Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheet
|
|
June 30,
|
|
|
|
|
|
|
2017
|
|
|
December 31,
|
|
|
|
(unaudited)
|
|
|
2016
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
880,000
|
|
|
$
|
136,000
|
|
Prepaid expenses and other current assets
|
|
|
40,000
|
|
|
|
26,000
|
|
Total current assets
|
|
|
920,000
|
|
|
|
162,000
|
|
Property and equipment, net of accumulated depreciation of $36,000 and $32,000 at June 30, 2017 and December 31, 2016, respectively
|
|
|
34,000
|
|
|
|
17,000
|
|
Other assets
|
|
|
1,000
|
|
|
|
7,000
|
|
Total assets
|
|
$
|
955,000
|
|
|
$
|
186,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable-license agreements
|
|
$
|
918,000
|
|
|
$
|
805,000
|
|
Accounts payable and accrued expenses
|
|
|
891,000
|
|
|
|
251,000
|
|
Accrued expenses and accounts payable-related parties
|
|
|
19,000
|
|
|
|
135,000
|
|
Deposit and other current liabilities
|
|
|
–
|
|
|
|
5,000
|
|
Convertible debentures, net of discounts of $327,000 and $92,000 at June 30, 2017 and December 31, 2016, respectively
|
|
|
503,000
|
|
|
|
348,000
|
|
Total current liabilities
|
|
|
2,331,000
|
|
|
|
1,544,000
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit
|
|
|
|
|
|
|
|
|
Common stock, $.001 par value: 300,000,000 shares
authorized, 224,508,406 and 199,045,026 shares issued and outstanding at June 30, 2017 and December 31, 2016,
respectively
|
|
|
224,508
|
|
|
|
199,045
|
|
Additional paid-in capital
|
|
|
107,003,492
|
|
|
|
103,716,955
|
|
Accumulated deficit
|
|
|
(108,604,000
|
)
|
|
|
(105,274,000
|
)
|
Total stockholders’ deficit
|
|
|
(1,376,000
|
)
|
|
|
(1,358,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
955,000
|
|
|
$
|
186,000
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Operations, Unaudited
|
|
Three months ended
|
|
|
Six months ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
50,000
|
|
|
$
|
–
|
|
Costs and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
580,000
|
|
|
|
626,000
|
|
|
|
1,838,000
|
|
|
|
1,261,000
|
|
Research and development expenses
|
|
|
56,000
|
|
|
|
73,000
|
|
|
|
120,000
|
|
|
|
148,000
|
|
Loss before other income (expense)
|
|
|
(636,000
|
)
|
|
|
(699,000
|
)
|
|
|
(1,908,000
|
)
|
|
|
(1,409,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(1,210,000
|
)
|
|
|
(439,000
|
)
|
|
|
(1,422,000
|
)
|
|
|
(933,000
|
)
|
Loss on disposition of equipment
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(3,000
|
)
|
Net Loss
|
|
|
(1,846,000
|
)
|
|
|
(1,138,000
|
)
|
|
|
(3,330,000
|
)
|
|
|
(2,345,000
|
)
|
Net loss per common share, basic and diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.01
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
|
207,419,243
|
|
|
|
192,010,704
|
|
|
|
203,362,641
|
|
|
|
188,616,394
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the SIX months Ended JUNE 30, 2017
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, January 1, 2017
|
|
|
199,045,026
|
|
|
$
|
199,045
|
|
|
$
|
103,716,955
|
|
|
$
|
(105,274,000
|
)
|
|
$
|
(1,358,000
|
)
|
Common stock issued on exercise of warrants
|
|
|
605,000
|
|
|
|
605
|
|
|
|
60,395
|
|
|
|
–
|
|
|
|
61,000
|
|
Common stock issued on conversion of notes payable
|
|
|
24,858,380
|
|
|
|
24,858
|
|
|
|
1,222,142
|
|
|
|
–
|
|
|
|
1,247,000
|
|
Fair value of warrants and beneficial conversion feature of issued convertible notes
|
|
|
–
|
|
|
|
–
|
|
|
|
1,469,000
|
|
|
|
–
|
|
|
|
1,469,000
|
|
Fair value of options and warrants issued as compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
535,000
|
|
|
|
–
|
|
|
|
535,000
|
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(3,330,000
|
)
|
|
|
(3,330,000
|
)
|
Balance, June 30, 2017
|
|
|
224,508,406
|
|
|
$
|
224,508
|
|
|
$
|
107,003,492
|
|
|
$
|
(108,604,000
|
)
|
|
$
|
(1,376,000
|
)
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
|
|
Six months ended
|
|
|
|
June 30
|
|
|
|
2017
|
|
|
2016
|
|
Cash flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,330,000
|
)
|
|
$
|
(2,345,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation expense
|
|
|
535,000
|
|
|
|
267,000
|
|
Issuance of common stock for services
|
|
|
–
|
|
|
|
33,000
|
|
Amortization of debt discount
|
|
|
1,381,000
|
|
|
|
922,000
|
|
Accrued interest expense
|
|
|
21,000
|
|
|
|
–
|
|
Loss on disposition of assets
|
|
|
–
|
|
|
|
3,000
|
|
Depreciation and amortization
|
|
|
4,000
|
|
|
|
4,000
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses and other assets
|
|
|
(8,000
|
)
|
|
|
3,000
|
|
Accounts payable and accrued expenses
|
|
|
640,000
|
|
|
|
49,000
|
|
Accounts payable – license agreements
|
|
|
113,000
|
|
|
|
94,000
|
|
Accounts payable and accrued expenses – related parties
|
|
|
(116,000
|
)
|
|
|
(32,000
|
)
|
Deposits and other current liabilities
|
|
|
(5,000
|
)
|
|
|
81,000
|
|
Net cash used in operating activities
|
|
|
(765,000
|
)
|
|
|
(921,000
|
)
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of equipment
|
|
|
(21,000
|
)
|
|
|
(5,000
|
)
|
Net cash used in investing activities
|
|
|
(21,000
|
)
|
|
|
(5,000
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of convertible notes and warrants
|
|
|
1,469,000
|
|
|
|
905,000
|
|
Net proceeds from exercise of warrants
|
|
|
61,000
|
|
|
|
–
|
|
Net cash provided by financing activities
|
|
|
1,530,000
|
|
|
|
905,000
|
|
Net increase (decrease) in cash
|
|
|
744,000
|
|
|
|
(21,000
|
)
|
Cash, beginning of period
|
|
|
136,000
|
|
|
|
349,000
|
|
Cash, end of period
|
|
$
|
880,000
|
|
|
$
|
328,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 to common stock
|
|
$
|
1,247,000
|
|
|
$
|
905,000
|
|
Fair value of warrants and beneficial conversion feature associated with issued convertible notes
|
|
|
1,469,000
|
|
|
|
905,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to condensed consolidated financial
statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
SIX MONTHS ENDED JUNE 30, 2017 AND 2016
|
1.
|
Description of Business
|
QS Energy, Inc. (“QS
Energy”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital
Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company
changed its name to QS Energy, Inc. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter
Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate
website, www.qsenergy.com.
