
Research and development
costs are expensed as incurred, and consist primarily of fees paid to consultants and outside service providers, and other expenses
relating to the acquisition, design, development and testing of the Company’s products. Certain research and development
activities are incurred under contract. In those instances, research and development costs are charged to operations ratably over
the life of the underlying contracts, unless the achievement of milestones, the completion of contracted work, or other information
indicates that a different expensing schedule is more appropriate. Payments made pursuant to research and development contracts
are initially recorded as advances on research and development contract services in the Company’s consolidated balance sheet
and then charged to research and development costs in the Company’s consolidated statement of operations as those contract
services are performed.
In January 2019, the
Company paid $500,000 as a deposit under terms of a work order for work to be performed by a pipeline operator. During the period
ended March 31, 2019, the Company amortized $100,000 of such amount as a research and development cost based on the progress of
work performed as required by the contract, and has reflected the $400,000 remaining amount as Prepaid expenses and other current
assets in the accompanying consolidated balance sheet as of March 31, 2019.
For the three-month
periods ended March 31, 2019 and 2018 research and development costs were $151,000 and $47,000, 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 three-month periods ended March 31, 2019 and 2018, patent
costs were $7,000 and $6,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements
of operations.
Recent Accounting Pronouncements
Recent accounting pronouncements
issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities
and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future
consolidated financial statement presentation or disclosures.
|
3.
|
Accrued Expenses and Accounts Payable
|
Accrued Expenses
As of March 31, 2019
and December 31, 2018, the Company owed $297,000 and $327,000, respectively, pursuant to a separation agreement with a former executive
officer effective April 1, 2017 as amended by letter agreements dated effective August 16, 2018 and March 31, 2019 which included
as part of Accrued expenses and accounts payable on the accompanying balance sheet. The amount is to be repaid at an amount of
$10,000 per month.
Accrued Expenses
and Accounts Payable – Related Parties
Accrued expense –
related parties consists of accrued current salaries of officers and fees due to members of the Board of Directors. As of March
31, 2019, and December 31, 2018, accrued expenses and accounts payable to related parties amounted to $25,000 and $55,000, respectively.
|
4.
|
Property and Equipment
|
At March 31, 2019 and
December 31, 2018, property and equipment consists of the following:
|
|
March 31,
2019
(unaudited)
|
|
|
December 31,
2018
|
|
|
|
|
|
|
|
|
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
|
|
|
(74,000
|
)
|
|
|
(73,000
|
)
|
Total
|
|
$
|
23,000
|
|
|
$
|
24,000
|
|
Depreciation expense
for the three-month periods ended March 31, 2019 and 2018 was $1,000 and $8,000, respectively.
|
|
March 31,
2019
(unaudited)
|
|
|
December 31
2018
|
|
Balance due on convertible notes
|
|
$
|
788,000
|
|
|
$
|
1,886,000
|
|
Accrued interest
|
|
|
137,000
|
|
|
|
123,000
|
|
Subtotal
|
|
|
925,000
|
|
|
|
2,009,000
|
|
Convertible note discount
|
|
|
(221,000
|
)
|
|
|
(1,100,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
704,000
|
|
|
$
|
909,000
|
|
The Company issues
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 receive 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.
As of December 31,
2018, total outstanding notes payable amounted to $1,886,000 which are due through December 2019 and unamortized note discount
of $1,100,000.
During the three-month
period ended March 31, 2019, the Company issued similar convertible promissory notes in the aggregate of $735,000 for cash of $668,000
or a discount of $67,000. The notes do not bear any interest; however, the implied interest rate used was 10% since the notes were
issued 10% less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.05 per
share. In addition, the Company also granted these note holders warrants to purchase 7.4 million shares of the Company’ common
stock. The warrants are fully vested, exercisable at $0.05 per share and will expire in one year. As a result, the Company recorded
a note discount of $668,000 to account for the relative fair value of the warrants, the notes’ beneficial conversion feature
(BCF), and original issue discount (OID). The note discounts are being amortized over the term of the note or amortized in full
upon the conversion to common stock. During the three-month period ended March 31, 2019 notes payable of $1,836,000 were converted
into 36,719,820 shares of common stock.
