Item 1. Unaudited Condensed Consolidated
Financial Statements
QS ENERGY, INC.
Condensed
Consolidated Balance Sheets
| | |
| | | |
| | |
| | |
March 31, 2022 | | |
December 31, | |
| | |
(unaudited) | | |
2021 | |
| ASSETS |
| Current assets: | |
| | | |
| | |
| Cash | |
$ | 62,000 | | |
$ | 114,000 | |
| Prepaid expenses | |
| 10,000 | | |
| 14,000 | |
| Total current assets | |
| 72,000 | | |
| 128,000 | |
| Property and equipment, net of accumulated depreciation of 93,000 and $92,000 at March 31, 2022 and December 31, 2021, respectively | |
| 8,000 | | |
| 9,000 | |
| Operating lease right of use asset | |
| 136,000 | | |
| 143,000 | |
| Total assets | |
$ | 216,000 | | |
$ | 280,000 | |
| | |
| | | |
| | |
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | |
| | | |
| | |
| Current liabilities: | |
| | | |
| | |
| Accounts payable-license agreements-past due | |
$ | 1,785,000 | | |
$ | 1,726,000 | |
| Accounts payable and accrued expenses | |
| 1,025,000 | | |
| 930,000 | |
| Convertible debentures, net of discounts of $52,000 and $86,000, respectively; includes $1,401,000 and $1,333,000, respectively, in default | |
| 1,562,000 | | |
| 1,503,000 | |
| PPP loan payable | |
| 126,000 | | |
| 150,000 | |
| Operating lease liabilities | |
| 39,000 | | |
| 38,000 | |
| Total current liabilities | |
| 4,537,000 | | |
| 4,347,000 | |
| Operating lease liabilities, net of current portion | |
| 98,000 | | |
| 106,000 | |
| Total liabilities | |
| 4,635,000 | | |
| 4,453,000 | |
| | |
| | | |
| | |
| Commitments and contingencies | |
| – | | |
| – | |
| | |
| | | |
| | |
| Stockholders’ deficit | |
| | | |
| | |
| Common stock, $.001 par value: 500,000,000 shares authorized, 356,491,888 and 355,300,222 shares issued and outstanding at March 31, 2022 and December 31, 2021, respectively | |
| 356,493 | | |
| 355,301 | |
| Additional paid-in capital | |
| 118,119,507 | | |
| 118,065,699 | |
| Accumulated deficit | |
| (122,895,000 | ) | |
| (122,594,000 | ) |
| Total stockholders’ deficit | |
| (4,419,000 | ) | |
| (4,173,000 | ) |
| Total liabilities and stockholders’ deficit | |
$ | 216,000 | | |
$ | 280,000 | |
See notes to condensed consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Operations, Unaudited
| | |
| | | |
| | |
| | |
Three months ended | |
| | |
March 31, | |
| | |
2022 | | |
2021 | |
| | |
| | |
| |
| Revenues | |
$ | – | | |
$ | – | |
| | |
| | | |
| | |
| Costs and expenses | |
| | | |
| | |
| Operating expenses | |
| 200,000 | | |
| 214,000 | |
| Research and development expenses | |
| 48,000 | | |
| 47,000 | |
| Loss from operations | |
| (248,000 | ) | |
| (261,000 | ) |
| | |
| | | |
| | |
| Other income (expense) | |
| | | |
| | |
| Gain on partial forgiveness of PPP note payable | |
| 24,000 | | |
| – | |
| Interest and financing expense | |
| (77,000 | ) | |
| (110,000 | ) |
| | |
| | | |
| | |
| Net Loss | |
$ | (301,000 | ) | |
$ | (371,000 | ) |
| | |
| | | |
| | |
| Net loss per common share, basic and diluted | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| Weighted average common shares outstanding, basic and diluted | |
| 355,742,036 | | |
| 323,167,576 | |
See notes to condensed consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statement of Stockholders’ Deficit, Unaudited
For
the Three months Ended MARCH 31, 2022 and 2021
| | |
| | | |
| | | |
| | | |
| | | |
| | |
| | |
Common Stock | | |
Additional
Paid-in | | |
Accumulated | | |
Total Stockholders’ | |
| | |
Shares | | |
Amount | | |
Capital | | |
Deficit | | |
Deficit | |
| Balance, January 1, 2021 | |
| 323,181,243 | | |
$ | 323,182 | | |
$ | 117,373,818 | | |
$ | (121,204,000 | ) | |
$ | (3,507,000 | ) |
| Adjustment for adoption of ASU 2020-06 | |
| | | |
| | | |
| (60,000 | ) | |
| 30,000 | | |
| (30,000 | ) |
| Common stock issued on conversion of notes payable | |
| 2,200,000 | | |
| 2,200 | | |
| 41,800 | | |
| – | | |
| 44,000 | |
| Value of warrants issued with convertible notes | |
| – | | |
| – | | |
| 30,000 | | |
| – | | |
| 30,000 | |
| Fair value of options and warrants issued as compensation | |
| – | | |
| – | | |
| 13,000 | | |
| – | | |
| 13,000 | |
| Issuance of common stock for cash | |
| 3,000,000 | | |
| 3,000 | | |
| 42,000 | | |
| – | | |
| 45,000 | |
| Net loss | |
| – | | |
| – | | |
| – | | |
| (371,000 | ) | |
| (371,000 | ) |
| Balance, March 31, 2021 | |
| 328,381,243 | | |
$ | 328,382 | | |
$ | 117,440,618 | | |
$ | (121,545,000 | ) | |
$ | (3,776,000 | ) |
| | |
Common Stock | | |
Additional
Paid-in | | |
Accumulated | | |
Total Stockholders’ | |
| | |
Shares | | |
Amount | | |
Capital | | |
Deficit | | |
Deficit | |
| Balance, January 1, 2022 | |
| 355,300,222 | | |
$ | 355,301 | | |
$ | 118,065,699 | | |
$ | (122,594,000 | ) | |
$ | (4,173,000 | ) |
| Common stock issued on conversion of notes payable | |
| 366,666 | | |
| 367 | | |
| 5,633 | | |
| – | | |
| 6,000 | |
| Common stock issued on exercise of warrants | |
| 825,000 | | |
| 825 | | |
| 24,175 | | |
| – | | |
| 25,000 | |
| Fair value of warrants issued as compensation | |
| – | | |
| – | | |
| 24,000 | | |
| – | | |
| 24,000 | |
| Net loss | |
| – | | |
| – | | |
| – | | |
| (301,000 | ) | |
| (301,000 | ) |
| Balance, March 31, 2022 | |
| 356,491,888 | | |
$ | 356,493 | | |
$ | 118,119,507 | | |
$ | (122,895,000 | ) | |
$ | (4,419,000 | ) |
See notes to condensed consolidated financial statements.
QS ENERGY, INC.
