NOTE
2 - GOING CONCERN AND MANAGEMENTS’ PLAN
As
of September 30, 2017, the Company had cash of $93,895 and has reported a net loss of $7,147,991 and has used cash in operations
of $3,385,026 for the nine months ended September 30, 2017. In addition, as of September 30, 2017 the Company has a working
capital deficit of $1,107,476 and an accumulated deficit of $60,706,471. These conditions indicate that there is substantial
doubt about the Company's ability to continue as a going concern within one year from the issuance date of the financial statements.
The
ability of the Company to continue as a going concern is dependent upon its ability to further implement its business plan and
generate sufficient revenue and its ability to raise additional funds by way of a public or private offering.
Historically,
the Company has financed its operations through equity and debt financing transactions and expects to continue incurring operating
losses for the foreseeable future. The Company’s plans and expectations for the next 12 months include raising additional
capital to help fund commercial operations, including product development. The Company utilizes cash in its operations of approximately
$515,000 per month. Management believes, but it cannot be certain, its current holdings of cash along with the cash to be generated
from expected product sales and future financings will be sufficient to meet its projected operating requirements for the next
twelve months from the date of this report.
If
these sources do not provide the capital necessary to fund the Company’s operations during the next twelve months from the
date of this report, the Company may need to curtail certain aspects of its operations or expansion activities, consider the sale
of its assets, or consider other means of financing. The Company can give no assurance that it will be successful in implementing
its business plan and obtaining financing on terms advantageous to the Company or that any such additional financing would be
available to the Company.
NOTE
3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the rules and
regulations of the SEC for interim financial information. In the opinion of the Company’s management, the accompanying condensed
consolidated financial statements reflect all adjustments, consisting of normal, recurring adjustments, considered necessary for
a fair presentation of the results for the interim periods ended September 30, 2017 and 2016. As this is an interim period financial
statement, certain adjustments are not necessary as with a financial period of a full year. Although management believes that
the disclosures in these unaudited condensed consolidated financial statements are adequate to make the information presented
not misleading, certain information and footnote disclosures normally included in financial statements that have been prepared
in accordance U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.
The
accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s financial
statements for the year ended December 31, 2016, which contains the audited financial statements and notes thereto, for the years
ended December 31, 2016 and 2015 included within the Company’s Form 10-K filed with the SEC on March 31, 2017. The interim
results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for
the year ended December 31, 2017 or for any future interim periods.
Use
of Estimates
The
Company prepares its financial statements in conformity with U.S. GAAP. These principles require management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management
believes that these estimates are reasonable and have been discussed with the Board of Directors; however, actual results could
differ from those estimates. The financial statements presented include inventory reserves, fair value of derivative financial
instruments, recoverability of deferred tax assets and collections of its receivables.
Concentrations
of Credit Risk
The
Company maintains its cash accounts at financial institutions which are insured by the Federal Deposit Insurance Corporation (“FDIC”).
At times, the Company may have deposits in excess of federally insured limits.
Revenue
Recognition
The
Company generates revenue through two processes: (1) the sale of its MagneGas2® fuel for metal cutting and (2) the sale of
its Plasma Arc Flow Units. Additionally, the Company also recognizes revenue from territorial license arrangements, and through
the sales of metal cutting gases and related products through their wholly owned subsidiary, Equipment Sales and Service, Inc.
(“ESSI”), a Florida corporation.
●
|
Revenue
for metal-working fuel is recognized when shipments are made to customers. The Company recognizes a sale when the product
has been shipped and risk of loss has passed to the customer and collectability is reasonably assured.
|
|
|
●
|
Revenue
generated from sales of each Plasma Arc Flow Unit is recognized on a percentage of completion, based on the progress during
manufacturing of a Plasma Arc Flow Unit. Plasma Arc Flow Units require a significant investment and generally have a 6 to
9 month production cycle. During the course of building a Plasma Arc Flow Unit the actual costs are tracked to our cost estimates
and revenue is proportionately recognized during the process. Significant deposits are required before production commences.
These deposits are classified as customer deposits. During production, costs and progress earnings are accumulated and included
in “Costs and earnings” as an asset, such amounts have been immaterial to date.
|
|
|
●
|
Licenses
are issued, per contractual agreement, for distribution rights within certain geographic territories. The Company recognizes
revenue ratably, based on the amounts paid or values received, over the term of the licensing agreement.
|
Fair
Value Measurements
Accounting
Standards Codification 820, “Fair Value Measurements and Disclosure,” (“ASC 820”) defines fair value as
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date, not adjusted for transaction costs. ASC 820 also establishes a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices
in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).
The
three levels are described below:
Level
1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that is accessible by the Company;
Level
2 Inputs – Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable,
either directly or indirectly;
Level
3 Inputs – Unobservable inputs for the asset or liability including significant assumptions of the Company and other market
participants.
The
carrying amount of the Company’s financial assets and liabilities, such as cash, accounts payable and accrued expenses approximate
their fair value because of the short maturity of those instruments.
Transactions
involving related parties cannot be presumed to be carried out on an arm’s-length basis, as the requisite conditions of
competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply
that the related party transactions were consummated on terms equivalent to those that prevail in arm’s-length transactions
unless such representations can be substantiated.
The
assets or liability’s fair value measurement within the fair value hierarchy is based upon the lowest level of any input
that is significant to the fair value measurement. The following tables provides a summary of financial instruments that are measured
at fair value as of September 30, 2017 and December 31, 2016, respectively.
The
Company utilized the following range of management assumptions in valuing the derivative conversion features during the period
January 1, 2017 through May 9, 2017, the date the derivative ceased to exist:
Exercise price
|
|
$
|
5.70 – 13.00
|
|
Risk free interest rate
|
|
|
1.94
|
%
|
Dividend yield
|
|
|
-
|
%
|
Expected volatility
|
|
|
142
|
%
|
Remaining term
|
|
|
4.25 – 7.07
|
|
September 30, 2017
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
In Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Liabilities
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Warrant liability
|
|
$
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
—
|
|
Embedded conversion feature
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Derivative liability – September 30, 2017
|
|
$
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
—
|
|
December 31, 2016
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
In Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Liabilities
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Warrant liability
|
|
$
|
7,195,617
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
7,195,617
|
|
Embedded conversion feature
|
|
|
504,968
|
|
|
|
—
|
|
|
|
—
|
|
|
|
504,968
|
|
Derivative liability – December 31, 2016
|
|
$
|
7,700,585
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
7,700,585
|
|
The
table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets and
liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the interim period
ended September 30, 2017:
|
|
|
|
|
Embedded
|
|
|
Total
|
|
|
|
Warrant
|
|
|
Conversion
|
|
|
Derivative
|
|
|
|
Liability
|
|
|
Feature
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Balance – December 31, 2016
|
|
$
|
7,195,617
|
|
|
$
|
504,968
|
|
|
$
|
7,700,585
|
|
Change in fair value
|
|
|
(2,131,990
|
)
|
|
|
(123,332
|
)
|
|
|
(2,255,322
|
)
|
Reclassification of derivative liabilities to equity
|
|
|
(396,854
|
)
|
|
|
(30,714
|
)
|
|
|
(427,568
|
)
|
Derivative extinguishment
|
|
|
(4,666,773
|
)
|
|
|
(350,922
|
)
|
|
|
(5,017,695
|
)
|
Balance – September 30, 2017
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The
Company’s Level 3 liabilities shown in the above table consist of warrants that contain a cashless exercise feature
that provides for their net share settlement at the option of the holder. In addition, the convertible debt conversion
feature has a price reset provision with no floor. The warrants also contain a fundamental transactions provision that
permits their settlement in cash at fair value at the option of the holder upon the occurrence of a change in control. Such
change in control events include tender offers or hostile takeovers, which are not within the sole control of the Company as
the issuer of these warrants. Settlement at fair value upon the occurrence of a fundamental transaction computed using the
Black Scholes Option Pricing Model using the following assumptions:
Assumptions
utilized in the valuation of Level 3 liabilities are described as follows:
|
|
For the nine months ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
Risk free interest rate
|
|
|
0.2%-1.94%
|
|
|
|
0.36
|
%
|
Expected term
|
|
|
0.25 to 7.07 years
|
|
|
|
0.25 to 7.5 years
|
|
Volatility
|
|
|
62% to 142%
|
|
|
|
0.62 to 1.3%
|
|
Dividends
|
|
$
|
0
|
|
|
$
|
0
|
|
The
risk-free interest rate was determined from the implied yields from U.S. Treasury zero-coupon bonds with a remaining term consistent
with the expected term of the instrument being valued. The expected term used is the contractual life of the instrument being
valued. Volatility was calculated using the Company’s historical common stock price over the expected term of the instruments
valued. Dividends were deemed to be $0 as the Company has historically never declared any dividends to its stock holders.
Derivative
Liability
The
Company evaluates its options, warrants or other contracts, if any, to determine if those contracts or embedded components of
those contracts qualify as derivatives to be separately accounted for in accordance with Accounting Standards Codification 815-10-05-4
and 815-40-25. The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each
balance sheet date and recorded as either an asset or a liability. In the event that the fair value is recorded as a liability,
the change in fair value is recorded in the condensed consolidated statement of operations as other income or expense.
Upon conversion, exercise or cancellation of a derivative instrument, the instrument is marked to fair value at the date of conversion,
exercise or cancellation and then the related fair value is reclassified to equity.
