Item 1. Unaudited
Condensed Consolidated Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheets
|
|
June 30, 2020
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2019
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
116,000
|
|
|
$
|
479,000
|
|
Prepaid expenses and other current assets
|
|
|
148,000
|
|
|
|
96,000
|
|
Total current assets
|
|
|
264,000
|
|
|
|
575,000
|
|
Property and equipment, net of accumulated depreciation of $84,000 and $80,000 at June 30, 2020 and December 31, 2019, respectively
|
|
|
20,000
|
|
|
|
23,000
|
|
Other assets
|
|
|
2,000
|
|
|
|
2,000
|
|
Total assets
|
|
$
|
286,000
|
|
|
$
|
600,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
1,373,000
|
|
|
$
|
1,255,000
|
|
Accounts payable and accrued expenses
|
|
|
685,000
|
|
|
|
557,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
6,000
|
|
|
|
7,000
|
|
Convertible debentures, net of discounts of $68,000 and $153,000 at June 30, 2020 and December 31, 2019, respectively
|
|
|
1,086,000
|
|
|
|
1,050,000
|
|
Other notes payable
|
|
|
151,000
|
|
|
|
–
|
|
Total current liabilities
|
|
|
3,301,000
|
|
|
|
2,869,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 500,000,000 shares authorized, 319,421,243 and 310,111,536 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
|
|
|
319,422
|
|
|
|
310,111
|
|
Additional paid-in capital
|
|
|
117,061,578
|
|
|
|
116,209,889
|
|
Accumulated deficit
|
|
|
(120,396,000
|
)
|
|
|
(118,789,000
|
)
|
Total stockholders’ deficit
|
|
|
(3,015,000
|
)
|
|
|
(2,269,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
286,000
|
|
|
$
|
600,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Operations, Unaudited
|
|
Three months ended
|
|
|
Six months ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
413,000
|
|
|
|
655,000
|
|
|
|
945,000
|
|
|
|
1,133,000
|
|
Research and development expenses
|
|
|
157,000
|
|
|
|
432,000
|
|
|
|
227,000
|
|
|
|
583,000
|
|
Loss before other expense
|
|
|
(570,000
|
)
|
|
|
(1,087,000
|
)
|
|
|
(1,172,000
|
)
|
|
|
(1,716,000
|
)
|
Other expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(271,000
|
)
|
|
|
(371,000
|
)
|
|
|
(435,000
|
)
|
|
|
(2,024,000
|
)
|
Net Loss
|
|
$
|
(841,000
|
)
|
|
$
|
(1,458,000
|
)
|
|
$
|
(1,607,000
|
)
|
|
$
|
(3,740,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share, basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding, basic and diluted
|
|
|
314,950,397
|
|
|
|
293,284,367
|
|
|
|
313,007,039
|
|
|
|
279,658,273
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the SIX months Ended June 30, 2020 and June 30, 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
|
|
|
3,677,190
|
|
|
|
3,677
|
|
|
|
269,323
|
|
|
|
–
|
|
|
|
273,000
|
|
Common stock issued on conversion of notes payable
|
|
|
38,406,486
|
|
|
|
38,406
|
|
|
|
2,006,594
|
|
|
|
–
|
|
|
|
2,045,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
1,118,000
|
|
|
|
–
|
|
|
|
1,118,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
194,000
|
|
|
|
–
|
|
|
|
194,000
|
|
Common stock issued for services
|
|
|
250,000
|
|
|
|
250
|
|
|
|
67,750
|
|
|
|
–
|
|
|
|
68,000
|
|
Net loss
|
|
|
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(3,740,000
|
)
|
|
|
(3,740,000
|
)
|
Balance, June 30, 2019
|
|
|
298,457,191
|
|
|
$
|
298,456
|
|
|
$
|
115,085,544
|
|
|
$
|
(116,908,000
|
)
|
|
$
|
(1,524,000
|
)
|
|
|
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
|
|
|
8,094,707
|
|
|
|
8,096
|
|
|
|
366,904
|
|
|
|
–
|
|
|
|
375,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
212,000
|
|
|
|
–
|
|
|
|
212,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
213,000
|
|
|
|
–
|
|
|
|
213,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
|
(1,607,000
|
)
|
|
|
(1,607,000
|
)
|
Balance, June 30, 2020
|
|
|
319,421,243
|
|
|
$
|
319,422
|
|
|
$
|
117,061,578
|
|
|
$
|
(120,396,000
|
)
|
|
$
|
(3,015,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the THREE months Ended June 30, 2020 and June 30, 2019
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, April 1, 2019
|
|
|
294,805,488
|
|
|
$
|
294,805
|
|
|
$
|
114,166,195
|
|
|
$
|
(115,450,000
|
)
|
|
$
|
