Item 1. Financial
Statements
Index
to the Financial Statements
Condensed
Consolidated Balance Sheets—June 30, 2018 (unaudited) and December 31, 2017
|
1
|
|
|
Unaudited
Condensed Consolidated Statements of Operations—For the Three and Six Months Ended June 30, 2018 and 2017 (unaudited)
|
2
|
|
|
Unaudited
Condensed Consolidated Statements of Cash Flows—For the Six Months Ended June 30, 2018 and 2017 (unaudited)
|
3
|
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
5
|
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
|
|
June 30,
2018
|
|
|
December 31,
2017
|
|
|
|
(unaudited)
|
|
|
|
|
Assets
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
20,000
|
|
|
$
|
208,000
|
|
Accounts receivable
|
|
|
9,000
|
|
|
|
14,000
|
|
Inventory
|
|
|
3,066,000
|
|
|
|
3,028,000
|
|
Prepaid expenses and other current assets
|
|
|
375,000
|
|
|
|
333,000
|
|
Total current assets
|
|
$
|
3,470,000
|
|
|
$
|
3,583,000
|
|
Property and equipment, net
|
|
|
2,500,000
|
|
|
|
2,660,000
|
|
Intangibles, net
|
|
|
10,000
|
|
|
|
13,000
|
|
Deposits and other long term assets
|
|
|
32,000
|
|
|
|
32,000
|
|
Total assets
|
|
$
|
6,012,000
|
|
|
$
|
6,288,000
|
|
Liabilities and stockholders’ deficit
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
1,988,000
|
|
|
$
|
1,749,000
|
|
Accrued expenses
|
|
|
1,741,000
|
|
|
|
1,380,000
|
|
Deferred revenues and customer advances
|
|
|
4,223,000
|
|
|
|
5,270,000
|
|
Accrued contract loss
|
|
|
427,000
|
|
|
|
617,000
|
|
Convertible unsecured notes payable, net of discounts
|
|
|
852,000
|
|
|
|
1,250,000
|
|
Convertible senior secured notes payable, net of discounts
|
|
|
5,419,000
|
|
|
|
5,994,000
|
|
Capital leases payable—short term
|
|
|
11,000
|
|
|
|
13,000
|
|
Total current liabilities
|
|
$
|
14,661,000
|
|
|
$
|
16,273,000
|
|
Long term liabilities:
|
|
|
|
|
|
|
|
|
Capital lease payable
|
|
|
8,000
|
|
|
|
12,000
|
|
Total liabilities
|
|
$
|
14,669,000
|
|
|
$
|
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 June 30, 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 June 30, 2018 and December 31, 2017, respectively
|
|
|
—
|
|
|
|
—
|
|
Additional paid-in capital
|
|
|
47,720,000
|
|
|
|
42,342,000
|
|
Accumulated deficit
|
|
|
(56,377,000
|
)
|
|
|
(52,339,000
|
)
|
Total stockholders’ deficit
|
|
$
|
(8,657,000
|
)
|
|
$
|
(9,997,000
|
)
|
Total liabilities and stockholders’ deficit
|
|
$
|
6,012,000
|
|
|
$
|
6,288,000
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Operations
(unaudited)
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,100,000
|
|
|
$
|
—
|
|
Cost of goods sold
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Gross profit
|
|
|
—
|
|
|
|
—
|
|
|
|
1,100,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
583,000
|
|
|
|
1,004,000
|
|
|
|
1,156,000
|
|
|
|
2,035,000
|
|
Research and development
|
|
|
396,000
|
|
|
|
600,000
|
|
|
|
837,000
|
|
|
|
1,183,000
|
|
Total operating expenses
|
|
|
979,000
|
|
|
|
1,604,000
|
|
|
|
1,993,000
|
|
|
|
3,218,000
|
|
Operating loss
|
|
|
(979,000
|
)
|
|
|
(1,604,000
|
)
|
|
|
(893,000
|
)
|
|
|
(3,218,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(70,000
|
)
|
|
|
(117,000
|
)
|
|
|
(136,000
|
)
|
|
|
(277,000
|
)
|
Amortization of debt discount
|
|
|
(1,803,000
|
)
|
|
|
(1,365,000
|
)
|
|
|
(3,011,000
|
)
|
|
|
(2,776,000
|
)
|
Loss on disposition of assets
|
|
|
—
|
|
|
|
(124,000
|
)
|
|
|
—
|
|
|
|
(137,000
|
)
|
Loss on debt extinguishment
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(10,000
|
)
|
Loss on modification of convertible debt
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(43,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses
|
|
|
(1,873,000
|
)
|
|
|
(1,606,000
|
)
|
|
|
(3,147,000
|
)
|
|
|
(3,243,000
|
)
|
Loss before provision for income taxes
|
|
|
(2,852,000
|
)
|
|
|
(3,210,000
|
)
|
|
|
(4,040,000
|
)
|
|
|
(6,461,000
|
)
|
Provision for income taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Net loss
|
|
$
|
(2,852,000
|
)
|
|
$
|
(3,210,000
|
)
|
|
$
|
(4,040,000
|
)
|
|
$
|
(6,461,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share—basic and diluted
|
|
$
|
(0.69
|
)
|
|
$
|
(0.79
|
)
|
|
$
|
(0.99
|
)
|
|
$
|
(1.61
|
)
|
Weighted average common shares—basic and diluted
|
|
|
4,106,393
|
|
|
|
4,063,660
|
|
|
|
4,097,277
|
|
|
|
4,007,953
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Cash Flows
(unaudited)
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,040,000
|
)
|
|
$
|
(6,461,000
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
163,000
|
|
|
|
252,000
|
|