Condensed
Consolidated Statements of Cash Flows, Unaudited
| | |
| | | |
| | |
| | |
Three months ended | |
| | |
March 31, | |
| | |
2022 | | |
2021 | |
| Cash flows from Operating Activities | |
| | | |
| | |
| Net loss | |
$ | (301,000 | ) | |
$ | (371,000 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | |
| | | |
| | |
| Fair value of options and warrants issued as compensation | |
| 24,000 | | |
| 13,000 | |
| Amortization of debt discount and accrued interest | |
| 65,000 | | |
| 98,000 | |
| Depreciation and amortization | |
| 1,000 | | |
| 1,000 | |
| Gain on partial forgiveness of PPP note payable | |
| (24,000 | ) | |
| – | |
| Changes in operating assets and liabilities: | |
| | | |
| | |
| Prepaid expenses and other current assets | |
| 4,000 | | |
| 31,000 | |
| Decrease in operating lease right of use asset | |
| 7,000 | | |
| – | |
| Accounts payable and accrued expenses | |
| 95,000 | | |
| 58,000 | |
| Accounts payable – license agreements | |
| 59,000 | | |
| 59,000 | |
| Accounts payable and accrued expenses – related parties | |
| – | | |
| 37,000 | |
| Operating lease liabilities | |
| (7,000 | ) | |
| – | |
| Net cash used in operating activities | |
| (77,000 | ) | |
| (74,000 | ) |
| | |
| | | |
| | |
| Cash flows from financing activities | |
| | | |
| | |
| Net proceeds from exercise of warrants | |
| 25,000 | | |
| – | |
| Net proceeds from private sale of restricted common stock | |
| – | | |
| 45,000 | |
| Net proceeds from issuance of convertible notes and warrants | |
| – | | |
| 30,000 | |
| Net cash provided by financing activities | |
| 25,000 | | |
| 75,000 | |
| | |
| | | |
| | |
| Net increase (decrease) in cash | |
| (52,000 | ) | |
| 1,000 | |
| Cash, beginning of period | |
| 114,000 | | |
| 52,000 | |
| Cash, end of period | |
$ | 62,000 | | |
$ | 53,000 | |
| | |
| | | |
| | |
| Supplemental disclosures of cash flow information | |
| | | |
| | |
| Cash paid during the year for: | |
| | | |
| | |
| Interest | |
$ | – | | |
$ | – | |
| Income Taxes | |
$ | – | | |
$ | – | |
| Non-cash investing and financing activities | |
| | | |
| | |
| Conversion of convertible debentures to common stock | |
$ | 11,000 | | |
$ | 44,000 | |
| Adjustment for adoption of ASU 2020-06 | |
$ | – | | |
$ | 30,000 | |
| Value of warrants issued with convertible notes | |
$ | – | | |
$ | 30,000 | |
See notes to condensed consolidated financial statements.
QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited
THREE MONTHS ENDED MARCH 31, 2022 AND 2021
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1. |
Description of Business |
QS Energy, Inc. (“QS
Energy”, “Company”) was incorporated on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation.
The Company changed its name to Save the World Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name
to QS Energy, Inc. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter. More information
including the Company’s fact sheet, logos, media articles, and update information are available at our corporate website, www.qsenergy.com.
QS Energy develops and is
seeking to commercialize energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics
of oil extraction and transport, and reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic
and international patents and patents pending, a substantial portion of which have been developed in conjunction with and exclusively
licensed from Temple University of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology
(AOT), a commercial-grade crude oil pipeline transportation flow-assurance product. AOT is engineered specifically to reduce pipeline
pressure loss, increase pipeline flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet
pipeline maximum viscosity requirements. AOT is a 100% solid-state system that has shown to reduce crude oil viscosity by applying a high
intensity electrical field to crude oil feedstock while in transit. The AOT product is seeking to transition from the testing, research
and development stage to initial production for continued testing in advance of our goal of seeking acceptance and adoption by the midstream
pipeline marketplace.
| |
2. |
Summary of Significant Accounting Policies |
Going Concern
The
accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial
statements, during the three-months ended March 31, 2022, the Company incurred a net loss of $301,000, used cash in operations of $77,000
and had a stockholders’ deficit of $4,419,000 as of March 31, 2022. In addition, as of March 31, 2022, twenty nine notes payable
with an aggregate balance of $1,401,000, license agreement payables of $1,785,000 and
certain obligations to a former officer are past due. These factors raise substantial doubt about the Company’s ability to continue
as a going concern. In addition, the Company's independent registered public accounting firm, in its report on the Company's December
31, 2021 financial statements, has raised substantial doubt about the Company's ability to continue as a going concern.
The ability of the Company
to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan.
The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
At March 31, 2022, the Company
had cash on hand in the amount of $62,000. Management estimates that the current funds on hand will be sufficient to continue operations
through approximately November 2022. Management is currently seeking additional funds, primarily through the issuance of debt and equity
securities for cash to operate our business, including without limitation the expenses it will incur in connection with the license agreements
with Temple; costs associated with product development and commercialization of the AOT technologies; costs to manufacture and ship the
products; costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining
our status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual property. In addition,
as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers
pursuant to employment agreements, certain payments to a former officer and consulting fees, during the remainder of 2022 and beyond.
No assurance can be given
that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the
Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or
cause substantial dilution for our stockholders in case of equity financing.
Basis of Presentation
The accompanying condensed
consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules
and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information
and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant
to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year
ended December 31, 2021, filed with the SEC on March 31, 2022. The condensed consolidated balance sheet as of December 31, 2021, included
herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures, including
notes, required by GAAP.
In the opinion of management,
the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's
financial position and results of operations for the interim periods reflected. Except as noted, all adjustments contained herein are
of a normal recurring nature. Results of operations for the fiscal periods presented herein are not necessarily indicative of the full
fiscal year-end results.
Estimates
The preparation of financial
statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Significant estimates include those related to accruals
for potential liabilities, assumptions used in valuing equity instruments issued for financing and services and realization of deferred
tax assets, among others. Actual results could differ from those estimates.
Consolidation Policy
The accompanying consolidated
financial statements of QS Energy Inc. include the accounts of QS Energy Inc. (the Parent) and its wholly owned subsidiaries, QS Energy
Pool, Inc. and STWA Asia Pte. Limited. Intercompany transactions and balances have been eliminated in consolidation.
Basic and Diluted Income (loss)
per share
Our computation of earnings
per share (“EPS”) includes basic and diluted EPS. Basic EPS is measured as the income (loss) available to common stockholders
divided by the weighted average common shares outstanding for the period. Diluted income (loss) per share reflects the potential dilution,
using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that then shared in the income (loss) of the Company as if they had been converted
at the beginning of the periods presented, or issuance date, if later.
At March 31, 2022 and 2021,
we excluded the following dilutive shares as their effect would have been anti-dilutive.
| Schedule of antidilutive shares | |
| | | |
| | |
| | |
March 31,
2022 | | |
March 31,
2021 | |
| Options | |
| 27,080,601 | | |
| 32,780,601 | |
| Warrants | |
| 19,652,149 | | |
| 9,058,676 | |
| Common stock issuable upon conversion of notes payable | |
| 24,284,235 | | |
| 15,721,479 | |
| Total | |
| 71,016,985 | | |
| 57,560,756 | |
Stock-Based
Compensation
The
Company periodically issues stock options and restricted stock awards to employees and non-employees in non-capital raising transactions
for services and for financing costs. Stock option grants, which are generally time or performance vested, are measured at the grant date
fair value and depending on the conditions associated with the vesting of the award, compensation cost is recognized on a straight-line
or graded basis over the vesting period. Recognition of compensation expense for non-employees is in the same period and manner as if
the Company had paid cash for the services. The fair value of stock options granted is estimated using the Black-Scholes option-pricing
model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life, and future dividends. The
assumptions used in the Black-Scholes option pricing model could materially affect compensation expense recorded in future periods.
Research and Development Costs
Research and development costs
are expensed as incurred, and consist primarily of fees paid to consultants and outside service providers, and other expenses relating
to the acquisition, design, development and testing of the Company’s products. Certain research and development activities are incurred
under contract. In those instances, research and development costs are charged to operations ratably over the life of the underlying contracts,
unless the achievement of milestones, the completion of contracted work, or other information indicates that a different expensing schedule
is more appropriate. Payments made pursuant to research and development contracts are initially recorded as advances on research and development
contract services in the Company’s consolidated balance sheet and then charged to research and development costs in the Company’s
consolidated statement of operations as those contract services are performed. For the three-month periods ended March 31, 2022 and 2021
research and development costs were $48,000 and $47,000, respectively.
Patent Costs
Patent costs consist of patent-related
legal and filing fees. Due to the uncertainty associated with the successful development of our AOT product, all patent costs are expensed
as incurred. During the three-month periods ended March 31, 2022 and 2021, patent costs were $3,000 and $4,000, respectively, and were
included as part of operating expenses in the accompanying condensed consolidated statements of operations.
Recent Accounting Pronouncements
In August 2020, the FASB
issued ASU No. 2020-06 (“ASU 2020-06”) “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and
Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40).” ASU 2020-06 reduces the number of
accounting models for convertible debt instruments by eliminating the cash conversion and beneficial conversion accounting models.
