NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Note 1: Organization and summary
of significant accounting policies
Nature of business
ThermoEnergy Corporation (“the Company”)
was incorporated in January 1988 for the purpose of developing and marketing advanced municipal and industrial wastewater treatment
and carbon reducing power generation technologies.
The Company’s
wastewater treatment systems are based on its proprietary Controlled Atmosphere Separation Technology (“CAST”) platform. The
Company’s patented and proprietary platform technology is combined with off-the-shelf technologies to provide systems that
are inexpensive, easy to operate and reliable. The Company’s wastewater treatment systems have global applications in hydraulic
fracturing (“fracking”) in the oil and gas industry, food and beverage processing, metal finishing, pulp & paper,
petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater. The CAST platform
technology is owned by the Company’s subsidiary, CASTion Corporation (“CASTion”).
The Company also
owns a patented pressurized oxycombustion technology (“POXC”) that converts fossil fuels (including coal, oil and natural
gas) and biomass into electricity while producing near zero air emissions and removing and capturing carbon dioxide in liquid form
for sequestration or beneficial reuse. This technology is intended to be used to build new or to retrofit old fossil fuel power
plants globally with near zero air emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically
than any other competing technology. The pressurized oxycombustion
technology is held in the Company’s subsidiary,
ThermoEnergy Power Systems, LLC (“TEPS”).
Principles of consolidation and basis
of presentation
The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation. The 15% third-party ownership interest in TEPS is recorded as a noncontrolling interest in the
consolidated financial statements. Financial results for Unity Power Alliance (“UPA”) have been consolidated for
the period from inception until the date it became a Joint Venture. Accordingly, the Company includes approximately $129,000
of sales and marketing expense related to UPA on its Consolidated Statement of Operations for the nine-month period ended
September 30, 2012. Financial results for UPA as a Joint Venture are accounted for under the equity method, as discussed in
Note 5. Certain prior year amounts have been reclassified to conform to current year classifications.
The accompanying unaudited financial statements
have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”)
for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine-month period ended September 30, 2012 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2012.
The preparation of these unaudited interim
consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
The balance sheet at December 31, 2011
has been derived from the audited financial statements at that date but does not include all of the information and footnotes required
by GAAP for complete financial statements. For further information, refer to the financial statements and footnotes thereto included
in the Annual Report on Form 10-K for the year ended December 31, 2011 of ThermoEnergy Corporation.
The Company has restated its unaudited
interim consolidated financial statements for the three and nine-month periods ended September 30, 2011. See Note 4.
Revenue recognition
The Company recognizes revenues using the
percentage-of-completion method. Under this approach, revenue is earned in proportion to total costs incurred in relation to total
costs expected to be incurred. Contract costs include all direct material and labor costs and indirect costs related to contract
performance, such as indirect labor, supplies, tools, repairs and depreciation.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Recognition of revenue and profit is dependent
upon a number of factors, including the accuracy of a variety of estimates made at the balance sheet date such as engineering progress,
materials quantities, the achievement of milestones, penalty provisions, labor productivity and cost estimates made. Due to uncertainties
inherent in the estimation process, actual completion costs may vary from estimates. Changes in job performance, job conditions
and estimated profitability may result in revisions to costs and income and are recognized beginning in the period in which they
become known. Provisions for estimated losses on uncompleted contracts are made in the period in which the estimated loss
first becomes known. The Company has not recorded any such provisions for the three and nine-month periods ended September 30,
2012.
Certain long-term contracts include a number
of different services to be provided to the customer. The Company records separately revenues, costs and gross profit related to
each of these services if they meet the contract segmenting criteria in Accounting Standards Codification (“ASC”) 605-35.
This policy may result in different interim rates of profitability for each segment than if the Company had recognized revenues
using the percentage-of-completion method based on the project’s estimated total costs.
Variable interest entities
The Company assesses whether its
involvement with another related entity constitutes a variable interest entity (“VIE”) through either direct or
indirect variable interest in that entity. If an entity is deemed to be a VIE, the Company must determine if it is the
primary beneficiary (i.e. the party that consolidates the VIE), in accordance with the accounting standard for the
consolidation of variable interest entities. VIEs are entities that, by design, either (1) lack sufficient equity to permit
the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity
investors that do not have the ability to make significant decisions relating to the entity’s operations through voting
rights, or do not have the obligation to absorb the expected losses and/or the right to receive the residual returns of the
entity. The Company qualitatively evaluates if it is the primary beneficiary of the VIE’s based on whether the Company
has (i) the power to direct those matters that most significantly impacted the activities of the VIE; and (ii) the obligation
to absorb losses or the right to receive benefits of the VIE. See Note 5 for further discussion of UPA as a variable interest
entity.
Accounts receivable, net
Accounts receivable are recorded at their
estimated net realizable value. Receivables related to the Company’s contracts have realization and liquidation periods of
less than one year and are therefore classified as current assets.