Stock-based compensation
|
|
|
248,000
|
|
|
|
653,000
|
|
Amortization of debt discount and deferred financing fees
|
|
|
3,017,000
|
|
|
|
2,772,000
|
|
Loss on debt conversions
|
|
|
—
|
|
|
|
53,000
|
|
Loss on asset disposal
|
|
|
—
|
|
|
|
152,000
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Restricted cash
|
|
|
—
|
|
|
|
50,000
|
|
Accounts and other receivables
|
|
|
—
|
|
|
|
(99,000
|
)
|
Prepaid expenses and other current assets
|
|
|
36,000
|
|
|
|
111,000
|
|
Inventory
|
|
|
(228,000
|
)
|
|
|
(243,000
|
)
|
Deferred revenues, net
|
|
|
(1,047,000
|
)
|
|
|
1,301,000
|
|
Deposits
|
|
|
—
|
|
|
|
5,000
|
|
Accounts payable and other current liabilities
|
|
|
609,000
|
|
|
|
204,000
|
|
Cash used in operating activities
|
|
$
|
(1,242,000
|
)
|
|
$
|
(1,250,000
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Proceeds from sale of assets
|
|
|
—
|
|
|
|
67,000
|
|
Net cash provided by (used in) investing activities
|
|
$
|
—
|
|
|
$
|
67,000
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from issuance of Senior Notes
|
|
|
1,060,000
|
|
|
|
—
|
|
Repayment of capital leases payable
|
|
|
(6,000
|
)
|
|
|
(6,000
|
)
|
Cash (used in) provided by financing activities
|
|
$
|
1,054,000
|
|
|
$
|
(6,000
|
)
|
Net decrease in cash and cash equivalents
|
|
|
(188,000
|
)
|
|
|
(1,189,000
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
208,000
|
|
|
|
1,310,000
|
|
Cash and cash equivalents at end of period
|
|
$
|
20,000
|
|
|
$
|
121,000
|
|
See
accompanying notes to condensed consolidated financial statements.
Ener-Core,
Inc.
Condensed
Consolidated Statements of Cash Flows (continued)
(unaudited)
|
|
Six Months Ended
June
30,
|
|
|
|
2018
|
|
|
2017
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest
|
|
$
|
—
|
|
|
$
|
75,000
|
|
Supplemental disclosure of non-cash activities:
|
|
|
|
|
|
|
|
|
Capital lease for purchase of equipment
|
|
$
|
—
|
|
|
$
|
25,000
|
|
Debt discount recorded upon issuance of warrants and
beneficial conversion features
|
|
$
|
5,110,000
|
|
|
$
|
73,000
|
|
Conversion of convertible senior secured notes into shares
of common stock
|
|
$
|
—
|
|
|
$
|
60,000
|
|
Accrued expenses exchanged for convertible senior secured
notes
|
|
$
|
135,000
|
|
|
$
|
—
|
|
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 industrial products based on proprietary technologies
that generate usable heat using a wide variety of organic gases as fuel for an ultra-low emissions oxidation reaction. Our
oxidizer vessels are capable of using a wide variety of organic compounds as fuel for a high-temperature oxidation reaction
including many “waste” compounds traditionally considered to be air pollution. Our technology allows for the use
of compounds that, historically, were unusable as fuels for traditional industrial gas to energy conversion systems 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
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 August 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 $2.6 million
between September 2017 and June 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 June 30, 2018 was approximately $20,000. We expect that our cash and cash equivalents as of June
30, 2018, combined with receipts on customer billings will continue to fund our working capital needs, general corporate purposes,
and related obligations into the third quarter of 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, judgement on potential
asset impairment 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
June 30, 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 June 30, 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 June 30, 2018 and December 31, 2017, two customers accounted for 100% of our accounts
receivable.
Accounts
Payable
As
of June 30, 2018 and December 31, 2017, five vendors collectively accounted for approximately 55% 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 June 30, 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 June 30, 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 June 30, 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 June 30, 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 $396,000 and $600,000 for the three months
ended June 30, 2018 and 2017, respectively and were $837,000 and $1,183,000 for the six months ended June 30, 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 61.5 million and 9.8
million shares of common stock issuable upon full exercise of all options and warrants 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 at June 30, 2018 and 2017, respectively.