As of March 31, 2019,
total outstanding notes payable amounted to $788,000, accrued interest of $137,000 and unamortized note discount of $221,000 for
a net balance of $704,000. A total of nine notes in the aggregate of $491,000 have reached maturity and are past due.
|
6.
|
Research and Development
|
The Company constructs,
develops and tests the AOT technologies with internal resources and through the assistance of various third-party entities. Costs
incurred and expensed include fees such as license fees, purchase of test equipment, pipeline pumping equipment, crude oil tank
batteries, viscometers, SCADA systems, computer equipment, payroll and other related equipment and various logistical expenses
for the purposes of evaluating and testing the Company’s AOT prototypes.
Costs incurred for
research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed.
Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial
uses are also expensed.
For the three-month
periods ended March 31, 2019 and 2018, our research and development expenses were $151,000 and $47,000 respectively.
AOT Product Development
and Testing
The Company constructs,
develops and tests the AOT technologies with internal resources and through the assistance of various third-party entities. Costs
incurred and expensed include fees such as testing fees, purchase of test equipment, pipeline pumping equipment, crude oil tank
batteries, viscometers, SCADA systems, computer equipment, payroll and other related equipment and various logistical expenses
for the purposes of evaluating and testing the Company’s AOT prototypes.
During the three-month
periods ended March 31, 2019, the Company incurred total expenses of $105,000 in the manufacture, delivery and testing of the AOT
prototype equipment. Included in this amount, were costs related to a $500,000 work order for work to be performed by a pipeline
operator. During the period ended March 31, 2019, the Company amortized $100,000 of such amount as a research and development cost
based on the progress of work performed as required by the contract, and has reflected the $400,000 remaining amount as Prepaid
expenses and other current assets in the accompanying consolidated balance sheet as of March 31, 2019. There were no such expenses
for the comparable period in 2018.
Temple University Licensing
Agreement
On August 1, 2011,
the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License
Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated
with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology
to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive, and the territory
licensed to the Company is worldwide and replace previously issued License Agreements.
Pursuant to the two
licensing agreements, the Company paid Temple a non-refundable license maintenance fee of $300,000 and agreed to pay (i) annual
maintenance fees of $187,500; (ii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing agreements;
and (iii) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon. The term of
the licenses commenced in August 2011 and will expire upon expiration of the patents. The agreements can also be terminated by
either party upon notification under terms of the licensing agreements or if the Company ceases the development of the patent or
fails to commercialize the patent rights.
Total expenses recognized
during each three-month period ended March 31, 2019 and 2018 pursuant to these two License Agreements amounted to $47,000 and has
been reflected in Research and Development expenses on the accompanying consolidated statements of operations. In the three-month
periods ended March 31, 2019 and 2018, the Company also recognized penalty interest on past-due balances of $21,000 and $16,000,
respectively, which is included as part of interest and financing expense in the accompanying statements of operations.
As of March 31,
2019 and December 31, 2018, total unpaid fees due to Temple pursuant to these agreements are $1,141,000 and $1,073,000,
respectively, which are included as part of Accounts Payable – license agreements in the accompanying consolidated
balance sheets. With regards to the unpaid fees to Temple, a total of $135,000 are deferred until such time the Company
achieves a revenue milestone of $835,000 or upon termination of the licensing agreements and the remaining $1,006,000 are
deemed past due. The Company is currently in negotiations with Temple to settle or cure the past due balance.
No revenues were earned
from the two License Agreements during the three-month periods ended March 31, 2019 and March 31,2018.
During the three months
ended March 31, 2019, the Company issued 38,681,973 shares of its common stock as follows:
|
·
|
The Company issued 36,719,820 shares of its common stock upon the conversion of $1,836,000 in convertible notes pursuant to the convertible notes conversion prices of $0.05 per share.
|
|
·
|
The Company issued 1,684,375 shares of its common stock upon the exercise of warrants for proceeds of $122,000 at exercise prices of $0.05 to $0.08 per share.
|
|
·
|
The Company issued 277,778 shares of its common stock upon the exercise of options for proceeds of $50,000 at exercise prices of $0.18 per share.
|
|
8.
|
Stock Options and Warrants
|
The Company periodically
issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing
costs. Options vest and expire according to terms established at the grant date.