QS Energy develops
and commercializes energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics
of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio
of domestic and international patents and patents pending, a substantial portion of which have been developed in conjunction with
and exclusively licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called
Applied Oil Technology™ (AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. Engineered specifically
to reduce pipeline pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and
drag reducing agents to meet pipeline maximum viscosity requirements, AOT is a 100% solid-state system that reduces crude oil viscosity
by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the
research and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption
by the midstream pipeline marketplace.
The Company also began
commercial development of a suite of products based around the Joule Heat technology. The Company began fabrication of prototype
equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter of 2014. The Company’s
first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational;
however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. In addition,
the Company filed two additional provisional patents related to the technology’s method and apparatus. In December 2015,
we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the
AOT Midstream. We currently plan to resume Joule Heat development in 2018 depending on the availability of sufficient capital and
other resources.
Basis of Presentation
The accompanying condensed
consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and
applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting.
Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been
condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements
should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual
Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the SEC. The condensed consolidated balance sheet as
of December 31, 2016 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, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and
had a stockholders’ deficit of $1,376,000 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, 2016 financial statements, has raised substantial doubt about the
Company's ability to continue as a going concern.
At June 30, 2017, the
Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue
operations through September 2017. Management is currently seeking additional funds, primarily through the issuance of debt and
equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with
the license and research and development agreements with Temple; costs associated with product development and commercialization
of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective
system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by, among
other things, filing periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed
below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers pursuant
to employment agreements, certain payments to a former officer, and consulting fees, during the remainder of 2017 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, 2017 and 2016, 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,
2017
|
|
|
June 30,
2016
|
|
Options
|
|
|
35,313,541
|
|
|
|
23,724,256
|
|
Warrants
|
|
|
21,507,270
|
|
|
|
9,342,892
|
|
Common stock issuable upon conversion of notes payable
|
|
|
9,968,933
|
|
|
|
2,401,667
|
|
Total
|
|
|
66,789,744
|
|
|
|
35,468,815
|
|
Estimates
The preparation of
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include
those related to assumptions used in valuing equity instruments issued for financing and for services, and reduction of deferred
tax assets. Actual results could differ from those estimates.
Revenue Recognition
Policy
The Company recognizes
lease revenue upon commencement of the lease. Revenue on future product sales will be recognized upon meeting the following criteria:
persuasive evidence of an arrangement exists; delivery has occurred or services rendered; the seller's price to the buyer is fixed
or determinable; and collectability is reasonably assured.
In the fourth quarter
2016, the Company entered a contract to provide onsite testing services to a Canadian oil producer and pipeline operator at a fixed
price of $50,000. The testing service was performed in January 2017 and was completed in March 2017.
Research and Development
Costs
Costs incurred for
research and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed.
Furthermore, costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial
uses are also expensed.
For the six-month periods
ended June 30, 2017 and 2016 research and development costs were $120,000 and $148,000, 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, 2017 and 2016, patent costs
were $24,000 and $30,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements
of operations. During the three-month periods ended June 30, 2017 and 2016, patent costs were $7,000 and $17,000, respectively,
and were included as part of operating expenses in the accompanying consolidated statements of operations.
Recent Accounting Pronouncements
In May 2014, the Financial
Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers.
ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance
under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition. ASU 2014-09 will require
that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also
will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer
contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill
a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted
only in annual reporting periods beginning after December 15, 2016, including interim periods therein. Entities will be able to
transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company
is in the process of evaluating the impact of ASU 2014-09 on the Company’s financial statements and disclosures. In February
2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of
use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02
is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified
retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after,
the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.
The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.
In February 2016, the
FASB issued Accounting Standards Update (ASU) No. 2016-02,
Leases
. ASU 2016-02 requires a lessee to record a right of use
asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is
effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified
retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after,
the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.
The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.
In July 2017, the FASB
issued Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II)
Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 allows companies
to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered
indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features
may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature
only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments,
an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders
in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions,
entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11
is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption
is permitted. The guidance in ASU 2017-11 is to be applied using a full or modified retrospective approach. The adoption of ASU
2017-11 is not currently expected to have any impact on the Company’s financial statement presentation or disclosures.
Other recent accounting
pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants,
and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company's
present or future consolidated financial statement presentation or disclosures.
|
3.
|
Accrued Expenses and Accounts Payable – Related Parties
|
Accrued expense –
related parties consists of accrued salaries of officers and fees due to members of the Board of Directors.
As of June 30, 2017
and December 31, 2016, accrued expenses and accounts payable to related parties amounted to $19,000 and $135,000, respectively.
|
4.
|
Property and Equipment
|
At June 30, 2017 and
December 31, 2016, property and equipment consists of the following:
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Office equipment
|
|
$
|
30,000
|
|
|
$
|
28,000
|
|
Furniture and fixtures
|
|
|
3,000
|
|
|
|
3,000
|
|
Testing Equipment
|
|
|
37,000
|
|
|
|
18,000
|
|
Subtotal
|
|
|
70,000
|
|
|
|
49,000
|
|
Less accumulated depreciation
|
|
|
(36,000
|
)
|
|
|
(32,000
|
)
|
Total
|
|
$
|
34,000
|
|
|
$
|
17,000
|
|
Depreciation expense
for the six-month periods ended June 30, 2017 and 2016 was $4,000 for each period. Depreciation expense for the three-month periods
ended June 30, 2017 and 2016 was $2,000 for each period.