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
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net loss
|
|
$
|
(2,852,000
|
)
|
|
$
|
(3,210,000
|
)
|
|
$
|
(4,040,000
|
)
|
|
$
|
(6,461,000
|
)
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,106,393
|
|
|
|
4,063,660
|
|
|
|
4,097,277
|
|
|
|
4,007,953
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.69
|
)
|
|
$
|
(0.79
|
)
|
|
$
|
(0.99
|
)
|
|
$
|
(1.61
|
)
|
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 June 30, 2018 or December
31, 2017. Inventories consist of:
|
|
June 30,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
Raw material and spare parts
|
|
$
|
973,000
|
|
|
$
|
953,000
|
|
Work-in-progress
|
|
|
2,093,000
|
|
|
|
2,075,000
|
|
Total
|
|
$
|
3,066,000
|
|
|
$
|
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:
|
|
June
30,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
Prepaid rent
|
|
$
|
—
|
|
|
$
|
10,000
|
|
Prepaid offering costs
|
|
|
303,000
|
|
|
|
194,000
|
|
Prepaid insurance
|
|
|
—
|
|
|
|
19,000
|
|
Prepaid other
|
|
|
44,000
|
|
|
|
63,000
|
|
Prepaid professional fees
|
|
|
28,000
|
|
|
|
32,000
|
|
Current portion—deferred financing fees for letter of credit
|
|
|
—
|
|
|
|
15,000
|
|
Total
|
|
$
|
375,000
|
|
|
$
|
333,000
|
|
Note
5—Property and Equipment, Net
Property
and equipment, net consisted of the following:
|
|
June
30,
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
|
|
|
(1,976,000
|
)
|
|
|
(1,816,000
|
)
|
Net
|
|
$
|
2,500,000
|
|
|
$
|
2,660,000
|
|
Assets
recorded under capital leases and included in property and equipment in our balance sheets consist of the following:
|
|
June
30,
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
|
|
|
(35,000
|
)
|
|
|
(41,000
|
)
|
Net assets under capital lease
|
|
$
|
17,000
|
|
|
$
|
25,000
|
|
Depreciation
expense for the three and six months ended June 30, 2018 and 2017 consisted of the following:
|
|
Three
Months Ended
June
30,
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Research
and development
|
|
$
|
77,000
|
|
|
$
|
98,000
|
|
|
$
|
154,000
|
|
|
$
|
198,000
|
|
General
and administrative
|
|
|
3,000
|
|
|
|
24,000
|
|
|
|
6,000
|
|
|
|
51,000
|
|
|
|
$
|
80,000
|
|
|
$
|
122,000
|
|
|
$
|
160,000
|
|
|
$
|
249,000
|
|
Amortization
of assets under capital lease was $3,000 and $6,000 for the three and six months ended June 30, 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;
|
|
June
30,
2018
(unaudited)
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Accrued professional fees
|
|
$
|
155,000
|
|
|
$
|
155,000
|
|
Accrued payroll and related expenses
|
|
|
779,000
|
|
|
|
648,000
|
|
Accrued board of directors’ fees
|
|
|
497,000
|
|
|
|
390,000
|
|
Accrued interest
|
|
|
238,000
|
|
|
|
138,000
|
|
Accrued other
|
|
|
72,000
|
|
|
|
49,000
|
|
Total accrued expenses
|
|
$
|
1,741,000
|
|
|
$
|
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:
|
|
June
30,
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 June 30, 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
|
|
|
—
|
|
|
|
2,822,000
|
|
|
|
143,000
|
|
|
|
2,965,000
|
|
2018 convertible senior secured notes issuance
|
|
|
1,328,000
|
|
|
|
(625,000
|
)
|
|
|
(76,000
|
)
|
|
|
627,000
|
|
Discount for additional beneficial conversion feature
|
|
|
—
|
|
|
|
(4,167,000
|
)
|
|
|
—
|
|
|
|
(4,167,000
|
)
|
Balance, June 30, 2018
|
|
|
12,015,000
|
|
|
|
(6,418,000
|
)
|
|
|
(178,000
|
)
|
|
|
5,419,000
|
|
Less: current portion
|
|
|
(12,015,000
|
)
|
|
|
6,418,000
|
|
|
|
178,000
|
|
|
|
(5,419,000
|
)
|
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.
On June 5, 2018, the Company entered into
a securities purchase agreement pursuant to which it issued convertible senior secured promissory notes in the aggregate principal
amount of approximately $439,444 (the “June 2018 Senior Notes”) and related warrants to purchase an aggregate of 878,889
shares of common stock at an exercise price of $0.30 per share, with aggregate cash gross proceeds to the Company of approximately
$394,500. The June 2018 Senior Notes are convertible into shares of common stock at a price of $0.25 per share. The June 2018 Senior
Notes rank pari passu with the 2018 Senior Notes, 2017 Senior Notes, 2016 Senior Notes (as defined below) and 2015 Senior Notes
(as defined below). The closing of the June 2018 Senior Notes financing occurred on June 5, 2018.
Concurrent with the closing of our debt
financing on June 5, 2018, pursuant to which certain investors purchased unregistered convertible senior secured promissory notes
in aggregate principal amount of approximately 439,444, the Company and certain investors agreed to amend certain outstanding Senior
Notes (as defined below) to reduce the conversion price of such Senior Notes from $2.50 per share of common stock to $0.25 per
share of common stock, which conversion price was $0.10 lower than the closing price of the Company’s common stock on such
date. We evaluated the conversion price adjustment to determine whether the change should be recorded as a debt extinguishment
or a modification of terms and determined that the price adjustment should be accounted for as a modification. The intrinsic value,
$0.10 per share of common stock, resulted in an additional beneficial conversion feature for the remaining Senior Notes of $4,167,000.