(989,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
1,715,037
|
|
|
|
1,715
|
|
|
|
99,285
|
|
|
|
–
|
|
|
|
101,000
|
|
Common stock issued on conversion of notes payable
|
|
|
1,686,666
|
|
|
|
1,686
|
|
|
|
207,314
|
|
|
|
–
|
|
|
|
209,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
450,000
|
|
|
|
–
|
|
|
|
450,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
95,000
|
|
|
|
–
|
|
|
|
95,000
|
|
Common stock issued for services
|
|
|
250,000
|
|
|
|
250
|
|
|
|
67,750
|
|
|
|
–
|
|
|
|
68,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
|
(1,458,000
|
)
|
|
|
(1,458,000
|
)
|
Balance, June 30, 2019
|
|
|
298,457,191
|
|
|
$
|
298,456
|
|
|
$
|
115,085,544
|
|
|
$
|
(116,908,000
|
)
|
|
$
|
(1,524,000
|
)
|
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, April 1, 2020
|
|
|
314,972,209
|
|
|
$
|
314,972
|
|
|
$
|
116,641,028
|
|
|
$
|
(119,555,000
|
)
|
|
$
|
(2,599,000
|
)
|
Common stock issued on exercise of warrants and options
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Common stock issued on conversion of notes payable
|
|
|
4,449,034
|
|
|
|
4,450
|
|
|
|
151,550
|
|
|
|
–
|
|
|
|
156,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
177,000
|
|
|
|
–
|
|
|
|
177,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
92,000
|
|
|
|
–
|
|
|
|
92,000
|
|
Common stock issued for services
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(841,000
|
)
|
|
|
(841,000
|
)
|
Balance, June 30, 2020
|
|
|
319,421,243
|
|
|
$
|
319,422
|
|
|
$
|
117,061,578
|
|
|
$
|
(120,396,000
|
)
|
|
$
|
(3,015,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Six months ended
|
|
|
|
June 30
|
|
|
|
2020
|
|
|
2019
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,607,000
|
)
|
|
$
|
(3,740,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
213,000
|
|
|
|
194,000
|
|
Issuance of common stock for services
|
|
|
–
|
|
|
|
68,000
|
|
Amortization of debt discount
|
|
|
318,000
|
|
|
|
1,961,000
|
|
Accrued interest expense
|
|
|
93,000
|
|
|
|
30,000
|
|
Depreciation and amortization
|
|
|
3,000
|
|
|
|
3,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other assets
|
|
|
(52,000
|
)
|
|
|
(205,000
|
)
|
Accounts payable and accrued expenses
|
|
|
128,000
|
|
|
|
(153,000
|
)
|
Accounts payable – license agreements
|
|
|
118,000
|
|
|
|
64,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
(1,000
|
)
|
|
|
(55,000
|
)
|
Deposits and other current liabilities
|
|
|
–
|
|
|
|
–
|
|
Net cash used in operating activities
|
|
|
(787,000
|
)
|
|
|
(1,833,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
212,000
|
|
|
|
1,118,000
|
|
Net proceeds from exercise of warrants
|
|
|
61,000
|
|
|
|
273,000
|
|
Net proceeds from other notes
|
|
|
151,000
|
|
|
|
–
|
|
Net cash provided by financing activities
|
|
|
424,000
|
|
|
|
1,391,000
|
|
Net decrease in cash
|
|
|
(363,000
|
)
|
|
|
(442,000
|
)
|
Cash, beginning of period
|
|
|
479,000
|
|
|
|
1,153,000
|
|
Cash, end of period
|
|
$
|
116,000
|
|
|
$
|
711,000
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
–
|
|
|
$
|
–
|
|
Income Taxes
|
|
$
|
–
|
|
|
$
|
1,600
|
|
Non-cash investing and financing activities
|
|
|
|
|
|
|
|
|
Conversion of convertible debentures and accrued interest to common stock
|
|
$
|
375,000
|
|
|
$
|
2,045,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
$
|
212,000
|
|
|
$
|
1,118,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
SIX MONTHS ENDED JUNE 30, 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 is developing
and seeking to commercialize 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. We are seeking to transition
our AOT product 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, 2019 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 six-months
ended June 30, 2020, the Company incurred a net loss of $1,607,000, used cash in operations of $787,000 and had a stockholders’
deficit of $3,015,000 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 June 30, 2020, the
Company had cash on hand in the amount of $116,000. 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 June 30, 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.
