ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with consolidated financial statements and the related notes that appear elsewhere within this report. Certain statements we make under this Item 7 constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. See “Forward-Looking Statements” in “Part I” preceding “Item 1 - Business.” You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors” in Item 1A above, as well as our consolidated financial statements, related notes and other financial information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission.
Background
Midwest Energy Emissions Corp. (the “Company”, “we”, “us” and “our”) is an environmental services and technology company specializing in mercury emission control technologies, primarily to utility and industrial coal-fired units. We deliver patented and proprietary solutions to the global coal-power industry to remove mercury from power plant emissions, providing performance guarantees, and leading-edge emissions services. We have developed patented technology and proprietary products that have been shown to achieve mercury removal at a significantly lower cost and with less operational impact than currently used methods, while maintaining and/or increasing unit output and preserving the marketability of fly-ash for beneficial use.
North America is currently the largest market for our technology. The U.S. EPA MATS (Mercury and Air Toxics Standards) rule requires that all coal and oil-fired power plants in the U.S., larger than 25MWs, must limit mercury in its emissions to below certain specified levels, according to the type of coal burned. Power plants were required to begin complying with MATS on April 16, 2015, unless they were granted a one-year extension to begin to comply. MATS, along with many state and provincial regulations, form the basis for mercury emission capture at coal fired plants across North America. Under the MATS regulation, Electric Generating Units (“EGUs”) are required to remove about 90% of the mercury from their emissions. We believe that we continue to meet the requirements of the industry as a whole and our technologies have been shown to achieve mercury removal levels compliant with all state, provincial and federal regulations at a lower cost and with less plant impact than our competition.
As is typical in this market, we are paid by the EGU based on how much of our material is injected to achieve the needed level of mercury removal. Our current clients pay us as material is delivered to their facility. Clients will use our material whenever their EGUs operate, although EGUs are not always in operation. EGUs typically may not be in operation due to maintenance reasons or when the price of power in the market is less than their cost to produce power. Thus, our revenues from EGU clients will not typically be a consistent stream but will fluctuate, especially seasonally as the market demand for power fluctuates.
The MATS regulation has been subject to legal challenge, and in June 2015, the U.S. Supreme Court held that the EPA unreasonably failed to consider costs in determining whether it is “appropriate and necessary” to regulate hazardous air pollutants, including mercury, from power plants. The Court remanded the case back to the U.S. Court of Appeals for the District of Columbia Circuit for further proceedings, but left the rule in place. In December 2015, the D.C. Circuit remanded the rule back to the EPA for further consideration while allowing MATS to remain in effect pending the EPA’s finding; the Supreme Court later denied a petition challenging the lower court’s decision to remand without vacating. On April 14, 2016, EPA issued a final supplemental finding reaffirming the MATS rule on the ground that it is supported by the cost analysis the Supreme Court required. That supplemental finding is under review by the D.C. Circuit, and the Company is unable to predict with certainty the outcome of these proceedings. On April 18, 2017, EPA asked the court to place that litigation in abeyance, stating that the Agency is reviewing the supplemental finding to determine whether it should be reconsidered in whole or in part. The court granted EPA’s abeyance request on April 27, 2017, and ordered EPA to file 90-day status reports starting July 26, 2017. In February 2019, the EPA published its proposed revised supplemental cost-benefits finding for MATS which concludes that the 2016 supplemental finding was flawed in part due to its reliance on co-benefits to justify MATS. Nevertheless, the EPA is proposing to leave the MATS rule in place. EPA also seeks public comment, however, on whether MATS may or must be rescinded if EPA reverses its earlier conclusion that it is “appropriate and necessary” to regulate power plant emissions of mercury and other hazardous air pollutants under the statutory provision authorizing MATS. The revised supplemental cost-benefits finding is subject to a public comment period until April 17, 2019. As of the date of the filing of this report, we are unable to predict whether the proposed supplemental cost-benefits finding will be finalized in substantially the form as proposed, or finalized at all. Any such final action will almost certainly be challenged in the courts, which could extend uncertainty over the status of MATS for a number of years. Investors should note that any changes to the MATS rule could have a negative impact on our business.
Executive Overview
We remain focused on positioning the Company for short and long-term growth. During 2018, we focused on execution at our customer sites and on continual operation improvement. We continue to make refinements to all of our key products, as we continue to focus on the customer and its operations. As part of our overall strategy, we have a number of initiatives which we believe will be able to drive our short and long-term growth:
|
·
|
Our acquisition of all the patent rights, including all patents and patents pending, domestic and foreign, which forms the basis of our mercury control technology, which acquisition was completed in April 2017 positions us to license systems using a two-part mercury control process. In this regard, we anticipate being able, and have begun efforts, to license our technologies to utilities and others across North America, Europe and elsewhere.
|
|
·
|
In the United States, we continue to seek new utility customers for our technology in order for them to meet the MATS requirements as well as maintaining our contractual arrangements with our current customers. In this regard, in October 2018, we secured a supply contract extension with our largest customer and also expanded into this customer’s fleet by securing two additional coal-fired boilers to which we supply our technology and products. In March 2019, we secured two additional coal-fired boilers within this customer’s fleet. In addition, in March 2019, we secured a contract renewal with another long-term customer and we entered into an agreement with a new utility customer to supply our technology and products.
|
|
·
|
In Europe, we are working to penetrate this market through our licensing agreement entered into in March 2018 with one of our primary suppliers. We believe such arrangement will make our technology more marketable throughout Europe and which will benefit the Company from such supplier’s knowledge and operations in the region.
|
|
·
|
During 2018, we engaged a Dallas-based intellectual property law firm to lead the Company’s efforts in licensing its patented SEA technologies across the United States coal fleet. We believe this engagement will aid us in moving our suite of technologies forward for the benefit of the utility industry in 2019 and beyond.
|
|
·
|
Subsequent to the year end, on February 25, 2019, we were able to complete the restructuring of our unsecured and secured debt obligations held by AC Midwest Energy LLC extending the maturity dates of these debts until 2022 and eliminating quarterly principal payment requirements. This restructuring reflects the commitment of our financial partner in our efforts to attract new business, manage our present customers and monetize our patent portfolio.
|
Although we face a host of challenges and risks, and acknowledge that revenues decreased significantly in 2018 compared to the prior year, we are optimistic about our future and expect our business to grow substantially.
Results of Operations
The Company saw a decrease in sales in 2018 as compared to 2017. The decrease in product sales is primarily due to the loss of customer EGU’s that were shut down as a result of competitive disadvantages to other EGU’s, optimization efforts with our customers, as well as lower capacity factors seen at some customer sites resulting in decreased product needed to keep our customers in MATS compliance.
Revenues
Sales
- We generated revenues of approximately $12,296,000 and $27,499,000 for the years ended December 31, 2018 and 2017. Total sorbent product sales for the year ended December 31, 2018 and 2017 were $12,115,000 and $26,050,000, respectively. The decrease from the prior year is primarily due to the loss of customer EGU’s.
Equipment sales for the years ended December 31, 2018 and 2017 were $49,000 and $794,000, respectively. Equipment sales for 2017 were primarily related to one front end injection system sold to a customer.
Other revenues for the years ended December 31, 2018 and 2017 were $132,000 and $655,000, respectively. This decrease is primarily associated with decreased demonstration revenues in 2018.
Costs and Expenses
Costs and expenses
were $17,090,000 and $29,862,000 during the years ended December 31, 2018 and 2017, respectively. The decrease in costs and expenses from the prior year is primarily attributable to a decrease in costs of sales in the current year. The decrease in cost of sales is primarily associated with the significant decrease in revenues in 2018 compared to 2017.
Costs of sales were
$9,148,000 and $19,017,000 for the year ended December 31, 2018 and 2017, respectively. The decrease in cost is primarily attributable to the decrease in product sales in 2018. Gross margin decreased to 25.6% in 2018 from 30.8% due to lower total volumes year over year and higher overhead costs applied per sales dollar. Equipment cost of sales during the year ended December 31, 2018 and 2017 was $40,000 and $575,000, respectively. The decrease in the equipment costs of sales in the year ended December 31, 2018 is due to the decrease in equipment sales compared to the prior year.
Selling, general and administrative expenses
were $5,895,000 and $8,471,000 for the years ended December 31, 2018 and 2017. The decrease in selling, general and administrative expenses is primarily attributed to a decrease in stock based compensation and sales compensation compared to 2017.
Interest expense
related to the financing of capital was $2,004,000 and $2,374,000 for the years ended December 31, 2018 and 2017, respectively. The decrease in interest expense is attributable to the decrease in non-cash interest charges as well as the decrease in secured debt in 2018 compared to 2017.
Net Loss
Net loss for the years ended December 31, 2018 and 2017 was $4,817,000 and $2,903,000 respectively. The change in net loss is primarily due to the decreased sales.
Taxes
Our deferred tax assets are primarily related to net operating losses and a valuation allowance has been established due to the uncertainty of the utilization of all of these assets in future periods. As of December 31, 2017, the deferred tax asset of $500,000 which was recorded as of December 31, 2016, was reversed due to there no longer being sufficient evidence available to support the realization of certain tax assets in future years. As of December 31, 2018 and 2017, our deferred tax assets are primarily related to accrued compensation and net operating losses. A 100% valuation allowance has been established due to the uncertainty of the utilization of these assets in future periods. As a result, the deferred tax asset was reduced to zero and no income tax benefit was recorded. Net operating loss carryforwards of approximately $4,328,000, if not utilized, will begin to expire in 2031, federal net operating losses incurred in 2018 have an indefinite life.
Liquidity and Capital Resources
The Company had $585,000 in cash on its balance sheet at December 31, 2018. The Company had working capital of $132,000 and an accumulated deficit $51.5 million. Additionally, the Company had a loss from operations in the amount of $2.8 million and cash used in operating activities of $1.1 million for the year ended December 31, 2018.
