Certain information and footnote disclosures
required under accounting principles generally accepted in the United States of America have been condensed or omitted from the
following consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the
“SEC”). It is suggested that the following condensed consolidated financial statements be read in conjunction with
the accompanying notes and financial statements and notes thereto in the annual financial statements included in the Annual Report
on Form 10-K for Ener-Core, Inc. for the fiscal year ended December 31, 2016, filed with the SEC on April 14, 2017.
Notes to Condensed Consolidated Financial
Statements
(unaudited)
Note 1—Organization
Organization
Ener-Core, Inc. (the “Company”,
“we”, “us”, “our”), a Delaware corporation, was formed on April 29, 2010 as Inventtech, Inc. On
July 1, 2013, we acquired our wholly owned subsidiary, Ener-Core Power, Inc., (formerly Flex Power Generation, Inc.), a Delaware
corporation. The stockholders of Ener-Core Power, Inc. are now our stockholders and the management of Ener-Core Power,
Inc. is now our management. The acquisition was treated as a “reverse merger” and our financial statements
are those of Ener-Core Power, Inc. All equity amounts presented have been retroactively restated to reflect the reverse
merger as if it had occurred on November 12, 2012.
Effective as of September 3, 2015, we
changed our state of incorporation from the State of Nevada to the State of Delaware (the “Reincorporation”), pursuant
to a plan of conversion dated September 2, 2015, following approval by our stockholders of the Reincorporation at our 2015 Annual
Meeting of Stockholders held on August 28, 2015. As a Delaware corporation following the Reincorporation, we are deemed to be
the same continuing entity as the Nevada corporation prior to the Reincorporation, and as such continue to possess all of the
rights, privileges and powers and all of the debts, liabilities and obligations of the prior Nevada corporation. Upon effectiveness
of the Reincorporation, all of the issued and outstanding shares of common stock of the Nevada corporation automatically converted
into issued and outstanding shares of common stock of the Delaware corporation without any action on the part of our stockholders.
Concurrent with the Reincorporation, on September 3, 2015 our authorized shares increased to 250,000,000 shares of stock consisting
of 200,000,000 authorized shares of common stock and 50,000,000 authorized shares of preferred stock.
Reverse Merger
We entered into an Agreement and Plan
of Merger (the “Merger Agreement”) with Ener-Core Power, Inc. and Flex Merger Acquisition Sub, Inc., a Delaware corporation
and our wholly owned subsidiary (“Merger Sub”), pursuant to which the Merger Sub merged with and into Ener-Core Power,
Inc., with Ener-Core Power, Inc. as the surviving entity (the “Merger”). Prior to the Merger, we were a public reporting
“shell company,” as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended. The Merger
Agreement was approved by the boards of directors of each of the parties to the Merger Agreement. In April 2013, the pre-merger
public shell company effected a 30-for-1 forward split of its common stock. All share amounts have been retroactively restated
to reflect the effect of the stock split.
As provided in the Contribution Agreement
dated November 12, 2012 (the “Contribution Agreement”) by and among FlexEnergy, Inc. (“FlexEnergy”), FlexEnergy
Energy Systems, Inc. (“FEES”), and Ener-Core Power, Inc., Ener-Core Power, Inc. was spun-off from FlexEnergy as a
separate corporation. As a part of that transaction, Ener-Core Power, Inc. received all assets (including intellectual
property) and certain liabilities pertaining to the Power Oxidizer business carved out of FlexEnergy. The owners of
FlexEnergy did not distribute ownership of Ener-Core Power, Inc. pro rata. The assets and liabilities were transferred
to us and recorded at their historical carrying amounts since the transaction was a transfer of net assets between entities under
common control.
On July 1, 2013, Ener-Core Power, Inc.
completed the Merger with us. Upon completion of the Merger, we immediately became a public company. The
Merger was accounted for as a “reverse merger” and recapitalization. As part of the Merger, 2,410,400 shares of outstanding
common stock of the pre-merger public shell company were cancelled. This cancellation has been retroactively accounted for
as of the inception of Ener-Core Power, Inc. on November 12, 2012. Accordingly, Ener-Core Power, Inc. was deemed to be the accounting
acquirer in the transaction and, consequently, the transaction was treated as a recapitalization of Ener-Core Power, Inc. Accordingly,
the assets and liabilities and the historical operations that are reflected in the financial statements are those of Ener-Core
Power, Inc. and are recorded at the historical cost basis of Ener-Core Power, Inc. Our assets, liabilities and results
of operations were de minimis at the time of the Merger.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Reverse Stock Split
The board of directors of the Company
approved a reverse stock split of the Company’s authorized, issued and outstanding shares of common stock, par value $0.0001
per share, as well as the Company’s authorized shares of preferred stock, par value $0.0001 per share, of which no shares
are issued and outstanding (together, the “Stock”), at a ratio of 1-for-50 (the “Reverse Stock Split”).
The Reverse Stock Split became effective on July 8, 2015 (the “Effective Date”). As a result of the Reverse Stock
Split, the authorized preferred stock decreased to 1,000,000 shares and the authorized common stock decreased to 4,000,000 shares.
Both the preferred stock and common stock par value remained at $0.0001 per share. The number of authorized shares subsequently
increased to 200,000,000 authorized shares of common stock and 50,000,000 authorized shares of preferred stock on September 3,
2015 with the Company’s reincorporation in Delaware, as described above.
On the Effective Date, the total number
of shares of common stock held by each stockholder of the Company were converted automatically into the number of shares of common
stock equal to: (i) the number of issued and outstanding shares of common stock held by each such stockholder immediately prior
to the Reverse Stock Split divided by (ii) 50. The Company issued one whole share of the post-Reverse Stock Split common stock
to any stockholder who otherwise would have received a fractional share as a result of the Reverse Stock Split, determined at
the beneficial owner level by share certificate. As a result, no fractional shares were issued in connection with the Reverse
Stock Split and no cash or other consideration will be paid in connection with any fractional shares that would otherwise have
resulted from the Reverse Stock Split. The Reverse Stock Split also affected all outstanding options and warrants by dividing
each option or warrant outstanding by 50, rounded up to the nearest option or warrant, and multiplying the exercise price by 50
for each option or warrant outstanding.
Description of the Business
We design, develop, license, manufacture
and have commercially deployed products based on proprietary technologies that generate industrial levels of usable heat in a
pressure vessel using a wide variety of organic gases as fuel for an oxidation reaction. Our technology allows for the use of
gases that, historically, were unusable as fuels for traditional industrial gas to energy conversion systems, such as combustion
chambers, and that typically required costly pollution abatement equipment in order for industries to reduce the pollutant gas
emissions and therefore to comply with increasingly stringent air pollution standards. Our technology facilitates a high-temperature
oxidation reaction for a variety of organic gases which in turn allows our pressure vessels to extract heat energy from organic
gases, including many “waste” gases considered to be air pollution by many industries.
We refer to our technology as “Power
Oxidation,” and refer to our products as “Power Oxidizers” or “Power Oxidation Vessels.” We develop
applications for our technology by integrating our Power Oxidizers with traditional gas-fired industrial equipment (such as boilers,
dryers, ovens, and chillers) that require steady and consistent heat sources. In our first deployed applications, our technology
serves as a low-emissions alternative for combustion chambers used with gas-fired electric turbines. Our Power Oxidizers produce
a steady heat source that can be used to (i) generate electricity by coupling our technology with a variety of modified gas turbines,
(ii) produce steam by coupling our technology with a variety of modified steam boilers, or (iii) provide on-site heat at industrial
facilities through heat exchanger applications.
Our proprietary and patented Power Oxidation
technology is designed to create greater industrial efficiencies by providing the opportunity to convert low-quality organic waste
gases generated from industrial processes into usable on-site energy, thereby decreasing both operating costs and significantly
reducing environmentally harmful gaseous emissions. We design, develop, license, manufacture and market our Power Oxidizers, which,
when bundled with an electricity generating turbine in the 250 kilowatt, or kW, and 2 megawatt, or MW, sizes, are called Powerstations.
We currently partner and are pursuing partnerships with large established manufacturers to integrate our Power Oxidizer with their
gas turbines, with the goal to open substantial new opportunities for our partners to market these modified gas turbines to industries
for which traditional power generation technologies previously were not technically feasible. We currently manufacture our Powerstations
in the 250 kW size and manufactured the Power Oxidizer for the 2 MW size for the initial two units sold. Beginning in 2017, pursuant
to the CMLA (as defined below), our 2 MW partner, Dresser-Rand a.s., a subsidiary of Dresser-Rand Group Inc., a Siemens company,
or Dresser-Rand, will begin to manufacture the 2 MW Power Oxidizers under a manufacturing license and will pay us a non-refundable
license fee for each unit manufactured by Dresser-Rand.
On November 14, 2014, we entered into
a commercial license agreement (“CLA”) with Dresser-Rand, pursuant to which we agreed to jointly develop a Powerstation
that consisted of our Power Oxidizer integrated with a Dresser-Rand KG2 turbine rated up to 2 MW of power output. The CLA granted
Dresser-Rand the right to market and sell the Dresser-Rand KG2-3GEF 2 MW gas turbine coupled with our Power Oxidizer. In June
2016, we executed a contract manufacturing and commercial licensing agreement (the “CMLA”) with Dresser-Rand, which
both companies intended would supersede and replace the CLA. In April 2017, we amended the terms of the CMLA to make the CMLA
effective as of January 1, 2017, at which time it superseded and replaced the CLA. The first two systems sold to Dresser-Rand
pursuant to the CLA were shipped to a Stockton, California biorefinery site owned by Pacific Ethanol, Inc. in the fourth quarter
of 2016. Under the CMLA, KG2 manufacturing will transition to Dresser-Rand and each KG2 unit sold will generate for us a non-refundable
license fee.
We sell our EC250 product directly and
through distributors in two countries, the United States and Netherlands.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Going Concern
Our condensed consolidated financial statements
are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United
States of America (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of
assets and settlement of liabilities in the normal course of business. Since our inception, we have made a substantial investment
in research and development to develop the Power Oxidizer, have successfully deployed an EC250 field test unit at the U.S. Army
base at Fort Benning, Georgia, and installed and commissioned our first commercial unit in the Netherlands in the second quarter
of 2014. In November 2014, we entered into the CLA to incorporate our Power Oxidizer into Dresser-Rand’s 1.75 MW turbine.
