Notes to Condensed Consolidated Unaudited Financial Statements
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 unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required for complete financial statements and should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
In management’s opinion, the unaudited condensed consolidated financial statements reflect all adjustments necessary to present fairly the financial position as of June 30, 2019, and results of operations, changes in stockholders’ deficit and cash flows for all periods presented. The interim results presented are not necessarily indicative of results that can be expected for a full year.
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.
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 six months ended June 30, 2019 and 2018, respectively.
Leases
In February 2016, the FASB issued new guidance which 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. The accounting standard, effective January 1, 2019, requires virtually all leases to be recognized on the Balance Sheet. Effective January 1, 2019, we adopted the standard using the modified retrospective method, under which we elected the package of practical expedients and transition provisions allowing us to bring our existing operating leases onto the Condensed Consolidated Balance Sheet without adjusting comparative periods, but recognizing a cumulative-effect adjustment to the opening balance of accumulated deficit on January 1, 2019. Under the guidance, we have also elected not to separate lease and non-lease components in recognition of the lease-related assets and liabilities, as well as the related lease expense.
We have operating leases for office space in two multitenant facilities, which are not recorded as assets and liabilities as those leases do not have terms greater than 12 months. We have an operating leases for a multi-purpose facility and bulk trailers used in operations which is recorded as an asset and liability as the lease has a terms greater than 12 months. Lease-related assets, or right-of-use assets, are recognized at the lease commencement date at amounts equal to the respective lease liabilities, adjusted for prepaid lease payments, initial direct costs, and lease incentives received. Lease-related liabilities are recognized at the present value of the remaining contractual fixed lease payments, discounted using our incremental borrowing rate. Operating lease expense is recognized on a straight-line basis over the lease term, while variable lease payments are expensed as incurred.
Upon adoption of the standard on January 1, 2019, we recorded $1,339,569 of right of use assets and $1,417,435 of lease-related liabilities, with the difference charged to accumulated deficit at that date.
For the three and six months ended June 30, 2019, the Company’s lease cost consist of the following components, each of which is included in costs and expenses within the Company’s consolidated statements of operations:
|
|
Three Months
Ended June 30,
2019
|
|
|
Six Months
Ended June 30,
2019
|
|
|
|
|
|
|
|
|
Operatig lease cost
|
|
$
|
109,710
|
|
|
$
|
219,420
|
|
Short-term lease cost (1)
|
|
|
6,450
|
|
|
|
12,900
|
|
Total lease cost
|
|
$
|
116,160
|
|
|
$
|
232,320
|
|
(1) Short-term lease costs includes any lease with a term of less than 12 months
|
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 June 30, 2019 and December 31, 2018 and is considered to be Level 1.
Financial instruments include cash, accounts receivable, accounts payable, deferred revenue, customer credits and short-term debt. The carrying amounts of these financial instruments approximated fair value at June 30, 2019 and December 31, 2018 due to their short-term maturities.
The fair value of the promissory notes payable at June 30, 2019 and December 31, 2018 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 June 30, 2019. 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 June 30, 2019
|
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
1,320,874
|
|
|
|
1,320,874
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
1,320,874
|
|
|
$
|
1,320,874
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Promissory notes
|
|
|
12,241,159
|
|
|
|
-
|
|
|
|
12,241,159
|
|
|
|
|
|
Total Libilities
|
|
$
|
12,241,159
|
|
|
$
|
-
|
|
|
$
|
12,241,159
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
$
|
-
|
|
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 June 30, 2019 and December 31, 2018, there were no material gains or losses recognized.
Revenue Recognition
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.
Disaggregation of Revenue
The Company generated revenue for the three and six months ended June 30, 2019 and 2018 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 $0 and $34,467 on June 30, 2019 and December 31, 2018, respectively. Amortization expense for the three and six months ended June 30, 2019 was $0 and $34,467, respectively and for the three and six months ended June 30, 2018 was $34,467 and $68,934, respectively. Amortization expense was included in cost of sales.
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. For the three and six months ended June 30, 2019 and 2018 basic and diluted earnings per share approximated each other. There were no dilutive potential common shares as of June 30, 2019 and 2018, 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.