During 2018, the Company restructured convertible notes totaling $560,000 into new loans that mature in 2023. In February 2019, the Company completed the restructuring of its unsecured and secured debt obligations held by its largest promissory noteholder, extending the maturity dates of these debts and the remaining convertible notes until 2022 and eliminating quarterly principal payment requirements. Based on the extended maturities the Company negotiated with its note holders, historical sales and gross margin trends with its current customers under contract and the incremental sales and gross margin from the newly announced customer contracts, management believes substantial doubt regarding the Company’s ability to continue as a going concern has been mitigated. The Company believes it will have sufficient working capital to fund operations for at least the next twelve months from the date of issuance of these financial statements.
Total assets
were $8,039,000 at December 31, 2018 versus $12,056,000 at December 31, 2017. The change in total assets is primarily attributable to the decreases in cash and accounts receivable due to the decrease in sales and operating activities in 2018 compared to 2017.
Total liabilities
were $16,660,000 at December 31, 2018 versus $16,481,000 at December 31, 2017. The increase in operating activities is primarily attributable to increases in deferred compensation and accounts payable and is offset by a decrease in deferred revenue. Deferred compensation increased in 2018 due to agreements made with certain employees and accounts payable increased due to extended terms with certain suppliers were utilized to manage our cash flow.
Operating activities
used $1,065,000 of cash for the year ended December 31, 2018 versus $472,000 for the year ended December 31, 2017. The increase in cash used in operating activities is primarily attributable to increase in net loss and is offset by a decrease in non-cash adjustments and cash provided by changes in asset and liability balances in 2018. Non-cash charges for stock based compensation, amortization and depreciation and deferred tax benefit decreased in 2018 compared to 2017. Cash provided by decreases in accounts receivable and increased deferred compensation were offset by decreased deferred revenue in 2018 compared to 2017.
Investing activities
used $132,000 and $3,306,000 during the year ended December 31, 2018 and 2017, respectively. The change in cash used in investing activities is primarily attributable to the purchase of patent rights during 2017 and decreased investment in property and equipment in 2018 compared to 2017.
Financing activities
used $636,000 during the year ended December 31, 2018 versus $1,555,000 for the year ended December 31, 2017. In 2018, $875,000 was used to make principle payments on the secured promissory note verses $1,500,000 in 2017. Also in 2018, we sold convertible notes and warrants totaling $300,000.
Off-Balance Sheet Arrangements
We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, and results of operations, liquidity or capital expenditures.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial conditions and results of operation are based upon the accompanying consolidated financial statements which have been prepared in accordance with the generally accepted accounting principles in the U.S. The preparation of the consolidated financial statements requires that we make estimates and assumptions that affect the amounts reported in assets, liabilities, revenues and expenses. Management evaluates on an on-going basis our estimates with respect to the valuation allowances for accounts receivable, income taxes, accrued expenses and equity instrument valuation, for example. We base these estimates on various assumptions and experience that we believe to be reasonable. The following critical accounting policies are those that are important to the presentation of our financial condition and results of operations. These policies require management’s most difficult, complex, or subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.
The following critical accounting policies affect our more significant estimates used in the preparation of our consolidated financial statements. In particular, our most critical accounting policies relate to the recognition of revenue, and the valuation of our stock-based compensation.
Accounts Receivable
Trade accounts receivable are stated at the amount the Company expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.
Revenue Recognition
The Company records revenue in accordance with ASC 606, Revenue from Contracts with Customers (“ASC 606”). The Company’s revenues are primarily comprised of sales of products. Revenue is recognized when the Company satisfies its performance obligation under the contract by transferring the promised product to its customer that obtains control of the product. A performance obligation is a promise in a contract to transfer a distinct product to a customer. Most of the Company’s contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.
Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products. As such, revenue is recorded net of returns, allowances, customer discounts, and incentives. Sales and other taxes are excluded from revenues. Invoiced shipping and handling costs are included in revenue.
The Company generated revenue for the years ended December 31, 2018 and 2017 by (i) delivering product to its commercial customers, (ii) completing and commissioning equipment projects at commercial customer sites and (iii) performing demonstrations of its technology at customers with the intent of entering into long term supply agreements based on the performance of the Company’s products during the demonstrations.
Revenue for product sales is recognized at the point of time in which the customer obtains control of the product, at the time title passes to the customer upon shipment or delivery of the product based on the applicable shipping terms.
Revenue for equipment sales is recognized upon commissioning and customer acceptance of the installed equipment per the terms of the purchase contract.
Revenue for demonstrations and consulting services is recognized when performance obligations contained in the contract have been completed, typically the completion of necessary field work and the delivery of any required analysis per the terms of the agreement.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carryforwards, 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s consolidated financial statements are based on a more-likely-than-not recognition threshold. The Company did not have any unrecognized tax benefits at December 31, 2018 or 2017. When necessary, the Company would accrue penalties and interest related to unrecognized tax benefits as a component of income tax expense.
The Company and its subsidiaries file a consolidated income tax return in the U.S. federal jurisdiction and three state jurisdictions. The Company is no longer subject to U.S. federal examinations for years prior to 2015 or state tax examinations for years prior to 2014.
Stock-Based Compensation
Share-based payments be reflected as an expense based upon the grant-date fair value of those grants over their vesting period. Accordingly, the fair value of each option grant, non-vested stock award and shares issued under our employee stock purchase plan, were estimated on the date of grant. We estimate the fair value of these grants using the Black-Scholes model which requires us to make certain estimates in the assumptions used in this model, including the expected term the award will be held, the volatility of the underlying common stock, the discount rate, dividends and the forfeiture rate. The expected term represents the period of time that grants and awards are expected to be outstanding. Expected volatilities were based on historical volatility of our stock. The risk-free interest rate approximates the U.S. treasury rate corresponding to the expected term of the option. Dividends were assumed to be zero. Forfeiture estimates are based on historical data. These inputs are based on our assumptions, which we believe to be reasonable but that include complex and subjective variables. Other reasonable assumptions could result in different fair values for our stock-based awards. Stock-based compensation expense, as determined using the Black-Scholes option-pricing model, is recognized on a straight-line basis over the service period, net of estimated forfeitures. To the extent that actual results or revised estimates differ from the estimates used, those amounts will be recorded as an adjustment in the period that estimates are revised.
Non-GAAP Financial Measures
Adjusted EBITDA
To supplement our consolidated financial statements presented in accordance with GAAP and to provide investors with additional information regarding our financial results, we consider and are including herein Adjusted EBITDA, a Non-GAAP financial measure. We view Adjusted EBITDA as an operating performance measure and, as such, we believe that the GAAP financial measure most directly comparable to it is net income (loss). We define Adjusted EBITDA as net income adjusted for interest and financing fees, income taxes, depreciation, amortization, stock based compensation, and other non-cash income and expenses. We believe that Adjusted EBITDA provides us an important measure of operating performance because it allows management, investors, debtholders and others to evaluate and compare ongoing operating results from period to period by removing the impact of our asset base, any asset disposals or impairments, stock based compensation and other non-cash income and expense items associated with our reliance on issuing equity-linked debt securities to fund our working capital.
Our use of Adjusted EBITDA has limitations as an analytical tool, and this measure should not be considered in isolation or as a substitute for an analysis of our results as reported under GAAP, as the excluded items may have significant effects on our operating results and financial condition. Additionally, our measure of Adjusted EBITDA may differ from other companies’ measure of Adjusted EBITDA. When evaluating our performance, Adjusted EBITDA should be considered with other financial performance measures, including various cash flow metrics, net income and other GAAP results. In the future, we may disclose different non-GAAP financial measures in order to help our investors and others more meaningfully evaluate and compare our future results of operations to our previously reported results of operations.
The following table shows our reconciliation of Net Income to Adjusted EBITDA for the years ended December 31, 2018 and 2017, respectively:
|
|
Year Ended
|
|
|
|
12/31/2018
|
|
|
12/31/2017
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,817
|
)
|
|
$
|
(2,903
|
)
|
|
|
|
|
|
|
|
|
|
Non-GAAP adjustments:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
796
|
|
|
|
1,354
|
|
Interest and letter of credit fees
|
|
|
2,004
|
|
|
|
2,374
|
|
Income taxes
|
|
|
22
|
|
|
|
540
|
|
Stock based compensation
|
|
|
491
|
|
|
|
1,532
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
$
|
(1,504
|
)
|
|
$
|
2,897
|
|
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MIDWEST ENERGY EMISSIONS CORP. AND SUBSIDIARIES
Index to Financial Information
Year Ended December 31, 2018
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
Midwest Energy Emissions Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Midwest Energy Emissions Corp. (the “Company”) as of December 31, 2018, the related consolidated statements of operations, stockholders’ deficit and cash flows for the year ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Marcum LLP
Marcum LLP
We have served as the Company’s auditor since 2018.
New York, NY
April 11, 2019
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Midwest Energy Emissions Corporation
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Midwest Energy Emissions Corporation (the Company) as of December 31, 2017, and the related consolidated statement of operations, stockholders’ deficit and cash flows for the year ended December 31, 2017 and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Midwest Energy Emissions Corporation as of December 31, 2017, and the results of its operations and its cash flows for each of the years in the year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Substantial Doubt Regarding Going Concern
As disclosed in Note 3 to the financial statements, the Company has experienced a net loss, and has an accumulated deficit of $46,667,000. The Company has convertible notes maturing during 2018 of $1,550,000 and current principal payments due in 2018 on outstanding promissory notes of $2,550,000. These matters raise substantial doubt regarding the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3 to the financial statements. The financial statements do not include any adjustments related to the outcome of this uncertainty.
Change in Accounting Principle - Early Adoption of Provisions in ASU 2017-11
As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for the classification of certain liability-classified financial instruments with down round features in 2017 and 2016 due to the adoption of Accounting Standards Update (“ASU”) 2017-11, “Earning Per Share (Topic 260) ; Distinguishing Liabilities from Equity (Topic 480) ; Derivatives and Hedging (Topic 815).
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company’s auditor since 2011.
/s/ Schneider Downs & Co., Inc.