In August 2015, the CLA became a mutually binding agreement due to the satisfaction of certain binding conditions contained in
the CLA. On June 29, 2016 we entered into the CMLA with Dresser-Rand, which both companies intended would supersede and replace
the CLA.
In April 2017, we amended the terms of
the CMLA to make the CMLA effective as of January 1, 2017, at which time it superseded and replaced the CLA. Pursuant to the amendment,
Dresser-Rand paid us $1.2 million in cash in April 2017, which represents advance payments on license fees for KG2/PO units representing
less than the required minimum number of licenses which would otherwise be required to maintain their exclusivity under the CMLA.
In exchange for this payment, we have agreed to provide a total credit of $1,760,000 against future license payments associated
for these KG2/PO units, consisting of a payment credit of $1,200,000 and an additional discount of $560,000. In July 2017, we executed
an additional amendment for additional payments of up to $250,000 to be applied against future license payments consisting of a
payment credit of approximately $365,000 and an additional discount of approximately $115,000 for a combined payment credit of
$2.1 million. We have not, as yet, received a purchase order for any system subject to these license fee advances. As such,
we do not consider the $1.45 million of advances to be backlog as of November 14, 2017.
The April 2017 amendment further settled
certain expense claims made by each party and provided for a mutual release. Because of this claims settlement, the Company accrued
$124,000 at September 30, 2017 and December 31, 2016. The payment of the claims accrual is to be made in advance of certain future
license fee payments payable from Dresser-Rand to the Company, expected during 2018.
We have sustained recurring net losses
and negative cash flows since inception and have not yet established an ongoing source of revenues sufficient to cover our operating
costs and allow us to continue as a going concern. Despite capital raises of $2.5 million in December 2015, $3.0 million in April
2016, $1.25 million in September 2016, $3.4 million in December 2016 and $900,000 in September and November 2017, we expect to
require additional sources of capital to support our growth initiatives. We must secure additional funding to continue as a going
concern and execute our business plan.
Through the end of 2015, our product sales
were limited to initial system sales that were not profitable and required additional cash in excess of expected cash receipts.
In addition, we incurred significant development and administrative expenses in order to develop our products with little or no
cash contribution from sales. Beginning in 2016, we began to focus on reduction of our operating costs payable in cash through
headcount and overhead cost reductions and saw an increase in cash collections from customers from sales transactions that are
expected to be cash flow positive. During 2015, we received no cash from license fees. In 2016, we received $1.1 million of cash
from license fees and we expect to receive additional license fees in 2017 from the CMLA, including $1.2 million received in the
second quarter of 2017, $250,000 in the third quarter of 2017 and additional license payments upon receipt of firm purchase orders
for licenses along with product sales receipts for 250kW unit sales.
Management’s plan is to obtain capital
sufficient to meet our operating expenses by seeking additional equity and/or debt financing. Our cash and cash equivalents balance
on September 30, 2017 was approximately $0.2 million. During the first three quarters of 2017, we continued our cost cutting measures
by entering into a lease for a lower-cost headquarters facility, which we have occupied since April 2017, and through additional
headcount reductions. We expect that the $0.2 million of cash and cash equivalents as of September 30, 2017, combined with receipts
on customer billings and $0.4 million in cash proceeds received in November 2017 in connection with the issuance by the Company
of additional secured indebtedness, will continue to fund our working capital needs, general corporate purposes, and related obligations
into the fourth quarter of 2017 at our reduced spending levels. However, we expect to require significantly more cash for working
capital and as financial security to support our growth initiatives.
We will pursue raising additional equity
and/or debt financing to fund our operations and product development. If future funds are raised through issuance of stock or
debt, these securities could have rights, privileges, or preferences senior to those of our common stock and debt covenants that
could impose restrictions on our operations. Any equity or convertible debt financing will likely result in additional dilution
to our current stockholders. We cannot make any assurances that any additional financing will be completed on a timely basis,
on acceptable terms or at all. Our inability to successfully raise capital in a timely manner will adversely impact our ability
to continue as a going concern. If our business fails or we are unable to raise capital on a timely basis, our investors may face
a complete loss of their investment.
The accompanying condensed consolidated
financial statements do not give effect to any adjustments that might be necessary if we were unable to meet our obligations or
continue operations as a going concern.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 2—Summary of Significant Accounting Policies
Basis of Presentation
The accompanying condensed consolidated
financial statements include our accounts and our wholly-owned subsidiary, Ener-Core Power, Inc. All significant intercompany
transactions and accounts have been eliminated in consolidation. All monetary amounts are rounded to the nearest $000, except
certain per share amounts.
The accompanying financial statements have been prepared in
accordance with GAAP.
The accompanying financial information
is unaudited, but, in the opinion of management, reflects all adjustments (which include only normally recurring adjustments)
necessary to present fairly the Company’s financial position, operating results and cash flows for the periods presented.
It is management’s opinion that all material adjustments (consisting of normal recurring adjustments) have been made, which
are necessary for a fair financial statement presentation.
Reclassifications
Certain amounts in the 2016 condensed
consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications
have no effect on previously reported net loss.
Segments
We operate in one segment. All of our
operations are located domestically.
Use of Estimates
The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses
during the reporting period. Significant items subject to such estimates and assumptions include but are not limited to: collectability
of receivables; the valuation of certain assets, useful lives, and carrying amounts of property and equipment, equity instruments
and share-based compensation; provision for contract losses; valuation allowances for deferred income tax assets; valuation of
derivative liabilities; and exposure to warranty and other contingent liabilities. We base our estimates on historical experience
and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates.
Concentrations of Credit Risk
Cash and Cash Equivalents
We maintain our non-interest bearing transactional
cash accounts at financial institutions for which the Federal Deposit Insurance Corporation (“FDIC”) provides insurance
coverage of up to $250,000. For interest bearing cash accounts, from time to time, balances exceed the amount insured by the FDIC.
We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk related to these
deposits. At September 30, 2017, we had no amounts in excess of the FDIC limit.
We consider all highly liquid investments
available for current use with an initial maturity of three months or less and are not restricted to be cash equivalents. We invest
our cash in short-term money market accounts.
Restricted Cash
Collateral Account
Under a credit card processing agreement
with a financial institution that was entered in 2013 and terminated in April 2017, we were required to maintain funds on deposit
with the financial institution as collateral. The amount of the deposit, which is at the discretion of the financial institution,
was $0 at September 30, 2017 and $50,000 at December 31, 2016.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Accounts Receivable
Our accounts receivable are typically from
credit worthy customers or, for international customers are supported by guarantees or letters of credit. For those customers to
whom we extend credit, we perform periodic evaluations of them and maintain allowances for potential credit losses as deemed necessary.
We generally do not require collateral to secure accounts receivable. We have a policy of reserving for uncollectible accounts
based on our best estimate of the amount of probable credit losses in existing accounts receivable. We periodically review our
accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors
that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to
the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of September
30, 2017 and December 31, 2016, three and two customers accounted for approximately 96% and 100% of our accounts receivable, respectively.
Accounts Payable
As of September 30, 2017 and December
31, 2016, one and eight vendors, respectively, collectively accounted for approximately 20% and 50% of our total accounts payable.
Inventory
Inventory, which consists of raw materials,
is stated at the lower of cost or net realizable value, with cost being determined by the average-cost method, which approximates
the first-in, first-out method. At each balance sheet date, we evaluate our ending inventory for excess quantities and obsolescence.
This evaluation primarily includes an analysis of forecasted demand in relation to the inventory on hand, among consideration
of other factors. Based upon the evaluation, provisions are made to reduce excess or obsolete inventories to their estimated net
realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the respective inventories.
At September 30, 2017 and December 31, 2016, we did not have a reserve for slow-moving or obsolete inventory.
Property and Equipment
Property and equipment are stated at cost,
and are being depreciated using the straight-line method over the estimated useful lives of the related assets, ranging from three
to ten years. Maintenance and repairs that do not improve or extend the lives of the respective assets are expensed. At the time
property and equipment are retired or otherwise disposed of, the cost and related accumulated depreciation accounts are relieved
of the applicable amounts. Gains or losses from retirements or sales are reflected in the condensed consolidated statements of
operations.
Deposits
Deposits primarily consist of amounts
incurred or paid in advance of the receipt of fixed assets or are deposits for rent and insurance.
Accrued Warranties
Accrued warranties represent the estimated
costs that will be incurred during the warranty period of our products. We make an estimate of expected costs that will be incurred
by us during the warranty period and charge that expense to the condensed consolidated statement of operations at the date of
sale. We also reevaluate the estimate at each balance sheet date and if the estimate is changed, the effect is reflected in the
condensed consolidated statement of operations. We had no warranty accrual at September 30, 2017 or December 31, 2016. We expect
that most terms for future warranties of our Powerstations and Oxidizers will be one to two years depending on the warranties
provided and the products sold. Accrued warranties for expected expenditures within one year are classified as current liabilities
and as non-current liabilities for expected expenditures for time periods beyond one year.
Intangible Assets
Our intangible assets represent intellectual
property acquired during the reverse merger. We amortize our intangible assets with finite lives over their estimated useful lives.
Impairment of Long-Lived Assets
We account for our long-lived assets in
accordance with the accounting standards which require that long-lived assets be reviewed for impairment whenever events or changes
in circumstances indicate that the historical carrying value of an asset may no longer be recoverable. We consider the carrying
value of assets may not be recoverable based upon our review of the following events or changes in circumstances: the asset’s
ability to continue to generate income from operations and positive cash flow in future periods; loss of legal ownership or title
to the assets; significant changes in our strategic business objectives and utilization of the asset; or significant negative
industry or economic trends. An impairment loss would be recognized when estimated future cash flows expected to result from the
use of the asset are less than its carrying amount. As of September 30, 2017 and December 31, 2016, we do not believe there have
been any impairments of our long-lived assets. There can be no assurance, however, that market conditions will not change or demand
for our products will continue, which could result in impairment of long-lived assets in the future.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Fair Value of Financial Instruments
Our financial instruments consist primarily
of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, derivative liabilities, and capital lease
liabilities. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available
to management as of September 30, 2017 and December 31, 2016. The carrying amounts of short-term financial instruments are reasonable
estimates of their fair values due to their short-term nature or proximity to market rates for similar items.