As a result, the Company’s convertible debt instruments will be accounted for as a single liability measured at its amortized
cost as long as no other features require bifurcation and recognition as derivatives. For contracts in an entity’s own equity,
the type of contracts primarily affected by this update are freestanding and embedded features that are accounted for as derivatives
under the current guidance due to a failure to meet the settlement conditions of the derivative scope exception. The Company
early adopted ASU No. 2020-06 effective January 1, 2021 using the modified retrospective approach. Upon adoption, the
following changes resulted: (i) the intrinsic value of the beneficial conversion feature recorded in 2020 was reversed as of the
effective date of adoption, thereby resulting in an increase in the convertible debentures with an offsetting adjustment to
additional paid in capital and (ii) interest expense recorded in 2020 that was related to the amortization of the discount related
to the beneficial conversion feature was reversed against opening accumulated deficit. Accordingly, the adoption of ASU 2020-06
resulted in a decrease to accumulated deficit of $30,000, a decrease in addition paid in capital of $60,000, and an increase in
total stockholders’ deficit of $30,000 on January 1, 2021.
Recent accounting pronouncements
issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities
and Exchange Commission did not or are not believed by management to have a material impact on the Company's present or future consolidated
financial statement presentation or disclosures.
| |
3. |
Accounts Payable and Accrued Expenses |
As
of March 31, 2022 and December 31, 2021, the Company owed $197,000 and $197,000, respectively, pursuant to a separation agreement with
a former executive officer effective April 1, 2017 as amended by letter agreements dated effective August 16, 2018 and March 31, 2019
which are included as part of Accounts payable and accrued expenses on the accompanying condensed consolidated balance sheets. The amount
is to be repaid at an amount of $10,000 per month. During the three months ended March 31, 2022 the Company made no payments.
| |
4. |
Convertible Notes Payable |
| Convertible Notes and Warrants | |
| | | |
| | |
| | |
March 31,
2022 (unaudited) | | |
December 31, 2021 | |
| Convertible notes | |
$ | 1,143,000 | | |
$ | 1,154,000 | |
| Accrued interest | |
| 471,000 | | |
| 435,000 | |
| Subtotal, including $1,401,000 and $1,333,000 in default at March 31, 2022 and December 31, 2021, respectively | |
| 1,614,000 | | |
| 1,589,000 | |
| Convertible note discount | |
| (52,000 | ) | |
| (86,000 | ) |
| Balance on convertible notes, net of note discounts | |
$ | 1,562,000 | | |
$ | 1,503,000 | |
The Company issues convertible
notes in exchange for cash. The notes typically do not bear any interest; however, there is an implied interest rate of 10% since the
notes are typically issued at a 10% discount. The notes are unsecured, and usually mature twelve months from issuance. The notes are convertible
at the option of the note holder into shares of the Company’s common stock at a conversion price stipulated in the conversion agreement.
In addition, the note holders receive warrants to purchase shares of common stock that are fully vested upon issuance and expire one year
from the date of issuance. As a result, the Company records a note discount to account for the relative fair value of the warrants, and
original issue discount of 10% (OID). The note discounts are amortized over the term of the notes.
As of December 31, 2021, total
outstanding notes payable and accrued interest totaled $1,589,000. During the three-month periods ended March 31, 2022, the Company issued
no convertible promissory notes. During the period ended March 31, 2022, convertible notes payable and accrued interest of $11,000 were
converted into 366,666 shares of common stock, and accrued interest of $36,000 was recorded. As of March 31, 2022, total outstanding convertible
notes payable and accrued interest totaled $1,614,000. As of March 31, 2022, a total of twenty-nine notes in the aggregate of $1,401,000
including accrued interest have reached maturity and are past due.
As of December 31, 2021, unamortized
discount totaled $86,000. During the three-months ended March 31, 2022, the Company recorded amortization of debt discount of $29,000
and $5,000 of debt discount was removed and included in the carrying amount of convertible notes that were converted. As of March 31,
2022, unamortized discount totaled $52,000. Note discounts are amortized over the term of the related note or amortized in full upon the
notes’ conversion to common stock.
As of March 31, 2022, the
convertible notes payable and accrued interest are convertible into 24,284,235 shares of common stock at conversion rates ranging from
$0.02 to $0.03 per share.
5. PPP
loan payable
In June 2020, the Company
was granted a loan (the “PPP loan”) from Cadence Bank in the aggregate amount of $151,000, pursuant to the Paycheck Protection
Program (the “PPP”) under the CARES Act.
The PPP loan agreement is
dated June 18, 2020, matures on June 18, 2025, bears interest at a rate of 1% per annum, with the first six months of interest deferred,
and is unsecured and guaranteed by the U.S. Small Business Administration (“SBA”). The PPP loan may be prepaid at any time
prior to maturity with no prepayment penalties. Funds from the PPP loan may only be used for qualifying expenses as described in the CARES
Act, including qualifying payroll costs, qualifying group health care benefits, qualifying rent and debt obligations, and qualifying utilities.
Under the terms of the PPP,
certain amounts of the loan may be forgiven if they are used for qualifying expenses. In January 2022, the Company received notice that
$24,049 of the PPP loan was forgiven, and a $24,049 gain on forgiveness of PPP loan was recorded. The balance of the PPP loan after recording
the forgiveness was $126,000. The terms of the PPP loan provide for customary events of default including, among other things, payment
defaults, breach of representations and warranties, and insolvency events. The Company was in compliance with the terms of the PPP loan
as of March 31, 2022.
| |
6. |
Research and Development |
The Company constructs, develops
and tests the AOT technologies with internal resources and through the assistance of various third-party entities. Costs incurred and
expensed include fees such as license fees, purchase of test equipment, pipeline pumping equipment, crude oil tank batteries, viscometers,
SCADA systems, computer equipment, payroll and other related equipment and various logistical expenses for the purposes of evaluating
and testing the Company’s AOT prototypes.
Costs incurred for research
and development are expensed as incurred. Purchased materials that do not have an alternative future use are also expensed. Furthermore,
costs incurred in the construction of prototypes with no certainty of any alternative future use and established commercial uses are also
expensed.
For the three-month periods
ended March 31, 2022 and 2021, our research and development expenses were $48,000 and $47,000, respectively.
AOT Prototypes
During the periods ended March
31, 2022 and 2021, the Company incurred total expenses of $1,000 and $0, respectively, in the manufacture and testing of the AOT prototype
equipment. These expenses have been reflected as part of Research and Development expenses on the accompanying condensed consolidated
statements of operations.
Temple University Licensing Agreements
On August 1, 2011, the Company
and Temple University (“Temple”) entered into two (2) Exclusive License Agreements (collectively, the “License Agreements”)
relating to Temple’s patent applications, patents and technical information pertaining to technology associated with an electric
and/or magnetic field assisted fuel injector system (the “First Temple License”), and to technology to reduce crude oil viscosity
(the “Second Temple License”). The License Agreements are exclusive, and the territory licensed to the Company is worldwide
and replace previously issued License Agreements.
Pursuant to the two licensing
agreements, the Company paid Temple a non-refundable license maintenance fee of $300,000 and agreed to pay (i) annual maintenance fees
of $187,500; (ii) royalty fee ranging from 4% up to 7% from revenues generated from the licensing agreements; and (iii) 25% of all revenues
generated from sub-licensees to secure or maintain the sub-license or option thereon. The term of the licenses commenced in August 2011
and will expire upon expiration of the patents. The agreements can also be terminated by either party upon notification under terms of
the licensing agreements or if the Company ceases the development of the patent or fails to commercialize the patent rights.
Total expenses recognized
during each three-month period ended March 31, 2022 and 2021 pursuant to these two License Agreements amounted to $47,000 and has been
reflected in Research and Development expenses on the accompanying condensed consolidated statements of operations. In the three-month
periods ended March 31, 2022 and 2021, the Company also recognized penalty interest on past-due balances of $12,000 and $12,000, respectively,
which is included as part of interest and financing expense in the accompanying condensed consolidated statements of operations.