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Convertible notes outstanding
|
|
$
|
787,000
|
|
|
$
|
417,000
|
|
Accrued interest
|
|
|
43,000
|
|
|
|
23,000
|
|
Subtotal
|
|
|
830,000
|
|
|
|
440,000
|
|
Unamortized note discounts
|
|
|
(327,000
|
)
|
|
|
(92,000
|
)
|
Balance on convertible notes, net of note discounts
|
|
$
|
503,000
|
|
|
$
|
348,000
|
|
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 price 10% less than its face value. The notes are unsecured, and usually mature twelve months
from issuance.
The notes are convertible at the option
of the note holder into the Company’s common stock at a conversion price stipulated in the conversion agreement. In addition,
the note holders received warrants to purchase shares of common stock that are fully vested and will expire in one year from the
date of issuance.
As a result, the Company records a note
discount to account for the relative fair value of the warrants, the notes’ beneficial conversion feature or BCF, and original
issue discount of 10% (OID). The note discounts are amortized over the term of the notes or amortized in full upon its conversion
to common stock. At December 31, 2016, total outstanding notes payable amounted to $417,000, accrued penalty interest of $23,000
and unamortized note discount of $92,000, or a net balance of $348,000.
During the six-month period ending June
30, 2017, the Company issued similar convertible promissory notes in the aggregate of $1,616,000 for cash of $1,469,000 or a discount
of $147,000. The notes do not bear any interest, however, the implied interest rate used was 10% since the notes were issued at
a price 10% less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.05 per
share. In addition, the Company also granted these note holders warrants to purchase 16,160,770 shares of the Company’ common
stock. The warrants are fully vested, exercisable at $0.05 per share and will expire in one year. As a result, the Company recorded
a note discount of $1,616,000 to account for the relative fair value of the warrants, the notes’ BCF, and OID. The note discounts
are being amortized over the term of the note or amortized in full upon the conversion to common stock.
During the period ended June 30, 2017,
a total of $1,247,000 notes payable was converted to 24,858,380 shares of common stock. In addition, the note discount of $1,381,000
was amortized to interest expense, and interest of $21,000 was accrued.
As of June 30, 2017, total outstanding
notes payable amounted to $787,000, accrued interest of $43,000 and unamortized note discount of $326,000 for a net balance of
$503,000. In addition, a total of five notes amounting to $295,000 reached maturity and are past due. The Company is currently
in negotiations with the noteholders to settle the matured notes payable.
|
6.
|
Research and Development
|
The Company constructs,
develops and tests the AOT and Joule Heat 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 and Joule Heat prototypes.
For the six-month periods
ended June 30, 2017 and 2016, our research and development expenses were $120,000 and $148,000 respectively. For the three-month
periods ended June 30, 2017 and 2016, our research and development expenses were $56,000 and $73,000, respectively.
AOT Product Development
and Testing
During the six-month
periods ended June 30, 2017 and 2016, the Company incurred total expenses of $26,000 and $54,000, respectively, in the manufacture,
delivery and testing of the AOT prototype equipment. During the three-month periods ended June 30, 2017 and 2016, the Company incurred
total expenses of $9,000 and $26,000, respectively. These expenses have been reflected as part of Research and Development expenses
on the accompanying consolidated statements of operations.
Temple University Licensing
Agreement
On August 1, 2011,
the Company and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License
Agreements”) relating to Temple’s patent applications, patents and technical information pertaining to technology associated
with an electric and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology
to reduce crude oil viscosity (the “Second Temple License”). The License Agreements are exclusive and the
territory licensed to the Company is worldwide and replace previously issued License Agreements.
Pursuant to the two
licensing agreements, the Company agreed to pay Temple the following: (i) non-refundable license maintenance fee of $300,000;
(ii) annual maintenance fees of $187,500; (iii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing
agreements; and (iv) 25% of all revenues generated from sub-licensees to secure or maintain the sub-license or option thereon.
Temple also agreed to defer $37,500 of the amount due if the Company agreed to fund at least $250,000 in research or development
of Temple’s patent rights licensed to the Company. The term of the licenses commenced in August 2011 and will expire upon
the expiration of the patents. The agreement can also be terminated by either party upon notification under terms of the licensing
agreements or if the Company ceases the development of the patent or failure to commercialize the patent rights.
Total expenses recognized
during each six-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $94,000. Total expenses
recognized during each three-month period ended June 30, 2017 and 2016 pursuant to these two agreements amounted to $47,000 These
expenses have been reflected in Research and Development expenses on the accompanying consolidated statements of operations.
As of June 30, 2017
and December 31, 2016, total unpaid fees due to Temple pursuant to these agreements amounted to $840,000 and $727,000, respectively,
which are included as part of Accounts Payable – licensing agreement in the accompanying consolidated balance sheets. As
of June 30, 2017, $222,000 of the $840,000 payable has been deferred until the licensing agreements are terminated and $581,000
is deemed past due.
The Company generated
$50,000 in revenue from the viscosity reduction license during the six-month period ended June 30, 2017. This amount is not sufficient
to be subject to additional license fees under the license agreement. No revenues were earned from the two license agreements during
the six-month period ended June 2016.
In July 2017, the Company
and Temple amended the license agreement related to the Company’s AOT viscosity reduction technology. Under this amendment,
Temple agreed to defer amounts currently due under the viscosity reduction license in the amount of $135,000, bringing the Company
current under the viscosity reduction technology license agreement. The Company is currently in negotiations with Temple to settle
amounts due under the second license agreement related to a fuel injector technology.
Temple University Sponsored
Research Agreement
On March 19,
2012, the Company entered into a Sponsored Research Agreement (“Research Agreement”) with Temple University
(“Temple”), whereby Temple, under the direction of Dr. Rongjia Tao, performed research related to the
Company’s AOT device (the “Project”), for the period April 1, 2012, through April 1, 2014. All rights and
title to intellectual property resulting from Temple’s work related to the Project were subjected to the Exclusive
License Agreements between Temple and the Company, dated August 1, 2011. In exchange for Temple’s
research efforts on the Project, the Company has agreed to pay Temple $500,000, payable in quarterly installments of $62,500.
The agreement expired in August 2015. As of June 30, 2017 and December 31, 2016, total unpaid fees due to Temple pursuant to
this agreement amounted to $78,000, which are included as part of Accounts Payable – licensing agreement in the
accompanying consolidated balance sheets. As of June 30, 2017, the entire $78,000 is deemed past due.