This additional beneficial conversion feature was recorded as an additional Senior Notes discount and will be amortized ratably
over the remaining life of the Senior Notes.
We incurred $76,000 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 June 2018 Senior
Notes, 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.
Ener-Core,
Inc.
Notes
to Condensed Consolidated Financial Statements (continued)
(unaudited)
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 $0.25
(as subject to adjustment therein) and will automatically convert into shares of the Company’s common stock on the fifth
trading day immediately following the issuance date of the Senior Notes on which (i) the Weighted Average Price (as defined in
the Senior Notes) of the Company’s common stock for each trading day during a twenty trading day period equals or exceeds
$5.00 (as adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction) and no Equity
Conditions Failure (as defined in the Senior Notes) has occurred. The Senior Notes also contain a blocker provision that prevents
the Company from effecting a conversion in the event that the holder, together with certain affiliated parties, would beneficially
own in excess of either 4.99% or 9.99%, with such threshold determined by the holder prior to issuance, of the shares of the Company’s
common stock outstanding immediately after giving effect to such conversion.
Upon an Event of Default and delivery to
the holder of the Senior Note of notice thereof, such holder may require the Company to redeem all or any portion of its Senior
Note at a price equal to 115% of the Conversion Amount (as defined in the Senior Notes) being redeemed. Additionally, upon a Change
of Control and delivery to the holder of the Senior Note of notice thereof, such holder may also require the Company to redeem
all or any portion of its Senior Note at a price equal to 115% of the Conversion Amount being redeemed. Further, at any time from
and after January 1, 2019 and provided that the Company has not received either (i) initial deposits for at least eight 2 MW Power
Oxidizer units or (ii) firm purchase orders totaling not less than $3,500,000 and initial payment collections of at least $1,600,000,
in each case during the period commencing on the issuance date of the 2016 Senior Notes and ending on December 31, 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.
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
|
|
|
Net
Total
|
|
Balance at December 31, 2017
|
|
$
|
1,250,000
|
|
|
$
|
—
|
|
|
$
|
1,250,000
|
|
Discount for additional beneficial conversion feature
|
|
|
—
|
|
|
|
(450,000
|
)
|
|
|
(450,000
|
)
|
Amortization of debt discount
|
|
|
—
|
|
|
|
52,000
|
|
|
|
52,000
|
|
|
|
|
1,250,000
|
|
|
|
(398,000
|
)
|
|
|
852,000
|
|
Less: current portion
|
|
$
|
(1,250,000
|
)
|
|
$
|
398,000
|
|
|
$
|
(852,000
|
)
|
Long term portion
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Concurrent with the issuance of the June
2018 Senior Notes and execution of related amendments to the other Senior Notes described in Note 8, the Company and certain investors
agreed to amend the Convertible Unsecured Notes to reduce the conversion price from $2.50 per share of common stock to $0.25 per
share of common stock, which conversion price was $0.10 lower than the closing price of the Company’s common stock on such
date. We evaluated the conversion price adjustment to determine whether the change should be recorded as a debt extinguishment
or a modification of terms and determined that the price adjustment should be accounted for as a modification. The intrinsic value,
or $0.10 per share of common stock, resulted in an additional beneficial conversion feature for the Convertible Unsecured Notes
of $450,000. This additional beneficial conversion feature was recorded as an additional Convertible Unsecured Notes discount and
will be amortized ratably over the remaining life of the Convertible Unsecured Notes.
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 June 30, 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:
|
|
June
30,
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
|
|
$
|
3,000
|
|
|
$
|
5,000
|
|
Capital lease payable to Dell
Computers secured by computer equipment, 4.99% interest, due on May 1, 2020, monthly payment of $716
|
|
|
16,000
|
|
|
|
20,000
|
|
Total capital leases
|
|
$
|
19,000
|
|
|
$
|
25,000
|
|
Less: current portion
|
|
|
(11,000
|
)
|
|
|
(13,000
|
)
|
Long term portion of capital leases
|
|
$
|
8,000
|
|
|
$
|
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
June 30, 2018, are as follows:
|
|
12
Months Ending
June 30,
|
|
Amount
|
|
|
|
2019
|
|
$
|
12,000
|
|
|
|
2020
|
|
|
8,000
|
|
|
|
|
|
|
|
|
Net
minimum lease payments
|
|
|
|
$
|
20,000
|
|
Less:
amount representing interest
|
|
|
|
|
(1,000
|
)
|
Present
value of net minimum lease payments
|
|
|
|
$
|
19,000
|
|
Less:
current maturities of capital lease payables
|
|
|
|
|
(11,000
|
)
|
Long
term capital lease payables
|
|
|
|
$
|
8,000
|
|
Note
11—Equity
During
the six months ended June 30, 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 June 30, 2018 were as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
Grant
|
|
|
|
Shares
|
|
|
Price
|
|
Balance,
December 31, 2017
|
|
|
210,000
|
|
|
$
|
1.55
|
|
Granted
|
|
|
—
|
|
|
$
|
—
|
|
Vested
|
|
|
(148,750
|
)
|
|
$
|
—
|
|
Unvested
balance, June 30, 2018
|
|
|
61,250
|
|
|
$
|
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 June 30, 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 June 30, 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 June 30, 2018, 112,483 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
June 30, 2018, total unrecognized deferred stock compensation expected to be recognized over the remaining weighted average vesting
periods of 1.89 years for outstanding grants was $0.6 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
|
|
|
(26,626
|
)
|
|
|
9.80
|
|
|
|
—
|
|
|
|
—
|
|
Balance, June 30, 2018
|
|
|
641,981
|
|
|
$
|
6.06
|
|
|
|
6.26
|
|
|
$
|
—
|
|
Exercisable on June 30, 2018
|
|
|
479,528
|
|
|
$
|
7.15
|
|
|
|
5.48
|
|
|
$
|
—
|
|
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 209,688 shares of the Company’s common stock were outstanding
and options to purchase 200,552 shares of the Company’s common stock were exercisable under the 2013 Plan and options to
purchase 432,293 shares of the Company’s common stock were outstanding with 278,976 exercisable under the 2015 Plan on June
30, 2018.
