Certain information and footnote disclosures
required under accounting principles generally accepted in the United States of America have been condensed or omitted from the
following consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the
“SEC”). It is suggested that the following condensed consolidated financial statements be read in conjunction with
the accompanying notes and financial statements and notes thereto in the annual financial statements included in the Annual Report
on Form 10-K for Ener-Core, Inc. for the fiscal year ended December 31, 2016, filed with the SEC on April 14, 2017.
Notes
to Condensed Consolidated Financial Statements
(unaudited)
Note
1—Organization
Organization
Ener-Core,
Inc. (the “Company”, “we”, “us”, “our”), a Delaware corporation, was formed on
April 29, 2010 as Inventtech, Inc. On July 1, 2013, we acquired our wholly owned subsidiary, Ener-Core Power, Inc.,
(formerly Flex Power Generation, Inc.), a Delaware corporation. The stockholders of Ener-Core Power, Inc. are now our
stockholders and the management of Ener-Core Power, Inc. is now our management. The acquisition was treated as a “reverse
merger” and our financial statements are those of Ener-Core Power, Inc. All equity amounts presented have been
retroactively restated to reflect the reverse merger as if it had occurred on November 12, 2012.
Effective
as of September 3, 2015, we changed our state of incorporation from the State of Nevada to the State of Delaware (the “Reincorporation”),
pursuant to a plan of conversion dated September 2, 2015, following approval by our stockholders of the Reincorporation at our
2015 Annual Meeting of Stockholders held on August 28, 2015. As a Delaware corporation following the Reincorporation, we are deemed
to be the same continuing entity as the Nevada corporation prior to the Reincorporation, and as such continue to possess all of
the rights, privileges and powers and all of the debts, liabilities and obligations of the prior Nevada corporation. Upon effectiveness
of the Reincorporation, all of the issued and outstanding shares of common stock of the Nevada corporation automatically converted
into issued and outstanding shares of common stock of the Delaware corporation without any action on the part of our stockholders.
Concurrent with the Reincorporation, on September 3, 2015 our authorized shares increased to 250,000,000 shares of stock consisting
of 200,000,000 authorized shares of common stock and 50,000,000 authorized shares of preferred stock.
Reverse
Merger
We
entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Ener-Core Power, Inc. and Flex Merger Acquisition
Sub, Inc., a Delaware corporation and our wholly owned subsidiary (“Merger Sub”), pursuant to which the Merger Sub
merged with and into Ener-Core Power, Inc., with Ener-Core Power, Inc. as the surviving entity (the “Merger”). Prior
to the Merger, we were a public reporting “shell company,” as defined in Rule 12b-2 of the Securities Exchange Act
of 1934, as amended. The Merger Agreement was approved by the boards of directors of each of the parties to the Merger
Agreement. In April 2013, the pre-merger public shell company effected a 30-for-1 forward split of its common stock.
All share amounts have been retroactively restated to reflect the effect of the stock split.
As
provided in the Contribution Agreement dated November 12, 2012 (the “Contribution Agreement”) by and among FlexEnergy,
Inc. (“FlexEnergy”), FlexEnergy Energy Systems, Inc. (“FEES”), and Ener-Core Power, Inc., Ener-Core Power,
Inc. was spun-off from FlexEnergy as a separate corporation. As a part of that transaction, Ener-Core Power, Inc. received
all assets (including intellectual property) and certain liabilities pertaining to the Power Oxidizer business carved out of FlexEnergy. The
owners of FlexEnergy did not distribute ownership of Ener-Core Power, Inc. pro rata. The assets and liabilities were
transferred to us and recorded at their historical carrying amounts since the transaction was a transfer of net assets between
entities under common control.
On
July 1, 2013, Ener-Core Power, Inc. completed the Merger with us. Upon completion of the Merger, we immediately became
a public company. The Merger was accounted for as a “reverse merger” and recapitalization. As part of the
Merger, 2,410,400 shares of outstanding common stock of the pre-merger public shell company were cancelled. This cancellation
has been retroactively accounted for as of the inception of Ener-Core Power, Inc. on November 12, 2012. Accordingly, Ener-Core
Power, Inc. was deemed to be the accounting acquirer in the transaction and, consequently, the transaction was treated as a recapitalization
of Ener-Core Power, Inc. Accordingly, the assets and liabilities and the historical operations that are reflected in
the financial statements are those of Ener-Core Power, Inc. and are recorded at the historical cost basis of Ener-Core Power,
Inc. Our assets, liabilities and results of operations were de minimis at the time of the Merger.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Reverse
Stock Split
The
board of directors of the Company approved a reverse stock split of the Company’s authorized, issued and outstanding shares
of common stock, par value $0.0001 per share, as well as the Company’s authorized shares of preferred stock, par value $0.0001
per share, of which no shares are issued and outstanding (together, the “Stock”), at a ratio of 1-for-50 (the “Reverse
Stock Split”). The Reverse Stock Split became effective on July 8, 2015 (the “Effective Date”). As a result
of the Reverse Stock Split, the authorized preferred stock decreased to 1,000,000 shares and the authorized common stock decreased
to 4,000,000 shares. Both the preferred stock and common stock par value remained at $0.0001 per share. The number of authorized
shares subsequently increased to 200,000,000 authorized shares of common stock and 50,000,000 authorized shares of preferred stock
on September 3, 2015 with the Company’s reincorporation in Delaware, as described above.
On
the Effective Date, the total number of shares of common stock held by each stockholder of the Company were converted automatically
into the number of shares of common stock equal to: (i) the number of issued and outstanding shares of common stock held by each
such stockholder immediately prior to the Reverse Stock Split divided by (ii) 50. The Company issued one whole share of the post-Reverse
Stock Split common stock to any stockholder who otherwise would have received a fractional share as a result of the Reverse Stock
Split, determined at the beneficial owner level by share certificate. As a result, no fractional shares were issued in connection
with the Reverse Stock Split and no cash or other consideration will be paid in connection with any fractional shares that would
otherwise have resulted from the Reverse Stock Split. The Reverse Stock Split also affected all outstanding options and warrants
by dividing each option or warrant outstanding by 50, rounded up to the nearest option or warrant, and multiplying the exercise
price by 50 for each option or warrant outstanding.
Description
of the Business
We
design, develop, license, manufacture and have commercially deployed products based on proprietary technologies that generate
industrial levels of usable heat in a pressure vessel using a wide variety of organic gases as fuel for an oxidation reaction.
Our technology allows for the use of gases that, historically, were unusable as fuels for traditional industrial gas to energy
conversion systems, such as combustion chambers, and that typically required costly pollution abatement equipment in order for
industries to reduce the pollutant gas emissions and therefore to comply with increasingly stringent air pollution standards.
Our technology facilitates a high-temperature oxidation reaction for a variety of organic gases which in turn allows our pressure
vessels to extract heat energy from organic gases, including many “waste” gases considered to be air pollution by
many industries.
We
refer to our technology as “Power Oxidation,” and refer to our products as “Power Oxidizers” or “Power
Oxidation Vessels.” We develop applications for our technology by integrating our Power Oxidizers with traditional gas-fired
industrial equipment (such as boilers, dryers, ovens, and chillers) that require steady and consistent heat sources. In our first
deployed applications, our technology serves as a low-emissions alternative for combustion chambers used with gas-fired electric
turbines. Our Power Oxidizers produce a steady heat source that can be used to (i) generate electricity by coupling our technology
with a variety of modified gas turbines, (ii) produce steam by coupling our technology with a variety of modified steam boilers,
or (iii) provide on-site heat at industrial facilities through heat exchanger applications.
Our proprietary and patented Power Oxidation
technology is designed to create greater industrial efficiencies by providing the opportunity to convert low-quality organic waste
gases generated from industrial processes into usable on-site energy, thereby decreasing both operating costs and significantly
reducing environmentally harmful gaseous emissions. We design, develop, license, manufacture and market our Power Oxidizers, which,
when bundled with an electricity generating turbine in the 250 kilowatt, or kW, and 2 megawatt, or MW, sizes, are called Powerstations.
We currently partner and are pursuing partnerships with large established manufacturers to integrate our Power Oxidizer with their
gas turbines, with the goal to open substantial new opportunities for our partners to market these modified gas turbines to industries
for which traditional power generation technologies previously were not technically feasible. We currently manufacture our Powerstations
in the 250 kW size and manufactured the Power Oxidizer for the 2 MW size for the initial two units sold. Beginning in 2017, pursuant
to the CMLA (as defined below), our 2 MW partner, Dresser-Rand a.s., a subsidiary of Dresser-Rand Group Inc., a Siemens company,
or Dresser-Rand, will manufacture the 2 MW Power Oxidizers under a manufacturing license and will pay us a non-refundable license
fee for each unit manufactured by Dresser-Rand.
On November 14, 2014, we entered into a commercial license agreement (“CLA”) with Dresser-Rand, pursuant to which
we agreed to jointly develop a Powerstation that consisted of our Power Oxidizer integrated with a Dresser-Rand KG2 turbine rated
up to 2 MW of power output. The CLA granted Dresser-Rand the right to market and sell the Dresser-Rand KG2-3GEF 2 MW gas turbine
coupled with our Power Oxidizer. In June 2016, we executed a contract manufacturing and commercial licensing agreement (the “CMLA”)
with Dresser-Rand, which both companies intended would supersede and replace the CLA. In April 2017, we amended the terms of the
CMLA to make the CMLA effective as of January 1, 2017, at which time it superseded and replaced the CLA. The first two systems
sold to Dresser-Rand pursuant to the CLA were shipped to a Stockton, California biorefinery site owned by Pacific Ethanol, Inc.
in the fourth quarter of 2016. Under the CMLA, KG2 manufacturing will transition to Dresser-Rand and each KG2 unit sold will generate
for us a non-refundable license fee.