Columbus, Ohio
April 17, 2018
MIDWEST ENERGY EMISSIONS CORP. AND SUBSIDIARIES
|
CONSOLIDATED BALANCE SHEETS
|
DECEMBER 31, 2018 AND 2017
|
|
|
|
|
|
|
|
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
ASSETS
|
Current assets
|
|
|
|
|
|
|
Cash
|
|
$
|
584,877
|
|
|
$
|
2,418,427
|
|
Accounts receivable
|
|
|
1,642,126
|
|
|
|
2,931,353
|
|
Inventory
|
|
|
509,416
|
|
|
|
659,579
|
|
Prepaid expenses and other assets
|
|
|
136,628
|
|
|
|
210,535
|
|
Customer acquisition costs, net
|
|
|
34,467
|
|
|
|
137,866
|
|
Total current assets
|
|
|
2,907,514
|
|
|
|
6,357,760
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
2,397,691
|
|
|
|
2,728,993
|
|
Intellectual property, net
|
|
|
2,733,662
|
|
|
|
2,934,862
|
|
Customer acquisition costs, net
|
|
|
-
|
|
|
|
34,467
|
|
Total assets
|
|
$
|
8,038,867
|
|
|
$
|
12,056,082
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' DEFICIT
|
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
1,858,326
|
|
|
$
|
1,795,703
|
|
Current portion of notes payable, net
|
|
|
-
|
|
|
|
3,961,417
|
|
Current portion of equipment notes payable
|
|
|
63,424
|
|
|
|
61,177
|
|
Accrued interest
|
|
|
96,902
|
|
|
|
77,500
|
|
Customer credits
|
|
|
167,000
|
|
|
|
167,000
|
|
Deferred compensation
|
|
|
555,877
|
|
|
|
-
|
|
Deferred revenue
|
|
|
-
|
|
|
|
517,060
|
|
Total current liabilities
|
|
|
2,741,529
|
|
|
|
6,579,857
|
|
|
|
|
|
|
|
|
|
|
Notes payable, net of discount and issuance costs, less current portion
|
|
|
13,814,208
|
|
|
|
9,733,361
|
|
Equipment notes payable, less current portion
|
|
|
104,226
|
|
|
|
167,650
|
|
Total liabilities
|
|
|
16,659,963
|
|
|
|
16,480,868
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES (Note 9)
|
|
|
|
|
|
|
|
|
Stockholders' deficit
|
|
|
|
|
|
|
|
|
Preferred stock, $.001 par value: 2,000,000 shares authorized
|
|
|
-
|
|
|
|
-
|
|
Common stock; $.001 par value; 150,000,000 shares authorized; 76,246,113 shares issued and outstanding as of December 31, 2018 and 2017
|
|
|
76,246
|
|
|
|
76,246
|
|
Additional paid-in capital
|
|
|
42,785,990
|
|
|
|
42,165,620
|
|
Accumulated deficit
|
|
|
(51,483,332
|
)
|
|
|
(46,666,652
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders' deficit
|
|
|
(8,621,096
|
)
|
|
|
(4,424,786
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders' deficit
|
|
$
|
8,038,867
|
|
|
$
|
12,056,082
|
|
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
|
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
12,295,862
|
|
|
$
|
27,499,080
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
9,147,745
|
|
|
|
19,016,932
|
|
Selling, general and administrative expenses
|
|
|
5,894,511
|
|
|
|
8,471,096
|
|
Loss on debt restructuring
|
|
|
44,036
|
|
|
|
-
|
|
Interest expense
|
|
|
1,975,097
|
|
|
|
2,154,570
|
|
Letter of credit fees
|
|
|
29,000
|
|
|
|
219,333
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
17,090,389
|
|
|
|
29,861,931
|
|
|
|
|
|
|
|
|
|
|
Net loss before provision for income taxes
|
|
|
(4,794,527
|
)
|
|
|
(2,362,851
|
)
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
(22,153
|
)
|
|
|
(540,422
|
)
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,816,680
|
)
|
|
$
|
(2,903,273
|
)
|
|
|
|
|
|
|
|
|
|
Net loss per common share - basic and diluted:
|
|
$
|
(0.06
|
)
|
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
76,137,894
|
|
|
|
75,061,800
|
|
The accompanying notes are an integral part of these consolidated financial statements.
MIDWEST ENERGY EMISSIONS CORP. AND SUBSIDIARIES
|
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
|
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Common Stock
|
|
|
Additional
|
|
|
Accumulated
|
|
|
Stockholders'
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Paid-in Capital
|
|
|
(Deficit)
|
|
|
Deficit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance - December 31, 2016
|
|
|
73,509,663
|
|
|
$
|
73,510
|
|
|
$
|
40,031,625
|
|
|
$
|
(43,763,379
|
)
|
|
$
|
(3,658,244
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued upon debt conversion
|
|
|
51,236
|
|
|
|
51
|
|
|
|
25,567
|
|
|
|
|
|
|
|
25,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued upon cashless warrant exercise
|
|
|
630,214
|
|
|
|
630
|
|
|
|
(630
|
)
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued for the acquisition of patents rights
|
|
|
925,000
|
|
|
|
925
|
|
|
|
517,075
|
|
|
|
|
|
|
|
518,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued to non-employees
|
|
|
1,000,000
|
|
|
|
1,000
|
|
|
|
230,250
|
|
|
|
|
|
|
|
231,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued per settlement agreement
|
|
|
130,000
|
|
|
|
130
|
|
|
|
60,970
|
|
|
|
|
|
|
|
61,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Re-issuance of warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
17,922
|
|
|
|
|
|
|
|
17,922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
1,282,841
|
|
|
|
-
|
|
|
|
1,282,841
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,903,273
|
)
|
|
|
(2,903,273
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance - December 31, 2017
|
|
|
76,246,113
|
|
|
$
|
76,246
|
|
|
$
|
42,165,620
|
|
|
$
|
(46,666,652
|
)
|
|
$
|
(4,424,786
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vesting of stock issued to non-employees in prior year
|
|
|
-
|
|
|
|
-
|
|
|
|
138,750
|
|
|
|
-
|
|
|
|
138,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
129,850
|
|
|
|
-
|
|
|
|
129,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of stock options
|
|
|
-
|
|
|
|
-
|
|
|
|
351,770
|
|
|
|
-
|
|
|
|
351,770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(4,816,680
|
)
|
|
|
(4,816,680
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance - December 31, 2018
|
|
|
76,246,113
|
|
|
$
|
76,246
|
|
|
$
|
42,785,990
|
|
|
$
|
(51,483,332
|
)
|
|
$
|
(8,621,096
|
)
|
The accompanying notes are an integral part of these consolidated financial statements.
MIDWEST ENERGY EMISSIONS CORP. AND SUBSIDIARIES
|
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2018
|
|
|
For the Year Ended December 31, 2017
|
|
|
|
|
|
|
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
Net loss
|
|
$
|
(4,816,680
|
)
|
|
$
|
(2,903,273
|
)
|
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net loss
to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Stock based compensation
|
|
|
490,520
|
|
|
|
1,532,013
|
|
Amortization of license fees
|
|
|
-
|
|
|
|
1,950
|
|
Amortization of patent rights
|
|
|
201,200
|
|
|
|
134,133
|
|
Amortization of discount of notes payable
|
|
|
678,061
|
|
|
|
745,652
|
|
Amortization of debt issuance costs
|
|
|
102,183
|
|
|
|
153,303
|
|
Amortization of customer acquisition costs
|
|
|
137,866
|
|
|
|
469,870
|
|
Depreciation expense
|
|
|
456,914
|
|
|
|
748,020
|
|
Loss on debt exchange
|
|
|
44,036
|
|
|
|
-
|
|
Gain on sale of equipment
|
|
|
6,303
|
|
|
|
-
|
|
Deferred tax benefit
|
|
|
-
|
|
|
|
500,000
|
|
Noncash settlement charge expenses
|
|
|
-
|
|
|
|
61,100
|
|
Change in assets and liabilities
|
|
|
|
|
|
|
|
|
Decrease in accounts receivable
|
|
|
1,289,227
|
|
|
|
621,743
|
|
Decrease (Increase) in inventory
|
|
|
150,163
|
|
|
|
(50,507
|
)
|
Decrease (Increase) in prepaid expenses and other assets
|
|
|
73,907
|
|
|
|
(11,040
|
)
|
Increase (decrease) in accounts payable and accrued liabilities
|
|
|
82,025
|
|
|
|
(2,568,482
|
)
|
Increase in deferred compensation
|
|
|
555,877
|
|
|
|
-
|
|
(Decrease) Increase in deferred revenue
|
|
|
(517,060
|
)
|
|
|
517,060
|
|
(Decrease) in customer credits
|
|
|
-
|
|
|
|
(423,206
|
)
|
Net cash used in operating activities
|
|
|
(1,065,458
|
)
|
|
|
(471,664
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
|
(131,915
|
)
|
|
|
(806,460
|
)
|
Purchase of intellectual property
|
|
|
-
|
|
|
|
(2,500,000
|
)
|
Net cash used in investing activities
|
|
|
(131,915
|
)
|
|
|
(3,306,460
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Payments of equipment notes payable
|
|
|
(61,177
|
)
|
|
|
(55,006
|
)
|
Proceeds from issuance of convertible promissory notes and warrants
|
|
|
300,000
|
|
|
|
-
|
|
Payments on secured promissory note
|
|
|
(875,000
|
)
|
|
|
(1,500,000
|
)
|
Net cash used in financing activities
|
|
|
(636,177
|
)
|
|
|
(1,555,006
|
)
|
|
|
|
|
|
|
|
|
|
Net decrease in cash
|
|
|
(1,833,550
|
)
|
|
|
(5,333,130
|
)
|
|
|
|
|
|
|
|
|
|
Cash - beginning of year
|
|
|
2,418,427
|
|
|
|
7,751,557
|
|
|
|
|
|
|
|
|
|
|
Cash - end of year
|
|
$
|
584,877
|
|
|
$
|
2,418,427
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
1,175,450
|
|
|
$
|
1,254,997
|
|
Taxes
|
|
$
|
22,153
|
|
|
$
|
40,422
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS
|
|
|
|
|
|
|
|
|
Conversion of secured notes payable into unsecured notes payable
|
|
$
|
560,000
|
|
|
$
|
-
|
|
Warrants issued upon debt exchange
|
|
$
|
89,500
|
|
|
|
-
|
|
Equipment purchases included in note payable
|
|
$
|
-
|
|
|
$
|
101,199
|
|
Conversion of debt and accrued interest to equity
|
|
$
|
-
|
|
|
$
|
25,618
|
|
The accompanying notes are an integral part of these consolidated financial statements.