The Company maintains allowances for specific
doubtful accounts based on estimates of losses resulting from the inability of customers to make required payments and records
these allowances as a charge to general and administrative expense. The Company’s method for estimating its allowance for
doubtful accounts is based on judgmental factors, including known and inherent risks in the underlying balances, adverse situations
that may affect the customer’s ability to pay and current economic conditions. Amounts considered uncollectible are written
off based on the specific customer balance outstanding. The Company did not have any allowance for doubtful accounts as of September
30, 2012 and December 31, 2011.
Inventories
Inventories are stated at the lower of
cost or net realizable value using the first-in, first-out method and consist primarily of raw materials and supplies. Work in
process inventories relate to systems currently being constructed for future use or sale.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Inventories consist of the following at
September 30, 2012 and December 31, 2011:
|
|
September
30,
2012
|
|
|
December
31,
2011
|
|
|
|
|
|
|
|
|
Raw materials
|
|
$
|
46
|
|
|
$
|
67
|
|
Work in process
|
|
|
—
|
|
|
|
100
|
|
|
|
$
|
46
|
|
|
$
|
167
|
|
Property and equipment
Property and equipment are stated at cost
and are depreciated over the estimated useful life of each asset. Depreciation is computed using the straight-line method. The
Company evaluates long-lived assets based on estimated future undiscounted net cash flows or other fair value measures whenever
significant events or changes in circumstances occur that indicate the carrying amount may not be recoverable. If that evaluation
indicates that an impairment has occurred, a charge is recognized to the extent the carrying amount exceeds the undiscounted cash
flows or fair values of the asset, whichever is more readily determinable.
The Company recorded a loss of $131,000
in the first quarter of 2012 related to the disposal of a system previously used for pre-sales testing. This loss is included in
sales and marketing expense on its Consolidated Statement of Operations for the nine-month period ended September 30, 2012.
The Company performed an evaluation of
its property and equipment as of September 30, 2011 in conjunction with relocating its headquarters and recorded a write-off of
$62,000. This impairment loss is included as a component of interest and other expense on the Company’s Consolidated Statement
of Operations for the three and nine-month periods ended September 30, 2011.
Contingencies
The Company accrues for costs relating
to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities,
when such liabilities become probable and reasonably estimable. Such estimates may be based on advice from third parties or on
management’s judgment, as appropriate. Revisions to accruals are reflected in earnings (loss) in the period in which different
facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to
the likelihood or amount of loss. Amounts paid upon the ultimate resolution of such liabilities may be materially different from
previous estimates and could require adjustments to the estimated liability to be recognized in the period such new information
becomes known.
Stock options
The Company accounts for stock options
in accordance with ASC Topics 505, “Equity” and 718, “Compensation – Stock Compensation”. These topics
require that the cost of all share-based payments to vendors and employees, including grants of employee stock options, be recognized
in the consolidated financial statements based on their fair values on the measurement date, which is generally the date of grant.
Such cost is recognized over the vesting period of the awards. The Company uses the Black-Scholes option pricing model to estimate
the fair value of “plain vanilla” stock option awards.
Fair value of financial instruments
and fair value measurements
The carrying amount of cash, accounts receivable,
other current assets, accounts payable and other current liabilities in the consolidated financial statements approximate fair
value because of the short-term nature of the instruments. The carrying amount of the Company’s convertible debt was $3,068,000
and $2,821,000 at September 30, 2012 and December 31, 2011, respectively, and approximates the fair value of these instruments.
The Company’s derivative liabilities are recorded at fair value. No assets are recorded at fair value as measured on a recurring
basis.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
The Company's liabilities carried at fair
value are categorized using inputs from the three levels of the fair value hierarchy, as follows:
|
Level 1:
|
Quoted prices in active markets for identical assets
or liabilities.
|
|
Level 2:
|
Inputs other than Level 1 that are observable, either
directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active;
or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets
or liabilities.
|
|
Level 3:
|
Unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the liabilities.
|
Series B Convertible Preferred Stock
The Company determined the
initial value of the Series B Convertible Preferred Stock and investor warrants using valuation models it considers to
be appropriate. Because the Series B Convertible Preferred Stock has an indefinite life, it is classified within
the stockholders’ deficiency section of the Company's consolidated balance sheets. The value of beneficial
conversion features upon issuance are considered a “deemed dividend” and are added as a component of net loss
attributable to common stockholders in the Company’s Consolidated Statements of Operations. There were no deemed
dividends in the three or nine-month periods ended September 30, 2012 or 2011.
Net income (loss) per share
Basic net income
(loss) per share (“EPS”) is computed by dividing the net income (loss) attributable to the common stockholders (the
numerator) by the weighted average number of shares of common stock outstanding (the denominator) during the reporting periods.
Fully diluted net income (loss) per share is computed by increasing the denominator by the weighted average number of additional
shares that could have been outstanding from securities convertible into common stock, such as stock options and warrants (using
the “treasury stock” method), and convertible preferred stock and debt (using the “if-converted” method),
unless the effect on net income (loss) per share is antidilutive. Under the “if-converted” method, convertible instruments
are assumed to have been converted as of the beginning of the period or when issued, if later. The effect of including additional
shares using the treasury stock and if-converted methods in computing the Company’s diluted net loss per share would be antidilutive
and, accordingly, such additional shares have not been considered in computing diluted net loss per share for the nine-month periods
ended September 30, 2012 and 2011 (as restated).