We
sell our EC250 product directly and through distributors in two countries, the United States and Netherlands.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Going
Concern
Our condensed consolidated financial statements
are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States
of America (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of assets and
settlement of liabilities in the normal course of business. Since our inception, we have made a substantial investment in research
and development to develop the Power Oxidizer, have successfully deployed an EC250 field test unit at the U.S. Army base at Fort
Benning, Georgia, and installed and commissioned our first commercial unit in the Netherlands in the second quarter of 2014. In
November 2014, we entered into the CLA to incorporate our Power Oxidizer into Dresser-Rand’s 1.75 MW turbine. In August 2015,
the CLA became a mutually binding agreement due to the satisfaction of certain binding conditions contained in the CLA. On June
29, 2016 we entered into the CMLA with Dresser-Rand, which both companies intended would supersede and replace the CLA.
In April 2017, we amended the terms of
the CMLA to make the CMLA effective as of January 1, 2017, at which time it superseded and replaced the CLA. Pursuant to the amendment,
Dresser-Rand paid us $1.2 million in cash in April 2017, which represents advance payments on license fees for KG2/PO units representing
less than the required minimum number of licenses which would otherwise be required to maintain their exclusivity under the CMLA.
In exchange for this payment, we have agreed to provide a total credit of $1,760,000 against future license payments associated
for these KG2/PO units, consisting of a payment credit of $1,200,000 and an additional discount of $560,000. In July 2017, we executed
an additional amendment for additional payments of up to $250,000 to be applied against future license payments consisting of a
payment credit of approximately $365,000 and an additional discount of approximately $115,000 for a combined payment credit of
$2.1 million.
The April 2017 amendment further settled
certain expense claims made by each party and provided for a mutual release. Because of this claims settlement, the Company accrued
$124,000 at June 30, 2017 and December 31, 2016. The payment of the claims accrual is to be made in advance of certain future
license fee payments payable from Dresser-Rand to the Company, expected during 2017.
We have sustained recurring net losses
and negative cash flows since inception and have not yet established an ongoing source of revenues sufficient to cover our operating
costs and allow us to continue as a going concern. Despite capital raises of $2.5 million in December 2015, $3.0 million in April
2016, $1.25 million in September 2016, and $3.4 million in December 2016, we expect to require additional sources of capital to
support our growth initiatives. We must secure additional funding to continue as a going concern and execute our business plan.
Through the end of 2015, our product sales
were limited to initial system sales that were not profitable and required additional cash in excess of expected cash receipts.
In addition, we incurred significant development and administrative expenses in order to develop our products with little or no
cash contribution from sales. Beginning in 2016 we began to focus on reduction of our operating costs payable in cash through headcount
and overhead cost reductions and saw an increase in cash collections from customers from sales transactions that are expected to
be cash flow positive. During 2015, we received no cash from license fees. In 2016, we received $1.1 million of cash from license
fees and we expect to receive additional license fees in 2017 from the CMLA, including $1.2 million received in the second quarter
of 2017, $250,000 expected in the third quarter of 2017 and additional license payments upon receipt of firm purchase orders for
licenses along with product sales receipts for 250kW unit sales.
Management’s plan is to obtain capital
sufficient to meet our operating expenses by seeking additional equity and/or debt financing. The cash and cash equivalents balance
(including restricted cash transferred to unrestricted cash in April 2017) on June 30, 2017 was approximately $0.1 million. During
the first half of 2017, we continued our cost cutting measures by entering into a lease for a lower-cost headquarters facility,
which we have occupied since April 2017, and through additional headcount reductions. We expect that the $0.1 million of cash and
cash equivalents as of June 30, 2017, combined with receipts on customer billings, will continue to fund our working capital needs,
general corporate purposes, and related obligations into the third quarter of 2017 at our reduced spending levels. However, we
expect to require significantly more cash for working capital and as financial security to support our growth initiatives.
We will pursue raising additional equity
and/or debt financing to fund our operations and product development. If future funds are raised through issuance of stock or debt,
these securities could have rights, privileges, or preferences senior to those of our common stock and debt covenants that could
impose restrictions on our operations. Any equity or convertible debt financing will likely result in additional dilution to our
current stockholders. We cannot make any assurances that any additional financing will be completed on a timely basis, on acceptable
terms or at all. Our inability to successfully raise capital in a timely manner will adversely impact our ability to continue as
a going concern. If our business fails or we are unable to raise capital on a timely basis, our investors may face a complete loss
of their investment.
The accompanying condensed consolidated
financial statements do not give effect to any adjustments that might be necessary if we were unable to meet our obligations or
continue operations as a going concern.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
2—Summary of Significant Accounting Policies
Basis
of Presentation
The
accompanying condensed consolidated financial statements include our accounts and our wholly-owned subsidiary, Ener-Core Power,
Inc. All significant intercompany transactions and accounts have been eliminated in consolidation. All monetary amounts
are rounded to the nearest $000, except certain per share amounts.
The
accompanying financial statements have been prepared in accordance with GAAP.
The accompanying financial information is unaudited, but, in
the opinion of management, reflects all adjustments (which include only normally recurring adjustments) necessary to present fairly
the Company’s financial position, operating results and cash flows for the periods presented. It is management’s opinion
that all material adjustments (consisting of normal recurring adjustments) have been made, which are necessary for a fair financial
statement presentation.
Reclassifications
Certain
amounts in the 2016 condensed consolidated financial statements have been reclassified to conform to the current year presentation.
These reclassifications have no effect on previously reported net loss.
Segments
We
operate in one segment. All of our operations are located domestically.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP 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 expenses during the reporting period. Significant items subject to such estimates and assumptions
include but are not limited to: collectability of receivables; the valuation of certain assets, useful lives, and carrying amounts
of property and equipment, equity instruments and share-based compensation; provision for contract losses; valuation allowances
for deferred income tax assets; valuation of derivative liabilities; and exposure to warranty and other contingent liabilities.
We base our estimates on historical experience and on various other assumptions that are believed 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.
Concentrations
of Credit Risk
Cash
and Cash Equivalents
We
maintain our non-interest bearing transactional cash accounts at financial institutions for which the Federal Deposit Insurance
Corporation (“FDIC”) provides insurance coverage of up to $250,000. For interest bearing cash accounts, from time
to time, balances exceed the amount insured by the FDIC. We have not experienced any losses in such accounts and believe we are
not exposed to any significant credit risk related to these deposits. At June 30, 2017, we had no amounts in excess of the FDIC
limit.
We
consider all highly liquid investments available for current use with an initial maturity of three months or less and are not
restricted to be cash equivalents. We invest our cash in short-term money market accounts.
Restricted
Cash
Collateral
Account
Under a credit card processing agreement with
a financial institution that was entered in 2013 and terminated in April 2017, we were required to maintain funds on deposit with
the financial institution as collateral. The amount of the deposit, which is at the discretion of the financial institution, was
$0 at June 30, 2017 and $50,000 at December 31, 2016.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Accounts Receivable
Our accounts receivable are typically
from credit worthy customers or, for international customers are supported by guarantees or letters of credit. For those customers
to whom we extend credit, we perform periodic evaluations of them and maintain allowances for potential credit losses as deemed
necessary. We generally do not require collateral to secure accounts receivable. We have a policy of reserving for uncollectible
accounts based on our best estimate of the amount of probable credit losses in existing accounts receivable. We periodically review
our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors
that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged
to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of
June 30, 2017, three customers accounted for approximately 96% of our accounts receivable and as of December 31, 2016, two customers
accounted for 100% of our accounts receivable.
Accounts Payable
As of June 30, 2017 and December 31,
2016, two and eight vendors, respectively, collectively accounted for approximately 28% and 50% of our total accounts payable.
Inventory
Inventory,
which consists of raw materials, is stated at the lower of cost or net realizable value, with cost being determined by the average-cost
method, which approximates the first-in, first-out method. At each balance sheet date, we evaluate our ending inventory for excess
quantities and obsolescence. This evaluation primarily includes an analysis of forecasted demand in relation to the inventory
on hand, among consideration of other factors. Based upon the evaluation, provisions are made to reduce excess or obsolete inventories
to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis
of the respective inventories. At June 30, 2017 and December 31, 2016, we did not have a reserve for slow-moving or obsolete inventory.
Property
and Equipment
Property
and equipment are stated at cost, and are being depreciated using the straight-line method over the estimated useful lives of
the related assets, ranging from three to ten years. Maintenance and repairs that do not improve or extend the lives of the respective
assets are expensed. At the time property and equipment are retired or otherwise disposed of, the cost and related accumulated
depreciation accounts are relieved of the applicable amounts. Gains or losses from retirements or sales are reflected in the condensed
consolidated statements of operations.
Deposits
Deposits
primarily consist of amounts incurred or paid in advance of the receipt of fixed assets or are deposits for rent and insurance.
Accrued
Warranties
Accrued
warranties represent the estimated costs that will be incurred during the warranty period of our products. We make an estimate
of expected costs that will be incurred by us during the warranty period and charge that expense to the condensed consolidated
statement of operations at the date of sale. We also reevaluate the estimate at each balance sheet date and if the estimate is
changed, the effect is reflected in the condensed consolidated statement of operations. We had no warranty accrual at June 30,
2017 or December 31, 2016. We expect that most terms for future warranties of our Powerstations and Oxidizers will be one to two
years depending on the warranties provided and the products sold. Accrued warranties for expected expenditures within one year
are classified as current liabilities and as non-current liabilities for expected expenditures for time periods beyond one year.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Intangible
Assets
Our
intangible assets represent intellectual property acquired during the reverse merger. We amortize our intangible assets with finite
lives over their estimated useful lives.
