Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheets
|
|
March 31, 2020
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2019
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
274,000
|
|
|
$
|
479,000
|
|
Prepaid expenses and other current assets
|
|
|
55,000
|
|
|
|
96,000
|
|
Total current assets
|
|
|
329,000
|
|
|
|
575,000
|
|
Property and equipment, net of accumulated depreciation of $82,000 and $80,000 at March 31, 2020 and December 31, 2019, respectively
|
|
|
21,000
|
|
|
|
23,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
352,000
|
|
|
$
|
600,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
1,314,000
|
|
|
$
|
1,255,000
|
|
Accounts payable and accrued expenses
|
|
|
649,000
|
|
|
|
557,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
5,000
|
|
|
|
7,000
|
|
Convertible debentures, net of discounts of $86,000 and $153,000 at March 31, 2020 and December 31, 2019, respectively
|
|
|
983,000
|
|
|
|
1,050,000
|
|
Total current liabilities
|
|
|
2,951,000
|
|
|
|
2,869,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 314,972,209 and 310,111,536 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
|
|
|
314,972
|
|
|
|
310,111
|
|
Additional paid-in capital
|
|
|
116,641,028
|
|
|
|
116,209,889
|
|
Accumulated deficit
|
|
|
(119,555,000
|
)
|
|
|
(118,789,000
|
)
|
Total stockholders’ deficit
|
|
|
(2,599,000
|
)
|
|
|
(2,269,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
352,000
|
|
|
$
|
600,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Operations, Unaudited
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
532,000
|
|
|
|
478,000
|
|
Research and development expenses
|
|
|
70,000
|
|
|
|
151,000
|
|
Loss from operations
|
|
|
(602,000
|
)
|
|
|
(629,000
|
)
|
|
|
|
|
|
|
|
|
|
Other expense
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(164,000
|
)
|
|
|
(1,653,000
|
)
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
(766,000
|
)
|
|
$
|
(2,282,000
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
311,063,681
|
|
|
|
265,880,777
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the Three months Ended MARCH 31, 2020 and march 31, 2019
|
|
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, 2020
|
|
|
310,111,536
|
|
|
$
|
310,111
|
|
|
$
|
116,209,889
|
|
|
$
|
(118,789,000
|
)
|
|
$
|
(2,269,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
1,215,000
|
|
|
|
1,215
|
|
|
|
59,785
|
|
|
|
–
|
|
|
|
61,000
|
|
Fair value of common stock issued on conversion of notes payable
|
|
|
3,645,673
|
|
|
|
3,646
|
|
|
|
215,354
|
|
|
|
–
|
|
|
|
219,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
35,000
|
|
|
|
–
|
|
|
|
35,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
121,000
|
|
|
|
–
|
|
|
|
121,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(766,000
|
)
|
|
|
(766,000
|
)
|
Balance, March 31, 2020
|
|
|
314,972,209
|
|
|
$
|
314,972
|
|
|
$
|
116,641,028
|
|
|
$
|
(119,555,000
|
)
|
|
$
|
(2,599,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(766,000
|
)
|
|
$
|
(2,282,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
121,000
|
|
|
|
99,000
|
|
Amortization of debt discount and accrued interest
|
|
|
152,000
|
|
|
|
1,632,000
|
|
Depreciation and amortization
|
|
|
2,000
|
|
|
|
1,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
41,000
|
|
|
|
(457,000
|
)
|
Accounts payable and accrued expenses
|
|
|
92,000
|
|
|
|
(100,000
|
)
|
Accounts payable – license agreements
|
|
|
59,000
|
|
|
|
68,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
(2,000
|
)
|
|
|
(30,000
|
)
|
Net cash used in operating activities
|
|
|
(301,000
|
)
|
|
|
(1,069,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
35,000
|
|
|
|
668,000
|
|
Net proceeds from exercise of warrants and options
|
|
|
61,000
|
|
|
|
172,000
|
|
Net cash provided by financing activities
|
|
|
96,000
|
|
|
|
840,000
|
|
Net increase (decrease) in cash
|
|
|
(205,000
|
)
|
|
|
(229,000
|
)
|
Cash, beginning of period
|
|
|
479,000
|
|
|
|
1,153,000
|
|
Cash, end of period
|
|
$
|
274,000
|
|
|
$
|
924,000
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
219,000
|
|
|
$
|
1,836,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
35,000
|
|
|
|
668,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
THREE MONTHS ENDED MARCH 31, 2020 AND
2019
|
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 is seeking to transition
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, 2020 filed with the SEC. The condensed consolidated balance sheet as of December
31, 2019 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, 2020, the Company incurred a net loss of $766,000, used cash in operations of $301,000
and had a stockholders’ deficit of $2,599,000 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, 2019 financial statements, has raised
substantial doubt about the Company's ability to continue as a going concern.