|
|
June 30,
2020
|
|
|
June 30,
2019
|
|
Options
|
|
|
42,440,601
|
|
|
|
39,450,603
|
|
Warrants
|
|
|
8,004,395
|
|
|
|
25,713,204
|
|
Common stock issuable upon conversion of notes payable
|
|
|
12,249,090
|
|
|
|
12,784,543
|
|
Total
|
|
|
62,694,086
|
|
|
|
77,948,350
|
|
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.
For the six-month periods
ended June 30, 2020 and 2019 research and development costs were $227,000 and $583,000, respectively. For the three-month periods
ended June 30, 2020 and 2019 research and development costs were $157,000 and $432,000, respectively.
Patent Costs
Patent costs consist
of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule
Heat products, all patent costs are expensed as incurred. During the six-month periods ended June 30, 2020 and 2019, patent costs
were $13,000 and $9,000, respectively, which is 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 June 30, 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 six months ended June 30, 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 fees due to members of the Board of Directors. As of June 30, 2020 and December 31, 2019,
accrued expenses and accounts payable to related parties amounted to $6,000 and $7,000, respectively.
|
4.
|
Property and Equipment
|
At June 30, 2020 and
December 31, 2019, property and equipment consists of the following:
|
|
June 30,
2020
|
|
|
December 31,
2019
|
|
Office equipment
|
|
$
|
36,000
|
|
|
$
|
36,000
|
|
Furniture and fixtures
|
|
|
5,000
|
|
|
|
5,000
|
|
Testing Equipment
|
|
|
37,000
|
|
|
|
37,000
|
|
Leasehold Improvements
|
|
|
26,000
|
|
|
|
25,000
|
|
Subtotal
|
|
|
104,000
|
|
|
|
103,000
|
|
Less accumulated depreciation
|
|
|
(84,000
|
)
|
|
|
(80,000
|
)
|
Total
|
|
$
|
20,000
|
|
|
$
|
23,000
|
|
Depreciation expense
for the six-month periods ended June 30, 2020 and 2019 was $3,000 and $3,000, respectively. Depreciation expense for the three-month
periods ended June 30, 2020 and 2019 was $2,000 and $1,000, respectively.
|
|
June 30,
2020
(unaudited)
|
|
|
December 31,
2019
|
|
Balance due on convertible notes
|
|
$
|
893,000
|
|
|
$
|
1,019,000
|
|
Accrued interest
|
|
|
261,000
|
|
|
|
184,000
|
|
Subtotal
|
|
|
1,154,000
|
|
|
|
1,203,000
|
|
Convertible note discount
|
|
|
(68,000
|
)
|
|
|
(153,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
1,086,000
|
|
|
$
|
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 six-month
period ended June 30, 2020, the Company issued similar convertible promissory notes in the aggregate of $233,000 for cash of $212,000
or a discount of $21,000. 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 3,324,517 shares of the Company’s 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 $212,000 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 six-month period ended June 30, 2020 notes payable and accrued interest of $375,000
were converted into 8,094,707 shares of common stock.
As of June 30, 2020,
total outstanding notes payable amounted to $893,000, accrued interest of $261,000 and unamortized note discount of $68,000 for
a net balance of $1,086,000. A total of twenty-one notes in the aggregate of $1,070,000 including accrued interest 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, prototype equipment fabrication and installation, purchase of test equipment,
pipeline pumping equipment, crude oil tank batteries, viscometers, SCADA systems, computer equipment, payroll and other related
equipment and various logistical expenses for the purposes of evaluating and testing the Company’s AOT prototypes.