Impairment
of Long-Lived Assets
We account for our long-lived assets in accordance with the accounting standards which require that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate that the historical carrying value of an asset may
no longer be recoverable. We consider the carrying value of assets may not be recoverable based upon our review of the following
events or changes in circumstances: the asset’s ability to continue to generate income from operations and positive cash
flow in future periods; loss of legal ownership or title to the assets; significant changes in our strategic business objectives
and utilization of the asset; or significant negative industry or economic trends. An impairment loss would be recognized when
estimated future cash flows expected to result from the use of the asset are less than its carrying amount. As of June 30, 2017
and December 31, 2016, we do not believe there have been any impairments of our long-lived assets. There can be no assurance,
however, that market conditions will not change or demand for our products will continue, which could result in impairment of
long-lived assets in the future.
Fair
Value of Financial Instruments
Our financial instruments consist primarily
of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, derivative liabilities, and capital lease
liabilities. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available
to management as of June 30, 2017 and December 31, 2016. The carrying amounts of short-term financial instruments are reasonable
estimates of their fair values due to their short-term nature or proximity to market rates for similar items.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Derivative
Financial Instruments
The
Company issues derivative financial instruments in conjunction with its debt and equity offerings and to provide additional incentive
to investors and placement agents. The Company uses derivative financial instruments in order to obtain the lowest cash cost-source
of funds. Derivative liabilities are recognized in the condensed consolidated balance sheets at fair value based on the criteria
specified in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) topic
815-40 “
Derivatives and Hedging—Contracts in Entity’s own Equity
.” The estimated fair value of
the derivative liabilities is calculated using either the Black-Scholes-Merton or Monte Carlo simulation model method.
The
Company issued warrants to purchase common stock and secured debt with a conversion feature in April and May 2015, September 2016
and December 2016. In December 2015, we amended the secured debt issued in April and May 2015 (the “2015 Senior Notes”)
to add a conversion feature. The Company issued additional warrants to purchase common stock with price reset provisions in December
2015, February 2016 and March 2016. These embedded derivatives and warrants were evaluated under ASC topic 815-40. We determined
that the conversion feature for the 2015 secured debt, the conversion feature for the September 2016 secured debt and the warrants
issued with price reset provisions should be accounted for as derivative liabilities. In August 2016, all outstanding warrants
that we previously determined should be accounted for as derivative liabilities were amended and we determined that, after giving
effect to the amendments, we were no longer required to account for the warrants as derivative liabilities. In December 2016,
we modified the terms of the September 2016 secured debt and determined that, after giving effect to the amendments, we were no
longer required to account for the conversion features as derivative liabilities. We determined that the conversion features of
the warrants issued in April and May 2015, September 2016 and December 2016 should not be accounted for as derivative liabilities.
Warrants and the debt conversion features determined to be derivative liabilities were bifurcated from the debt host and were
classified as liabilities on the condensed consolidated balance sheet. Warrants not determined to be derivative liabilities were
recorded to debt discount and paid-in capital. We record the warrants and embedded derivative liabilities at fair value and adjust
the carrying value of the warrants to purchase common stock and embedded derivatives to their estimated fair value at each reporting
date with the increases or decreases in the fair value of such warrants and derivatives at each reporting date, recorded as a
gain or (loss) in the condensed consolidated statements of operations. The warrants issued in 2015 that we no longer account for
as derivative liabilities were recorded to debt discount with a corresponding entry to paid-in capital. The warrants that were
amended in 2016 such that we were no longer required to account for them as derivative liabilities were marked to market immediately
prior to the amendment and the fair value was reclassified on the amendment date from derivative liabilities to paid-in capital.
Revenue
Recognition
We
generate revenue from the sale of our clean power energy systems and from consulting services. Revenue is recognized when there
is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed or determinable
and collectability of the resulting receivable is reasonable assured. Amounts billed to clients for shipping and handling are
classified as sales of product with related costs incurred included in cost of sales.
Provisions
for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period
the related revenue is recorded. We defer any revenue for which the services have not been performed or are subject to refund
until such time that we and our customer jointly determine that the services have been performed or no refund will be required.
Revenues under long-term construction contracts
are generally recognized using the completed-contract method of accounting. Long-term construction-type contracts for which reasonably
dependable estimates cannot be made or for which inherent hazards make estimates difficult are accounted for under the completed-contract
method. Revenues under the completed-contract method are recognized upon substantial completion—that is acceptance by the
customer, compliance with performance specifications demonstrated in a factory acceptance test or a similar event. Accordingly,
during the period of contract performance, billings and costs are accumulated on the balance sheet, but no profit or income is
recorded before completion or substantial completion of the work. Anticipated losses on contracts are recognized in full in the
period in which losses become probable and estimable. Changes in estimate of profit or loss on contracts are included in earnings
on a cumulative basis in the period the estimate is changed. As of June 30, 2017 and December 31, 2016, we had provisions for contract
losses in the amounts of $760,000 and $724,000, respectively.
Our deferred revenue balances as of June
30, 2017 consisted primary of billings and receipts of the Dresser-Rand licenses and the two Power Oxidizer units sold to Dresser-Rand
and installed at a Pacific Ethanol location in Stockton, California. While delivery of the Power Oxidizer units has occurred,
customer acceptance had not occurred as of June 30, 2017 and a contractual risk of loss still remained on the licensing collections.
As such, we did not recognize revenues for the three or six months ended June 30, 2017.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Research
and Development Costs
Research
and development costs are expensed as incurred. Research and development costs were $600,000 and $755,000 for the three months
ended June 30, 2017 and 2016, respectively, and were $1,183,000 and $1,698,000 for the six months ended June 30, 2017 and 2016,
respectively.
Share-Based
Compensation
We
maintain an equity incentive plan and record expenses attributable to the awards granted under the equity incentive plan. We amortize
share-based compensation from the date of grant on a weighted average basis over the requisite service (vesting) period for the
entire award.
We
account for equity instruments issued to consultants and vendors in exchange for goods and services at fair value. The measurement
date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for
performance by the consultant or vendor is reached or (ii) the date at which the consultant’s or vendor’s performance
is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over
the term of the consulting agreement.
In accordance with the accounting standards,
an asset acquired in exchange for the issuance of fully vested, non-forfeitable equity instruments should not be presented or
classified as an offset to equity on the grantor’s balance sheet once the equity instrument is granted for accounting purposes.
Accordingly, we record the fair value of the fully vested, non-forfeitable common stock issued for future consulting services
as prepaid expense in our condensed consolidated balance sheets.
Income
Taxes
We
account for income taxes under FASB ASC 740 “Income Taxes.” Under the asset and liability method of FASB ASC 740,
deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial
statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period the enactment occurs. A valuation allowance is provided for certain deferred tax assets
if it is more likely than not that we will not realize tax assets through future operations.
Earnings
(Loss) per Share
Basic
loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of
common stock assumed to be outstanding during the period of computation. Diluted loss per share is computed similar
to basic loss per share except that the denominator is increased to include the number of additional shares of common stock that
would have been outstanding if the potential shares had been issued and if the additional shares of common stock were dilutive. Approximately
10.3 million and 1.6 million shares of common stock issuable upon full exercise of all options and warrants at June 30, 2017 and
2016, respectively, and all shares potentially issuable in the future under the terms of the Secured Notes Payable for 2017 and
Senior Notes Payable for 2016 were excluded from the computation of diluted loss per share due to the anti-dilutive effect on
the net loss per share.
All
share and per share amounts in the table below have been adjusted to reflect the 1-for-50 reverse split of our issued and outstanding
common stock on July 8, 2016, retroactively.
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June 30,
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Six Months Ended
June 30,
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2017
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2016
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|
|
2017
|
|
|
2016
|
|
Net loss
|
|
$
|
(3,210,000
|
)
|
|
$
|
(2,185,000
|
)
|
|
$
|
(6,461,000
|
)
|
|
$
|
(6,033,000
|
)
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,063,660
|
|
|
|
3,708,782
|
|
|
|
4,007,953
|
|
|
|
3,400,711
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.79
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(1.61
|
)
|
|
$
|
(1.84
|
)
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Comprehensive
Income (Loss)
We
have no items of other comprehensive income (loss) in any period presented. Therefore, net loss as presented in our condensed
consolidated statements of operations equals comprehensive loss.
Recently
Issued Accounting Pronouncements
From time to time, the FASB issues Accounting
Standards Updates (“ASUs”) to amend the authoritative literature in ASC. Management believes that those issued to date
that are not described below either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable
to us or (iv) are not expected to have a significant impact our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606). In April 2016, the FASB issued Accounting Standards Update 2016-10, Revenue
from Contracts with Customers: Identifying Performance Obligations and Licensing. ASU 2014-09, with additional guidance and clarification
from ASU 2016-10, provides a framework for addressing revenue recognition issues and, upon its effective date, replaces almost
all existing revenue recognition guidance, including industry-specific guidance, in current U.S. generally accepted accounting
principles. ASU 2016-10 provides additional guidance specific to licensing and royalty revenue recognition. ASU 2014-09 is effective
beginning with the calendar year ended December 31, 2017. The Company adopted ASU 2014-09 and ASU 2016-10 effective as of January
1, 2017. There was no impact to the Company’s financial position, results of operations, or cash flows as a result of the
adoption.
In July 2015, the FASB issued ASU 2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory. ASU 2015-11 requires that entities measure inventory at the lower
of cost and net realizable value. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, including interim
periods within those fiscal years and early application is permitted. The Company adopted ASU 2015-11 effective as of January 1,
2017. There was no impact to the Company’s financial position, results of operations, or cash flows as a result of the adoption.
In November 2015, the FASB issued ASU 2015-17,
Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires that entities’ deferred tax
liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for
fiscal years beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018. The
Company has not yet assessed the impact ASU 2015-17 will have upon adoption.