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Stock Options
|
|
|
12,563,326
|
|
|
|
8,680,893
|
|
Warrants
|
|
|
4,102,098
|
|
|
|
7,237,763
|
|
Convertible debt
|
|
|
6,300,000
|
|
|
|
3,100,000
|
|
Total common stock equivalents excluded from diluted net loss per share
|
|
|
22,965,424
|
|
|
|
19,018,656
|
|
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 June 30, 2019 is maintained at high-quality financial institutions and has not incurred any losses to date.
Customer and Supplier Concentration
For each of the six months ended June 30, 2019 and 2018, 100% of the Company’s revenue related to eight customers. At June 30, 2019 and 2018, 100% of the Company’s accounts receivable related to seven and eight customers, respectively.
For each of the six months ended June 30, 2019 and 2018, 91% and 90% of the Company’s purchases related to two suppliers, respectively. At June 30, 2019 and 2018, 71% 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 Issued Accounting Standards
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 condensed consolidated financial statements, the Company had $1,321,000 in cash on its balance sheet at June 30, 2019. The Company had a working capital deficit of $72,000 and an accumulated deficit $52.0 million. Additionally, the Company had a net loss in the amount of $475,000 and cash used by operating activities of $507,000 for the six months ended June 30, 2019, respectively.
The accompanying condensed consolidated financial statements as of June 30, 2019 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 its largest promissory noteholder, extending the maturity dates of these debts and the remaining convertible notes until 2022 and eliminating quarterly principal payment requirements. In June 2019, the Company sold $1,300,000 of new convertible notes which mature in 2024. 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 $345,263 and $306,651, raw materials inventory valued at $112,189 and $87,730 and equipment and parts inventory valued at $114,100 and $113,035 as of June 30, 2019 and December 31, 2018, respectively.
Note 5 - Property and Equipment, Net
Property and equipment at June 30, 2019 and December 31, 2018 are as follows:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Equipment & Installation
|
|
$
|
1,965,659
|
|
|
$
|
1,965,659
|
|
Trucking equipment
|
|
|
983,948
|
|
|
|
983,948
|
|
Computer equipment and software
|
|
|
117,212
|
|
|
|
117,212
|
|
Office equipment
|
|
|
27,155
|
|
|
|
27,155
|
|
Total equipment
|
|
|
3,093,974
|
|
|
|
3,093,974
|
|
|
|
|
|
|
|
|
|
|
Less: accumulated depreciation
|
|
|
(2,667,025
|
)
|
|
|
(2,503,990
|
)
|
Construction in process
|
|
|
1,807,707
|
|
|
|
1,807,707
|
|
Property and equipment, net
|
|
$
|
2,234,656
|
|
|
$
|
2,397,691
|
|
The Company uses the straight-line method of depreciation over 2 to 5 years. During the six months ended June 30, 2019 and 2018 depreciation expense was $163,035, and $227,968.
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.
License and patent costs capitalized as of June 30, 2019 and December 31, 2018 are as follows:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Patents
|
|
$
|
3,068,995
|
|
|
$
|
3,068,995
|
|
Less: Accumulated Amortization
|
|
|
(435,933
|
)
|
|
|
(335,333
|
)
|
License, Net
|
|
$
|
2,633,062
|
|
|
$
|
2,733,662
|
|
Amortization expense for each of the six months ended June 30, 2019 and 2018 was $100,602. Estimated annual amortization for each of the next five years is approximately $201,200.
Note 7 –Convertible Notes Payable
The Company has the following convertible notes payable outstanding as of June 30, 2019 and December 31, 2018:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
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
|
|
|
$
|
990,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible promissory notes which mature beginning 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
|
|
|
|
860,000
|
|
|
|
|
|
|
|
|
|
|
Unsecured convertible promissory notes which mature beginning on June 18, 2024, bear interest at 12% per annum, and are convertible into one share of common stock, par value $0.001 per share.