On July 14, 2017, the
Company and Temple reached agreement to settle these past due amounts under a payment plan, paying the amount before the end of
December 2017.
In addition, Temple
University continues to provide laboratory testing and support related to the Company’s commercialization efforts. This continuing
work is provided on at a fixed price, on an ad hoc basis depending upon the scope of work. During the six-month period ending June
30, 2017, the Company incurred a total of $3,000 in ad hoc testing with Temple University. No ad hoc testing was performed during
the three-month period ending June 30, 2017. Temple ad hoc testing expense is reported as part of Research and development expenses
in the accompanying consolidated statements of operations.
During the six months
ended June 30, 2017, the Company issued 24,858,380 shares of its common stock upon the conversion of $1,247,000 in convertible
notes at conversion rates ranging from $0.05 and $0.10 per share.
|
8.
|
Stock Options and Warrants
|
The Company periodically
issues stock options and warrants to directors, employees, and non-employees in capital raising transactions, for services and
for financing costs. Options vest and expire according to terms established at the grant date.
Options
Options vest according
to the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining contractual
life of employee and non-employee options outstanding at June 30, 2017 was 6.1 years. Stock option activity for the period January
1, 2017 up to June 30, 2017, was as follows:
|
|
|
Options
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
January 1, 2017
|
|
|
|
23,474,256
|
|
|
$
|
0.28
|
|
|
Granted
|
|
|
|
11,839,285
|
|
|
|
0.12
|
|
|
Exercised
|
|
|
|
–
|
|
|
|
–
|
|
|
Forfeited
|
|
|
|
–
|
|
|
|
–
|
|
|
June 30, 2017
|
|
|
|
35,313,541
|
|
|
$
|
0.23
|
|
The weighted average
exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of June 30, 2017 were as
follows:
|
|
|
|
|
Outstanding Options
|
|
|
|
Exercisable Options
|
|
|
Option
Exercise Price
Per Share
|
|
|
|
Shares
|
|
|
|
Life
(Years)
|
|
|
|
Weighted
Average Exercise
Price
|
|
|
|
Shares
|
|
|
|
Weighted
Average Exercise
Price
|
|
|
$ 0.05 - $ 0.99
|
|
|
|
35,163,095
|
|
|
|
6.1
|
|
|
$
|
0.22
|
|
|
|
29,017,262
|
|
|
$
|
0.23
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
150,446
|
|
|
|
6.1
|
|
|
$
|
1.18
|
|
|
|
150,446
|
|
|
$
|
1.18
|
|
|
|
|
|
|
35,313,541
|
|
|
|
6.1
|
|
|
$
|
0.23
|
|
|
|
29,167,708
|
|
|
$
|
0.23
|
|
During the
six-month period ending June 30, 2017, the Company granted options to purchase 8,339,285 shares of common stock to members
of the Company’s Board of Directors. The options are exercisable at $0.05 to $0.13 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 $379,000
using the Black-Scholes Option Pricing model with the following assumptions: life of 5 years; risk free interest rate of
1.94%; volatility of 123% to 144%, and dividend yield of 0%.
During the six-month
period ending June 30, 2017, the Company granted two officers and an employee of the Company stock options to purchase a total
of 3,500,000 shares of common stock. The stock options vest over a two-year period, exercisable at a price range of $0.07 through
$0.40 per share and will expire in 10 years. Total fair value of the stock options amounted to $182,000 which will be expensed
over the vesting period. In addition, as a result of the resignation of the Company’s CEO and three members of the Board
of Directors, the Company agreed to modify the vesting term of 4.5 million options granted to them in January 2017 and fully vested
those options resulting in a charge of $308,000 to account for the fair value of these options.
There were no other changes in the remaining terms of the original grant.
During the six-month
periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value of options that vested
of $535,000 and $181,000 respectively, which is included in Operating expenses in the Company’s statement of operations.
During the three-month periods ended June 30, 2017 and 2016, the Company recognized compensation costs based on the fair value
of options that vested of $300,000 and $100,000 respectively, which is included in Operating expenses in the Company’s statement
of operations.
At June 30, 2017, the
Company’s closing stock price was $0.22 per share. The aggregate intrinsic value of the options outstanding at June 30, 2017
was $1,574,000. Future unamortized compensation expense on the unvested outstanding options at June 30, 2017 is $438,000 to be
recognized through December 2017.
Warrants
The following table
summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2017
up to June 30, 2017.
|
|
|
Warrants
|
|
|
Weighted Avg.
Exercise Price
|
|
|
January 1, 2017
|
|
|
|
11,446,892
|
|
|
$
|
0.15
|
|
|
Granted
|
|
|
|
16,160,770
|
|
|
|
0.05
|
|
|
Exercised
|
|
|
|
(605,000
|
)
|
|
|
–
|
|
|
Cancelled
|
|
|
|
(5,495,392
|
)
|
|
|
0.13
|
|
|
June 30, 2017
|
|
|
|
21,507,270
|
|
|
$
|
0.08
|
|
The weighted average
exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of June 30, 2017 were as
follows:
|
|
|
|
|
Outstanding Warrants
|
|
|
|
Exercisable Warrants
|
|
|
Warrant
Exercise Price Per Share
|
|
|
|
Shares
|
|
|
|
Life
(Years)
|
|
|
|
Weighted
Average
Exercise Price
|
|
|
|
Shares
|
|
|
|
Weighted
Average
Exercise Price
|
|
|
$ 0.05 - $ 0.99
|
|
|
|
21,507,270
|
|
|
|
1.1
|
|
|
$
|
0.08
|
|
|
|
21,407,270
|
|
|
$
|
0.08
|
|
|
$ 1.00 - $ 1.99
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
|
21,507,270
|
|
|
|
1.1
|
|
|
$
|
0.08
|
|
|
|
21,407,270
|
|
|
$
|
0.08
|
|
In the six-month period
ending June 30, 2017, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 16,160,770 shares
of common stock with an exercise price of $0.05 per share, vesting immediately upon grant and expiring one year from the date of
grant (see Note 5).
During the six-month
periods ended June 30, 2017 and 2016, the Company recognized compensation costs of $1,000 and $86,000, respectively, based on the
fair value of warrants previously issued for services that vested during the period, which is included in Operating expenses in
the Company’s statement of operations. During the three-month periods ended June 30, 2017 and 2016, the Company recognized
compensation costs of $1,000 and $58,000, respectively, based on the fair value of warrants that vested, which is included in Operating
expenses in the Company’s statement of operations.