Derivative Financial Instruments
The Company issues derivative financial
instruments in conjunction with its debt and equity offerings and to provide additional incentive to investors and placement agents.
The Company uses derivative financial instruments in order to obtain the lowest cash cost-source of funds. Derivative liabilities
are recognized in the condensed consolidated balance sheets at fair value based on the criteria specified in Financial Accounting
Standards Board (“FASB”) Accounting Standards Codification (“ASC”) topic 815-40 “
Derivatives
and Hedging—Contracts in Entity’s own Equity
.” The estimated fair value of the derivative liabilities is
calculated using either the Black-Scholes-Merton or Monte Carlo simulation model method.
The Company issued warrants to purchase
common stock and secured debt with a conversion feature in April and May 2015, September 2016 and December 2016. In December 2015,
we amended the secured debt issued in April and May 2015 (the “2015 Senior Notes”) to add a conversion feature. The
Company issued additional warrants to purchase common stock with price reset provisions in December 2015, February 2016 and March
2016. These embedded derivatives and warrants were evaluated under ASC topic 815-40. We determined that the conversion feature
for the 2015 secured debt, the conversion feature for the September 2016 secured debt and the warrants issued with price reset
provisions should be accounted for as derivative liabilities. In August 2016, all outstanding warrants that we previously determined
should be accounted for as derivative liabilities were amended and we determined that, after giving effect to the amendments,
we were no longer required to account for the warrants as derivative liabilities. In December 2016, we modified the terms of the
September 2016 secured debt and determined that, after giving effect to the amendments, we were no longer required to account
for the conversion features as derivative liabilities. We determined that the conversion features of the warrants issued in April
and May 2015, September 2016 and December 2016 should not be accounted for as derivative liabilities. Warrants and the debt conversion
features determined to be derivative liabilities were bifurcated from the debt host and were classified as liabilities on the
condensed consolidated balance sheet. Warrants not determined to be derivative liabilities were recorded to debt discount and
paid-in capital. We record the warrants and embedded derivative liabilities at fair value and adjust the carrying value of the
warrants to purchase common stock and embedded derivatives to their estimated fair value at each reporting date with the increases
or decreases in the fair value of such warrants and derivatives at each reporting date, recorded as a gain or (loss) in the condensed
consolidated statements of operations. The warrants issued in 2015 that we no longer account for as derivative liabilities were
recorded to debt discount with a corresponding entry to paid-in capital. The warrants that were amended in 2016 such that we were
no longer required to account for them as derivative liabilities were marked to market immediately prior to the amendment and
the fair value was reclassified on the amendment date from derivative liabilities to paid-in capital.
Revenue Recognition
We generate revenue from the licensing
of our Power Oxidizer technologies and sale of our clean power energy systems and from consulting services. Revenue is recognized
when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed or
determinable and collectability of the resulting receivable is reasonable assured. Amounts billed to clients for shipping and handling
are classified as sales of product with related costs incurred included in cost of sales.
Provisions for discounts and rebates to
customers, estimated returns and allowances, and other adjustments are provided for in the same period the related revenue is
recorded. We defer any revenue for which the services have not been performed or are subject to refund until such time that we
and our customer jointly determine that the services have been performed or no refund will be required.
Revenues under long-term construction
contracts are generally recognized using the completed-contract method of accounting. Long-term construction-type contracts for
which reasonably dependable estimates cannot be made or for which inherent hazards make estimates difficult are accounted for
under the completed-contract method. Revenues under the completed-contract method are recognized upon substantial completion—that
is acceptance by the customer, compliance with performance specifications demonstrated in a factory acceptance test or a similar
event. Accordingly, during the period of contract performance, billings and costs are accumulated on the balance sheet, but no
profit or income is recorded before completion or substantial completion of the work. Anticipated losses on contracts are recognized
in full in the period in which losses become probable and estimable. Changes in estimate of profit or loss on contracts are included
in earnings on a cumulative basis in the period the estimate is changed. As of September 30, 2017 and December 31, 2016, we had
provisions for contract losses in the amounts of $760,000 and $724,000, respectively.
Our deferred revenue balances as of September
30, 2017 consisted primary of billings and receipts of the Dresser-Rand licenses and the two Power Oxidizer units sold to Dresser-Rand
and installed at a Pacific Ethanol location in Stockton, California. While delivery of the Power Oxidizer units has occurred,
customer acceptance had not occurred as of September 30, 2017 and a contractual risk of loss still remained on the licensing collections.
As such, we did not recognize revenues for the three or nine months ended September 30, 2017.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Research and Development Costs
Research and development costs are expensed
as incurred. Research and development costs were $452,000 and $1,170,000 for the three months ended September 30, 2017 and 2016,
respectively, and were $1,634,000 and $2,871,000 for the nine months ended September 30, 2017 and 2016, respectively.
Share-Based Compensation
We maintain an equity incentive plan and
record expenses attributable to the awards granted under the equity incentive plan. We amortize share-based compensation from
the date of grant on a weighted average basis over the requisite service (vesting) period for the entire award.
We account for equity instruments issued
to consultants and vendors in exchange for goods and services at fair value. The measurement date for the fair value of the equity
instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor
is reached or (ii) the date at which the consultant’s or vendor’s performance is complete. In the case of equity instruments
issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
In accordance with the accounting standards,
an asset acquired in exchange for the issuance of fully vested, non-forfeitable equity instruments should not be presented or
classified as an offset to equity on the grantor’s balance sheet once the equity instrument is granted for accounting purposes.
Accordingly, we record the fair value of the fully vested, non-forfeitable common stock issued for future consulting services
as prepaid expense in our condensed consolidated balance sheets.
Income Taxes
We account for income taxes under FASB
ASC 740 “Income Taxes.” Under the asset and liability method of FASB ASC 740, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or
settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income
in the period the enactment occurs. A valuation allowance is provided for certain deferred tax assets if it is more likely than
not that we will not realize tax assets through future operations.
Earnings (Loss) per Share
Basic loss per share is computed by dividing
net loss attributable to common stockholders by the weighted average number of shares of common stock assumed to be outstanding
during the period of computation. Diluted loss per share is computed similar to basic loss per share except that the
denominator is increased to include the number of additional shares of common stock that would have been outstanding if the potential
shares had been issued and if the additional shares of common stock were dilutive. Approximately 10.6 million and 1.6 million shares
of common stock issuable upon full exercise of all options and warrants at September 30, 2017 and 2016, respectively, and all shares
potentially issuable in the future under the terms of the Convertible Secured Notes Payable for 2017 and Senior Notes Payable for
2016 were excluded from the computation of diluted loss per share due to the anti-dilutive effect on the net loss per share.
All share and per share amounts in the
table below have been adjusted to reflect the 1-for-50 reverse split of our issued and outstanding common stock on July 8, 2015,
retroactively.
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Net loss
|
|
$
|
(2,435,000
|
)
|
|
$
|
(1,596,000
|
)
|
|
$
|
(8,896,000
|
)
|
|
$
|
(7,628,000
|
)
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,063,660
|
|
|
|
3,785,216
|
|
|
|
4,026,726
|
|
|
|
3,591,233
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.60
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
(2.21
|
)
|
|
$
|
(2.12
|
)
|
Comprehensive Income (Loss)
We have no items of other comprehensive
income (loss) in any period presented. Therefore, net loss as presented in our condensed consolidated statements of operations
equals comprehensive loss.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Recently Issued Accounting Pronouncements
From time to time, the FASB issues Accounting
Standards Updates (“ASUs”) to amend the authoritative literature in ASC. Management believes that those issued to
date that are not described below either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable
to us or (iv) are not expected to have a significant impact our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers (Topic 606). In April 2016, the FASB issued Accounting Standards Update 2016-10, Revenue
from Contracts with Customers: Identifying Performance Obligations and Licensing. ASU 2014-09, with additional guidance and clarification
from ASU 2016-10, provides a framework for addressing revenue recognition issues and, upon its effective date, replaces almost
all existing revenue recognition guidance, including industry-specific guidance, in current U.S. generally accepted accounting
principles. ASU 2016-10 provides additional guidance specific to licensing and royalty revenue recognition. ASU 2014-09 is effective
beginning with the calendar year ended December 31, 2017. The Company adopted ASU 2014-09 and ASU 2016-10 effective as of January
1, 2017. There was no impact to the Company’s financial position, results of operations, or cash flows as a result of the
adoption.
In July 2015, the FASB issued ASU 2015-11,
Inventory (Topic 330): Simplifying the Measurement of Inventory. ASU 2015-11 requires that entities measure inventory at the lower
of cost and net realizable value. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, including interim
periods within those fiscal years and early application is permitted. The Company adopted ASU 2015-11 effective as of January
1, 2017. There was no impact to the Company’s financial position, results of operations, or cash flows as a result of the
adoption.
In November 2015, the FASB issued ASU
2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires that entities’ deferred
tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective
for fiscal years beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018.
The Company has not yet assessed the impact ASU 2015-17 will have upon adoption.
In February 2016, the FASB issued ASU
2016-2, Leases (Topic 842). ASU 2016-2 affects any entity entering into a lease and changes the accounting for operating leases
to require companies to record an operating lease liability and a corresponding right-of-use lease asset, with limited exceptions.
ASU 2016-2 is effective for fiscal years beginning after December 15, 2018. Early adoption is allowed. We have not yet assessed
the impact ASU 2016-2 will have upon adoption.
In May 2017, the FASB issued ASU 2017-9,
Compensation-Stock Compensation (Topic 718). ASU 2017-9 provides guidance about which changes to the terms or conditions of a
share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-9 is effective for all entities
for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is allowed.
We have not yet assessed the impact ASU 2017-9 will have upon adoption.
In July 2017, the FASB issued ASU 2017-11,
Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part
I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for
Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests
with a Scope Exception. The amendments in Part I of this ASU change the classification analysis of certain equity-linked financial
instruments (or embedded features) with down round features. The amendments in Part II of this ASU recharacterize the indefinite
deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception.