Midwest Energy Emissions Corp. and Subsidiaries
Notes to Consolidated Financial Statements for the years ended December 31, 2018 and 2017
Note 1 - Organization
Midwest Energy Emissions Corp.
Midwest Energy Emissions Corp. (the “Company") is organized under the laws of the State of Delaware with 150,000,000 authorized shares of common stock, par value $.001 per share and 2,000,000 authorized shares of preferred stock, par value $0.001 per share.
MES, Inc.
MES, Inc. is incorporated in the State of North Dakota. MES, Inc. is a wholly owned subsidiary of Midwest Energy Emissions Corp. and is engaged in the business of developing and commercializing state of the art control technologies relating to the capture and control of mercury emissions from coal fired boilers in the United States and Canada.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with the Generally Accepted Accounting Principles in the United States of America (“GAAP”).
Principles of Consolidation
The consolidated financial statements include the accounts of Midwest Energy Emissions Corp. and its wholly-owned subsidiary, MES, Inc. Intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, valuation of equity issuances and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The Company uses estimates in accounting for, among other items, revenue recognition, allowance for doubtful accounts, income tax provisions, excess and obsolete inventory reserve and impairment of intellectual property. Actual results could differ from those estimates.
Cash
The Company considers all highly liquid debt instruments and other short-term investments with maturity of three months or less, when purchased, to be cash equivalents. At December 31, 2018 and 2017, the Company had no cash equivalents.
Accounts Receivable
Trade accounts receivable are stated at the amount the Company expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. At December 31, 2018 and 2017, the allowance for doubtful accounts was zero.
Inventory
Inventories are stated at the lower of cost (first-in, first-out basis) or net realizable value. Inventories are periodically evaluated to identify obsolete or otherwise impaired products and are written off when management determines usage is not probable. The Company estimates the balance of excess and obsolete inventory by analyzing inventory by age using last used and original purchase date and existing sales pipeline for which the inventory could be used. There was a minimal valuation allowance recorded as of December 31, 2018 and 2017.
Property and Equipment
Property and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings. For consolidated financial statement purposes, equipment is recorded at cost and depreciated using the straight-line method over their estimated useful lives of 2 to 5 years. Leasehold improvements are recorded at cost and depreciated using the straight-line method over the life of the lease.
Expenditures for repairs and maintenance which do not materially extend the useful lives of property and equipment are charged to operations. Management reviews the carrying value of its property and equipment for impairment on an annual basis.
Intellectual Property
Intellectual is recorded at cost and amortized over its estimated useful life of 15 years. Management reviews intellectual property for impairment when events or changes in circumstances indicate the carrying amount of an asset or asset group may not be recoverable. In the event that impairment indicators exist, a further analysis is performed and if the sum of the expected undiscounted future cash flows resulting from the use of the asset or asset group is less than the carrying amount of the asset or asset group, an impairment loss equal to the excess of the asset or asset group's carrying value over its fair value is recorded. Management considers historical experience and all available information at the time the estimates of future cash flows are made, however, the actual cash values that could be realized may differ from those that are estimated.
Recoverability of Long-Lived and Intangible Assets
Long-lived assets and certain identifiable intangibles held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of the long-lived and or intangible assets would be adjusted, based on estimates of future discounted cash flows. The Company evaluated the recoverability of the carrying value of the Company’s equipment. No impairment charges were recognized for the years ended December 31, 2018 and 2017, respectively.
Stock-Based Compensation
The Company accounts for stock-based compensation awards in accordance with the provisions of ASC 718,
Compensation-Stock Compensation
(“ASC 718”), which requires equity-based compensation, be reflected in the consolidated financial statements over the period of service which is typically the vesting period based on the estimated fair value of the awards.
Fair Value of Financial Instruments
The fair value hierarchy has three levels based on the inputs used to determine fair value, which are as follows:
|
·
|
Level 1
- Unadjusted quoted prices available in active markets for the identical assets or liabilities at the measurement date.
|
|
·
|
Level 2
- Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
|
|
·
|
Level 3 -
Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
|
The fair value hierarchy requires the use of observable market data when available. In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
Cash was the only asset measured at fair value on a recurring basis by the Company at December 31, 2018 and December 31, 2017 and is considered to be Level 1.
Financial instruments include cash, accounts receivable, accounts payable, accrued expenses, deferred revenue, customer credits and short-term debt. The carrying amounts of these financial instruments approximated fair value at December 31, 2018 and 2017 due to their short-term maturities.
The fair value of the promissory notes payable at December 31, 2018 and 2017 approximated the carrying amount as the notes were issued during the years ended December 31, 2018 and 2017 at interest rates prevailing in the market and interest rates have not significantly changed as of December 31, 2018. The fair value of the promissory notes payable was determined on a Level 2 measurement. Discounts on issued debt, as well as debt issuance costs, are amortized over the term of the individual promissory notes.
The following tables present the Company’s assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
|
|
|
|
|
Fair Value Measurement as of December 31, 2018
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
584,877
|
|
|
|
584,877
|
|
|
-
|
|
|
|
-
|
|
Total Assets
|
|
$
|
584,877
|
|
|
$
|
584,877
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Promissory notes
|
|
|
13,814,208
|
|
|
|
-
|
|
|
|
13,814,208
|
|
|
|
-
|
|
Total Libilities
|
|
$
|
13,814,208
|
|
|
$
|
-
|
|
|
$
|
13,814,208
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement as of December 31, 2017
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
2,418,427
|
|
|
|
2,418,427
|
|
|
|
-
|
|
|
|
-
|
|
Total Assets
|
|
$
|
2,418,427
|
|
|
$
|
2,418,427
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Promissory notes
|
|
|
13,694,778
|
|
|
|
-
|
|
|
|
13,694,778
|
|
|
|
-
|
|
Total Libilities
|
|
$
|
13,694,778
|
|
|
$
|
-
|
|
|
$
|
13,694,778
|
|
|
$
|
-
|
|
Foreign Currency Transactions
The Company's functional currency is the United States Dollar (the "U.S. Dollar"). Transactions denominated in currencies other than the U.S. Dollar are re-measured to the U.S. Dollar at the period-end exchange rates. Any associated transactional currency re-measurement gains and losses are recognized in current operations. At both December 31, 2018 and 2017, there were no material gains or losses recognized.
Revenue Recognition
For the year ended December 31, 2018, the Company records revenue in accordance with ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
Revenue is recognized when the Company satisfies its performance obligation under the contract by transferring the promised product to its customer that obtains control of the product. A performance obligation is a promise in a contract to transfer a distinct product to a customer. Most of the Company’s contracts have a single performance obligation, as the promise to transfer products or services is not separately identifiable from other promises in the contract and, therefore, not distinct.
Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products. As such, revenue is recorded net of returns, allowances, customer discounts, and incentives. Sales and other taxes are excluded from revenues. Invoiced shipping and handling costs are included in revenue. The adoption of this standard did not have a material impact on the Company’s financial statements.
For the year ended December 31, 2017, the Company recorded revenue from sales in accordance with ASC 605,
Revenue Recognition
(“ASC 605”). The criteria for recognition are as follows:
1. Persuasive evidence of an arrangement exists;
2. Delivery has occurred or services have been rendered;
3. The seller’s price to the buyer is fixed or determinable; and
4. Collectability is reasonably assured.
Determination of criteria (3) and (4) was based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments were provided for in the same period the related sales are recorded.
Disaggregation of Revenue
The Company generated revenue for the years ended December 31, 2018 and 2017 by (i) delivering product to its commercial customers, (ii) completing and commissioning equipment projects at commercial customer sites and (iii) performing demonstrations of its technology at customers with the intent of entering into long term supply agreements based on the performance of the Company’s products during the demonstrations.
Revenue for product sales is recognized at the point of time in which the customer obtains control of the product, at the time title passes to the customer upon shipment or delivery of the product based on the applicable shipping terms.
Revenue for equipment sales is recognized upon commissioning and customer acceptance of the installed equipment per the terms of the purchase contract.
Revenue for demonstrations and consulting services is recognized when performance obligations contained in the contract have been completed, typically the completion of necessary field work and the delivery of any required analysis per the terms of the agreement.
Customer Acquisition Costs
Customer acquisition costs are amortized on a straight-line bases over the life of the initial customer contract. The capitalized balance of customer acquisition costs was $34,467 and $172,333 on December 31, 2018 and December 31, 2017, respectively. Amortization expense for the years ended December 31, 2018 and 2017 was $137,866 and $469,870, respectively and included in cost of sales.
Deferred Revenue
Revenue is recognized in the period that delivery is made and performance obligations are met. In accordance with the terms of an agreement with one customer, the Company allocated a fixed amount of payments made against the total deliveries of product made during the contract period. Due to this agreement $517,060 was deferred as of December 31, 2017 and was recognized in 2018 when product was delivered to the customer
.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carryforwards, 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s consolidated financial statements are based on a more-likely-than-not recognition threshold. The Company did not have any unrecognized tax benefits at December 31, 2018 or 2017. When necessary, the Company would accrue penalties and interest related to unrecognized tax benefits as a component of income tax expense.
The Company and its subsidiaries file a consolidated income tax return in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. federal examinations for years prior to 2015 or state tax examinations for years prior to 2014.
