Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2018

or

 

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission File Number 0-29185

 

QS ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

Nevada 52-2088326

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

23902 FM 2978

Tomball, TX 77375

(Address, including zip code, of principal executive offices)

 

(805)-845-3561

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Exchange Act: None.

 

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.001 par value.

 

Check whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

 

  Large accelerated filer  ☐ Accelerated filer ☐
  Non-accelerated filer ☐ Smaller reporting company ☒
  Emerging growth company ☐  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

The number of shares of the Registrant’s Common Stock outstanding as of May 14, 2018 was 243,104,265.

 

 

 

   

 

 

QS ENERGY, INC.
FORM 10-Q

 

INDEX

 

PART I – FINANCIAL INFORMATION 3
Item 1.   Unaudited Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations, Unaudited 4
Condensed Consolidated Statement of Stockholders’ Deficit, Unaudited 5
Condensed Consolidated Statements of Cash Flows, Unaudited 6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3.   Quantitative and Qualitative Disclosure about Market Risk 21
Item 4.   Controls and Procedures 21
PART II – OTHER INFORMATION  
Item 1.   Legal Proceedings 22
Item 1A.   Risk Factors 22
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3.   Defaults Upon Senior Securities 22
Item 4.   Mine Safety Disclosures 22
Item 5.   Other Information 22
Item 6.   Exhibits 23
SIGNATURES 24
EXHIBITS 25
EXHIBIT 31.1  
EXHIBIT 31.2  
EXHIBIT 32  

 

 

 

 

 i 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Unaudited Condensed Consolidated Financial Statements

 

QS ENERGY, INC.

Condensed Consolidated Balance Sheets

 

   March 31,     
   2018   December 31, 
   (unaudited)   2017 
ASSETS
Current assets:          
Cash  $225,000   $204,000 
Prepaid expenses and other current assets   23,000    38,000 
Total current assets   248,000    242,000 
Property and equipment, net of accumulated depreciation of $59,000 and $51,000 at March 31, 2018 and December 31, 2017, respectively   38,000    46,000 
Other assets   2,000    2,000 
Total assets  $288,000   $290,000 
           
LIABILITIES AND STOCKHOLDERS’ DEFICIT          
Current liabilities:          
Accounts payable-license agreements  $915,000   $852,000 
Accounts payable and accrued expenses   763,000    748,000 
Accrued expenses and accounts payable-related parties   37,000    31,000 
Convertible debentures, net of discounts of $183,000 and $47,000 at March 31, 2018 and December 31, 2017, respectively   577,000    533,000 
Total current liabilities   2,292,000    2,164,000 
           
Commitments and contingencies          
           
Stockholders’ deficit          
Common stock, $.001 par value: 500,000,000 shares authorized, 236,751,367 and 234,076,907 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively   236,752    234,077 
Additional paid-in capital   108,568,248    108,000,923 
Accumulated deficit   (110,809,000)   (110,109,000)
Total stockholders’ deficit   (2,004,000)   (1,874,000)
Total liabilities and stockholders’ deficit  $288,000   $290,000 

    

See notes to condensed consolidated financial statements.

 

 

 

 3 

 

 

QS ENERGY, INC.

Condensed Consolidated Statements of Operations, Unaudited

 

   Three months ended 
   March 31, 
   2018   2017 
         
Revenues  $   $50,000 
           
Costs and Expenses          
Operating expenses   494,000    1,258,000 
Research and development expenses   47,000    64,000 
Loss before other income (expense)   (541,000)   (1,272,000)
           
Other income (expense)          
Interest and financing expense   (159,000)   (212,000)
           
Net Loss   (700,000)   (1,484,000)
Net loss per common share, basic and diluted  $(0.00)  $(0.01)
Weighted average common shares outstanding, basic and diluted   234,610,752    199,260,966 

 

See notes to condensed consolidated financial statements.

 

 

 

 4 

 

 

QS ENERGY, INC.

Condensed Consolidated Statement of Stockholders’ Deficit, Unaudited

For the Three months Ended MARCH 31, 2018

 

   Common Stock   Additional
Paid-in
   Accumulated   Total Stockholders’ 
   Shares   Amount   Capital   Deficit   Deficit 
Balance, January 1, 2018   234,076,907   $234,077   $108,000,923   $(110,109,000)  $(1,874,000)
Common stock issued on exercise of warrants and options   1,345,710    1,346    69,654         71,000 
Fair value of common stock issued on conversion of notes payable   1,278,750    1,279    97,721         99,000 
Fair value of warrants and beneficial conversion feature of issued convertible notes             245,000         245,000 
Fair value of options and warrants issued as compensation             143,000         143,000 
Common stock issued for services   50,000    50    11,950         12,000 
Net loss                  (700,000)   (700,000)
Balance, March 31, 2018   236,751,367   $236,752   $108,568,248   $(110,809,000)  $(2,004,000)

 

See notes to condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 5 

 

 

  

QS ENERGY, INC.