The
classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is
re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject
to reclassification are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative
instrument liabilities will be classified in the balance sheet as current or non-current based on whether or not net-cash settlement
of the derivative instrument is expected within 12 months of the balance sheet date.
The Company had no derivative liabilities
as of September 30, 2017.
Beneficial
conversion feature of convertible notes payable
The
Company accounts for convertible notes payable in accordance with the guidelines established by the FASB Accounting Standards
Update (“ASU”) Topic 470-20, Debt with Conversion and Other Options, Emerging Issues Task Force (“EITF”)
98-5, Accounting for Convertible Securities with beneficial conversion features or Contingently Adjustable Conversion Ratios,
and EITF 00-27, Application of Issue No 98-5 To Certain Convertible Instruments. The beneficial conversion feature of a convertible
note is normally characterized as the convertible portion or feature of certain notes payable that provide a rate of conversion
that is below market value or in-the-money when issued. The Company records a beneficial conversion feature related to the issuance
of a convertible note when issued and also records the estimated fair value of any warrants issued with those convertible notes.
The beneficial conversion features that are contingent upon the occurrence of a future event are recorded when the contingency
is resolved.
The
beneficial conversion feature of a convertible note is measured by first allocating a portion of the note’s proceeds to
any warrants, if applicable, as a discount on the carrying amount of the convertible on a relative fair value basis. The discounted
face value is then used to measure the effective conversion price of the note. The effective conversion price and the market price
of the Company’s common stock are used to calculate the intrinsic value of the conversion feature. The intrinsic value is
recorded in the financial statements as a debt discount from the face amount of the note and such discount is amortized over the
expected term of the convertible note (or to the conversion date of the note, if sooner) and is charged to interest expense.
Stock-Based
Compensation
The
Company accounts for stock based compensation costs under the provisions of Accounting Standards Codification 718, “Compensation—Stock
Compensation” (“ASC 718”), which requires the measurement and recognition of compensation expense related to
the fair value of stock based compensation awards that are ultimately expected to vest. Stock based compensation expense recognized
includes the compensation cost for all stock based payments granted to employees, officers, and directors based on the grant date
fair value estimated in accordance with the provisions of ASC 718. ASC 718 is also applied to awards modified, repurchased, or
canceled during the periods reported.
Stock-Based
Compensation for Non-Employees
The
Company accounts for warrants and options issued to non-employees under Accounting Standards Codification 505-50, “Equity
– Equity Based Payments to Non-Employees”, using the Black-Scholes option-pricing model. The value of such non-employee
awards unvested are re-measured over the vesting terms at each reporting date.
The
Company incurred stock-based compensation charges, net of estimated forfeitures of $406,486 and $343,331 for the
three months ended September 30, 2017 and $2,288,741 and $820,500 for the nine months ended September 30, 2017 and
2016, respectively and has included such amounts in selling, general and administrative expenses in the condensed consolidated
statements of operations.
Basic
and Diluted Net (Loss) per Common Share
Basic
(loss) per common share is computed by dividing the net (loss) by the weighted average number of shares of common stock outstanding
for each period. Diluted (loss) per share is computed by dividing the net (loss) by the weighted average number of shares of common
stock outstanding plus the dilutive effect of shares issuable through the common stock equivalents.
As
of September 30, 2017 and 2016 the Company’s common stock equivalents outstanding.
|
|
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
Options
|
|
|
230,100
|
|
|
|
4,729,500
|
|
Common Stock Warrants
|
|
|
3,333,334
|
|
|
|
23,266,241
|
|
Preferred Stock Warrants
|
|
|
8,228,333
|
|
|
|
-
|
|
Convertible secured debentures
|
|
|
82,857
|
|
|
|
1,754,386
|
|
Total common stock equivalents outstanding
|
|
|
11,874,624
|
|
|
|
29,750,127
|
|
Derivative
Financial Instruments
The
fair value of an embedded conversion option that is convertible into a variable amount of shares and warrants that include price
protection reset provision features are deemed to be “down-round protection” and, therefore, do not meet the scope
exception for treatment as a derivative under Accounting Standards Codification 815 “Derivatives and Hedging” (“ASC
815”), since “down-round protection” is not an input into the calculation of the fair value of the conversion
option and warrants and cannot be considered “indexed to the Company’s own stock” which is a requirement for
the scope exception as outlined under ASC 815. The accounting treatment of derivative financial instruments requires that the
Company record the embedded conversion option and warrants at their fair values as of the inception date of the agreement and
at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income
or expense for each reporting period at each balance sheet date. The Company reassesses the classification of its derivative instruments
at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified
as of the date of the event that caused the reclassification. As a result of entering into a convertible credit facility for which
such instruments contained a variable conversion feature with no floor, the Company has adopted a sequencing policy in accordance
with Accounting Standards Codification 815-40-35-12 whereby all future instruments may be classified as a derivative liability
with the exception of instruments related to share-based compensation.
The
Black-Scholes option valuation model was used to estimate the fair value of the warrants and conversion options. The model includes
subjective input assumptions that can materially affect the fair value estimates. The Company determined the fair value of the
Binomial Lattice Model and the Black-Scholes Valuation Model to be materially the same. The expected volatility is estimated based
on the most recent historical period of time equal to the weighted average life of the warrants. Conversion options are recorded
as debt discount and are amortized as interest expense over the life of the underlying debt instrument.
The Company had no derivative liabilities
as of September 30, 2017.
Recent
Accounting Policies
In
May 2016, the FASB issued ASU 2016-12,
Revenue from Contracts with Customers
(“ASC 606”)
: Narrow-Scope
Improvements and Practical Expedients
, (“ASU 2016-12”). The amendments in ASU 2016-12 provide clarifying guidance
in certain narrow areas and add some practical expedients. Specifically, the amendments in this update (1) clarify the objective
of the collectability criterion in step 1, and provides additional clarification for when to recognize revenue for a contract
that fails step 1, (2) permit an entity, as an accounting policy election, to exclude amounts collected from customers for all
sales (and other similar) taxes from the transaction price (3) specify that the measurement date for noncash consideration is
contract inception, and clarifies that the variable consideration guidance applies only to variability resulting from reasons
other than the form of the consideration, (4) provide a practical expedient that permits an entity to reflect the aggregate effect
of all modifications that occur before the beginning of the earliest period presented when identifying the satisfied and unsatisfied
performance obligations, determining the transaction price, and allocating the transaction price to the satisfied and unsatisfied
performance obligations, (5) clarifies that a completed contract for purposes of transition is a contract for which all (or substantially
all) of the revenue was recognized under legacy GAAP before the date of initial application. Further, accounting for elements
of a contract that do not affect revenue under legacy GAAP are irrelevant to the assessment of whether a contract is complete.
In addition, the amendments permit an entity to apply the modified retrospective transition method either to all contracts or
only to contracts that are not completed contracts, and (6) clarifies that an entity that retrospectively applies the guidance
in ASC 606 to each prior reporting period is not required to disclose the effect of the accounting change for the period of adoption.
However, an entity is still required to disclose the effect of the changes on any prior periods retrospectively adjusted. The
effective date and transition requirements for the amendments are the same as the effective date and transition requirements in
ASC 606. The guidance is effective for the Company beginning January 1, 2019, although early adoption is permitted beginning January
1, 2017. The Company is in the process of performing an initial review of custom contracts to determine the impact that ASU 2014-09
and its subsequent updates through December 31, 2016 will have on the Company's condensed consolidated financial statements
or financial statement disclosures upon adoption. Based on this preliminary review, the Company believes that the timing and measurement
of revenue for these customers will be similar to the current revenue recognition. However, this view is preliminary and could
change based on the detailed analysis associated with the conversion and implementation phases of ASU 2014-09. The Company will
complete the assessment during 2017, and will include other significant customers as part of the review. The Company
intends to transition method, retrospectively adopting with the cumulative effect of initially applying the standard at the date
of initial application.
In
May 2017, the FASB issued ASU 2017-09, “
Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,”
which 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. This standard is required to be adopted in the first quarter of 2018. The Company
is currently evaluating the impact this guidance will have on its condensed consolidated financial statements and related
disclosures.
In
July 2017, the FASB issued ASU 2017-11, “Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480)
and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; 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”. Part I of this update addresses the complexity of accounting
for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments
(or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current
accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible
instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Part
II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence
of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite
deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain
mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not have an accounting effect. This
ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company has
early adopted the accounting guidance and as such, has not accounted for down round provisions as derivative liabilities.
In
September 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-03,
Revenue
Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842).
The
new standard, among other things, provides additional implementation guidance with respect to Accounting Standards Codification
(ASC) Topic 606 and ASC Topic 842. ASU 2017-03 is effective for annual and interim fiscal reporting periods beginning after December
15, 2017. The Company is currently evaluating the impact of the new standard, but does not expect it to have a material impact
on its implementation strategies or its condensed consolidated financial statements upon adoption.
Subsequent
Events
The
Company evaluates events that have occurred after the balance sheet date but before the financial statements are issued. Based
upon the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required
adjustment or disclosure in the condensed consolidated financial statements, except as disclosed in Note. 9
NOTE
4 - INVENTORY, NET
Inventory
primarily consists of:
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
Production materials consumables, spare parts, and accessories
|
|
$
|
991,908
|
|
|
$
|
937,133
|
|
Work in process
|
|
|
862,949
|
|
|
|
853,800
|
|
Total at cost
|
|
|
1,854,857
|
|
|
|
1,790,933
|
|
Slow moving inventory reserve
|
|
|
(250,000
|
)
|
|
|
(175,000
|
)
|
|
|
|
|
|
|
|
|
|
Inventory, net
|
|
$
|
1,604,857
|
|
|
$
|
1,615,933
|
|
NOTE
5 – NOTES PAYABLE
Notes
Payable – Related Parties
On
April 3, 2017, the Company entered into a $50,000 promissory note with a member of the Board of Directors. The note bears interest
of 15% as is due on July 3, 2017. As of November 14, 2017, the Note has not been repaid.