Basic and Diluted Loss Per Common Share
Basic net loss per common share is computed using the weighted average number of common shares outstanding. Diluted loss per share reflects the potential dilution from common stock equivalents, such as stock issuable pursuant to the exercise of stock options and warrants. There were no dilutive potential common shares as of December 31, 2018 or 2017, because the Company incurred net losses and basic and diluted losses per common share are the same. The following common stock equivalents were excluded from the computation of diluted net loss per share of common stock because they were anti-dilutive. The exercise of these common stock equivalents would dilute earnings per share if the Company becomes profitable in the future.
|
|
December 31
|
|
|
December 31
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Stock Options
|
|
|
9,161,510
|
|
|
|
8,463,184
|
|
Warrants
|
|
|
4,105,398
|
|
|
|
7,237,763
|
|
Convertible debt
|
|
|
3,700,000
|
|
|
|
3,100,000
|
|
Total common stock equivalents excluded from diluted net loss per share
|
|
|
16,966,908
|
|
|
|
18,800,947
|
|
Concentration of Credit Risk
Financial instruments that subject the Company to credit risk consist of cash and equivalents on deposit with financial institutions and accounts receivable. The Company’s cash as of December 31, 2018 is maintained at high-quality financial institutions and has not incurred any losses to date.
Customer and Supplier Concentration
For each of the years ended December 31, 2018 and 2017, 100% of the Company’s revenue related to eight customers. At December 31, 2018 and 2017, 100% of the Company’s accounts receivable related to seven and six customers, respectively.
For each of the years ended December 31, 2018 and 2017, 52% and 65% of the Company’s purchases related to two suppliers, respectively. At December 31, 2018 and 2017, 72% and 53% of the Company’s accounts payable and accrued expenses related to two vendors, respectively. The Company believes there are numerous other suppliers that could be substituted should the supplier become unavailable or non-competitive.
Contingencies
Certain conditions may exist which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company, or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed unless they arise from guarantees, in which case the guarantees would be disclosed.
Recently Adopted Accounting Standards
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. ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings.
The guidance in ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, and the guidance is to be applied using a full or modified retrospective approach. The Company early adopted ASU 2017-11 and changed its method of accounting for certain warrants that were initially recorded as liabilities during the year ended December 31, 2014 on a full retrospective basis.
Recently Issued Accounting Standards
In February 2016, the FASB issued ASU No. 2016-02 (“ASU 2016-02”), “Leases (Topic 842).” ASU 2016-02 requires lessees to recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. In July 2018, the FASB issued ASU No. 2018-10, “Codification Improvements to Topic 842, Leases,” to clarify how to apply certain aspects of the new leases standard. In July 2018, the FASB also issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements,” which provides a transition option to not apply the new leases standard to comparative periods presented in a company’s financial statements in the year of adoption. Under this option, a cumulative-effect adjustment to the opening balance of retained earnings would be recorded on the date of adoption.
ASU 2016-02 will be effective for the Company beginning on January 1, 2019. We expect that this standard will have a material effect on our financial statements. While we continue to assess all of the effects of adoption, we currently believe the most significant effects relate to the recognition of new right-of-use assets and lease liabilities on our balance sheet for leases of trailers used in the delivery of our products. We do not expect this standard to have a material impact on the statement of operations or statement of cash flows. We do not expect a significant change in our leasing activities between now and adoption. On adoption, we currently expect to recognize additional operating liabilities of approximately $1,353,000 with corresponding right-of-use assets of the same amount based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases. The new standard also provides practical expedients for an entity's ongoing accounting. We currently expect to elect the short-term lease recognition exemption for all leases that qualify. This means, for those leases that qualify, we will not recognize right-of-use assets or lease liabilities, and this includes not recognizing right-of-use assets or lease liabilities for existing short-term leases of those assets in transitions. We also currently expect to elect the practical expedient to not separate lease and non-lease components for all of our leases.
In June 2018, the FASB issued ASU No. 2018-07, “Compensation - Stock Compensation (Topic 718)” (“ASU 2018-07”). ASU 2018-07 is intended to reduce cost and complexity and to improve financial reporting for nonemployee share based payments. Currently, the accounting requirements for nonemployee and employee share-based payment transactions are significantly different. ASU 2018-07 expands the scope of Topic 718, Compensation - Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity - Equity-Based Payments to Nonemployees. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and including interim periods within that fiscal year. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The Company is currently evaluating ASU 2018-07 and its impact on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). The amendments in ASU 2018-13 modify the disclosure requirements associated with fair value measurements based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments are effective for all entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating ASU 2018-13 and its impact on its consolidated financial statements.
Note 3 - Liquidity and Financial Condition
Under ASU 2014-15 Presentation of Financial Statements-Going Concern (Subtopic 205-40) (“ASC 205-40”), the Company has the responsibility to evaluate whether conditions and/or events raise substantial doubt about its ability to meet its future financial obligations as they become due within one year after the date that the financial statements are issued. As required by ASC 205-40, this evaluation shall initially not take into consideration the potential mitigating effects of plans that have not been fully implemented as of the date the financial statements are issued. Management has assessed the Company’s ability to continue as a going concern in accordance with the requirement of ASC 205-40.
As reflected in the consolidated financial statements, the Company had $585,000 in cash on its balance sheet at December 31, 2018. The Company had working capital of $132,000 and an accumulated deficit $51.5 million. Additionally, the Company had a loss from operations in the amount of $2.8 million and cash used in operating activities of $1.1 million for the year ended December 31, 2018.
The accompanying consolidated financial statements as of December 31, 2018 have been prepared assuming the Company will continue as a going concern. During 2018, the Company restructured convertible notes totaling $560,000 into new loans that mature in 2023. In February 2019, the Company completed the restructuring of its unsecured and secured debt obligations held by its largest promissory noteholder, extending the maturity dates of these debts and the remaining convertible notes until 2022 and eliminating quarterly principal payment requirements. Based on the extended maturities the Company negotiated with its note holders, historical sales and gross margin trends with its current customers under contract and the incremental sales and gross margin from the newly announced customer contracts, management believes substantial doubt regarding the Company’s ability to continue as a going concern has been mitigated. The Company believes it will have sufficient working capital to fund operations for at least the next twelve months from the date of issuance of these financial statements.
Note 4 - Inventory
The Company held product supply inventory valued at $306,651 and $375,882, raw materials inventory valued at $87,730 and $154,952 and equipment and parts inventory valued at $113,035 and $128,744 as of December 31, 2018 and December 31, 2017, respectively.
Note 5 - Property and Equipment, Net
Property and equipment at December 31, 2018 and 2017 are as follows:
|
|
December 31
|
|
|
December 31
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Equipment
|
|
$
|
1,965,659
|
|
|
$
|
1,965,659
|
|
Trucking equipment
|
|
|
983,948
|
|
|
|
1,010,961
|
|
Office equipment
|
|
|
27,155
|
|
|
|
27,155
|
|
Computer equipment and software
|
|
|
117,212
|
|
|
|
117,212
|
|
Total equipment
|
|
|
3,093,974
|
|
|
|
3,120,987
|
|
|
|
|
|
|
|
|
|
|
Less: accumulated depreciation
|
|
|
(2,503,990
|
)
|
|
|
(2,067,786
|
)
|
Total equipment in use, net
|
|
|
589,984
|
|
|
|
1,053,201
|
|
|
|
|
|
|
|
|
|
|
Construction in process
|
|
|
1,807,707
|
|
|
|
1,675,792
|
|
Property and equipment, net
|
|
$
|
2,397,691
|
|
|
$
|
2,728,993
|
|
During the years ended December 31, 2018 and 2017, depreciation expense charged to operations was $456,914 and $748,020, respectively.
Note 6 - Intellectual Property
On January 15, 2009, the Company entered into an "Exclusive Patent and Know-How License Agreement Including Transfer of Ownership" with the Energy and Environmental Research Center Foundation, a non-profit entity (“EERCF”). Under the terms of the Agreement, the Company has been granted an exclusive license by EERCF for the technology to develop, make, have made, use, sell, offer to sell, lease, and import the technology in any coal-fired combustion systems (power plant) worldwide and to develop and perform the technology in any coal-fired power plant in the world.
On April 24, 2017, the Company closed on the acquisition from EERCF of all patent rights, including all patents and patents pending, domestic and foreign, relating to the foregoing technology. A total of 42 domestic and foreign patents and patent applications were included in the acquisition. In accordance with the terms of the License Agreement, the patent rights were acquired for the purchase price of (i) $2,500,000 in cash, and (ii) 925,000 shares of common stock of which 628,998 shares were issued to EERCF and 296,002 were issued to the inventors who had been designated by EERCF. The shares issued were valued at $518,000 ($0.56 per share), representing the value as of the closing date.
Patent costs capitalized as of December 31, 2018 and 2017 are as follows:
|
|
December 31
|
|
|
December 31
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Patents
|
|
$
|
3,068,995
|
|
|
$
|
3,068,995
|
|
Less: Accumulated Amortization
|
|
|
(335,333
|
)
|
|
|
(134,133
|
)
|
License, Net
|
|
$
|
2,733,662
|
|
|
$
|
2,934,862
|
|
Amortization expense for the years ended December 31, 2018 and 2017 was $201,200 and $136,083, respectively. Estimated annual amortization for each of the next five years is approximately $201,200.
