Item 1. Financial
Statements
Index
to the Financial Statements
Condensed
Consolidated Balance Sheets—March 31, 2018 (unaudited) and December 31, 2017
|
2
|
|
|
Unaudited
Condensed Consolidated Statements of Operations—For the Three Months Ended March 31, 2018 and 2017 (unaudited)
|
3
|
|
|
Unaudited
Condensed Consolidated Statements of Cash Flows—For the Three Months Ended March 31, 2018 and 2017 (unaudited)
|
4
|
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
6
|
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, 2017, filed with the SEC on April 16, 2018.
Ener-Core,
Inc.
Condensed
Consolidated Balance Sheets
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
|
|
(unaudited)
|
|
|
|
|
Assets
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
106,000
|
|
|
$
|
208,000
|
|
Accounts receivable
|
|
|
9,000
|
|
|
|
14,000
|
|
Inventory
|
|
|
3,035,000
|
|
|
|
3,028,000
|
|
Prepaid expenses and other current assets
|
|
|
401,000
|
|
|
|
333,000
|
|
Total current assets
|
|
$
|
3,551,000
|
|
|
$
|
3,583,000
|
|
Property and equipment, net
|
|
|
2,580,000
|
|
|
|
2,660,000
|
|
Intangibles, net
|
|
|
12,000
|
|
|
|
13,000
|
|
Deposits and other long term assets
|
|
|
32,000
|
|
|
|
32,000
|
|
Total assets
|
|
$
|
6,175,000
|
|
|
$
|
6,288,000
|
|
Liabilities and stockholders’ deficit
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
1,865,000
|
|
|
$
|
1,749,000
|
|
Accrued expenses
|
|
|
1,462,000
|
|
|
|
1,380,000
|
|
Deferred revenues and customer advances
|
|
|
4,223,000
|
|
|
|
5,270,000
|
|
Accrued contract loss
|
|
|
454,000
|
|
|
|
617,000
|
|
Convertible unsecured notes payable
|
|
|
1,250,000
|
|
|
|
1,250,000
|
|
Convertible senior secured notes payable, net of
discounts
|
|
|
7,835,000
|
|
|
|
5,994,000
|
|
Capital leases payable—short term
|
|
|
11,000
|
|
|
|
13,000
|
|
Total current liabilities
|
|
$
|
17,100,000
|
|
|
$
|
16,273,000
|
|
Long term liabilities:
|
|
|
|
|
|
|
|
|
Capital lease payable
|
|
|
10,000
|
|
|
|
12,000
|
|
Total liabilities
|
|
$
|
17,110,000
|
|
|
$
|
16,285,000
|
|
Commitments and contingencies (Note 15)
|
|
|
|
|
|
|
|
|
Stockholders’ deficit:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.0001 par value. Authorized 50,000,000 shares; no shares issued and outstanding at March 31, 2018 and December 31, 2017
|
|
$
|
—
|
|
|
$
|
—
|
|
Common stock, $0.0001 par value. Authorized 200,000,000 shares; 4,106,393 and 4,081,393 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively
|
|
|
—
|
|
|
|
—
|
|
Additional paid-in capital
|
|
|
42,592,000
|
|
|
|
42,342,000
|
|
Accumulated deficit
|
|
|
(53,527,000
|
)
|
|
|
(52,339,000
|
)
|
Total stockholders’ deficit
|
|
$
|
(10,935,000
|
)
|
|
$
|
(9,997,000
|
)
|
Total liabilities and
stockholders’ deficit
|
|
$
|
6,175,000
|
|
|
$
|
6,288,000
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Operations
(unaudited)
|
|
Three Months Ended
March
31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
1,100,000
|
|
|
$
|
—
|
|
Total costs of goods sold
|
|
|
—
|
|
|
|
—
|
|
Gross profit
|
|
|
1,100,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
573,000
|
|
|
|
1,031,000
|
|
Research and development
|
|
|
441,000
|
|
|
|
582,000
|
|
Total operating expenses
|
|
|
1,014,000
|
|
|
|
1,613,000
|
|
Operating income (loss)
|
|
|
86,000
|
|
|
|
(1,613,000
|
)
|
|
|
|
|
|
|
|
|
|
Other expenses:
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(1,274,000
|
)
|
|
|
(1,571,000
|
)
|
Loss on debt conversion
|
|
|
—
|
|
|
|
(53,000
|
)
|
Other expense, net
|
|
|
—
|
|
|
|
(14,000
|
)
|
Total other (expenses)
|
|
|
(1,274,000
|
)
|
|
|
(1,638,000
|
)
|
Loss before provision for income taxes
|
|
|
(1,188,000
|
)
|
|
|
(3,251,000
|
)
|
Provision for income taxes
|
|
|
—
|
|
|
|
—
|
|
Net loss
|
|
$
|
(1,188,000
|
)
|
|
$
|
(3,251,000
|
)
|
|
|
|
|
|
|
|
|
|
Loss per share—basic and diluted
|
|
$
|
(0.29
|
)
|
|
$
|
(0.85
|
)
|
Weighted average common shares—basic and diluted
|
|
|
4,088,059
|
|
|
|
3,844,149
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Cash Flows
(unaudited)
|
|
Three Months Ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,188,000
|
)
|
|
$
|
(3,251,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
81,000
|
|
|
|
127,000
|
|
Stock-based compensation
|
|
|
94,000
|
|
|
|
270,000
|
|
Loss on debt conversions
|
|
|
—
|
|
|
|
53,000
|
|
Amortization of debt discount and deferred financing fees
|
|
|
1,207,000
|
|
|
|
1,409,000
|
|
Loss on asset disposal
|
|
|
—
|
|
|
|
14,000
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts and other receivables
|
|
|
—
|
|
|
|
(44,000
|
)
|
Prepaid expenses and other current assets
|
|
|
10,000
|
|
|
|
57,000
|
|
Inventory
|
|
|
(170,000
|
)
|
|
|
(162,000
|
)
|
Deferred revenues
|
|
|
(1,047,000
|
)
|
|
|
46,000
|
|
Deposits
|
|
|
—
|
|
|
|
5,000
|
|
Accounts payable and other current liabilities
|
|
|
250,000
|
|
|
|
189,000
|
|
Cash used in operating activities
|
|
$
|
(763,000
|
)
|
|
$
|
(1,287,000
|
)
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
—
|
|
|
|
(1,000
|
)
|
Proceeds from sale of assets
|
|
|
—
|
|
|
|
11,000
|
|
Net cash from investing activities
|
|
$
|
—
|
|
|
$
|
10,000
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Repayment of capital leases payable
|
|
|
(4,000
|
)
|
|
|
(3,000
|
)
|
Proceeds from issuance of convertible senior secured notes
|
|
|
665,000
|
|
|
|
—
|
|
Net cash from (used in) financing activities
|
|
$
|
661,000
|
|
|
$
|
(3,000
|
)
|
Decrease in cash and cash equivalents
|
|
|
(102,000
|
)
|
|
|
(1,280,000
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
208,000
|
|
|
|
1,310,000
|
|
Cash and cash equivalents at end of period
|
|
$
|
106,000
|
|
|
$
|
30,000
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Cash Flows (continued)
(unaudited)
|
|
Three Months Ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest
|
|
$
|
—
|
|
|
$
|
214,000
|
|
Supplemental disclosure of non-cash activities:
|
|
|
|
|
|
|
|
|
Debt discount recorded upon issuance of warrants
|
|
$
|
136,000
|
|
|
$
|
73,000
|
|
Accrued expenses exchanged for convertible senior secured notes
|
|
$
|
135,000
|
|
|
$
|
—
|
|
Conversion of convertible senior secured notes into shares of common stock
|
|
|
—
|
|
|
|
60,000
|
|
Shares of common stock issued for prepaid retainer
|
|
$
|
20,000
|
|
|
$
|
—
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
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 pressure vessels are capable of using a wide
variety of organic gases as fuel for a high-temperature oxidation reaction including many “waste” gases considered
to be air pollution. 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
required by industrial plants to comply with increasingly stringent air pollution standards.
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 heat source alternative to 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 (“kW”), and 2 megawatt (“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. Going forward, 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 (“Dresser-Rand”), will manufacture the 2 MW Power Oxidizers under a manufacturing license
and will pay us a non-refundable license fee for each unit manufactured by Dresser-Rand.
On November 14, 2014, we entered into a
commercial license agreement (“CLA”) with Dresser-Rand, pursuant to which we agreed to jointly develop a Powerstation
that consisted of our Power Oxidizer integrated with a Dresser-Rand KG2 turbine rated up to 2 MW of power output. The CLA granted
Dresser-Rand the right to market and sell the Dresser-Rand KG2-3GEF 2 MW gas turbine coupled with our Power Oxidizer. In June 2016,
we executed a contract manufacturing and commercial licensing agreement (the “CMLA”) with Dresser-Rand, which both
companies intended would supersede and replace the CLA. In April 2017, we amended the terms of the CMLA to make the CMLA effective
as of January 1, 2017, at which time it superseded and replaced the CLA. The first two systems sold to Dresser-Rand pursuant to
the CLA were shipped to a Stockton, California biorefinery site owned by Pacific Ethanol, Inc. in the fourth quarter of 2016 and
were operational in January 2018. Due to issues unrelated to the Power Oxidizer performance, full commissioning of these units
is expected in the third quarter of 2018. Under the CMLA, moving forward, 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 for a combined payment credit of $2.0 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 cash advances to be backlog as of May 21, 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 $2.2 million
between September 2017 and March 2018, along with $1.45 million received in 2017 for advances on license fees, 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 received additional license fees in 2017 from the CMLA, including $1.2
million received in the second quarter of 2017 and $250,000 in the third quarter of 2017. We expect to receive additional license
payments upon receipt of firm purchase orders for licenses in 2018 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 March 31, 2018 was approximately $0.1 million. We expect
that the $0.1 million of cash and cash equivalents as of March 31, 2018, combined with receipts on customer billings will continue
to fund our working capital needs, general corporate purposes, and related obligations into the second quarter of 2018 at our current
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. In the opinion of management,
all adjustments that are necessary for a fair statement of the results for interim periods have been included.
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; 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.
Foreign
Currency Adjustments
At March 31, 2018 and December 31, 2017, we
did not hold any foreign currency asset or liability amounts. Gains and losses resulting from foreign currency transactions are
reported as other income in the period they occurred.
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 March 31, 2018, we had $0 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.
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 March 31, 2018 and December 31, 2017, two customers accounted for 100%
of our accounts receivable.
Accounts
Payable
As of March 31, 2018 and December 31, 2017,
five vendors collectively accounted for approximately 54% and 53% of our total accounts payable, respectively.
Inventory
Inventory, which consists of raw materials and work-in-progress, 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 March 31, 2018 and December 31, 2017,
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 December
31, 2017 or March 31, 2018. We expect that most terms for future warranties of our Powerstations and Oxidizers will be one to
two years depending on the warranties provided and the products sold. Accrued warranties for expected expenditures within one
year are classified as current liabilities and as non-current liabilities for expected expenditures for time periods beyond one
year.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Intangible
Assets
Our
intangible assets represent intellectual property acquired during the reverse merger. We amortize our intangible assets with finite
lives over their estimated useful lives.