On
April 11, 2017, the Company entered into a $50,000 promissory note with the Company’s Chief Executive Officer (“CEO”).
The note bears interest of 15% and is due on July 11, 2017. The CEO funded an additional $7,103 and the entire balance was repaid
as of August 21, 2017.
During
the period July 1, 2017 through September 30, 2017, the Company’s Chief Executive officer continued to fund working capital
in the amount of $174,801. There is no formal note agreement
, stated interest rate or maturity date.
Note
Payable:
On
May 9, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with an institutional investor providing
for the sale and issuance of 8% Senior Debentures. Pursuant to the SPA, the Company agreed to sell, and the investor agreed to
purchase up to an aggregate of $1,000,000 principal amount of Senior Debentures (“Debenture”). The Debenture is due
in November 2017 and bears interest at a rate of 8% per annum based on a 360-day year. The Company is required to make interest
payments quarterly beginning on the original issuance date of the Debenture. The Debenture is unsecured and is not convertible.
The
Company recognized issuance costs of $60,000 as recognized as a debt discount and will expense over the maturity of the note using
the straight-line method which approximates the interest rate method. During the three months ended September 30, 2017
the Company recorded an expense of $30,000, and during the nine months ended September 30, 2017 the Company recorded an expense
of $46,957 leaving an unamortized balance of $13,043.
Convertible
Note Payable:
Pursuant
to terms of that certain Exchange Agreement entered into in conjunction with the SPA, the Company also agreed to amend the terms
of a certain Convertible Debenture held by the investor, which had a current outstanding principal amount of $829,000 on
the date of the Exchange (May 9, 2017), as follows: (i) the Conversion Price of the Convertible Debenture is reduced from $0.57
to $0.30, subject to adjustment under the Exchange Agreement or under the terms of such Convertible Debenture, which will result
in an increase of 1,308,947 shares of Common Stock that may be issuable upon conversion of the Convertible Debenture and (ii)
the Company shall be permitted to prepay the then-outstanding principal amount of the Convertible Debenture, together with a prepayment
premium in the amount of 10% of the principal amount being prepaid.
The Company assessed the exchange for extinguishment
versus modification accounting. The Company evaluated the fair value of the instrument prior to the exchange and compared such
value to the fair value of the consideration received. Because the fair value of the consideration received was greater than 10%,
the Company applied extinguishment accounting, resulting in an extinguishment loss of $513,725, which was recorded in other
income/expense. In addition, because the derivative liability embedded in the convertible note ceased to exist, the Company
recorded $350,922 into paid in capital.
The
Company recorded a full beneficial conversion discount against the note of $829,000 and will expense such discount over the remaining
maturity of the note using the straight line method which approximates the interest rate method.
During the period ended September 30, 2017,
the noteholder converted $800,000 in principal into 2,285,714 shares of the Company’s common stock at a conversion rate of
$0.35 per share. As a result of the conversion, the Company fully accreted the $800,000 in debt discount. During the period
ended September 30, 2017, the Company recorded an expense of $1,496 on the remaining debt discount associated with the remaining
$29,000 in unconverted principal.
NOTE
6 - STOCKHOLDERS’ EQUITY
On
May 18, 2017, the Company filed a Certificate of Amendment to Certificate of Incorporation (the “Certificate of Amendment”)
with the Delaware Secretary of State to effect a one-for-ten reverse split of the Company’s issued and outstanding common
stock (the “Reverse Stock Split”), and the Reverse Stock Split became effective in accordance with the terms of the
Certificate of Amendment at 5:00 p.m. Eastern Time on May 19, 2017 (the “Effective Time”).
At
the Effective Time, every ten shares of the Company’s common stock issued and outstanding were automatically combined into
one share of common stock, without any change in the par value per share. The Company did not issue any fractional shares
in connection with the Reverse Stock Split. Instead, fractional shares were entitled, upon surrender of certificate(s)
representing shares, to receive a cash payment in lieu of the fractional shares without interest. The Reverse Stock Split did
not modify the rights or preferences of the common stock. Proportional adjustments have been made to the conversion and exercise
prices of the Company’s outstanding warrants, convertible notes, convertible preferred stock and stock options, and to the
number of shares issued and issuable under the Company’s equity compensation plans.
All
share and per share amounts for the common stock have been retroactively restated to give effect to the reverse split.
On
June 14, 2017, the Company filed an Amended and Restated Certificate of Incorporation with the Secretary of State of the State
of Delaware to, among other things, increase the number of authorized shares of common stock from ninety million (90,000,000)
to one hundred ninety million (190,000,000). The proposal for the amendment was approved by the Company’s shareholders at
a Special Meeting of Shareholders held on May 17, 2017.
On
July 12, 2017, the Board of Directors submitted the following actions to the Majority Stockholder for ratification and approval
by consent in lieu of meeting, and the Majority Stockholder has ratified and approved the following actions: approving the MagneGas
Corporation Amended and Restated 2014 Equity Incentive Award Plan (the “New Plan”), for the principal purpose of increasing
the number of shares that may be issued or transferred pursuant to awards under the New Plan.
Common
shares issued for services
During
the three months ended September 30, 2017, the Company issued 815,000 shares of the Company’s common stock to key advisors
and consultants of the Company. The total value of these issuances is $741,675.
During
the nine months ended September 30, 2017, the Company issued 1,442,276 shares of the Company’s common stock to key
advisors and consultants of the Company. The total value of these issuances is $2,288,741.
Common
Stock Issued for Exercise of Warrants
During
the nine months ended September 30, 2017 the Company issued 79,371 shares of common stock for the exercise of warrants, cash proceeds
were $7,937. The exercise of these warrants resulted in a reduction of the derivative liability associated with these warrants
of $396,854, which has been reclassified to additional paid in capital.
Conversion
of Convertible Note into Shares of Common Stock
During
the nine months ended September 30, 2017 the Company issued 10,000 shares of common stock for conversion of $57,000 of senior
convertible debentures. The conversion of the $57,000 resulted in the reduction of the derivative liability associated with the
embedded conversion feature of $30,714, which has been reclassified to additional paid in capital.
Series
A Preferred Stock
As
of September 30, 2017, the Company has designated 1,000,000 shares of Series A Preferred Stock and 1,000,000 shares are issued
and outstanding. The Series A Preferred Stock does not have any conversion provision or provides for cumulative dividends and
each share of Series A Preferred Stock had voting rights equal to 100,000 shares of common stock. The Series A Preferred Stock
has no redemption provision at the option of the holder and accordingly has been classified as permanent equity.
Series
B Convertible Preferred Stock
On
May 9, 2017, the Company entered into an Exchange Agreement (“Exchange Agreement”) with an institutional investor
(“Investor”). Under the terms of the Exchange Agreement, the Investor agreed to exchange with the Company (the “Exchange”),
Warrants, exercisable for 22,198,554 shares of Company Common Stock, for (i) 2,700 shares of newly issued Series B Convertible
Preferred Stock at a stated value of $1,000 per share and convertible into 9,000,000 shares of Common Stock at a conversion price
of $3.00 and (ii) 1,000,000 shares of newly issued Common Stock (collectively, the “Exchange Securities”). The preferred
stock and common shares were recorded at fair market value. As a result of the Exchange Agreement and the derivative warrant
liability ceasing to exist, the Company recorded a $4,666,773 addition to paid in capital.
Pursuant
to terms of the Exchange Agreement, the Company also agreed to amend the terms of the Convertible Debentures, which had
a current outstanding principal amount of $829,000, as follows: (i) the Conversion Price of the Convertible Debenture was
reduced from $5.70 to $3.00, subject to adjustment under the Exchange Agreement or under the terms of such Convertible Debenture,
which will result in an increase of 1,308,947 shares of Common Stock that may be issuable upon conversion of the Convertible Debenture
and (ii) the Company shall be permitted to prepay the then-outstanding principal amount of the Convertible Debenture, together
with a prepayment premium in the amount of 10% of the principal amount being prepaid.
In
conjunction with the Exchange, the Company filed a Certificate of Designation with the Delaware Secretary of State. The Certificate
of Designation designated a new class of Series B Convertible Preferred Stock (“Preferred Stock”). The Preferred Stock
is convertible in shares of Common Stock at a price of $3.00 per share. The Corporation previously received the unanimous written
consent of the Board of Directors and the holder of the Series A Preferred Stock authorizing the creation of the class of Series
B Convertible Preferred Stock. The holders of Series B Convertible Preferred Stock would receive upon liquidation, the same amount
that a holder of common stock would receive if the preferred stock were fully converted, paid pari passu with all holders of common
stock.
As
of May 9, 2017, the Company has issued 2,700 shares of newly designated Series B Convertible Preferred Stock of which none are
outstanding as of September 30, 2017. The Series B Convertible Preferred Stock included a conversion into common stock at price
of $3.00 per share subject to subsequent equity sales reset provisions. The conversion provision was at the option of the holder
and the Series B Convertible Preferred Stock did not provide for cumulative dividends.