At March 31, 2020,
the Company had cash on hand in the amount of $274,000. Management estimates that the current funds on hand will be sufficient
to continue operations through July 2020. 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 2020 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, 2020 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,
2020
|
|
|
March 31,
2019
|
|
Options
|
|
|
42,390,601
|
|
|
|
39,711,022
|
|
Warrants
|
|
|
6,749,883
|
|
|
|
26,102,430
|
|
Common stock issuable upon conversion of notes payable
|
|
|
3,645,673
|
|
|
|
11,058,950
|
|
Total
|
|
|
52,786,157
|
|
|
|
76,872,402
|
|
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.
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 twelve
months ended December 31, 2019, the Company amortized $483,000 of such amount as a research and development cost based on the progress
of work performed as required by the contract, and reflected the $17,000 remaining
amount as Prepaid expenses and other current assets in the accompanying consolidated balance sheet as of December 31, 2019. In
March 2020, the Company paid an additional $25,000 as a deposit under terms of a work order for additional work to be performed
by a pipeline operator. During the three-month periods ended March 31, 2020, the Company amortized $17,000
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 $25,000 remaining amount as Prepaid expenses and other current assets in the accompanying consolidated balance
sheet as of March 31, 2020.
For the three-month periods ended March
31, 2020 and 2019 research and development costs were $70,000 and $151,000, 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 product,
all patent costs are expensed as incurred. During the three-month periods ended March 31, 2020 and 2019, patent costs were $6,000
and $7,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations.
Recent Accounting Pronouncements
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, 2020
and December 31, 2019, the Company owed $197,000 and $207,000, 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. During the three months ended March 31, 2020 the Company made $10,000 in payments reducing the outstanding balance
to $197,000.
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, 2020, and December 31, 2019, accrued expenses and accounts payable to related parties amounted to $5,000 and $7,000, respectively.
|
4.
|
Property and Equipment
|
At March 31, 2020 and
December 31, 2019, property and equipment consists of the following:
|
|
March 31,
2020
(unaudited)
|
|
|
December 31,
2019
|
|
|
|
|
|
|
|
|
Office equipment
|
|
$
|
36,000
|
|
|
$
|
36,000
|
|
Furniture and fixtures
|
|
|
5,000
|
|
|
|
5,000
|
|
Testing Equipment
|
|
|
37,000
|
|
|
|
37,000
|
|
Leasehold Improvements
|
|
|
25,000
|
|
|
|
25,000
|
|
Subtotal
|
|
|
103,000
|
|
|
|
103,000
|
|
Less accumulated depreciation
|
|
|
(82,000
|
)
|
|
|
(80,000
|
)
|
Total
|
|
$
|
21,000
|
|
|
$
|
23,000
|
|
Depreciation expense
for the three-month periods ended March 31, 2020 and 2019 was $2,000 and $1,000, respectively.
|
|
March 31,
2020
(unaudited)
|
|
|
December 31,
2019
|
|
Balance due on convertible notes
|
|
$
|
854,000
|
|
|
$
|
1,019,000
|
|
Accrued interest
|
|
|
215,000
|
|
|
|
184,000
|
|
Subtotal
|
|
|
1,069,000
|
|
|
|
1,203,000
|
|
Convertible note discount
|
|
|
(86,000
|
)
|
|
|
(153,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
983,000
|
|
|
$
|
1,050,000
|
|
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,
2019, total outstanding notes payable amounted to $1,019,000 which are due through December 2019 and unamortized note discount
of $153,000.
During the three-month
periods ended March 31, 2020, the Company issued similar convertible promissory notes in the aggregate of $39,000 for cash of $35,000
or a discount of $4,000. 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 $0.035 per
share. In addition, the Company also granted these note holders warrants to purchase 550,000 shares of the Company’ common
stock. The warrants are fully vested, exercisable at $0.035 per share and will expire in one year. As a result, the Company recorded
a note discount of $35,000 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, 2020 notes payable of $219,000 were converted
into 3,645,673 shares of common stock.