The
following table summarizes information about stock options outstanding and exercisable at June 30, 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
|
|
|
515,748
|
|
|
|
7.28
|
|
|
$
|
3.35
|
|
|
|
354,859
|
|
|
$
|
3.62
|
|
$10.01–$15.00
|
|
|
26,300
|
|
|
|
5.49
|
|
|
$
|
12.50
|
|
|
|
24,736
|
|
|
$
|
12.50
|
|
$15.01–$20.00
|
|
|
84,845
|
|
|
|
0.99
|
|
|
$
|
17.50
|
|
|
|
84,845
|
|
|
$
|
17.50
|
|
$20.01–$25.00
|
|
|
15,088
|
|
|
|
2.39
|
|
|
$
|
23.20
|
|
|
|
15,088
|
|
|
$
|
23.20
|
|
|
|
|
641,981
|
|
|
|
6.26
|
|
|
$
|
6.06
|
|
|
|
479,528
|
|
|
$
|
7.15
|
|
Stock-based
compensation expense consisted of the following:
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Research and development
|
|
$
|
46,000
|
|
|
$
|
134,000
|
|
|
$
|
97,000
|
|
|
$
|
303,000
|
|
General and administrative
|
|
|
108,000
|
|
|
|
249,000
|
|
|
|
151,000
|
|
|
|
350,000
|
|
|
|
$
|
154,000
|
|
|
$
|
383,000
|
|
|
$
|
248,000
|
|
|
$
|
653,000
|
|
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 six months ended
June 30, 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
|
|
Issued for June 2018 Senior Notes
|
|
|
878,889
|
|
|
|
0.30
|
|
Balance outstanding at June 30, 2018
|
|
|
7,319,043
|
|
|
$
|
2.47
|
|
All
warrants were exercisable at June 30, 2018, the weighted average exercise price per share was $2.47 and the weighted average remaining
life was 3.54 years. The warrants outstanding as of June 30, 2018 had an intrinsic value of $176,000 relating solely to the June
2018 warrant series.
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.
On June 5, 2018, the Company issued warrants
to purchase up to an aggregate of 878,889 shares of common stock to the holders of the June 2018 Senior Notes with an exercise
price of $0.30 per share. The Company incorporated the fair value of the warrants issued of $227,000, valued using the Black-Scholes
pricing model, into the debt discount recorded for the June 2018 Senior Notes, as described in Note 8.
Warrants
outstanding as of June 30, 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
|
|
June 2018 Senior Notes Warrants
|
|
Jun-18
|
|
Jun-23
|
|
|
878,889
|
|
|
|
0.30
|
|
Warrants outstanding and exercisable
at June 30, 2018
|
|
|
|
|
|
|
7,319,043
|
|
|
$
|
2.47
|
|
(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 June 30, 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 June
30, 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 June 30, 2018 and December 31, 2017, we had provisions for contract losses of $427,000 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 June 30, 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 and six months ended June 30, 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 June 2018, we
sold and issued to 26 accredited investors 2017 Senior Notes, 2018 Senior Notes and June 2018 Senior Notes in an aggregate principal
amount of approximately $2.8 million, five-year warrants to purchase an aggregate of 977,773 shares of our common stock at an exercise
price of $1.50 per share and five-year warrants to purchase an aggregate of 878,889 shares of our common stock at an exercise price
of $0.30 per share, with aggregate net proceeds to us of approximately $2.5 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
|
|
|
33,334
|
|
|
|
57,778
|
(2)
|
|
|
30,000
|
|
(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.
|
|
|
(2)
|
Includes warrants to purchase 2,222 shares of common stock at an exercise price of $1.50 issued in January
2018 and warrants to purchase 55,556 shares of common stock at an exercise price of $0.30 per share issued in June 2018.
|
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 $3.0 million (the “December 2016 Financing”). The following current
and former officers and directors participated in the December 2016 Financing, in which they purchased the number of
securities listed adjacent to their name.