Options
Options vest according
to the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining contractual
life of employee and non-employee options outstanding at March 31, 2018 was 5.5 years. Stock option activity for the period
January 1, 2019 up to March 31, 2019, was as follows:
|
|
|
Options
|
|
|
Weighted
Avg. Exercise
Price
|
|
January 1, 2019
|
|
|
|
35,301,300
|
|
|
$
|
0.22
|
|
Granted
|
|
|
|
4,687,500
|
|
|
$
|
0.08
|
|
Exercised
|
|
|
|
(277,778
|
)
|
|
$
|
0.18
|
|
Forfeited
|
|
|
|
–
|
|
|
|
–
|
|
March 31, 2019
|
|
|
|
39,711,022
|
|
|
$
|
0.20
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2019 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 - $0.24
|
|
|
8,175,972
|
|
|
8.3
|
|
$0.10
|
|
|
14,360,347
|
|
|
$0.10
|
$0.25 - $0.49
|
|
|
20,913,552
|
|
|
3.0
|
|
$0.27
|
|
|
18,913,552
|
|
|
$0.27
|
$0.50 - $0.99
|
|
|
471,052
|
|
|
5.1
|
|
$0.85
|
|
|
471,052
|
|
|
$0.85
|
$1.00 - $2.00
|
|
|
150,446
|
|
|
4.3
|
|
$1.18
|
|
|
150,446
|
|
|
$1.18
|
|
|
|
39,711,022
|
|
|
5.5
|
|
$0.20
|
|
|
33,895,397
|
|
|
$0.21
|
During the three-month
period ending March 31, 2019, and pursuant to the Company’s Board Compensation policy approved by the Board June 19, 2015,
the Company granted options to purchase 4,687,500 shares of common stock to members of the Company’s Board of Directors.
The options are exercisable at $0.08 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 $328,000 using the Black-Scholes Option Pricing model with the following assumptions:
life of 5 years; risk free interest rate of 2.5%; volatility of 122% and dividend yield of 0%.
During the three-month
periods ended March 31, 2019 and 2018, the Company recognized compensation costs based on the fair value of options that vested
of $99,000 and $143,000 respectively.
At March 31, 2019,
the Company’s closing stock price was $0.30 per share. The aggregate intrinsic value of the options outstanding at March
31, 2019 was $4,443,000. Future unamortized compensation expense on the unvested outstanding options at March 31, 2019 is approximately
$249,000 to be recognized through December 2019.
Warrants
The following table
summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2019
up to March 31, 2019.
|
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
January 1, 2019
|
|
|
|
21,055,355
|
|
|
$
|
0.09
|
|
Granted
|
|
|
|
7,350,200
|
|
|
|
0.05
|
|
Exercised
|
|
|
|
(1,684,375
|
)
|
|
|
0.07
|
|
Cancelled
|
|
|
|
(618,750
|
)
|
|
|
0.08
|
|
March 31, 2019
|
|
|
|
26,102,430
|
|
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2019 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 - $0.24
|
|
|
23,390,763
|
|
|
|
0.8
|
|
|
$
|
0.05
|
|
|
|
23,390,763
|
|
|
$
|
0.05
|
|
$0.25 - $0.49
|
|
|
2,641,667
|
|
|
|
2.0
|
|
|
|
0.30
|
|
|
|
2,641,667
|
|
|
|
0.30
|
|
$0.50 - $1.00
|
|
|
70,000
|
|
|
|
5.1
|
|
|
|
0.80
|
|
|
|
70,000
|
|
|
|
0.80
|
|
|
|
|
26,102,430
|
|
|
|
0.9
|
|
|
|
0.08
|
|
|
|
26,102,430
|
|
|
|
0.08
|
|
In the three-month
period ending March 31, 2019, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 7,350,200
shares of common stock with an exercise price of $.05 per share, vesting immediately upon grant and expiring one year from the
date of grant (see Note 5, above).
During the three-month
period ended March 31, 2019, warrants to acquire 1,684,375 shares of common stock were exercised resulting in net proceeds to the
Company of $122,000.
At March 31, 2019,
the aggregate intrinsic value of the warrants outstanding was $5,803,000.
|
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
From April 1, 2019
up to May 13, 2019, Company issued 220,000 shares of common stock upon conversion of previously issued convertible notes in aggregate
value of $10,500.
Exercise of Warrants
From April 1, 2019
up to May 13, 2019, the Company issued 1,014,063 shares of common stock upon the exercise of previously issued warrants for aggregate
cash proceeds of $51,425.
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations
The following discussion
and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial
Statements and supplementary data referred to in this Form 10-Q.
This discussion contains
forward-looking statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue
sources and concentration, selling, general and administrative expenses, research and development expenses, capital resources,
additional financings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed
elsewhere in this Form 10-Q, and in the “Risk Factors” section filed with the SEC on April 2, 2018, that could cause
actual results to differ materially from those projected. Unless otherwise expressly indicated, the information set forth in this
Form 10-Q is as of March 31, 2018, and we undertake no duty to update this information.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) develops and commercializes
energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil 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 commercial 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 2019.