At June 30, 2017, the
aggregate intrinsic value of the warrants outstanding was $3,114,000. Future unamortized compensation expense on the unvested outstanding
warrants at June 30, 2017 is approximately $3,000 to be recognized through July 2018.
|
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.
On April 1, 2017, the
Company executed a separation agreement and release effective with the Company’s Chief Executive Officer (CEO). As part of
the agreement, the Company agreed to pay the CEO $580,000 in severance, payable in equal installment over 24 months. In addition,
the Company also agreed to pay the CEO’s medical insurance for 24 months and provide use of a cell phone for 12 months with
an estimated cost of $44,000. As a result, the Company accrued the entire amount of $624,000 which was also reported as part of
Operating Expenses in the accompanying consolidated statements of operations. As of June 30, 2017, the outstanding balance amounted
to $546,000 which was reported as part of Accounts Payable and Accrued Expenses in the accompanying consolidated balance sheets.
Grant of Stock Options
In July 2017, the Company’
shareholders elected a new member to the Board of Directors. Upon this election, in accordance with the Company’s Board of
Directors compensation policy, the Company granted the new director stock options to purchase a total of 122,567 shares of common
stock. The stock options vest monthly through December 31, 2017, are exercisable at $0.19 per share and will expire 10 years from
the date of issuance. Total fair value of the stock options amounted to $20,000 which will be expensed over the vesting period.
Agreements
On July 13, 2017, the
Company and Temple University entered into an amendment to the exclusive license agreement related to the Company’s AOT viscosity
reduction technology. The amendment defers those outstanding fees in the amount of $135,000 owed by the Company to Temple University
under the license agreement, until such time as the Company either receives sales receipts exceeding $835,000 or sublicenses the
agreement. Further, the amendment established interest rates for outstanding fees and terms of payment for an annual license fee
between the Company and Temple University.
Additionally, on July
13, 2017, the Company and Temple University entered into a payment agreement related to the sponsored research agreement of March
19, 2012 between the parties, as amended on March 19, 2013. Under the terms of the payment agreement, the Company and Temple University
agreed to a payment schedule for outstanding fees in the amount of $78,314, owed by the Company to the Temple under the research
agreement. Under the terms of the payment agreement, these fees are payable $20,000 upon the effective date of the Agreement, and
the balance payable in six equal monthly installments of $9,719.
Conversion of Convertible Notes
From July 1, 2017 up
to August 7, 2017, Company issued 3,453,092 shares of restricted common stock upon conversion of previously issued convertible
notes in aggregate value of $174,000.
Exercise of Warrants
From July 1, 2017 up
to August 7, 2017, the Company issued 2,500,000 shares of restricted common stock on the exercise of warrants in aggregate value
of $203,250.
Exercise of Options
In July 2017, the Company
issued 271,752 shares of restricted common stock on the exercise of options by a member of the Company’s Board of Directors.
Private Sale
of Unregistered Securities
In July, 2017, the
Company issued 181,355 shares of restricted common stock at a price of $0.21 per share, total proceeds of $38,000 by a member of
the Company’s board of directors in private offerings exempt from registration.
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, particularly in “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,
2017, and we undertake no duty to update this information.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) develops and commercializes
energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil 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. AOT technology delivers reductions in crude
oil viscosity and pipeline pressure loss as demonstrated in independent third-party tests performed by the U.S. Department of Energy,
the PetroChina Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™, at full-scale test facilities in the
U.S. and China, and under commercial operating conditions on one of North America’s largest high-volume crude oil pipelines.
Recent testing on a commercial crude oil condensate pipeline demonstrated high correlation between laboratory analysis and full-scale
AOT operations under commercial operating conditions with onsite measurements and data collected by the pipeline operator on its
supervisory control and data acquisition (“SCADA”) system. The AOT product has transitioned from laboratory testing
and ongoing research and development to initial production and continued testing in advance of our goal of seeking acceptance and
adoption by the midstream pipeline marketplace. We continue to devote the bulk of our efforts to the promotion, design, testing
and the commercial manufacturing and operations of our crude oil pipeline products in the upstream and midstream energy sector.
We anticipate that these efforts will continue during 2017 and 2018.
Our Company was incorporated
on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save
the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The name change
was effected 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. The Company’s common stock is quoted under the symbol
“QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and
media articles are available at our corporate website, www.qsenergy.com.
Between 2011 and 2012,
the Company transitioned from prototype testing of its AOT technology at the U.S. Department of Energy Rocky Mountain Oilfield
Testing Center, Midwest, Wyoming (“RMOTC”), to the design and production of full-scale commercial prototype units.
The Company worked in a collaborative engineering environment with multiple energy industry companies to refine the AOT Midstream
commercial design to comply with the stringent standards and qualification processes as dictated by independent engineering audit
groups and North American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known as
AOT Midstream, was completed.
In 2013, the Company
entered into an Equipment Lease/Option to Purchase Agreement (“TransCanada Lease”) with TransCanada Keystone Pipeline,
L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada") which agreed to lease and test the effectiveness of
the Company’s AOT technology and equipment on one of TransCanada’s operating pipelines. As previously reported in our
10-K report filed with the SEC on March 16, 2015, in June 2014, the equipment was accepted by TransCanada and the lease commenced
and the first full test of the AOT equipment on the Keystone pipeline was performed in July 2014 by Dr. Rongjia Tao of Temple University,
with subsequent testing performed by an independent laboratory, ATS RheoSystems, a division of CANNON™ (“ATS”)
in September 2014. Upon review of the July 2014 test results and preliminary report by Dr. Tao, QS Energy and TransCanada mutually
agreed that this initial test was flawed due to, among other factors, the short-term nature of the test, the inability to isolate
certain independent pipeline operating factors such as fluctuations in upstream pump station pressures, and limitations of the
AOT device to produce a sufficient electric field to optimize viscosity reduction. Subsequent testing by ATS in September 2014
demonstrated viscosity reductions of 8% to 23% depending on flow rates and crude oil types in transit. In its summary report, ATS
concluded that i) data indicated a decrease in viscosity of crude oil flowing through the TransCanada pipeline due to AOT treatment
of the crude oil; and ii) the power supply installed on our equipment would need to be increased to maximize reduction in viscosity
and take full advantage of the AOT technology. While more testing is required to establish the commercial efficacy of our AOT technology,
we are encouraged by the findings of these field tests performed under commercial operating conditions. The TransCanada Lease was
terminated by TransCanada, effective October 15, 2014. Upon termination of the TransCanada Lease, all equipment was uninstalled,
returned, inspected and configured for re-deployment.