As of March 31, 2020,
total outstanding notes payable amounted to $854,000, accrued interest of $215,000 and unamortized note discount of $86,000 for
a net balance of $983,000. A total of sixteen notes in the aggregate of $600,000 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, 2020 and 2019, our research and development expenses were $70,000 and $151,000, 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 year ended
December 31, 2019, the Company incurred costs related to a work order for work to be performed by a pipeline operator under which
the Company paid a $500,000 deposit in advance of work to be performed. During the period ended December 31, 2019, the Company
amortized $483,000 of such amount as a research and development cost based on the progress of work performed as required by the
contract, and reflected the $17,000 remaining amount on deposit as Prepaid expenses and other current assets in the accompanying
consolidated balance sheet as of December 31, 2019. During the period ended March 31, 2020, the Company amortized the remaining
$17,000 of such amount as a research and development cost based on the progress of work performed as required by the contract.
During the period ended
March 31, 2020, the work order was increased by $25,000 and the Company paid an additional $25,000 deposit in advance of work to
be performed, and has reflected the $25,000 remaining amount on deposit as Prepaid expenses and other current assets in the accompanying
consolidated balance sheet as of March 31, 2020.
Temple University Licensing
Agreements
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, 2020 and 2019 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, 2020 and 2019, the Company also recognized penalty interest on past-due balances of $12,000 and $21,000,
respectively, which is included as part of interest and financing expense in the accompanying statements of operations.
As of March 31, 2020
and December 31, 2019, total unpaid fees due to Temple pursuant to these agreements are $1,314,000 and $1,255,000, 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 $1,179,000 are deemed past due. The Company is currently
in discussions 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, 2020 and March 31,2019.
During the three months
ended March 31, 2020, the Company issued 4,860,673 shares of its common stock as follows:
|
·
|
The Company issued 3,645,673 shares of its common stock upon the conversion of $219,000 in convertible notes pursuant to the convertible notes conversion prices of $0.05 to $0.15 per share.
|
|
·
|
The Company issued 1,155,000 shares of its common stock upon the exercise of warrants for proceeds of $58,000 at exercise prices of $0.05 per share.
|
|
·
|
The Company issued 60,000 shares of its common stock upon the exercise of options for proceeds of $3,000 at exercise prices of $0.05 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, 2020 was 4.8 years. Stock option activity for the period
January 1, 2020 up to March 31, 2020, was as follows:
|
|
|
Options
|
|
|
Weighted
Avg. Exercise
Price
|
|
January 1, 2020
|
|
|
|
39,750,603
|
|
|
$
|
0.20
|
|
Granted
|
|
|
|
2,699,998
|
|
|
$
|
0.14
|
|
Exercised
|
|
|
|
(60,000
|
)
|
|
$
|
0.05
|
|
Forfeited
|
|
|
|
–
|
|
|
$
|
–
|
|
March 31, 2020
|
|
|
|
42,390,601
|
|
|
$
|
0.20
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2020 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
|
|
|
20,855,551
|
|
|
|
7.6
|
|
|
$
|
0.10
|
|
|
|
18,880,553
|
|
|
$
|
0.10
|
|
$0.25 - $0.49
|
|
|
20,913,552
|
|
|
|
2.0
|
|
|
|
0.27
|
|
|
|
20,913,552
|
|
|
|
0.27
|
|
$0.50 - $0.99
|
|
|
471,052
|
|
|
|
4.1
|
|
|
|
0.85
|
|
|
|
471,052
|
|
|
|
0.85
|
|
$1.00 - $2.00
|
|
|
150,446
|
|
|
|
3.3
|
|
|
|
1.18
|
|
|
|
150,446
|
|
|
|
1.18
|
|
|
|
|
42,390,601
|
|
|
|
4.8
|
|
|
|
0.20
|
|
|
|
40,415,603
|
|
|
|
0.20
|
|
During the three-month
period ending March 31, 2020, and pursuant to the Company’s Board Compensation policy approved by the Board June 19, 2015,
the Company granted options to purchase 2,699,998 shares of common stock to members of the Company’s Board of Directors and
an executive officer under terms of an employment agreement. The options are exercisable at $0.03 to $0.15 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 $338,000
using the Black-Scholes Option Pricing model with the following assumptions: life of 5.5 years; risk free interest rate of 1.6%
to 1.7%; volatility of 128% to 138% and dividend yield of 0%.