Note 7 - Notes Payable
The Company has the following notes payable outstanding as of December 31:
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured convertible promissory notes which mature upon the retirement of the New AC Midwest Secured Debt, bear interest at 10% per annum, and are convertible into one share of common stock, par value $0.001 per share.
|
|
$
|
990,000
|
|
|
$
|
1,550,000
|
|
|
|
|
|
|
|
|
|
|
Secured promissory note which matures on August 25, 2022 and bears interest at 12% per annum.
|
|
|
271,686
|
|
|
|
1,146,686
|
|
|
|
|
|
|
|
|
|
|
Unsecured promissory note which matures on December 15, 2020, and bears interest at LIBOR + 500 per annum.
|
|
|
13,000,000
|
|
|
|
13,000,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible promissory notes which mature on June 15, 2023, bear interest at 12% per annum, and are convertible into one share of common stock, par value $0.001 per share.
|
|
$
|
860,000
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Total convertible notes payable before discount
|
|
|
15,121,686
|
|
|
|
15,696,686
|
|
|
|
|
|
|
|
|
|
|
Less discounts
|
|
|
(1,249,620
|
)
|
|
|
(1,841,867
|
)
|
Less debt issuance costs
|
|
|
(57,858
|
)
|
|
|
(160,041
|
)
|
|
|
|
|
|
|
|
|
|
Total notes payable
|
|
|
13,814,208
|
|
|
|
13,694,778
|
|
|
|
|
|
|
|
|
|
|
Less current portion
|
|
|
-
|
|
|
|
4,050,000
|
|
|
|
|
|
|
|
|
|
|
Notes payable, net of current portion
|
|
$
|
13,814,208
|
|
|
$
|
9,644,778
|
|
As of December 31, 2018, scheduled principal payments due on convertible notes payable are as follows:
Twelve months ended December 31,
|
|
|
|
2019
|
|
$
|
-
|
|
2020
|
|
|
13,000,000
|
|
2021
|
|
|
-
|
|
2022
|
|
|
1,261,686
|
|
2023
|
|
|
860,000
|
|
|
|
$
|
15,121,686
|
|
As of December 31, 2018, future amortization of discounts and debt issuance costs are as follows:
Twelve months ended December 31,
|
|
Discounts
|
|
|
Debt issuance
costs
|
|
2019
|
|
$
|
612,690
|
|
|
$
|
31,559
|
|
2020
|
|
|
586,692
|
|
|
|
26,299
|
|
2021
|
|
|
19,596
|
|
|
|
-
|
|
2022
|
|
|
19,596
|
|
|
|
-
|
|
2023
|
|
|
11,046
|
|
|
|
-
|
|
|
|
$
|
1,249,620
|
|
|
$
|
57,858
|
|
From July 30, 2013 through December 24, 2013, the Company sold convertible notes and warrants to unaffiliated accredited investors totaling $1,902,500. The notes bear interest at 10% per annum, are secured by the Company’s assets, and are convertible into one share of common stock, par value $0.001 per share, with the initial conversion ratio equal to $0.50 per share. The notes had an initial term of three years, but the maturity of the notes was extended during 2014 to match the retirement of the New AC Midwest Secured Debt. These securities were sold in reliance upon the exemption provided by Section 4(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act. Interest expense for the years ended December 31, 2018 and 2017, was $124,967 and $155,618, respectively. A discount on the notes payable of $841,342 was recorded based on the value of the warrants issued using a Black-Scholes options pricing model and was amortized over the initial five year life of the notes. Amortized interest expense for the years ended December 31, 2018 and 2017 on this discount was $74,447 and $152,558, respectively. As of December 31, 2018 and 2017, total principal of $990,000 and $1,550,000, respectively, was outstanding on these notes.
On June 15, 2018, the Company issued 2018 Unsecured Notes totaling $560,000 and warrants to certain holders of the 2013 Notes in exchange for their secured 2013 Notes (see description above of the private placement offering commenced during the second quarter of 2018). The 2018 Unsecured Notes have a term of five years, bear interest at 12% per annum, and are convertible into one share of common stock, par value $0.001 per share, with the initial conversion ratio equal to $0.50 per share. For each dollar exchanged, the investor received a warrant to purchase one share of common stock of the Company at an exercise price of $0.70 per share. The 2018 Unsecured Notes may be converted at any time and from time to time in whole or in part prior to the maturity date thereof. Loss on this debt exchange was $44,036. A discount on the notes payable of $89,500 was recorded based on the value of the fair value of the note and warrants exchanged. The included warrants were valued using a Black-Scholes options pricing model. From August 31, 2018 through October 30, 2018, the Company issued additional 2018 Notes totaling $300,000 and warrants to unaffiliated accredited investors. A discount on the notes payable of $40,350 was recorded based on the fair value of the warrants issued with this note using a Black-Scholes options pricing model. Amortized interest expense for the years ended December 31, 2018 and 2017 on these discounts was $8,700 and $0, respectively. These securities were issued in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act as well as under Section 3(a)(9) under the Securities Act. Interest expense for the years ended December 31, 2018 and 2017, was $46,587 and $0, respectively. As of December 31, 2018 and 2017, total principal of $860,000 and $0 was outstanding on the 2018 Unsecured Notes. The significant assumptions utilized for these Black Scholes calculations consist of an expected life of equal to the expiration term of the option, historical volatility of 100% respectively, and a risk free interest rate of 3%.
New AC Midwest Secured Note
The New AC Midwest Secured Note, which will mature on August 25, 2022 and is guaranteed by MES, is non-convertible and bears interest at a rate of 15.0% per annum, payable quarterly in arrears on or before the last day of each fiscal quarter. The New AC Midwest Secured Note is secured by all of the assets of the Companies. Interest expense for the years ended December 31, 2018 and 2017 was $66,694 and $267,847, respectively. As of December 31, 2018 and 2017, total principal of $271,686 and $1,146,686, respectively, was outstanding on this note. On February 25 2019, per Amendment No. 3 (“Amendment No. 3”) to the Amended and Restate Financing Agreement (See Note 13), AC Midwest agreed to waive of compliance with a certain financial covenants of the Restated Financing Agreement and strike this covenant in its entirety as of the effective date of the amendment. Also, pursuant to Amendment No. 3, the parties agreed that the maturity date for the remaining principal balance due under the AC Midwest Secured Note would be extended from December 15, 2018 to August 25, 2022.
AC Midwest Subordinated Note
The AC Midwest Subordinated Note, which will mature on December 15, 2020 and is guaranteed by MES, is non-convertible and bears interest equal to the three-month LIBOR rate plus 5.0% per annum, payable quarterly on or before the last day of each fiscal quarter beginning December 31, 2017. The interest rate shall be subject to adjustment each quarter based on the then current LIBOR rate. Commencing on June 15, 2017 and continuing on each September 15, December 15, March 15 and June 15 thereafter, the Company pays principal on the AC Midwest Subordinated Note in equal installments of (i) $500,000 per quarter for the 2017 calendar year, (ii) $625,000 per quarter for the 2018 calendar year, and (iii) thereafter $750,000 per quarter, with a final payment of all outstanding principal together with such other amounts as shall then be due and owing from the Company to AC Midwest on the maturity date. Notwithstanding the foregoing, until the New AC Midwest Secured Note is paid in full, AC Midwest will not be entitled to receive any payment on account of the AC Midwest Subordinated Note (other than regularly scheduled interest payments). Interest expense for the years ended December 31, 2018 and 2017 was $942,319 and $818,357, respectively. As of December 31, 2018 and 2017, total principal of $13,000,000 and $13,000,000 respectively, was outstanding on this note. The Company determined that the rate of interest on the AC Midwest Subordinated Note was a below market rate of interest and determined that a discount of $2,400,000 should be recorded. This discount is based on an applicable market rate for unsecured debt for the Company of 15% and will be amortized as interested expense over the life of the loan. Amortized discount recorded as interest expense for the years ended December 31, 2018 and 2017 was $593,094 and $593,094 respectively. The AC Midwest Subordinated Note was cancelled on February 25, 2019 (see Note 13).
On January 28, 2016, the Companies entered into Amendment No. 3 to Financing Agreement and Reaffirmation of Guaranty (the "Third Amended Financing Agreement") with AC Midwest Energy LLC (the “Lender”), pursuant to which Lender agreed to cause its bank to arrange for the issuance to a certain customer of the Company a standby letter of credit in the amount of $2,000,000 (the "Letter of Credit") to permit the Company to enter into a contract for mercury capture program with such customer. The Letter of Credit is to guarantee the Company's performance under its contract with such customer. Under the Third Amended Financing Agreement, and in consideration for the issuance of the Letter of Credit for the benefit of the Company, the Company shall pay AC Midwest a fee equal to 12.0% per annum of the amount available to be drawn under the Letter of Credit payable on the last day of each calendar month. No amounts were drawn on this letter of credit, which was terminated as of December 31, 2018. Fee expense for the years ended December 31, 2018 and 2017 was $29,000 and $219,333, respectively.
Note 8 - Equipment Notes Payable
The Company has retail installment purchase contracts on equipment outstanding of $167,650 and $228,826 as of December 31, 2018 and 2017, respectively. These loans bear interest rates ranging from 4.22% to 5.62% and mature through 2022.
As of December 31, 2018, scheduled principal payments due on convertible notes payable are as follows:
For the year ended December 31,
|
|
|
|
2019
|
|
|
63,424
|
|
2020
|
|
|
63,281
|
|
2021
|
|
|
36,146
|
|
2022
|
|
|
4,799
|
|
|
|
$
|
167,650
|
|
Note 9 - Commitments and Contingencies
Property Leases
On January 27, 2015, the Company entered into a lease for office space in Lewis Center, Ohio, commencing February 1, 2015 which lease as amended expires in February 2020. The lease provides for the option to extend the lease for up to five additional years. Monthly rent was $1,463 during 2018 and currently is $1,575 through February 2020.
On July 1, 2015, the Company entered into a five year lease for warehouse space in Corsicana, Texas. Rent is $3,750 monthly throughout the term of the lease. The Company is also responsible for the pro rata share of the projected monthly expenses for the property taxes. The current pro rata share is $882.
On September 1, 2015, the Company entered into a three year lease for office space in Grand Forks, North Dakota. Rent was $3,500 monthly for the first year and decreased to $2,500 through August 31, 2018.
On September 1, 2018, the Company entered into a one year lease for office space in Grand Forks, North Dakota. Monthly rent is $575 a month through August 2019.
Future minimum lease payments under these non-cancelable leases are approximately as follows:
For the Year Ended December 31
|
|
|
|
2019
|
|
|
68,275
|
|
2020
|
|
|
25,650
|
|
|
|
$
|
93,925
|
|
Rent expense was approximately $96,000 and $130,000 for the years ended December 31, 2018 and 2017, respectively.
Operating Leases
In 2016, the Company entered into a six year agreement to lease trailers used in the delivery of its products. Monthly payments currently total $32,820.
Future minimum lease payments under these leases are approximately as follows:
For the Year Ended December 31
|
|
|
|
2019
|
|
|
393,840
|
|
2020
|
|
|
393,840
|
|
2021
|
|
|
393,840
|
|
2022
|
|
|
306,100
|
|
|
|
$
|
1,487,620
|
|
Trailer rent expense recorded in cost of sales associated with this agreement was $394,000 and $394,000 for the years ended December 31, 2018 and 2017.