Those amendments do not have an accounting effect. Amendments in Part I of this ASU are effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2018. The amendments in Part II of the ASU do not require any
transition guidance because those amendments do not have an accounting effect. Early adoption is permitted for all entities, including
adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected
as of the beginning of the fiscal year that includes that interim period. We have not yet assessed the impact ASU 2017-11 will
have upon adoption.
Note 3—Inventory
Inventory primarily consists of Powerstation
parts used as raw materials for the Company’s EC250 and KG2 orders. Work-in-progress inventory consists of Powerstation
parts and employee and contract labor assembly costs for Powerstation sub-assemblies. Sub-assemblies and parts are typically shipped
to end customer locations and assembled on-site. Completed Powerstations awaiting final installation and commissioning would be
carried as finished goods. There was no finished goods inventory at either September 30, 2017 or December 31, 2016. Inventories
consist of:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
Raw material and spare parts
|
|
$
|
1,105,000
|
|
|
$
|
990,000
|
|
Work-in-progress
|
|
|
1,988,000
|
|
|
|
1,774,000
|
|
Total
|
|
$
|
3,093,000
|
|
|
$
|
2,764,000
|
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 4—Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets
consisted of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
Prepaid rent
|
|
$
|
—
|
|
|
$
|
52,000
|
|
Prepaid insurance
|
|
|
30,000
|
|
|
|
43,000
|
|
Prepaid other
|
|
|
78,000
|
|
|
|
96,000
|
|
Prepaid professional fees
|
|
|
51,000
|
|
|
|
1,000
|
|
Prepaid deferred financing fees
|
|
|
29,000
|
|
|
|
110,000
|
|
Total
|
|
$
|
188,000
|
|
|
$
|
302,000
|
|
Note 5—Property and Equipment, Net
Property and equipment, net consisted of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
Machinery and equipment
|
|
$
|
4,309,000
|
|
|
$
|
4,377,000
|
|
Office furniture and fixtures
|
|
|
49,000
|
|
|
|
217,000
|
|
Computer equipment and software
|
|
|
202,000
|
|
|
|
176,000
|
|
Total cost
|
|
|
4,560,000
|
|
|
|
4,770,000
|
|
Less accumulated depreciation
|
|
|
(1,816,000
|
)
|
|
|
(1,523,000
|
)
|
Net
|
|
$
|
2,744,000
|
|
|
$
|
3,247,000
|
|
Assets recorded under capital leases and included in property
and equipment in our balance sheets consist of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
Machinery and equipment
|
|
$
|
27,000
|
|
|
$
|
27,000
|
|
Computer equipment and software
|
|
|
84,000
|
|
|
|
59,000
|
|
Total assets under capital lease
|
|
|
111,000
|
|
|
|
86,000
|
|
Less accumulated amortization
|
|
|
(82,000
|
)
|
|
|
(71,000
|
)
|
Net assets under capital lease
|
|
$
|
29,000
|
|
|
$
|
15,000
|
|
Depreciation expense for the three and
nine months ended September 30, 2017 and 2016 consisted of the following:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Research and development
|
|
$
|
81,000
|
|
|
$
|
102,000
|
|
|
$
|
282,000
|
|
|
$
|
304,000
|
|
General and administrative
|
|
|
5,000
|
|
|
|
29,000
|
|
|
|
56,000
|
|
|
|
88,000
|
|
|
|
$
|
86,000
|
|
|
$
|
131,000
|
|
|
$
|
338,000
|
|
|
$
|
392,000
|
|
Amortization of assets under capital lease
was $2,000 for the three months ended September 30, 2017 and 2016, respectively, and $3,000 for the nine months ended September
30, 2017 and 2016, respectively.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 6—Accrued Expenses
Accrued expenses consisted of the following;
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Accrued professional fees
|
|
$
|
160,000
|
|
|
$
|
138,000
|
|
Accrued compensation
|
|
|
578,000
|
|
|
|
346,000
|
|
Accrued board of directors’ fees
|
|
|
330,000
|
|
|
|
130,000
|
|
Accrued interest
|
|
|
105,000
|
|
|
|
29,000
|
|
Accrued other
|
|
|
200,000
|
|
|
|
20,000
|
|
Total accrued expenses
|
|
$
|
1,373,000
|
|
|
$
|
663,000
|
|
Note 7—Deferred Revenues and Customer Advances
Deferred revenues and customer advances
consist of balances billed on existing customer contracts for which the revenue cycle is not complete. Customer advances on equipment
sales represent down payments and progress payments under the terms and conditions of equipment sales of our Power Oxidizer and
Powerstation units. Prepaid license fees represent payments of license fees by Dresser-Rand and received in September 2016 but
for which right of return existed as of September 30, 2017. Deferred revenues and customer advances consisted of the following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Customer advances on equipment sales
|
|
$
|
2,877,000
|
|
|
$
|
2,776,000
|
|
Prepaid license fees
|
|
|
2,550,000
|
|
|
|
1,100,000
|
|
Total deferred revenues and customer
advances
|
|
$
|
5,427,000
|
|
|
$
|
3,876,000
|
|
Note 8—Convertible Senior Notes Payable
Convertible Senior Notes payable consisted of the following
as of September 30, 2017:
|
|
Principal
|
|
|
Debt
Discount
|
|
|
Offering Costs
|
|
|
Net
Total
|
|
Balance, December 31, 2016
|
|
$
|
9,191,000
|
|
|
$
|
(8,152,000
|
)
|
|
$
|
(409,000
|
)
|
|
$
|
630,000
|
|
Amortization of Debt Discount and Offering Costs
|
|
|
—
|
|
|
|
3,048,000
|
|
|
|
152,000
|
|
|
|
3,200,000
|
|
Conversion into common shares
|
|
|
(60,000
|
)
|
|
|
50,000
|
|
|
|
3,000
|
|
|
|
(7,000
|
)
|
2017 Senior Notes Issued
|
|
|
556,000
|
|
|
|
(158,000
|
)
|
|
|
(35,000
|
)
|
|
|
363,000
|
|
Balance, September 30, 2017
|
|
|
9,687,000
|
|
|
|
(5,212,000
|
)
|
|
|
(289,000
|
)
|
|
|
4,186,000
|
|
Less: Current Portion
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Long Term Portion
|
|
$
|
9,687,000
|
|
|
$
|
(5,212,000
|
)
|
|
$
|
(289,000
|
)
|
|
$
|
4,186,000
|
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
In the fourth quarter of 2016, the Company
entered into a securities purchase agreement pursuant to which it issued a new series of convertible senior secured notes (collectively
the “2016 Senior Notes”) and related warrants, and entered into amendment agreements related to its 2015 Senior Notes
and the convertible unsecured promissory notes of the Company issued in September 2016 (the “Convertible Unsecured Notes”),
as described in Note 9 below. The Company issued and sold new 2016 Senior Notes with a face value of $3,747,000 and an original
issue discount of $375,000 for gross cash proceeds of $3,372,000. Additionally, the Company amended and restated the 2015 Senior
Notes, the aggregate principal amount of which was $5,000,000 prior to such amendment and restatement. Upon the amendment and restatement
of the 2015 Senior Notes, the face value of such 2015 Senior Notes was $5,556,000 with an original issue discount of $556,000.
In September 2017, the Company entered
into a securities purchase agreement pursuant to which it issued a new series of convertible senior secured notes (collectively
the “2017 Senior Notes”) and related warrants at identical terms as the 2016 Senior Notes described above except for
the initial exercise price of the detachable warrants. The Company issued and sold new 2017 Senior Notes with a face value of $556,000
and an original issue discount of $56,000 for gross cash proceeds of $500,000. In conjunction with the issuance of the 2017 Senior
Notes, the Company issued five-year warrants to purchase up to 222,222 shares of the Company’s common stock at $1.50 per
share, which were valued using Black-Scholes option pricing model at $128,000. We allocated the fair value of these warrants and
the conversion feature of the 2017 Senior Notes to debt discount as follows: $102,000 allocated to detachable warrants and $0 allocated
to the conversion feature. We recorded an additional debt discount of $56,000 for the original issue discount, resulting in a debt
discount recorded at issuance of $158,000. We will amortize this discount to interest expense over the expected remaining life
of the 2017 Senior Notes, which mature on December 31, 2018.
We incurred $35,000 of offering costs in
conjunction with the issuance and sale of the 2017 Senior Notes, consisting of legal and professional fees. We will amortize the
offering costs to interest expense over the expected remaining life of the 2017 Senior Notes.
In conjunction with the issuance and/or
amendment and restatement, as applicable, of the aggregate face value of $9,302,000 of the 2016 Senior Notes and 2015 Senior Notes,
the Company issued five-year warrants to purchase up to 3,720,839 shares of the Company’s common stock at $3.00 per share,
which were valued using Black-Scholes option pricing model at $6,003,000. We allocated the fair value of these warrants and the
conversion feature of the 2016 Senior Notes and 2015 Senior Notes to debt discount as follows: $3,495,000 allocated to detachable
warrants and $4,133,000 allocated to the conversion feature. We recorded an additional debt discount of $930,000 for the original
issue discount, resulting in a debt discount recorded at issuance of $8,558,000. We will amortize this discount to interest expense
over the expected remaining life of the 2016 Senior Notes and 2015 Senior Notes, which mature on December 31, 2018.
We incurred $479,000 of offering costs
in conjunction with the issuance and sale of the 2016 Senior Notes and amendment and restatement of the 2015 Senior Notes, consisting
of $298,000 of placement agent fees and costs and $181,000 of legal and professional fees. We will amortize the offering costs
to interest expense over the expected remaining life of the 2016 Senior Notes and 2015 Senior Notes.
The Company refers to the 2017 Senior Notes,
the 2016 Senior Notes and the amended and restated 2015 Senior Notes, collectively, as the “Senior Notes”. The Senior
Notes are fully secured by all assets of the Company and the Company’s subsidiaries. The Senior Notes are convertible at
a price per share of $2.50, which is adjustable upon a Company stock split, reverse split, or common share dividend.