Impairment
of Long-Lived Assets
We account for our long-lived assets in
accordance with the accounting standards which require that long-lived assets be reviewed for impairment whenever events or changes
in circumstances indicate that the historical carrying value of an asset may no longer be appropriate. 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 March 31, 2018 and December 31, 2017, we do not believe there have been any
impairments of our long-lived assets. There can be no assurance, however, that market conditions will not change or demand for
our products will continue, which could result in impairment of long-lived assets in the future.
Fair
Value of Financial Instruments
Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts
payable, and capital lease liabilities. Fair value estimates discussed herein are based upon certain market assumptions and pertinent
information available to management as of March 31, 2018 and December 31, 2017. 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.
We
determine the fair value of our financial instruments based on a three-level hierarchy established for fair value measurements
under which these assets and liabilities must be grouped, based on significant levels of observable or unobservable inputs. Observable
inputs reflect market data obtained from independent sources, while unobservable inputs reflect management’s market assumptions.
This hierarchy requires the use of observable market data when available. These two types of inputs have created the following
fair-value hierarchy:
|
●
|
Level
1: Valuations based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities. Currently, we classify our cash and cash equivalents as Level 1 financial instruments.
|
|
|
|
|
●
|
Level
2: Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement
date quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially
the full term of the asset or liability. We do not currently have any accounts under Level 2.
|
|
|
|
|
●
|
Level
3: Valuations based on inputs that require inputs that are both significant to the fair value measurement and unobservable
and involve management judgment (i.e., supported by little or no market activity). Currently, we classify our warrants and
conversion options accounted for as derivative liabilities as Level 3 financial instruments.
|
If
the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy
level is based upon the lowest level of input that is significant to the fair value measurement.
Revenue Recognition
In May 2014, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 (Topic 606) “Revenue from Contracts
with Customers,” which supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic
605). Topic 606 requires entities to recognize revenue when control of the promised goods or services is transferred to customers.
The amount of revenue recognized must reflect the consideration the entity expects to be entitled to receive in exchange for those
goods or services. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. See Note
13 for further details.
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 $441,000 and $582,000 for the three months
ended March 31, 2018 and 2017, 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
Accounting Standards Codification (“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 12.2 million and 9.8
million shares of common stock issuable upon full exercise of all options and warrants at March 31, 2018 and 2017, respectively,
and all shares potentially issuable in the future under the terms of the convertible senior secured notes payable 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
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,188,000
|
)
|
|
$
|
(3,251,000
|
)
|
Weighted average number of shares of common stock outstanding:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,088,059
|
|
|
|
3,844,149
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.29
|
)
|
|
$
|
(0.85
|
)
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Comprehensive
Income (Loss)
We
have no items of other comprehensive income (loss) in any period presented. Therefore, net loss as presented in our condensed
consolidated statements of operations equals comprehensive loss.
Recently Issued Accounting Pronouncements
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 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.
In September 2017, the FASB issued ASU
No. 2017-13,
Revenue Recognition, Revenue from Contracts with Customers, Leases.
The ASU adds SEC paragraphs to the new
revenue and leases sections of the ASC on the announcement the SEC Observer made at the July 20, 2017 meeting of the Emerging Issues
Task Force. The SEC Observer said that the SEC staff would not object if entities that are considered public business entities
only because their financial statements or financial information is required to be included in another entity’s SEC filing
use the effective dates for private companies when they adopt ASC 606, Revenue from Contracts with Customers, and ASC 842, Leases.
This would include entities whose financial statements are included in another entity’s SEC filing because they are significant
acquirees under Rule 3-05 of Regulation S-X, significant equity method investees under Rule 3-09 of Regulation S-X and equity method
investees whose summarized financial information is included in a registrant’s financial statement notes under Rule 4-08(g)
of Regulation S-X. We are currently evaluating the impact of adopting this guidance.
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 March 31, 2018 or December
31, 2017. Inventories consist of:
|
|
March 31, 2018
|
|
|
December 31, 2017
|
|
Raw material and spare parts
|
|
$
|
942,000
|
|
|
$
|
953,000
|
|
Work-in-progress
|
|
|
2,093,000
|
|
|
|
2,075,000
|
|
Total
|
|
$
|
3,035,000
|
|
|
$
|
3,028,000
|
|
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:
|
|
March 31,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
Prepaid rent
|
|
$
|
—
|
|
|
$
|
10,000
|
|
Prepaid offering costs
|
|
|
303,000
|
|
|
|
194,000
|
|
Prepaid insurance
|
|
|
17,000
|
|
|
|
19,000
|
|
Prepaid other
|
|
|
61,000
|
|
|
|
63,000
|
|
Prepaid professional fees
|
|
|
20,000
|
|
|
|
32,000
|
|
Current portion—deferred financing fees for letter of credit
|
|
|
—
|
|
|
|
15,000
|
|
Total
|
|
$
|
401,000
|
|
|
$
|
333,000
|
|
Note
5—Property and Equipment, Net
Property
and equipment, net consisted of the following:
|
|
March 31,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
Machinery and equipment
|
|
$
|
4,225,000
|
|
|
$
|
4,225,000
|
|
Office furniture and fixtures
|
|
|
49,000
|
|
|
|
49,000
|
|
Computer equipment and software
|
|
|
202,000
|
|
|
|
202,000
|
|
Total cost
|
|
|
4,476,000
|
|
|
|
4,476,000
|
|
Less accumulated depreciation
|
|
|
(1,896,000
|
)
|
|
|
(1,816,000
|
)
|
Net
|
|
$
|
2,580,000
|
|
|
$
|
2,660,000
|
|
Assets
recorded under capital leases and included in property and equipment in our balance sheets consist of the following:
|
|
March 31,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
Machinery and equipment
|
|
$
|
27,000
|
|
|
$
|
27,000
|
|
Computer equipment and software
|
|
|
25,000
|
|
|
|
39,000
|
|
Total assets under capital lease
|
|
|
52,000
|
|
|
|
66,000
|
|
Less accumulated amortization
|
|
|
(31,000
|
)
|
|
|
(41,000
|
)
|
Net assets under capital lease
|
|
$
|
21,000
|
|
|
$
|
25,000
|
|
Depreciation
expense for the three months ended March 31, 2018 and 2017 consisted of the following:
|
|
Three Months Ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Research and development
|
|
$
|
77,000
|
|
|
$
|
100,000
|
|
General and administrative
|
|
|
3,000
|
|
|
|
27,000
|
|
|
|
$
|
80,000
|
|
|
$
|
127,000
|
|
Amortization
of assets under capital lease was $3,000 and $3,000 for the three months ended March 31, 2018 and 2017, respectively.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
6—Accrued Expenses
Accrued
expenses consisted of the following;
|
|
March 31, 2018
(unaudited)
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Accrued professional fees
|
|
$
|
186,000
|
|
|
$
|
155,000
|
|
Accrued payroll and related expenses
|
|
|
591,000
|
|
|
|
648,000
|
|
Accrued board of directors’ fees
|
|
|
450,000
|
|
|
|
390,000
|
|
Accrued interest
|
|
|
170,000
|
|
|
|
138,000
|
|
Accrued other
|
|
|
65,000
|
|
|
|
49,000
|
|
Total accrued expenses
|
|
$
|
1,462,000
|
|
|
$
|
1,380,000
|
|
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
or spare parts for those units. Prepaid license fees represent payments of license fees by Dresser-Rand that we received in 2017
but for which the underlying unit sales had not been completed. Deferred revenues and customer advances consisted of the following:
|
|
March 31, 2018
(unaudited)
|
|
|
December 31, 2017
|
|
|
|
|
|
|
|
|
Customer advances on equipment sales
|
|
$
|
2,773,000
|
|
|
$
|
2,720,000
|
|
Prepaid license fees
|
|
|
1,450,000
|
|
|
|
2,550,000
|
|
Total deferred revenues and customer advances
|
|
$
|
4,223,000
|
|
|
$
|
5,270,000
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Note
8—Convertible Senior Notes Payable
Convertible
Senior Notes payable consisted of the following as of March 31, 2018:
|
|
Principal
|
|
|
Debt
Discount
|
|
|
Offering Costs
|
|
|
Net
Total
|
|
Balance, December 31, 2017
|
|
$
|
10,687,000
|
|
|
|
(4,448,000
|
)
|
|
|
(245,000
|
)
|
|
|
5,994,000
|
|
Amortization of debt discount and offering costs
|
|
|
—
|
|
|
|
1,142,000
|
|
|
|
65,000
|
|
|
|
1,207,000
|
|
2018 convertible senior secured notes issuance
|
|
|
889,000
|
|
|
|
(225,000
|
)
|
|
|
(30,000
|
)
|
|
|
634,000
|
|
Balance, March 31, 2018
|
|
|
11,576,000
|
|
|
|
(3,531,000
|
)
|
|
|
(210,000
|
)
|
|
|
7,835,000
|
|
Less: current portion
|
|
|
(11,576,000
|
)
|
|
|
3,531,000
|
|
|
|
210,000
|
|
|
|
(7,835,000
|
)
|
Long term portion
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
On January 25, 2018, the Company and certain
investors agreed to further amend and restate the securities purchase agreement under which such investors purchased unregistered
convertible senior secured promissory notes in September, November and December 2017 in aggregate principal amount of approximately
$1,555,556 (the “2017 Senior Notes”), pursuant to which the Company agreed to issue to certain accredited investors,
pursuant to a series of joinder agreements, additional unregistered convertible senior secured promissory notes in aggregate principal
amount of approximately $555,556 (the “2018 Senior Notes”) and five-year warrants to purchase an aggregate of 222,219
shares of common stock at an exercise price of $1.50 per share, with aggregate gross proceeds to the Company of $465,000 and cancellation
of indebtedness of $35,000. The closing of the first 2018 Senior Notes financing occurred on January 25, 2018.
On March 26, 2018, the Company and certain
investors agreed to further amend and restate the securities purchase agreement under which such investors purchased the 2017 Senior
Notes and 2018 Senior Notes, pursuant to which the Company agreed to issue to certain accredited investors, pursuant to a series
of joinder agreements, additional 2018 Senior Notes in principal amount of approximately $333,335 and five-year warrants to purchase
an aggregate of 133,332 shares of common stock at an exercise price of $1.50 per share, with aggregate cash gross proceeds to the
Company of approximately $200,000 and cancellation of indebtedness of approximately $100,000, which consists of earned and unpaid
salary due to certain employees of the Company who elected to receive payment in the form of 2018 Senior Notes in lieu of cash.
The closing of the second 2018 Senior Notes financing occurred on March 26, 2018.
We incurred $30,000 of offering costs in
conjunction with the issuance and sale of the 2018 Senior Notes consisting of legal and professional fees. We will amortize the
offering costs to interest expense over the expected remaining life of the 2018 Senior Notes.
The Company refers to the 2018 Senior Notes,
the 2017 Senior Notes, the convertible senior secured promissory notes in the fourth quarter of 2016 (the “2016 Senior Notes”)
and the amended and restated convertible senior secured promissory notes originally issued in April and May 2015 (the “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.