During
the nine months ended September 30, 2017, 2,700 shares of the Series B Convertible Preferred Stock were converted into 900,000
shares of the Company’s common stock an exchange rate of $3.00 per share.
Series
C Convertible Preferred Stock
On
June 12, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with one or more investors. Under
the terms of the SPA, the Company agreed to issue and sell to each investor, Series C Convertible Preferred Stock (“Preferred
Shares”), Series C Convertible Preferred Warrants (“Preferred Warrants”) and Common Stock Purchase Warrants
(“Common Stock Warrants”), for a total gross purchase price of up to $25,000,000. At the initial closing under the
SPA, the Company issued a total of 75 Preferred Shares at a purchase price of $900 per share. The Preferred Warrants are
exercisable for a total of 24,925 Preferred Shares at an exercise price of $900 per share. The Preferred Shares have
an initial conversion price of $3.00 and are initially convertible into an aggregate of 8,333,334 shares of common stock.
The Common Stock Warrants are exercisable for 2,916,667 shares of common stock, representing thirty-five percent (35%) of the
total number of shares of common stock initially issuable upon conversion of the Preferred Shares. The exercise price of the Common
Stock Warrants is $3.00 per share and are exerciseable for 5 years.
In conjunction with the SPA, the Company
designated a new class of preferred stock as “Series C Convertible Preferred Stock” in the aggregate amount of 25,000
shares. The Preferred Shares have a stated value of $1,000, with an aggregate value of $25,000,000. The initial conversion price
of the Preferred Shares is $3.00.
The holders of Preferred Shares are entitled
to receive dividends, when and as declared by the Board, from time to time, in its sole discretion. From and after the occurrence
of a Triggering Event (as defined in the certificate of designation for the Preferred Shares) until such time as all Triggering
Events then outstanding are cured, the holders shall be entitled to receive Dividends at a rate of eighteen percent (18.0%) per
annum, which dividends shall be computed on the basis of a 360-day year and twelve 30-day months and shall compound each calendar
month. No such triggering events occurred during the period ended September 30, 2017.
At
any time after the occurrence of a Triggering Event the holder may, at its option, convert any Preferred Shares at an Alternate
Conversion Price. The “Alternate Conversion Price” means the lower of (A) the applicable conversion price as then
in effect and (B) the greater of (x) $0.35 and (y) the lowest of (i) 85% of the VWAP of the common stock as of the trading day
immediately preceding the delivery or deemed delivery of the applicable conversion notice, (ii) 85% of the VWAP of the common
stock as of the trading day of the delivery or deemed delivery of the applicable conversion notice and (iii) 85% of the price
computed as the quotient of (I) the sum of the VWAP of the common stock for each of the ten (10) trading days with the lowest
VWAP of the common stock during the twenty (20) consecutive trading day period ending and including the trading day immediately
preceding the delivery or deemed delivery of the applicable conversion notice, divided by (II) ten (10).
In
lieu of conversion, upon a Triggering Event, the holder may require the Company to redeem all or any of the Preferred Shares at
a price equal to the greater of (i) the product of (A) the conversion amount of the Preferred Shares to be redeemed multiplied
by (B) a redemption premium of 115% and (ii) the product of (X) the conversion rate with respect to the conversion amount in effect
at such time of redemption multiplied by (Y) the product of (1) a redemption premium of 115% multiplied by (2) the greatest closing
sale price of the common stock on any trading day during the period commencing on the date immediately preceding such Triggering
Event and ending on the date the Company makes the entire redemption payment.
The
Company may, at its option following notice to each holder, redeem such amount of Preferred Shares by paying to each holder the
corresponding installment amount in cash. The applicable installment conversion price with respect to a particular date of determination,
shall be equal to the lower of (A) the conversion price then in effect and (B) the greater of (x) $0.35 and (y) the lower of (i)
85% of the VWAP of the common stock as of the trading day immediately preceding the applicable Installment Date and (ii) 85% of
the quotient of (A) the sum of the VWAP of the common stock for each of the ten (10) trading days with the lowest VWAP of the
common stock during the twenty (20) consecutive trading day period ending and including the trading day immediately prior to the
applicable Installment Date, divided by (B) ten (10).
If
the Company elects to effect an installment redemption in lieu of an installment conversion, in whole or in part, such Preferred
Shares shall be redeemed by the Company in cash on the applicable Installment Date in an amount equal to 103% of the applicable
installment redemption amount.
As a
result of such Triggering Event discussed above, the Series C Preferred Stock has redeemable features which are not in
the Company’s control and therefore should not be included in permanent equity. Management has classified the Series
C Preferred Stock in temporary equity in accordance with ASC 480-10-S99-3A on the condensed Consolidated Balance Sheet.
During the nine months ended September
30, 2017, the warrant holders exercised 240 Preferred Warrants into 240 Preferred Shares. The investors simultaneously converted
the 240 shares (and the previously issued 75 Preferred Shares) into 785,243 shares of the Company’s Common Stock.
Management analyzed the conversion features
embedded in the Preferred Warrants and Preferred Shares and because the Preferred Warrants may not be exercised unless the registration
statement is effective, no derivative liability has been recognized. The Company recorded a beneficial conversion feature in the
amount of $826,182. The beneficial conversion feature was recognized as a deemed dividend.
Maxim
Group, LLC (“Maxim”) acted as the exclusive placement agent for the aforementioned transaction. The Company agreed
to pay Maxim a cash fee payable upon each closing equal to 6.0% of the gross proceeds ($4,050 in cash fees and a legal expense
reimbursement of $5,000) received by the Company at each Closing (the “Placement Fee”). Such fees were recognized
as stock issuance costs. Additionally, the Company granted to Maxim (or its designated affiliates) warrants to purchase up to
416,667 shares common stock (the “Placement Agent Warrants”). The Placement Agent Warrants expire five (5) years after
the Closing. The Placement Agent Warrants are exercisable at a price per share equal to $3.30. The Placement Agent Warrants are
not be redeemable and are exercisable for 5 years. The Placement Agent Warrants may be exercised in whole or in part and provide
for a “cashless” exercise, except in the event the shares of common stock issuable upon exercise of the Placement
Agent Warrants are registered for resale, in which case they provide for a “cash” exercise only. The Placement Agent Warrants
were recorded at fair value as a stock issuance costs. Although the Placement Agent Warrants contain certain change in control
provisions that are potentially settleable in cash, such settlement is at the Company’s discretion.
Series
D Convertible Preferred Stock
On
July 21, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with one or more investors. Under
the terms of the SPA, the Company agreed to issue and sell to each Investor, and each investor severally, but not jointly, agreed
to purchase from the Company shares of Common Stock (“Common Stock”), and Series D Convertible Preferred Warrants
(“Preferred Warrants”) for a total gross purchase price of up to $844,422. On July 27, 2017, at the initial
closing under the SPA, the Company issued to the Investors a total of 150,000 shares of Common Stock at a purchase price of $1.00
per share. The Preferred Warrants are exercisable for a total of 694,422 Preferred Shares at an exercise price of $1.00 per share.
The Preferred Shares have an initial conversion price of $1.00 and are initially convertible into an aggregate of 694,422 shares
of Common Stock.
The
Company designated a new class of preferred stock as “Series D Convertible Preferred Stock” in the aggregate amount
of 694,422 shares. The Preferred Shares have a stated value of $1.00, with an aggregate value of $694,422.
The
holders of Preferred Shares shall be entitled to receive dividends, when and as declared by the Board, from time to time, in its
sole discretion. From and after the occurrence of a Triggering Event (as defined in the certificate of designations for the Preferred
Shares) until such time as all Triggering Events then outstanding are cured, the holders shall be entitled to receive Dividends
at a rate of eighteen percent (18.0%) per annum, which dividends shall be computed on the basis of a 360-day year and twelve 30-day
months and shall compound each calendar month.
The
initial conversion price of the Preferred Shares is $1.00.
During the period July 1, 2017 through September
30, 2017, the 694,422 shares of Series D Preferred Shares were converted into 1,801,497 shares of the Company’s
Common Stock at an average conversion price of $0.39 per share.
Series
E Convertible Preferred Stock
On
September 15, 2017,
the Company designated a new class of preferred stock as “Series E Convertible Preferred Stock”
in the aggregate amount of 455,882 shares. The Preferred Shares have a stated value of $1.36, with an aggregate value of $620,000.
The
holders of Preferred Shares will be entitled to receive dividends, when and as declared by the Board, from time to time,
in its sole discretion. From and after the occurrence of a Triggering Event (as defined in the certificate of designations for
the Preferred Shares) until such time as all Triggering Events then outstanding are cured, the holders shall be entitled to receive
Dividends at a rate of eighteen percent (18.0%) per annum, which dividends shall be computed on the basis of a 360-day year and
twelve 30-day months and shall compound each calendar month.
The
initial conversion price of the Preferred Shares will be $1.36.