As of March 31, 2022 and December
31, 2021, total unpaid fees due to Temple pursuant to these agreements are $1,785,000 and $1,726,000, respectively, which are included
as part of Accounts Payable – license agreements in the accompanying condensed consolidated balance sheets. With regards to the
unpaid fees to Temple, a total of $135,000 are deferred until such time the Company achieves a revenue milestone of $835,000 or upon termination
of the licensing agreements and the remaining $1,650,000 are deemed past due. The Company is currently in discussions with Temple to settle
or cure the past due balance.
No revenues were earned from
the two License Agreements during the three-month periods ended March 31, 2022 and March 31, 2021.
During the three months ended
March 31, 2022, the Company issued 1,191,666 shares of its common stock as follows:
| |
· |
The Company issued 366,666 shares of its common stock upon the conversion of $11,000 in convertible notes pursuant to the convertible notes conversion price of $0.03 per share. |
| |
· |
The Company issued 825,000 shares of its common stock upon the exercise of warrants of $25,000 valued at $0.03 per share. |
| |
8. |
Stock Options and Warrants |
The Company periodically issues
stock options and warrants to employees and non-employees in capital raising transactions, for services, and for financing costs.
Options
Options vest according to
the terms of the specific grant and expire from 2 to 10 years from date of grant. The weighted-average, remaining contractual life
of employee and non-employee options outstanding at March 31, 2022 was 5.4 years. Stock option activity for the period January 1, 2022
up to March 31, 2022, was as follows:
| Schedule of stock option activity | |
| | | |
| | |
| | |
Options | | |
Weighted
Avg. Exercise
Price | |
| January 1, 2022 | |
| 31,080,601 | | |
$ | 0.17 | |
| Granted | |
| – | | |
| – | |
| Exercised | |
| – | | |
| – | |
| Expired | |
| (4,000,000 | ) | |
| 0.25 | |
| March 31, 2022 | |
| 27,080,601 | | |
$ | 0.16 | |
The weighted average exercise
prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2022 were as follows:
| Schedule of options outstanding by per share price | |
| |
| |
| | |
| |
| |
| | |
Outstanding Options | |
Exercisable Options |
Option Exercise Price Per Share | |
Shares | |
Life
(Years) | |
| Weighted
Average Exercise
Price | |
Shares | |
| Weighted
Average Exercise
Price |
| $0.02 - $0.24 | |
22,305,551 | |
5.9 | |
$ | 0.10 | |
22,305,551 | |
$ | 0.10 |
| $0.25 - $0.49 | |
4,153,552 | |
3.6 | |
| 0.35 | |
4,153,552 | |
| 0.35 |
| $0.50 - $0.99 | |
471,052 | |
2.1 | |
| 0.85 | |
471,052 | |
| 0.85 |
| $1.00 - $2.00 | |
150,446 | |
1.3 | |
| 1.18 | |
150,446 | |
| 1.18 |
| | |
27,080,601 | |
5.4 | |
| 0.16 | |
27,080,601 | |
| 0.16 |
During the three-month
periods ended March 31, 2022 and 2021, the Company recognized compensation costs based on the fair value of options that vested of $0
and $10,000 respectively.
At March 31, 2022, the aggregate
intrinsic value of the options outstanding at March 31, 2021 was $22,000.
Warrants
The following table summarizes
certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2022 up to March 31,
2022.
| Schedule of warrant activity | |
| | | |
| | |
| | |
Warrants | | |
Weighted Avg.
Exercise Price | |
| January 1, 2022 | |
| 19,977,149 | | |
$ | 0.04 | |
| Granted | |
| 599,999 | | |
| 0.04 | |
| Exercised | |
| (825,000 | ) | |
| 0.03 | |
| Expired | |
| (99,999 | ) | |
| 0.09 | |
| March 31, 2022 | |
| 19,652,149 | | |
$ | 0.04 | |
The weighted average exercise
prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2022 were as follows:
| Schedule of warrants outstanding by per share price | |
| |
| |
| | |
| |
| |
| | |
Outstanding Warrants | |
Exercisable Warrants |
| Warrant Exercise Price Per Share | |
Shares | |
Life
(Years) | |
| Weighted Average Exercise Price | |
Shares | |
| Weighted Average Exercise Price |
| $0.02 - $0.24 | |
19,582,149 | |
0.6 | |
$ | 0.04 | |
19,548,816 | |
$ | 0.04 |
| $0.25 - $0.49 | |
– | |
– | |
| – | |
– | |
| – |
| $0.50 - $1.00 | |
70,000 | |
2.1 | |
| 0.80 | |
70,000 | |
| 0.80 |
| | |
19,652,149 | |
0.6 | |
| 0.04 | |
19,618,816 | |
| 0.04 |
In
the three-month period ending March 31, 2022, the Company issued warrants to purchase 599,999 shares of common stock in exchange for services.
The warrants are exercisable at a price of $0.03 to $0.05, vesting up to one month from the date of grant, and expiring two to five years
from the date of grant. Total fair value of these warrants at grant date was $24,000 using the Black-Scholes Option Pricing model with
the following assumptions : life of 2 to 5 years; risk free interest
rate of 0.73% to 2.14%; volatility of 193% to 245% and dividend yield of 0%. During the three-month period ended March 31, 2022, the Company
recognized compensation costs based on the fair value of warrants that vested of $24,000.
At March 31, 2022, the aggregate
intrinsic value of warrants outstanding was $68,000.
| |
9. |
Commitments and Contingencies |
There is no current or pending
litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of
business.
QS Energy is working to maintain
normal operations during the current COVID-19 pandemic under social distancing and shelter-in-place guidelines as recommended or required
by the CDC, federal, state and county government agencies. The Company has moved many operational functions to the cloud. Our employees
can perform most vital functions remotely. Most day-to-day operations have been minimally impacted by COVID-19. It is unclear what impact
COVID-19 may have on our supply chain, or on our ability to operate on-site at the demonstration project. The Company has experienced
delays and cost overruns due to COVID-19 impacts on our supply chain. We have not been made aware of any COVID-19 restrictions at the
demonstration site that would impact our ability to restart our demonstration testing. No assurances can be made that COVID-19 will not
materially affect our supply chain, will not negatively affect access to the demonstration site, restrict operations at the demonstration
site, or negatively impact our ability to fund continued operations.
In April and May 2022, the
Company issued 1,582,500 shares of common stock upon the exercise of warrants for proceeds of $47,000 at an exercise price of $0.03 per
share.
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and
analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements
and supplementary data referred to in this Form 10-Q.
This discussion contains forward-looking
statements that involve risks and uncertainties. Such statements, which include statements concerning future revenue sources and concentration,
selling, general and administrative expenses, research and development expenses, capital resources, additional financings and additional
losses, are subject to risks and uncertainties, including, but not limited to, those discussed elsewhere in this Form 10-Q, and in the
“Risk Factors” that could cause actual results to differ materially from those projected. Unless otherwise expressly indicated,
the information set forth in this Form 10-Q is as of March 31, 2022, and we undertake no duty to update this information.
Overview
QS Energy, Inc. (“QS
Energy” or “Company” or “we” or “us” or “our”) develops and seeks to commercialize
energy efficiency technologies that assist in meeting increasing global energy demands, improving the economics of oil transport, and
reducing greenhouse gas emissions. The Company's intellectual properties include a portfolio of domestic and international patents and
patents pending, a substantial portion of which have been developed in conjunction with and exclusively licensed from Temple University
of Philadelphia, PA (“Temple”). QS Energy's primary technology is called Applied Oil Technology (AOT), a commercial-grade
crude oil pipeline transportation flow-assurance product. Engineered specifically to reduce pipeline pressure loss, increase pipeline
flow rate and capacity, and reduce shippers’ reliance on diluents and drag reducing agents to meet pipeline maximum viscosity requirements,
AOT is a 100% solid-state system that is designed to reduce crude oil viscosity by applying a high intensity electrical field to crude
oil while in transit.