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 issued in September 2016 (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 July 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 June 30, 2018, 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 agreements for the Senior Notes and the Transaction Documents.
Note
9—Convertible Unsecured Notes
Convertible Unsecured Notes payable consisted of the following:
|
|
Notes
|
|
|
Debt
Discount
|
|
|
Offering
Costs
|
|
|
Net
Total
|
|
Balance at December 31, 2017 and March 31, 2018
|
|
$
|
1,250,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,250,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: current portion
|
|
$
|
(1,250,000
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(1,250,000
|
)
|
Long term portion
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
On September 1, 2016, we entered into a
securities purchase agreement and related notes and warrants pursuant to which we issued the Convertible Unsecured Notes and detachable
five-year warrants to purchase an aggregate of 124,999 shares of the Company’s common stock at an exercise price of $4.00
per share (the “September 2016 Financing”). The Company received total gross proceeds of $1,250,000, less transaction
expenses of $45,000 consisting of legal costs for net proceeds of $1,205,000. We recorded a discount of $553,000 on the date of
issuance representing the fair value of the warrants issued and the value of the beneficial conversion feature on the date of issuance.
In the fourth quarter of 2016, we increased our debt discount recorded by $335,000, consisting of $305,000 recorded for the issuance
of additional warrants at fair value of $305,000 and $30,000 for the difference in fair value for warrants repriced from $4.00
per share to $3.00 per share.
The Convertible Unsecured Notes bear interest
at a rate of 12% per annum and were scheduled to 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 March 31, 2018, 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 (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—Capital Leases Payable
Capital
Leases Payable
Capital
leases payable consisted of the following:
|
|
March 31,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Capital lease payable to De Lage Landen secured by forklift, 10.0% interest, due on October 1, 2018, monthly payment of $452
|
|
$
|
4,000
|
|
|
$
|
5,000
|
|
Capital lease payable to Dell Computers secured by computer equipment, 4.99% interest, due on May 1, 2020, monthly payment of $716
|
|
|
17,000
|
|
|
|
20,000
|
|
Total capital leases
|
|
$
|
21,000
|
|
|
$
|
25,000
|
|
Less: current portion
|
|
|
(11,000
|
)
|
|
|
(13,000
|
)
|
Long term portion of capital leases
|
|
$
|
10,000
|
|
|
$
|
12,000
|
|
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
The
future minimum lease payments required under the capital leases and the present value of the net minimum lease payments as of
March 31, 2018, are as follows:
|
|
12 Months Ending March 31,
|
|
Amount
|
|
|
|
2018
|
|
$
|
11,000
|
|
|
|
2019
|
|
|
8,000
|
|
|
|
2020
|
|
|
3,000
|
|
Net minimum lease payments
|
|
|
|
$
|
22,000
|
|
Less: amount representing interest
|
|
|
|
|
(1,000
|
)
|
Present value of net minimum lease payments
|
|
|
|
$
|
21,000
|
|
Less: current maturities of capital lease payables
|
|
|
|
|
(11,000
|
)
|
Long term capital lease payables
|
|
|
|
$
|
10,000
|
|
Note
11—Equity
During
the three months ended March 31, 2018, the Company issued 25,000 shares of common stock in exchange for services valued at $20,000.
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. All restricted stock issued is valued at the market price
on the date of grant.
Restricted stock activities during the three months ended March
31, 2018 were as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Grant
|
|
|
|
Shares
|
|
|
Price
|
|
Balance, December 31, 2017
|
|
|
210,000
|
|
|
$
|
1.55
|
|
Granted
|
|
|
—
|
|
|
$
|
—
|
|
Vested
|
|
|
(113,750
|
)
|
|
$
|
—
|
|
Unvested balance, March 31, 2018
|
|
|
96,250
|
|
|
$
|
1.55
|
|
Expenses
related to vesting of restricted stock are included in stock-based compensation expense. The remaining unvested shares of restricted
stock vest 50% per year on March 31, 2019 and 2020.
Note
12—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 March 31, 2018, the Company had
issued 210,000 shares of common stock and options to purchase an aggregate of 444,000 shares of common stock under the 2015
Plan.
The
2015 Plan permits the granting of any or all of the following types of awards: incentive stock options, non-qualified stock options,
stock appreciation rights, restricted stock, restricted stock units, other stock-based awards, and performance awards payable
in a combination of cash and company shares. As of March 31, 2018, 85,857 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 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 March 31, 2018, total unrecognized deferred
stock compensation expected to be recognized over the remaining weighted average vesting periods of 1.94 years for outstanding
grants was $0.7 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, 2017
|
|
|
668,607
|
|
|
$
|
6.21
|
|
|
|
7.38
|
|
|
$
|
—
|
|
Forfeited or granted during 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Balance, March 31, 2018
|
|
|
668,607
|
|
|
$
|
6.21
|
|
|
|
7.12
|
|
|
$
|
—
|
|
Exercisable on March 31, 2018
|
|
|
434,497
|
|
|
$
|
7.98
|
|
|
|
6.24
|
|
|
$
|
—
|
|
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 224,314 shares of the Company’s common stock were outstanding
and options to purchase 208,553 shares of the Company’s common stock were exercisable under the 2013 Plan and options to
purchase 444,293 shares of the Company’s common stock were outstanding with 225,944 exercisable under the 2015 Plan on March
31, 2018.
The
following table summarizes information about stock options outstanding and exercisable at March 31, 2018:
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
Number
|
|
Remaining
|
|
|
Average
|
|
|
Number
|
|
|
Average
|
|
|
|
|
of
|
|
Contractual
|
|
|
Exercise
|
|
|
of
|
|
|
Exercise
|
|
Exercise Prices
|
|
|
Shares
|
|
Life
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
|
|
|
|
|
(In years)
|
|
|
|
|
|
|
|
|
|
|
$0–$10.00
|
|
|
529,748
|
|
|
8.21
|
|
|
$
|
3.35
|
|
|
|
298,668
|
|
$
|
3.77
|
|
$10.01–$15.00
|
|
|
28,300
|
|
|
5.70
|
|
|
$
|
12.50
|
|
|
|
25,270
|
|
$
|
12.50
|
|
$15.01–$20.00
|
|
|
94,845
|
|
|
2.08
|
|
|
$
|
17.50
|
|
|
|
94,845
|
|
$
|
17.50
|
|
$20.01–$25.00
|
|
|
15,714
|
|
|
3.32
|
|
|
$
|
23.24
|
|
|
|
15,714
|
|
$
|
23.24
|
|
|
|
|
668,607
|
|
|
7.12
|
|
|
$
|
6.21
|
|
|
|
434,497
|
|
$
|
7.98
|
|
Stock-based compensation expense consisted of the following:
|
|
Three Months Ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
51,000
|
|
|
$
|
169,000
|
|
General and administrative
|
|
|
43,000
|
|
|
|
101,000
|
|
|
|
$
|
94,000
|
|
|
$
|
270,000
|
|
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 three months ended March 31, 2018
.
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
Average
|
|
|
|
of
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
Balance outstanding at December 31, 2017
|
|
|
6,084,603
|
|
|
$
|
3.38
|
|
Issued for 2018 Senior Notes
|
|
|
355,551
|
|
|
|
1.50
|
|
Balance outstanding at March 31, 2018
|
|
|
6,440,154
|
|
|
$
|
3.28
|
|
All
warrants were exercisable at March 31, 2018, the weighted average exercise price per share was $3.28 and the weighted average
remaining life was 3.6 years. The warrants outstanding as of March 31, 2018 had no intrinsic value.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
2018
Senior Notes Warrants
Between January and March 2018, the Company
issued warrants to purchase up to an aggregate of 355,551 shares of common stock to the holders of the 2018 Senior Notes with an
exercise price of $1.50 per share. The Company incorporated the fair value of the warrants issued of $135,000, valued using the
Black-Scholes pricing model, into the debt discount recorded for the 2018 Senior Notes, as described in Note 8.
Warrants
outstanding as of March 31, 2018 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)
|
|
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 Convertible Unsecured Notes Warrants
(13)
|
|
Sep–Dec-16
|
|
Sep–Dec-21
|
|
|
312,499
|
|
|
|
3.00
|
|
2016 Senior Notes Warrants
|
|
Dec-16
|
|
Dec-21
|
|
|
3,720,839
|
|
|
|
3.00
|
|
2017 Convertible Unsecured Notes Warrants (13)
|
|
Jan-17
|
|
Jan-22
|
|
|
62,500
|
|
|
|
3.00
|
|
2017 Backstop Warrants
|
|
Apr-17
|
|
Apr-22
|
|
|
41,000
|
|
|
|
3.00
|
|
2017 Senior Notes Warrants
|
|
Sep/Nov/Dec-17
|
|
Sep/Nov/Dec-22
|
|
|
622,222
|
|
|
|
1.50
|
|
2018 Senior Notes Warrants
|
|
Jan/Mar-18
|
|
Jan/Mar-23
|
|
|
355,551
|
|
|
|
1.50
|
|
Warrants outstanding and exercisable at March 31, 2018
|
|
|
|
|
|
|
6,440,154
|
|
|
$
|
3.28
|
|
(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.
|
|
|
(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.
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
(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 issuance of the 2015 Senior Notes. 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 15. 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 2017, the exercise price was reduced to $3.00 per share as a term of an amendment to the backstop security.
|
(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 an amendment of the 2015 Senior Notes in December 2015. 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.
|
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 an amendment of the 2015 Senior Notes in December 2015. 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 an amendment of the 2015 Senior Notes in December 2015. 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 8 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 warrants to purchase up to 62,500 shares of common stock 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.
|
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 13—Revenue
On January 1, 2018, we adopted Topic
606. We elected to use the modified retrospective approach for contracts that were not completed as of January 1, 2018. Results
for reporting periods beginning after January 1, 2018 are presented in accordance with Topic 606, while prior period
amounts are not adjusted and continue to be reported in accordance with our historic accounting method under Topic 605. As a result
of applying the new standard, there were no changes to any financial statement line item.
Performance Obligations
Our performance obligations include delivery
of product, installation of product, and servicing of product as well as technology transfer licensing and royalty-based licensing
for subsequent sales of units under license. We recognize product revenue performance obligations when the product is delivered
to the customer and commissioned for use by the customer. Upon commissioning and at that point in time, the control of the product
is transferred to the customer. We recognize technology transfer licensing upon successful integration of the technology into usable
products. Our royalty-based licenses are calculated as a percentage of the value of the units sold under license. We recognize
royalty-based licensing upon subsequent unit orders, represented by purchase orders from our licensing partners with specified
unit values. We expect to satisfy our current and future performance obligations within a few months of entering into the contract.
Depending on the size of the project, the performance obligations could be satisfied sooner or later.
Our customers have a limited right to return
our products which is not expected to be material and would further result in cancellation penalties. We provide a warranty on
some of our products ranging from nine months to one year, depending on the contract with an option to purchase extended warranties.
The amount accrued for expected returns and warranty claims was immaterial as of March 31, 2018.