During the three-month
periods ended March 31, 2020 and 2019, the Company recognized compensation costs based on the fair value of options that vested
of $115,000 and $99,000 respectively.
During the three-month
periods ended March 31, 2020, a Board Member exercised an option to purchase 60,000 shares of common stock at an exercise price
of $0.05 per share for a total exercise price of $3,000.
At March 31, 2020,
the Company’s closing stock price was $0.07 per share. The aggregate intrinsic value of the options outstanding at March
31, 2020 was $133,000. Future unamortized compensation expense on the unvested outstanding options at March 31, 2020 is approximately
$245,000 to be recognized through December 2020.
Warrants
The following table
summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2020
up to March 31, 2020.
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
January 1, 2020
|
|
|
13,065,084
|
|
|
$
|
0.11
|
|
Granted
|
|
|
649,999
|
|
|
|
0.04
|
|
Exercised
|
|
|
(1,155,000
|
)
|
|
|
0.05
|
|
Cancelled
|
|
|
(5,810,200
|
)
|
|
|
0.05
|
|
March 31, 2020
|
|
|
6,749,883
|
|
|
$
|
0.17
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2020 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
|
|
|
4,679,883
|
|
|
|
0.7
|
|
|
$
|
0.10
|
|
|
|
4,646,550
|
|
|
$
|
0.11
|
|
$0.25 - $0.49
|
|
|
2,000,000
|
|
|
|
1.6
|
|
|
|
0.30
|
|
|
|
2,000,000
|
|
|
|
0.30
|
|
$0.50 - $1.00
|
|
|
70,000
|
|
|
|
4.1
|
|
|
|
0.80
|
|
|
|
70,000
|
|
|
|
0.80
|
|
|
|
|
6,749,883
|
|
|
|
1.0
|
|
|
|
0.17
|
|
|
|
6,716,550
|
|
|
|
0.17
|
|
In the three-month
period ending March 31, 2020, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 550,000 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).
In the three-month
period ending March 31, 2020, the Company issued warrants to purchase 99,999 shares of common stock in exchange for services. The
warrants are exercisable at a price of $0.04 to $0.14, vesting one month from the date of grant and expiring two years from the
date of grant. Total fair value of these options at grant date was $7,000 using the Black-Scholes Option Pricing model with the
following assumptions: life of 2 years; risk free interest rate of 0.4% to 1.5%; volatility of 163% to 173% and dividend yield
of 0%. During the three-month periods ended March 31, 2020, the Company recognized compensation costs based on the fair value of
warrants that vested of $7,000.
During the three-month
period ended March 31, 2020, warrants to acquire 1,155,000 shares of common stock were exercised resulting in net proceeds to the
Company of $58,000.
At March 31, 2020,
the aggregate intrinsic value of the warrants outstanding was $20,000.
|
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.
QS Energy is working
to maintain normal operations during the current COVID-19 pandemic under social distancing and shelter-in-place guidelines as recommended
or required by the CDC, federal, state and county government agencies. The Company has moved many operational functions to the
cloud. Our employees can perform most vital functions remotely. Most day-to-day operations have been minimally impacted by COVID-19.
It is unclear what impact COVID-19 may have on our supply chain, or on our ability to operate on-site at the demonstration project.
The Company has experienced delays and cost overruns due to COVID-19 impacts on our supply chain. We have not been made aware of
any COVID-19 restrictions at the demonstration site that would impact our ability to restart our demonstration testing. No assurances
can be made that COVID-19 will not materially affect our supply chain, will not negatively affect access to the demonstration site,
restrict operations at the demonstration site, or negatively impact our ability to fund continued operations.
Unregistered
Sales of Equity Securities
From March 1, 2020,
through June 23, 2020, the Company issued and sold to accredited US investors an aggregate of $230,000 Convertible Promissory Notes
(the “Notes”) and warrants to purchase an aggregate of 2,735,238 shares of common stock (the “Warrants”).
The Company received proceeds from the private placement of $209,000, which funds were used, and are being used, for general corporate
purposes and working capital.