In February 2016, the FASB issued ASU 2016-2,
Leases (Topic 842). ASU 2016-2 affects any entity entering into a lease and changes the accounting for operating leases to require
companies to record an operating lease liability and a corresponding right-of-use lease asset, with limited exceptions. ASU 2016-2
is effective for fiscal years beginning after December 15, 2018. Early adoption is allowed. We have not yet assessed the impact
ASU 2016-2 will have upon adoption.
In May 2017, the FASB issued ASU 2017-9,
Compensation-Stock Compensation (Topic 718). ASU 2017-9 provides guidance about which changes to the terms or conditions of a share-based
payment award require an entity to apply modification accounting in Topic 718. ASU 2017-9 is effective for all entities for annual
periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is allowed. We have
not yet assessed the impact ASU 2017-9 will have upon adoption.
In July 2017, the FASB issued ASU 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. The amendments in Part I of this ASU change the classification analysis of certain equity-linked financial
instruments (or embedded features) with down round features. The amendments in Part II of this ASU recharacterize the indefinite
deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception.
Those amendments do not have an accounting effect. Amendments in Part I of this ASU are effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2018. The amendments in Part II of the ASU do not require any transition
guidance because those amendments do not have an accounting effect. Early adoption is permitted for all entities, including adoption
in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of
the beginning of the fiscal year that includes that interim period. We have not yet assessed the impact ASU 2017-11 will have upon
adoption.
Note 3—Inventory
Inventory primarily consists of Powerstation
parts used as raw materials for the Company’s EC250 and KG2 orders. Work-in-progress inventory consists of Powerstation
parts and employee and contract labor assembly costs for Powerstation sub-assemblies. Sub-assemblies and parts are typically shipped
to end customer locations and assembled on-site. Completed Powerstations awaiting final installation and commissioning would be
carried as finished goods. There was no finished goods inventory at either June 30, 2017 or December 31, 2016. Inventories consist
of:
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
Raw material and spare parts
|
|
$
|
1,080,000
|
|
|
$
|
990,000
|
|
Work-in-progress
|
|
|
1,985,000
|
|
|
|
1,774,000
|
|
Total
|
|
$
|
3,065,000
|
|
|
$
|
2,764,000
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
4—Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets consisted of the following:
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
Prepaid rent
|
|
$
|
—
|
|
|
$
|
52,000
|
|
Prepaid insurance
|
|
|
30,000
|
|
|
|
43,000
|
|
Prepaid other
|
|
|
53,000
|
|
|
|
96,000
|
|
Prepaid professional fees
|
|
|
62,000
|
|
|
|
1,000
|
|
Prepaid deferred financing fees
|
|
|
44,000
|
|
|
|
110,000
|
|
Total
|
|
$
|
189,000
|
|
|
$
|
302,000
|
|
Note
5—Property and Equipment, Net
Property
and equipment, net consisted of the following:
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
Machinery and equipment
|
|
$
|
4,311,000
|
|
|
$
|
4,377,000
|
|
Office furniture and fixtures
|
|
|
49,000
|
|
|
|
217,000
|
|
Computer equipment and software
|
|
|
202,000
|
|
|
|
176,000
|
|
Total cost
|
|
|
4,562,000
|
|
|
|
4,770,000
|
|
Less accumulated depreciation
|
|
|
(1,732,000
|
)
|
|
|
(1,523,000
|
)
|
Net
|
|
$
|
2,830,000
|
|
|
$
|
3,247,000
|
|
Assets
recorded under capital leases and included in property and equipment in our balance sheets consist of the following:
|
|
June
30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
Machinery and equipment
|
|
$
|
27,000
|
|
|
$
|
27,000
|
|
Computer equipment and software
|
|
|
84,000
|
|
|
|
59,000
|
|
Total assets under capital lease
|
|
|
111,000
|
|
|
|
86,000
|
|
Less accumulated amortization
|
|
|
(77,000
|
)
|
|
|
(71,000
|
)
|
Net assets under capital lease
|
|
$
|
34,000
|
|
|
$
|
15,000
|
|
Depreciation
expense for the three and six months ended June 30, 2017 and 2016 consisted of the following:
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Research and development
|
|
$
|
98,000
|
|
|
$
|
103,000
|
|
|
$
|
198,000
|
|
|
$
|
203,000
|
|
General and administrative
|
|
|
24,000
|
|
|
|
29,000
|
|
|
|
51,000
|
|
|
|
58,000
|
|
|
|
$
|
122,000
|
|
|
$
|
132,000
|
|
|
$
|
249,000
|
|
|
$
|
261,000
|
|
Amortization of assets under capital
lease was $2,000 for the three months ended June 30, 2017 and 2016, respectively, and $3,000 for the six months ended June 30,
2017 and 2016, respectively.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
6—Accrued Expenses
Accrued
expenses consisted of the following;
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
Accrued professional fees
|
|
$
|
105,000
|
|
|
$
|
138,000
|
|
Accrued compensation
|
|
|
441,000
|
|
|
|
346,000
|
|
Accrued board of directors’ fees
|
|
|
120,000
|
|
|
|
40,000
|
|
Accrued interest
|
|
|
10,000
|
|
|
|
29,000
|
|
Accrued other
|
|
|
90,000
|
|
|
|
20,000
|
|
Total accrued expenses
|
|
$
|
766,000
|
|
|
$
|
573,000
|
|
Note
7—Deferred Revenues and Customer Advances
Deferred
revenues and customer advances consist of balances billed on existing customer contracts for which the revenue cycle is not complete.
Customer advances on equipment sales represent down payments and progress payments under the terms and conditions of equipment
sales of our Power Oxidizer and Powerstation units. Prepaid license fees represent payments of license fees by Dresser-Rand and
received in September 2016 but for which right of return existed as of June 30, 2017. Deferred revenues and customer advances
consisted of the following:
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
Customer advances on equipment sales
|
|
$
|
2,877,000
|
|
|
$
|
2,776,000
|
|
Prepaid license fees
|
|
|
2,300,000
|
|
|
|
1,100,000
|
|
Total deferred revenues and customer advances
|
|
$
|
5,177,000
|
|
|
$
|
3,876,000
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
8—Convertible Senior Notes Payable
Convertible
Senior Notes payable consisted of the following as of June 30, 2017:
|
|
Principal
|
|
|
Debt
Discount
|
|
|
Offering Costs
|
|
|
Net
Total
|
|
Balance, December 31, 2016
|
|
$
|
9,191,000
|
|
|
$
|
(8,152,000
|
)
|
|
$
|
(409,000
|
)
|
|
$
|
630,000
|
|
Amortization of Debt Discount and Offering Costs
|
|
|
—
|
|
|
|
2,029,000
|
|
|
|
102,000
|
|
|
|
2,131,000
|
|
Conversion into common shares
|
|
|
(60,000
|
)
|
|
|
50,000
|
|
|
|
3,000
|
|
|
|
(7,000
|
)
|
Balance, June 30, 2017
|
|
|
9,131,000
|
|
|
|
(6,073,000
|
)
|
|
|
(304,000
|
)
|
|
|
2,754,000
|
|
Less: Current Portion
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Long Term Portion
|
|
$
|
9,131,000
|
|
|
$
|
(6,073,000
|
)
|
|
$
|
(304,000
|
)
|
|
$
|
2,754,000
|
|
In
the fourth quarter of 2016, the Company entered into a securities purchase agreement pursuant to which it issued a new series
of convertible senior secured notes (collectively the “2016 Senior Notes”) and related warrants, and entered into
amendment agreements related to its 2015 Senior Notes and the convertible unsecured promissory notes of the Company issued in
September 2016 (the “Convertible Unsecured Notes”), as described in Note 9 below. The Company issued and sold new
2016 Senior Notes with a face value of $3,747,000 and an original issue discount of $375,000 for gross cash proceeds of $3,372,000.
Additionally, the Company amended and restated the 2015 Senior Notes, the aggregate principal amount of which was $5,000,000 prior
to such amendment and restatement. Upon the amendment and restatement of the 2015 Senior Notes, the face value of such 2015 Senior
Notes was $5,556,000 with an original issue discount of $556,000. The Company refers to the 2016 Senior Notes and the amended
and restated 2015 Senior Notes, collectively, as the “Senior Notes”. The Senior Notes are fully secured by all assets
of the Company and the Company’s subsidiaries. The Senior Notes are convertible at a price per share of $2.50, which is
adjustable upon a Company stock split, reverse split, or common share dividend. In conjunction with the issuance and/or amendment
and restatement, as applicable, of the aggregate face value of $9,302,000 of the Senior Notes, the Company issued five-year warrants
to purchase up to 3,720,839 shares of the Company’s common stock at $3.00 per share, which were valued using Black-Scholes
option pricing model at $6,003,000. We allocated the fair value of these warrants and the conversion feature of the Senior Notes
to debt discount as follows: $3,495,000 allocated to detachable warrants and $4,133,000 allocated to the conversion feature. We
recorded an additional debt discount of $930,000 for the original issue discount, resulting in a debt discount recorded at issuance
of $8,558,000. We will amortize this discount to interest expense over the expected remaining life of the Senior Notes, which
mature on December 31, 2018.
We
incurred $479,000 of offering costs in conjunction with the issuance and sale of the 2016 Senior Notes and amendment and restatement
of the 2015 Senior Notes, consisting of $298,000 of placement agent fees and costs and $181,000 of legal and professional fees.
We will amortize the offering costs to interest expense over the expected remaining life of the Senior Notes.