At
any time after the occurrence of a Triggering Event the holder may, at its option, convert any Preferred Shares at an Alternate
Conversion Price. The “Alternate Conversion Price” means with respect to any Alternate Conversion that price which
shall be the lowest of (A) the applicable Conversion Price as in effect on the applicable Conversion Date of the applicable Alternate
Conversion and (B) the greater of (x) the Floor Price and (y) the lowest of (i) 75% of the Closing Bid Price of the Common Stock
as of the Trading Day immediately preceding the delivery or deemed delivery of the applicable Conversion Notice, (ii) 75% of the
VWAP of the Common Stock as of the Trading Day of the delivery or deemed delivery of the applicable Conversion Notice, (iii) 75%
of the sum of the lowest VWAP of the Common Stock for each Trading Day during three (3) out of the ten (10) consecutive Trading
Day period ending and including the Trading Day immediately preceding the delivery or deemed delivery of the applicable Conversion
Notice, divided by (I) three (3), (iv) 75% of the price computed as the quotient of (I) the sum of the lowest VWAP of the Common
Stock for each Trading Day during five (5) of the twenty (20) consecutive Trading Day period ending and including the Trading
Day immediately preceding the delivery or deemed delivery of the applicable Conversion Notice, divided by (II) five (5).
In
lieu of conversion, upon a Triggering Event, the holder may require the Company to redeem all or any of the Preferred Shares at
a price equal to the greater of (i) the product of (A) the Conversion Amount of the Preferred Shares to be redeemed multiplied
by (B) the 115% and (ii) the product of (X) the Conversion Rate with respect to the Conversion Amount of such Preferred Shares
in effect at such time as such Holder delivers a Triggering Event Redemption Notice multiplied by (Y) the product of (1) the 115%
multiplied by (2) the greatest Closing Sale Price of the Common Stock on any Trading Day during the period commencing on the date
immediately preceding such Triggering Event and ending on the date the Company makes the entire payment required to be made.
As
of September 30, 2017, no issuances on the Series E Preferred Stock had been made.
Options
Options
outstanding as of September 30, 2017 consisted of the following:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Options
|
|
|
Exercise
|
|
|
Remaining
|
|
|
Intrinsic
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life in Years
|
|
|
Value
|
|
December 31, 2016
|
|
|
468,100
|
|
|
|
13.70
|
|
|
|
1.23
|
|
|
|
13.60
|
|
Granted
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(238,000
|
)
|
|
|
15.00
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
|
230,100
|
|
|
|
10.77
|
|
|
|
1.83
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2017
|
|
|
230,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of September 30, 2017, the fair value of non-vested options totaled $549,128 which will be amortized to expense over the weighted
average remaining term of 1.83 years.
The
fair value of each employee option grant is estimated on the date of the grant using the Black-Scholes option-pricing model. Key
weighted-average assumptions used to apply this pricing model during the nine months ended 2016 were as follows:
Risk free interest rate
|
|
|
1.10
|
%
|
Expected term
|
|
|
3-5 years
|
|
Volatility
|
|
|
55.6
|
%
|
Dividends
|
|
$
|
0
|
|
Common
Stock Warrants
Warrants
outstanding as of September 30, 2017 consisted of the following:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Warrants
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life in Years
|
|
Balance -December 31, 2016
|
|
|
22,992,262
|
|
|
|
9.10
|
|
|
|
5.8
|
|
Granted
|
|
|
3,333,334
|
|
|
|
3.04
|
|
|
|
5.0
|
|
Exercised
|
|
|
(793,708
|
)
|
|
|
0.10
|
|
|
|
|
|
Forfeited/Exchanged
|
|
|
(22,198,554
|
)
|
|
|
12.40
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance- September 30, 2017
|
|
|
3,333,334
|
|
|
|
3.04
|
|
|
|
4.65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2017
|
|
|
3,333,334
|
|
|
|
|
|
|
|
|
|
During
the nine months ended September 30, 2017 the Company issued 79,371 shares of common stock for the exercise of warrants, cash proceeds
were $7,937.
Preferred
Stock Warrants
Warrants
outstanding to purchase Series C Preferred Stock as of September 30, 2017 consisted of the following:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Warrants
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life in Years
|
|
Balance -December 31, 2016
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Granted
|
|
|
24,925
|
|
|
|
900
|
|
|
|
5.0
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Forfeited/Exchanged
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance- September 30, 2017
|
|
|
24,925
|
|
|
|
900
|
|
|
|
4.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2017
|
|
|
24,925
|
|
|
|
|
|
|
|
|
|
NOTE
7 - RELATED PARTY TRANSACTIONS
The
Company previously occupied 5,000 square feet of a building owned by a related party. Rent was payable at
$4,000 on a month to month basis. The facility allowed for expansion needs. The lease was held by EcoPlus, Inc.,
a company that is effectively controlled by Dr. Ruggero Santilli, a former officer and director of the Company and one of the
people who currently has voting and investment control over 1,000,000 shares of Series A Preferred Stock which, in turn, has 100,000
votes per share on any matters brought to a vote of the common stock shareholders. Rent expense for both the nine months ended
September 30, 2017 and 2016 under this lease was approximately $12,000. The lease was terminated on May 27, 2017.
NOTE
8 - COMMITMENTS AND CONTINGENCIES
Litigation
Certain
conditions may exist as of the date the condensed consolidated financial statements are issued which may result in a loss
to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company assesses such
contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related
to legal proceedings that are pending against the Company, or unasserted claims that may result in such proceedings, the Company
evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of
relief sought or expected to be sought therein.
If
the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability
can be estimated, then the estimated liability would be accrued in the Company’s condensed consolidated financial
statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible,
or is probable, but cannot be estimated, then the nature of the contingent liability and an estimate of the range of possible
losses, if determinable and material, would be disclosed.
Loss
contingencies considered remote are generally not disclosed, unless they involve guarantees, in which case the guarantees would
be disclosed. There can be no assurance that such matters will not materially and adversely affect the Company’s business,
financial position, and results of operations or cash flows.
On
April 16, 2015, there was an accident at the Company’s facilities which occurred during the gas filling process. As a result
of the accident, one employee was killed and one was injured but has recovered and has returned to work. Although the Company
has Workers Compensation Insurance and General Liability Insurance, the financial impact of the accident is unknown at this time.
No customers have terminated their relationship with the Company as a result of the accident. On October 14, 2015 the Company
received their final report from the Occupational and Safety Hazard Administration (“OSHA”) related to the accident.
The OSHA report included findings, many of which were already resolved and a proposed citation. The Company was not cited for
any willful misconduct and no final determination was made as to the cause of the accident. The Company received citations related
to various operational issues and received an initial fine of $52,000. The Company has also been informed by the U.S. Department
of Transportation that it has closed its preliminary investigation with no findings or citations to the Company. The U.S. Department
of Transportation has the right to re-open the investigation should new information become available.
The
Company is still investigating the cause of the accident and there have been no conclusive findings as of this time. It is unknown
whether the final cause of the accident will be determined and whether those findings will negatively impact Company operations
or sales. The Company continues to be fully operational and transparent with all regulatory agencies. As of September 30, 2016
the Company has not accrued for any contingency.
On
November 18, 2016 a lawsuit was filed in District Court in Pinellas County, Florida by the Estate of Michael Sheppard seeking
unspecified damages. The lawsuit alleges that the Company was negligent and grossly negligent in various aspects of its safety,
training and overall work environment that led to the accident. The Company was not cited by OSHA for any willful misconduct nor
did it receive any citations from the Department of Transportation. As of September 30, 2017 the Company has not accrued for any
contingency.
NOTE
9 – SUBSEQUENT EVENTS
During the period October 1, 2017 through
November 14, 2017, the warrant holders exercised 2,005 Preferred Warrants into 2,005 Series C Preferred Shares. The investors
converted the 1,827 Series C Preferred Shares into 5,100,497 shares of the Company’s Common Stock.
On November 1, 2017, the Company issued
250,000 shares of the Company’s common stock to a consultant of the Company. The total value of this issuance is $113,750
(or $0.455/share).
On October 2, 2017, The Company entered
into an “Assignment of Purchase Agreement” (the “Assignment”) with its wholly owned subsidiary MagneGas
Energy Solutions, LLC (“Subsidiary”). Under the terms of the Assignment, the Company’s wholly owned Subsidiary
shall assume the position of the Company in that certain “MagneGas Systems Purchase Agreement” entered into between
the Company and Talon Ventures & Consulting GmbH, on December 30, 2016 (“Purchase Agreement”).
On October 16, 2017, The Company and its
wholly owned subsidiary entered into a second MagneGas Systems Purchase Agreement (“Second Purchase Agreement”) with
Talon Ventures & Consulting GMBH, a company constituted under the laws of Germany (“Talon”) to manufacturer
and deliver a 300KW stationary gasification system (“Unit”). The purchase price for the Unit is $1,575,000.00 (the
“Purchase Price”). A partial payment of $1,000,000 shall be made to MagneGas within six (6) months following the execution
of the Second Purchase Agreement. The balance of the Purchase Price must be paid to MagneGas on or before the one year anniversary
following the execution of this Agreement. MagneGas shall complete manufacture of the Unit on or before the one year anniversary
of the Second Purchase Agreement.
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
|
Cautionary
Notice Regarding Forward Looking Statements
The
following is a “safe harbor” statement under the Private Securities Litigation Reform Act of 1995. Statements contained
in this document that are not based on historical facts are “forward-looking statements.” This Management’s
Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q contain forward-looking
statements. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance
and underlying assumptions that are not statements of historical facts. This document and any other written or oral statements
made by us or on our behalf may include forward-looking statements, which reflect our current views with respect to future events
and financial performance. We may, in some cases, use words such as “project,” “believe,” “anticipate,”
“plan,” “expect,” “estimate,” “intend,” “continue,” “should,”
“would,” “could,” “potentially,” “will,” “may” or similar words and
expressions that convey uncertainty of future events or outcomes to identify these forward-looking statements.