Fixed Price Contract
The Company’s multi-year contracts with its commercial customers contain fixed prices for product. These contracts expire through 2019 and expose the Company to the potential risks associated with rising material costs during that same period. Revenue reported during interim periods were recorded based on the facts and circumstances at the time and any differences noted when the final revenue is determined is considered to be a change in estimate for the period.
Legal proceedings
The Company is involved in various claims and legal proceedings arising from the normal course of business. While the ultimate liability, if any, from these proceedings is presently indeterminable, in the opinion of management, these matters should not have a material adverse effect on the Company’s consolidated financial statements.
Note 10 - Equity
The Company was established with two classes of stock, common stock - 150,000,000 shares authorized at a par value of $0.001 and preferred stock - 2,000,000 shares authorized at a par value of $0.001.
The Company is authorized to issue up to 2,000,000 shares of "blank check" preferred stock at a par value of $0.001 which may be issued from time to time in one or more classes and in one or more series within a class upon authorization by our Board of Directors. The Board of Directors, without further approval of the shareholders, is authorized to fix the preferences, limitations and relative rights of the shares of each class or series within a class. The issuance of preferred stock could adversely affect the voting power, conversion or other rights of holders of common stock. Preferred stock could be issued quickly with terms calculated to delay or prevent a change in control of the Company or make removal of management more difficult. Additionally, the issuance of preferred stock may have the effect of decreasing the market price of our common stock.
Common Stock
From January 13, 2017 to May 3, 2017, the Company issued 630,214 shares of common stock upon the cashless exercise of warrants to purchase 901,280 shares of common stock for $0.35 per share based on a market values from $1.18 to $1.33 per share as determined under the terms of the warrants.
On March 30, 2017, the Company issued 51,236 shares of common stock upon the conversion of a note with principal and accrued interest totaling $25,618, that bears interest at 10% per annum, and was convertible into one share of common stock, par value $0.001 per share, with a conversion ratio equal to $0.50 per share.
On April 24, 2017, the Company issued 925,000 shares of common stock in connection with the closing on the acquisition of certain patent rights from Energy & Environmental Research Center Foundation (“EERCF”) for the purchase price of $2,500,000 paid to EERCF in cash, 628,998 shares of common stock to EERCF and 296,002 shares to inventors designated by EERCF. The shares issued were valued at $0.56 per share, representing the value as of the closing date.
On May 16, 2017, the Company issued 130,000 shares of common stock pursuant to a Settlement Agreement with two unrelated third parties which shares were valued at $0.47 per share based on the market value as of May 16, 2017.
Pursuant to the terms of a consulting agreement entered into on July 31, 2017, effective as of July 1, 2017, the Company issued 1,000,000 shares of common stock to Dathna Partners, LLC which shall be earned in the following manner: 250,000 shares will be earned by the consultant and deemed immediately vested on the effective date, and the remaining 750,000 shares will be earned by the consultant and deemed vested, in 12 equal monthly installments of 62,500 shares beginning on July 31, 2017 and monthly thereafter until June 30, 2018. The shares issued were valued at $0.37 per share, representing the value as of the issuance date. Compensation expense for the years ended December 31, 2018 and 2017 on the issued shares was $138,750 and $231,250, respectively.
Note 11 - Stock Based Compensation
Effective July 20, 2005, the Board of Directors of the Company approved the 2005 Stock Option and Restricted Stock Plan (the “
2005 Plan
”). The 2005 Plan reserves approximately 136,364 post Reverse Stock Split shares of common stock for grants of incentive stock options, nonqualified stock options, warrants and restricted stock awards to employees, non-employee directors and consultants performing services for the Company. Options and warrants granted under the 2005 Plan have an exercise price equal to or greater than the fair market value of the underlying common stock at the date of grant and become exercisable based on a vesting schedule determined at the date of grant. The options expire 10 years from the date of grant whereas warrants generally expire 5 years from the date of grant. Restricted stock awards granted under the 2005 Plan are subject to a vesting period determined at the date of grant.
On May 6, 2009, the Board of Directors adopted, subject to stockholder approval, which was obtained at the annual stockholders meeting held on June 19, 2009, an amendment to the 2005 Plan that increased the number of shares subject to the Stock Plan. The total number of shares subject to the Stock Plan was revised to 454,545 shares by the Reverse Stock Split. On October 9, 2014, the Board of Directors terminated this plan upon the approving an amendment to the 2014 Equity Incentive Plan.
On January 10, 2014, the Board of Directors of the Company approved and adopted, subject to stockholder approval, which was obtained at the annual stockholders meeting held on November 16, 2014, the Midwest Energy Emissions Corp. 2014 Equity Incentive Plan (the “2014 Equity Plan”). The number of shares of the Company’s Common Stock that may be issued under the 2014 Equity Plan is 2,500,000 shares, subject to the adjustment for stock dividends, stock splits, recapitalizations and similar corporate events. Eligible participants under the 2014 Equity Plan shall include officers, employees of or consultants to the Company or any of its subsidiaries, or any person to whom an offer of employment is extended, or any person who is a non-employee director of the Company. On October 9, 2014, the Board of Directors approved and adopted the First Amendment to the plan, subject to stockholder approval, which was obtained at the annual stockholders meeting held on November 18, 2014, which increased the number of shares issuable under the plan to 7,500,000.
On February 9, 2017, the Board of Directors of the Company adopted the Midwest Energy Emissions Corp. 2017 Equity Incentive Plan (the “2017 Equity Plan”), which was approved by stockholders at the annual stockholders meeting held on June 6, 2017. The 2017 Equity Plan provides for the grant of incentive stock options (subject to applicable stockholder approval), nonqualified stock options, restricted stock awards, stock appreciation rights, restricted share units, performance awards and other type of awards described therein. Eligible recipients under the 2017 Equity Plan include the Company’s officers, directors, employees and consultants of the Company or one of its subsidiaries. The maximum number of shares of common stock that may be issued under the 2017 Equity Plan is 8,000,000. The 2017 Equity Plan will be administered by the Board or one or more committees appointed by the Board. The 2017 Equity Plan replaces the 2014 Equity Plan which was terminated by the Board of Directors on April 28, 2017.
The Company accounts for stock-based compensation awards in accordance with the provisions of ASC 718, which addresses the accounting for employee stock options which requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the consolidated financial statements over the vesting period based on the estimated fair value of the awards.
A summary of stock option activity for the years ended December 31, 2018 and 2017 is presented below:
|
|
Number of
Shares
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Life (years)
|
|
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
|
7,550,457
|
|
|
|
1.29
|
|
|
|
3.2
|
|
|
|
-
|
|
Grants
|
|
|
1,615,000
|
|
|
|
0.98
|
|
|
|
4.8
|
|
|
|
-
|
|
Expirations
|
|
|
(577,273
|
)
|
|
|
1.02
|
|
|
|
-
|
|
|
|
-
|
|
Cancellations
|
|
|
(125,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
December 31, 2017
|
|
|
8,463,184
|
|
|
|
1.26
|
|
|
|
3.0
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grants
|
|
|
1,423,326
|
|
|
|
0.26
|
|
|
|
4.4
|
|
|
|
-
|
|
Expirations
|
|
|
(725,000
|
)
|
|
|
0.69
|
|
|
|
-
|
|
|
|
-
|
|
December 31, 2018
|
|
|
9,161,510
|
|
|
|
1.15
|
|
|
|
2.0
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
7,688,184
|
|
|
|
1.27
|
|
|
|
3.0
|
|
|
|
|
|
December 31, 2018
|
|
|
9,161,510
|
|
|
|
1.15
|
|
|
|
2.0
|
|
|
|
|
|
The Company utilized the Black-Scholes options pricing model. The significant assumptions utilized during the years ended December 31, 2018 and 2017 for the Black Scholes calculations consist of an expected life of equal to the expiration term of the option, historical volatility of 100% and 74.9%, respectively, and a risk free interest rate of 3% and 3%, respectively. No adjustment to compensation expense is recorded for vested options that are forfeited.
On February 1, 2017, the Company issued nonqualified stock options to acquire a total of 250,000 shares under the Company’s 2014 Equity Plan. Options to acquire a total of 100,000 of such shares have expired or been cancelled. The options granted are exercisable at $1.20 per share, representing the fair market value of the common stock as of the date of the grant as determined under the 2014 Equity Plan. The options are fully vested and exercisable as of the date of grant and will expire five years thereafter. Based on a Black-Scholes valuation model, these options were valued at $233,817 in accordance with FASB ASC Topic 718.
During 2017, the Company issued nonqualified stock options to acquire 1,365,000 shares under the Company’s 2017 Equity Plan. Options to acquire a total of 250,000 of such shares have expired or been cancelled. The options granted are exercisable at prices ranging from $0.24 to $1.15 per share, representing the fair market value of the common stock as of the date of the grant as determined under the 2017 Equity Plan. The options are fully vested and exercisable as of the date of grant and will expire five year thereafter. Based on a Black-Scholes valuation model, these options were valued at $1,062,014 in accordance with FASB ASC Topic 718.
During 2018, the Company issued nonqualified stock options to acquire 1,423,236 shares under the Company’s 2017 Equity Plan. The options granted are exercisable at prices ranging from $0.17 to $0.33 per share, representing the fair market value of the common stock as of the date of the grant as determined under the 2017 Equity Plan. The options are fully vested and exercisable as of the date of grant and will expire five year thereafter. Based on a Black-Scholes valuation model, these options were valued at $272,620 in accordance with FASB ASC Topic 718.
On February 5, 2018, the Company released the restriction on stock options to acquire 750,000 shares of the Company’s common stock issued to Rick MacPherson on August 31, 2016 making them now fully vested and exercisable. Based on a Black-Scholes valuation model, these options were valued at $76,543 in accordance with FASB ASC Topic 718.
Note 12 - Warrants
Unless sold and issued warrants are subject to the provisions of FASB ASC 815-10, the Company utilized a Black-Scholes options pricing model to value the warrants sold and issued. This model requires the input of highly subjective assumptions such as the expected stock price volatility and the expected period until the warrants are exercised. When calculating the value of warrants issued, the Company uses a volatility factor of 100%, a risk free interest rate and the life of the warrant for the exercise period.