Contract Balances
All of the current contracts are expected
to be completed within one year. We have elected to use the practical expedient in 340-40-25-4 (regarding the incremental costs
of obtaining a contract) for costs related to contracts that are estimated to be complete within one year and as a result, we have
not recognized a contract asset account. If we had chosen not to use this practical expedient, we would not expect a material difference
in the contract balances. For our product sales where amounts received or expected to be received are less than the expected costs
of a contract, we record contract loss provisions and contract loss liabilities. 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 March 31, 2018 and December 31, 2017, we had provisions
for contract losses of $454,000 and $617,000, respectively.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
Licensing Arrangements
Patent and technology licensing arrangements
result in fixed payments received over time, with guaranteed minimum payments on occasion, variable payments calculated based on
the licensee’s sale or use of the intellectual property (“IP”), or a mix of fixed and variable payments.
Under our existing licensing arrangements,
Dresser-Rand has a worldwide perpetual license (the “License”) to manufacture, market, commercialize and sell Power
Oxidizers as part of a Dresser-Rand KG2-3GEF 2 MW gas turbine coupled with our Power Oxidizer (a “Combined System”)
within the 1 MW to 4 MW range of power capacity. Initially, the License will be exclusive within this power capacity range, for
so long as Dresser-Rand sells a minimum number of units of the Combined System in each annual sales threshold (the “Sales
Threshold”), subject to certain conditions and exceptions. If Dresser-Rand does not meet either the initial or any subsequent
annual Sales Thresholds, and the Sales Threshold is not otherwise waived, Dresser-Rand may maintain exclusivity of the License
by making a true-up payment to us for each unit that is in deficit of the Sales Threshold (a “True-Up Payment”);
provided,
however
, that Dresser-Rand may not maintain an exclusive License by making a True-Up Payment for more than two consecutive
Sales Threshold periods. In the event Dresser-Rand does not meet the Sales Threshold, does not qualify for a waiver and elects
not to make the True-Up Payment, the License will convert to a non-exclusive License.
|
●
|
For fixed-fee arrangements, consisting of the initial licensing fee to facilitate the integration of the technology into a Combined System, the Company recognizes revenue upon control over the underlying IP use right transferring to the licensee and for the initial license, where the initial commercial units are deemed to be operational in order to verify technological feasibility. Where a licensee has the contractual right to terminate a fixed-fee arrangement for convenience without any substantive penalty payable upon such termination, the Company applies the guidance in Topic 606 to the duration of the contract in which the parties have present enforceable rights and obligations and only recognizes revenue for amounts that are due and payable. To date, all fixed-fee arrangements have been paid in full prior to revenue recognition.
|
|
|
|
|
●
|
For variable arrangements, the Company recognizes revenue based on the licensee’s sale or usage of the IP during the period of reference, represented by receipt of purchase orders from the licensee representing use of the IP. To date, amounts received under variable arrangements have been recorded as deferred revenues since the licensee has not provided purchase orders for Combined Systems utilizing IP for the variable arrangement component of the licensing arrangement.
|
These arrangements do not typically grant the licensee the right
to terminate for convenience and where such rights exist, termination is prospective, with no refund of fees already paid by the
licensee.
The Company’s per-unit royalty agreement
contains a provision which sets forth minimum amounts to be received by the Company in order for Dresser-Rand to maintain exclusivity
of its License as a True-Up Payment. Under ASC 606, we would consider any such True-Up Payments as minimum royalties at a fixed
transaction price to which the Company will have an unconditional right once all other performance obligations, if any, are satisfied.
Therefore, if the Company receives any True-Up Payments for exclusivity in the future, such receipts would be recorded as revenues
in the period in which all remaining revenue recognition criteria have been met.
Significant Judgments
For license or royalty based revenue contracts,
we invoice the customer when the performance obligation is satisfied and payment is due. For our royalty-based contract with Dresser-Rand,
we invoice 50% of the order upon license order placement and the second 50% on the earlier of subsequent unit delivery or 12 months,
whichever occurs first. For our products sold under contract, terms such as progress billings or longer terms are agreed to on
a case-by-case basis. We do not have significant financing components, non-cash consideration, or variable consideration except
that our royalty-based unit licenses vary by the value of the unit sold, which is established at order placement. As of March 31,
2018, we had $4.2 million allocated to performance obligations that were unsatisfied and we expect those obligations to be satisfied
within one year.
Disaggregation of Revenue
All revenue recognized in the condensed
consolidated statement of operations is considered to be revenue from contracts with customers. For the three months ended March
31, 2018, all revenues were associated with technology transfer licenses under fixed-fee arrangements.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Note 14—Related Party Transactions
Between September 2017 and March 2018,
we sold and issued to 23 accredited investors 2017 Senior Notes and 2018 Senior Notes in an aggregate principal amount of approximately
$2.4 million and five-year warrants to purchase an aggregate of 977,773 shares of our common stock at an exercise price of $1.50
per share, with aggregate net proceeds to us of approximately $2.1 million of cash and conversion of $0.1 million of accrued liabilities.
The following officers and directors participated in such transactions, in which they purchased the number of securities listed
adjacent to their name.
Name
|
|
Position with Company
|
|
Principal Amount of Notes
($)
|
|
|
Number of
Shares
Underlying Warrants
(#)
|
|
|
Aggregate
Purchase Price
($)
|
|
Domonic J. Carney
|
|
Chief Financial Officer
|
|
|
87,222
|
(1)
|
|
|
34,888
|
|
|
|
78,500
|
|
Mark Owen
|
|
Vice President, Business Development
|
|
|
34,722
|
|
|
|
13,888
|
|
|
|
31,250
|
|
Douglas Hamrin
|
|
Vice President, Engineering
|
|
|
25,278
|
|
|
|
10,111
|
|
|
|
22,750
|
|
Michael Hammons
|
|
Director
|
|
|
5,556
|
|
|
|
2,222
|
|
|
|
5,000
|
|
(1)
|
Includes 2017 Senior Notes in the principal amounts of $27,778 and $8,333 purchased in the name of Charles Schwab & Co Inc. FBO Domonic Carney IRA in September and December 2017, respectively, over which Mr. Carney has investment control and which securities he may be deemed to beneficially owned.
|
In December 2016, we sold and issued to
21 accredited investors the 2016 Senior Notes in an aggregate principal amount of approximately $3.7 million and five-year warrants
to purchase an aggregate of 1,498,622 shares of our common stock at an exercise price of $3.00 per share, with aggregate net proceeds
to us after a ten percent original issue discount and placement agent fee of approximately $3.0 million (the “December 2016
Financing”). The following officers and directors participated in the December 2016 Financing, in which they purchased the
number of securities listed adjacent to their name.
Name
|
|
Position
with Company
|
|
Principal Amount of Notes
($)
|
|
|
Number of
Shares
Underlying Warrants
(#)
|
|
|
Aggregate
Purchase Price
($)
|
|
Alain J. Castro
|
|
Director
and Chief Executive Officer
|
|
|
28,000
|
|
|
|
11,200
|
|
|
|
25,200
|
|
Stephen Markscheid
|
|
Director
|
|
|
20,000
|
|
|
|
8,000
|
|
|
|
18,000
|
|
Note 15—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 ended 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.
Ener-Core, Inc.
Notes to Condensed Consolidated Financial
Statements (continued)
(unaudited)
Through March 31, 2017, our headquarters
was located at 9400 Toledo Way, Irvine, California 92618. The property consisted of a mixed use commercial office,
production, and warehouse facility of 32,649 square feet and expired December 31, 2016. We extended the lease at a reduced rate
until March 31, 2017. The monthly rent was $15,000 per month for the three months ended March 31, 2017. As of April
1, 2017, our headquarters are located at 8965 Research Drive, Irvine, California 92618 and consists of a mixed use commercial
office of 4,960 square feet. From January through March 2017, our monthly rent was $15,000 for the Toledo Way property holdover
and, from April 1, 2017, our monthly rent is $10,168 per month, with annual escalations on April 1, 2018 to $10,473 per month
and on April 1, 2019 to $10,787 per month for the Research Drive property. The Toledo Way lease terminated on April 1, 2017 and
the Research Drive property lease expires on March 31, 2020. Our rent expense under these leases was $37,000 and $67,000 for the
three months ended March 31, 2018 and 2017, respectively.
Future minimum rental payments under operating
leases that have initial noncancelable lease terms in excess of one year as of March 31, 2017 are as follows:
Nine months ending December 31, 2018
|
|
$
|
94,000
|
|
Year ending December 31, 2019
|
|
|
128,000
|
|
Year ending December 31, 2020
|
|
|
32,000
|
|
Total
|
|
$
|
254,000
|
|
Standby Letter of Credit
Pursuant to the terms of the CLA, the
Company was 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 was required to make any payments on the Letter of Credit, subject to the terms
of the Intercreditor Agreement (as defined below), the Company would have been required to reimburse the investor the full amount
of any such payment. Such payment obligation was 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 were 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 was scheduled to 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 was obligated to pay a monthly
fee equal to 1% of the amount of the Letter of Credit for the first twelve months with an additional one-time fee equal to 4% of
the amount of the Letter of Credit at the one year anniversary, and a monthly fee equal to 2% for an additional twelve months.
Concurrent with the execution of the
amendment to the CMLA in April 2017, we and Dresser-Rand agreed to modify the requirements for our existing backstop security.
As modified, we were required to maintain a $500,000 backstop security, reduced from $2.1 million, the monthly fee reduced to
1% of the amount of the amended Letter or Credit and the backstop security was extended from June 2017 to March 31, 2018. The
Letter of Credit and the related backstop security were cancelled on April 10, 2018, with an effective date of March 31, 2018,
with no claims having been made by Dresser-Rand thereunder.
Note 16—Subsequent Events
None
Item 2. Management’s Discussion and
Analysis of Financial Condition and Results of Operations.
Unless otherwise indicated, the following
discussion and analysis of our financial condition is as of March 31, 2018 Our results of operations should be read in conjunction
with our unaudited condensed consolidated financial statements and notes thereto included elsewhere in this quarterly report on
Form 10-Q and the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for
the year ended December 31, 2017.
Forward-Looking Statements
Forward-looking statements contained in
this quarterly report on Form 10-Q are made under the Safe Harbor Provision of the Private Securities Litigation Reform Act of
1995. These forward-looking statements involve risks, uncertainties, assumptions, and other factors, which, if they do not materialize
or prove correct, could cause our results to differ materially from historical results, or those expressed or implied by such forward-looking
statements. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements,
including statements containing the words “can,” “may,” “scheduled,” “planned,”
“expects,” “believes,” “strategy,” “opportunity,” “anticipates,” and
similar words. These statements may include, among others, plans, strategies, and objectives of management for future operations;
any statements regarding proposed new products, services, or developments; any statements regarding future economic conditions
or performance; statements of belief; and any statements of assumptions underlying any of the foregoing. The information contained
in this quarterly report on Form 10-Q is as of the date of this report. Except as otherwise expressly referenced herein, we assume
no obligation to update forward-looking statements.