Our Company was incorporated
on February 18, 1998, as a Nevada Corporation under the name Mandalay Capital Corporation. The Company changed its name to Save the World
Air, Inc. on February 11, 1999. Effective August 11, 2015, the Company changed its name to QS Energy, Inc. The name change was affected
through a short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Additionally, QS Energy Pool, Inc., a California
corporation, was formed as a wholly owned subsidiary of the Company on July 6, 2015 to serve as a vehicle for the Company to explore,
review and consider acquisition opportunities. To date, QS Energy Pool has not entered into any acquisition transaction. However, the
Company may still consider entering into potential beneficial acquisitions. The Company is considering dissolving QS Energy Pool to reduce
costs associated with operating this subsidiary. The Company’s common stock is quoted under the symbol “QSEP” on the
Over-the-Counter market. More information including the Company’s updates, fact sheet, logos and media articles are available at
our corporate website, www.qsenergy.com.
As previously reported in
our Form 10-K filed with the SEC on July 22, 2021, QS Energy’s AOT technology has been tested in a variety of configurations at
small-scale in the laboratory and at full-scale in the field under commercial operating conditions, including tests performed U.S. Department
of Energy, the PetroChina Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™. The Company’s first two full-scale
midstream pipeline installations were on TransCanada’s Keystone pipeline in 2014 and a pipeline operated by Kinder Morgan Crude
& Condensate, LLC in 2015. Tests performed at these two facilities were limited due primarily to technical issues with the AOT equipment.
Although tests at these facilities provided limited sets of data, the equipment did not operate properly, and no conclusions could be
reached regarding the efficacy or commercial viability of the AOT technology. Also, in 2014, the Company began development of a product
based on an electrical heat system which reduces oil viscosity through a process known as joule heat (“Joule Heat”). In December
2015, we suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the AOT. For more
information regarding prior history, development and testing of the AOT technology, and specifics regarding these earlier tests and technical
issues experience, please refer to our Form 10-K filed with the SEC on July 22, 2021.
In July 2017, the Company
filed for trademark protection for the word “eDiluent” in advance of rolling out a marketing and revenue strategy based on
the concept of using AOT to reduce pipeline dependence upon diluent to reduce viscosity of crude oils. A primary function of AOT is to
reduce viscosity by means of its solid-state electronics technology, in essence providing an electronic form of diluent, or “eDiluent”.
Subject to successful testing of our AOT technology and the availability of sufficient operating capital, the Company plans to market
and sell a value-added service under the name eDiluent, designed to be upsold by the Company’s midstream pipeline customers in an
effort to provide the Company with long-term recurring revenues.
Throughout 2018 our primary
strategic goal was focused on installing and operating a demonstration AOT project on a commercial crude oil pipeline. Much of our time
was spent meeting with industry executives and engineers in North and South America and working with local representatives in the Asian
and the Middle Eastern markets. In December 2018, we reached mutual agreement with a major U.S.-based pipeline operator on a demonstration
project under which we would install and operate our AOT equipment on a crude oil pipeline located in the Southern United States. We believed
at the time that the selected project site could be ideal for demonstration purposes, delivering heavy crudes which, based on samples
tested at Temple University, and, subject to the discussion below, could experience significant viscosity reduction when treated with
our AOT technology.
While management focused on
finding a partner and finalizing terms of the demonstration project, and in our continuing efforts to commercialize our AOT technology,
our engineering team worked throughout 2018 to prepare one of our inventoried AOT units for deployment. All system upgrades, inspections
and testing protocols were completed in December 2018. The pipeline operator finalized site selection and began site design and engineering
in January 2019, completing site preparation and equipment installation in June 2019. The project was installed within budget, quality
compliant, and without safety incidents. The system passed the pre-start safety review, data acquisition signal verifications, and mechanical
inspections. Under full crude oil flow, the system was confirmed to have no leaks and no environmental issues were noted. Data collected
during the full-flow startup phase confirmed internal differential pressures to be negligible and consistent with design specifications.
However, when the system was energized, and the unit was run-up to high-voltage operations, the primary power supply began to operate
erratically and had to be taken offline. Subsequent inspection determined the primary power supply had failed.
After removing the primary
power supply, our engineers reconfigured the system to run off a smaller secondary power supply. Although this unit was not capable of
achieving target treatment voltage, we performed limited testing and troubleshooting measures, after which the damaged power supply was
shipped to the manufacturer for expedited repair and reconditioning. Inspections performed during the repair process indicated internal
power supply components had been physically damaged. Though not definitive, it appears that damage may have occurred during transit prior
to initial installation at the demonstration site. While the demonstration project was offline for power supply repairs, our engineering
team worked with oil samples pulled from the operating pipeline for testing at our then Tomball laboratory facility. These tests were
designed to confirm our target power requirements as accurately as possible and help us fine-tune enhancements planned for a new optimized
AOT internal grid pack design we had planned to test at the demonstration site as part of our continuing reliability engineering effort.
During initial testing with
the small power supply, current draw was greater than prior field deployments. While it was expected that the small power supply would
not achieve treatment voltage, as voltage was increased, actual current draw experienced under test conditions exceeded the operating
limit of the power supply. Subsequent laboratory and in-field testing performed at our then Tomball facility showed the electrical conductivity
of the oil to be quite high and in line with field observations. Although these tests indicated the unit was generally functioning properly,
results further indicated the damaged power supply, once repaired, would not be capable of providing sufficient power to fully treat the
crude oil due to the oil’s high electrical conductivity. In anticipation of this result, the Company had initiated parallel tasks
in advance of testing of: i) installation of the repaired power supply and performance of limited testing to confirm laboratory and in-field
test results; and ii) procurement of a new power supply capable of providing significantly more power and a modified AOT grid pack assembly
reconfigured and generally optimized based on the latest laboratory and in-field test results.
When the repaired power supply
was installed in August 2019, the system operated as expected, and limited testing was performed. Results of this limited testing were
consistent with laboratory tests performed to date. As expected, however, the repaired power supply was not capable of providing sufficient
power to fully treat the crude oil under commercial operating conditions. Based on results of this limited testing, Company engineers
completed designs and began implementation of modifications to the AOT internal grid pack assembly.
The new high capacity power
supply and modified grid pack were installed in December 2019. However, prior to flooding the system with crude oil, early-phase startup
testing indicated an electrical short circuit. Subsequent inspection revealed damage to the internal grid pack which likely occurred during
installation or during the startup testing cycle. The grid pack was shipped offsite for repairs with reinstallation scheduled for January
2020.
The AOT demonstration project
continued to experience setbacks during the first quarter of 2020. After repairing and re-installing the modified grid pack, the system
shut down again during commissioning presenting with error conditions similar to the December 2019 failure. At that time, based on external
inspections and on-site testing, our engineers suspected the grid pack had again been damaged during re-installation and that such suspected
damage was the most likely cause of the electrical short circuit. It was determined at that time the best course of action would be to
remove the modified grid pack and re-install the original grid pack which had previously been installed multiple times without sustaining
damage, and perform a detailed inspection of the modified grid pack in an effort to determine the cause of the electrical short circuit.
Executing this plan, our team
removed the modified grid pack and re-installed the original grid pack assembly in January 2020. After removal, our engineers performed
a detailed inspection of the modified grid pack. Inconsistent with expectations, no damage to the modified grid pack was found during
this inspection, leaving the cause of the electrical short circuit undiagnosed.
In January and February 2020,
our engineers tested and attempted to operate the AOT under a variety of conditions. In these tests, the system could be run at high voltage
under static “shut-in” conditions; however, the system continued to shut down due to an electrical short circuit when operated
under pressure. In simple terms, this means the system could be flooded with crude oil and powered up in excess of 10,000 volts when the
system was shut-in by closing the intake and outtake valves which isolates the system from the pipeline’s operating pressure. However,
once the valves were opened and the system was subjected to the pipeline’s operating pressure, the system developed an electrical
short circuit and shut down.