Condensed Consolidated Statements of Cash Flows, Unaudited

 

   Three months ended 
   March 31 
   2018   2017 
Cash flows from Operating Activities          
Net loss  $(700,000)  $(1,484,000)
Adjustments to reconcile net loss to net cash used in operating activities:          
Stock based compensation expense   143,000    235,000 
Issuance of common stock for services   12,000     
Amortization of debt discount and accrued interest   143,000    192,000 
Depreciation and amortization   8,000    2,000 
Changes in operating assets and liabilities:          
Prepaid expenses and other current assets   15,000    (5,000)
Accounts payable and accrued expenses   15,000    141,000 
Accounts payable – license agreements   63,000    66,000 
Accounts payable and accrued expenses – related parties   6,000    662,000 
Deposits and other current liabilities       20,000 
Net cash used in operating activities   (295,000)   (171,000)
Cash flows from investing activities          
Purchase of equipment       (19,000)
Net cash used in investing activities       (19,000)
Cash flows from financing activities          
Net proceeds from issuance of convertible notes and warrants   245,000    201,000 
Net proceeds from exercise of warrants and options   71,000     
Net cash provided by financing activities   316,000    201,000 
Net increase in cash   21,000    11,000 
Cash, beginning of period   204,000    136,000 
Cash, end of period  $225,000   $147,000 
           
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  $99,000   $120,000 
Fair value of warrants and beneficial conversion feature associated with issued convertible notes   245,000    201,000 

 

See notes to condensed consolidated financial statements.

 

 

 

 6 

 

 

QS ENERGY, INC.
Notes to Condensed Consolidated Financial Statements, Unaudited

THREE MONTHS ENDED MARCH 31, 2018 AND 2017

 

  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 Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

 

QS Energy develops and commercializes 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. 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 reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. The AOT product has transitioned from the 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.

 

The Company commenced, but has suspended for now, commercial development of a suite of products based around the Joule Heat technology. The Company began fabrication of prototype equipment to be operated under a joint development agreement with a commercial entity in the fourth quarter of 2014. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. In addition, the Company filed two additional provisional patents related to the technology’s method and apparatus. In December 2015, we temporarily suspended Joule Heat development activities to focus Company resources on finalizing commercial development of the AOT Midstream. We currently plan to resume Joule Heat development in in the future depending on the availability of sufficient capital and other resources.

 

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, 2017 filed with the SEC. The condensed consolidated balance sheet as of December 31, 2017 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 fiscal year-end results.

 

  2. Summary of Significant Accounting Policies

 

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.

 

 

 

 7 

 

 

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, 2018, the Company incurred a net loss of $700,000, used cash in operations of $295,000 and had a stockholders’ deficit of $2,004,000 as of that date. 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.

 

In addition, the Company's independent registered public accounting firm, in its report on the Company's December 31, 2017 financial statements, has raised substantial doubt about the Company's ability to continue as a going concern.

 

At March 31, 2018, the Company had cash on hand in the amount of $225,000. Management estimates that the current funds on hand will be sufficient to continue operations through August 2018. 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 2018 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.

 

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. In computing diluted income (loss) per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. Potential common shares that have an antidilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.

 

Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the respective periods. Basic and diluted (loss) per common share is the same for periods in which the Company reported an operating loss because all warrants and stock options outstanding are anti-dilutive. At March 31, 2018 and 2017, we excluded the outstanding securities summarized below, which entitle the holders thereof to acquire shares of common stock as their effect would have been anti-dilutive.

 

   March 31,
2018
   March 31,
2017
 
Options   37,301,300    29,974,256 
Warrants   17,590,812    9,064,317 
Common stock issuable upon conversion of notes payable   7,047,333    4,527,233 
Total   61,939,445    43,565,806 

 

 

 

 

 8 

 

 

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.

 

Revenue Recognition Policy

 

In September 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09 (ASU No. 2014-09) regarding revenue recognition. The new standard provides authoritative guidance clarifying the principles for recognizing revenue and developing a common revenue standard for U.S. generally accepted accounting principles. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange for those goods or services. The ASU became effective January 1, 2018.

 

The Company’s commercialization of our energy efficiency technologies that would assist in meeting increasing global energy demands, improving the economics of oil extraction and transport, and reducing greenhouse gas emission have not yet reached the market and therefore; have not generated considerable revenue. Due to the nature of the products leased by the Company and the stage of development in which the products reside the adoption of the new standard has had no quantitative effect on the financial statements.

 

Under the new guidance, revenue is recognized when control of promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those leased products and ancillary services. The Company will review its lease transactions to identify contractual rights, performance obligations, and transaction prices, including the allocation of prices to separate performance obligations, if applicable. Revenue and costs of sales are recognized once products/services are delivered to the customer’s control and performance obligations are satisfied.

 

Patent Costs

 

Patent costs consist of patent-related legal and filing fees. Due to the uncertainty associated with the successful development of our AOT and Joule Heat products, all patent costs are expensed as incurred. During the three-month periods ended March 31, 2018 and 2017, patent costs were $6,000 and $16,000, respectively, and were included as part of operating expenses in the accompanying consolidated statements of operations.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017. Entities will be able to transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company has determined that the adoption of ASU 2014-09 did not have a material impact on the Company’s financial statements.

 

In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and disclosures.