Costs incurred for
research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed.
Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial
uses are also expensed.
For the six-month periods
ended June 30, 2020 and 2019, our research and development expenses were $227,000 and $583,000 respectively. For the three-month
periods ended June 30, 2020 and 2019, our research and development expenses were $157,000 and $432,000 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
June 30, 2020, the work order was increased by $85,000 and the Company paid an additional $85,000 deposit in advance of work to
be performed.
During the period ended
June 30, 2020, and the Company amortized $72,000 of amounts paid on deposit under the work order as a research and development
cost based on the progress of work performed as required by the contract, and reflected the $30,000 remaining amount on deposit
as Prepaid expenses and other current assets in the accompanying consolidated balance sheet as of June 30, 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 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
pursuant to these two License Agreements amounted to $94,000 during each six-month periods ended June 30, 2020 and 2019. Total
expenses recognized during each three-month periods ended June 30, 2020 and 2019 pursuant to these two License Agreements amounted
to $47,000 and $47,000, respectively. Total expenses have been reflected in Research and Development expenses on the accompanying
consolidated statements of operations. In the six-month periods ended June 30, 2020 and 2019, the Company also recognized penalty
interest on past-due balances of $24,000 and $33,000, respectively, which is included as part of interest and financing expense
in the accompanying statements of operations.
As of June 30, 2020
and December 31, 2019, total unpaid fees due to Temple pursuant to these agreements are $1,373,000 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 $1,238,000 is 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 June 30, 2020 and June 30,2019.
During the six months
ended June 30, 2020, the Company issued 9,309,707 shares of its common stock as follows:
|
·
|
The Company issued 8,094,707 shares of its common stock upon the conversion of $375,000 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 an exercise price 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 an exercise price 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 June 30, 2020 was 4.6 years. Stock option activity for the period January
1, 2020 up to June 30, 2020, was as follows:
|
|
Options
|
|
|
Weighted
Avg. Exercise
Price
|
|
January 1, 2020
|
|
|
39,750,603
|
|
|
$
|
0.20
|
|
Granted
|
|
|
2,999,998
|
|
|
|
0.14
|
|
Exercised
|
|
|
(60,000
|
)
|
|
|
0.05
|
|
Forfeited
|
|
|
(250,000
|
)
|
|
|
0.15
|
|
June 30, 2020
|
|
|
42,440,601
|
|
|
$
|
0.20
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of June 30, 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
|
|
|
|
20,905,551
|
|
|
|
7.4
|
|
|
$
|
0.10
|
|
|
|
19,722,219
|
|
|
$
|
0.10
|
|
$0.25 - $0.49
|
|
|
|
20,913,552
|
|
|
|
1.8
|
|
|
|
0.27
|
|
|
|
20,913,552
|
|
|
|
0.27
|
|
$0.50 - $0.99
|
|
|
|
471,052
|
|
|
|
3.8
|
|
|
|
0.85
|
|
|
|
471,052
|
|
|
|
0.85
|
|
$1.00 - $2.00
|
|
|
|
150,446
|
|
|
|
3.1
|
|
|
|
1.18
|
|
|
|
150,446
|
|
|
|
1.18
|
|
|
|
|
|
42,440,601
|
|
|
|
4.6
|
|
|
$
|
0.20
|
|
|
|
41,257,269
|
|
|
$
|
0.20
|
|
During the six-month
period ending June 30, 2020, and pursuant to the Company’s Board Compensation policy approved by the Board June 19, 2015,
the Company granted options to purchase 2,999,998 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 $0.02 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 $324,000
using the Black-Scholes Option Pricing model with the following assumptions: life of 5.5 years; risk free interest rate of 0.6%
to 1.7%; volatility of 128% to 138% and dividend yield of 0%.
During the six-month
periods ended June 30, 2020 and 2019, the Company recognized compensation costs based on the fair value of options that vested
of $202,000 and $183,000 respectively. During the three-month periods ended June 30, 2020 and 2019, the Company recognized compensation
costs based on the fair value of options that vested of $87,000 and $85,000 respectively.