As the presence of high pressure
appeared to trigger the short circuit, our engineers believed it is unlikely the fault was in the grid pack assembly as this component
was fully submerged in crude oil and would generally be subjected to equal pressure on all components. The electrical short was more likely
developing in the electrical connection assembly built into the blind flange at the top of the pressure vessel, which would be subjected
to high pressure under normal operating conditions. Unfortunately, this electrical connection assembly could not be inspected without
destroying the assembly itself. Instead, our engineers developed a plan to replace the installed the blind flange and electrical connection
assembly with components from inventory which would be rebuilt prior to installation.
As part of an ongoing reliability-engineering
effort, our engineers at that time worked on incremental modifications to improve electrical isolation within the blind flange and electrical
connection assembly. These previously developed plans allowed us to move quickly with vendors and present an expedited plan to the pipeline
operator. In March 2020, our engineers designed modifications to the blind flange, electrical connections and related housing intended
to minimize the effects of high pressure and likelihood of internal electrical short circuits. Concurrently, a blind flange with high
voltage assembly was shipped from inventory to a shop with specialized equipment used to strip the flange of all electrical insulation
materials. Once the stripping process was complete, castings were made to complete the internal assembly. Our engineers believed at the
time that this modification could solve the electrical short issue we have experienced in prior tests.
While the blind flange assembly
was being remanufactured, we took the opportunity to implement a number of relatively minor modifications to other system configurations
which had been planned for future units based on results of our engineering team’s reliability engineering work over the past two
years. These modifications were designed to improve the reliability of internal electrical connections, increase the structural support
of the internal grid pack, and maintain higher quality control over internal component positioning and alignment during vertical installation.
Notwithstanding our efforts,
the AOT system continues to be non-operational under normal operating conditions. As reported in previous updates on our website at https://qsenergy.com/updates
and in our Form 8-K filed with the SEC on March 4, 2020, the AOT system experienced shutdowns during the commissioning process. In December
2019, after installing a modified grid pack and new high-capacity power supply, the system shut down presenting with an electrical short
which was determined to be due to damage to the system’s internal grid pack likely incurred during installation. After repairing
and re-installing the modified grid pack in January 2020, the system shut down again during commissioning presenting with error conditions
similar to the December 2019 failure. At that time, based on external inspections and on-site testing, our engineers suspected the grid
pack had again been damaged during re-installation and that such suspected damage was the most likely cause of the electrical short circuit.
As reported in our January 24, 2020 website update page, it was determined at that time the best course of action would be to remove the
modified grid pack and re-install the original grid pack which had previously been installed multiple times without sustaining damage,
and perform a detailed inspection of the modified grid pack in an effort to determine the cause of the electrical short circuit.
We have tested and attempted
to operate the AOT under a variety of conditions. As noted above, we have been able to bring the system up to high voltage under static
“shut-in” conditions; however, the system continued to shut down due to an electrical short circuit when operated under pressure.
Because of our inability to fully diagnose the cause of our current electrical problems, we can provide no assurances that we will not
face other operational issues after completing a full diagnosis and evaluation of our technology.
As previously reported, in
December 2018, we entered into an agreement with a major U.S.-based pipeline operator under which the Company installed its AOT equipment
on a crude oil pipeline located in the Southern United States for testing and demonstration purposes. Based on laboratory tests and operations
of prototype equipment at other locations, we had a reasonable expectation that the equipment would operate successfully and that test
results would demonstrate quantifiable benefits to pipeline operators. This has not occurred. As discussed below, our equipment is no
longer installed or being tested at this demonstration site.
As reported in the Company’s
Form 10-K and Form 10-Q filed with the SEC on March 31, 2021 and June 29, 2020, respectively, and in the Company’s Form 10-K filed
with the SEC on March 31, 2022, website updates published on the Company’s website at https://qsenergy.com/updates, the Company
has experienced a number of difficulties and delays at the demonstration site. Despite identifying and implementing numerous design modifications
over the past several months, the Company has been unable to successfully operate its AOT equipment.
In late June 2020, equipment
modifications intended to mitigate electrical short circuit issues identified in earlier tests were completed. During startup testing,
the system experienced a new failure mode in which the system could be operated at a baseline high voltage (well below operational voltage
required to treat heavy crude), but after a period of time, the system would drop to very low voltage indicating a reduction in electrical
resistance in the AOT. This voltage drop was both dynamic, developing over time as electrical current was applied; and transient, in that
the power supply could be shut-down and re-started with this voltage drop characteristic repeating. After reviewing these results and
running subsequent in-field tests at the direction of the power supply manufacturer, they recommended a configuration modification to
the control module of the system’s high-voltage power supply which, in their experience, could resolve the system’s ability
to maintain constant voltage under our unique operating conditions in which the AOT essentially acts as a very large capacitor. During
the first week of July 2020, we modified the power supply control module at the direction of the power supply manufacturer. Though this
modification did appear to solve the voltage drop issue, the AOT could not achieve operational voltage as the system control module indicated
arc-faults when high voltage was applied above the baseline voltage levels. After many attempts to bring the system up to operating voltage,
arc-faults continued until the AOT demonstrated symptoms of what appeared to be a dead short (electrical short-to-ground; voltage dropped
to zero) and the system could no longer be re-started.
Our engineers have working
concepts as to what may be causing this most recent failure but will not be able to fully diagnose these issues at the demonstration site.
After discussions with our demonstration pipeline partner, it was mutually agreed that the best course of action would be to move the
equipment from the demonstration site to another location where our engineers could disassemble and inspect the equipment. Our AOT equipment
has been moved to storage, inspection, and testing sites in the state of Mississippi and in Tomball, Texas. Our former demonstration partner
has indicated their continued interest in our AOT technology and may consider installation and operation of a new AOT demonstration project
if our operational issues can be resolved.
Though our engineers have
working concepts as to what may be causing the most recent voltage drop and arc-fault issues, it is unknown whether these issues can be
solved with minor modifications to the current design. To fully diagnose and resolve these issues, new testing would likely need to be
performed in a laboratory setting. The time and cost of implementing such a plan would likely be significant. The Company did not have
sufficient capital to take on this endeavor. We shut down all testing of our AOT product in July 2020, due to a lack of operating capital.
See, however, note 11 (Subsequent Events) of our Consolidated Financial Statements, attached to our Form 10-K filed with the SEC on July
22, 2021, for an update of limited capital we received in the first two quarters of 2021, allowing us to commence some additional testing
of our AOT product. See also note 10 (Subsequent Events) of the Consolidated Financial Statements contained in this Form 10-Q report,
and Item 2 of Part II of this Form 10-Q report.
Following our receipt of the
limited capital identified in the paragraph above, and under new management, our engineer went to the new site of our AOT equipment to
inspect the condition of the equipment and develop logistics of testing going forward. Our engineer commenced re-testing operations in
June 2021. Our engineer has reported that the AOT has been unloaded and the electrical connection has been ordered. The unit will undergo
testing to try and duplicate the electrical short condition experienced at the test site. After initial testing, a troubleshooting sequence
will be performed to attempt to identify the location of the short. If an electrical short can be found based on our hypothesis, we intend
to resolve it. If the electrical short cannot be found the AOT will be disassembled and tested in pieces, assuming we are able to raise
sufficient capital to do so. Additionally, laboratory materials testing of the electrical insulation will be initiated. Measurement of
the electrical properties of both newly cast and material both exposed and submerged in fluid will be done to determine if the resin remains
our material of choice. Our engineer reports that he is expecting to visit the AOT in July 2021 to inspect all the connections and conduct
initial testing while the AOT is empty. He further reports that lab test fixtures are being designed and initial designs could be available
for review in August 2021. Because of our inability fully to diagnose the cause of our current electrical problems, we can provide no
assurances that we will not face other operational issues after completing a full diagnosis and evaluation of our technology, requiring
additional capital, which, as stated above, may not be available to us.