 

 

 

 9 

 

 

Other 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. Accrued Expenses and Accounts Payable

 

Accrued Expenses

 

On April 1, 2017, the Company executed a separation agreement and release effective with the Company’s Chief Executive Officer (CEO). As part of the agreement, the Company agreed to pay the CEO $580,000 in severance, payable in equal installment over 24 months. In addition, the Company also agreed to continue paying certain expenses for the CEO for 24 months with an estimated cost of $44,000. As a result, the Company accrued the entire $624,000 as of March 31, 2017 which was also reported as part of Operating expenses in the accompanying consolidated statements of operations. As of March 31, 2018 and December 31, 2017, $377,000 and $390,000, respectively, was due to our former CEO which was reported as part of Accrued expenses and accounts payable in the accompanying consolidated balance sheet.

 

Accrued Expenses and Accounts Payable – Related Parties

 

Accrued expense – related parties consists accrued salaries of officers and fees due to members of the Board of Directors. As of March 31, 2018, and December 31, 2017, accrued expenses and accounts payable to related parties amounted to $37,000 and $31,000, respectively.

 

  4. Property and Equipment

 

At March 31, 2018 and December 31, 2017, property and equipment consists of the following:

 

   March 31,
2018
(unaudited)
   December 31,
2017
 
         
Office equipment  $30,000   $30,000 
Furniture and fixtures   5,000    5,000 
Testing Equipment   37,000    37,000 
Leasehold Improvements   25,000    25,000 
Subtotal   97,000    97,000 
Less accumulated depreciation   (59,000)   (51,000)
Total  $38,000   $46,000 

 

Depreciation expense for the three-month periods ended March 31, 2018 and 2017 was $8,000 and $2,000, respectively.

 

  5. Convertible Notes  

 

  

March 31,
2018

(unaudited)

  

December 31

2017

 
Balance due on convertible notes  $680,000   $509,000 
Accrued interest   80,000    71,000 
Subtotal   760,000    580,000 
Convertible note discount   (183,000)   (47,000)
Balance on convertible notes, net of note discounts  $577,000   $533,000 

 

As in the prior years, the Company continues to issue 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 the Company’s common stock at a conversion price stipulated in the conversion agreement. In addition, the note holders received warrants to purchase shares of common stock that are fully vested and will expire in 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, the notes’ beneficial conversion feature or BCF, and original issue discount of 10% (OID). The note discounts are amortized over the term of the notes or amortized in full upon its conversion to common stock. At December 31, 2017, total outstanding notes payable amounted to $509,000, accrued penalty interest of $71,000 and unamortized note discount of $47,000, or a net balance of $533,000.

 

 

 

 10 

 

 

During the three-month period ended March 31, 2018, the Company issued similar convertible promissory notes in the aggregate of $270,000 for cash of $245,000 or a discount of $25,000. The notes do not bear any interest, however, the implied interest rate used was 10% since the notes were issued 10% less than its face value. The notes are unsecured, mature in twelve months from issuance and convertible at $0.08 per share. In addition, the Company also granted these note holders warrants to purchase 1.7 million shares of the Company’ common stock. The warrants are fully vested, exercisable at $0.08 per share and will expire in one year. As a result, the Company recorded a note discount of $270,000 to account for the relative fair value of the warrants, the notes’ beneficial conversion feature (BCF), and original issue discount (OID). The note discounts are being amortized over the term of the note or amortized in full upon the conversion to common stock. During the three-month period ended March 31, 2018 notes payable of $99,000 were converted into 1,278,750 shares of common stock.

 

As of March 31, 2018, total outstanding notes payable amounted to $680,000, accrued interest of $80,000 and unamortized note discount of $183,000 for a net balance of $577,000. A total of four notes in the aggregate of $399,000 have reached maturity and are past due.

 

  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, 2018 and 2017, our research and development expenses were $47,000 and $64,000 respectively.

 

AOT Product Development and Testing

 

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 testing 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.

 

During the three-month periods ended March 31, 2017, the Company incurred total expenses of $17,000 in the manufacture, delivery and testing of the AOT prototype equipment. The Company incurred similar expenses in the three-month period ended March 31, 2018. These expenses have been reflected as part of Research and Development expenses on the accompanying consolidated statements of operations.

  

Temple University Licensing Agreement

 

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.

 

 

 

 11 

 

 

As of December 31, 2016, total unpaid fees due to Temple pursuant to these agreements amounted to $726,000. In July 2017, the Company and Temple amended the Second Temple License agreement. Pursuant to the amendment, the Company paid Temple $62,000 and Temple agreed to defer payment of the remaining $135,000 in unpaid licensing fee until such time the Company generates revenues totaling $835,000 from the license. In addition, the unpaid balance of $135,000 will accrue interest of 9% per annum. As of December 31, 2017, all amounts owed under the Second Temple License agreement are either current or deferred under terms of the amendment.

 

Total expenses recognized during each three-month period ended March 31, 2018 and 2017 pursuant to these two agreements amounted to $47,000 and has been reflected in Research and Development expenses on the accompanying consolidated statements of operations. In the three-month periods ended March 31, 2018 and 2017, the Company also recognized penalty interest on past-due balances of $16,000 and $20,000, respectively, which is included as part of interest and financing expense in the accompanying statements of operations.