|
|
$
|
1,300,000
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Total convertible notes payable before discount
|
|
|
3,150,000
|
|
|
|
1,850,000
|
|
|
|
|
|
|
|
|
|
|
Less discounts
|
|
|
(275,646
|
)
|
|
|
(89,430
|
)
|
|
|
|
|
|
|
|
|
|
Convertible notes payable
|
|
|
2,874,354
|
|
|
|
1,760,570
|
|
As of June 30, 2019, remaining scheduled principal payments due on convertible notes payable are as follows:
|
Twelve months ended December 31,
|
|
|
|
2019
|
|
$
|
-
|
|
2020
|
|
|
-
|
|
2021
|
|
|
-
|
|
2022
|
|
|
990,000
|
|
2023
|
|
|
860,000
|
|
Thereafter
|
|
|
1,300,000
|
|
|
|
$
|
3,150,000
|
|
As of June 30, 2019, the remaining future amortization of discounts are as follows:
Twelve months ended June 30,
|
|
Discounts
|
|
2019
|
|
$
|
29,565
|
|
2020
|
|
|
59,129
|
|
2021
|
|
|
59,129
|
|
2022
|
|
|
59,129
|
|
2023
|
|
|
50,579
|
|
Thereafter
|
|
|
18,116
|
|
|
|
$
|
275,646
|
|
Note 8 - Secured Note Payable
On November 29, 2016, pursuant to a new restated financing agreement entered with AC Midwest Energy, LLC (“AC Midwest”) on November 1, 2016, the Company closed on a new secured note with AC Midwest (“The New AC Midwest Secured Note”) in the principle amount of $9,646,686, which was to mature on December 15, 2018.The New AC Midwest Secured Note 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 three and six months ended June 30, 2019 was $10,301 and $20,490, respectively. Interest expense for the three and six months ended June 30, 2018 was $14,853 and $45,712, respectively. On February 25, 2019, per Amendment No. 3 (“Amendment No. 3”) to the Amended and Restate Financing Agreement, AC Midwest agreed to waive compliance with a certain financial covenant 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. As of June 30, 2019 and December 31, 2018, total principal of $271,686 and $271,686 was outstanding on this note.
Note 9 – Unsecured Note Payable
On November 29, 2016, pursuant to a new restated financing agreement entered with AC Midwest on November 1, 2016, the Company closed on an unsecured note with AC Midwest (“The AC Midwest Unsecured Note”) in the principle amount of $13,000,000, which was to mature on December 15, 2020. On February 25, 2019, the Company, entered into an Unsecured Note Financing Agreement (the “Unsecured Note Financing Agreement”) with AC Midwest, pursuant to which AC Midwest issued an unsecured note in the principal amount of $13,154,930.60 (the “New AC Midwest Unsecured Note”), which represented the outstanding principal and accrued and unpaid interest at closing. The Company recorded a gain of $3,412,204 on this exchange which is primarily related to the difference in fair value of the notes on the date of the exchange.
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 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 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 $11,113,087 should be recorded. This discount is based on an applicable market rate for unsecured debt for the Company of 21% and will be amortized as interested expense over the life of the loan. Amortized discount recorded as interest expense for the three and six months ended June 30, 2019 was $628,286 and $837,714, respectively. As of June 30, 2019, the unamortized balance of the discount was $10,275,373.
Note 10 - 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.
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 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. The lease was extended on June 1, 2019 for five years.
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 remaining minimum lease payments under these non-cancelable leases are approximately as follows:
For the the twelve months ended December 31
|
|
|
|
2019
|
|
$
|
230,020
|
|
2020
|
|
|
441,990
|
|
2021
|
|
|
438,840
|
|
2022
|
|
|
333,960
|
|
2023
|
|
|
45,000
|
|
Thereafter
|
|
|
11,250
|
|
Total
|
|
|
1,501,060
|
|
Less discount
|
|
|
(299,591
|
)
|
Less short term leases
|
|
|
(13,750
|
)
|
Total lease liabilities
|
|
|
1,187,719
|
|
|
|
|
|
|
Less current portion
|
|
|
(381,245
|
)
|
Operating lease obligation, net of current portion
|
|
$
|
806,474
|
|
The weighted average remaining lease term for operating leases is 2.4 years and the weighted average discount rate used in calculating the operating lease asset and liability is 5.0%. For the six months ended June 30, 2019, payments on lease obligations were $229,716 and amortization on the right of use assets was $188,841.