Overview
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. Going forward, pursuant
to the CMLA (as defined below), our 2 MW partner, Dresser-Rand a.s., a subsidiary of Dresser-Rand Group Inc., a Siemens company,
or Dresser-Rand, will manufacture the 2 MW Power Oxidizers under a manufacturing license and will pay us a non-refundable license
fee for each unit manufactured by Dresser-Rand.
Historically, basic industries such as
Petroleum, Plastics, Steel and Paper have consumed electricity in their manufacturing processes and created heat for their manufacturing
processes through the burning of fossil fuels in a combustion chamber. Nearly all such combustion chambers use high quality premium
fuels and burn those fuels at high temperatures, while low-quality waste gases were typically destroyed or vented into the atmosphere.
Our technology utilizes these waste gases by modifying turbines with our gradual oxidation vessel. Inside this vessel, gases are
injected and diffused to facilitate an oxidation reaction under optimized pressure and temperature conditions. This reaction occurs
as a sustainable exothermic reaction which converts hydrocarbon gases into heat and at sufficient temperature and residence time
to also destroy other contaminants and thereby return a nearly contaminant-free source of heat energy. This heat then powers a
turbine in a combined heat and power application to create electricity with residual heat sufficient to operate industrial heat
equipment such as boilers, ovens, or dryers. This technology unlocks a new, global source of clean power generation (electricity,
steam and/or heat energy) while reducing harmful emissions. Our Power Oxidizers can utilize unrefined methane gas from landfills
and anaerobic digesters, which provide us with a lower fuel cost than existing and standard Combined Heat and Power, or CHP, or
co-generation equipment. Our goal is to enable industrial process facilities to generate clean energy from their existing waste
gases as a full or partial fuel source, thus reducing the amount of energy they purchase from their regional utilities, and simultaneously
reducing their pollution profile, including costs of compliance with local, state, and federal air quality regulations, by avoiding
or reducing their reliance on the chemicals, catalysts and complex permitting required by existing pollution abatement systems.
Our Products and Value Proposition
We have developed a 250 kW Power Oxidizer
that we integrate with a 250 kW gas turbine to produce 250 kW Powerstations. We have EC250 Powerstations currently installed at
a landfill site in the Netherlands and at the Irvine campus of the University of California, Irvine, and a third Powerstation currently
in the production phase planned for installation at a landfill in southern California. We have also designed, built, and deployed
a Power Oxidizer of a significantly larger size, capable of generating sufficient heat and airflow to power a 2 MW KG2 gas turbine
produced by Dresser-Rand. Together, the Power Oxidizer and KG2 turbine comprise a 2 MW KG2/PO unit. The initial unit was constructed
in the first quarter of 2016 and was used in field tests during 2016 at a third party location in Southern California. We have
sold two 2 MW KG2/PO units to Dresser-Rand, each of which was delivered to the Stockton, California biorefinery site owned by Pacific
Ethanol in October 2016. In December 2016, we combined two of our 2 MW Power Oxidizers with KG2 turbines and installed the resulting
two KG2/PO units. Final commissioning has been delayed due to project changes outside of the scope of our deliverables under the
larger project installation. The units became operational in January 2018 and we anticipate full project handoff in
the third quarter of 2018. We believe this scaled-up version of our Power Oxidizer, once combined with the KG2 turbine, results
in a Powerstation product that is better aligned with the scale of emissions (and energy requirements) observed at the industrial
facilities that we believe stand to benefit most from this technology. As with the 250 kW Powerstation, the larger 2 MW Powerstations
are designed to provide an alternative to typical combustion-based power generation and enable industries to utilize their own
waste gases to generate power.
We also expect to integrate our Power Oxidizer
technology into additional sized gas turbines as well as other applications that can use the heat generated by our Power Oxidizers
to power other industrial applications. We believe other waste gas-to-heat opportunities, powered by an ultra-low pollution Power
Oxidizer, include: (i) the generation of steam from coupling a Power Oxidizer with a traditional steam boiler, (ii) use in industrial
grade dryers for kilns or industrial drying customer requirements, and (iii) use in industrial chiller units for customers requiring
cold air or water in their processes.
We believe our Power Oxidizer solutions
provide an enhanced value proposition over the value proposition provided by standard CHP solutions. Standard CHP solutions typically
provide cost savings to industrial customers by using a common, lower cost heat source to both generate electricity and to provide
heat to be used in industrial processes such as for steam, drying, ovens, or chiller units for air conditioning or cold storage.
We believe our Power Oxidizers provide
a superior return to standard CHP solutions due to our ability to oxidize low energy content gases at very low pollution output.
As such, our Power Oxidizers are designed to serve as an opportunity for our industrial customers to reduce their fuel costs with
an added benefit of serving as a built-in pollution abatement solution.
Utilizing Power Oxidizers to provide heat
for a CHP system results in a significantly lower fuel cost per generated kilowatt hour since Power Oxidizers can operate using
any one or a combination of premium and refined natural gas, a wide variety of lower quality, low hydrocarbon gases, traditionally
considered to be “waste” gases, as well as certain Volatile Organic Compounds, or VOCs, such as paint solvents. These
gases and compounds are typically seen as a waste by-product of industrial processes, which often represent a source of pollution
and, in turn, require expensive waste abatement equipment and significant recurring operating costs.
We also believe our Power Oxidizers provide
a superior air pollution waste abatement solution for industrial customers. Typically, industrial customers require electricity
and steam and generate industrial gases as a by-product of their facility operations. Prior to the introduction of our Powerstations,
these customers would purchase or produce energy using a traditional gas turbine or gas reciprocating engine, which both use a
combustion chamber to ignite natural gas and generate air pollution in the form of carbon dioxide, carbon monoxide and nitrogen
oxides. The traditional gas turbine (or traditional engine) and by-product gases generally require pollution control equipment
and recurring costs in order to comply with existing pollution standards, which vary by geography. Since both the natural gas fuel
and the industrial by-product gases are oxidized in our Power Oxidizers over a much longer residence time than the comparable times
of traditional combustion processes, the Power Oxidizer reduces both the gas fuels and by-products to levels below substantially
all of the existing and proposed air quality emission standards in most areas of the world.
Dresser-Rand 2 MW Integration
On November 14, 2014, we entered into a
Commercial License Agreement, or, as amended, the CLA, with Dresser-Rand through our wholly-owned subsidiary, Ener-Core Power,
Inc., which granted Dresser-Rand the right to market and sell the Dresser-Rand KG2-3GEF 2 MW gas turbine coupled with our Power
Oxidizer, as a Combined PowerStation System, and the exclusive right to commercialize our Power Oxidizer within the 1–4 MW
range of power capacity, bundled with the Dresser-Rand KG2 gas-turbine product line. Between November 14, 2014 and December 31,
2016, we integrated the equipment and conducted field tests on the initial Combined System, which consists of a Dresser-Rand KG2-3GEF
2 MW gas turbine coupled with our Power Oxidizer, located in Corona, California. By April 2017, with the execution of the amendment
of the CMLA, as described below, we had passed all required field tests on the initial Combined System and were required to conduct
one additional field test on one of the two production systems located at the Stockton, California biorefinery site owned by Pacific
Ethanol, Inc., or Pacific Ethanol, which we sold to Dresser-Rand and delivered to the installation site in Stockton in October
2016. In December 2016, we combined the two 2 MW Power Oxidizers with two KG2 turbines and installed the resulting two Combined
Systems. In April 2017, we conducted the tests on one of the Combined Systems in Stockton and, in May 2017, provided the test results
to Dresser-Rand for its review. The two Combined Systems made operational in January 2018 but were unable to be fully commissioned
for reasons unrelated to the Power Oxidizer components. Full commissioning and handoff of the two Combined Systems is expected
in the third quarter of 2018.
Dresser-Rand Commercial and Manufacturing
Agreement
On June 29, 2016, we entered into a Commercial
and Manufacturing License Agreement, or the CMLA, with Dresser-Rand, through our wholly-owned subsidiary, Ener-Core Power, Inc.
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.
Under the CMLA, as amended, Dresser-Rand
has a worldwide license to manufacture, market, commercialize and sell the Power Oxidizer as part of the Combined System within
the 1 MW to 4 MW range of power capacity, or the License. Initially, the License will be exclusive, even as to us, and will remain
exclusive for so long as Dresser-Rand sells a minimum number of units of the Combined System in each annual sales threshold, or
the Sales Threshold, over a predetermined Sales Threshold time period, subject to certain conditions and exceptions. The initial
Sales Threshold began on July 15, 2017 and will be fifteen months long. Each subsequent Sales Threshold will be one year in length
thereafter. If Dresser-Rand does not meet either the initial or any subsequent Sales Threshold, and the Sales Threshold is not
otherwise waived, Dresser-Rand may maintain exclusivity of the License by making a true-up payment to us for each unit that is
in deficit of the Sales Threshold, or a True-Up Payment;
provided, however
, that Dresser-Rand may not maintain an exclusive
License by making a True-Up Payment for more than two consecutive Sales Threshold periods. In the event Dresser-Rand does not meet
the Sales Threshold, does not qualify for a waiver and elects not to make the True-Up Payment, the License will convert to a non-exclusive
License.
Upon a sale by Dresser-Rand of a Combined
System unit to a customer, before any discounts, the CMLA requires Dresser-Rand to make a license fee payment to us equal to a
percentage of the sales price of the Combined System purchased, in accordance with a predetermined fee schedule that is anticipated
to result in a payment of between $370,000 and $650,000 per Combined System unit sold, or the License Fee. Payment terms to us
from Dresser-Rand will be 50% of each License Fee within 30 days of order and 50% upon the earlier of the Combined System commissioning
or twelve months after the order date.
In April 2017, we executed an amendment
to the CMLA with Dresser-Rand, pursuant to which Dresser-Rand paid us $1.2 million in cash in April 2017, which represents advance
payments on a portion of the total 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 a portion of 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 for a combined payment credit of $2.0 million. To date, we have billed and collected the
entire $1,450,000 relating to the April 2017 and July 2017 amendments.
Dresser-Rand may also request that we undertake
design and development work on modifications to the Combined Systems, each referred to as a Bespoke Development. We and Dresser-Rand
will negotiate any fees resulting from any such Bespoke Development on a case-by-case basis. Further, any obligation by us to undertake
such Bespoke Development will be conditioned upon the execution of mutually agreed-upon documentation.
As long as the exclusive License remains in effect, we will provide certain ongoing sales and marketing
support services, at no additional cost to Dresser-Rand, subject to certain agreed restrictions. Any additional sales and marketing
services agreed upon by us and Dresser-Rand will be compensated at a mutually agreed upon rate.