On June 15, 2018, the Company issued unsecured convertible notes and warrants to unaffiliated accredited investors totaling $560,000 in exchange for outstanding secured convertible notes payable. The notes are convertible into one share of common stock, with the initial conversion ratio equal to $0.50 per share. The investors received a total of 560,000 warrants to purchase one shares of common stock with an exercise price of $0.70 per share. These securities were sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act, as well as under Section 3(a)(9) under the Securities Act. Using a Black-Scholes Valuation model these warrants had a value of $89,450 which was recorded as a discount on the notes payable and will be amortized over the life of the associated notes payable.
On August 31, 2018, the Company issued unsecured convertible notes and warrants to unaffiliated accredited investors totaling $200,000. The notes are convertible into one share of common stock, with the initial conversion ratio equal to $0.50 per share. The investors received a total of 200,000 warrants to purchase one shares of common stock with an exercise price of $0.70 per share. These securities were sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act. Using a Black-Scholes Valuation model these warrants had a value of $28,900 which was recorded as a discount on the notes payable and will be amortized over the life of the associated notes payable.
On October 31, 2018, the Company issued unsecured convertible notes and warrants to unaffiliated accredited investors totaling $100,000. The notes are convertible into one share of common stock, with the initial conversion ratio equal to $0.50 per share. The investors received a total of 100,000 warrants to purchase one shares of common stock with an exercise price of $0.70 per share. These securities were sold in reliance upon the exemption provided by Section 4(a)(2) of the Securities Act and the safe harbor of Rule 506 under Regulation D promulgated under the Securities Act. Using a Black-Scholes Valuation model these warrants had a value of $11,450 which was recorded as a discount on the notes payable and will be amortized over the life of the associated notes payable.
The following table summarizes information about common stock warrants outstanding at December 31, 2018:
Outstanding
|
|
|
Exercisable
|
|
Exercise
Price
|
|
|
Number
Outstanding
|
|
|
Weighted Average Remaining
Contractual Life
(years)
|
|
|
Weighted
Average Exercise
Price
|
|
|
Number
Exercisable
|
|
|
Weighted
Average Exercise
Price
|
|
|
0.87
|
|
|
|
1,303,300
|
|
|
|
0.36
|
|
|
|
0.87
|
|
|
|
1,303,300
|
|
|
|
0.87
|
|
|
0.70
|
|
|
|
860,000
|
|
|
|
4.55
|
|
|
|
0.65
|
|
|
|
860,000
|
|
|
|
0.65
|
|
|
0.45
|
|
|
|
150,000
|
|
|
|
1.92
|
|
|
|
0.45
|
|
|
|
150,000
|
|
|
|
0.45
|
|
|
0.35
|
|
|
|
1,792,098
|
*
|
|
|
1.53
|
|
|
|
0.35
|
|
|
|
1,792,098
|
|
|
|
0.35
|
|
$0.50 - $3.30
|
|
|
|
4,105,398
|
|
|
|
1.81
|
|
|
|
|
|
|
|
4,105,398
|
|
|
|
|
|
Note * 916,720 warrants exercisable at $0.35 contain dilution protections that increase the number of shares purchasable at exercise upon the issuance of securities at a price below the current exercise price.
Note 13 - Tax
Below is breakdown of the income tax provisions for the years ended December 31:
|
|
2018
|
|
|
2017
|
|
Current:
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
State and local
|
|
$
|
22,153
|
|
|
$
|
40,422
|
|
Total Current
|
|
|
22,153
|
|
|
|
40,422
|
|
Deferred federal income tax benefit
|
|
|
-
|
|
|
|
500,000
|
|
|
|
|
|
|
|
|
|
|
Net Provision (Benefit)
|
|
$
|
22,153
|
|
|
$
|
540,422
|
|
A reconciliation of the provision (benefit) for income taxes with amounts determined by applying the statutory U.S. federal income tax rate to income before income taxes is as follows for the years ended December 31:
|
|
2018
|
|
|
2017
|
|
Computed tax at the federal statutory rate
|
|
$
|
(1,007,000
|
)
|
|
$
|
(817,000
|
)
|
State taxes
|
|
|
22,000
|
|
|
|
14,000
|
|
Debt discounts
|
|
|
142,000
|
|
|
|
254,000
|
|
Other permanent and prior period adjustments
|
|
|
213,000
|
|
|
|
36,000
|
|
Valuation allowance
|
|
|
652,000
|
|
|
|
513,000
|
|
Income tax provisoin
|
|
$
|
22,000
|
|
|
$
|
-
|
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows at December 31:
|
|
2018
|
|
|
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
4,328,000
|
|
|
$
|
3,840,000
|
|
Stock based compensation
|
|
|
888,000
|
|
|
|
903,000
|
|
Accrued Compensation
|
|
|
115,000
|
|
|
|
-
|
|
Total deferred tax assets
|
|
|
5,331,000
|
|
|
|
4,743,000
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(51,000
|
)
|
|
|
(137,000
|
)
|
Other
|
|
|
(33,000
|
)
|
|
|
(11,000
|
)
|
Total deferred tax liabilites
|
|
|
(84,000
|
)
|
|
|
(148,000
|
)
|
|
|
|
|
|
|
|
|
|
Valuation Allowance
|
|
|
(5,247,000
|
)
|
|
|
(4,595,000
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
-
|
|
|
$
|
-
|
|
The 2017 Tax Cut and Jobs Act (“The Act”) reduces the federal statutory corporate tax rate from 34.0% to 21.0% for the Company’s tax years beginning in 2018. This resulted in the re-measurement of the federal portion of its deferred tax assets and liabilities. In 2017, this resulted in a $2.8 million reduction of net deferred tax assets which was offset by an equivalent adjustment to the valuation allowance. The Company has completed its accounting for the Act, which did not have a material impact on the financial statements.
For the years ended December 31, 2018 and 2017, the Company incurred net operating losses and, accordingly, no provision for income taxes has been recorded. In addition, a valuation allowance was recorded and no benefit for income taxes was recorded due to the uncertainty of the realization of any tax assets. The valuation allowance increased by $652,000 from December 2017 to December 31, 2018. At December 31, 2018, the Company had approximately $20,608,000 of federal net operating losses after considering the effects of Section 382 and other limitations on the utilization of certain losses. The net operating loss carryforwards incurred in 2017 and before, if not utilized, will begin to expire in 2031. Federal net operating losses incurred in 2018 can be carried forward indefinitely.
The Company’s effective income tax rates for the years ended December 31, 2018 and 2017, respectively are different than what would be expected if the statutory rate were applied to net income before income tax expense primarily because of expense charges in connection with various non-cash financing transactions, the use of net operating loss carryforwards, and the change in the valuation allowance.
Note 14 - Subsequent Event
On February 25, 2019, the Company, along with its wholly-owned subsidiary, MES, Inc. (“MES”, and together with the Company, collectively the “Companies”), entered into an Unsecured Note Financing Agreement (the “Unsecured Note Financing Agreement”) with AC Midwest, pursuant to which AC Midwest exchanged the AC Midwest Subordinated Note, together with all accrued and unpaid interest thereon, for a new unsecured note in the principal amount of $13,154,930.60 (the “New AC Midwest Unsecured Note”).
The New AC Midwest Unsecured Note, which has been issued in exchange for the AC Midwest Subordinated Note which has now been cancelled, will mature on August 25, 2022 (the “Maturity Date”). It is guaranteed by MES and bears a zero cash interest rate. If the original principal amount is paid in full on or before August 25, 2020 (18 months from issuance), AC Midwest shall be entitled to a profit participation preference equal to 0.5 times the original principal amount, and if the original principal amount is paid in full after August 25, 2020, AC Midwest shall be entitled to a profit participation preference equal to 1.0 times the original principal amount (the “Profit Share”). The Profit Share is “non-recourse” and shall only be derived from and computed on the basis of, and paid from, Net Litigation Proceeds from claims relating to the Company’s intellectual property, Net Revenue Share and Adjusted Free Cash Flow (as such terms are defined in the Unsecured Note Financing Agreement).
The Company shall pay the principal outstanding, as well as the Profit Share, in an amount equal to 60.0% of Net Litigation Proceeds until such time as any litigation funder has been paid in full and, thereafter, in an amount equal to 75.0% of such Net Litigation Proceeds until the Unsecured Note and Profit Share have been paid in full. In addition, and within 30 days following the end of each fiscal quarter, the Company shall pay the principal outstanding and Profit Share in an aggregate amount equal to the Net Revenue Share (which means 60.0% of Net Licensing Revenue (as defined) from licensing the Company’s intellectual property) plus Adjusted Free Cash Flow until the Unsecured Note and Profit Share have been paid in full, provided, however, that such payments shall exclude the first $3,500,000 of Net Licensing Revenue and Adjusted Free Cash Flow achieved commencing with the fiscal quarter ending March 31, 2019. Any remaining principal balance due on the Unsecured Note shall be due and payable in full on the Maturity Date. The Profit Share, however, if not paid in full on or before the Maturity Date, shall remain subject to Unsecured Note Financing Agreement until full and final payment.
The New AC Midwest Unsecured Note, which is not be subject to any financial covenants, does contain certain other affirmative and negative covenants.
In addition, on February 25, 2019, and effective as of December 15, 2018, the Companies entered into Amendment No. 3 (“Amendment No. 3”) to the Amended and Restated Financing Agreement with AC Midwest which was entered into on November 1, 2016, as previously amended on June 14, 2018 and September 12, 2018 (the “Restated Financing Agreement”). Pursuant to Amendment No. 3, the parties agreed that the maturity date for the remaining principal balance of $271,686 due under the AC Midwest Secured Note (which prior to Amendment No. 3 was due on December 15, 2018) would be extended to August 25, 2022. In addition, AC Midwest has agreed to waive the minimum EBITDA covenant contained in the Restated Financing Agreement and further to strike such covenant from the Restated Financing Agreement in its entirety as of the effective date of Amendment No. 3. Pursuant to this amendment, affected balances due on secured promissory notes totaling $1,261,686 have been disclosed as long term debt at December 31, 2018.