 

As of March 31, 2018, and December 31, 2017, total unpaid fees due to Temple pursuant to these agreements amounted to $905,000 and $842,000, respectively, which are included as part of Accounts payable – licensing agreements in the accompanying consolidated balance sheets. With regards to the unpaid fees to Temple, a total of $52,000 are current, $392,000 are deferred until such time the Company achieves a revenue milestone of $835,000 or upon termination of the licensing agreements and the remaining $461,000 are deemed past due. The past due amount of $461,000 is owed pursuant to the First Temple License. The Company is currently in negotiations with Temple to settle or cure the past due balance.

 

The Company generated $50,000 in revenue from the viscosity reduction license during the three-month period ended March 31, 2017. This amount is not sufficient to be subject to additional license fees under the license agreement. No revenues were earned from the two license agreements during the three-month period ended March 2018. 

 

Temple University Sponsored Research Agreement

 

From March 2012 through August 2015, the Company Temple University (“Temple”) provided research services at a fixed annual cost under a Sponsored Research Agreement (“Research Agreement”). The Research Agreement expired in August 2015. Temple University continues to perform laboratory tests on an as-needed basis, expenses are incurred on a per-test basis.

 

As of March 31, 2018, and December 31, 2017, total unpaid fees due to Temple pursuant to the Research Agreement were $10,000, which are included as part of Accounts payable – licensing agreements in the accompanying consolidated balance sheets. As of March 31, 2018, the entire $10,000 is deemed past due.

 

  7. Common Stock

 

During the three months ended March 31, 2018, the Company issued 2,674,460 shares of its common stock as follows:

 

  · The Company issued 1,278,750 shares of its common stock upon the conversion of $99,000 in convertible notes pursuant to the convertible notes conversion prices of $0.08 per share.

 

  · The Company issued 1,166,000 shares of its common stock upon the exercise of warrants for proceeds of $58,000 at exercise prices of $0.05 per share.

 

  · The Company issued 179,710 shares of its common stock upon the exercise of options for proceeds of $13,000 at exercise prices of $0.07 per share.

 

  · The Company issued 50,000 shares of common stock in exchange for services in aggregate value of $12,000.

 

  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 vest and expire according to terms established at the grant date.

 

 

 

 

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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, 2018 was 5.7 years. Stock option activity for the period January 1, 2018 up to March 31, 2018, was as follows:

 

    Options   Weighted
Avg. Exercise
Price
 
 January 1, 2018    35,397,675   $0.23 
 Granted    2,083,335   $0.18 
 Exercised    (179,710)  $0.07 
 Forfeited         
 March 31, 2018    37,301,300   $0.22 

 

The weighted average exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest as of March 31, 2018 were as follows:

 

    Outstanding Options   Exercisable Options
Option
Exercise Price
Per Share
  Shares     Life
(Years)
  Weighted
Average Exercise
Price
  Shares     Weighted
Average Exercise
Price
$ 0.05 - $ 0.99     37,150,854     5.7   $0.22     31,488,353     $0.22
$ 1.00 - $ 1.99     150,446     5.3   $1.18     150,446     $1.18
      37,301,300     5.6   $0.22     31,638,799     $0.22

 

During the three-month period ending March 31, 2018, and pursuant to the Company’s Board Compensation policy approved by the Board June 19, 2015, the Company granted options to purchase 2,083,335 shares of common stock to members of the Company’s Board of Directors. The options are exercisable at $0.18 share, vest monthly over a twelve-month period, and expire ten years from the date granted. Total fair value of these options at grant date was $313,000 using the Black-Scholes Option Pricing model with the following assumptions: life of 5 years; risk free interest rate of 1.7%; volatility of 118% and dividend yield of 0%.

 

During the three-month periods ended March 31, 2018 and 2017, the Company recognized compensation costs based on the fair value of options that vested of $143,000 and $231,000 respectively.

 

At March 31, 2018, the Company’s closing stock price was $0.13 per share. The aggregate intrinsic value of the options outstanding at March 31, 2018 was $598,000. Future unamortized compensation expense on the unvested outstanding options at March 31, 2018 is approximately $311,000 to be recognized through March 2019.

 

Warrants

 

The following table summarizes certain information about the Company’s stock purchase warrants activity for the period starting January 1, 2018 up to March 31, 2018.

 

    Warrants   Weighted Avg.
Exercise Price
 
 January 1, 2018    17,622,437   $0.09 
 Granted    1,684,375    0.08 
 Exercised    (1,166,000)   0.05 
 Cancelled    (550,000)   0.05 
 March 31, 2018    17,590,812   $0.10 

 

 

 

 13 

 

 

The weighted average exercise prices, remaining contractual lives for warrants granted, exercisable, and expected to vest as of March 31, 2018 were as follows:

 

    Outstanding Warrants     Exercisable Warrants  
Warrant Exercise Price Per Share   Shares     Life
(Years)
    Weighted
Average Exercise Price
    Shares     Weighted
Average Exercise Price
 
$ 0.05 - $ 0.99     17,590,812       0.7     $ 0.10       17,590,812     $ 0.10  

 

In the three-month period ending March 31, 2018, pursuant to terms of convertible notes issued, the Company granted warrants to purchase 1,684,375 shares of common stock with an exercise price of $.08 per share, vesting immediately upon grant and expiring one year from the date of grant (see Note 5).

 

During the three-month period ended March 31, 2018, warrants to acquire 1,345,710 shares of common stock were exercised resulting in net proceeds to the Company of $71,000.

 

At March 31, 2018, the aggregate intrinsic value of the warrants outstanding was $1,108,000.