Upon
an Event of Default, the Senior Notes will bear interest at a rate of 10% per annum. The Senior Notes will mature on December
31, 2018 and rank senior to the Convertible Unsecured Notes. The Senior Notes are convertible at the option of the holder into
the Company’s common stock at an exercise price of $2.50 (as subject to adjustment therein) and will automatically convert
into shares of the Company’s common stock on the fifth trading day immediately following the issuance date of the Senior
Notes on which (i) the Weighted Average Price (as defined in the Senior Notes) of the Company’s common stock for each trading
day during a twenty trading day period equals or exceeds $5.00 (as adjusted for any stock dividend, stock split, stock combination,
reclassification or similar transaction) and no Equity Conditions Failure (as defined in the Senior Notes) has occurred. The Senior
Notes also contain a blocker provision that prevents the Company from effecting a conversion in the event that the holder, together
with certain affiliated parties, would beneficially own in excess of either 4.99% or 9.99%, with such threshold determined by
the holder prior to issuance, of the shares of the Company’s common stock outstanding immediately after giving effect to
such conversion.
Upon
an Event of Default and delivery to the holder of the Senior Note of notice thereof, such holder may require the Company to redeem
all or any portion of its Senior Note at a price equal to 115% of the Conversion Amount (as defined in the Senior Notes) being
redeemed. Additionally, upon a Change of Control and delivery to the holder of the Senior Note of notice thereof, such holder
may also require the Company to redeem all or any portion of its Senior Note at a price equal to 115% of the Conversion Amount
being redeemed. Further, at any time from and after January 1, 2018 and provided that the Company has not received either (i)
initial deposits for at least eight 2 MW Power Oxidizer units or (ii) firm purchase orders totaling not less than $3,500,000 and
initial payment collections of at least $1,600,000, in each case during the period commencing on the issuance date of the 2016
Senior Notes and ending on December 31, 2017, the holder of the Senior Note may require the Company to redeem all or any portion
of its Senior Note at a price equal to 100% of the Conversion Amount being redeemed.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
At any time after the issuance date of the
Senior Notes, the Company may redeem all or any portion of the then outstanding principal and accrued and unpaid interest with
respect to such principal, at 100% of such aggregate amount; provided, however, that the aggregate Conversion Amount to be redeemed
pursuant to all Senior Notes must be at least $500,000, or such lesser amount as is then outstanding. The portion of the Senior
Note(s) to be redeemed shall be redeemed at a price equal to the greater of (i) 110% of the Conversion Amount of the Senior Note
being redeemed and (ii) the product of (A) the Conversion Amount being redeemed and (B) the quotient determined by dividing (I)
the greatest Weighted Average Price (as defined in the Senior Notes) of the shares of the Company’s common stock during
the period beginning on the date immediately preceding the date of the notice of such redemption by the Company and ending on
the date on which the redemption by the Company occurs by (II) the lowest Conversion Price (as defined in the Senior Notes) in
effect during such period.
The
Senior Notes contain a provision that prevents the Company from entering into or becoming party to a Fundamental Transaction (as
defined in the Senior Notes) unless the Company’s successor entity assumes all of the Company’s obligations under
the Senior Notes and the related transaction documents (the “Transaction Documents”) pursuant to written agreements
in form and substance satisfactory to at least a certain number of holders of the Senior Notes.
In connection with foregoing, Ener-Core
Power, Inc., the Company’s wholly-owned subsidiary, entered into a Guaranty, pursuant to which it agreed to guarantee all
of the obligations of the Company under the securities purchase agreement for the 2016 Senior Notes, the Senior Notes and the Transaction
Documents.
In connection with the issuance and sale
of the 2016 Senior Notes, the Company entered into a Registration Rights Agreement with the investors (the “Registration
Rights Agreement”), pursuant to which the Company is required to file one or more registration statements with the Securities
and Exchange Commission (the “SEC”) to register for resale by the investors the shares issuable upon conversion of
the 2016 Senior Notes (the “Conversion Shares”) and shares underlying certain warrants issued to the holders of the
2016 Senior Notes (the “Warrant Shares”), and use its best efforts to maintain the effectiveness of such registration
statement(s). The Company was required to file the first such registration statement promptly following the initial closing date
under the securities purchase agreement for the 2016 Senior Notes, which occurred on December 2, 2016, but in no event later than
the date that is forty-five (45) days after such initial closing date. The Registration Rights Agreement required the Company
to obtain effectiveness of the required registration statement by specified deadlines contained in the Registration Rights Agreement.
The Company complied with its obligation to file such registration statement on January 17, 2017 and the SEC declared such registration
statement effective on February 21, 2017.
During
the six months ended June 30, 2017, two holders of Senior Notes converted $60,000 of principal into 24,000 shares of the Company’s
common stock. As a result of these conversions, the Company incurred a loss of $53,000, representing the unamortized debt discount
and deferred financing fees.
Note
9—Convertible Unsecured Notes
Convertible
Unsecured Notes payable consisted of the following as of June 30, 2017:
|
|
Notes
|
|
|
Debt
Discount
|
|
|
Offering Costs
|
|
|
Net
Total
|
|
December 31, 2016 Balance
|
|
$
|
1,250,000
|
|
|
$
|
(666,000
|
)
|
|
$
|
(30,000
|
)
|
|
$
|
554,000
|
|
Amortization of debt discount and deferred financing costs
|
|
|
—
|
|
|
|
552,000
|
|
|
|
22,000
|
|
|
|
574,000
|
|
Issuance of additional warrants
|
|
|
|
|
|
|
(73,000
|
)
|
|
|
—
|
|
|
|
(73,000
|
)
|
Ending balance—June 30, 2017
|
|
|
1,250,000
|
|
|
|
(187,000
|
)
|
|
|
(8,000
|
)
|
|
|
1,055,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Current Portion
|
|
$
|
(1,250,000
|
)
|
|
$
|
187,000
|
|
|
$
|
8,000
|
|
|
$
|
(1,055,000
|
)
|
Long Term Portion
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
On September 1, 2016, we entered into a securities
purchase agreement and related notes and warrants pursuant to which we issued the Convertible Unsecured Notes and detachable five-year
warrants to purchase an aggregate of 124,999 shares of the Company’s common stock at an exercise price of $4.00 per share
(the “September 2016 Financing”). The Company received total gross proceeds of $1,250,000, less transaction expenses
of $45,000 consisting of legal costs for net proceeds of $1,205,000. We recorded a discount of $553,000 on the date of issuance
representing the fair value of the warrants issued and the value of the beneficial conversion feature on the date of issuance.
In the fourth quarter of 2016, we increased our debt discount recorded by $335,000, consisting of $305,000 recorded for the issuance
of additional warrants at fair value of $305,000 and $30,000 for the difference in fair value for warrants repriced from $4.00
per share to $3.00 per share.
The
Convertible Unsecured Notes bear interest at a rate of 12% per annum and mature on September 1, 2017; provided, however, that
the Company may not prepay any portion of the outstanding principal and accrued and unpaid interest under the Convertible Unsecured
Notes so long as any of the Senior Notes remain outstanding and in no event will the maturity date of such Convertible Unsecured
Notes be earlier than at least ninety-one (91) days after the maturity date under the Senior Notes. The Convertible Unsecured
Notes are subordinate to the Senior Notes described in Note 8. The Convertible Unsecured Notes were initially convertible at the
option of the holder into common stock at a conversion price of $4.31 per share and will automatically convert into shares of
common stock in the event of a conversion of at least 50% of the then outstanding (i) principal, (ii) accrued and unpaid interest
with respect to such principal and (iii) accrued and unpaid late charges, if any, with respect to such principal and interest,
under the Senior Notes. In connection with the issuance of the 2016 Senior Notes and amendment and restatement of the 2015 Senior
Notes, the conversion price was reduced to $2.50 per share. The Convertible Unsecured Notes also contain a blocker provision that
prevents the Company from effecting a conversion in the event that the holder, together with certain affiliated parties, would
beneficially own in excess of 9.99% of the shares of common stock outstanding immediately after giving effect to such conversion.
At any time after the issuance date of the Convertible Unsecured Notes, the Company may, at its option, redeem all or any portion
of the then outstanding principal and accrued and unpaid interest with respect to such principal (the “Company Optional
Redemption Amount”), at 100% of such aggregate amount; provided, however, that the Company may not redeem all or any portion
of the Company Optional Redemption Amount so long as any of the Senior Notes remain outstanding without the prior written consent
of the collateral agent with respect to such Senior Notes and certain investors holding the requisite number of conversion shares
and warrant shares underlying the Senior Notes and April and May 2015 Warrants.
The securities purchase agreement for the
Convertible Unsecured Notes called for the issuance of additional five-year warrants to purchase an aggregate of 62,500 shares
at an exercise price of $4.00 per share on each of the 61st, 91st, 121st and 151st days after the closing of the September 2016
Financing, or, in each case, an Additional Warrant Date, but only in the event the Company had not consummated a further financing
consisting of the issuance of common stock and warrants for aggregate gross proceeds of at least $3,000,000 prior to such respective
Additional Warrant Date. As of January 30, 2017, the Company had not consummated a further financing and, as a result, issued
warrants to purchase an aggregate of 250,000 shares of the Company’s common stock, consisting of the issuance of an aggregate
of 62,500 shares of the Company’s common stock on each of November 1, 2016, December 1, 2016, December 31, 2016 and January
30, 2017. The Company valued the warrants to purchase an aggregate of 62,500 shares of common stock issued in the first quarter
of 2017 using the Black-Scholes option pricing model at $73,000 and recorded an additional discount on the date of issuance. The
Company evaluated the accounting of the additional detachable warrants and determined that the warrants should not be accounted
for as derivative liabilities.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
10—Fair Value Measurements and Disclosures
Fair
value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly
transaction between market participants at the measurement date and in the principal or most advantageous market for that asset
or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset
or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration
of non-performance risk, including the Company's own credit risk.