If we and Dresser-Rand so elect, we may
manufacture a certain number of Power Oxidizers as part of a certain number of Combined System projects during a transition period,
or the Transition Phase, beginning after execution of the CMLA and prior to the period in which Dresser-Rand manufactures its first
three Power Oxidizers as part of at least two individual Combined System projects, or the Initial Manufacturing Phase, as mutually
agreed by the parties. So long as the License remains exclusive during the Transition Phase, if any, and the Initial Manufacturing
Phase, we will provide a mutually agreed upon number of hours of engineering support services. After the conclusion of the Initial
Manufacturing Phase, we will, for so long as the License remains exclusive, continue providing up to an agreed upon number of hours
of such support services on an annual basis at no additional cost to Dresser-Rand, subject to certain conditions. Any additional
engineering support services agreed upon by us and Dresser-Rand will be compensated at an hourly rate, to be upwardly adjusted
annually. During the Transition Phase, we must also develop the spare parts list pertaining to the scope of supply to allow Dresser-Rand
to offer service agreements for the Combined System.
Under the CLA, we were required to maintain
a backstop security, or Backstop Security, in favor of Dresser-Rand in support of all products manufactured, supplied or otherwise
provided by us during the period beginning on the execution date of the CLA, or the Execution Date, and continuing through the
expiration of the warranty period for the Combined System units sold to customers as of the Execution Date. Concurrent with the
execution of the amendment to the CMLA in April 2017, we and Dresser-Rand modified the Backstop Security requirement to reduce
the initial Backstop Security and to not require future backstop securities for future sales. In April 2017, we reduced our existing
Backstop Security from $2.1 million to $500,000, and the existing Backstop Security termination date was extended from June 2017
to March 31, 2018. The letter of credit and the related Backstop Security were cancelled on April 10, 2018, with an effective date
of March 31, 2018, with no claims having been made by Dresser-Rand thereunder.
Dresser-Rand must also: (i) develop the
controls strategy for the Dresser-Rand gas turbine control system and integrate it with the Power Oxidizer control system; (ii)
with support from us, manufacture and commercialize the Combined System following the Transition Phase; (iii) with support from
us, develop and prioritize sales opportunities for the Combined System; (iv) assume the sales lead role with respect to each customer;
and (v) take commercial lead in developing sales to customers. In addition, Dresser-Rand will be primarily responsible for overall
warranty and other commercial conditions to Combined System customers, as well as sole project and service provider and interface
with customers. Dresser-Rand will also be responsible for warranty, service and after-sales technical assistance for all portions
of Combined Systems that comprise Dresser-Rand products. We, however, will be responsible for warranty and service for all products
manufactured or otherwise provided by us prior to or during the Transition Phase.
The CMLA prohibits us from, without the
prior written consent of Dresser-Rand, permitting the creation of any encumbrance, lien or pledge of our intellectual property
which would result in any modification to, revocation of, impairment of or other adverse effect on Dresser-Rand’s rights
with respect to the exclusive License. In addition, all intellectual property rights that are owned by either us or Dresser-Rand
as of the Execution Date will remain the sole property of such party, subject to the licenses described in the CMLA. The CMLA also
contains provisions that govern the treatment of process and technology developments and any joint inventions that (i) relate to
the subject matter of the CMLA and (ii) occur after the Execution Date and during the term thereof.
The CMLA also contains certain restrictions on publicity and obligates Dresser-Rand to use its commercially
reasonable efforts to include our name and logo and otherwise promote our brand and Power Oxidizers in a mutually agreed-upon manner.
We and Dresser-Rand have also mutually agreed to withhold disclosure of certain commercial and technologically sensitive terms
of the CMLA including technical specifications, License Fee percentages, and the Sales Threshold minimum annual quantities to maintain
exclusivity.
Commercial Sales Efforts
We are entering the CHP market, which is
highly competitive and historically conservative in its acceptance of new technologies. To date, we have sold and delivered one
250 kW commercial Powerstation unit to the Netherlands and have sold one additional 250 kW Powerstation unit to a landfill site
in Southern California. We also sold two 2 MW Power Oxidizers to Dresser-Rand in October 2016, which were delivered to a Stockton,
California biorefinery site owned by Pacific Ethanol and placed into commercial operation in January 2018. These three systems
represent our $2.9 million order backlog as of May 21, 2018. To date, we have billed and collected $2.8 million of our existing
backlog. To date, full commissioning has not occurred for the two Pacific Ethanol systems due to site specific items unrelated
to our portion of the larger Pacific Ethanol project. The two systems have operated in excess of 1,000 hours to date and full commissioning
is expected in the third quarter of 2018.
In May 2016, we received a conditional
purchase order for four 250 kW Powerstations, which are scheduled to be installed at the Toyon Canyon landfill site in Los Angeles,
California in the middle of 2018. This order is valued at approximately $4.0 million and is subject to additional pre-sales engineering
and permitting requirements, which have been delayed. We continue to be involved in the pre-sales activity for this project and
we expect an ordering decision in the second quarter of 2018.
In April 2017, we executed an amendment to the CMLA with Dresser-Rand, pursuant to which Dresser-Rand
paid us $1.2 million in April 2017 and a further $250,000 in July 2017. These payments represent an advance payment on a portion
of future license fees for KG2/PO units to be sold under the CMLA. 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 May 21, 2018.
Dresser-Rand Initial Commercial
Activity
In January 2015, Pacific Ethanol announced
the first sale of the new KG2-3GEF/PO unit, which placed a two unit order with Dresser-Rand. Pursuant to the terms of the CLA,
we began working on the initial phase of these two systems immediately after the announcement of the order received by Dresser-Rand
from Pacific Ethanol. In August 2015, we received a binding purchase order from Dresser-Rand for two KG2/PO Power Oxidizer units
rated for 1.75 MW for a total purchase price of $2.1 million, subsequently changed to $2.0 million by mutual agreement. We received
the entire $2.0 million purchase price in the fourth quarter of 2015 after we satisfied the Dresser-Rand performance security requirement
in November 2015. In September 2016, we secured the release of the license fees payable from Dresser-Rand, which had previously
been placed in an escrow account and which were contingent upon satisfaction of the “Full-Scale Acceptance Test,” or
FSAT, a technical milestone under the CLA that included a multitude of tests using a full, working Combined System. We received
$1.1 million in cash, representing the $1.6 million license fee net of $500,000 paid to Dresser-Rand for engineering services.
We recognized $1.1 million of net license fees as revenues for the three months ended March 31, 2018, effective on the date the
two Pacific Ethanol units were placed into initial operation through grid synchronization, representing a successful technology
integration milestone.
Other Commercial Efforts
In May 2015, we received an award for our
second commercial EC250 Powerstation as part of a California Energy Commission award of $1.5 million to the University of California,
Irvine’s Advanced Power & Energy Program. We received a formal purchase order of approximately $900,000 in the third
quarter of 2015 and through March 31, 2018, we have billed and collected $815,000. We anticipate that delivery and commission of
this Powerstation will occur in 2018.
During 2018, our commercial sales and marketing
focus is to work with the domestic and international sales and marketing teams from Dresser-Rand to facilitate additional KG2/PO
unit sales in order to drive Power Oxidizer sales and facilitate our technology adoption. While we expect to close multiple KG2/PO
opportunities in 2018, some of our potential orders for KG2/PO units require the initial system commissioning, which we expect
to occur in the third quarter of 2018. In parallel, our existing internal sales team has continued to advance commercial opportunities
and enter new industrial markets with our EC250 product. We have also expanded our understanding of our greater, integrated Powerstation
solution and are working towards value-added partnership relationships with key providers of products which can use our ultra-low
emissions heat.
Additionally, we are currently exploring
projects that would entail construction of our own power installations using a Build-Own-Operate (BOO) model, which we forecast
could provide unlevered internal rates of return in excess of 20%, depending upon a variety of factors, including the degree to
which such projects are successful. While we expect to receive the bulk of our future revenues for the next several years from
the CMLA with Dresser-Rand, we believe that the selected project opportunities may provide an additional revenue channel. We are
evaluating our possible role in the development of certain California-based projects which would involve the integration of our
technology with additional third-party equipment, to provide a recurring revenue stream from power sales and increase our cash
flows from other sources that make use of our Power Oxidizer systems. We are exploring the possibility of financing any such projects
from external sources. To the extent we engage in such projects, we do not expect them to be deployed prior to our fiscal year
ending December 31, 2019. To the extent that we engage in such projects and they are successful, we expect them to increase our
revenues and cash flows, increase our asset base, and accelerate the technological adoption and commercial acceptance of our Power
Oxidizer technology. We may not, however, achieve positive results in any such projects and all projects under consideration are
in the early planning stages.
Revenue, Order-to-Cash Cycle and Customer
Order Cash Flows
Our order-to-cash cycle is lengthy and
requires multiple steps to complete. As such, we utilize and evaluate certain metrics such as bookings, backlog, and billed backlog.
The initial commercial phase involves our sales team identifying a suitable project and evaluating each site to determine whether
our value proposition fits the potential customer’s needs. We evaluate potential industrial sites based on the amount, density
and quality of the waste gas produced, the impacts of air quality penalties and required pollution abatement, and the expected
cost savings or sales value of on-site power production. We also evaluate with the potential customer whether there are other
financial considerations that could further strengthen the economic payback to the potential customer (which could include revenue
increases that may result from pollution abatement benefits or emission credits or tax avoidance). As part of this evaluation,
we work with potential customers to produce financial models, which seek to capture and quantify all of the various benefits of
the potential project to determine the overall economic payback to the potential customer. If the potential customer determines
to proceed after this evaluation, we enter into an agreement with the customer, which typically includes purchase order arrangements.
Customer orders, which are defined as
firm commitments to purchase with fixed and determinable prices and contracted delivery terms, are considered bookings and are
included as backlog. From the date of booking until the projected shipping date, we follow the standard practices that are typically
followed by other power equipment producers, which include payment terms that involve customer advance payments designed to mirror
our cash inventory outlays for sourcing parts and materials necessary to assemble the power plants to achieve a neutral customer
order cash flow until delivery. All customer advance payments are recorded as billings, are reported as billed backlog and are
represented on our balance sheet as deferred revenue or customer advances. As the Power Oxidizer plant assets are built, the costs
are capitalized as inventory.
Powerstations are shipped to the customer
locations and assembled on site. We supervise the assembly and commissioning of the Powerstations, which can take several months
to complete. Once commissioning of the fully installed Powerstation(s) is/(are) concluded and title passes to the customer, we
issue the final billings and recognize revenues and costs of revenues by decrementing deferred revenues and inventory respectively.
We also charge customers for commissioning
services, post-sale support, and post-warranty service and maintenance on our Power Oxidizer units. We provide a standard warranty,
which typically ends between nine months and one year after commissioning.
We recognized $1.1 million of license fee
revenues for the three months ended March 31, 2018 from previously recorded deferred revenues. We evaluated the revenue recognition
under the new applicable accounting guidance, Topic 606, and determined that the revenue recognition for the licensing fees was
tied to the transfer of technology and the integration of the technology embedded in the Power Oxidizers with the Dresser-Rand
KG2 units. Upon the commercial installation of the units, and since the units had in excess of 1,000 hours of commercial operation
during the three months ended March 31, 2018, the use of the technology was transferred, and the revenue cycle was completed.