 

  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.

 

  10. Subsequent Events

 

Issuance of Convertible Notes

 

From April 1, 2018 up to April 6, 2018, the Company issued convertible notes in aggregate of $81,000 in exchange for cash of $72,000. The notes are unsecured, convertible into 1 million shares in common stock of the Company at a conversion price of $0.08 per share and mature in one year. In connection with these notes, the Company also issued warrants to purchase 0.5 million shares of common stock of the Company at an exercise price of $0.08 per share and expiring one year from the date of issuance. As a result, the Company will record a note discount of $81,000 to account for the relative fair value of the warrants, the notes’ beneficial conversion feature and original issue discount which will be amortized as interest expense over the life of the notes.

 

Conversion of Convertible Notes

 

From April 1, 2018 up to May 14, 2018, Company issued 1,654,125 shares of common stock upon conversion of previously issued convertible notes in aggregate value of $122,000.

 

Exercise of Warrants

 

From April 1, 2018 up to May 12, 2018, the Company issued 4,698,773 shares of common stock upon the exercise of previously issued warrants for aggregate cash proceeds of $243,000.

 

 

 

 

 

 

 

 

 

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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” section filed with the SEC on April 2, 2018, 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, 2018, 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 commercializes 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. 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 reduces crude oil viscosity by applying a high intensity electrical field to crude oil feedstock while in transit. AOT technology delivers reductions in crude oil viscosity and pipeline pressure loss as demonstrated in independent third-party tests performed by the U.S. Department of Energy, the PetroChina Pipeline R&D Center, and ATS RheoSystems, a division of CANNON™, at full-scale test facilities in the U.S. and China, and under commercial operating conditions on one of North America’s largest high-volume crude oil pipelines. Prior testing on a commercial crude oil condensate pipeline demonstrated high correlation between laboratory analysis and full-scale AOT operations under commercial operating conditions with onsite measurements and data collected by the pipeline operator on its supervisory control and data acquisition (“SCADA”) system. The AOT product has transitioned from laboratory testing and ongoing research and development to initial production and continued testing in advance of our goal of seeking acceptance and adoption by the midstream pipeline marketplace. We continue to devote the bulk of our efforts to the promotion, design, testing and the commercial manufacturing and operations of our crude oil pipeline products in the upstream and midstream energy sector. We anticipate that these efforts will continue during 2018.

 

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. In 2017, the Company ended acquisition activities and is considering dissolving QS Energy Pool in 2018 to reduce costs associated with operating this subsidiary. The Company’s common stock is quoted under the symbol “QSEP” on the Over-the-Counter Bulletin Board. More information including the Company’s fact sheet, logos and media articles are available at our corporate website, www.qsenergy.com.

 

Between 2011 and 2012, the Company transitioned from prototype testing of its AOT technology at the U.S. Department of Energy Rocky Mountain Oilfield Testing Center, Midwest, Wyoming (“RMOTC”), to the design and production of full-scale commercial prototype units. The Company worked in a collaborative engineering environment with multiple energy industry companies to refine the AOT Midstream commercial design to comply with the stringent standards and qualification processes as dictated by independent engineering audit groups and North American industry regulatory bodies. In May 2013, the Company’s first commercial prototype unit known as AOT Midstream, was completed.

 

 

 

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In 2013, the Company entered into an Equipment Lease/Option to Purchase Agreement (“TransCanada Lease”) with TransCanada Keystone Pipeline, L.P. by its agent TC Oil Pipeline Operations, Inc. ("TransCanada") which agreed to lease and test the effectiveness of the Company’s AOT technology and equipment on one of TransCanada’s operating pipelines. As previously reported in our 10-K report filed with the SEC on March 16, 2015, in June 2014, the equipment was accepted by TransCanada and the lease commenced and the first full test of the AOT equipment on the Keystone pipeline was performed in July 2014 by Dr. Rongjia Tao of Temple University, with subsequent testing performed by an independent laboratory, ATS RheoSystems, a division of CANNON™ (“ATS”) in September 2014. Upon review of the July 2014 test results and preliminary report by Dr. Tao, QS Energy and TransCanada mutually agreed that this initial test was flawed due to, among other factors, the short-term nature of the test, the inability to isolate certain independent pipeline operating factors such as fluctuations in upstream pump station pressures, and limitations of the AOT device to produce a sufficient electric field to optimize viscosity reduction. Subsequent testing by ATS in September 2014 demonstrated viscosity reductions of 8% to 23% depending on flow rates and crude oil types in transit. In its summary report, ATS concluded that i) data indicated a decrease in viscosity of crude oil flowing through the TransCanada pipeline due to AOT treatment of the crude oil; and ii) the power supply installed on our equipment would need to be increased to maximize reduction in viscosity and take full advantage of the AOT technology. While more testing is required to establish the commercial efficacy of our AOT technology, we are encouraged by the findings of these field tests performed under commercial operating conditions. The TransCanada Lease was terminated by TransCanada, effective October 15, 2014. Upon termination of the TransCanada Lease, all equipment was uninstalled, returned, inspected and configured for re-deployment.