Inputs
used in measuring fair value are prioritized into a three-level hierarchy based on whether the inputs to those measurements are
observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs
reflect the Company's market assumptions. The fair-value hierarchy requires the use of observable market data when available and
consists of the following levels:
|
●
|
Level
1—Quoted prices for identical instruments in active markets;
|
|
●
|
Level
2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets
that are not active; and model-derived valuations in which all significant inputs are observable in active markets; and
|
|
●
|
Level
3—Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
|
As of June 30, 2017, there
were no investments that required fair value measurement disclosure.
Note
11—Capital Leases Payable
Capital
Leases Payable
Capital
leases payable consisted of the following:
|
|
June 30,
2017
(unaudited)
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
Capital lease payable to De Lange Landon secured by forklift, 10.0% interest, due on October 1, 2018, monthly payment of $452.
|
|
$
|
7,000
|
|
|
$
|
10,000
|
|
Capital lease payable to Dell Computers secured by computer equipment, 15.09% interest, due on November 22, 2017, monthly payment of $394.
|
|
|
2,000
|
|
|
|
4,000
|
|
Capital lease payable to Dell Computers secured by computer equipment, 4.99% interest, due on May 1, 2020, monthly payment of $716.
|
|
|
24,000
|
|
|
|
—
|
|
Total capital leases
|
|
$
|
33,000
|
|
|
$
|
14,000
|
|
Less: current portion
|
|
|
(15,000
|
)
|
|
|
(10,000
|
)
|
Long-term portion of capital leases
|
|
$
|
18,000
|
|
|
$
|
4,000
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
The
future minimum lease payments required under the capital leases and the present value of the net minimum lease payments as of
June 30, 2017, are as follows:
|
|
Year Ending December 31,
|
|
Amount
|
|
|
|
2017
|
|
$
|
10,000
|
|
|
|
2018
|
|
|
12,000
|
|
|
|
2019
|
|
|
8,000
|
|
|
|
2020
|
|
|
5,000
|
|
Net minimum lease payments
|
|
|
|
$
|
35,000
|
|
Less: Amount representing interest
|
|
|
|
|
(2,000
|
)
|
Less: Taxes
|
|
|
|
|
-
|
|
Present value of net minimum lease payments
|
|
|
|
$
|
33,000
|
|
Less: Current maturities of capital lease payables
|
|
|
|
|
(15,000
|
)
|
Long-term capital lease payables
|
|
|
|
$
|
18,000
|
|
Note
12—Equity
During
the six months ended June 30, 2017 holders of our Senior Notes converted $60,000 of Senior Notes principal into 24,000 shares
of the Company’s common stock.
Note
13—Stock Options and Warrants
Stock
Options
On
July 1, 2013, the Company’s board of directors adopted and approved the 2013 Equity Incentive Plan (the “2013 Plan”)
and amended the 2013 Plan on March 24, 2015 to increase the number of shares available for issuance. The 2013 Plan previously
authorized us to grant non-qualified stock options and restricted stock purchase rights to purchase up to 420,000 shares of the
Company’s common stock to employees (including officers) and other service providers. With the approval of the 2015 Plan,
described below, as of August 29, 2015, no shares of common stock were available for issuance under the 2013 Plan, other than
pursuant to previously issued options.
On July 15, 2015, the Company’s
board of directors approved the 2015 Omnibus Incentive Plan (the “2015 Plan”), which was approved by the Company’s
stockholders on August 28, 2015. Upon adoption, the 2015 Plan authorized us to grant up to 300,000 shares of the Company’s
common stock and replaced the 2013 Equity Incentive Plan. As a result of the approval of the 2015 Plan, no additional grants will
be made under the 2013 Plan. On August 22, 2016, the Company’s board of directors approved an amendment to the 2015 Plan
to increase the total authorized pool available under the 2015 Plan to 600,000 shares of the Company’s common stock, subject
to automatic increase for any shares subject to outstanding awards under the 2013 Plan that are subsequently canceled or expire.
The Company’s stockholders approved the foregoing amendment on September 26, 2016. As of June 30, 2017, 27,465 shares of
the Company’s common stock were available for issuance under the 2015 Plan.
The 2015 Plan permits the granting
of any or all of the following types of awards: incentive stock options, non-qualified stock options, stock appreciation rights,
restricted stock, restricted stock units, other stock-based awards, and performance awards payable in a combination of cash and
company shares. As of June 30, 2017, the Company has issued 210,000 shares of restricted common stock and options to purchase
an aggregate of 440,000 shares of the Company’s common stock.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
The
2015 Plan has the following limitations:
|
●
|
Limitation
on terms of stock options and stock appreciation rights
. The maximum term of each stock option and stock appreciation
right (SAR) is 10 years.
|
|
●
|
No
repricing or grant of discounted stock options
. The 2015 Plan does not permit the repricing of options or SARs either
by amending an existing award or by substituting a new award at a lower price without stockholder approval. The 2015 Plan
prohibits the granting of stock options or SARs with an exercise price less than the fair market value of the Company’s
common stock on the date of grant.
|
|
●
|
Clawback
.
Awards granted under the 2015 Plan are subject to any then current compensation recovery or clawback policy of the Company
that applies to awards under the 2015 Plan and all applicable laws requiring the clawback of compensation.
|
|
●
|
Double-trigger
acceleration
. Acceleration of the vesting of employee awards that are assumed or replaced by the resulting entity after
a change in control is not permitted unless an employee’s employment is also terminated by the Company without cause
or by the employee with good reason within two years of the change in control.
|
|
●
|
Code
Section 162(m) Eligibility
. The 2015 Plan provides flexibility to grant awards that qualify as “performance-based”
compensation under Internal Revenue Code Section 162(m).
|
|
●
|
Dividends
.
Dividends or dividend equivalents on stock options, SARs or unearned performance shares under the 2015 Plan will not be paid.
|
At
June 30, 2017, total unrecognized deferred stock compensation expected to be recognized over the remaining weighted-average vesting
periods of 3.87 years for outstanding grants was $1.5 million.
The
fair value of option awards is estimated on the grant date using the Black-Scholes option valuation model.
Estimates
of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity
awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by us.
Stock-based
compensation expense is recorded only for those awards expected to vest. Currently, the forfeiture rate used to calculate stock-based
compensation expense is zero, which approximates the effective actual forfeiture rate. The rate is adjusted if actual forfeitures
differ from the estimates in order to recognize compensation cost only for those awards that actually vest. If factors change
and different assumptions are employed in future periods, the share-based compensation expense may differ from that recognized
in previous periods.
Stock-based
award activity was as follows:
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Life
|
|
|
Value
|
|
Balance, December 31, 2016
|
|
|
273,550
|
|
|
$
|
13.70
|
|
|
|
5.02
|
|
|
$
|
—
|
|
Forfeited during 2017
|
|
|
(38,027
|
)
|
|
|
16.05
|
|
|
|
—
|
|
|
|
—
|
|
Granted during 2017
|
|
|
440,000
|
|
|
|
2.50
|
|
|
|
9.76
|
|
|
|
—
|
|
Balance, June 30, 2017
|
|
|
675,523
|
|
|
$
|
5.38
|
|
|
|
8.09
|
|
|
$
|
—
|
|
Exercisable on June 30, 2017
|
|
|
341,390
|
|
|
$
|
9.29
|
|
|
|
6.76
|
|
|
$
|
—
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
The
options granted have a contract term ranging between three and ten years. Options granted typically vest over a four-year period,
with 25% vesting after one year and the remainder ratably over the remaining three years.
Of the Company’s outstanding options,
options to purchase 235,523 shares of the Company’s common stock were outstanding and options to purchase 195,373 shares
of the Company’s common stock were exercisable under the 2013 Plan and options to purchase 440,000 shares of the Company’s
common stock were outstanding with 146,016 exercisable under the 2015 Plan on June 30, 2017.
The following table summarizes information about stock options
outstanding at June 30, 2017:
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted-
|
|
|
|
|
|
Weighted-
|
|
|
|
Number
|
|
|
Remaining
|
|
|
Average
|
|
|
Number
|
|
|
Average
|
|
Exercise
|
|
of
|
|
|
Contractual
|
|
|
Exercise
|
|
|
of
|
|
|
Exercise
|
|
Prices
|
|
Shares
|
|
|
Life
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
|
|
|
|
|
(In years)
|
|
|
|
|
|
|
|
|
|
|
$0–$10.00
|
|
|
532,140
|
|
|
|
9.18
|
|
|
$
|
3.35
|
|
|
|
205,728
|
|
|
$
|
3.98
|
|
$10.01–$15.00
|
|
|
30,300
|
|
|
|
6.42
|
|
|
$
|
12.50
|
|
|
|
22,579
|
|
|
$
|
12.50
|
|
$15.01–$20.00
|
|
|
96,845
|
|
|
|
2.83
|
|
|
$
|
17.50
|
|
|
|
96,845
|
|
|
$
|
17.50
|
|
$20.01–$25.00
|
|
|
16,238
|
|
|
|
4.03
|
|
|
$
|
23.26
|
|
|
|
16,238
|
|
|
$
|
23.26
|
|
|
|
|
675,523
|
|
|
|
8.02
|
|
|
$
|
6.27
|
|
|
|
341,390
|
|
|
$
|
9.29
|
|
Stock
based compensation expense consisted of the following:
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Research and development
|
|
$
|
134,000
|
|
|
$
|
149,000
|
|
|
$
|
303,000
|
|
|
$
|
310,000
|
|
General and administrative
|
|
|
249,000
|
|
|
|
202,000
|
|
|
|
350,000
|
|
|
|
417,000
|
|
|
|
$
|
383,000
|
|
|
$
|
351,000
|
|
|
$
|
653,000
|
|
|
$
|
727,000
|
|
Restricted Stock
Restricted stock grants consist of shares
of common stock of the Company owned by employees, consultants, and directors that are subject to vesting conditions, typically
for services provided to the Company. All unvested shares of restricted stock are subject to repurchase rights and, therefore,
are recorded as restricted stock.