The
forward-looking statements in this document are based upon various assumptions, many of which are based on management’s
discussion and analysis or plan of operations and elsewhere in this report. Although we believe that these assumptions were reasonable
when made, these statements are not guarantees of future performance and are subject to certain risks and uncertainties, some
of which are beyond our control, and are difficult to predict. Actual results could differ materially from those expressed in
forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements, which reflect
management’s view only as of the date of this report.
Certain
Terms Used in this Report
When
this report uses the words “we,” “us,” “our,” and the “Company,” they refer to
MagneGas Corporation and our wholly-owned subsidiaries. “SEC” refers to the Securities and Exchange Commission.
Overview.
MagneGas
Corporation is a technology company that utilizes a plasma based system for the gasification and sterilization of liquid waste.
A byproduct of our process is a hydrogen based fuel called MagneGas2®” that we sell for metal cutting as an alternative
to acetylene. In addition, we are developing the use of our fuel for co-combustion with hydrocarbon fuels to reduce emissions.
We also market, for sale or licensure, our proprietary plasma arc technology for the processing of liquid waste (the “Plasma
Arc Flow® System”). We have established a retail and distribution platform to sell our fuel for use in the metalworking
industries. We have also developed a global network of brokers to sell our system for processing liquid waste and we are testing
our fuel through a third party laboratory for use in the reduction of coal emissions. Additionally, we intend to acquire complementary
gas distribution businesses in order to become a larger distributor of MagneGas2®, other industrial gases and related equipment.
In
October of 2014, we purchased Equipment Sales and Services, Inc. (“ESSI”) for $3 million cash. ESSI is a full line
seller of industrial gases and equipment for the welding and metal cutting industries. Since acquiring ESSI, we have opened three
additional retail locations and distribute our proprietary MagneGas2® product as well as other gases and welding supplies
through ESSI, our wholly owned subsidiary.
On
February 1, 2017, the Company formed two wholly owned subsidiaries in the State of Delaware called MagneGas Energy Solutions,
LLC and MagneGas Welding Supply, LLC, respectively.
On
March 3, 2017, the Company formed three wholly owned subsidiaries in the State of Delaware called MagneGas Real Estate Holdings,
LLC, MagneGas IP, LLC and MagneGas Production, LLC, respectively.
Results
of Operations.
Comparison
for the three and nine months ended September 30, 2017 and 2016
Revenues
For
the three and nine months ended September 30, 2017 and 2016 we generated revenues of $879,511 and $2,717,503 compared to $1,037,668
and $2,540,588. For the three and nine months ended September 30, 2017 and 2016, we generated revenues from our metal cutting
fuel of $879,511 and $2,717,503 compared to $676,518 and $1,985,688, respectively. The increase in revenues was primarily due
to successful expansion through our two new locations in Lakeland and Sarasota, FL. We also experienced an expansion in our existing
customer base in Clearwater, FL, and in improvement in our revenues per customer for some of the clients we added in 2016 that
expanded their relationship with our subsidiary, ESSI in 2017.
The
decrease in revenue during the three months ended September 30, 2017 was primarily attributable to damaging hurricanes that paralyzed
much of the gulf coast during August and September of 2017. The three months ended September 30, 2017 were also negatively impacted
by the fact that no unit sales were recognized, as compared to the same period in the prior year, when the Company recognized
$361,150. The remaining $676,518 were sales under ESSI for industrial gas and welding supplies. When the revenues for the three
months ended September 30, 2017 are compared to these figures, revenues actually increased 30% when unit sales are excluded from
the prior year.
For
the three and nine months ended September 30, 2017 and 2016 cost of revenues were $552,374 and $1,588,419 compared to $632,531
and $1,470,569, respectively. For the three and nine months ended September 30, 2017 and 2016, we generated a gross profit of
$327,137 and $1,129,084 compared to $405,137 and $1,070,019. An improved gross profit can be attributed to strategic price
increases and controlling the cost of materials. The Company implemented price increased for the sales of MagneGas2 in during
the three months ended September 30, 2017. The Company’s cost of producing MagneGas2 continued to decline during the period,
also positively impacting the cost of goods sold. Lastly, product mix was also a factor in the improvement in cost of goods sold.
Operating
Expenses
Operating costs for
the three and nine months ended September 30, 2017 and 2016 were $2,620,664 and $9,018,931 compared to $3,011,124
and $9,024,824. During the nine months ended September 30, 2017 we recognized a non-cash charge of $2,288,741 in stock
based compensation paid to consultants and third party vendors, compared to $820,500 in the comparable nine months ended
September 30, 2016. Other non-cash operating expenses were due to depreciation and amortization charges of $526,602 for the nine
month period ended September 30, 2017, compared to $507,000 for the nine months ended September 30, 2016.
In
the current quarter, as in prior quarters, we used common stock as a method of payment for certain services, primarily the advertising
and promotion of the technology to increase investor and customer awareness and as incentive to its key employees and consultants.
We expect to continue these arrangements, though due to a stronger operating position, this method of payment may become limited
to employees.
Net
Loss
Our operating results
for the nine months ended September 30, 2017 have recognized losses in the amount of $7,147,991 compared to $10,839,326
for the nine months ended September 30, 2016. The decrease in our loss was primarily attributable to an increase in
gross profit of approximately $59,065, and an increase in other income and expense as a result of an increased gain on
fair value adjustment of our derivative liabilities by approximately $2,462,293.
Liquidity
and Capital Resources.
As of September 30, 2017, the Company had
cash of $93,895 and has reported a net loss of $7,147,991 and has used cash in operations of $3,385,026 for the
nine months ended September 30, 2017. In addition, as of September 30, 2017 the Company has a working capital deficit of $1,107,476
and an accumulated deficit of $60,706,471. These conditions indicate that there is substantial doubt about the Company's
ability to continue as a going concern within one year from the issuance date of the financial statements.
The
ability of the Company to continue as a going concern is dependent upon its ability to further implement its business plan and
generate sufficient revenue and its ability to raise additional funds by way of a public or private offering.
Historically,
the Company has financed its operations through equity and debt financing transactions and expects to continue incurring operating
losses for the foreseeable future. The Company’s plans and expectations for the next 12 months include raising additional
capital to help fund commercial operations, including product development. The Company utilizes cash in its operations of approximately
$515,000 per month. Management believes, but it cannot be certain, its current holdings of cash along with the cash to be generated
from expected product sales and future financings will be sufficient to meet its projected operating requirements for the next
twelve months from the date of this report.
Cash
Flows from Continuing Operations
.
Cash
flows from continuing operations for operating, financing and investing activities for the nine months ended September 30, 2017
and 2016 are summarized in the following table:
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Operating activities
|
|
$
|
(3,385,026
|
)
|
|
$
|
(6,455,538
|
)
|
Investing activities
|
|
|
(85,906
|
)
|
|
|
(1,272,237
|
)
|
Financing activities
|
|
|
1,948,417
|
|
|
|
3,590,362
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash from continuing operations
|
|
$
|
(1,522,515
|
)
|
|
$
|
(4,137,413
|
)
|
For
the nine months ended September 30, 2017, we used cash of $3,385,026 in operations in 2017 and used cash of $6,455,538
in operations in 2016. Our cash use for 2017 was primarily attributable to general operations. Our cash use for 2016 was primarily
attributable to the completion of our new headquarters and consulting expenses related to research and development, investor relations,
public relations and new business development. During the nine months ended September 30, 2017, cash used by investing activities
consisted of $85,906. During the nine months ended September 30, 2016, cash used by investing activities consisted of $1,272,237
primarily due to the purchases of assets offset by the sale of land. Cash provided by financing activities for the nine months
ended September 30, 2017 was $1,948,417 as compared to cash provided by financing activities for the nine months ended
September 30, 2016 of $3,590,362. The net decrease in cash during the nine months ended September 30, 2017 was 1,522,515 as compared
to $4,137,413 for the nine months ended September 30, 2016.
Note
Payable
On
May 9, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with an institutional investor providing
for the sale and issuance of 8% Senior Debentures. Pursuant to the SPA, the Company agreed to sell, and the investor agreed to
purchase up to an aggregate of $1,000,000 principal amount of Senior Debentures (“Debenture”). The Debenture is due
in November 2017 and bears interest at a rate of 8% per annum based on a 360-day year. The Company is required to make interest
payments quarterly beginning on the original issuance date of the Debenture. The Debenture is unsecured and is not convertible.
The
Company recognized issuance costs of $60,000 as recognized as a debt discount and will expense over the maturity of the note.
During the period ended September 30, 2017, the Company recorded an expense of $46,957.
Series
B Convertible Preferred Stock
On
May 9, 2017, the Company entered into an Exchange Agreement (“Exchange Agreement”) with an institutional investor
(“Investor”). Under the terms of the Exchange Agreement, the Investor agreed to exchange with the Company (the “Exchange”),
Warrants, exercisable for 22,198,554 shares of Company Common Stock, for (i) 2,700 shares of newly issued Series B Convertible
Preferred Stock at a stated value of $1,000 per share and convertible into 9,000,000 shares of Common Stock at a conversion price
of $3.00 and (ii) 1,000,000 shares of newly issued Common Stock (collectively, the “Exchange Securities”). The preferred
stock and common shares were recorded at fair market value.