The Notes are due twelve
(12) months from their respective issuance dates (the “Maturity Date”). The Notes do not bear interest and were issued
in the face amount equal to 110% of the purchasers’ commitments. The Notes are convertible into shares of the Company’s
common stock at a rate of $0.035 per share. If the Notes are not paid in full by the Maturity Date, the balance remaining on the
Maturity Date shall be increased by 10% and the Company shall be required to pay interest at a rate of 10% per annum thereon until
all sums thereunder are paid in full.
The Warrants are exercisable
into shares of the Company’s common stock for a term of one (1) year at an exercise price of $0.035 per share. The Warrants
also contain provisions that protect the holders against dilution by adjustment of the conversion price in certain events involving
a reduction or increase in the Company’s shares.
The offering was made
to U.S. “accredited investors,” as the term is defined in Regulation D under the Securities Act of 1933, as amended
(the “Securities Act”), and was made without general advertising or solicitation. The securities sold in the offering
were not registered under the Securities Act, or the securities laws of any state, and were offered and sold in reliance on exemptions
from registration including the exemption from registration afforded by Section 4(a)(2) of the Securities Act and Regulation S
promulgated under the Securities Act, and corresponding provisions of state securities law, which, respectively, exempt transactions
by an issuer not involving any public offering or transactions with non-U.S. Investors.
Of these aggregate
amounts, the Company received proceeds of $174,000 on the sale of $191,000 in Notes and Warrants to purchase 2,735,238 shares of
common stock were purchased subsequent to the March 31, 2020 reporting date of this Form 10-Q.
A copy of the offering
is attached hereto as Exhibit 10.2.
Conversion of
Convertible Notes
From April 1, 2020
up to June 26, 2020, Company issued 5,680,791 shares of common stock upon conversion of previously issued convertible notes in
aggregate value of $235,000
Exercise of Warrants
From April 1, 2020
up to June 26, 2020, the Company issued 1,045,000 shares of common stock upon the exercise of previously issued warrants for aggregate
cash proceeds of $52,000
Cares Act Funding
In June 2020, the Company
(“Borrower”) entered into an unsecured promissory note with Cadence Bank (“Lender”) in the amount of $151,200
(“Note”). The Note is payable in 53 monthly consecutive principal and interest payments of $2,584.57 each, beginning
January 2, 2021, with interest calculated on the unpaid principal balances using an interest rate of 1.000% per annum based on
a year of 360 days. This estimated final payment is based on the assumption that all payments will be made exactly as scheduled;
the actual final payment will be for all principal and accrued interest not yet paid, together with any other unpaid amounts under
this Note.
The Lender made this
loan pursuant to the Paycheck Protection Program (the "PPP") created by Section 1102 of the Coronavirus Aid, Relief,
and Economic Security Act (the "CARES Act") and governed by the CARES Act, section 7(a)(36) of the Small Business Act,
any rules or guidance that has been issued by the Small Business Administration implementing the PPP, or any other applicable Loan
Program Requirements, as defined in 13 CFR 120.10, as amended from time to time (collectively "PPP Loan Program Requirements").
Notwithstanding anything to the contrary herein, Borrower (a) agrees that this Promissory Note shall be interpreted and construed
to be consistent with the PPP Loan Program Requirements and (b) authorizes the Lender to unilaterally amend any provision to the
Promissory Note to the extent required to comply with the PPP Loan Program Requirements.
Borrower may apply
to Lender for forgiveness of the amount due under terms of the Note. A copy of the Note is attached as Exhibit 10.1.
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” 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, 2020, 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 seeks
to commercialize 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.
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 may 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 updates,
fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.
As previously reported
in our Form 10-K filed with the SEC on March 30, 2020, QS Energy’s AOT technology has been tested in a variety of configurations
at small-scale in the laboratory and at full-scale in the field under commercial operating conditions, including tests performed
U.S. Department of Energy, the PetroChina Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™. The Company’s
first two full-scale midstream pipeline installations were on TransCanada’s Keystone pipeline in 2014 and a pipeline operated
by Kinder Morgan Crude & Condensate, LLC in 2015. Tests performed at these two facilities were limited due primarily to technical
issues with the AOT equipment. Although tests at these facilities provided limited sets of data, the equipment did not operate
properly, and no conclusions could be reached regarding the efficacy or commercial viability of the AOT technology. Also, in 2014,
the Company began development of a product based on an electrical heat system which reduces oil viscosity through a process known
as joule heat (“Joule Heat”). In December 2015, we suspended Joule Heat development activities to focus Company resources
on finalizing commercial development of the AOT. For more information regarding prior history, development and testing of the AOT
technology, and specifics regarding these earlier tests and technical issues experience, please refer to our Form 10-K filed with
the SEC on March 30, 2020.