On July 15, 2014, the
Company entered into an Equipment Lease/Option to Purchase Agreement (“Kinder Morgan Lease”) with Kinder Morgan Crude
& Condensate, LLC (“Kinder Morgan”) under which Kinder Morgan agreed to lease and test the effectiveness of the
Company’s AOT technology and equipment on one of Kinder Morgan’s operating pipelines. Equipment provided under the
Lease includes a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons per minute. The equipment was
delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, during pre-start testing, low electrical
impedance was measured in the unit, indicating an electrical short. A replacement unit was installed May 2015. The second unit
also presented with low impedance when flooded with crude condensate from Kinder Morgan’s pipeline. Subsequent to design
modifications, a remanufactured AOT unit was installed and tested at Kinder Morgan’s pipeline facility in August 2015. Initial
results were promising, with the unit operating generally as expected. However, voltage dropped as preliminary tests continued,
indicating decreased impedance within the AOT pressure vessel. QS Energy personnel and outside consultants performed a series of
troubleshooting assessments and determined that, despite modifications made to the AOT, conductive materials present in the crude
oil condensate continued to be the root cause of the decreased impedance. Based on these results, QS Energy and Kinder Morgan personnel
mutually agreed to put a hold on final acceptance of equipment under the lease and temporarily suspend in-field testing to provide
time to re-test crude oil condensate in a laboratory setting, and thoroughly review and test selected AOT component design and
fabrication. Subsequent analysis and testing led to changes in electrical insulation, inlet flow improvements and other component
modifications. These design changes were implemented and tested by Industrial Screen and Maintenance (ISM), one of QS Energy's
supply chain partners in Casper, Wyoming. Tests performed by ISM at its Wyoming facility indicated significant improvements to
system impedance and efficiency of electric field generation.
In February 2016, the
modified AOT equipment was installed at Kinder Morgan’s facility. Pre-acceptance testing was performed in April 2016, culminating
in more than 24 hours of continuous operations. In-field viscosity measurements and pipeline data collected during this test indicated
the AOT equipment operated as expected, resulting in viscosity reductions equivalent to those measured under laboratory conditions.
Supervisory Control And Data Acquisition (“SCADA”) pipeline operating data collected by Kinder Morgan during this test
indicated a pipeline pressure drop reduction consistent with expectations. Kinder Morgan provided the Company with a number of
additional crude oil samples which were tested in the laboratory for future test correlation and operational planning purposes.
Based on final analysis of in-field test results, SCADA operating data and subsequent analysis of crude oil samples at Temple University,
Kinder Morgan and QS Energy are considering moving the AOT test facility to a different, higher-volume pipeline location. In the
meantime, the Kinder Morgan Lease is in suspension and lease payments have not yet commenced.
Southern Research Institute
(SRI) was engaged by QS Energy in 2015 to investigate the root cause of the crude oil condensate impedance issue by replicating
conditions experienced in the field utilizing a laboratory-scaled version of the AOT and crude oil condensate samples provided
by Kinder Morgan. In addition, QS Energy retained an industry expert petroleum pipeline engineer to review the AOT design and suggest
design modifications to resolve the crude oil condensate impedance issue. This engineer has studied design details, staff reports
and forensic photographs of each relevant AOT installation and test. Based on these investigations, specific modifications were
proposed to resolve the impedance issue, and improve the overall efficiency of the AOT device, resulting in a new value-engineered
design of certain AOT internal components.
The Company is actively
seeking new deployments of its AOT technology. In August, 2015, QS Energy was invited to an offshore oil transfer platform in the
Gulf of Mexico. This offshore platform was assessed by QS Energy personnel for a potential deployment of the AOT viscosity reduction
technology as a solution for super-heavy crude oil flow assurance issues. Following the site visit, subject to non-disclosure agreements
executed by all parties, laboratory testing was performed on crude oil samples provided by the operator, which demonstrated significant
AOT viscosity reductions. Detailed hydraulic analysis based on laboratory results and pipeline operating parameters was presented
to the operator demonstrating potential benefits of AOT technology within the operator’s specified infrastructure. Based
on this analysis, the Company was directed by the operator to prepare a preliminary configuration for AOT units optimized for the
operator’s high-volume, space-constrained operations. Company engineers and supply chain partners have prepared an optimized
configuration and production budget. Based on this optimized configuration, the operator is considering an onsite pilot test with
full scale AOT equipment for deployment in 2018 or 2019.
The Company is in discussions
with a large Middle Eastern oil company regarding AOT technology in the Middle East, having tested multiple oil samples provided
by this oil company at Temple University in 2015 and 2016. The most recent round of testing on Middle Eastern oil company samples
was completed early 2017, demonstrating AOT viscosity reductions of 20% to 50% in a laboratory setting.
During the third quarter
2016, the Company developed a new onsite testing program designed to accelerate the AOT sales cycle. This program utilizes a fully
functional laboratory-scale AOT device designed and developed by the Company in 2015, and tested at the Southern Research Institute.
Under this new program, Company engineers will set up a temporary lab at the customer’s site to test a full range of crude
oils. Fees charged for providing this service will be dependent on scope of services, crude oil sample to be tested, and onsite
time requirements. This program has received a positive response from potential customers. In the fourth quarter 2016, the Company
entered a contract to provide these onsite testing services to a Canadian oil producer and pipeline operator over a one-week period
in early 2017 at a fixed price of $50,000. This initial test was performed in January 2017; data analysis and final report was
completed in March 2017.
In 2014, the Company
began development of a new suite of products based around the new electrical heat system which reduces oil viscosity through a
process known as joule heat (“Joule Heat”). The Company is designing and optimizing the Joule Heat technology for the
upstream oil transportation market. The Company filed two provisional patents related to the technology’s method and apparatus
in the second quarter and fourth quarter of 2013, respectively. The first of the two provisional patents was finalized and submitted
to non-provisional status on April 29, 2014. The second of the two provisional patents was finalized and submitted to non-provisional
status at the end of the third quarter 2014.