Recent accounting pronouncements
In
May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements
in U.S. GAAP and IFRS,” which converges fair value measurement and disclosure guidance in U.S. GAAP with fair value measurement
and disclosure guidance issued by the International Accounting Standards Board (“IASB”). The amendments in the authoritative
guidance do not modify the requirements for when fair value measurements apply. The amendments generally represent clarifications
on how to measure and disclose fair value under ASC 820, “Fair Value Measurement.” The authoritative guidance is effective
prospectively for interim and annual periods beginning after December 15, 2011. Early adoption of the authoritative guidance
is not permitted.
The Company has adopted the provisions of ASU 2011-04 in the Company’s fiscal year beginning January
1, 2012, and the provisions of this guidance did not have a material impact on its financial statements or disclosures.
Note 2: Management's consideration
of going concern matters
The accompanying financial statements have
been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation
of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years, and such
losses have continued through the quarter ended September 30, 2012.
At September 30, 2012, the Company had
cash of $528,000, a decrease of approximately $2.5 million from December 31, 2011. The Company has incurred net losses since inception,
including a net loss of approximately $5.9 million during the nine-month period ended September 30, 2012 and had an accumulated
deficit of approximately $119.5 million at September 30, 2012.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Based upon management's projections, the
Company will require additional capital to continue commercialization of the Company’s power and water technologies (the
“Technologies”) and to support current operations. The Company had a working capital deficit of approximately $5.7
million at September 30, 2012. Any change to management projections will increase or decrease this deficit. In addition, the Company
may be subject to tax liens if it cannot abide by the terms of the Offer in Compromise approved by the Internal Revenue Service
to satisfactorily settle outstanding payroll tax liabilities (see Note 10). Management is considering several alternatives for mitigating
these conditions.
These uncertainties raise substantial doubt
about the Company's ability to continue as a going concern. The financial statements included in this Form 10-Q have been prepared
on a going concern basis and as such do not include any adjustments that might result from the outcome of this uncertainty.
Management successfully completed a program
to eliminate the Company’s outstanding secured debt in 2011 and is actively seeking to raise substantial funding through
additional equity or debt financing that will allow the Company to operate until it becomes cash flow positive from operations.
Management is also actively pursuing commercial contracts to generate operating revenue. Management has determined that the financial
success of the Company is largely dependent upon the Company’s ability to collaborate with financially sound third parties
to pursue projects involving the Technologies.
As more fully
described in Note 7, the Company initiated the following financing transactions during 2012:
On January 10,
2012,
the Company received proceeds totaling $498,000, net of issuance costs, from the exercise of an
aggregate of 5,633,344 warrants at an exercise price of $0.095 per share.
On July 11, 2012,
the Company received proceeds totaling $1,566,000, net of issuance costs, from the issuance of 17,316,250 shares of the Company’s
Common Stock, warrants for the purchase of an additional 18,670,375 shares at an exercise price of $0.15 per share and warrants
for the purchase of an additional 1,354,125 shares at an exercise price of $0.10 per share.
On August 9, 2012,
the Company received proceeds totaling $729,000, net of issuance costs, from the issuance of 8,287,500 shares of the Company’s
Common Stock, warrants for the purchase of an additional 9,116,250 shares at an exercise price of $0.15 per share and warrants
for the purchase of an additional 828,750 shares at an exercise price of $0.10 per share.
Also, as more
fully described in Note 11, on October 9, 2012 the Company received proceeds of $331,000, net of issuance costs, from the issuance
of 3,765,000 shares of the Company’s Common Stock, warrants for the purchase of an additional 4,141,500 shares at an exercise
price of $0.15 per share and warrants for the purchase of an additional 376,500 shares at an exercise price of $0.10 per share.
As discussed in
Note 6, the Company’s 2011 Convertible Bridge Notes mature on December 31, 2012. These Notes are convertible into shares
of a future series of Preferred Stock at a conversion price to be determined. While the Company intends to convert these Notes
before the maturity date, there can be no assurance that such a conversion will take place. If the Company does not convert these
Notes before the maturity date, it will seek to extend the maturity date on these Notes, which are held by four principal investors
of the Company.
See Note 3
for a discussion of the termination of the Company’s contract with the New York City Department of Environmental
Regulation (“NYCDEP”).
Note 3: Risks and Uncertainties
On August 22, 2012, the NYCDEP
issued a stop work order to the Company relative to its contract to install an Ammonia Removal Process (“ARP”)
system at the NYCDEP’s wastewater treatment facility in the 26
th
Ward. On November 13, 2012, the NYCDEP
notified the Company that it is terminating the contract, effective November 29, 2012.