Pursuant
to terms of the Exchange Agreement, the Company also agreed to amend the terms of the Convertible Debentures, which had
a current outstanding principal amount of $829,000, as follows: (i) the Conversion Price of the Convertible Debenture was
reduced from $5.70 to $3.00, subject to adjustment under the Exchange Agreement or under the terms of such Convertible Debenture,
which will result in an increase of 1,308,947 shares of Common Stock that may be issuable upon conversion of the Convertible Debenture
and (ii) the Company shall be permitted to prepay the then-outstanding principal amount of the Convertible Debenture, together
with a prepayment premium in the amount of 10% of the principal amount being prepaid.
In
conjunction with the Exchange, the Company filed a Certificate of Designation with the Delaware Secretary of State. The Certificate
of Designation designated a new class of Series B Convertible Preferred Stock (“Preferred Stock”). The Preferred Stock
is convertible in shares of Common Stock at a price of $3.00 per share. The Corporation previously received the unanimous written
consent of the Board of Directors and the holder of the Series A Preferred Stock authorizing the creation of the class of Series
B Convertible Preferred Stock. The holders of Series B Convertible Preferred Stock would receive upon liquidation, the same amount
that a holder of common stock would receive if the preferred stock were fully converted, paid pari passu with all holders of common
stock.
As
of May 9, 2017, the Company has issued 2,700 shares of newly designated Series B Convertible Preferred Stock of which 600 are
outstanding as of September 30, 2017. The Series B Convertible Preferred Stock included a conversion into common stock at price
of $3.00 per share subject to subsequent equity sales reset provisions. The conversion provision was at the option of the holder
and the Series B Convertible Preferred Stock did not provide for cumulative dividends.
During
the nine months ended September 30, 2017, 2,700 shares of the Series B Convertible Preferred Stock were converted into 900,000
shares of the Company’s common stock an exchange rate of $3.00 per share.
Series
C Convertible Preferred Stock
On
June 12, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with one or more investors. Under
the terms of the SPA, the Company agreed to issue and sell to each investor, Series C Convertible Preferred Stock (“Preferred
Shares”), Series C Convertible Preferred Warrants (“Preferred Warrants”) and Common Stock Purchase Warrants
(“Common Stock Warrants”), for a total gross purchase price of up to $25,000,000. At the initial closing under the
SPA, the Company issued a total of 75 Preferred Shares at a purchase price of $900 per share. The Preferred Warrants are
exercisable for a total of 24,925 Preferred Shares at an exercise price of $900 per share. The Preferred Shares have an initial
conversion price of $3.00 and are initially convertible into an aggregate of 8,333,334 shares of common stock. The Common Stock
Warrants are exercisable for 2,916,667 shares of common stock, representing thirty-five percent (35%) of the total number of shares
of common stock initially issuable upon conversion of the Preferred Shares. The exercise price of the Common Stock Warrants is
$3.00 per share and are exerciseable for 5 years.
In
conjunction with the SPA, the Company designated a new class of preferred stock as “Series C Convertible Preferred Stock”
in the aggregate amount of 25,000 shares. The Preferred Shares have a stated value of $1,000, with an aggregate value of $25,000,000.
The initial conversion price of the Preferred Shares is $3.00.
The
holders of Preferred Shares are entitled to receive dividends, when and as declared by the Board, from time to time, in its sole
discretion. From and after the occurrence of a Triggering Event (as defined in the certificate of designation for the Preferred
Shares) until such time as all Triggering Events then outstanding are cured, the holders shall be entitled to receive Dividends
at a rate of eighteen percent (18.0%) per annum, which dividends shall be computed on the basis of a 360-day year and twelve 30-day
months and shall compound each calendar month. No such triggering events occurred during the period ended September 30, 2017.
At
any time after the occurrence of a Triggering Event the holder may, at its option, convert any Preferred Shares at an Alternate
Conversion Price. The “Alternate Conversion Price” means the lower of (A) the applicable conversion price as then
in effect and (B) the greater of (x) $0.35 and (y) the lowest of (i) 85% of the VWAP of the common stock as of the trading day
immediately preceding the delivery or deemed delivery of the applicable conversion notice, (ii) 85% of the VWAP of the common
stock as of the trading day of the delivery or deemed delivery of the applicable conversion notice and (iii) 85% of the price
computed as the quotient of (I) the sum of the VWAP of the common stock for each of the ten (10) trading days with the lowest
VWAP of the common stock during the twenty (20) consecutive trading day period ending and including the trading day immediately
preceding the delivery or deemed delivery of the applicable conversion notice, divided by (II) ten (10).
In
lieu of conversion, upon a Triggering Event, the holder may require the Company to redeem all or any of the Preferred Shares at
a price equal to the greater of (i) the product of (A) the conversion amount of the Preferred Shares to be redeemed multiplied
by (B) a redemption premium of 115% and (ii) the product of (X) the conversion rate with respect to the conversion amount in effect
at such time of redemption multiplied by (Y) the product of (1) a redemption premium of 115% multiplied by (2) the greatest closing
sale price of the common stock on any trading day during the period commencing on the date immediately preceding such Triggering
Event and ending on the date the Company makes the entire redemption payment.
The
Company may, at its option following notice to each holder, redeem such amount of Preferred Shares by paying to each holder the
corresponding installment amount in cash. The applicable installment conversion price with respect to a particular date of determination,
shall be equal to the lower of (A) the conversion price then in effect and (B) the greater of (x) $0.35 and (y) the lower of (i)
85% of the VWAP of the common stock as of the trading day immediately preceding the applicable Installment Date and (ii) 85% of
the quotient of (A) the sum of the VWAP of the common stock for each of the ten (10) trading days with the lowest VWAP of the
common stock during the twenty (20) consecutive trading day period ending and including the trading day immediately prior to the
applicable Installment Date, divided by (B) ten (10).
If
the Company elects to effect an installment redemption in lieu of an installment conversion, in whole or in part, such Preferred
Shares shall be redeemed by the Company in cash on the applicable Installment Date in an amount equal to 103% of the applicable
installment redemption amount.
As
a result of such Triggering Event discussed above, the Series C Preferred Stock has redeemable features which are not in the Company’s
control and therefore should not be included in permanent equity. Management has classified the Series C Preferred Stock
in temporary equity in accordance with ASC 480-10-S99-3A on the Condensed Consolidated Balance Sheet.
During
the nine months ended September 30, 2017, the warrant holders exercised 240 Preferred Warrants into 240 Preferred Shares. The
investors simultaneously converted the 240 shares (and the previously issued 75 Preferred Shares) into 785,243 shares of the Company’s
Common Stock.
Management
analyzed the conversion features embedded in the Preferred Warrants and Preferred Shares and because the Preferred Warrants may
not be exercised unless the registration statement is effective, no derivative liability has been recognized. The Company recorded
a beneficial conversion feature in the amount of $826,182. The beneficial conversion feature was recognized as a deemed dividend.
Maxim
Group, LLC (“Maxim”) acted as the exclusive placement agent for the aforementioned transaction. The Company agreed
to pay Maxim a cash fee payable upon each closing equal to 6.0% of the gross proceeds ($4,050 in cash fees and a legal expense
reimbursement of $5,000) received by the Company at each Closing (the “Placement Fee”). Such fees were recognized
as stock issuance costs. Additionally, the Company granted to Maxim (or its designated affiliates) warrants to purchase up to
416,667 shares common stock (the “Placement Agent Warrants”). The Placement Agent Warrants expire five (5) years after
the Closing. The Placement Agent Warrants are exercisable at a price per share equal to $3.30. The Placement Agent Warrants are
not be redeemable and are exercisable for 5 years. The Placement Agent Warrants may be exercised in whole or in part and provide
for a “cashless” exercise, except in the event the shares of common stock issuable upon exercise of the Placement
Agent Warrants are registered for resale, in which case they provide for a “cash” exercise only. The Placement Agent Warrants
were recorded at fair value as a stock issuance costs.
Series D Convertible Preferred Stock
On July 21, 2017, the Company entered into
a Securities Purchase Agreement (“SPA”) with one or more investors. Under the terms of the SPA, the Company agreed
to issue and sell to each Investor, and each investor severally, but not jointly, agreed to purchase from the Company shares of
Common Stock (“Common Stock”), and Series D Convertible Preferred Warrants (“Preferred Warrants”) for
a total gross purchase price of up to $844,422. On July 27, 2017, at the initial closing under the SPA, the Company issued to
the Investors a total of 150,000 shares of Common Stock at a purchase price of $1.00 per share. The Preferred Warrants are exercisable
for a total of 694,422 Preferred Shares at an exercise price of $1.00 per share. The Preferred Shares have an initial conversion
price of $1.00 and are initially convertible into an aggregate of 694,422 shares of Common Stock.
The Company designated a new class of preferred
stock as “Series D Convertible Preferred Stock” in the aggregate amount of 694,422 shares. The Preferred Shares have
a stated value of $1.00, with an aggregate value of $694,422. No Preferred Shares were issued at the Closing of the Offering.
The holders of Preferred Shares shall be
entitled to receive dividends, when and as declared by the Board, from time to time, in its sole discretion. From and after the
occurrence of a Triggering Event (as defined in the certificate of designations for the Preferred Shares) until such time as all
Triggering Events then outstanding are cured, the holders shall be entitled to receive Dividends at a rate of eighteen percent
(18.0%) per annum, which dividends shall be computed on the basis of a 360-day year and twelve 30-day months and shall compound
each calendar month.
The initial conversion price of the Preferred Shares is $1.00.