During the visit a plan was
developed to prepare the location for the inspection and testing of the AOT and AOT components. A transformer was needed to provide power
to the power supply. Due to supply chain issues the transformer delivery was delayed until July.
Re-testing of the AOT began
in July 2021 and the dead short condition that had developed during the demonstration was not present. Various tests were conducted to
control variables and identify possible reasons for the arcs and short circuits. We ran tests to isolate debris, plate spacing, alignment
of grid pack, presence of oil and presence of the pressure vessel. The best results obtained with the new stack were when the stack had
been cleaned, assembled in a hanging position and was outside of the vessel.
For comparison the old stack
was tested in a similar manner, and, by chance, arcs were observed near insulated parts. The stack was inspected where the arcs were witnessed,
and damaged insulation was found. It seems likely these locations failed during the demonstration and led to the short circuits.
Testing of grid screens in
isolation showed the ability to achieve much higher voltages. Additional testing following our
Form 10-Q report for the period ended September 30, 2021 resulted in conceptual methods/designs to control the variables in a full stack
to achieve similar voltages as the isolation tests. The new design will control plate alignment and flatness to a much greater extent
than the previous design. Secondarily, the new design constrains the stack alignment during installation should prevent shifting and damage
during installation.
The results of the electrical
testing of the insulating material showed that the material is functioning as designed. However, during the testing it was discovered
that the material swells when exposed to crude oil. The current design does not accommodate a change in size of the parts. New materials
were sourced and tested as potential replacements. A couple of new materials have been found that offer improved stability when submerged
in crude oil for extended periods of time. To expedite the search several materials tested were purchased of the shelf while working with
our vendors to source new commercial materials. The data has been shared with our vendors and they are working on providing us with samples
of commercial versions of the promising materials.
We have also validated that
a new design concept for the grid pack will reduce arcing and allowed us to apply full voltage during a recent test. A 3rd
party engineering firm with proper experience and three-dimensional modeling software was engaged. A design review has been completed
and final drawings have been received. Drawings have been sent to our vendors for review and pending no issues the ordering process for
prototype parts, for fit and electrical testing, should be well under way by March 31, 2022.
The design criteria mentioned
above were shared in our investor update, dated April 15, 2022and are reproduced here for ease of reference:
1. Round
the edges of all metal surfaces.
2. Eliminate
perpendicular surface of insulators.
3. Ensure
the gaps between adjacent grid plates are uniform.
4. Ensure
there can be no interference from mating parts when making any connections but most especially electrical connections.
5. Change
grid plate’s shape eliminating all corners and fully insulate the perimeter of the grid plate.
6. Find
new insulating material for supports and spacers.
7. Change
blind mechanical and electrical designs to be less sensitive to physical changes in insulation.
The work through May 2022
has mainly focused on selecting a new material of construction for the insulating parts to reduce possible absorption of oil by the insulators.
Adsorbing components from crude oil could lead to a change in size and possibly to unanticipated mechanical and electrical properties.
The new material shows minimal change and is over 90% improved than the previous insulating material in accelerated aging tests.
Due to slow response times
from our initial design contractor, we selected a new contractor to complete the design work. We continue to seek an immersion test to
finalize the new insulator design despite the change. We are hopeful the results will confirm our new design will be fit for purpose and
will be able to greenlight the construction and testing of the full sized AOT.
If we are able to raise sufficient
capital to continue our ongoing research, development, and testing efforts for a full scale AOT, we would also consider designing, testing
and commercializing a smaller scale AOT unit targeting upstream, trucking and rail applications. This strategy could reduce development
time and costs, with the intention of moving back into the midstream crude oil pipeline market subsequent to successful commercial operations
at a smaller scale.
The Company currently has
limited capital resources and will need to raise substantial capital to continue operations. We are considering all options but can provide
no assurances that additional capital will be available to us, or if it is, that such additional capital will be offered at acceptable
terms, nor can we provide any assurances that if capital would be available to us on acceptable terms, any redesign and testing of our
AOT equipment would prove successful.
Assuming the corrective actions
discussed above are achieved, our plans moving forward are centered on achieving commercial adoption of our AOT device. Assuming successful
testing and operations, we believe the AOT project should provide data requested by prospective customers such as real-time changes in
viscosity, pipeline pressure drop reduction and increases in pipeline operating flowrates. All collected data at the AOT demonstration
site will be normalized such that it can be used to evaluate the financial and operational benefits across a wide range of commercial
operating scenarios without disclosing confidential details of any demonstration partner’s operations. We believe that real-world
data from our AOT project may be used to accelerate our desire to achieve commercial adoption of our AOT technology, positioning us to
re-engage with industry executives.
Providing sufficient working
capital can be obtained, QS Energy intends to continue to work to maintain normal operations during the current COVID-19 pandemic under
social distancing and shelter-in-place guidelines as recommended or required by the CDC, federal, state and county government agencies.
Over the past few years, the Company moved much of its operations to the cloud. Our employees can perform most vital functions remotely.
Currently, most day-to-day operations have been minimally impacted by COVID-19.
It is unclear, however, what
impact COVID-19 may have on our supply chain, or on our ability to operate and test our AOT technology. As of the date of this report,
few suppliers related to our testing efforts have announced reduced operating capacity or advised us of delays related to COVID-19 restrictions;
furthermore, we have not been made aware of any COVID-19 restrictions at that would impact our ability to restart our onsite testing activities.
COVID-19 has had a significant
negative financial impact across a wide spectrum of industries, both in terms of operations and access to operating capital. The Company’s
ability to continue operations is, in part, dependent on our access to funding. A published by the National Association of Manufacturers
in March 2020 reports that due to COVID-19, 35% of manufacturers surveyed anticipate supply chain disruptions, 53% anticipate changes
to operations, and 78% anticipate a negative financial impact. With these facts in mind, no assurances can be made that COVID-19 will
not affect our supply chain, will not negatively affect access or operating restrictions on our AOT technology, or negatively impact our
ability to fund continued operations.
Our expenses to date have
been funded through the sale of shares of common stock and convertible debt, as well as proceeds from the exercise of stock purchase warrants
and options. We will need to raise substantial additional capital through 2022, and beyond, to fund work on our AOT, our sales and marketing
efforts, continuing research and development, and certain other expenses, including without limitation, legal and accounting expenses,
until we are able to achieve a revenue base. We can provide no assurances that additional capital will be available to us, or if it is,
that such additional capital will be offered at acceptable terms.
There are significant risks
associated with our business, our Company and our stock. See “Risk Factors,” below.
We are dedicated to the crude
oil production and transportation marketplace, with a specifically targeted product offering for enhancing the flow-assurance parameters
of new and existing pipeline gathering and transmission systems.
Our primary goal is to provide
the oil industry with a cost-effective method by which to increase the number of barrels of oil able to be transported per day through
the industry’s existing and newly built pipelines. The greatest impact on oil transport volume may be realized through reductions
in pipeline operator reliance on diluent for viscosity reduction utilizing AOT technology; a process the Company refers to as electronic
diluent, or “eDiluent”. The Company filed for trademark protection of the term eDiluent in 2017. We also seek to provide the
oil industry with a way to reduce emissions from operating equipment. We believe our goals may be realizable via viscosity reduction using
our AOT product line.
We believe QS Energy’s
technologies will enable the petroleum industry to gain key value advantages boosting profit, while satisfying the needs of regulatory
bodies at the same time. Key players in the pipeline industry continue to demonstrate interest in our technologies.
Our manufacturing strategy
is to contract with third-party vendors and suppliers, each with a strong reputation and proven track record in the pipeline industry.
These vendors are broken up by product component subcategory, enabling multiple manufacturing capacity redundancies and safeguards to
be utilized. In addition, this strategy allows the Company to eliminate the prohibitively high capital expenditures such as costs of building,
operating and maintaining its own manufacturing facilities, ratings, personnel and licenses, thereby eliminating unnecessary capital intensity
and risk.