The Company suspended all work on this
contract as of August 22, 2012 and has halted all work with its major vendors. The Company has accordingly ceased recognition of
revenues as of August 22, 2012 and has recorded all incremental costs as period costs on its Consolidated Statement of Operations.
As of November 13, 2012, the Company has billed approximately $14.8 million to the NYCDEP related to this contract, of which
approximately $13.3 million has been paid and $1.5 million remains outstanding. These amounts do not include any future billings
for costs incurred as a result of this termination.
Because of this contract termination, the Company's revenues, expenses,
and income will be adversely affected in future periods, as this contract represented approximately 80% of the Company's revenues
for the year ended December 31, 2011 and approximately 63% and 81% of the Company's revenues for the three and nine-month
periods ended September 30, 2012, respectively. The Company has yet to begin discussions with the NYCDEP about the termination,
and accordingly, the Company cannot determine a final outcome at this time.
Note 4: Restatement
The unaudited quarterly financial information
for the quarterly periods ended March 31, 2011, June 30, 2011 and September 30, 2011 have been restated to correct errors in the
valuation of the Company’s derivative liabilities and accounting for certain financing transactions in those periods. These
errors in the Company’s financing transactions were caused by the Company incorrectly accounting for the amendment of its
CASTion Notes and its 2010 Bridge Notes as a debt modification instead of a debt extinguishment in the first quarter of 2011. The
errors in the Company’s derivative liabilities were due to deficiencies in the Company’s valuation model and methodology
used to calculate the fair value of such liabilities in the first three quarters of 2011.
The Company restated the effects of these
errors for the affected periods in its Annual Report on Form 10-K as of and for the year ended December 31, 2011. The net effect
of these errors is (i) a $4.7 million understatement of the Company’s net loss to common stockholders in the quarter ended
March 31, 2011, (ii) a $1.5 million overstatement of the Company’s net loss to common stockholders in the quarter ended June
30, 2011 and (iii) a $3.9 million overstatement of the Company’s net loss to common stockholders in the quarter ended September
30, 2011. The net effect is that the Company’s net loss to common stockholders for the nine-month period ended September
30, 2011 was overstated by approximately $0.7 million. None of the errors related to the Company’s cash position, revenues
or loss from operations for any of the periods in which such errors occurred.
This Quarterly Report on Form 10-Q for
the quarter ended September 30, 2012 reflects the impact of this restatement on the applicable unaudited quarterly financial information
for the three and nine months ended September 30, 2011 presented in the Consolidated Statements of Operations and Consolidated
Statements of Cash Flows.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Quarterly Reports on Form 10-Q, as originally
filed, for each of the first three quarters of 2011 have not been and will not be amended. The financial statements included in
such reports should not be relied on.
The impact of the errors on the Company’s
Consolidated Statement of Operations for the three and nine months ended September 30, 2011 is summarized below (in thousands):
|
|
Three Months Ended
September 30, 2011
|
|
|
Nine Months Ended
September 30, 2011
|
|
|
|
As
Originally
Reported
|
|
|
As Restated
|
|
|
As
Originally
Reported
|
|
|
As Restated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
$
|
(1,470
|
)
|
|
$
|
(1,470
|
)
|
|
$
|
(5,296
|
)
|
|
$
|
(5,296
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant expense
|
|
|
(1,799
|
)
|
|
|
—
|
|
|
|
(1,799
|
)
|
|
|
—
|
|
Derivative liability income (loss)
|
|
|
(653
|
)
|
|
|
440
|
|
|
|
403
|
|
|
|
3,963
|
|
Loss on extinguishment of debt
|
|
|
(2,042
|
)
|
|
|
(5,159
|
)
|
|
|
(2,042
|
)
|
|
|
(12,551
|
)
|
Interest and other expense, net
|
|
|
(263
|
)
|
|
|
(220
|
)
|
|
|
(2,751
|
)
|
|
|
(1,124
|
)
|
Equity in losses of joint venture
|
|
|
(117
|
)
|
|
|
(117
|
)
|
|
|
(386
|
)
|
|
|
(386
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(6,344
|
)
|
|
|
(6,526
|
)
|
|
|
(11,871
|
)
|
|
|
(15,394
|
)
|
Net loss attributable to noncontrolling interest
|
|
|
17
|
|
|
|
17
|
|
|
|
57
|
|
|
|
57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to ThermoEnergy Corporation
|
|
|
(6,327
|
)
|
|
|
(6,509
|
)
|
|
|
(11,814
|
)
|
|
|
(15,337
|
)
|
Deemed dividend on Series B Convertible Preferred Stock
|
|
|
(4,045
|
)
|
|
|
—
|
|
|
|
(4,271
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to ThermoEnergy Corporation common stockholders
|
|
$
|
(10,372
|
)
|
|
$
|
(6,509
|
)
|
|
$
|
(16,085
|
)
|
|
$
|
(15,337
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share attributable to ThermoEnergy Corporation common stockholders, basic and diluted
|
|
$
|
(0.18
|
)
|
|
$
|
(0.11
|
)
|
|
$
|
(0.28
|
)
|
|
$
|
(0.27
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used in computing loss per share, basic and diluted
|
|
|
56,867,098
|
|
|
|
56,867,098
|
|
|
|
56,506,905
|
|
|
|
56,506,905
|
|
Note 5: Joint Ventures
Babcock-Thermo Clean Combustion LLC
On February 25, 2009, the Company’s
majority-owned subsidiary, TEPS, and Babcock Power Development, LLC (“BPD”), a subsidiary of Babcock Power, Inc., entered
into a Limited Liability Company Agreement (the “LLC Agreement”) establishing Babcock-Thermo Carbon Capture LLC, a
Delaware limited liability company now known as Babcock-Thermo Clean Combustion LLC (the “Joint Venture”) for the purpose
of developing and commercializing its proprietary POXC technology.