Upon an Event of Default, the Senior Notes
will bear interest at a rate of 10% per annum. The Senior Notes will mature on December 31, 2018 and rank senior to the Convertible
Unsecured Notes. The Senior Notes are convertible at the option of the holder into the Company’s common stock at an exercise
price of $2.50 (as subject to adjustment therein) and will automatically convert into shares of the Company’s common stock
on the fifth trading day immediately following the issuance date of the Senior Notes on which (i) the Weighted Average Price (as
defined in the Senior Notes) of the Company’s common stock for each trading day during a twenty trading day period equals
or exceeds $5.00 (as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction)
and no Equity Conditions Failure (as defined in the Senior Notes) has occurred. The Senior Notes also contain a blocker provision
that prevents the Company from effecting a conversion in the event that the holder, together with certain affiliated parties,
would beneficially own in excess of either 4.99% or 9.99%, with such threshold determined by the holder prior to issuance, of
the shares of the Company’s common stock outstanding immediately after giving effect to such conversion.
Upon an Event of Default and delivery
to the holder of the Senior Note of notice thereof, such holder may require the Company to redeem all or any portion of its Senior
Note at a price equal to 115% of the Conversion Amount (as defined in the Senior Notes) being redeemed. Additionally, upon a Change
of Control and delivery to the holder of the Senior Note of notice thereof, such holder may also require the Company to redeem
all or any portion of its Senior Note at a price equal to 115% of the Conversion Amount being redeemed. Further, at any time from
and after January 1, 2018 and provided that the Company has not received either (i) initial deposits for at least eight 2 MW Power
Oxidizer units or (ii) firm purchase orders totaling not less than $3,500,000 and initial payment collections of at least $1,600,000,
in each case during the period commencing on the issuance date of the 2016 Senior Notes and ending on December 31, 2017, the holder
of the Senior Note may require the Company to redeem all or any portion of its Senior Note at a price equal to 100% of the Conversion
Amount being redeemed.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
At any time after the issuance date of
the Senior Notes, the Company may redeem all or any portion of the then outstanding principal and accrued and unpaid interest
with respect to such principal, at 100% of such aggregate amount; provided, however, that the aggregate Conversion Amount to be
redeemed pursuant to all Senior Notes must be at least $500,000, or such lesser amount as is then outstanding. The portion of
the Senior Note(s) to be redeemed shall be redeemed at a price equal to the greater of (i) 110% of the Conversion Amount of the
Senior Note being redeemed and (ii) the product of (A) the Conversion Amount being redeemed and (B) the quotient determined by
dividing (I) the greatest Weighted Average Price (as defined in the Senior Notes) of the shares of the Company’s common
stock during the period beginning on the date immediately preceding the date of the notice of such redemption by the Company and
ending on the date on which the redemption by the Company occurs by (II) the lowest Conversion Price (as defined in the Senior
Notes) in effect during such period.
The Senior Notes contain a provision that
prevents the Company from entering into or becoming party to a Fundamental Transaction (as defined in the Senior Notes) unless
the Company’s successor entity assumes all of the Company’s obligations under the Senior Notes and the related transaction
documents (the “Transaction Documents”) pursuant to written agreements in form and substance satisfactory to at least
a certain number of holders of the Senior Notes.
In connection with foregoing, Ener-Core
Power, Inc., the Company’s wholly-owned subsidiary, entered into a Guaranty, pursuant to which it agreed to guarantee all
of the obligations of the Company under the securities purchase agreement for the 2016 Senior Notes, the Senior Notes and the
Transaction Documents.
In connection with the issuance and sale
of the 2016 Senior Notes, the Company entered into a Registration Rights Agreement with the investors (the “Registration
Rights Agreement”), pursuant to which the Company is required to file one or more registration statements with the Securities
and Exchange Commission (the “SEC”) to register for resale by the investors the shares issuable upon conversion of
the 2016 Senior Notes (the “Conversion Shares”) and shares underlying certain warrants issued to the holders of the
2016 Senior Notes (the “Warrant Shares”), and use its best efforts to maintain the effectiveness of such registration
statement(s). The Company was required to file the first such registration statement promptly following the initial closing date
under the securities purchase agreement for the 2016 Senior Notes, which occurred on December 2, 2016, but in no event later than
the date that is forty-five (45) days after such initial closing date. The Registration Rights Agreement required the Company
to obtain effectiveness of the required registration statement by specified deadlines contained in the Registration Rights Agreement.
The Company complied with its obligation to file such registration statement on January 17, 2017 and the SEC declared such registration
statement effective on February 21, 2017.
During the nine months ended September
30, 2017, two holders of Senior Notes converted an aggregate of $60,000 of principal outstanding under the Senior Notes into 24,000
shares of the Company’s common stock. As a result of these conversions, the Company incurred a loss of $53,000, representing
the unamortized debt discount and deferred financing fees.
Note 9—Convertible Unsecured Notes
Convertible Unsecured Notes payable consisted of the following
as of September 30, 2017:
|
|
Notes
|
|
|
Debt
Discount
|
|
|
Offering
Costs
|
|
|
Net
Total
|
|
December 31, 2016 Balance
|
|
$
|
1,250,000
|
|
|
$
|
(666,000
|
)
|
|
$
|
(30,000
|
)
|
|
$
|
554,000
|
|
Amortization of debt discount
and deferred financing costs
|
|
|
—
|
|
|
|
739,000
|
|
|
|
30,000
|
|
|
|
769,000
|
|
Issuance of additional warrants
|
|
|
—
|
|
|
|
(73,000
|
)
|
|
|
—
|
|
|
|
(73,000
|
)
|
Ending balance—September 30, 2017
|
|
|
1,250,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,250,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Current Portion
|
|
$
|
(1,250,000
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(1,250,000
|
)
|
Long Term Portion
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
On September 1, 2016, we entered into
a securities purchase agreement and related notes and warrants pursuant to which we issued the Convertible Unsecured Notes and
detachable five-year warrants to purchase an aggregate of 124,999 shares of the Company’s common stock at an exercise price
of $4.00 per share (the “September 2016 Financing”). The Company received total gross proceeds of $1,250,000, less
transaction expenses of $45,000 consisting of legal costs for net proceeds of $1,205,000. We recorded a discount of $553,000 on
the date of issuance representing the fair value of the warrants issued and the value of the beneficial conversion feature on
the date of issuance. In the fourth quarter of 2016, we increased our debt discount recorded by $335,000, consisting of $305,000
recorded for the issuance of additional warrants at fair value of $305,000 and $30,000 for the difference in fair value for warrants
repriced from $4.00 per share to $3.00 per share.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
The Convertible Unsecured Notes bear interest
at a rate of 12% per annum and mature on September 1, 2017; provided, however, that the Company may not prepay any portion of the
outstanding principal and accrued and unpaid interest under the Convertible Unsecured Notes so long as any of the Senior Notes
remain outstanding and in no event will the maturity date of such Convertible Unsecured Notes be earlier than at least ninety-one
(91) days after the maturity date under the Senior Notes. As of September 30, 2017, the Convertible Unsecured Notes remain outstanding.
The Convertible Unsecured Notes are subordinate to the Senior Notes described in Note 8. The Convertible Unsecured Notes were initially
convertible at the option of the holder into common stock at a conversion price of $4.31 per share and will automatically convert
into shares of common stock in the event of a conversion of at least 50% of the then outstanding (i) principal, (ii) accrued and
unpaid interest with respect to such principal and (iii) accrued and unpaid late charges, if any, with respect to such principal
and interest, under the Senior Notes. In connection with the issuance of the 2016 Senior Notes and amendment and restatement of
the 2015 Senior Notes, the conversion price was reduced to $2.50 per share. The Convertible Unsecured Notes also contain a blocker
provision that prevents the Company from effecting a conversion in the event that the holder, together with certain affiliated
parties, would beneficially own in excess of 9.99% of the shares of common stock outstanding immediately after giving effect to
such conversion. At any time after the issuance date of the Convertible Unsecured Notes, the Company may, at its option, redeem
all or any portion of the then outstanding principal and accrued and unpaid interest with respect to such principal (the “Company
Optional Redemption Amount”), at 100% of such aggregate amount; provided, however, that the Company may not redeem all or
any portion of the Company Optional Redemption Amount so long as any of the Senior Notes remain outstanding without the prior written
consent of the collateral agent with respect to such Senior Notes and certain investors holding the requisite number of conversion
shares and warrant shares underlying the Senior Notes and related warrants.
The securities purchase agreement for
the Convertible Unsecured Notes called for the issuance of additional five-year warrants to purchase an aggregate of 62,500 shares
at an exercise price of $4.00 per share on each of the 61st, 91st, 121st and 151st days after the closing of the September 2016
Financing, or, in each case, an Additional Warrant Date, but only in the event the Company had not consummated a further financing
consisting of the issuance of common stock and warrants for aggregate gross proceeds of at least $3,000,000 prior to such respective
Additional Warrant Date. As of January 30, 2017, the Company had not consummated a further financing and, as a result, issued
warrants to purchase an aggregate of 250,000 shares of the Company’s common stock, consisting of the issuance of an aggregate
of 62,500 shares of the Company’s common stock on each of November 1, 2016, December 1, 2016, December 31, 2016 and January
30, 2017. The Company valued the warrants to purchase an aggregate of 62,500 shares of common stock issued in the first quarter
of 2017 using the Black-Scholes option pricing model at $73,000 and recorded an additional discount on the date of issuance. The
Company evaluated the accounting of the additional detachable warrants and determined that the warrants should not be accounted
for as derivative liabilities.
Note 10—Fair Value Measurements and Disclosures
Fair value is defined as the price that
would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants
at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be
calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific
to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including the
Company's own credit risk.
Inputs used in measuring fair value are
prioritized into a three-level hierarchy based on whether the inputs to those measurements are observable or unobservable. Observable
inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions.