Restricted stock activities during the six months ended June
30, 2017 were as follows:
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Grant
|
|
|
|
Shares
|
|
|
Price
|
|
Balance, December 31, 2016
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
|
210,000
|
|
|
$
|
1.55
|
|
Vested
|
|
|
(65,625
|
)
|
|
$
|
—
|
|
Unvested balance, June 30, 2017
|
|
|
144,375
|
|
|
$
|
1.55
|
|
Expenses related to vesting of restricted
stock are included in stock-based compensation expense. The remaining unvested shares of restricted stock vest 33% per year on
March 31, 2018, 2019 and 2020.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Warrants
From time to time, we issue warrants to
purchase shares of our common stock to investors, note holders and to non-employees for services rendered or to be rendered in
the future. The following table represents the activity for warrants outstanding, exchanged, and issued for the six months ended
June 30, 2017.
Balance outstanding at December 31, 2016
|
|
|
5,358,881
|
|
|
$
|
3.77
|
|
Issued for Convertible Unsecured Notes
|
|
|
62,500
|
|
|
|
3.00
|
|
Issued for amendments to Backstop Security
|
|
|
41,000
|
|
|
|
3.00
|
|
Balance outstanding at June 30, 2017
|
|
|
5,462,381
|
|
|
$
|
3.59
|
|
All warrants were exercisable at June
30, 2017, the weighted average exercise price per share was $3.59 and the weighted average remaining life was 4.16 years. The
warrants outstanding as of June 30, 2017 had no intrinsic value.
Convertible
Unsecured Notes Warrants
On
September 1, 2016, the Company issued warrants to purchase up to 124,999 shares of common stock to the holders of the Convertible
Unsecured Notes payable. Under the terms of Securities Purchase Agreement for the Convertible Unsecured Notes, the holders of
the Convertible Unsecured Notes were entitled, in the aggregate, to receive additional warrants to purchase up to 62,500 shares
of common stock on each of the following dates: November 1, 2016, December 1, 2016, December 31, 2016, and January 30, 2017, in
each case only in the event that the Convertible Unsecured Notes are not repaid or converted into an equity transaction prior
to each issuance date. The Company issued warrants to purchase up to 250,000 shares of the Company’s common stock between
November 1, 2016 and January 30, 2017, each with a five-year term. The September 1, 2016 and November 1, 2016 warrants were issued
with a $4.00 per share exercise price, subsequently amended to a $3.00 per share exercise price. The Company recorded the difference
in fair value, valued using the Black Scholes pricing model as $30,000 as a result of the price change as an additional debt discount
to be amortized over the expected remaining life of the Convertible Unsecured Notes. The warrants issued on December 1, 2016,
December 31, 2016 and January 30, 2017 were issued with a $3.00 per share exercise price.
Warrants
outstanding as of June 30, 2017 consist of:
|
|
Issue
Date
|
|
Expiry
Date
|
|
Number of
Warrants
|
|
|
Exercise
Price
per Share
|
|
2013 Services Warrants—July
|
|
Jul-13
|
|
Jul-18
|
|
|
9,494
|
|
|
$
|
37.50
|
|
2013 Services Warrants—August
|
|
Aug-13
|
|
Aug-18
|
|
|
729
|
|
|
|
37.50
|
|
2013 Services Warrants—November
|
|
Nov-13
|
|
Nov-18
|
|
|
2,400
|
|
|
|
50.00
|
|
2014 Services Warrants—April(1)
|
|
Apr-14
|
|
Apr-19
|
|
|
13,657
|
|
|
|
39.00
|
|
2014 Services Warrants—September(2)
|
|
Aug-14
|
|
Aug-19
|
|
|
16,000
|
|
|
|
25.00
|
|
2014 PIPE Warrants—September(3)
|
|
Sept-14
|
|
Sept-18
|
|
|
26,500
|
|
|
|
25.00
|
|
2014 Services Warrants—November(4)
|
|
Nov-14
|
|
Nov-18
|
|
|
6,500
|
|
|
|
25.00
|
|
2014 Settlement Warrants—December(5)
|
|
Dec-14
|
|
Dec-19
|
|
|
38,464
|
|
|
|
25.00
|
|
2015 Senior Notes Warrants(6)(14)
|
|
Apr/May-15
|
|
Apr/May-20
|
|
|
219,785
|
|
|
|
3.00
|
|
2015 Services Warrants—May(7)
|
|
May-15
|
|
May-20
|
|
|
5,514
|
|
|
|
12.50
|
|
2015 LOC Guarantee Warrants—November(8)
|
|
Nov-15
|
|
Nov-20
|
|
|
74,000
|
|
|
|
3.00
|
|
2015 Debt Amendment Warrants—December(9)(15)
|
|
Dec-15
|
|
Dec-20
|
|
|
50,000
|
|
|
|
3.00
|
|
2015 PIPE Warrants—December(10)(15)
|
|
Dec-15
|
|
Dec-20
|
|
|
312,500
|
|
|
|
4.00
|
|
2016 Debt Amendment Warrants—February(11)(15)
|
|
Feb-16
|
|
Feb-21
|
|
|
50,000
|
|
|
|
3.00
|
|
2016 Debt Amendment Warrants—March(12)(15)
|
|
Mar-16
|
|
Mar-21
|
|
|
500,000
|
|
|
|
3.00
|
|
2016 Unsecured Debt Warrants (13)
|
|
Sep-16–Jan-17
|
|
Sep-21–Jan-22
|
|
|
374,499
|
|
|
|
3.00
|
|
2016 Senior Notes Warrants
|
|
Dec-16
|
|
Dec-21
|
|
|
3,720,839
|
|
|
|
3.00
|
|
2017 Backstop Security Amendments—April(16)
|
|
Apr-17
|
|
Apr-22
|
|
|
41,000
|
|
|
|
3.00
|
|
Warrants outstanding and exercisable at June 30, 2017
|
|
|
|
|
|
|
5,462,381
|
|
|
$
|
3.59
|
|
(1)
|
The
2014 Services Warrants—April were issued for fees incurred in conjunction with the issuance of convertible notes in
2014. The warrants were valued on the issuance date at $11.50 per share in conjunction with the valuation approach used for
the initial valuation of the warrants issued in connection with the convertible notes issued in 2014.
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
(2)
|
The
2014 Services Warrants—September were issued to a consultant in exchange for advisory services with no readily available
fair value. The warrants were originally issued at an exercise price of $39.00 per share and had a one-time price reset provision
to the exercise price of the warrants issued to investors in the convertible notes offering in April 2014 if the exercise
price of such convertible notes warrants changed prior to September 30, 2014. On September 22, 2014, the exercise price was
changed to $25.00 per share. There are no further exercise price changes for this warrant series. The warrants were valued
using the Black-Scholes option pricing model at $131,000 on the issuance date with an additional $6,000 recorded to expense
on September 22, 2014 to reflect the change in fair value resulting from the exercise price change.
|
|
|
(3)
|
On
September 22, 2014, the Company issued warrants to purchase up to 26,500 shares of common stock with an exercise price of
$25.00 per share in conjunction with placement agent services for the Company’s September 2014 private equity placement.
The warrants were valued using the Black-Scholes option pricing model at $296,000 on the issuance date.
|
(4)
|
On
November 26, 2014, the Company issued warrants to purchase up to 6,500 shares of common stock with an exercise price of $25.00
per share for compensation for investor relations services provided. The warrants were valued using the Black-Scholes option
pricing model at $43,000 on the issuance date.
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(5)
|
On
December 1, 2014, the Company issued warrants to purchase up to 19,232 shares of common stock with an exercise price of $39.00
per share and on December 15, 2014 issued warrants to purchase up to 19,232 shares of common stock with an exercise price
of $25.00 per share to settle potential legal disputes resulting from claims made by the investors in the November 2013 private
equity placement. The warrants issued on December 1, 2014 were issued concurrent with the issuance of 8,462 shares of the
Company’s common stock in partial settlement of the potential legal disputes arising from claims by two investors. The
Company settled all remaining potential legal disputes with all of the remaining investors in the November 2013 private placement
on December 15, 2014 by issuing the second tranche of warrants and setting the exercise price of each warrant series issued
at $25.00 with no further reset provisions. The combined issuance of the warrants and expense resulting from any price changes
were valued using the Black-Scholes option pricing model at $246,000 and expensed to general and administrative expense.
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(6)
|
On
April 23, 2015, the Company issued warrants to purchase up to 136,267 shares of common stock and on May 7, 2015, the Company
issued warrants to purchase up to 83,518 shares of common stock, each with an exercise price of $12.50 per share in conjunction
with the 2015 Senior Notes described in Note 9. The warrants were valued using the Black-Scholes option pricing model at $2,139,000
on the issuance date. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with
the issuance of the 2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00 per share.
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(7)
|
On
May 1, 2015, the Company issued warrants to purchase up to 5,514 shares of common stock with an exercise price of $12.50 per
share in conjunction with placement agent services for the Company’s May 2015 private equity placement. The warrants
were valued using the Black-Scholes option pricing model at $56,000 on the issuance date.
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(8)
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On November 2, 2015, the Company issued warrants to purchase up to 74,000 shares of common stock with an exercise price of $15.00 per share in conjunction with the Letter of Credit described in Note 14. The warrants were valued using the Black-Scholes option pricing model at $246,000 on the issuance date. The warrants are exercisable beginning on November 1, 2016. On April 27, 2017, the exercise price was reduced to $3.00 per share in conjunction with the amendment of the Letter of Credit described in Note 14. The Company recorded additional deferred financing charges of $30,000, representing the difference in fair value immediately before and after the repricing, which will be amortized ratably to expense through March 31, 2018.