In July 2017, the Company
filed for trademark protection for the word “eDiluent” in advance of rolling out a 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”. Subject to successful testing of our AOT technology and the availability of sufficient operating capital,
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.
Throughout 2018 our
primary strategic goal was 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 under which we would install and operate our AOT equipment on a crude oil pipeline located in the Southern
United States. We believe the selected project site could be ideal for demonstration purposes, delivering heavy crudes which, based
on samples tested at Temple University, and, subject to the discussion below, could experience significant viscosity reduction
when treated with our AOT technology.
While management focused
on finding a partner and finalizing terms of the demonstration project, and in our continuing efforts to commercialize our AOT
technology, our engineering team worked throughout 2018 to prepare one of our inventoried AOT units for deployment. All system
upgrades, inspections and testing protocols were completed in December 2018. The pipeline operator finalized site selection and
began site design and engineering in January 2019, completing site preparation and equipment installation in June 2019. The project
was installed within budget, quality compliant, and without safety incidents. The system passed the pre-start safety review, data
acquisition signal verifications, and mechanical inspections. Under full crude oil flow, the system was confirmed to have no leaks
and no environmental issues were noted. Data collected during the full-flow startup phase confirmed internal differential pressures
to be negligible and consistent with design specifications. However, when the system was energized, and the unit was run-up to
high-voltage operations, the primary power supply began to operate erratically and had to be taken offline. Subsequent inspection
determined the primary power supply had failed.
After removing the
primary power supply, our engineers reconfigured the system to run off a smaller secondary power supply. Although this unit was
not capable of achieving target treatment voltage, we performed limited testing and troubleshooting measures, after which the damaged
power supply was shipped to the manufacturer for expedited repair and reconditioning. Inspections performed during the repair process
indicated internal power supply components had been physically damaged. Though not definitive, it appears that damage may have
occurred during transit prior to initial installation at the demonstration site. While the demonstration project was offline for
power supply repairs, our engineering team worked with oil samples pulled from the operating pipeline for testing at our Tomball
laboratory facility. These tests were designed to confirm our target power requirements as accurately as possible and help us fine-tune
enhancements planned for a new optimized AOT internal grid pack design we had planned to test at the demonstration site as part
of our continuing reliability engineering effort.
During initial testing
with the small power supply, current draw was greater than prior field deployments. While it was expected that the small power
supply would not achieve treatment voltage, as voltage was increased, actual current draw experienced under test conditions exceeded
the operating limit of the power supply. Subsequent laboratory and in-field testing performed at our Tomball facility showed the
electrical conductivity of the oil to be quite high and in line with field observations. Although these tests indicated the unit
was generally functioning properly, results further indicated the damaged power supply, once repaired, would not be capable of
providing sufficient power to fully treat the crude oil due to the oil’s high electrical conductivity. In anticipation of
this result, the Company had initiated parallel tasks in advance of testing of: i) installation of the repaired power supply and
performance of limited testing to confirm laboratory and in-field test results; and ii) procurement of a new power supply capable
of providing significantly more power and a modified AOT grid pack assembly reconfigured and generally optimized based on the latest
laboratory and in-field test results.
When the repaired power
supply was installed in August 2019, the system operated as expected, and limited testing was performed. Results of this limited
testing were consistent with laboratory tests performed to date. As expected, the repaired power supply was not capable of providing
sufficient power to fully treat the crude oil under commercial operating conditions. Based on results of this limited testing,
Company engineers completed designs and began implementation of modifications to the AOT internal grid pack assembly.
The new high capacity
power supply and modified grid pack were installed in December 2019. However, prior to flooding the system with crude oil, early-phase
startup testing indicated an electrical short circuit. Subsequent inspection revealed damage to the internal grid pack which likely
occurred during installation or during the startup testing cycle. The grid pack was shipped offsite for repairs with reinstallation
scheduled for January 2020.