At June 30, 2020, the
Company’s closing stock price was $0.05 per share. The aggregate intrinsic value of the options outstanding at June 30, 2020
was $2,000. Future unamortized compensation expense on the unvested outstanding options at June 30, 2020 is approximately $144,000
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 June 30, 2020.
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
January 1, 2020
|
|
|
13,065,084
|
|
|
$
|
0.11
|
|
Granted
|
|
|
3,524,515
|
|
|
|
0.04
|
|
Exercised
|
|
|
(1,155,000
|
)
|
|
|
0.05
|
|
Cancelled
|
|
|
(7,430,204
|
)
|
|
|
0.07
|
|
June 30, 2020
|
|
|
8,004,395
|
|
|
$
|
0.13
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of June 30, 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
|
|
|
|
5,934,395
|
|
|
|
0.9
|
|
|
$
|
0.06
|
|
|
|
5,901,062
|
|
|
$
|
0.06
|
|
$0.25 - $0.49
|
|
|
|
2,000,000
|
|
|
|
1.3
|
|
|
|
0.30
|
|
|
|
2,000,000
|
|
|
|
0.30
|
|
$0.50 - $1.00
|
|
|
|
70,000
|
|
|
|
3.8
|
|
|
|
0.80
|
|
|
|
70,000
|
|
|
|
0.80
|
|
|
|
|
|
8,004,395
|
|
|
|
1.0
|
|
|
$
|
0.13
|
|
|
|
7,971,062
|
|
|
$
|
0.13
|
|
In the six-month period
ending June 30, 2020, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 3,324,517 shares
of common stock with an exercise price of $.04 to $0.18 per share, vesting immediately upon grant and expiring one year from the
date of grant (see Note 5, above).
In the six-month period
ending June 30, 2020, the Company issued warrants to purchase 199,998 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 $11,000 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 six-month period ended June 30, 2020, the Company recognized compensation costs based on the fair value of warrants that vested
of $11,000.
At June 30, 2020, the
aggregate intrinsic value of the warrants outstanding was $51,000.
In June 2020, the Company
(“Borrower”) entered into an unsecured promissory note with Cadence Bank (“Lender”) in the amount of $151,000
(“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.
No interest has accrued
on this Note during the period ended June 30, 2020 as the Note closed and was funded at the end of June 2020. The balance due under
the Note of $151,000 is reflected in Other notes payable on the accompanying consolidated balance sheet.
Under the terms of
the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses. The Company intends to apply for
forgiveness of the PPP loan with respect to these qualifying expenses, however, we cannot assure that such forgiveness of any portion
of the PPP loan will occur. As for the potential loan forgiveness, once the PPP loan is, in part or wholly, forgiven and a legal
release is received, the liability would be reduced by the amount forgiven and a gain on extinguishment would be recorded. The
terms of the PPP loan provide for customary events of default including, among other things, payment defaults, breach of representations
and warranties, and insolvency events. The Company was in compliance with the terms of the PPP loan as of June 30, 2020.
|
10.
|
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. No assurances can be made that
COVID-19 will not materially affect operations or negatively impact our ability to fund continued operations.
AOT Demonstration
Project
As previously reported
in our Form 8-K filed with the SEC on July 13, 2020, our AOT equipment was removed from the demonstration site on July 8, 2020.
Due to a lack of capital available to the Company, our AOT testing activities have ceased and our AOT equipment is now in storage.
Subject to an infusion of capital into the company, we plan to assess the AOT equipment and seek to restart development and testing
activities. See item 2, below, under the Overview section thereunder for a discussion of the status of our AOT testing efforts
and the removal of our equipment from the demonstration site.
Issuance of Unregistered
Securities
In August 2020, the
Company issued 666,667 shares of restricted common stock for proceeds of $10,000 at a price of $0.015, along with other considerations.
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 June 30, 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 under development 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.
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. 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.
Reinstallation of the
modified equipment was completed in late June 2020. Commissioning and equipment testing resumed shortly thereafter.