Of our remaining deferred revenues:
|
·
|
We have $2.0 million of deferred revenues
for the Power Oxidizers sold to Dresser-Rand since the commissioning of these units was not completed as of March 31, 2018;
|
|
·
|
We have $0.8 million of deferred revenues for the Powerstation sold to the California Energy Commission since the unit was not commissioned as of March 31, 2018; and
|
|
·
|
We have the $1.5 million of deferred license fees paid by Dresser-Rand since the underlying units associated
with those license fees were not sold or delivered by Dresser-Rand.
|
Operating Income and Losses
For the three months ended March 31, 2018,
we recorded our first-ever profitable quarter from operations, the effect of the recognition of $1,100,000 of license revenue associated
with the successful technology transfer, as reduced by $1,014,000 of operating expenses, for operating income of $86,000. This
compares to an operating loss of $1,613,000 for the three months ended March 31, 2017 on no revenues. Notwithstanding the foregoing,
the license revenues recognized for the technology transfer to Dresser-Rand are non-recurring in nature, and we anticipate that
future operating income or losses will depend on sales-based royalties which have not, as yet, been realized.
Operating Expense Reduction
Beginning in the first quarter of 2016, we evaluated our cash spending, including the costs incurred with
our withdrawn underwritten public offering. Beginning in the second quarter of 2016, we identified and implemented cost reductions,
primarily the reduction of employee and consulting headcount and professional services, and we implemented additional cost reductions
later in 2016 and into 2017. During 2017, we reduced our headcount downsized our office and manufacturing facilities and eliminated
additional consultants. Our goal for 2017 was to bring our “Non-GAAP” cash-basis operating expenses (consisting of
GAAP basis operating expenses adjusted for capitalized recurring expenses and excluding stock compensation and depreciation) to
below $1.0 million per quarter on a recurring basis and to receive payments from customers and licensors which will offset, in
part, our research and development spending and further reduce our cash burn. For the three months ended March 31, 2018, the following
table reconciles our operating expenses to this target:
|
|
Three Months Ended
March 31,
2018
(unaudited)
|
|
|
|
|
|
Operating Expenses
|
|
$
|
1,014,000
|
|
Plus:
|
|
|
|
|
Recurring employee related expenses capitalized into inventory
|
|
|
49,000
|
|
Less:
|
|
|
|
|
Stock-based compensation
|
|
|
(94,000
|
)
|
Depreciation and amortization
|
|
|
(81,000
|
)
|
Adjusted “Non-GAAP” cash basis operating expenses
|
|
$
|
888,000
|
|
Reverse Merger
Prior to the reverse merger discussed
below, pursuant to a contribution agreement dated November 12, 2012 by and among FlexEnergy, Inc., FlexEnergy Energy Systems,
Inc., and Ener-Core Power, Inc., Ener-Core Power, Inc. (formerly Flex Power Generation, Inc.) was spun-off from FlexEnergy, Inc.
as a separate corporation. As part of that transaction, Ener-Core Power, Inc. received all of the assets (including intellectual
property) and liabilities pertaining to the Power Oxidizer business, which was the business carved out of FlexEnergy, Inc.
We were originally incorporated on April
29, 2010 in Nevada under the name Inventtech, Inc. On April 16, 2013, we entered into a merger agreement with Ener-Core Power,
Inc. and a wholly-owned 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. Prior to the merger, we were a public reporting “shell company,” as defined in
Rule 12b-2 under the Securities Exchange Act of 1934, as amended, or the Exchange Act. On May 6, 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 that stock split.
On July 1, 2013, we completed the reverse
merger with Ener-Core Power, Inc., which remains our operating subsidiary. The merger was accounted for as a “reverse merger”
and recapitalization. As part of the reverse merger, 120,520,000 shares of outstanding common stock of the pre-merger public shell
company were cancelled (unadjusted for our July 8, 2015 reverse stock split). 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 condensed consolidated 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 reverse merger.
Reverse Stock Split
The convertible senior secured promissory
notes that we originally issued in April and May 2015 included three covenants, one of which was a requirement that we enter into
a reverse stock split in order to increase our share price above $5.00 in anticipation of an underwritten public offering. Our
board of directors approved a reverse stock split of our authorized, issued and outstanding shares of common stock, as well as
our authorized shares of preferred stock, par value $0.0001 per share, of which no shares are issued and outstanding, at a ratio
of 1-for-50, or our Reverse Stock Split. On July 8, 2015, the Reverse Stock Split became effective and the total number of shares
of common stock held by each stockholder of the Company 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. We 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 was paid in connection with any fractional shares that would otherwise have resulted from the Reverse Stock
Split. All share and per share amounts have been adjusted to reflect the reverse stock split.
Also on the effective date, all of our
options, warrants and other convertible securities outstanding immediately prior to the Reverse Stock Split were adjusted by dividing
the number of shares of common stock into which the options, warrants and other convertible securities are exercisable or convertible
by 50 and multiplying the exercise or conversion price thereof by 50, all in accordance with the terms of the plans, agreements
or arrangements governing such options, warrants and other convertible securities and subject to rounding to the nearest whole
share. Such proportional adjustments were also made to the number of shares and restricted stock units issued and issuable under
our equity compensation plans. The condensed consolidated financial statements and notes to the condensed consolidated financial
statements included elsewhere in this report give retroactive effect to the Reverse Stock Split for all periods presented.
Reincorporation
Effective as of September 3, 2015, we
changed our state of incorporation from the State of Nevada to the State of Delaware, or 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. In connection with the Reincorporation, we filed articles of conversion with the State
of Nevada and a certificate of conversion with the State of Delaware. Upon effectiveness of the Reincorporation, the rights of
our stockholders became governed by the Delaware General Corporation Law, the certificate of incorporation filed in Delaware and
newly adopted bylaws. As a Delaware corporation following the Reincorporation, which we refer to as Ener-Core Delaware, we are
deemed to be the same continuing entity as the Nevada corporation prior to the Reincorporation, which we refer to as Ener-Core
Nevada. As such, Ener-Core Delaware continues to possess all of the rights, privileges and powers of Ener-Core Nevada, all of
the properties of Ener-Core Nevada and all of the debts, liabilities and obligations of Ener-Core Nevada, including all contractual
obligations, and continues with the same name, business, assets, liabilities, headquarters, officers and directors as immediately
prior to the Reincorporation. Upon effectiveness of the Reincorporation, all of the issued and outstanding shares of common stock
of Ener-Core Nevada automatically converted into issued and outstanding shares of common stock of Ener-Core Delaware without any
action on the part of our stockholders.
Financing Activities
On January 25, 2018, the Company and certain
investors agreed to further amend and restate the securities purchase agreement under which such investors purchased unregistered
convertible senior secured promissory notes in September, November and December 2017 in aggregate principal amount of approximately
$1,555,556, or the 2017 Senior Notes, pursuant to which the Company agreed to issue to certain accredited investors, pursuant to
a series of joinder agreements, additional unregistered convertible senior secured promissory notes in aggregate principal amount
of approximately $555,556, or the 2018 Senior Notes, and five-year warrants to purchase an aggregate of 222,219 shares of common
stock at an exercise price of $1.50 per share, with aggregate gross cash proceeds to the Company of $465,000 and cancellation of
indebtedness of approximately $35,000 consisting primarily of unpaid and past due interest on the Company’s backstop security
in lieu of cash payment. The first closing of the 2018 Senior Notes financing occurred on January 25, 2018.
On March 26, 2018, the Company and certain
investors agreed to further amend and restate the securities purchase agreement under which such investors purchased the 2017 Senior
Notes and 2018 Senior Notes, pursuant to which the Company agreed to issue to certain accredited investors, pursuant to a series
of joinder agreements, additional 2018 Senior Notes in principal amount of approximately $333,335 and five-year warrants to purchase
an aggregate of 133,332 shares of common stock at an exercise price of $1.50 per share, with aggregate cash gross proceeds to the
Company of approximately $200,000 and cancellation of indebtedness of approximately $100,000, which consists of earned and unpaid
salary due to certain employees of the Company who elected to receive payment in the form of 2018 Senior Notes in lieu of cash.
The second closing of the 2018 Senior Notes financing occurred on March 26, 2018.
Critical Accounting Policies and Estimates
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. In the opinion of management, all adjustments which are necessary for a fair statement of the results for
interim periods have been included.
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; 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.
Foreign Currency Adjustments
At March 31, 2018 and December 31, 2017,
we did not hold any foreign currency asset or liability amounts. Gains and losses resulting from foreign currency transactions
are reported as other income in the period they occurred.
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, or 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 March 31, 2018, we had $0 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.
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 March
31, 2018 and December 31, 2017, two customers accounted for 100% of our accounts receivable.
Accounts Payable
As of March 31, 2018 and December 31, 2017,
five vendors collectively accounted for approximately 54% and 53% of our total accounts payable, respectively.
Inventory
Inventory, which consists of raw materials
and work-in-progress, 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 March 31, 2018 and December 31, 2017, 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 December 31, 2017 or March 31, 2018. 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 appropriate. 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 March 31, 2018 and December 31, 2017, we do not believe there have been any
impairments of our long-lived assets. There can be no assurance, however, that market conditions will not change or demand for
our products will continue, which could result in impairment of long-lived assets in the future.
Fair Value of Financial Instruments
Our financial instruments consist primarily
of cash and cash equivalents, accounts receivable, accounts payable, and capital lease liabilities. Fair value estimates discussed
herein are based upon certain market assumptions and pertinent information available to management as of March 31, 2018 and December
31, 2017. 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.
We determine the fair value of our financial
instruments based on a three-level hierarchy established for fair value measurements under which these assets and liabilities
must be grouped, based on significant levels of observable or unobservable inputs. Observable inputs reflect market data obtained
from independent sources, while unobservable inputs reflect management’s market assumptions. This hierarchy requires the
use of observable market data when available. These two types of inputs have created the following fair-value hierarchy:
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Level
1: Valuations based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities. Currently, we classify our cash and cash equivalents as Level 1 financial instruments.
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●
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Level 2: Valuations
based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date quoted
prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the
full term of the asset or liability. We do not currently have any accounts under Level 2.
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●
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Level 3: Valuations
based on inputs that require inputs that are both significant to the fair value measurement and unobservable and involve management
judgment (i.e., supported by little or no market activity). Currently, we classify our warrants and conversion options accounted
for as derivative liabilities as Level 3 financial instruments.
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If the inputs
used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level
is based upon the lowest level of input that is significant to the fair value measurement.
Revenue Recognition
In May 2014, the Financial Accounting Standards
Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09 (Topic 606) “Revenue from Contracts with Customers,”
which supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605). Topic 606 requires
entities to recognize revenue when control of the promised goods or services is transferred to customers. The amount of revenue
recognized must reflect the consideration the entity expects to be entitled to receive in exchange for those goods or services.
We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. See Note 13 of the accompanying
notes to our condensed consolidated financial statements for further details.
Research and Development Costs
Research and development costs are expensed
as incurred. Research and development costs were $441,000 and $582,000 for the three months ended March 31, 2018 and 2017, 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
Accounting Standards Codification, or 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 12.2 million and 9.8
million shares of common stock issuable upon full exercise of all options and warrants at March 31, 2018 and 2017, respectively
and all shares potentially issuable in the future under the terms of the convertible senior secured notes payable 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.