Name
|
|
Position with Company
|
|
Principal
Amount of Notes
($)
|
|
|
Number
of
Shares
Underlying
Warrants
(#)
|
|
|
Aggregate
Purchase
Price
($)
|
|
Alain J. Castro
|
|
Former 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 and six months ended
June 30, 2018 and 2017, respectively.
Future
minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year as of June 30,
2018 are as follows:
Six months ending December 31, 2018
|
|
$
|
63,000
|
|
Year ending December 31, 2019
|
|
|
128,000
|
|
Year ending December 31, 2020
|
|
|
32,000
|
|
Total
|
|
$
|
223,000
|
|
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 June 30, 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 use sub-premium organic gases and compounds as a fuel source; thereby decreasing both industrial operating costs and significantly
reducing environmentally harmful gaseous emissions. Either as a standalone fuel source or as a supplement to a premium fuel source,
our Power Oxidizers utilize and eliminate low-quality organic waste compounds, including organic gases such as methane as well
as volatile organic compounds (VOCs) such as solvents or paint thinners. 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 and VOCs 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 or VOCs
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 additional third-party equipment such as a turbine in a combined heat and power
application to create electricity and with sufficient residual heat 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
expect to integrate our Power Oxidizer technology into additional sized gas turbines as well as other
“downstream” 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 further expect to integrate our Power Oxidizer technology into
“upstream” equipment such as anaerobic digesters and rotary concentrators which will serve to expand our
potential fuel sources from sub-premium fuels such as volatile organic compounds (VOCs) and unrefined hydrocarbon gases.
These additional fuel sources are expected to reduce the annual fuel-related operating costs of projects that incorporate our
Power Oxidizers and become a significant competitive advantage.
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 underway and 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 third 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 August 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 six months ended
June 30, 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 June 30, 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 six months ended June 30, 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 six months ended June 30, 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 June 30, 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 June 30, 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.
|
Management
Change
On December 17, 2017, we and Alain Castro,
our former Chief Executive Officer, entered into a Separation Agreement pursuant to which we and Mr. Castro mutually agreed to
terminate Mr. Castro’s employment, as well as his position as our Chief Executive Officer, effective as of a date no later
than May 31, 2018. Beginning in January 2018, the our Board of Directors began an executive search for Mr. Castro’s replacement.
On May 31, 2018, Mr. Castro resigned as a director and our Chief Executive Officer. Effective on June 1, 2018, our Board of Directors
named our Chief Financial Officer as our Interim President and Principal Executive Officer until we identify a replacement for
Mr. Castro.
Operating
Losses
For the six months ended June 30, 2018,
we recognized $1,100,000 of license revenue associated with the successful technology transfer, as reduced by
$1,993,000 of operating expenses, for operating loss of $893,000. This compares to an operating loss of $3,218,000 for the six
months ended June 30, 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 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 beyond
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 June 30, 2018, the following table reconciles our operating expenses to this target:
|
|
Three Months Ended
June 30,
2018
(unaudited)
|
|
|
|
|
|
Operating Expenses
|
|
$
|
979,000
|
|
Less:
|
|
|
|
|
Stock-based compensation
|
|
|
(154,000
|
)
|
Depreciation and amortization
|
|
|
(82,000
|
)
|
Adjusted “Non-GAAP” cash basis operating expenses
|
|
$
|
743,000
|
|
During
the quarter ended June 30, 2018 we did not allocate any recurring operating expenses to inventory.
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.
On June 5, 2018, we entered into a securities
purchase agreement pursuant to which we issued convertible senior secured promissory notes in the aggregate principal amount of
approximately $439,444, or the June 2018 Senior Notes, and related warrants to purchase an aggregate of 878,889 shares of common
stock at an exercise price of $0.30 per share, with aggregate cash gross proceeds to us of approximately $394,500. The June 2018
Senior Notes are convertible into shares of common stock at a price of $0.25 per share. The June 2018 Senior Notes rank pari passu
with the 2018 Senior Notes, 2017 Senior Notes, 2016 Senior Notes (as defined below) and 2015 Senior Notes (as defined below). The
closing of the June 2018 Senior Notes financing occurred on June 5, 2018.
Concurrent with the June 5, 2018 third
closing, all previously outstanding convertible senior secured promissory notes, or Senior Notes, and convertible unsecured notes,
or Convertible Unsecured Notes had the conversion price reset from $2.50 per share to $0.25 per share.
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, judgement on potential
asset impairment 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
June 30, 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 June 30, 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 June 30, 2018 and December 31, 2017, two customers accounted for 100% of our accounts
receivable.
Accounts
Payable
As
of June 30, 2018 and December 31, 2017, five vendors collectively accounted for approximately 55% 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 June 30, 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 June 30, 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 June 30, 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 June 30, 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, 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 $396,000 and $600,000 for the three
months ended June 30, 2018 and 2017, respectively, and were $837,000 and $1,183,000 for the six months ended June 30, 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 61.5 million and 9.8
million shares of common stock issuable from the combination of full exercise of all options and warrants, 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 at June 30, 2018 and 2017, respectively.