The fair-value hierarchy requires the use of observable market data when available and consists of the following levels:
|
●
|
Level 1—Quoted prices
for identical instruments in active markets;
|
|
●
|
Level
2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets
that are not active; and model-derived valuations in which all significant inputs are observable in active markets; and
|
|
●
|
Level 3—Valuations
derived from valuation techniques in which one or more significant inputs are unobservable.
|
As of September 30, 2017, there were no investments that required
fair value measurement disclosure.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 11—Capital Leases Payable
Capital Leases Payable
Capital leases payable consisted of the
following:
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Capital lease payable to De Lange Landon secured by forklift, 10.0% interest, due on October 1, 2018, monthly payment of $452.
|
|
$
|
6,000
|
|
|
$
|
10,000
|
|
Capital lease payable to Dell Computers secured by computer equipment, 15.09% interest, due on November 22, 2017, monthly payment of $394.
|
|
|
1,000
|
|
|
|
4,000
|
|
Capital lease payable to Dell Computers secured by computer equipment, 4.99% interest, due on May 1, 2020, monthly payment of $716.
|
|
|
23,000
|
|
|
|
—
|
|
Total capital leases
|
|
$
|
30,000
|
|
|
$
|
14,000
|
|
Less: current portion
|
|
|
(15,000
|
)
|
|
|
(10,000
|
)
|
Long-term portion of capital leases
|
|
$
|
15,000
|
|
|
$
|
4,000
|
|
The future minimum lease payments required
under the capital leases and the present value of the net minimum lease payments as of September 30, 2017, are as follows:
|
|
Year Ending December 31,
|
|
Amount
|
|
|
|
2017
|
|
$
|
7,000
|
|
|
|
2018
|
|
|
12,000
|
|
|
|
2019
|
|
|
8,000
|
|
|
|
2020
|
|
|
5,000
|
|
Net minimum lease payments
|
|
|
|
$
|
32,000
|
|
Less: Amount representing interest
|
|
|
|
|
(2,000
|
)
|
Less: Taxes
|
|
|
|
|
—
|
|
Present value of net minimum lease payments
|
|
|
|
$
|
30,000
|
|
Less: Current maturities of capital lease payables
|
|
|
|
|
(15,000
|
)
|
Long-term capital lease payables
|
|
|
|
$
|
15,000
|
|
Note 12—Equity
During the nine months ended September
30, 2017 holders of our Senior Notes converted an aggregate of $60,000 of principal outstanding under the Senior Notes into 24,000
shares of the Company’s common stock.
Note 13—Stock Options and Warrants
Stock Options
On July 1, 2013, the Company’s board
of directors adopted and approved the 2013 Equity Incentive Plan (the “2013 Plan”) and amended the 2013 Plan on March
24, 2015 to increase the number of shares available for issuance. The 2013 Plan previously authorized us to grant non-qualified
stock options and restricted stock purchase rights to purchase up to 420,000 shares of the Company’s common stock to employees
(including officers) and other service providers. With the approval of the 2015 Plan, described below, as of August 29, 2015,
no shares of common stock were available for issuance under the 2013 Plan, other than pursuant to previously issued options.
On July 15, 2015, the Company’s board
of directors approved the 2015 Omnibus Incentive Plan (the “2015 Plan”), which was approved by the Company’s
stockholders on August 28, 2015. Upon adoption, the 2015 Plan authorized us to grant up to 300,000 shares of the Company’s
common stock and replaced the 2013 Equity Incentive Plan. As a result of the approval of the 2015 Plan, no additional grants will
be made under the 2013 Plan. On August 22, 2016, the Company’s board of directors approved an amendment to the 2015 Plan
to increase the total authorized pool available under the 2015 Plan to 600,000 shares of the Company’s common stock, subject
to automatic increase for any shares subject to outstanding awards under the 2013 Plan that are subsequently canceled or expire.
The Company’s stockholders approved the foregoing amendment on September 26, 2016. As of September 30, 2017, 83,465 shares
of the Company’s common stock were available for issuance under the 2015 Plan.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
The 2015 Plan permits the granting of
any or all of the following types of awards: incentive stock options, non-qualified stock options, stock appreciation rights,
restricted stock, restricted stock units, other stock-based awards, and performance awards payable in a combination of cash and
company shares. As of September 30, 2017, the Company has issued 210,000 shares of restricted common stock and options to purchase
an aggregate of 440,000 shares of the Company’s common stock.
The 2015 Plan has the following limitations:
|
●
|
Limitation
on terms of stock options and stock appreciation rights
. The maximum term of each stock option and stock appreciation
right (SAR) is 10 years.
|
|
●
|
No
repricing or grant of discounted stock options
. The 2015 Plan does not permit the repricing of options or SARs either
by amending an existing award or by substituting a new award at a lower price without stockholder approval. The 2015 Plan
prohibits the granting of stock options or SARs with an exercise price less than the fair market value of the Company’s
common stock on the date of grant.
|
|
●
|
Clawback
.
Awards granted under the 2015 Plan are subject to any then current compensation recovery or clawback policy of the Company
that applies to awards under the 2015 Plan and all applicable laws requiring the clawback of compensation.
|
|
●
|
Double-trigger
acceleration
. Acceleration of the vesting of employee awards that are assumed or replaced by the resulting entity after
a change in control is not permitted unless an employee’s employment is also terminated by the Company without cause
or by the employee with good reason within two years of the change in control.
|
|
●
|
Code
Section 162(m) Eligibility
. The 2015 Plan provides flexibility to grant awards that qualify as “performance-based”
compensation under Internal Revenue Code Section 162(m).
|
|
●
|
Dividends
.
Dividends or dividend equivalents on stock options, SARs or unearned performance shares under the 2015 Plan will not be paid.
|
At September 30, 2017, total unrecognized
deferred stock compensation expected to be recognized over the remaining weighted-average vesting periods of 3.60 years for outstanding
grants was $1.2 million.
The fair value of option awards is estimated
on the grant date using the Black-Scholes option valuation model.
Estimates of fair value are not intended
to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events
are not indicative of the reasonableness of the original estimates of fair value made by us.
Stock-based compensation expense is recorded
only for those awards expected to vest. Currently, the forfeiture rate used to calculate stock-based compensation expense is zero,
which approximates the effective actual forfeiture rate. The rate is adjusted if actual forfeitures differ from the estimates
in order to recognize compensation cost only for those awards that actually vest. If factors change and different assumptions
are employed in future periods, the share-based compensation expense may differ from that recognized in previous periods.
Stock-based award activity was as follows:
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Price
|
|
|
Life
|
|
|
Value
|
|
Balance, December 31, 2016
|
|
|
273,550
|
|
|
$
|
13.70
|
|
|
|
5.02
|
|
|
$
|
—
|
|
Forfeited during 2017
|
|
|
(42,551
|
)
|
|
|
15.82
|
|
|
|
—
|
|
|
|
—
|
|
Granted during 2017
|
|
|
440,000
|
|
|
|
2.50
|
|
|
|
9.76
|
|
|
|
—
|
|
Balance, September 30, 2017
|
|
|
670,999
|
|
|
$
|
6.21
|
|
|
|
7.80
|
|
|
$
|
—
|
|
Exercisable on September 30, 2017
|
|
|
361,828
|
|
|
$
|
8.87
|
|
|
|
6.60
|
|
|
$
|
—
|
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
The options granted have a contract term
ranging between three and ten years. Options granted typically vest over a four-year period, with 25% vesting after one year and
the remainder ratably over the remaining three years.
Of the Company’s outstanding options,
options to purchase 224,999 shares of the Company’s common stock were outstanding and options to purchase 196,341 shares
of the Company’s common stock were exercisable under the 2013 Plan and options to purchase 446,000 shares of the Company’s
common stock were outstanding with 177,487 exercisable under the 2015 Plan on September 30, 2017.
The following table summarizes information about stock options
outstanding at September 30, 2017:
|
|
Options
Outstanding
|
|
|
Options
Exercisable
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted-
|
|
|
|
|
|
Weighted-
|
|
|
|
Number
|
|
|
Remaining
|
|
|
Average
|
|
|
Number
|
|
|
Average
|
|
Exercise
|
|
of
|
|
|
Contractual
|
|
|
Exercise
|
|
|
of
|
|
|
Exercise
|
|
Prices
|
|
Shares
|
|
|
Life
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
|
|
|
|
|
(In
years)
|
|
|
|
|
|
|
|
|
|
|
$0–$10.00
|
|
|
532,140
|
|
|
|
8.93
|
|
|
$
|
3.35
|
|
|
|
228,599
|
|
|
$
|
3.87
|
|
$10.01–$15.00
|
|
|
28,300
|
|
|
|
6.20
|
|
|
$
|
12.50
|
|
|
|
22,670
|
|
|
$
|
12.50
|
|
$15.01–$20.00
|
|
|
94,845
|
|
|
|
2.58
|
|
|
$
|
17.50
|
|
|
|
94,845
|
|
|
$
|
17.50
|
|
$20.01–$25.00
|
|
|
15,714
|
|
|
|
3.82
|
|
|
$
|
23.24
|
|
|
|
15,714
|
|
|
$
|
23.24
|
|
|
|
|
670,999
|
|
|
|
7.80
|
|
|
$
|
6.21
|
|
|
|
361,828
|
|
|
$
|
8.67
|
|
Stock based compensation expense consisted of the following:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Research and development
|
|
$
|
65,000
|
|
|
$
|
113,000
|
|
|
$
|
368,000
|
|
|
$
|
423,000
|
|
General and administrative
|
|
|
70,000
|
|
|
|
187,000
|
|
|
|
421,000
|
|
|
|
604,000
|
|
|
|
$
|
135,000
|
|
|
$
|
300,000
|
|
|
$
|
789,000
|
|
|
$
|
1,027,000
|
|
Restricted Stock
Restricted stock grants consist of shares
of common stock of the Company owned by employees, consultants, and directors that are subject to vesting conditions, typically
for services provided to the Company. All unvested shares of restricted stock are subject to repurchase rights and, therefore,
are recorded as restricted stock.
Restricted stock activities during the nine months ended September
30, 2017 were as follows:
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Grant
|
|
|
|
Shares
|
|
|
Price
|
|
Balance, December 31, 2016
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
|
210,000
|
|
|
$
|
1.55
|
|
Vested
|
|
|
(65,625
|
)
|
|
$
|
—
|
|
Unvested balance, September 30, 2017
|
|
|
144,375
|
|
|
$
|
1.55
|
|
Expenses related to vesting of restricted
stock are included in stock-based compensation expense. The remaining unvested shares of restricted stock vest 33% per year on
March 31, 2018, 2019 and 2020.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Warrants
From time to time, we issue warrants to
purchase shares of our common stock to investors, note holders and to non-employees for services rendered or to be rendered in
the future. The following table represents the activity for warrants outstanding, exchanged, and issued for the nine months ended
September 30, 2017.