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|
Three Months Ended
March 31,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,188,000
|
)
|
|
$
|
(3,251,000
|
)
|
Weighted average number of shares of common stock outstanding:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,088,059
|
|
|
|
3,844,149
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.29
|
)
|
|
$
|
(0.85
|
)
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Comprehensive Income (Loss)
We have no items of other comprehensive
income (loss) in any period presented. Therefore, net loss as presented in our condensed consolidated statements of operations
equals comprehensive loss.
Recently Issued Accounting Pronouncements
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 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.
In September 2017, the FASB issued ASU
No. 2017-13,
Revenue Recognition, Revenue from Contracts with Customers, Leases.
The ASU adds U.S. Securities and Exchange
Commission (“SEC”) paragraphs to the new revenue and leases sections of the ASC on the announcement the SEC Observer
made at the July 20, 2017 meeting of the Emerging Issues Task Force. The SEC Observer said that the SEC staff would not object
if entities that are considered public business entities only because their financial statements or financial information is required
to be included in another entity’s SEC filing use the effective dates for private companies when they adopt ASC 606, Revenue
from Contracts with Customers, and ASC 842, Leases. This would include entities whose financial statements are included in another
entity’s SEC filing because they are significant acquirees under Rule 3-05 of Regulation S-X, significant equity method investees
under Rule 3-09 of Regulation S-X and equity method investees whose summarized financial information is included in a registrant’s
financial statement notes under Rule 4-08(g) of Regulation S-X. We are currently evaluating the impact of adopting this guidance.
RESULTS OF OPERATIONS FOR THE THREE
MONTHS ENDED MARCH 31, 2018, COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2017
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|
Three
Months Ended
March 31,
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|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
1,100,000
|
|
|
$
|
—
|
|
Total costs of goods sold
|
|
|
—
|
|
|
|
—
|
|
Gross profit (loss)
|
|
|
1,100,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
573,000
|
|
|
|
1,031,000
|
|
Research and development
|
|
|
441,000
|
|
|
|
582,000
|
|
Total operating expenses
|
|
|
1,014,000
|
|
|
|
1,613,000
|
|
Operating income (loss)
|
|
|
86,000
|
|
|
|
(1,613,000
|
)
|
|
|
|
|
|
|
|
|
|
Other (expenses):
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(1,274,000
|
)
|
|
|
(1,571,000
|
)
|
Loss on debt conversion
|
|
|
—
|
|
|
|
(53,000
|
)
|
Other expense, net
|
|
|
—
|
|
|
|
(14,000
|
)
|
Total other (expenses)
|
|
|
(1,274,000
|
)
|
|
|
(1,638,000
|
)
|
Loss before provision for income taxes
|
|
|
(1,188,000
|
)
|
|
|
(3,251,000
|
)
|
Provision for income taxes
|
|
|
—
|
|
|
|
—
|
|
Net loss
|
|
$
|
(1,188,000
|
)
|
|
$
|
(3,251,000
|
)
|
|
|
|
|
|
|
|
|
|
Loss per share—basic
and diluted
|
|
$
|
(0.29
|
)
|
|
$
|
(0.85
|
)
|
Weighted average common shares—basic
and diluted
|
|
|
4,088,059
|
|
|
|
3,844,149
|
|
Revenue, Cost of Goods Sold and Gross Profit
(Loss)
For the three months ended March 31, 2018,
we recognized $1.1 million of license fee revenues. There were no revenues for the three months ended March 31, 2017.
We recorded no direct costs associated
with the license revenues recognized for the technology transfer to Dresser-Rand during the three months ended March 31, 2018.
Costs associated with the technology transfer were incurred prior to the quarter ended March 31, 2018 and consisted of engineering
and development costs incurred in prior periods and expensed as incurred to research and development expenses.
Estimated costs to construct
and commission the initial two Power Oxidizers sold to Dresser-Rand that exceed collected billings are recorded as a contract
loss provision to cost of goods sold in prior reporting periods. No such loss provisions were recorded to cost of goods sold in
either of the three months ended March 31, 2018 or 2017.
Operating Expenses
Total operating expenses decreased by $599,000,
or 37.1%, to $1,014,000 for the three months ended March 31, 2018 from $1,613,000 for the same period in the prior year. The reduction
is primarily due to the results of cost savings efforts begun in April 2016 and continuing into 2017, reduced headcount costs,
lower facilities costs associated with our headquarters move, lower contractor and professional fees, and lower stock-based compensation
expenses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses
costs include officer compensation, salaries and benefits, stock-based compensation expense, consulting fees, legal expenses, intellectual
property costs, accounting and auditing fees, investor relations costs, insurance, public company reporting costs and listing fees,
and corporate overhead related costs. Total selling, general and administrative expenses for the three months ended
March 31, 2018 decreased $458,000, or 44.4%, to $573,000 from $1,031,000 for the same period of the prior year. The decrease
was primarily due to decreases of $116,000 in stock-based compensation, $124,000 in employee salaries, $144,000 in legal and professional
expenses, and $85,000 in lower facilities costs.
Research and Development
Research and development costs include
development expenses for the Power Oxidizer and integration expenses related to our Power Oxidizer products with other partners
such as Dresser-Rand and include salaries and benefits, consultant fees, cost of supplies and materials for samples and prototypes,
depreciation, as well as outside services costs. Research and development expense for the three months ended March 31,
2018 decreased $141,000, or 24.2%, to $441,000 from $582,000 for the same period of the prior year. The decrease is
primarily due to decreased engineering headcount costs of $53,000, a decrease in stock-based compensation expense of $60,000, and
$22,000 in lower overhead expenses. During the three months ended March 31, 2018, we capitalized $49,000 of employee-related expense
into inventory in connection with the commissioning of the Pacific Ethanol units in Stockton, California.
Other Income (Expenses):
Other income (expenses) for the three months
ended March 31, 2018 consisted of $1.3 million of non-cash interest on outstanding convertible senior secured promissory notes,
or Senior Notes, and cash interest on outstanding convertible unsecured notes, or Convertible Unsecured Notes, and for the Company’s
backstop security.
Other income (expenses) for the three months
ended March 31, 2017 consisted primarily of amortization of discount and deferred financing costs on the $9.1 million of Senior
Notes, cash and non-cash interest on the Convertible Unsecured Notes, cash payments on the Company’s backstop security collateral,
and losses on conversions of Senior Notes principal resulting from acceleration of unamortized note discount related to the converted
Senior Notes.
Net Loss
For the three months ended March 31, 2018
our net loss was approximately $1.2 million, primarily from selling, general and administrative expenses of $0.6 million, research
and development costs of $0.4 million and $1.3 million of other expenses (net) consisting of interest expense, of which $1.2 million
is non-cash interest expense.
For the three months ended March 31, 2017,
our net loss was approximately $3.3 million, primarily from selling, general and administrative expenses of $1.0 million, research
and development costs of $0.6 million, and $1.6 million of other expenses (net) consisting primarily of interest expense, of which
$1.4 million is non-cash interest expense.
Loss per share
Loss per share, basic and diluted were
($0.29) and ($0.85) for the three months ended March 31, 2018 and 2017, respectively.
Liquidity
Cash Flows used in Operating Activities
Our cash used in operating activities
was approximately $0.8 million and $1.3 million for the three months ended March 31, 2018 and 2017, respectively. Cash used in
operating activities for the three months ended March 31, 2018 of $0.8 million resulted from a net loss of approximately $1.2
million, reduced by net non-cash charges of $1.4 million for stock-based compensation, non-cash interest expense due to amortization
of debt discount and deferred financing charges, and depreciation, and a change of $1.0 million in working capital, primarily
due to a $1.0 million decrease in deferred revenues, a $0.2 million increase in inventory and prepaid expenses, offset by a $0.2
million increase in accounts payable and accrued expenses.
Cash used in operating activities for
the three months ended March 31, 2017 resulted from a net loss of approximately $3.2 million, reduced by net non-cash charges
of $1.9 million for stock-based compensation, non-cash interest expense due to amortization of debt discount and deferred financing
charges, and depreciation, and a change of $0.1 million in working capital, primarily due to a $0.2 million increase in inventory
and prepaid expenses, offset by a $0.3 million increase in accounts payable.
Cash Flows from Investing Activities
We had no cash flows from investing activities
for the three months ended March 31, 2018. Cash flows from investing activities of $10,000 for the three months ended March 31,
2017 represents miscellaneous equipment and inventory sold during our facilities move in 2017.
Cash Flows from Financing Activities
Cash provided by financing activities
for the three months ended March 31, 2018 consisted of $665,000 of cash proceeds from the issuance of additional Senior Notes,
reduced by $4,000 for the repayment of capital leases. Cash used from financing activities for the three months ended March 31,
2017 of $3,000 consisted of the repayment of existing capital leases for office equipment.
Capital Resources
Our principal capital requirements are
to fund our working capital requirements, invest in research and development and capital equipment and fund the continued costs
of public company compliance requirements. We have historically funded our operations through debt and equity financings.
From our inception, we have incurred losses
from operations. For the three months ended March 31, 2018, we had operating income of $0.1 million and had a net loss of approximately
$1.2 million. As of March 31, 2018, we had an accumulated deficit of approximately $53.5 million. For the three months ended March
31, 2018, we used cash in operations of approximately $0.8 million, which raises substantial doubt about our ability to continue
as a going concern.
We expect to continue to incur substantial
additional operating losses from costs related to the continuation of product and technology marketing and administrative activities. Our
cash on hand at March 31, 2018 was approximately $0.1 million.
Our sales cycle can exceed 24 months and
while we expect to receive additional license fees from our customers and additional cash payments on Powerstation orders, we
do not expect to generate sufficient revenue or customer deposits in the next twelve months to cover our operating costs. We
anticipate that we will pursue raising additional debt or equity financing to fund new product development and execute on the
commercialization of our product plans.
Until we achieve our product commercialization
plans and are able to generate sales to realize the benefits of the strategy and sufficiently increase cash flow from operations,
we will require additional capital to meet our working capital requirements, research and development, capital requirements and
compliance requirements and will continue to pursue raising additional equity and/or debt financing.
Our principal sources of liquidity are
cash and receivables. As of March 31, 2018, cash and cash equivalents were $0.1 million, or 1.7% of total assets, compared
to $0.2 million, or 3.3% of total assets, at December 31, 2017. The decrease in cash and cash equivalents was primarily
attributable to cash used in operating activities of $0.8 million offset by cash proceeds from Senior Notes of $0.7 million.
We have not yet achieved profitable operations
and have yet to establish an ongoing source of revenue to cover operating costs and meet our ongoing obligations. Our cash needs
for the next 12 months are projected to be in excess of $6 million, which includes the following:
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Employee, occupancy and related
costs: $3.0 million
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Professional fees and business development costs:
$0.7 million
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Research and development
programs: $0.3 million
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Corporate filings: $0.5 million
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Working capital: $1.5 million
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Off-Balance Sheet Arrangements
Other than the backstop security described
above, we have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any
third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’
equity that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets
transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have
any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages
in leasing, hedging or research and development services with us.
Inflation
We believe that inflation has not had a material effect on
our operations to date.