During the period July 1, 2017 through
September 30, 2017, the 694,422 shares of Series D Preferred Shares were converted into 1,801,497 shares of the Company’s
Common Stock at an average conversion price of $0.39 per share.
Series E Convertible Preferred Stock
On September 15, 2017, the Company entered
into a Securities Purchase Agreement (“SPA”) with one or more investors identified on the signature pages thereto
(“Investors”) attached to the SPA. Under the terms of the SPA, the Company issued and sold to each Investor, and each
Investor severally, but not jointly, agreed to purchase from the Company shares of Series E Convertible Preferred Stock (“Preferred
Stock”), and Series E Convertible Preferred Warrants (“Preferred Warrants”) (collectively, the “Transaction
Securities”) as set forth on the Schedule of Buyers attached to the SPA for a total gross purchase price of up to $620,000
(the “Offering”). At the initial closing under the SPA, the Company issued to the Investors a total of 36,765 shares
of Preferred Stock at a purchase price of $1.36 per share. The Preferred Warrants are exercisable for a total of 419,117 Preferred
Shares at an exercise price of $1.36 per share. The Preferred Shares have an initial conversion price of $1.36 and will be initially
convertible into an aggregate of 36,765 shares of Common Stock.
The Company obtained the written consent
of the holders of a majority of its outstanding voting securities approving the terms of the Offering and the issuance of the
Transaction Securities, including the potential issuance of more than 20% of the Company’s issued and outstanding common
stock in connection with the Offering, in accordance with Nasdaq Listing Rule 5635. The Offering was made pursuant to a prospectus
supplement and accompanying base prospectus relating to the Company’s effective shelf registration statement on Form S-3
(File No. 333-207928).
In conjunction with the Transaction, the
Company designated a new class of preferred stock as “Series E Convertible Preferred Stock” in the aggregate amount
of 455,882 shares. The Preferred Shares have a stated value of $1.36, with an aggregate value of $620,000.
The holders of Preferred Shares are entitled
to receive dividends, when and as declared by the Board, from time to time, in its sole discretion. From and after the occurrence
of a Triggering Event (as defined in the certificate of designations for the Preferred Shares) until such time as all Triggering
Events then outstanding are cured, the holders shall be entitled to receive Dividends at a rate of eighteen percent (18.0%) per
annum, which dividends shall be computed on the basis of a 360-day year and twelve 30-day months and shall compound each calendar
month.
The initial conversion price of the Preferred
Shares is $1.36.
At any time after the occurrence of a Triggering
Event the holder may, at its option, convert any Preferred Shares at an Alternate Conversion Price. The “Alternate Conversion
Price” means with respect to any Alternate Conversion that price which shall be the lowest of (A) the applicable Conversion
Price as in effect on the applicable Conversion Date of the applicable Alternate Conversion and (B) the greater of (x) the Floor
Price and (y) the lowest of (i) 75% of the Closing Bid Price of the Common Stock as of the Trading Day immediately preceding the
delivery or deemed delivery of the applicable Conversion Notice, (ii) 75% of the VWAP of the Common Stock as of the Trading Day
of the delivery or deemed delivery of the applicable Conversion Notice, (iii) 75% of the sum of the lowest VWAP of the Common
Stock for each Trading Day during three (3) out of the ten (10) consecutive Trading Day period ending and including the Trading
Day immediately preceding the delivery or deemed delivery of the applicable Conversion Notice, divided by (I) three (3), (iv)
75% of the price computed as the quotient of (I) the sum of the lowest VWAP of the Common Stock for each Trading Day during five
(5) of the twenty (20) consecutive Trading Day period ending and including the Trading Day immediately preceding the delivery
or deemed delivery of the applicable Conversion Notice, divided by (II) five (5).
In lieu of conversion, upon a Triggering
Event, the holder may require the Company to redeem all or any of the Preferred Shares at a price equal to the greater of (i)
the product of (A) the Conversion Amount of the Preferred Shares to be redeemed multiplied by (B) the 115% and (ii) the product
of (X) the Conversion Rate with respect to the Conversion Amount of such Preferred Shares in effect at such time as such Holder
delivers a Triggering Event Redemption Notice multiplied by (Y) the product of (1) the 115% multiplied by (2) the greatest Closing
Sale Price of the Common Stock on any Trading Day during the period commencing on the date immediately preceding such Triggering
Event and ending on the date the Company makes the entire payment required to be made.
The Preferred Warrants will be exercisable
for a total of 419,117 shares of Series E Convertible Preferred Stock at an exercise price of $1.36 per share. Under the terms
of the Preferred Warrants, so long as (I) no Equity Conditions Failure (as defined in the Preferred Warrants) then exists (unless
waived in writing by the Holder), (II) no more than 100,000 Preferred Shares are then outstanding and (III) no Forced Exercise
(as defined below) has occurred in the Seven (7) Trading Day period immediately prior to the applicable date of determination,
the Company shall have the right to require the Holder to exercise the Warrant into up to such aggregate number of fully paid,
validly issued and non-assessable Warrant Preferred Shares equal to the lesser of (x) 500,000 and (y) 30% of the aggregate dollar
trading volume of the Common Stock (as reported by Bloomberg) during the three (3) consecutive Trading Day period immediately
prior to the applicable Forced Exercise Notice Date (as defined in the Preferred Warrant)(such lesser number of Warrant Preferred
Shares, the “Maximum Forced Exercise Share Amount”), as designated in the applicable Forced Exercise Notice, to be
issued and delivered in accordance with the Preferred Warrant (each, a “Forced Exercise”).
As of September 30, 2017, no issuances
on the Series E Preferred Stock had been made.
Insurance
The
Company has insurance to cover Liabilities related to environmental and pollution contingencies of $1,000,000 per loss and $2,000,000
in the aggregate.
Critical
Accounting Policies.
Our
significant accounting policies are presented in this Report in our Notes to financial statements, which are contained in this
Quarterly Report. The significant accounting policies that are most critical and aid in fully understanding and evaluating the
reported financial results include the following:
The
Company prepares its financial statements in conformity with U.S. GAAP. These principles require management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management
believes that these estimates are reasonable and have been discussed with our Board of Directors (the “Board”); however,
actual results could differ from those estimates.
We
issue restricted stock to consultants for various services. Cost for these transactions are measured at the fair value of the
consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The value of
the common stock is measured at the earlier of (i) the date at which a firm commitment for performance by the counterparty to
earn the equity instruments is reached or (ii) the date at which the counterparty’s performance is complete.
Long-lived
assets such as property, equipment and identifiable intangibles are reviewed for impairment whenever facts and circumstances indicate
that the carrying value may not be recoverable. When required impairment losses on assets to be held and used are recognized based
on the fair value of the asset. The fair value is determined based on estimates of future cash flows, market value of similar
assets, if available, or independent appraisals, if required. If the carrying amount of the long-lived asset is not recoverable
from its undiscounted cash flows, an impairment loss is recognized for the difference between the carrying amount and fair value
of the asset. When fair values are not available, the Company estimates fair value using the expected future cash flows discounted
at a rate commensurate with the risk associated with the recovery of the assets.
The
Company generates revenue through two processes: (1) the sale of its MagneGas2® fuel for metal cutting and (2) the sale of
its Plasma Arc Flow Units. Additionally, the Company also recognizes revenue from territorial license arrangements, and through
the sales of metal cutting gases and related products through their wholly owned subsidiary, ESSI.
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Revenue
for metal-working fuel is recognized when shipments are made to customers. We recognize a sale when the product has been shipped
and risk of loss has passed to the customer.
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Our
Plasma Arc Flow Units require a significant investment and generally have a 6 to 9 month production cycle. During the course
of building a Plasma Arc Flow Unit the actual costs are tracked in work in process. Significant deposits are required before
production. These deposits are classified as customer deposits.
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Licenses
are issued, per contractual agreement, for distribution rights within certain geographic territories. We recognize revenue
ratably, based on the amounts paid or values received, over the term of the licensing agreement.
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The
fair value of an embedded conversion option that is convertible into a variable amount of shares and warrants that include price
protection reset provision features are deemed to be “down-round protection” and, therefore, do not meet the scope
exception for treatment as a derivative under Accounting Standards Codification 815 “Derivatives and Hedging” (“ASC
815”), since “down-round protection” is not an input into the calculation of the fair value of the conversion
option and warrants and cannot be considered “indexed to the Company’s own stock” which is a requirement for
the scope exception as outlined under ASC 815. The accounting treatment of derivative financial instruments requires that the
Company record the embedded conversion option and warrants at their fair values as of the inception date of the agreement and
at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income
or expense for each reporting period at each balance sheet date. The Company reassesses the classification of its derivative instruments
at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified
as of the date of the event that caused the reclassification. As a result of entering into a convertible credit facility for which
such instruments contained a variable conversion feature with no floor, the Company has adopted a sequencing policy in accordance
with Accounting Standards Codification 815-40-35-12 whereby all future instruments may be classified as a derivative liability
with the exception of instruments related to share-based compensation issued to employees.
The
Black-Scholes option valuation model was used to estimate the fair value of the warrants and conversion options. The model includes
subjective input assumptions that can materially affect the fair value estimates. The Company determined the fair value of the
Binomial Lattice Model and the Black-Scholes Valuation Model to be materially the same. The expected volatility is estimated based
on the most recent historical period of time equal to the weighted average life of the warrants. Conversion options are recorded
as debt discount and are amortized as interest expense over the life of the underlying debt instrument.
Off
Balance Sheet Arrangements.
The
Company has no off balance sheet arrangements.