Note 11 – Commitments and Contingencies
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 12 - Stock Based Compensation
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 six months ended June 30, 2019 is presented below:
|
|
Number of
Shares
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining Contractual
Life (years)
|
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
9,161,510
|
|
|
|
1.15
|
|
|
|
2.0
|
|
|
|
-
|
|
Expirations
|
|
|
(635,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
March 31, 2019
|
|
|
8,526,510
|
|
|
|
1.19
|
|
|
|
1.9
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grants
|
|
|
4,600,000
|
|
|
|
0.27
|
|
|
|
5.0
|
|
|
|
-
|
|
Expirations
|
|
|
(563,184
|
)
|
|
|
11.19
|
|
|
|
-
|
|
|
|
-
|
|
June 30, 2019
|
|
|
12,563,326
|
|
|
|
0.55
|
|
|
|
4.5
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
|
12,563,326
|
|
|
|
0.55
|
|
|
|
4.5
|
|
|
|
-
|
|
The Company utilized the Black-Scholes options pricing model. The significant assumptions utilized for the Black Scholes calculations consist of an expected life of equal to the expiration term of the option, historical volatility of 100%, and a risk free interest rate of 3%
On May 14, 2019, Frederick Van Zijl resigned as a director of the Company. In connection with such resignation, the Company has agreed to issue, and Mr. Van Zijl has agreed to accept, an aggregate of 235,184 shares of common stock of the Company in full and complete payment for service on the Board since his appointment in October 2018. Compensation of $63,500 based on the market price of the shares on the date of issuance was included in selling, general and administrative expenses within the Company’s condensed consolidated statements of operations.
On June 4, 2019, Allan T. Grantham resigned as a director of the Company. In connection with such resignation, the Company has agreed to issue, and Mr. Grantham has agreed to accept, an aggregate of 229,333 shares of common stock of the Company in full and complete payment for service on the Board for 2018 and 2019. Compensation of $55,040 based on the market price of the shares on the date of issuance was included in selling, general and administrative expenses within the Company’s condensed consolidated statements of operations.
On June 28, 2019, the Company granted nonqualified stock options to acquire an aggregate of 4,600,000 shares of the Company’s common stock under the Company’s 2017 Equity Plan to certain executive officers, employees and others. The options granted are exercisable at $0.27 per share, representing the fair market value of the common stock on the date of 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 years thereafter. Based on a Black-Scholes valuation model, these options were valued at $898,207 in accordance with FASB ASC Topic 718 which was included in selling, general and administrative expenses within the Company’s condensed consolidated statements of operations.
Also on June 28, 2019, the Company extended the expiration dates of previously granted nonqualified stock options to acquire an aggregate of 4,675,000 shares of the Company’s common stock under the Company’s 2014 Equity Plan to certain executive officers, employees and others. The extended options are exercisable from $0.42 to $1.36 per share, representing the original fair market value of the common stock on the date of grant as determined under the 2014 Equity Plan. The options are fully vested and exercisable and will now expire five years from the date of the extension. Based on a Black-Scholes valuation model, these options were valued at $745,989 in accordance with FASB ASC Topic 718 which was included in selling, general and administrative expenses within the Company’s condensed consolidated statements of operations.
Note 13 - 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.
The following table summarizes information about common stock warrants outstanding at June 30, 2019:
Outstanding
|
|
|
Exercisable
|
|
Exercise
Price
|
|
|
Number
Outstanding
|
|
|
Weighted
Average
Remaining
Contractual
Life (years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Number
Exercisable
|
|
|
Weighted
Average
Exercise
Price
|
|
|
0.70
|
|
|
|
2,160,000
|
|
|
|
4.61
|
|
|
|
0.70
|
|
|
|
2,160,000
|
|
|
|
0.70
|
|
|
0.45
|
|
|
|
150,000
|
|
|
|
1.42
|
|
|
|
0.45
|
|
|
|
150,000
|
|
|
|
0.45
|
|
|
0.35
|
|
|
|
1,792,098
|
*
|
|
|
1.04
|
|
|
|
0.35
|
|
|
|
1,792,098
|
|
|
|
0.35
|
|
$
|
0.50 - $3.30
|
|
|
|
4,102,098
|
|
|
|
2.93
|
|
|
|
|
|
|
|
4,102,098
|
|
|
|
|
|
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.
During June 2019, the Company issued unsecured convertible notes and warrants to unaffiliated accredited investors totaling $1,300,000. The notes are convertible into shares of common stock, with the initial conversion ratio equal to $0.50 per share. The investors received warrants to purchase a total of 1,300,000 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 $197,664 which was recorded as a discount on the notes payable and will be amortized over the life of the associated notes payable.
Note 14 – Subsequent Events
From July 1 through August 14, 2019, the Company issued unsecured convertible notes and warrants to unaffiliated accredited investors totaling $500,000. The notes are convertible into shares of common stock, with the initial conversion ratio equal to $0.50 per share. The investors received warrants to purchase a total of 500,000 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.