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 crude oil condensate 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 appeared 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 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, demonstrating 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. Results of this test were promising, however due to
the short duration of the test and limited data collection, definitive conclusions regarding the AOT performance and its impact
on pipeline operations could not be reached. Based on final analysis of in-field test results, SCADA operating data and subsequent
analysis of crude oil condensate samples at Temple University, it is unlikely Kinder Morgan would use the AOT at the original test
location or other condensate pipeline. Kinder Morgan has expressed interest in AOT operations at one of their heavy crude pipeline
locations subject to results of other AOT demonstration projects and has provided the Company with additional crude oil samples
which have been tested at Temple University for future test correlation and operational planning purposes. 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 an onsite testing program to demonstrate AOT viscosity reduction at prospective customer sites. This
program utilized a 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 oil producer has since requested access to observe a full-scale demonstration facility and view operating data
when they become available.
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 1, 2019.
Throughout 2018 our
primary strategic goal has been focused on installing and operating a demonstration AOT project on a commercial crude oil pipeline.
Much of our time was spent meeting with industry executives and engineers in North and South America and working with local representatives
in the Asian and the Middle Eastern markets. In December 2018, we reached mutual agreement with a major U.S.-based pipeline operator
on a demonstration project and are now prepared to deliver and install our AOT equipment on a crude oil pipeline located in the
Southern United States in 2019. We believe the selected project site should be ideal for demonstration purposes, delivering heavy
crudes which, based on samples tested at Temple University, should experience significant viscosity reduction when treated with
our AOT technology.
While management focused
on finding a partner and finalizing terms of the demonstration project, our engineering team worked throughout 2018 to improve
our AOT design and prepare one of our inventoried AOT units for deployment. All system upgrade, inspections and testing protocols
were completed in December 2018, and the AOT unit is now ready for delivery to the demonstration site. The pipeline operator finalized
site selection and began site design and engineering in January 2019. We shipped the AOT equipment to the demonstration site in
April 2019. Based on the most recent project update provided by the pipeline operator, we anticipate installation to be completed
in late May 2019 and anticipate demonstration operations to begin early June 2019.
Plans moving forward
are centered on achieving commercial adoption of our AOT device leading to sales and revenue in 2019. Over the past year, we have
met with many industry executives who expressed interest in AOT subject to seeing and evaluating commercial operations and data.
Assuming successful operations, the demonstration AOT project should provide data requested such as real-time changes in viscosity,
pipeline pressure drop reduction and increases in pipeline operating flowrates. All collected data will be normalized such that
it can be used to evaluate the financial and operational benefits across a wide range of commercial operating scenarios without
disclosing confidential details of our demonstration partner’s operations. We believe that real-world data from our proposed
pilot AOT project may be used to accelerate our desire to achieve commercial adoption of our AOT technology, positioning us to
re-engage with industry executives, targeting sales in late 2019.
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 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 could be designed to demonstrate
AOT for upstream and trucking applications. We continued work with an existing client in Asia on a potential AOT demonstration
project; however, progress on this project 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 with operations in Russia and other regions in the former Soviet Union
with expressed interest in receiving a proposal to install AOTs on a new 2,000 km pipeline. Ongoing communications are continuing
with energy companies in Europe and the Middle East. Our ability to do business in some of these and other potential target markets,
specifically including Russia, China and Venezuela are now, or may in be future become, restricted or impacted by sanctions, tariffs
and other government actions imposed by the United States or foreign governments.
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 2019, 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 Operations for Three months
ended March 31, 2019 and 2018
|
|
Three months ended
|
|
|
|
March 31
|
|
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
478,000
|
|
|
|
494,000
|
|
|
|
(16,000
|
)
|
Research and development expenses
|
|
|
151,000
|
|
|
|
47,000
|
|
|
|
104,000
|
|
Loss before other income (expense)
|
|
|
(629,000
|
)
|
|
|
(541,000
|
)
|
|
|
(88,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(1,653,000
|
)
|
|
|
(159,000
|
)
|
|
|
(1,494,000
|
)
|
Net Loss
|
|
$
|
(2,282,000
|
)
|
|
$
|
(700,000
|
)
|
|
$
|
(1,582,000
|
)
|
Operating expenses
were $478,000 for the three-month period ended March 31, 2019, compared to $494,000 for the three-month period ended March 31,
2018, a decrease of $16,000. This is due to decreases in non-cash expenses of $64,000, and an increase in cash expenses of $48,000.