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(9)
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On
December 30, 2015, the Company issued warrants to purchase up to 50,000 shares of common stock with an initial exercise price
of $12.50 per share in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above.
On March 31, 2016, concurrent with the issuance of the March 2016 Warrants, the exercise price was reduced to $5.00 per share.
On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the issuance of the
2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00 per share.
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(10)
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On
December 31, 2015, the Company issued warrants to purchase up to 312,500 shares of common stock with an initial exercise price
of $5.00 per share in conjunction with the December private equity placement (the “December PIPE”). The warrants
initially provided that if, prior to the earlier of June 30, 2016 or thirty days after the date on which the December PIPE
shares and underlying warrants are registered for resale, the Company issued common share derivative securities at a price
per share less than $5.00 per share, the Company was obligated to reduce the exercise price of the December PIPE warrants
to a price per share equal to the newly issued shares or derivative common stock securities. This price protection clause
expired on June 30, 2016. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent
with the issuance of the 2016 Senior Notes the exercise price of the warrants was further reduced to $3.00 per share.
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Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
(11)
|
On February 2, 2016, the Company issued warrants to purchase up to 50,000 shares of common stock with an initial exercise price of $12.50 per share in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above. The warrants were valued using the Black-Scholes option pricing model at $148,000 on the issuance date and were recorded as a derivative liability and additional debt discount. The warrants provided that, in the event that the Company issued additional common stock derivative securities at a price per share less than the exercise price, the Company was obligated to reduce the exercise price of the February 2016 Warrants to a price per share equal to the newly issued shares or derivative common stock securities. On March 31, 2016, concurrent with the issuance of the additional debt amendment warrants, the exercise price was reduced to $5.00 per share. This price protection clause expired on June 30, 2016. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00 per share.
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(12)
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On March 31, 2016, the Company issued warrants to purchase up to 500,000 shares of common stock with an initial exercise price of $5.00 per share in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above. The warrants were valued using the Black-Scholes option pricing model at $1,497,000 on the issuance date and were recorded as a derivative liability and additional debt discount. The warrants provided that, in the event that the Company issued additional common stock derivative securities at a price per share less than the exercise price, the Company was obligated to reduce the exercise price of the March 2016 Warrants to a price per share equal to the newly issued shares or derivative common stock securities. This price protection clause expired on June 30, 2016. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00 per share.
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(13)
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On September 1, 2016, the Company issued warrants to purchase up to 124,999 shares of common stock with an initial exercise price of $4.00 per share in conjunction with Unsecured Convertible Notes as described in Note 9 above. The warrants were valued using the Black-Scholes option pricing model at $271,000 on the issuance date and were recorded as additional debt discount. Between November 1, 2016 and December 31, 2016, the Company issued additional warrants to purchase up to 187,500 shares of common stock, as described above. The additional warrants were valued using the Black-Scholes option pricing model at $305,000 and were recorded as additional debt discount. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the warrants issued on November 1, 2016 was reduced to $3.00 per share. The warrants issued on December 1, 2016, December 31, 2016, and January 30, 2017 were issued with an initial exercise price of $3.00 per share. On January 30, 2017 the Company issued 62,500 warrants with an exercise price of $3.00 per share
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(14)
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Warrant exercise price was reduced from $12.50 to $4.00 per share on August 24, 2016 and further reduced to $3.00 per share concurrent with the issuance of the 2016 Senior Notes.
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(15)
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Warrant exercise price was reduced from $5.00 to $4.00 per share on August 24, 2016 and further reduced to $3.00 per share concurrent with the issuance of the 2016 Senior Notes. On August 24, 2016, the warrant agreement was amended to remove all provisions that had previously required derivative liability accounting treatment.
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(16)
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On April 27, 2017, the Company issued a warrant to purchase 41,000 shares of common stock at an exercise price of $3.00 per share in conjunction with the amendment of the Letter of Credit described in Note 14. The warrant was valued using the Black-Scholes option pricing model at $26,000, which will be recorded to deferred financing charges and amortized to expense ratably through the end of March 2018.
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Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
14—Commitments and Contingencies
We
may become a party to litigation in the normal course of business. We accrue for open claims based on our historical experience
and available insurance coverage. In the opinion of management, there are no legal matters involving us that would have a material
adverse effect upon our financial condition, results of operations or cash flows.
Lease
We lease our office facility, research and
development facility and equipment under operating leases, which for the most part, are renewable. The leases also provide that
we pay insurance and taxes. Our primary operating lease expired on December 31, 2016 and we extended the lease for a three-month
period ending March 31, 2017 at a reduced interim rate. We signed a new lease in February 2017 for a separate facility and moved
into our new headquarters facilities in April 2017.
Through
March 31, 2017, our headquarters was located at 9400 Toledo Way, Irvine, California 92618. The property consisted of
a mixed use commercial office, production, and warehouse facility of 32,649 square feet and expired December 31, 2016. We extended
the lease at a reduced rate until March 31, 2017. The monthly rent was $15,000 per month for the three months ended
March 31, 2017. As of April 1, 2017, our headquarters are located at 8965 Research Drive, Irvine, California 92618 and consists
of a mixed use commercial office of 4,960 square feet. From January through March 2017, our monthly rent was $15,000 for the Toledo
Way property holdover and, from April 1, 2017, our monthly rent is $10,168 per month, with annual escalations on April 1, 2018
to $10,473 per month and on April 1, 2019 to $10,787 per month for the Research Drive property. The Toledo Way lease terminated
on April 1, 2017 and the Research Drive property lease expires on March 31, 2020.
Future
minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year as of June 30,
2017 are as follows:
Six months ending December 31, 2017
|
|
$
|
61,000
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|
Year ending December 31, 2018
|
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125,000
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|
Year ending December 31, 2019
|
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128,000
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Year ending December 31, 2020
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32,000
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Total
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$
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346,000
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|
In
addition, we lease space from the Regents of the University of California, Irvine, for the installation and demonstration of the
EC250 equipment. The lease expired on January 1, 2015 and reverted to a month-to-month lease with a monthly payment of $7,780.
The university will provide certain goods and services including certain research and development services.
Standby
Letter of Credit
Pursuant
to the terms of the CLA, the Company is required to provide a backstop security of $2.1 million to secure performance of certain
obligations under the CLA (the “Backstop Security”). Effective November 2, 2015, the Company executed that certain
Backstop Security Support Agreement (the “Support Agreement”), pursuant to which an investor agreed to provide the
Company with financial and other assistance (including the provision of sufficient and adequate collateral) as necessary in order
for the Company to obtain a $2.1 million letter of credit acceptable to Dresser-Rand as the Backstop Security and with an expiration
date of June 30, 2017 (“Letter of Credit”). If the investor is required to make any payments on the Letter of Credit,
subject to the terms of the Intercreditor Agreement (as defined below), the Company must reimburse the investor the full amount
of any such payment. Such payment obligation is secured by a pledge of certain collateral of the Company pursuant to a Security
Agreement dated November 2, 2015 (“Security Agreement”), and the security interest in favor of and the payment obligations
to the investor are subject to the terms of that certain Subordination and Intercreditor Agreement executed concurrently with
the Support Agreement and Security Agreement (the “Intercreditor Agreement”) by and among the investor, the Company
and the collateral agent pursuant to the Senior Notes.
The
term of the Company’s obligations under the Support Agreement (the “Term”) commenced on November 2, 2015, the
issuance date of the Letter of Credit, and will terminate on the earliest of: (a) replacement of the Letter of Credit with an
alternative Backstop Security in favor of Dresser-Rand, (b) Dresser-Rand eliminating the Backstop Security requirement under the
CLA, or (c) the last day of the twenty-fourth calendar month following the commencement of the Term. In consideration of the investor’s
support commitment, the Company paid the investor a one-time fee equal to 4% of the amount of the Letter of Credit and is obligated
to pay a monthly fee equal to 1% of the amount of the Letter of Credit for the first twelve months. If the Support Agreement has
not terminated after the initial twelve months, the Company will pay another one-time fee equal to 4% of the amount of the Letter
of Credit, and a monthly fee equal to 2% of the amount of the Letter of Credit for up to another twelve months.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Amendments to Backstop Security and
Senior Notes
Effective as of April 27, 2017, the Company
executed a First Amendment to the Support Agreement (the “BSSA Amendment”), with the individual investor. The BSSA
Amendment is intended to conform the terms of the Support Agreement and related Letter of Credit to the terms of the CMLA. The
BSSA Amendment (i) reduces the security obligation underlying the Letter of Credit from $2.1 million to $500,000, consistent with
the current terms of the CMLA, (ii) extends the term of the backstop security to March 31, 2018, (iii) reduces the related fee
payable under the Support Agreement to 1% per month for the remainder of the term, (iv) provided for the amendment and restatement
of the warrant issued to the investor in connection with the execution of the Support Agreement in order to reduce the exercise
price per share of common stock of to $3.00 and insert a beneficial ownership blocker provision at 4.99% (as amended and restated,
the “Restated Warrant”) and (v) provided that the Company would issue the investor an additional warrant to purchase
41,000 shares of Common Stock at an exercise price of $3.00 per share, subject to a 4.99% beneficial ownership blocker.
In connection with the execution of the
BSSA Amendment, on April 27, 2017, we and certain investors holding Senior Notes executed first amendments to such Senior Notes
to revise the definition of “Backstop Agreement” to include any amendments, restatements, supplements or other modifications
thereof, as may be permitted thereunder.
Note 15—Subsequent Events
None.