The AOT demonstration
project continued to experience setbacks during the first quarter of 2020. After repairing and re-installing the modified grid
pack, the system shut down again during commissioning presenting with error conditions similar to the December 2019 failure. At
that time, based on external inspections and on-site testing, our engineers suspected the grid pack had again been damaged during
re-installation and that such suspected damage was the most likely cause of the electrical short circuit. It was determined at
that time the best course of action would be to remove the modified grid pack and re-install the original grid pack which had previously
been installed multiple times without sustaining damage, and perform a detailed inspection of the modified grid pack in an effort
to determine the cause of the electrical short circuit.
Executing this plan,
our team removed the modified grid pack and re-installed the original grid pack assembly in January 2020. After removal, our engineers
performed a detailed inspection of the modified grid pack. Inconsistent with expectations, no damage to the modified grid pack
was found during this inspection, leaving the cause of the electrical short circuit undiagnosed.
In January and February
2020, our engineers tested and attempted to operate the AOT under a variety of conditions. In these tests, the system could be
run at high voltage under static “shut-in” conditions; however, the system continued to shut down due to an electrical
short circuit when operated under pressure. In simple terms, this means the system could be flooded with crude oil and powered
up in excess of 10,000 volts when the system was shut-in by closing the intake and outtake valves which isolates the system from
the pipeline’s operating pressure. However, once the valves were opened and the system was subjected to the pipeline’s
operating pressure, the system developed an electrical short circuit and shut down.
As the presence of
high pressure appeared to trigger the short circuit, our engineers believe it is unlikely the fault was in the grid pack assembly
as this component was fully submerged in crude oil and would generally subjected to equal pressure on all components. The electrical
short was more likely developing in the electrical connection assembly built into the blind flange at the top of the pressure vessel,
which would be subjected to high pressure under normal operating conditions. Unfortunately, this electrical connection assembly
could not be inspected without destroying the assembly itself. Instead, our engineers developed a plan to rebuild the blind flange
and electrical connection assembly and modify the design to better isolate and insulate all electrical pathways, connections, and
components.
While the blind flange
assembly was being remanufactured, we took the opportunity to implement a number of relatively minor modifications to other system
configurations which had been planned for future units based on results of our engineering team’s reliability engineering
work over the past two years. These modifications were designed to improve the reliability of internal electrical connections,
increase the structural support of the internal grid pack, and maintain higher quality control over internal component positioning
and alignment during vertical installation.
As of March 31, 2020,
we were in the process of finalizing the timelines and budget for this plan based on vendor backlog for each of the tasks. Based
on progress to date, reinstallation and commissioning of the modified equipment should be completed in June 2020. Subject to successful
commissioning of the equipment, testing is scheduled to resume by the end of June 2020, or shortly thereafter.
For information regarding
developments at the AOT demonstration test site subsequent to the March 31, 2020 reporting date of this Form 10-Q, see Item 5,
below.
The Company’s
ability to continue operations at the demonstration site is dependent upon continued support of pipeline management and our ability
to fund continued operations. We can provide no assurances pipeline management will continue to support ongoing work at the demonstration
site, or that our plan to rebuild and test the electrical connection assembly will be successful. Because of our inability to fully
diagnose the cause of our current electrical problems, we can provide no assurances that we will not face other operational issues
after completing a full diagnosis and evaluation of our technology.
Assuming the corrective
actions discussed above are achieved, our plans moving forward are centered on achieving commercial adoption of our AOT device.
Assuming successful operations, we believe the demonstration AOT project should provide data requested by prospective customers
such as real-time changes in pipeline pressure drop reduction and increases in pipeline operating flowrates. All collected data
at the AOT demonstration site 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 demonstration 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 possible sales in late 2020 or 2021.
QS Energy is working
to maintain normal operations during the current COVID-19 pandemic under social distancing and shelter-in-place guidelines as recommended
or required by the CDC, federal, state and county government agencies. Over the past few years, the Company moved much of its operations
to the cloud. Our employees can perform most vital functions remotely. Currently, most day-to-day operations have been minimally
impacted by COVID-19.
It is unclear, however,
what impact COVID-19 may have on our supply chain, or on our ability to operate on-site at the demonstration project. As of the
date of this report, the Company has experienced delays and some cost overruns due to COVID-19 impacts on our supply chain. We
have not been made aware of any COVID-19 restrictions at the demonstration site that would impact our ability to restart our demonstration
testing.