 

On July 15, 2014, the Company entered into an Equipment Lease/Option to Purchase Agreement (“Kinder Morgan Lease”) with Kinder Morgan Crude & Condensate, LLC (“Kinder Morgan”) under which Kinder Morgan agreed to lease and test the effectiveness of the Company’s AOT technology and equipment on one of Kinder Morgan’s operating pipelines. Equipment provided under the Lease includes a single AOT Midstream pressure vessel with a maximum flow capacity of 5,000 gallons per minute. The equipment was delivered to Kinder Morgan in December 2014 and installed in March 2015. In April 2015, during pre-start testing, low electrical impedance was measured in the unit, indicating an electrical short. A replacement unit was installed May 2015. The second unit also presented with low impedance when flooded with crude condensate from Kinder Morgan’s pipeline. Subsequent to design modifications, a remanufactured AOT unit was installed and tested at Kinder Morgan’s pipeline facility in August 2015. Initial results were promising, with the unit operating generally as expected. However, voltage dropped as preliminary tests continued, indicating decreased impedance within the AOT pressure vessel. QS Energy personnel and outside consultants performed a series of troubleshooting assessments and determined that, despite modifications made to the AOT, conductive materials present in the crude oil condensate continued to be the root cause of the decreased impedance. Based on these results, QS Energy and Kinder Morgan personnel mutually agreed to put a hold on final acceptance of equipment under the lease and temporarily suspend in-field testing to provide time to re-test crude oil condensate in a laboratory setting, and thoroughly review and test selected AOT component design and fabrication. Subsequent analysis and testing led to changes in electrical insulation, inlet flow improvements and other component modifications. These design changes were implemented and tested by Industrial Screen and Maintenance (ISM), one of QS Energy's supply chain partners in Casper, Wyoming. Tests performed by ISM at its Wyoming facility indicated significant improvements to system impedance and efficiency of electric field generation.

 

In February 2016, the modified AOT equipment was installed at Kinder Morgan’s facility. Pre-acceptance testing was performed in April 2016, culminating in more than 24 hours of continuous operations. In-field viscosity measurements and pipeline data collected during this test indicated the AOT equipment operated as expected, resulting in viscosity reductions equivalent to those measured under laboratory conditions. Supervisory Control And Data Acquisition (“SCADA”) pipeline operating data collected by Kinder Morgan during this test indicated a pipeline pressure drop reduction consistent with expectations. Kinder Morgan provided the Company with a number of additional crude oil samples which were tested in the laboratory for future test correlation and operational planning purposes. Based on final analysis of in-field test results, SCADA operating data and subsequent analysis of crude oil samples at Temple University, Kinder Morgan and QS Energy are considering moving the AOT test facility to a different, higher-volume pipeline location. The Kinder Morgan Lease is currently in suspension and lease payments have not yet commenced.

 

Southern Research Institute (SRI) was engaged by QS Energy in 2015 to investigate the root cause of the crude oil condensate impedance issue by replicating conditions experienced in the field utilizing a laboratory-scaled version of the AOT and crude oil condensate samples provided by Kinder Morgan. In addition, QS Energy retained an industry expert petroleum pipeline engineer to review the AOT design and suggest design modifications to resolve the crude oil condensate impedance issue. This engineer has studied design details, staff reports and forensic photographs of each relevant AOT installation and test. Based on these investigations, specific modifications were proposed to resolve the impedance issue, and improve the overall efficiency of the AOT device, resulting in a new value-engineered design of certain AOT internal components.

 

 

 

 16 

 

 

The Company is actively seeking deployments of its AOT technology. In August 2015, QS Energy was invited to an offshore oil transfer platform in the Gulf of Mexico. This offshore platform was assessed by QS Energy personnel for a potential deployment of the AOT viscosity reduction technology as a solution for super-heavy crude oil flow assurance issues. Following the site visit, subject to non-disclosure agreements executed by all parties, laboratory testing was performed on crude oil samples provided by the operator, which demonstrated significant AOT viscosity reductions. Detailed hydraulic analysis based on laboratory results and pipeline operating parameters was presented to the operator demonstrating potential benefits of AOT technology within the operator’s specified infrastructure. Based on this analysis, the Company prepared a preliminary configuration for AOT units optimized for the operator’s high-volume, space-constrained operations. Company engineers and supply chain partners presented an optimized configuration and production budget. Discussions continue with this operator regarding an onsite pilot test deployment of the proposed AOT configuration, targeting project planning in 2018 and potential deployment in 2019.

 

In 2017, the Company shifted its business development efforts to the development of one or more pilot projects intended to demonstrate and document AOT efficacy, operational benefits, and financial impact. The Company is working with prospective customers on potential pilot project sites in three primary markets: U.S., South America, and Asia. Each of these prospects operates heavy crude oil pipelines. The Company’s short-term goal is to have at least one pilot project operational in 2018 with the intention of converting from pilot operations to revenue-generating commercial operations and future commercial AOT deployment. Company’s efforts are tightly focused on executing its pilot program strategy and conversations continue with prospective customers in the Gulf Coast, Canada, and the Middle East.