As reported the Company’s
Form 8-K filed with the SEC on July 13, 2020, the system experienced a new failure mode during startup testing in which the system
could be operated at a baseline high voltage (well below operational voltage required to treat heavy crude), but after a period
of time, the system would drop to very low voltage indicating a reduction in electrical resistance in the AOT. This voltage drop
was both dynamic, developing over time as electrical current was applied; and transient, in that the power supply could be shut-down
and re-started with this voltage drop characteristic repeating. After reviewing these results and running subsequent in-field tests
at the direction of the power supply manufacturer, they recommended a configuration modification to the control module of the system’s
high-voltage power supply which, in their experience, could resolve the system’s ability to maintain constant voltage under
our unique operating conditions in which the AOT essentially acts as a very large capacitor. During the first week of July, we
modified the power supply control module at the direction of the power supply manufacturer. Though this modification did appear
to solve the voltage drop issue, the AOT could not achieve operational voltage as the system control module indicated arc-faults
when high voltage was applied above the baseline voltage levels. After many attempts to bring the system up to operating voltage,
arc-faults continued until the AOT demonstrated symptoms of what appeared to be a dead short (electrical short-to-ground; voltage
dropped to zero) and the system could no longer be re-started.
Our engineers have
working concepts as to what may be causing this most recent failure but will not be able to fully diagnose these issues at the
demonstration site. After discussions with our demonstration pipeline partner, it has been mutually agreed that the best course
of action would be to move the equipment from the demonstration site to another location where our engineers could disassemble
and inspect the equipment. Our demonstration partner has indicated their continued interest in our AOT technology and may consider
installation and operation of a new AOT demonstration project if our operational issues can be resolved.
In late July, our equipment
was removed from the demonstration site and was been relocated to a facility where we may have access to heavy equipment and other
resources necessary to disassemble and inspect the equipment.
Though our engineers
do have working concepts as to what may be causing the most recent voltage drop and arc-fault issues, it is unknown whether these
issues can be solved with minor modifications to the current design. To fully diagnose and resolve these issues, new testing would
likely need to be performed in a laboratory setting. The time and cost of implementing such a plan would likely be significant.
The Company does not currently have sufficient capital to take on this endeavor.
QS Energy operations
have been minimally impacted by COVID-19; however, 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 operations 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 continued
testing and development of our AOT technology, 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.
I. Six months ended June 30, 2020 and 2019
Results of Operations for six months
ended June 30, 2020 and 2019
|
|
Six months ended
|
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
945,000
|
|
|
|
1,133,000
|
|
|
|
(188,000
|
)
|
Research and development expenses
|
|
|
227,000
|
|
|
|
583,000
|
|
|
|
(356,000
|
)
|
Loss before other income (expense)
|
|
|
(1,172,000
|
)
|
|
|
(1,716,000
|
)
|
|
|
(544,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(435,000
|
)
|
|
|
(2,024,000
|
)
|
|
|
(1,589,000
|
)
|
Net Loss
|
|
$
|
(1,607,000
|
)
|
|
$
|
(3,740,000
|
)
|
|
$
|
(2,133,000
|
)
|
Operating expenses
were $945,000 for the six-month period ended June 30, 2020, compared to $1,133,000 for the six-month period ended June 30, 2019,
a decrease of $188,000. This is due to decreases in non-cash expenses of $48,000 and in cash expenses of $140,000. Specifically,
the decrease in non-cash expenses is attributable to an increase stock compensation expense attributable to options granted to
employees and directors of $19,000, offset by a decrease in common stock and warrants issued as compensation for services of $67,000.
The decrease in cash expense is attributable increases in consulting fees of $49,000, insurance of $27,000, legal and accounting
of $8,000, and rent and utilities of $10,000, offset by a decrease in mail and freight of $9,000, office expenses of $40,000, public
and investor relations of $39,000, salaries and benefits of $101,000, travel expenses of $29,000, property taxes of $9,000, and
other expenses of $7,000.
Research and development
expenses were $227,000 for the six-month period ended June 30, 2020, compared to $583,000 for the six-month period ended June 30,
2019, a decrease of $356,000. This decrease is attributable a decrease in prototype product development costs of $356,000.