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
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net loss
|
|
$
|
(2,852,000
|
)
|
|
$
|
(3,210,000
|
)
|
|
$
|
(4,040,000
|
)
|
|
$
|
(6,461,000
|
)
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
4,106,393
|
|
|
|
4,063,660
|
|
|
|
4,097,277
|
|
|
|
4,007,953
|
|
Net loss attributable to common stockholders per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.69
|
)
|
|
$
|
(0.79
|
)
|
|
$
|
(0.99
|
)
|
|
$
|
(1.61
|
)
|
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 AND SIX MONTHS ENDED JUNE 30, 2018, COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2017
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,100,000
|
|
|
$
|
—
|
|
Cost of goods sold
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Gross profit
|
|
|
—
|
|
|
|
—
|
|
|
|
1,100,000
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative
|
|
|
583,000
|
|
|
|
1,004,000
|
|
|
|
1,156,000
|
|
|
|
2,035,000
|
|
Research and development
|
|
|
396,000
|
|
|
|
600,000
|
|
|
|
837,000
|
|
|
|
1,183,000
|
|
Total operating expenses
|
|
|
979,000
|
|
|
|
1,604,000
|
|
|
|
1,993,000
|
|
|
|
3,218,000
|
|
Operating loss
|
|
|
(979,000
|
)
|
|
|
(1,604,000
|
)
|
|
|
(893,000
|
)
|
|
|
(3,218,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(70,000
|
)
|
|
|
(117,000
|
)
|
|
|
(136,000
|
)
|
|
|
(277,000
|
)
|
Amortization of debt discount
|
|
|
(1,803,000
|
)
|
|
|
(1,365,000
|
)
|
|
|
(3,011,000
|
)
|
|
|
(2,776,000
|
)
|
Loss on disposition of assets
|
|
|
—
|
|
|
|
(124,000
|
)
|
|
|
—
|
|
|
|
(137,000
|
)
|
Loss on debt extinguishment
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(10,000
|
)
|
Loss on modification of convertible debt
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(43,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses
|
|
|
(1,873,000
|
)
|
|
|
(1,606,000
|
)
|
|
|
(3,147,000
|
)
|
|
|
(3,243,000
|
)
|
Loss before provision for income taxes
|
|
|
(2,852,000
|
)
|
|
|
(3,210,000
|
)
|
|
|
(4,040,000
|
)
|
|
|
(6,461,000
|
)
|
Provision for income taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Net loss
|
|
$
|
(2,852,000
|
)
|
|
$
|
(3,210,000
|
)
|
|
$
|
(4,040,000
|
)
|
|
$
|
(6,461,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share—basic and diluted
|
|
$
|
(0.69
|
)
|
|
$
|
(0.79
|
)
|
|
$
|
(0.99
|
)
|
|
$
|
(1.61
|
)
|
Weighted average common shares—basic and diluted
|
|
|
4,106,393
|
|
|
|
4,063,660
|
|
|
|
4,097,277
|
|
|
|
4,007,953
|
|
Revenue,
Cost of Goods Sold and Gross Profit (Loss)
For
the three months ended June 30, 2018, we recognized no revenues. For the six months ended June 30, 2018, we recognized $1.1 million
of license fee revenues. There were no revenues for the three or six months ended June 30, 2017.
We
recorded no direct costs associated with the license revenues recognized for the technology transfer to Dresser-Rand during the
six months ended June 30, 2018. Costs associated with the technology transfer were incurred prior to the six months ended June
30, 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 June 30, 2018 or 2017.
Operating
Expenses
Total operating expenses decreased by $625,000,
or 40.0%, to $979,000 for the three months ended June 30, 2018 from $1,604,000 for the same period in the prior year. The reduction
is primarily due to the results of cost savings efforts from reduced headcount costs, lower facilities costs associated with our
headquarters move, lower contractor and professional fees, and lower stock-based compensation expenses.
Total operating expenses decreased by $1,225,000 or 38.1% to $1,993,000 for the six months ended June
30, 2018 from $3,218,000 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 throughout 2018, primarily driven by lower employee headcount as well as reduced 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
June 30, 2018 decreased $421,000, or 41.9%, to $583,000 from $1,004,000 for the same period of the prior year. The decrease
was primarily due to $247,000 in employee and officer salaries and stock-based compensation charges, $78,000 in lower legal and
professional expenses, $45,000 lower non-recurring charges relating to financing costs and $40,000 in lower travel, facilities,
and other cost savings.
Total selling, general and administrative
expenses for the six months ended June 30, 2018 decreased $879,000 or 43.2% to $1,156,000 from $2,035,000 for the same period
of the prior year. The decrease was primarily due to reductions of $222,000 in professional services, $97,000 lower occupancy
costs resulting from our facilities move in 2017, $188,000 lower salaries and benefits due to headcount reductions, reduction
of $23,000 for travel-related costs, and $300,000 less in stock-based compensation.
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 June 30,
2018 decreased $204,000, or 34.0%, to $396,000 from $600,000 for the same period of the prior year. The decrease is
primarily due to decreased engineering headcount costs of $57,000, a decrease in stock-based compensation expense of $45,000, a
decrease of $27,000 of outsourced research and development, and $67,000 in lower overhead expenses.