TEPS entered into a license agreement with
the Joint Venture and BPD, pursuant to which it has granted to the Joint Venture an exclusive, irrevocable (except as otherwise
provided therein), world-wide and royalty-free license to TEPS’ intellectual property related to or necessary to practice
the POXC technology. In the LLC Agreement, BPD agreed to develop, at its own expense, intellectual property in connection with
three critical subsystems relating to the POXC technology. BPD entered into a license agreement with the Joint Venture and TEPS
pursuant to which it granted the Joint Venture an exclusive, irrevocable (except as otherwise provided therein), world-wide, fully
paid up and royalty-free license to BPD’s know-how and other relevant proprietary intellectual property. Pursuant to the
LLC Agreement, TEPS and BPD each owned a 50% membership interest in the Joint Venture.
On March 2, 2012, TEPS entered into a Dissolution
Agreement with BPD to terminate the Limited Liability Company Agreement and dissolve the Joint Venture. The BTCC Board of Managers
is supervising the wind down and dissolution process.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Unity Power Alliance LLC
On March 8, 2012, the Company announced
the formation of Unity Power Alliance LLC (“UPA”). UPA was formed with the intention to work with partners and stakeholders
to develop and commercialize its pressurized oxycombustion technology.
On June 20, 2012, the Company entered into
an agreement with Itea S.p.A. (“Itea”) for the development of pressurized oxycombustion in North America. The two parties,
through UPA, will utilize the two parties’ propriety technology to advance, develop and promote the use of the coal application
of pressurized oxycombustion, construct a pilot plant utilizing the technology, and subsequently construct a demonstration facility
based on the technology as implemented in the pilot plant. Itea was granted the option to acquire a 50% ownership interest in UPA
for $1,250. On July 16, 2012, Itea exercised its option and acquired the 50% ownership interest in UPA.
UPA is governed by a Board of Directors,
with half of the directors nominated by each of the Company and Itea. Administrative expenses of UPA are borne jointly by the Company
and Itea, and financing for development expenses will be obtained from third parties.
Also on June 20, 2012 the Company and Itea
entered into a License Agreement whereby the Company and the Company’s majority-owned subsidiary, TEPS, and Itea granted
a non-exclusive, non-transferable royalty-free license to UPA to use their intellectual property relating to pressurized oxycombustion.
The licenses to UPA became effective upon Itea’s acquisition of its ownership interest in UPA. The License Agreement further
provides that, if UPA successfully obtains funding and project support to construct the pilot plant, the parties may grant licenses
of their respective intellectual property and know-how to each other or to third parties for the operation of power plants based
on such intellectual property and know-how, and royalties will be shared as defined in the License Agreement.
In September 2012, UPA was awarded a
$1 million Phase 1 grant from the U.S. Department of Energy to help fund a project under a special DOE program to advance
technologies for efficient, clean coal power and carbon capture. As of September 30, 2012, UPA has not received any funding
and has not recorded any revenues related to this grant. As part of UPA's project, in October 2012, the Company received a
$900,000 contract from UPA to build a bench-scale “flameless” combustion reactor under the grant.
In accordance with ASC 810,
Consolidation
,
the Company determined that it held an variable interest in UPA and that UPA was a variable-interest entity. However, the Company
has concluded that it is not required to consolidate the financial statements of UPA as of and for the three and nine-month periods
ended September 30, 2012. The
Company reviewed the most significant activities of UPA and determined that because the Company shares the power to direct the
activities of UPA with Itea, it is not the primary beneficiary of UPA. Accordingly, the financial results of UPA is accounted for under the equity method of accounting.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
Note 6: Convertible debt
Unsecured convertible debt consisted of
the following at September 30, 2012 and December 31, 2011 (in thousands):
|
|
September
30,
2012
|
|
|
December
31,
2011
|
|
Roenigk 2007 Convertible Promissory Note, 5%, due March 21, 2013, less discount of $78 at December 31, 2011
|
|
$
|
—
|
|
|
$
|
860
|
|
Roenigk 2008 Convertible Promissory Note, 5%, due March 7, 2013, less discount of $181 at December 31, 2011
|
|
|
—
|
|
|
|
711
|
|
December 2011 Convertible Promissory Notes, 12.5%, due December 31, 2012
|
|
|
1,250
|
|
|
|
1,250
|
|
Roenigk 2012 Convertible Promissory Note, 8%, due March 31, 2014, less discount of $126 at September 30, 2012
|
|
|
1,818
|
|
|
|
—
|
|
|
|
|
3,068
|
|
|
|
2,821
|
|
Less: Current portion
|
|
|
(1,250
|
)
|
|
|
(1,250
|
)
|
|
|
$
|
1,818
|
|
|
$
|
1,571
|
|
Roenigk 2007 Convertible Promissory
Note
On March 21, 2007 the Company issued to
Mr. Martin A. Roenigk, a member of the Company’s Board of Directors as of that date, a 5% Convertible Promissory Note due
March 21, 2013 in the principal amount of $750,000. The principal amount and accrued interest on the Note is convertible into shares
of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable
semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon
payment of a $2,500 deferral fee. The Company added $24,000 of accrued interest to the principal balance of the Note during the
nine months ended September 30, 2012. Total interest added to the principal balance of the Note was $213,000 as of June 20, 2012.