COVID-19 has had a
significant negative financial impact across a wide spectrum of industries, both in terms of operations and access to operating
capital. The Company’s ability to continue operations is, in part, dependent on our access to funding. A published by the
National Association of Manufacturers in March 2020 reports that due to COVID-19, 35% of manufacturers surveyed anticipate supply
chain disruptions, 53% anticipate changes to operations, and 78% anticipate a negative financial impact. With these facts in mind,
no assurances can be made that COVID-19 will not materially affect our supply chain, will not negatively affect access to the demonstration
site, restrict operations at the demonstration site, or negatively impact our ability to fund continued operations.
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 2020, and beyond, to fund work at the
demonstration site, our sales and marketing efforts, continuing research and development, and certain other expenses, until we
are able to achieve a revenue base. We can provide no assurances that additional capital will be available to us, or if it is,
that such additional capital will be offered at acceptable terms.
There are significant
risks associated with our business, our Company and our stock. See Part II Item 1A, “Risk Factors,” below.
Results of Operations for Three months
ended March 31, 2020 and 2019
|
|
Three months ended
|
|
|
|
March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
532,000
|
|
|
|
478,000
|
|
|
|
54,000
|
|
Research and development expenses
|
|
|
70,000
|
|
|
|
151,000
|
|
|
|
(81,000
|
)
|
Loss before other income (expense)
|
|
|
(602,000
|
)
|
|
|
(629,000
|
)
|
|
|
27,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(164,000
|
)
|
|
|
(1,653,000
|
)
|
|
|
1,489,000
|
|
Net Loss
|
|
$
|
(766,000
|
)
|
|
$
|
(2,282,000
|
)
|
|
$
|
1,516,000
|
|
Operating expenses
were $532,000 for the three-month period ended March 31, 2020, compared to $478,000 for the three-month period ended March 31,
2019, an increase of $54,000. This is due to increases in non-cash expenses of $23,000, and an increase in cash expenses of $31,000.
Specifically, the decrease in non-cash expenses are attributable to increases in warrants issued as compensation for services of
$7,000, and stock compensation expense attributable to options granted to employees and directors of $16,000. The increase in cash
expense is attributable increases in consulting fees of $42,000, insurance of $10,000, legal and accounting of $25,000, public
and investor relations of $9,000, rent and utilities of $11,000, and travel expenses of $11,000, offset by decreases in mail and
freight of $6,000, office expenses of $10,000, salaries and benefits of $60,000, and other expenses of $1,000.
Research and development
expenses were $70,000 for the three-month period ended March 31, 2020, compared to $151,000 for the three-month period ended March
31, 2019, a decrease of $81,000. This decrease is attributable a decrease in prototype product development costs of $81,000.
Other income and expense
were $164,000 expense for the three-month period ended March 31, 2020, compared to $1,653,000 expense for the three-month period
ended March 31, 2019, a net decrease in other expenses of $1,489,000. This increase is attributable to an increase in non-cash
other expenses of $1,489,000. 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 $1,480,000, and other non-cash interest
of $9,000.
The Company had a net
loss of $766,000, or $0.00 per share, for the three-month period ended March 31, 2020, compared to a net loss of $2,282,000, or
$0.01 per share, for the three-month period ended March 31, 2019.
Liquidity and Capital Resources
General
As reflected in the
accompanying condensed consolidated financial statements, the Company has not yet generated significant revenues and has incurred
recurring net losses. We have incurred negative cash flow from operations since our inception in 1998 and a stockholders’
deficit of $2,599,000 as of March 31, 2020. Our negative operating cash flow for the periods ended March 31, 2020 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 $766,000 and a negative cash flow from operations of $301,000 for the three-month
period ended March 31, 2020. 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, 2020 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, 2020, we received cash totaling $96,000 from issuance of our convertible notes payable and exercise of options and warrants
to purchase common stock and used cash in operations of $301,000. At March 31, 2020, we had cash on hand in the amount of $274,000.
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 2020 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, Part I, Item 1, 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 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 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 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, 2020, the Company incurred a net loss of $766,000, used cash in operations of $301,000
and had a stockholders’ deficit of $2,599,000 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, 2020,
the Company had cash on hand in the amount of $274,000. Management estimates that the current funds on hand will be sufficient
to continue operations through July 2020. 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 2020 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.