 

During the third quarter 2016, the Company developed a new onsite testing program to demonstrate AOT viscosity reduction at prospective customer sites. This program utilized a fully functional laboratory-scale AOT device designed and developed by the Company and tested at the Southern Research Institute. Under this program, Company engineers set up a temporary lab at the customer’s site to test a full range of crude oils. Fees charged for providing this service were dependent on scope of services, crude oil sample to be tested, and onsite time requirements. In the fourth quarter 2016, the Company entered a contract to provide these onsite testing services to a North American oil producer and pipeline operator over a one-week period in early 2017 at a fixed price of $50,000. This test was performed in January 2017; data analysis and final report was completed in March 2017. Test results demonstrated viscosity reduction under limited laboratory conditions. The test equipment was not capable of controlling temperature as required to simulate operating conditions. The oil producer has requested access to a full-scale pilot facility and operating data when available. The Company plans to upgrade the laboratory-scale AOT device in 2018 to include temperature control and is actively pursuing a pilot site to demonstrate AOT operations.

 

In July 2017, the Company filed for trademark protection for the word “eDiluent” in advance of rolling out a new 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”. 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.

 

In 2014, the Company began development of a new suite of products based around the new electrical heat system which reduces oil viscosity through a process known as joule heat (“Joule Heat”). The Company plans on designing and optimizing the Joule Heat technology for the upstream oil transportation market. The Company filed two provisional patents related to the technology’s method and apparatus in the second quarter and fourth quarter of 2013, respectively. The first of the two provisional patents was finalized and submitted to non-provisional status on April 29, 2014. The second of the two provisional patents was finalized and submitted to non-provisional status at the end of the third quarter 2014.

 

In October 2014, QS Energy entered into a Joint Development Agreement with Newfield Exploration Company (“Newfield”) to test a prototype of QS Energy Joule Heat equipment, and combined Joule Heat and AOT technology, on a crude oil pipeline serving the Greater Monument Butte oilfield located in the Uintah Basin of Utah. This test of the Joule Heat technology provides ideal conditions to demonstrate efficiency and efficacy. The Uintah Basin is 5,000 to 10,000 feet above sea level with average low winter temperatures of 16ºF. Crude oil pumped from the region is highly paraffinic with the consistency of shoe polish at room temperature. Uintah's black wax crude must remain at a minimum of 95ºF and yellow wax above 115ºF and therefore requires a substantial amount of heat to keep it above its high pour point. Operators in the upstream market often run at temperatures of 140ºF to 160ºF. Newfield, like many other companies in the region, incurs significant operating expense in the form of fuel and power used to heat the waxy crude and counter the cold climate conditions characteristic of Utah. The Company’s first Joule Heat prototype was installed for testing purposes at the Newfield facility in June 2015 and the system is operational; however, changes to the prototype configuration will be required to determine commercial effectiveness of this unit. During the third and fourth quarters of 2015, we worked with Newfield and Dr. Carl Meinhart to modify the prototype configuration based on observed pipeline and Joule Heat operating factors. In addition, QS Energy provided a scaled-down version of the Joule Heat unit for static and flow-through testing at SRI. Testing performed by SRI in September 2015 on a laboratory-scale Joule Heat unit demonstrated the ability of the Joule Heat technology to deliver temperature increases in the laboratory setting.

 

 

 

 17 

 

 

In 2015, the Company worked in collaboration with Newfield, SRI, Dr. Carl Meinhart, and our manufacturing partner to design and build an AOT prototype unit, for operations in the upstream crude oil pipeline market (“AOT Upstream”). In December 2015, we temporarily suspended Joule Heat and AOT Upstream development activities to focus Company resources on finalizing commercial development of the AOT Midstream. Testing terminated at SRI and all prototype equipment was returned to the Company.

 

During the third quarter 2017, the Company built a dedicated laboratory space at its Tomball Texas facility, and now has the capability to perform onsite testing utilizing our laboratory-scale AOT device, among other equipment. Development of an AOT unit for use in crude oil upstream and gathering operations was restarted in September 2017 utilizing resources at the Tomball facility, and the Company plans to resume Joule Heat development in the future depending on the availability of sufficient capital and other resources. Also, during the third quarter 2017, the Company built an outdoor facility at its Tomball Texas facility for onsite storage of AOT inventory and other large equipment. The Tomball facility is owned by the Company’s CEO as described in our Form 10-K filed with the SEC on April 2, 2018.

 

Our expenses to date have been funded primarily 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 2018, and beyond, to fund our sales and marketing efforts, continuing research and development, and certain other expenses, until our revenue base grows sufficiently.

 

There are significant risks associated with our business, our Company and our stock. See “Risk Factors,” below.

 

Results of Operations for Three months ended March 31, 2018 and 2017

 

   Three months ended 
   March 31 
   2018   2017   Change 
Revenues  $   $50,000   $(50,000)
Costs and Expenses               
Operating expenses   494,000    1,258,000    (764,000)
Research and development expenses   47,000    64,000    (17,000)
Loss before other income (expense)   (541,000)   (1,272,000)   731,000 
Other income (expense)               
Interest and financing expense   (159,000)   (212,000)   53,000 
Net Loss  $(700,000)  $(1,484,000)  $784,000 

 

During the period ended March 31, 2017, the Company recognized revenues of $50,000 pursuant to the completion of a lease and testing agreement of the Company’s AOT equipment. The Company recognized no revenues during the period ended March 31, 2017.