Research and development expense for the
six months ended June 30, 2017 decreased $346,000, or 29.2%, to $837,000 from $1,183,000 for the same period of the prior year. The
decrease is primarily due to a $110,000 decrease in employee compensation due to headcount reductions, $105,000 less in stock-based
compensation and $90,000 of rent and allocated overhead due to the headquarters move to our smaller facility. During the six months
ended June 30, 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 Expenses:
Other expenses for the three and six months
ended June 30, 2018 consisted of primarily non-cash interest on the outstanding Senior Notes and cash interest on outstanding Convertible
Unsecured Notes and for the Company’s backstop security, which expired.
Other expenses for the three and six months
ended June 30, 2017 consisted primarily of amortization of discount and deferred financing costs on the $9.1 million Senior Notes,
cash and non-cash interest on the Convertible Unsecured Notes, cash payments on the 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 June 30, 2018
our net loss was approximately $2.9 million, primarily from selling, general and administrative expenses of $0.6 million, research
and development costs of $0.4 million and $1.9 million of other expenses consisting of interest expense, of which $1.8 million
is non-cash interest expense. For the three months ended June 30, 2017 our net loss was approximately $3.2 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 consisting primarily of interest expense, of which $1.4 million is non-cash interest.
For the six months ended June 30, 2018,
our net loss was approximately $4.0 million, primarily from selling, general and administrative expenses of $1.2 million, research
and development costs of $0.8 million, and offset by $1.1 million of gross margin resulting from the recognition of $1.1 million
of license revenue in January 2018 and $3.2 million of other expenses consisting primarily interest expense, of which $3.0 million
is non-cash interest expense. For the six months ended June 30, 2017, our net loss was approximately $6.5 million, primarily from
selling, general and administrative expenses of $2.0 million, research and development costs of $1.2 million, and $3.2 million
of other expenses consisting primarily of $3.0 million of interest expense, of which $2.8 million is non-cash interest expense
and other expenses of $0.2 million including a non-recurring $0.1 million loss on disposition of assets related to our facilities
move in March 2017.
Loss
per share
Loss per share, basic and diluted were
($0.69) and ($0.79) for the three months ended June 30, 2018 and 2017, respectively and were ($0.99) and ($1.61) for the six months
ended June 30, 2018 and 2017, respectively.
Liquidity
The
following table sets forth our cash flow information as follows:
|
|
Six Months Ended June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
$ Change
|
|
|
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
(1,242,000
|
)
|
|
$
|
(1,250,000
|
)
|
|
$
|
8,000
|
|
Investing activities
|
|
|
—
|
|
|
|
(67,000
|
)
|
|
|
67,000
|
|
Financing activities
|
|
$
|
1,054,000
|
|
|
|
(6,000
|
)
|
|
|
1,060,000
|
|
Cash
Flows used in Operating Activities
Our cash used in operating activities was
approximately $1.2 million and $1.3 million for the six months ended June 30, 2018 and 2017, respectively. Cash used in operating
activities for the six months ended June 30, 2018 of $1.3 million resulted from a net loss of approximately $4.0 million, reduced
by net non-cash charges of $3.4 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 $0.6 million in working capital, primarily due to a $1.1 million
decrease in deferred revenues, a $0.2 million increase in inventory and prepaid expenses, offset by a $0.6 million increase in
accounts payable and accrued expenses.
Cash
used in operating activities for the six months ended June 30, 2017 resulted from a net loss of approximately $6.5 million, reduced
by net non-cash charges of $3.7 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 $1.8 million in working capital, primarily due to a $2.3 million
increase in deferred revenue, inventory and prepaid expenses, offset by a $0.4 million reduction in accounts payable.
Cash
Flows from Investing Activities
We
had no cash flows from investing activities for the six months ended June 30, 2018. Cash provided by investing activities of
$0.1 million for the six months ended June 30, 2017 was attributable to miscellaneous equipment and inventory sold during our
facilities move.
Cash
Flows from Financing Activities
Cash
provided by financing activities for the six months ended June 30, 2018 consisted of $1,060,000 of cash proceeds from the issuance
of additional Senior Notes, reduced by $6,000 for the repayment of capital leases. Cash used from financing activities for the
six months ended June 30, 2017 of $3,000 consisted of the repayment of existing capital leases for office equipment. Cash provided
by financing activities for the six months ended June 30, 2017 of $6,000 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 six months ended June 30, 2018, we had operating loss of $1.0 million and had a net loss of approximately
$4.0 million. As of June 30, 2018, we had an accumulated deficit of approximately $56.4 million. For the six months ended June
30, 2018, we used cash in operations of approximately $1.3 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 June 30, 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 June 30, 2018, cash and cash equivalents were $20,000,
or 0.3% 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 $1.3 million offset by cash proceeds from
Senior Notes of $1.1 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 $5 million, which includes
the following:
|
●
|
Employee,
occupancy and related costs: $2.1 million
|
|
|
|
|
●
|
Professional
fees and business development costs: $0.6 million
|
|
●
|
Research
and development programs: $0.3 million
|
|
|
|
|
●
|
Corporate
filings: $0.5 million
|
|
●
|
Working
capital: $1.5 million
|
Off-Balance
Sheet Arrangements
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.