In October 2014, QS
Energy entered into a Joint Development Agreement with Newfield Exploration Company (“Newfield”) to test a prototype
of QS Energy Joule Heat equipment, and combined Joule Heat and AOT technology, on a crude oil pipeline serving the Greater Monument
Butte oilfield located in the Uintah Basin of Utah. This test of the Joule Heat technology provides ideal conditions to demonstrate
efficiency and efficacy. The Uintah Basin is 5,000 to 10,000 feet above sea level with average low winter temperatures of 16ºF.
Crude oil pumped from the region is highly paraffinic with the consistency of shoe polish at room temperature. Uintah's black wax
crude must remain at a minimum of 95ºF and yellow wax above 115ºF and therefore requires a substantial amount of heat
to keep it above its high pour point. Operators in the upstream market often run at temperatures of 140ºF to 160ºF. Newfield,
like many other companies in the region, incurs significant operating expense in the form of fuel and power used to heat the waxy
crude and counter the cold climate conditions characteristic of Utah. The Company’s first Joule Heat prototype was installed
for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration
will be required to determine commercial effectiveness of this unit. During the third and fourth quarters of 2015, we worked with
Newfield and Dr. Carl Meinhart to modify the prototype configuration based on observed pipeline and Joule Heat operating factors.
In addition, QS Energy provided a scaled-down version of the Joule Heat unit for static and flow-through testing at SRI. Testing
performed by SRI in September 2015 on a laboratory-scale Joule Heat unit demonstrated the ability of the Joule Heat technology
to deliver temperature increases in the laboratory setting.
In 2015, the Company
worked in collaboration with Newfield, SRI, Dr. Carl Meinhart, and our manufacturing partner to design and build an AOT prototype
unit, for operations in the upstream crude oil pipeline market (“AOT Upstream”), specifically configured for pipeline
operating factors observed at Newfield’s Utah site. Our original plan was to retrofit an earlier prototype device previously
tested at RMOTC; however, after multiple site visits and discussions with Newfield, it was determined a new, smaller unit, specifically
optimized for Newfield operations would be more appropriate for this field test opportunity. We plan to jointly test the AOT Upstream
prototype unit under typical upstream commercial pipeline conditions on Newfield’s pipeline in conjunction with the previously
installed Joule Heat unit.
In December 2015, we
temporarily suspended Joule Heat and AOT Upstream development activities to focus Company resources on finalizing commercial development
of the AOT Midstream. Testing terminated at SRI and all prototype equipment was returned to the Company. We currently plan to resume
Joule Heat and AOT Upstream development in 2017 depending on the availability of sufficient capital and other resources.
In July 2015, the Company
formed QS Energy Pool, Inc., a wholly owned subsidiary of QS Energy, Inc., for the sole purpose of taking advantage of asset acquisition
opportunities in the oil and gas operations market. QS Energy Pool is specifically targeting the acquisition of one or more operating
companies or properties with proven positive cash flow, providing operating income and bottom line revenue which are both accretive
to and synergistic with QS Energy, Inc.’s current operations. QS Energy has identified multiple attractive opportunities
to acquire producing oil and gas field operations. Our strategy is to acquire producing oil and gas fields with production profiles
of at least ten years, proven long-term development rights, and demonstrated positive cash flow at commodity prices as low as $25/barrel
of oil and $2.00/MCF of gas. Any such acquisitions would be subject on our ability to obtain acquisition financing under acceptable
terms and conditions. To date, we have not acquired any oil and gas properties, and there can be no assurances that we will do
so in the future. We can provide no assurances that acquisition financing would be available to us.
Our expenses to date
have been funded primarily through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise
of stock purchase warrants and options. We will need to raise substantial additional capital through 2017, and beyond, to fund
our sales and marketing efforts, continuing research and development, and certain other expenses, until our revenue base grows
sufficiently.
There are significant
risks associated with our business, our Company and our stock. See “Risk Factors” in Part II, Item 1A below.
Results of Operation for Six and Three-month
periods ended June 30, 2017 and 2016
|
I.
|
Six months ended June 30, 2017 and 2016
|
|
|
Six months ended
|
|
|
|
June 30
|
|
|
|
2017
|
|
|
2016
|
|
|
Change
|
|
Revenues
|
|
$
|
50,000
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
1,838,000
|
|
|
|
1,261,000
|
|
|
|
577,000
|
|
Research and development expenses
|
|
|
120,000
|
|
|
|
148,000
|
|
|
|
(28,000
|
)
|
Loss before other income (expense)
|
|
|
(1,908,000
|
)
|
|
|
(1,409,000
|
)
|
|
|
(499,000
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(1,422,000
|
)
|
|
|
(933,000
|
)
|
|
|
(489
|
)
|
Loss on disposition of equipment
|
|
|
–
|
|
|
|
(3,000
|
)
|
|
|
3,000
|
|
Net Loss
|
|
$
|
(3,330,000
|
)
|
|
$
|
(2,345,000
|
)
|
|
$
|
(2,345,000
|
)
|
During the six-month
period ended June 30, 2017, the Company recognized revenues of $50,000 pursuant to the completion of lease and testing agreement
of the Company’s AOT equipment. There was no similar transaction during the period ended June 30, 2016.
Operating expenses
were $1,838,000 for the six-month period ended June 30, 2017, compared to $1,261,000 for the six-month period ended June 30, 2016,
an increase of $577,000. This is due to increases in non-cash expenses of $237,000, and in cash expenses of $337,000. Specifically,
the increase in non-cash expenses are attributable to increases in depreciation of $1,000 and stock compensation expenses attributable
to the fair value of options granted to directors and employees of $355,000, offset by decreases in stock compensation expenses
attributable to the fair value of warrants granted to consultants of $119,000. The increase in cash expense is attributable to
severance package expense of $671,000 with our Chief Executive Officer, and an increase in legal and accounting of $21,000, offset
by decreases in consulting fees of $160,000, corporate expenses of $52,000, insurance of $23,000, rent of 51,000, salaries and
benefits of $25,000, and other expenses of $41,000.
Research and development
expenses were $120,000 for the six-month period ended June 30, 2017, compared to $148,000 for the six-month period ended June 30,
2016, a decrease of $28,000. This decrease is attributable to a decrease in prototype product development costs of $30,000, off-set
by an increase in product testing, research, patents and other costs of $2,000.