Other income and expense
were $435,000 expense for the six-month period ended June 30, 2020, compared to $2,024,000 expense for the six-month period ended
June 30, 2019, a net decrease in other expenses of $1,589,000. This decrease is attributable to a decrease in non-cash other expenses
of $1,589,000. The decrease in non-cash other expense is due to decreases in expense attributable to interest, beneficial conversion
factors and warrants associated with convertible notes issued in the amount of $1,580,000, and other non-cash interest of $9,000.
The Company had a net
loss of $1,607,000 or $0.01 per share, for the six-month period ended June 30, 2020, compared to a net loss of $3,740,000, or $0.01
per share, for the six-month period ended June 30, 2019.
II. Three months ended June 30, 2020 and 2019
|
|
Three months ended
|
|
|
|
June 30
|
|
|
|
2020
|
|
|
2019
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
413,000
|
|
|
|
655,000
|
|
|
|
(242,000
|
)
|
Research and development expenses
|
|
|
157,000
|
|
|
|
432,000
|
|
|
|
(275,000
|
)
|
Loss before other income (expense)
|
|
|
(570,000
|
)
|
|
|
(1,087,000
|
)
|
|
|
(517,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(271,000
|
)
|
|
|
(371,000
|
)
|
|
|
(100,000
|
)
|
Net Loss
|
|
$
|
(841,000
|
)
|
|
$
|
(1,458,000
|
)
|
|
$
|
(617,000
|
)
|
The Company had no
revenues in the three month-periods ended June 30, 2020 and 2019.
Operating expenses
were $413,000 for the three-month period ended June 30, 2020, compared to $655,000 for the three-month period ended June 30, 2020,
a decrease of $242,000. This is due to decreases in non-cash expenses of $71,000 and cash expenses of $170,000. Specifically, the
decrease in non-cash expenses is attributable to an increase in in stock compensation expenses attributable to the fair value of
options granted to directors and employees of $3,000, offset by a decrease in common stock and warrants issued as compensation
for services of $74,000. The decrease in cash expense is attributable increases in consulting fees of $8,000 and insurance of $17,000,
offset by a decrease in mail and freight of $3,000, office expenses of $30,000, legal and accounting of $17,000, public and investor
relations of $48,000, rent and utilities of $1,000, salaries and benefits of $41,000, travel of $40,000, property tax of $9,000,
and other expenses of $7,000.
Research and development
expenses were $157,000 for the three-month period ended June 30, 2020, compared to $432,000 for the three-month period ended June
30, 2019, a decrease of $275,000. This decrease is attributable to decreases in prototype product development costs of $275,000.
Other income and expense
were $271,000 expense for the three-month period ended June 30, 2020, compared to $371,000 expense for the three-month period ended
June 30, 2019, a net decrease in other expenses of $100,000. This decrease is attributable to a decrease in non-cash other expenses
of $100,000. The decrease in non-cash other expense is due to a decrease in expense attributable to interest, beneficial conversion
factors and warrants associated with convertible notes issued in the amount of $100,000.
The Company had a net
loss of $841,000, or $0.00 per share, for the three-month period ended June 30, 2020, compared to a net loss of $1,458,000, or
$0.00 per share, for the three-month period ended June 30, 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 $3,015,000 as of June 30, 2020. Our negative operating cash flow for the periods ended June 30, 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 $1,607,000 and a negative cash flow from operations of $787,000 for the six-month
period ended June 30, 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
June 30, 2020, we received cash totaling $424,000 from issuance of our convertible notes payable, exercise of options and warrants
to purchase common stock, and CARES Act funding and used cash in operations of $787,000. At June 30, 2020, we had cash on hand
in the amount of $116,000. 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 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 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 revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note
1 to Notes to the Condensed Consolidated Financial Statements. Actual results could differ from those estimates.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation
expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The
assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.
Going Concern
The accompanying consolidated financial statements
have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and
commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six-months
ended June 30, 2020, the Company incurred a net loss of $1,607,000, used cash in operations of $787,000 and had a stockholders’
deficit of $3,015,000 as of that date. These factors raise substantial doubt about the Company’s ability to continue as
a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise
additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary
if the Company is unable to continue as a going concern.
At June 30, 2020, the
Company had cash on hand in the amount of $116,000. 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.