Balance outstanding at December 31, 2016
|
|
|
5,358,881
|
|
|
$
|
3.77
|
|
Issued for Convertible Secured Notes
|
|
|
222,222
|
|
|
|
1.50
|
|
Issued for Convertible Unsecured Notes
|
|
|
62,500
|
|
|
|
3.00
|
|
Issued for amendments to Backstop
Security
|
|
|
41,000
|
|
|
|
3.00
|
|
Balance outstanding at September 30, 2017
|
|
|
5,684,603
|
|
|
$
|
3.51
|
|
All warrants were exercisable at September
30, 2017, the weighted average exercise price per share was $3.51 and the weighted average remaining life was 3.95 years. The
warrants outstanding as of September 30, 2017 had no intrinsic value.
Convertible Secured Notes Warrants
On September 19, 2017, the Company issued
warrants to purchase up to 222,222 shares of common stock to the holders of the 2017 Senior Notes with a $1.50 per share exercise
price. The Company incorporated the fair value of the warrants issued of $128,000, valued using the Black-Scholes pricing model
into the debt discount recorded for the 2017 Senior Notes as described in Note 8.
Convertible Unsecured Notes Warrants
On September 1, 2016, the Company issued
warrants to purchase up to 124,999 shares of common stock to the holders of the Convertible Unsecured Notes payable. Under the
terms of Securities Purchase Agreement for the Convertible Unsecured Notes, the holders of the Convertible Unsecured Notes were
entitled, in the aggregate, to receive additional warrants to purchase up to 62,500 shares of common stock on each of the following
dates: November 1, 2016, December 1, 2016, December 31, 2016, and January 30, 2017, in each case only in the event that the Convertible
Unsecured Notes are not repaid or converted into an equity transaction prior to each issuance date. The Company issued warrants
to purchase up to 250,000 shares of the Company’s common stock between November 1, 2016 and January 30, 2017, each with a
five-year term. The September 1, 2016 and November 1, 2016 warrants were issued with a $4.00 per share exercise price, subsequently
amended to a $3.00 per share exercise price. The Company recorded the difference in fair value, valued using the Black-Scholes
pricing model as $30,000 as a result of the price change as an additional debt discount to be amortized over the expected remaining
life of the Convertible Unsecured Notes. The warrants issued on December 1, 2016, December 31, 2016 and January 30, 2017 were issued
with a $3.00 per share exercise price.
Warrants outstanding as of September 30,
2017 consist of:
|
|
Issue
Date
|
|
Expiry
Date
|
|
Number
of
Warrants
|
|
|
Exercise
Price
per
Share
|
|
2013 Services Warrants—July
|
|
Jul-13
|
|
Jul-18
|
|
|
9,494
|
|
|
$
|
37.50
|
|
2013 Services Warrants—August
|
|
Aug-13
|
|
Aug-18
|
|
|
729
|
|
|
|
37.50
|
|
2013 Services Warrants—November
|
|
Nov-13
|
|
Nov-18
|
|
|
2,400
|
|
|
|
50.00
|
|
2014 Services Warrants—April(1)
|
|
Apr-14
|
|
Apr-19
|
|
|
13,657
|
|
|
|
39.00
|
|
2014 Services Warrants—September(2)
|
|
Aug-14
|
|
Aug-19
|
|
|
16,000
|
|
|
|
25.00
|
|
2014 PIPE Warrants—September(3)
|
|
Sept-14
|
|
Sept-18
|
|
|
26,500
|
|
|
|
25.00
|
|
2014 Services Warrants—November(4)
|
|
Nov-14
|
|
Nov-18
|
|
|
6,500
|
|
|
|
25.00
|
|
2014 Settlement Warrants—December(5)
|
|
Dec-14
|
|
Dec-19
|
|
|
38,464
|
|
|
|
25.00
|
|
2015 Senior Notes Warrants(6)(14)
|
|
Apr/May-15
|
|
Apr/May-20
|
|
|
219,785
|
|
|
|
3.00
|
|
2015 Services Warrants—May(7)
|
|
May-15
|
|
May-20
|
|
|
5,514
|
|
|
|
12.50
|
|
2015 LOC Guarantee Warrants—November(8)
|
|
Nov-15
|
|
Nov-20
|
|
|
74,000
|
|
|
|
3.00
|
|
2015 Debt Amendment Warrants—December(9)(15)
|
|
Dec-15
|
|
Dec-20
|
|
|
50,000
|
|
|
|
3.00
|
|
2015 PIPE Warrants—December(10)(15)
|
|
Dec-15
|
|
Dec-20
|
|
|
312,500
|
|
|
|
4.00
|
|
2016 Debt Amendment Warrants—February(11)(15)
|
|
Feb-16
|
|
Feb-21
|
|
|
50,000
|
|
|
|
3.00
|
|
2016 Debt Amendment Warrants—March(12)(15)
|
|
Mar-16
|
|
Mar-21
|
|
|
500,000
|
|
|
|
3.00
|
|
2016 Unsecured Debt Warrants (13)
|
|
Sep-16–Jan-17
|
|
Sep-21–Jan-22
|
|
|
374,999
|
|
|
|
3.00
|
|
2016 Senior Notes Warrants
|
|
Dec-16
|
|
Dec-21
|
|
|
3,720,839
|
|
|
|
3.00
|
|
2017 Backstop Security Amendments—April(16)
|
|
Apr-17
|
|
Apr-22
|
|
|
41,000
|
|
|
|
3.00
|
|
2017 Senior Notes Warrants
|
|
Sep-17
|
|
Sep-22
|
|
|
222,222
|
|
|
|
1.50
|
|
Warrants outstanding and exercisable
at September 30, 2017
|
|
|
|
|
|
|
5,684,603
|
|
|
$
|
3.51
|
|
(1)
|
The
2014 Services Warrants—April were issued for fees incurred in conjunction with the issuance of convertible notes in
2014. The warrants were valued on the issuance date at $11.50 per share in conjunction with the valuation approach used for
the initial valuation of the warrants issued in connection with the convertible notes issued in 2014.
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
(2)
|
The
2014 Services Warrants—September were issued to a consultant in exchange for advisory services with no readily available
fair value. The warrants were originally issued at an exercise price of $39.00 per share and had a one-time price reset provision
to the exercise price of the warrants issued to investors in the convertible notes offering in April 2014 if the exercise
price of such convertible notes warrants changed prior to September 30, 2014. On September 22, 2014, the exercise price was
changed to $25.00 per share. There are no further exercise price changes for this warrant series. The warrants were valued
using the Black-Scholes option pricing model at $131,000 on the issuance date with an additional $6,000 recorded to expense
on September 22, 2014 to reflect the change in fair value resulting from the exercise price change.
|
|
|
(3)
|
On September 22,
2014, the Company issued warrants to purchase up to 26,500 shares of common stock with an exercise price of $25.00 per share
in conjunction with placement agent services for the Company’s September 2014 private equity placement. The warrants
were valued using the Black-Scholes option pricing model at $296,000 on the issuance date.
|
(4)
|
On November
26, 2014, the Company issued warrants to purchase up to 6,500 shares of common stock with an exercise price of $25.00 per
share for compensation for investor relations services provided. The warrants were valued using the Black-Scholes option pricing
model at $43,000 on the issuance date.
|
(5)
|
On December
1, 2014, the Company issued warrants to purchase up to 19,232 shares of common stock with an exercise price of $39.00 per
share and on December 15, 2014 issued warrants to purchase up to 19,232 shares of common stock with an exercise price of $25.00
per share to settle potential legal disputes resulting from claims made by the investors in the November 2013 private equity
placement. The warrants issued on December 1, 2014 were issued concurrent with the issuance of 8,462 shares of the Company’s
common stock in partial settlement of the potential legal disputes arising from claims by two investors. The Company settled
all remaining potential legal disputes with all of the remaining investors in the November 2013 private placement on December
15, 2014 by issuing the second tranche of warrants and setting the exercise price of each warrant series issued at $25.00
with no further reset provisions. The combined issuance of the warrants and expense resulting from any price changes were
valued using the Black-Scholes option pricing model at $246,000 and expensed to general and administrative expense.
|
|
|
(6)
|
On April 23, 2015,
the Company issued warrants to purchase up to 136,267 shares of common stock and on May 7, 2015, the Company issued warrants
to purchase up to 83,518 shares of common stock, each with an exercise price of $12.50 per share in conjunction with the 2015
Senior Notes described in Note 9. The warrants were valued using the Black-Scholes option pricing model at $2,139,000 on the
issuance date. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the
issuance of the 2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00 per share.
|
|
|
(7)
|
On May 1, 2015,
the Company issued warrants to purchase up to 5,514 shares of common stock with an exercise price of $12.50 per share in conjunction
with placement agent services for the Company’s May 2015 private equity placement. The warrants were valued using the
Black-Scholes option pricing model at $56,000 on the issuance date.
|
(8)
|
On November
2, 2015, the Company issued warrants to purchase up to 74,000 shares of common stock with an exercise price of $15.00 per
share in conjunction with the Letter of Credit described in Note 14. The warrants were valued using the Black-Scholes option
pricing model at $246,000 on the issuance date. The warrants are exercisable beginning on November 1, 2016. On
April 27, 2017, the exercise price was reduced to $3.00 per share in conjunction with the amendment of the Letter of Credit
described in Note 14. The Company recorded additional deferred financing charges of $30,000, representing the difference
in fair value immediately before and after the repricing, which will be amortized ratably to expense through March 31, 2018.
|
(9)
|
On December
30, 2015, the Company issued warrants to purchase up to 50,000 shares of common stock with an initial exercise price of $12.50
per share in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above. On March
31, 2016, concurrent with the issuance of the March 2016 Warrants, the exercise price was reduced to $5.00 per share. On August
24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the issuance of the 2016 Senior
Notes, the exercise price of the warrants was further reduced to $3.00 per share.
|
|
|
(10)
|
On December 31,
2015, the Company issued warrants to purchase up to 312,500 shares of common stock with an initial exercise price of $5.00
per share in conjunction with the December private equity placement (the “December PIPE”). The warrants initially
provided that if, prior to the earlier of June 30, 2016 or thirty days after the date on which the December PIPE shares and
underlying warrants are registered for resale, the Company issued common share derivative securities at a price per share
less than $5.00 per share, the Company was obligated to reduce the exercise price of the December PIPE warrants to a price
per share equal to the newly issued shares or derivative common stock securities. This price protection clause expired on
June 30, 2016. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per share. Concurrent with the
issuance of the 2016 Senior Notes the exercise price of the warrants was further reduced to $3.00 per share.