Specifically, the decrease in non-cash expenses are attributable to decreases in depreciation of $1,000, common stock and warrants
issued as compensation for services of $12,000, and stock compensation expense attributable to options granted to employees and
directors of $44,000. The increase in cash expense is attributable increases in corporate expenses of $1,000, freight and mail
of $4,000, insurance of $10,000, office expenses of $14,000, public and investor relations of $21,000, salaries and benefits of
$2,000, travel expenses of $2,000, and other expenses of $4,000, offset by a decrease in legal and accounting of $10,000.
Research and development
expenses were $151,000 for the three-month period ended March 31, 2019, compared to $47,000 for the three-month period ended March
31, 2018, an increase of $104,000. This increase is attributable an increase in prototype product development costs of $104,000.
Other income and expense
were $1,653,000 expense for the three-month period ended March 31, 2019, compared to $159,000 expense for the three-month period
ended March 31, 2018, a net increase in other expenses of $1,494,000. This increase is attributable to an increase in non-cash
other expenses of $1,494,000. The increase in non-cash other expense is due to increases in expense attributable to interest, beneficial
conversion factors and warrants associated with convertible notes issued in the amount of $1,489,000, and other non-cash interest
of $5,000.
The Company had a net
loss of $2,282,000, or $0.01 per share, for the three-month period ended March 31, 2019, compared to a net loss of $700,000, or
$0.00 per share, for the three-month period ended March 31, 2018.
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 $989,000 as of March 31, 2019. Our negative operating cash flow for the periods ended March 31, 2019 was funded primarily
through issuance of convertible notes and execution of options and warrants to purchase common stock.
The accompanying condensed
consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and
the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed consolidated
financial statements, the Company had a net loss of $2,282,000 and a negative cash flow from operations of $1,069,000 for the three-month
period ended March 31, 2019. 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, 2018 financial statements, has
raised substantial doubt about the Company’s ability to continue as a going concern. Our ability to continue as a going concern
is dependent upon our ability to raise additional funds and implement our business plan. The consolidated financial statements
do not include any adjustments that might be necessary if we are unable to continue as a going concern.
Summary
During the period ended
March 31, 2019, we received cash totaling $668,000 from issuance of our convertible notes payable and exercise of options and warrants
to purchase common stock and used cash in operations of $1,069,000. At March 31, 2019, we had cash on hand in the amount of $924,000.
We will need additional funds to operate our business, including without limitation the expenses we will incur in connection with
the license agreements with Temple University; costs associated with product development and commercialization of the AOT and related
technologies; costs to manufacture and ship our products; costs to design and implement an effective system of internal controls
and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic reports with the
SEC and costs required to protect our intellectual property. In addition, as discussed above, we have substantial contractual commitments,
including without limitation salaries to our executive officers pursuant to employment agreements, certain severance payments to
a former officer and consulting fees, during the remainder of 2019 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Licensing Fees to Temple
University
For details of the
licensing agreements with Temple University, see Financial Statements attached hereto, Note 6 (Research and Development).
Critical Accounting Policies and Estimates
Our discussion and
analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going
basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical
experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates.
The methods, estimates
and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report
in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies
that are both most important to the portrayal of a company’s financial condition and results of operations and those that
require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about
matters that are inherently uncertain at the time of estimation. For a more detailed discussion of the accounting policies of the
Company, see Note 1 of the Notes to the Condensed Consolidated Financial Statements, “Summary of Significant Accounting Policies”.
We believe the following
critical accounting policies, among others, require significant judgments and estimates used in the preparation of our consolidated
financial statements.
Estimates
The preparation of
consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note
1 to Notes to the Condensed Consolidated Financial Statements. Actual results could differ from those estimates.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation
expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The
assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.
Going Concern
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
during the three-months ended March 31, 2019, the Company incurred a net loss of $2,282,000, used cash in operations of $1,069,000
and had a stockholders’ deficit of $989,000 as of that date. These factors raise substantial doubt about the Company’s
ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s
ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that
might be necessary if the Company is unable to continue as a going concern.
At March 31, 2019,
the Company had cash on hand in the amount of $924,000. Management estimates that the current funds on hand will be sufficient
to continue operations through September 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 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 2019 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.