Results of Operations for Three months ended
March 31, 2022 and 2021
| | |
Three months ended | |
| | |
March 31, | |
| | |
2022 | | |
2021 | | |
Change | |
| Revenues | |
$ | – | | |
$ | – | | |
$ | – | |
| Costs and Expenses | |
| | | |
| | | |
| | |
| Operating expenses | |
| 200,000 | | |
| 214,000 | | |
| (14,000 | ) |
| Research and development expenses | |
| 48,000 | | |
| 47,000 | | |
| 1,000 | |
| Loss from operations | |
| (248,000 | ) | |
| (261,000 | ) | |
| 13,000 | |
| Other income (expense) | |
| | | |
| | | |
| | |
| Forgiveness of PPP loan payable | |
| 24,000 | | |
| – | | |
| 24,000 | |
| Interest and financing expense | |
| (77,000 | ) | |
| (110,000 | ) | |
| 33,000 | |
| Net Loss | |
$ | (301,000 | ) | |
$ | (371,000 | ) | |
$ | 70,000 | |
Operating expenses were $200,000
for the three-month period ended March 31, 2022, compared to $214,000 for the three-month period ended March 31, 2021, a decrease of $14,000.
This is due to an increase in non-cash expenses of $11,000, offset by a decrease in cash expenses of $25,000. Specifically, the increase
in non-cash expenses are attributable to an increase in warrants issued as compensation for services of $21,000, offset by a decrease
in stock compensation expense attributable to options granted to employees and directors of $10,000. The decrease in cash expense is attributable
increases in consulting fees of $50,000, legal and accounting of $43,000, office expenses of $4,000, travel expenses of $3,000, and other
expenses of $1,000, offset by decreases in rent and utilities of $49,000, salaries and benefits of $38,000, insurance of $35,000, corporate
expenses of $3,000, patent expenses of $1,000.
Research and development expenses
were $48,000 for the three-month period ended March 31, 2022, compared to $47,000 for the three-month period ended March 31, 2021, an
increase of $1,000. This increase is attributable an increase in prototype product development costs of $1,000.
Other income and expense were
$53,000 expense for the three-month period ended March 31, 2022, compared to $110,000 expense for the three-month period ended March 31,
2021, a net decrease in other expenses of $57,000. This decrease is attributable to a decrease in non-cash other expenses of $33,000,
offset by an increase in PPP forgiveness debt income of $24,000. The decrease in non-cash other expense is due to decreases in expense
attributable to interest, beneficial conversion factors and warrants associated with convertible notes issued in the amount of $33,000.
The Company had a net loss
of $301,000, or $0 per share, for the three-month period ended March 31, 2022, compared to a net loss of $371,000, or $0 per share, for
the three-month period ended March 31, 2021.
Liquidity and Capital Resources
General
As reflected in the accompanying
condensed consolidated financial statements, the Company has not yet generated significant revenues and has incurred recurring net losses.
We have incurred negative cash flow from operations since our inception in 1998 and a stockholders’ deficit of $4,419,000 as of
March 31, 2022. Our negative operating cash flow for the periods ended March 31, 2022 was funded primarily through issuance of convertible
notes and execution of options and warrants to purchase common stock.
The
accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization
of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed
consolidated financial statements, the Company had a net loss of $301,000 and a negative cash flow from operations of $77,000 for the
three-month period ended March 31, 2022. In addition, as of March 31, 2022, twenty-nine notes payable with an aggregate balance of $1,401,000
and certain obligations to a former officer are past due . These
factors raise substantial doubt about our ability to continue as a going concern. In addition, the Company’s independent registered
public accounting firm, in its report on the Company’s December 31, 2021 financial statements, has raised substantial doubt about
the Company’s ability to continue as a going concern.
Our ability to continue as
a going concern is dependent upon our ability to raise additional funds and implement our business plan. The consolidated financial statements
do not include any adjustments that might be necessary if we are unable to continue as a going concern.
Summary
During the period ended March
31, 2022, we received cash totaling $25,000 from issuance of exercised warrants and used cash in operations of $77,000. At March 31, 2022,
we had cash on hand in the amount of $62,000. We will need additional funds to operate our business, including without limitation the
expenses we will incur in connection with the license agreements with Temple University; costs associated with product development and
commercialization of the AOT and related technologies; costs to manufacture and ship our products; costs to design and implement an effective
system of internal controls and disclosure controls and procedures; costs of maintaining our status as a public company by filing periodic
reports with the SEC and costs required to protect our intellectual property. In addition, as discussed above, we have substantial contractual
commitments, including without limitation salaries to our executive officers pursuant to employment agreements, certain severance payments
to a former officer and consulting fees, during the remainder of 2022 and beyond.
No assurance can be given
that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company.
Licensing Fees to Temple University
For details of the licensing
agreements with Temple University, see Financial Statements, Part I, Item 1, Note 6 (Research and Development).
Critical Accounting Policies and Estimates
Our discussion and analysis
of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements
and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses,
and related disclosure of contingent assets and liabilities. We evaluate, on an on-going basis, our estimates and judgments, including
those related to the useful life of the assets. We base our estimates on historical experience and assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these estimates.
The methods, estimates and
judgments we use in applying our most critical accounting policies have a significant impact on the results that we report in our consolidated
financial statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important
to the portrayal of a company’s financial condition and results of operations and those that require management’s most difficult,
subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain at the time
of estimation. For a more detailed discussion of the accounting policies of the Company, see Note 2 of the Notes to the Consolidated Financial
Statements, “Summary of Significant Accounting Policies”.
We believe the following critical
accounting policies, among others, require significant judgments and estimates used in the preparation of our consolidated financial statements.
Estimates
The preparation of consolidated
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of expenses during the reporting period. Certain significant estimates were made in connection
with preparing our consolidated financial statements as described in Note 2 to Notes to Consolidated Financial Statements. Actual results
could differ from those estimates.
Stock-Based Compensation
The Company periodically issues
stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The
Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance provided by the
Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized over the vesting period.
The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance
of the Financial Accounting Standards Board whereas the value of the stock compensation is based upon the measurement date as determined
at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity
instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line
basis. In certain circumstances where there are no future performance requirements by the non-employee, option grants are immediately
vested and the total stock-based compensation charge is recorded in the period of the measurement date.
The fair value of the Company's
common stock option grants is estimated using the Black-Scholes Option Pricing model, which uses certain assumptions related to risk-free
interest rates, expected volatility, expected life of the common stock options, and future dividends. Compensation expense is recorded
based upon the value derived from the Black-Scholes Option Pricing model, and based on actual experience. The assumptions used in the
Black-Scholes Option Pricing model could materially affect compensation expense recorded in future periods.
Going Concern
The
accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial
statements, during the three-months ended March 31, 2022, the Company incurred a net loss of $301,000, used cash in operations of $77,000
and had a stockholders’ deficit of $4,419,000 as of March 31, 2022. In addition, as of March 31, 2022, twenty nine notes payable
with an aggregate balance of $1,401,000 and certain obligations to a former officer are past due .
These factors raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to
continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The
financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
At March 31, 2022, the Company
had cash on hand in the amount of $62,000. Management estimates that the current funds on hand will be sufficient to continue operations
through November 2022. Management is currently seeking additional funds, primarily through the issuance of debt and equity securities
for cash to operate our business, including without limitation the expenses it will incur in connection with the license agreements with
Temple; costs associated with product development and commercialization of the AOT technologies; costs to manufacture and ship the products;
costs to design and implement an effective system of internal controls and disclosure controls and procedures; costs of maintaining our
status as a public company by filing periodic reports with the SEC and costs required to protect our intellectual property. In addition,
as discussed below, the Company has substantial contractual commitments, including without limitation salaries to our executive officers
pursuant to employment agreements, certain payments to a former officer and consulting fees, during the remainder of 2022 and beyond.
No assurance can be given
that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the
Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or
cause substantial dilution for our stockholders in case of equity financing.
Recent Accounting Polices
See Footnote 2 in the accompanying
financial statements for a discussion of recent accounting policies.