Other income and expense
were $1,422,000 expense for the six-month period ended June 30, 2017, compared to $933,000 expense for the six-month period ended
June 30, 2016, a net increase in other expenses of $489,000. This increase is attributable to an increase in non-cash other expenses
of $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 $469,000 and other non-cash interest of $20,000.
The Company had a net
loss of $3,330,000, or $0.02 per share, for the six-month period ended June 30, 2017, compared to a net loss of $2,345,000, or
$0.01 per share, for the six-month period ended June 30, 2016.
|
II.
|
Three months ended June 30, 2017 and 2016
|
|
|
Three months ended
|
|
|
|
June 30
|
|
|
|
2017
|
|
|
2016
|
|
|
Change
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
580,000
|
|
|
|
626,000
|
|
|
|
(46,000
|
)
|
Research and development expenses
|
|
|
56,000
|
|
|
|
73,000
|
|
|
|
(17,000
|
)
|
Loss before other income (expense)
|
|
|
(636,000
|
)
|
|
|
(699,000
|
)
|
|
|
63,000
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and financing expense
|
|
|
(1,210,000
|
)
|
|
|
(439,000
|
)
|
|
|
(771,000
|
)
|
Net Loss
|
|
$
|
(1,846,000
|
)
|
|
$
|
(1,138,000
|
)
|
|
$
|
(708
|
)
|
The Company had no
revenues in the three month-periods ended June 30, 2017 and 2016.
Operating expenses
were $580,000 for the three-month period ended June 30, 2016, compared to $626,000 for the three-month period ended June 30, 2016,
a decrease of $46,000. This is due to an increase in non-cash expenses of $142,000, and a decrease in cash expenses of $188,000.
Specifically, the increase in non-cash expenses are attributable to decreases in depreciation of $1,000 and stock compensation
expenses attributable to the fair value of warrants granted to consultants and others of $76,000, offset by an increase in stock
compensation expenses attributable to the fair value of options granted to directors and employees of $219,000. The decrease in
cash expense is attributable to decreases in consulting fees of $56,000, corporate expenses of $43,000, insurance of $13,000, legal
and accounting fees of $13,000, rent of $37,000, salaries and benefits of $24,000, and other expenses of $2,000.
Research and development
expenses were $56,000 for the three-month period ended June 30, 2017, compared to $73,000 for the three-month period ended June
30, 2016, a decrease of $17,000. This decrease is attributable to decreases in prototype product development costs of $17,000.
Other income and expense
were $1,210,000 expense for the three-month period ended June 30, 2017, compared to $439,000 expense for the three-month period
ended June 30, 2016, a net increase in other expenses of $771,000. This increase is attributable to an increase in non-cash other
expenses of $771,000. The increase in non-cash other expense is due to an increase in expense attributable to interest, beneficial
conversion features and warrants associated with convertible notes issued in the amount of $771,000.
The Company had a net
loss of $1,846,000, or $0.01 per share, for the three-month period ended June 30, 2017, compared to a net loss of $1,138,000, or
$0.01 per share, for the three-month period ended June 30, 2016.
Liquidity and Capital Resources
General
As reflected in the
accompanying condensed consolidated financial statements, the Company has not yet generated significant revenues and has incurred
recurring net losses. We have incurred negative cash flow from operations since our inception in 1998 and a stockholders’
deficit of $1,376,000 as of June 30, 2017. Our negative operating cash flow for the periods ended June 30, 2017 was funded primarily
through issuance of convertible notes.
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 $3,330,000 and a negative cash flow from operations of $765,000 for the six-month
period ended June 30, 2017 and stockholders’ deficit of $1,376,000. 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, 2016 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, 2017, we received cash totaling $1,530,000 from issuance of our convertible notes payable and exercise of warrants, and
used cash in operations of $765,000. At June 30, 2017, we had cash on hand in the amount of $880,000. We will need additional funds
to operate our business, including without limitation the expenses we will incur in connection with the license and research and
development agreements with Temple University, as amended; costs associated with product development and commercialization of the
AOT and related technologies; costs to manufacture and ship our products; costs to design and implement an effective system of
internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic
reports with the SEC and costs required to protect our intellectual property. In addition, as discussed above, we have substantial
contractual commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain
severance payments to a former officer and consulting fees, during the remainder of 2017 and beyond.
No assurance can be
given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Licensing Fees to Temple
University
For details of the
licensing agreements with Temple University, see Financial Statements included in this report, Note 6 (Research and Development).
Critical Accounting Policies and Estimates
Our discussion and
analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going
basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical
experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates.
The methods, estimates
and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report
in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies
that are both most important to the portrayal of a company’s financial condition and results of operations and those that
require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about
matters that are inherently uncertain at the time of estimation. For a more detailed discussion of the accounting policies of the
Company, see Note 1 of the Notes to the Condensed Consolidated Financial Statements, “Summary of Significant Accounting Policies”.
We believe the following
critical accounting policies, among others, require significant judgments and estimates used in the preparation of our consolidated
financial statements.
Estimates
The preparation of
consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note
1 to Notes to the Condensed Consolidated Financial Statements. Actual results could differ from those estimates.
Stock-Based Compensation
The Company periodically
issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing
costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance
provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized
over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at
which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded
in the period of the measurement date.
The fair value of the
Company's common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions
related to risk-free interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation
expense is recorded based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The
assumptions used in the Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.
Going Concern
The accompanying consolidated
financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements,
during the six-months ended June 30, 2017, the Company incurred a net loss of $3,330,000, used cash in operations of $765,000 and
had a stockholders’ deficit of $1,376,000 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, 2017, the
Company had cash on hand in the amount of $880,000. Management estimates that the current funds on hand will be sufficient to continue
operations through November 2017. Management is currently seeking additional funds, primarily through the issuance of debt and
equity securities for cash to operate our business, including without limitation the expenses it will incur in connection with
the license and research and development agreements with Temple; costs associated with product development and commercialization
of the AOT and Joule Heat technologies; costs to manufacture and ship the products; costs to design and implement an effective
system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing
periodic reports with the SEC and costs required to protect our intellectual property. In addition, as discussed below, the Company
has substantial contractual commitments, including without limitation salaries to our executive officers pursuant to employment
agreements, certain payments to a former officer and consulting fees, during the remainder of 2017 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.