On June 20, 2012, the Noteholder tendered
this Note, together with the 2008 Convertible Promissory Note discussed below, as consideration for the issuance of the 2012 Convertible
Promissory Note, as discussed below.
Roenigk 2008 Convertible Promissory
Note
On March 7, 2008, Mr. Roenigk exercised
his option to make an additional $750,000 investment in the Company under the terms of the Securities Purchase Agreement between
the Company and Mr. Roenigk dated March 21, 2007. The Company issued to Mr. Roenigk a 5% Convertible Promissory Note due March
7, 2013 in the principal amount of $750,000. The principal amount and accrued interest on the Note is convertible into shares of
Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable
semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon
payment of a $2,500 deferral fee. The Company added $22,000 of accrued interest to the principal balance of the Note during the
nine months ended September 30, 2012. Total interest added to the principal balance of the Note was $165,000 as of June 20, 2012.
On June 20, 2012, the Noteholder tendered
this Note, together with the 2007 Convertible Promissory Note discussed above, as consideration for the issuance of the 2012 Convertible
Promissory Note, as discussed below.
December 2011 Convertible Promissory
Notes
On December 2, 2011 the Company entered
into Bridge Loan Agreements with four of its principal investors pursuant to which the Investors agreed to make bridge loans to
the Company of $1.25 million in exchange for 12.5% Promissory Notes (the “December 2011 Bridge Notes”). The
December 2011 Bridge Notes bear interest at the rate of 12.5% per year and are due and payable on December 31, 2012. The entire
unpaid principal amount, together with all interest then accrued and unpaid under each December 2011 Bridge Note, is convertible
into shares of a future series of Preferred Stock at a conversion price to be determined.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
The December 2011 Bridge Notes contain
other conventional provisions, including the acceleration of repayment obligations upon the occurrence of certain specified Events
of Default. No such Events of Default occurred as of September 30, 2012 and through the date of this filing.
Roenigk 2012 Convertible Promissory
Note
On June 20, 2012, the Company issued a
Convertible Promissory Note dated April 1, 2012 in the principal amount of $1,877,217 in exchange for the 2007 Convertible Promissory
Note and the 2008 Convertible Promissory Note (the “Old Notes”). The Note bears interest at the rate of 5% per annum
from April 1, 2012 through May 31, 2012, then bears interest at the rate of 8% per annum until the maturity date, March 31, 2014.
The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50
per share at any time at the election of the holder. Interest on the Note is payable semi-annually. The Company may, at its discretion,
defer any scheduled interest payment until the maturity date of the Note upon payment of a $5,000 deferral fee. The Company added
$67,000 of accrued interest to the principal balance of the Note during the nine months ended September 30, 2012.
The exchange of the Old Notes for this
Note has been accounted for as a troubled debt restructuring in the second quarter of 2012. In summary, the Company was granted
a one year extension of the maturity date of the Old Notes, and the interest rate was increased from 5% to 8% per annum. The Company
evaluated the anticipated future cash flows of this Note and determined that they exceed the carrying value (and accrued interest
thereon) of the Old Notes. As a result, the Company did not record a loss or gain on this transaction.
Note 7: Equity
Common Stock
On January 10,
2012,
the Company entered into Warrant Amendment Agreements with six individuals who acquired warrants
from five funds affiliated with Security Investors, LLC for the purchase of an aggregate of 5,633,344 shares of the Company’s
Common Stock (collectively, the “Warrants”). Pursuant to the Warrant Amendment Agreements, the Company amended the
Warrants to change the exercise prices from $0.30 per share to $0.095 per share, and the Investors agreed to exercise all of the
Warrants immediately for cash. The Company received proceeds totaling $498,000, net of issuance costs, from the exercise of the
Warrants.