 

Operating expenses were $494,000 for the three-month period ended March 31, 2018, compared to $1,258,000 for the three-month period ended March 31, 2017, a decrease of $764,000. This is due to decreases in non-cash expenses of $75,000, and in cash expenses of $689,000. Specifically, the decrease in non-cash expenses are attributable to increases in common stock and warrants issued as compensation for services of $11,000, and depreciation of $8,000, offset by a decrease in stock compensation expense attributable to options granted to employees and directors of $92,000. The decrease in cash expense is attributable to decreases in severance expenses of $624,000, salaries and benefits of $11,000, consulting fees of $11,000, corporate and office expenses of 8,000, legal and accounting fees of $31,000, and patent expenses of $11,000, offset by increases in rent and utilities of $3,000, and other expenses of $4,000.

 

Research and development expenses were $47,000 for the three-month period ended March 31, 2018, compared to $64,000 for the three-month period ended March 31, 2017, a decrease of $17,000. This decrease is attributable a decrease in prototype product development costs of $17,000.

 

 

 

 18 

 

 

Other income and expense were $159,000 expense for the three-month period ended March 31, 2018, compared to $212,000 expense for the three-month period ended March 31, 2017, a net decrease in other expenses of $53,000. This decrease is attributable to a decrease in non-cash other expenses of $53,000. 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 $49,000, and other non-cash interest of $4,000.

 

The Company had a net loss of $700,000, or $0.00 per share, for the three-month period ended March 31, 2018, compared to a net loss of $1,484,000, or $0.01 per share, for the three-month period ended March 31, 2017.

 

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 $2,004,000 as of March 31, 2018. Our negative operating cash flow for the periods ended March 31, 2018 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 $700,000 and a negative cash flow from operations of $295,000 for the three-month period ended March 31, 2018. 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, 2017 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, 2018, we received cash totaling $316,000 from issuance of our convertible notes payable and exercise of options and warrants to purchase common stock and used cash in operations of $295,000. At March 31, 2018, we had cash on hand in the amount of $225,000. 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 2018 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 attached hereto, Note 6 (Research and Development).

 

 

 

 19 

 

 

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 1 of the Notes to the Condensed 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 revenues and expenses during the reporting period. Certain significant estimates were made in connection with preparing our consolidated financial statements as described in Note 1 to Notes to the Condensed 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.

 

 

 

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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, 2018, the Company incurred a net loss of $700,000, used cash in operations of $295,000 and had a stockholders’ deficit of $2,004,000 as of that date. 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, 2018, the Company had cash on hand in the amount of $225,000. Management estimates that the current funds on hand will be sufficient to continue operations through August 2018. 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 2018 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.

 

Item 3. Quantitative and Qualitative Disclosure about Market Risk

 

We issue from time to time fixed rate discounted convertible notes. Our convertible notes and our equity securities are exposed to risk as set forth below, in Part II Item 1A, “Risk Factors.” Please also see Item 2, above, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 4. Controls and Procedures

 

  1. Disclosure Controls and Procedures

 

The Company's management, with the participation of the Company's chief executive officer and chief financial officer, evaluated, as of March 31, 2018, the effectiveness of the Company's disclosure controls and procedures, which were designed to be effective at the reasonable assurance level. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of the Company's disclosure controls and procedures as of March 31, 2017, management, the chief executive officer and the chief financial officer concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level at that date.

 

(a)       Changes in Internal Control over Financial Reporting

 

No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three-month period ended March 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

 

 

 

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PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

There is no litigation of any significance with the exception of the matters that have arisen under, and are being handled in, the normal course of business.

 

Item 1A.  Risk Factors

 

There have been no material changes in the risk factors previously disclosed in Form 10-K for the period ended December 31, 2017, which we filed with the SEC on April 2, 2018.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuances

 

In private offerings exempt from registration, during the three months ended March 31, 2018, the Company issued 1,278,750 shares of its common stock upon the conversion of $99,000 in convertible notes at $0.08 per share. In connection with the issuances of the foregoing securities, the Company relied on the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended, for transactions not involving a public offering.

 

The proceeds received by the Company in connection with the above issuances of shares were used for general corporate purposes.

 

Item 3. Defaults Upon Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

None

 

Item 5. Other Information

 

None

 

 

 

 

 

 

 

 

 

 

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Item 6. Exhibits

 

Exhibit No.   Description
     
31.1   Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
     
31.2   Certification of Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
     
32   Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C.  Section 1350
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Schema Document
     
101.CAL   XBRL Calculation Linkbase Document
     
101.LAB   XBRL Label Linkbase Document
     
101.PRE   XBRL Presentation Linkbase Document
     
101.DEF   XBRL Definition Linkbase Document
     

 

 

 

 

 

 

 

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, hereunto duly authorized.

 

  QS ENERGY, INC.    
     
       
Date: May 15, 2018 By: /s/ Michael McMullen  
    Michael McMullen  
    Chief Financial Officer   
       

 

 

 

 

 

 

 

 

 

 

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EXHIBITS

 

Exhibit No.   Description
     
31.1   Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
     
31.2   Certification of Chief Financial Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
     
32   Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C.  Section 1350
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Schema Document
     
101.CAL   XBRL Calculation Linkbase Document
     
101.LAB   XBRL Label Linkbase Document
     
101.PRE   XBRL Presentation Linkbase Document
     
101.DEF   XBRL Definition Linkbase Document 

 

 

 

 

 

 

 

 

 

 

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