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
(11)
|
On February
2, 2016, the Company issued warrants to purchase up to 50,000 shares of common stock with an initial exercise price of $12.50
per share in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above. The warrants
were valued using the Black-Scholes option pricing model at $148,000 on the issuance date and were recorded as a derivative
liability and additional debt discount. The warrants provided that, in the event that the Company issued additional common
stock derivative securities at a price per share less than the exercise price, the Company was obligated to reduce the exercise
price of the February 2016 Warrants to a price per share equal to the newly issued shares or derivative common stock securities.
On March 31, 2016, concurrent with the issuance of the additional debt amendment warrants, the exercise price was reduced
to $5.00 per share. This price protection clause expired on June 30, 2016. On August 24, 2016, the exercise price of the warrants
was reduced to $4.00 per share. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the
warrants was further reduced to $3.00 per share.
|
|
|
(12)
|
On March 31, 2016,
the Company issued warrants to purchase up to 500,000 shares of common stock with an initial exercise price of $5.00 per share
in conjunction with the amendment of the 2015 Senior Notes in December 2015, as described in Note 9 above. The warrants were
valued using the Black-Scholes option pricing model at $1,497,000 on the issuance date and were recorded as a derivative liability
and additional debt discount. The warrants provided that, in the event that the Company issued additional common stock derivative
securities at a price per share less than the exercise price, the Company was obligated to reduce the exercise price of the
March 2016 Warrants to a price per share equal to the newly issued shares or derivative common stock securities. This price
protection clause expired on June 30, 2016. On August 24, 2016, the exercise price of the warrants was reduced to $4.00 per
share. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the warrants was further reduced to $3.00
per share.
|
|
|
(13)
|
On September 1,
2016, the Company issued warrants to purchase up to 124,999 shares of common stock with an initial exercise price of $4.00
per share in conjunction with Unsecured Convertible Notes as described in Note 9 above. The warrants were valued using the
Black-Scholes option pricing model at $271,000 on the issuance date and were recorded as additional debt discount. Between
November 1, 2016 and December 31, 2016, the Company issued additional warrants to purchase up to 187,500 shares of common
stock, as described above. The additional warrants were valued using the Black-Scholes option pricing model at $305,000 and
were recorded as additional debt discount. Concurrent with the issuance of the 2016 Senior Notes, the exercise price of the
warrants issued on November 1, 2016 was reduced to $3.00 per share. The warrants issued on December 1, 2016, December 31,
2016, and January 30, 2017 were issued with an initial exercise price of $3.00 per share. On January 30, 2017 the
Company issued 62,500 warrants with an exercise price of $3.00 per share
|
|
|
(14)
|
Warrant exercise
price was reduced from $12.50 to $4.00 per share on August 24, 2016 and further reduced to $3.00 per share concurrent with
the issuance of the 2016 Senior Notes.
|
|
|
(15)
|
Warrant exercise
price was reduced from $5.00 to $4.00 per share on August 24, 2016 and further reduced to $3.00 per share concurrent with
the issuance of the 2016 Senior Notes. On August 24, 2016, the warrant agreement was amended to remove all provisions that
had previously required derivative liability accounting treatment.
|
|
|
(16)
|
On April 27, 2017,
the Company issued a warrant to purchase 41,000 shares of common stock at an exercise price of $3.00 per share in conjunction
with the amendment of the Letter of Credit described in Note 14. The warrant was valued using the Black-Scholes option pricing
model at $26,000, which will be recorded to deferred financing charges and amortized to expense ratably through the end of
March 2018.
|
Note 14—Commitments and Contingencies
We may become a party to litigation in
the normal course of business. We accrue for open claims based on our historical experience and available insurance coverage.
In the opinion of management, there are no legal matters involving us that would have a material adverse effect upon our financial
condition, results of operations or cash flows.
Lease
We lease our office facility, research
and development facility and equipment under operating leases, which for the most part, are renewable. The leases also provide
that we pay insurance and taxes. Our primary operating lease expired on December 31, 2016 and we extended the lease for a three-month
period ending March 31, 2017 at a reduced interim rate. We signed a new lease in February 2017 for a separate facility and moved
into our new headquarters facilities in April 2017.
Through March 31, 2017, our headquarters
was located at 9400 Toledo Way, Irvine, California 92618. The property consisted of a mixed use commercial office,
production, and warehouse facility of 32,649 square feet and expired December 31, 2016. We extended the lease at a reduced rate
until March 31, 2017. As of April 1, 2017, our headquarters are located at 8965 Research Drive, Irvine, California
92618 and consists of a mixed use commercial office of 4,960 square feet. From January through March 2017, our monthly rent was
$15,000 for the Toledo Way property holdover and, from April 1, 2017, our monthly rent is $10,168 per month, with annual escalations
on April 1, 2018 to $10,473 per month and on April 1, 2019 to $10,787 per month for the Research Drive property. The Toledo Way
lease terminated on April 1, 2017 and the Research Drive property lease expires on March 31, 2020.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Future minimum rental payments under operating
leases that have initial noncancelable lease terms in excess of one year as of September 30, 2017 are as follows:
Three months ending December 31, 2017
|
|
$
|
31,000
|
|
Year ending December 31, 2018
|
|
|
125,000
|
|
Year ending December 31, 2019
|
|
|
128,000
|
|
Year ending December 31, 2020
|
|
|
32,000
|
|
Total
|
|
$
|
316,000
|
|
In addition, we lease space from the Regents
of the University of California, Irvine, for the installation and demonstration of the EC250 equipment. The lease expired on January
1, 2015 and reverted to a month-to-month lease with a monthly payment of $7,780. The university will provide certain goods and
services including certain research and development services.
Standby Letter of Credit
Pursuant to the terms of the CLA, the
Company is required to provide a backstop security of $2.1 million to secure performance of certain obligations under the CLA
(the “Backstop Security”). Effective November 2, 2015, the Company executed that certain Backstop Security Support
Agreement (the “Support Agreement”), pursuant to which an investor agreed to provide the Company with financial and
other assistance (including the provision of sufficient and adequate collateral) as necessary in order for the Company to obtain
a $2.1 million letter of credit acceptable to Dresser-Rand as the Backstop Security and with an expiration date of June 30, 2017
(“Letter of Credit”). If the investor is required to make any payments on the Letter of Credit, subject to the terms
of the Intercreditor Agreement (as defined below), the Company must reimburse the investor the full amount of any such payment.
Such payment obligation is secured by a pledge of certain collateral of the Company pursuant to a Security Agreement dated November
2, 2015 (“Security Agreement”), and the security interest in favor of and the payment obligations to the investor
are subject to the terms of that certain Subordination and Intercreditor Agreement executed concurrently with the Support Agreement
and Security Agreement (the “Intercreditor Agreement”) by and among the investor, the Company and the collateral agent
pursuant to the Senior Notes.
The term of the Company’s obligations
under the Support Agreement (the “Term”) commenced on November 2, 2015, the issuance date of the Letter of Credit,
and will terminate on the earliest of: (a) replacement of the Letter of Credit with an alternative Backstop Security in favor
of Dresser-Rand, (b) Dresser-Rand eliminating the Backstop Security requirement under the CLA, or (c) the last day of the twenty-fourth
calendar month following the commencement of the Term. In consideration of the investor’s support commitment, the Company
paid the investor a one-time fee equal to 4% of the amount of the Letter of Credit and is obligated to pay a monthly fee equal
to 1% of the amount of the Letter of Credit for the first twelve months. If the Support Agreement has not terminated after the
initial twelve months, the Company will pay another one-time fee equal to 4% of the amount of the Letter of Credit, and a monthly
fee equal to 2% of the amount of the Letter of Credit for up to another twelve months.
Amendments to Backstop Security and
Senior Notes
Effective as of April 27, 2017, the Company
executed a First Amendment to the Support Agreement (the “BSSA Amendment”), with the individual investor. The BSSA
Amendment is intended to conform the terms of the Support Agreement and related Letter of Credit to the terms of the CMLA. The
BSSA Amendment (i) reduces the security obligation underlying the Letter of Credit from $2.1 million to $500,000, consistent with
the current terms of the CMLA, (ii) extends the term of the backstop security to March 31, 2018, (iii) reduces the related fee
payable under the Support Agreement to 1% per month for the remainder of the term, (iv) provided for the amendment and restatement
of the warrant issued to the investor in connection with the execution of the Support Agreement in order to reduce the exercise
price per share of common stock of to $3.00 and insert a beneficial ownership blocker provision at 4.99% (as amended and restated,
the “Restated Warrant”) and (v) provided that the Company would issue the investor an additional warrant to purchase
41,000 shares of Common Stock at an exercise price of $3.00 per share, subject to a 4.99% beneficial ownership blocker.
In connection with the execution of the
BSSA Amendment, on April 27, 2017, we and certain investors holding Senior Notes executed first amendments to such Senior Notes
to revise the definition of “Backstop Agreement” to include any amendments, restatements, supplements or other modifications
thereof, as may be permitted thereunder.
Note 15—Subsequent Events
In November 2017, the Company amended and
restated the securities purchase agreement pursuant to which the Company issued the 2017 Senior Notes, in connection with which
the Company issued and sold additional 2017 Senior Notes with an aggregate face value of $444,000 and an original issue discount
of $44,000 for gross cash proceeds of $400,000. In conjunction with the issuance of the additional 2017 Senior Notes, the Company
issued additional five-year warrants to purchase up to 177,778 shares of the Company’s common stock at an exercise price
of $1.50 per share.