On February 10, 2012, the Company issued
419,180 shares of Common Stock to ARC Capital (BVI) Limited. (“ARC”) in partial consideration for financial advisory
and other consulting services performed by ARC pursuant to a Financial Advisory and Consulting Agreement dated as of November 7,
2011. The value of this Common Stock was recorded as a component of general and administrative expense on the Company’s Consolidated
Statement of Operations in the fourth quarter of 2011.
On July 11, 2012, the Company entered into
Securities Purchase Agreements (the “Agreements”) with twenty-four individuals and entities (the “Investors”)
pursuant to which the Company issued an aggregate of 17,316,250 shares of Common Stock, Warrants for the purchase of an additional
18,670,375 shares of Common Stock at an exercise price of $0.15 per share and Warrants for the purchase of an additional 1,354,125
shares of Common Stock at an exercise price of $0.10 per share. The aggregate purchase price for the Shares and Warrants was $1,731,625,
and the Company received proceeds of $1,565,908, net of issuance costs. The Warrants entitle the holders thereof to purchase shares
of Common Stock at any time on or prior to July 11, 2017.
On August 9, 2012, the Company entered
into Securities Purchase Agreements (the “Agreements”) with eleven additional individuals and entities (the “Investors”)
pursuant to which the Company issued an aggregate of 8,287,500 shares of Common Stock, Warrants for the purchase of an additional
9,116,250 shares of Common Stock at an exercise price of $0.15 per share and Warrants for the purchase of an additional 828,750
shares of Common Stock at an exercise price of $0.10 per share. The aggregate purchase price for the Shares and Warrants was $828,750,
and the Company received proceeds of $729,068, net of issuance costs. The Warrants entitle the holders thereof to purchase shares
of Common Stock at any time on or prior to July 11, 2017.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
The Agreements described above include
a price protection provision pursuant to which, at any time on or before January 11, 2014, the Company issues and sells any shares
of Common Stock or securities convertible into Common Stock (“Convertible Securities”) at a price less than $0.10 per
share (a “Dilutive Transaction”), the purchase price for the Shares shall automatically be reduced to a price equal
to the price at which such shares were issued and sold (the “Reduced Price”) and the Company will issue to the Investors,
for no additional consideration, a sufficient number of additional Shares so that the effective price per Share equals the Reduced
Price. The Warrants include a similar price protection provision pursuant to which, upon a Dilutive Transaction, the exercise price
of the Warrants shall automatically be reduced to a price equal to 150% of the Reduced Price. Upon such adjustment, the number
of Warrant Shares issuable upon exercise of a Warrant shall automatically be adjusted by multiplying the number of shares issuable
upon exercise of such Warrant immediately prior to the Dilutive Issuance by a fraction, (i) the numerator of which shall be the
exercise price immediately prior to the Dilutive Issuance and (ii) the denominator of which shall be the exercise price as adjusted.
See Note 8 for further discussion of the accounting treatment of these price protection revisions.
See Note 11 for discussion of the Company’s
sale of Common Stock on October 9, 2012.
At September 30, 2012, approximately 261
million shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements
and other commitments.
Stock Options
During the nine-month period ended September
30, 2012, the Board of Directors awarded employees and an advisor to the Board of Directors a total of 7,060,000 stock options
under the Company’s 2008 Incentive Stock Plan. The options are exercisable at $0.097 - $0.30 per share for a ten year period.
The exercise price was equal to or greater than the market price on the respective grant dates. Options granted to non-employee
directors vest on the date of the Company’s 2012 Annual Meeting of Stockholders; options granted to employees vest ratably
over a four-year period.
The following table presents option expense
included in expenses in the Company’s Consolidated Statements of Operations for the nine-month periods ended September 30,
2012 and 2011:
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
$
|
6
|
|
|
$
|
19
|
|
General and administrative
|
|
|
580
|
|
|
|
613
|
|
Engineering, research and development
|
|
|
70
|
|
|
|
51
|
|
Sales and marketing
|
|
|
63
|
|
|
|
74
|
|
Option expense before tax
|
|
|
719
|
|
|
|
757
|
|
Benefit for income tax
|
|
|
—
|
|
|
|
—
|
|
Net option expense
|
|
$
|
719
|
|
|
$
|
757
|
|
Option expense for the three and nine-month
periods ended September 30, 2012 was calculated using an expected forfeiture rate of 0% - 20%. A forfeiture rate of 0% was
used for the comparative period of 2011.
The fair value of options granted during
the nine-month periods ended September 30, 2012 and 2011 were estimated at the date of grant using a Black-Scholes option pricing
model with the following assumptions:
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
0.83% - 2.23%
|
|
|
|
3.5
|
%
|
Expected option life (years)
|
|
|
6.25 – 10.0
|
|
|
|
6.25
|
|
Expected volatility
|
|
|
91% - 92%
|
|
|
|
91
|
%
|
Expected dividend rate
|
|
|
0%
|
|
|
|
0
|
%
|
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
A summary of the Company’s stock
option activity and related information for the nine-month periods ended September 30, 2012 and 2011 follows:
|
|
2012
|
|
|
2011
|
|
|
|
Number of
Shares
|
|
|
Wtd. Avg.
Exercise
Price per
Share
|
|
|
Number of
Shares
|
|
|
Wtd. Avg.
Exercise
Price per
Share
|
|
Outstanding, beginning of year
|
|
|
19,674,102
|
|
|
$
|
0.38
|
|
|
|
22,065,402
|
|
|
$
|
0.57
|
|
Granted
|
|
|
7,060,000
|
|
|
$
|
0.16
|
|
|
|
1,200,000
|
|
|
$
|
0.30
|
|
Canceled
|
|
|
(800,000
|
)
|
|
$
|
0.30
|
|
|
|
(4,088,800
|
)
|
|
$
|
1.38
|
|
Outstanding, end of period
|
|
|
25,934,102
|
|
|
$
|
0.32
|
|
|
|
19,176,602
|
|
|
$
|
0.47
|
|
Exercisable, end of period
|
|
|
13,733,112
|
|
|
$
|
0.41
|
|
|
|
9,864,590
|
|
|
$
|
0.62
|
|
The weighted average fair value of options
granted was approximately $0.11 and $0.23 per share for the nine-month periods ended September 30, 2012 and 2011, respectively.
The weighted average fair value of options vested was approximately $942,000 and $718,000 for the nine-month periods ended September
30, 2012 and 2011, respectively.
Exercise prices for options outstanding
as of September 30, 2012 ranged from $0.097 to $1.50. The weighted average remaining contractual life of those options was approximately
7.9 years at September 30, 2012. The weighted average remaining contractual life of options vested and exercisable was approximately
7.1 years at September 30, 2012.
As of September 30, 2012, there was approximately
$730,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the
Company’s stock option plans. That cost is expected to be recognized over a weighted-average period of 1.3 years. The Company
recognizes stock-based compensation on the straight-line method.
Warrants
At September 30, 2012, there were outstanding
warrants for the purchase of 106,685,446 shares of the Company’s Common Stock at prices ranging from $0.01 per share to $0.55
per share (weighted average exercise price was $0.30 per share). The expiration dates of these warrants are as follows:
Year
|
|
Number
of
Warrants
|
|
2012
|
|
|
11,333,333
|
|
2013
|
|
|
8,896,554
|
|
2014
|
|
|
6,159,436
|
|
2015
|
|
|
6,188,879
|
|
2016
|
|
|
42,795,244
|
|
After 2016
|
|
|
31,312,000
|
|
|
|
|
106,685,446
|
|
Note 8: Derivative Liabilities
As part of the financing transactions in
the third quarter of 2012 as discussed in Note 7, if the Company issues and sells any shares of Common Stock or securities convertible
into Common Stock (“Convertible Securities”) at a price less than $0.10 per share at any time on or before January
11, 2014 (a “Dilutive Transaction”), the purchase price for the shares shall automatically be reduced to a price equal
to the price at which such shares were issued and sold (the “Reduced Price”), and the Company will issue to the Investors,
for no additional consideration, a sufficient number of additional shares so that the effective price per share equals the Reduced
Price.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
The Warrants include a similar price protection
provision pursuant to which, upon a Dilutive Transaction, the exercise price of the Warrants shall automatically be reduced to
a price equal to 150% of the Reduced Price. Upon such adjustment, the number of shares issuable upon exercise shall automatically
be adjusted by multiplying the number of shares issuable upon exercise of such warrant immediately prior to the Dilutive Transaction
by a fraction, (i) the numerator of which shall be the exercise price immediately prior to the Dilutive Transaction and (ii) the
denominator of which shall be the exercise price as adjusted.
Because these provisions as described above
are not indexed to the Company’s Common Stock, the value of the anti-dilution features of the Common Stock and the value
of the Warrants must be bifurcated and treated as derivative liabilities. As a result, the Company initially recorded derivative
liabilities totaling $2,734,000 in the third quarter of 2012. Because the Company recorded derivative liabilities that exceeded
the proceeds received in the third quarter of 2012, the Company recorded a charge of approximately $565,000. This amount is recorded
as other derivative expense on the Company’s Consolidated Statement of Operations for the three and nine-month periods ended
September 30, 2012.
Liabilities measured at fair value on a
recurring basis as of September 30, 2012 are as follows: (in thousands)
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
Description
|
|
Balance as of
September 30,
2012
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities – current portion
|
|
$
|
41
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
41
|
|
Derivative liabilities – long-term portion
|
|
|
2,400
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,441
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,441
|
|
The Monte Carlo Simulation lattice model
was used to determine the fair values at September 30, 2012. The significant assumptions used were: exercise prices between $0.10
and $0.36; the Company’s stock price on September 28, 2012, $0.10; expected volatility of 55% - 75%; risk free interest rate
between 0.16% and 0.23%; and a remaining contract term between 3 months and 58 months.
Liabilities measured at fair value on a
recurring basis as of December 31, 2011 are as follows: (in thousands)
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
Description
|
|
Balance as of
December 31,
2011
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities – current portion
|
|
$
|
706
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
706
|
|
Derivative liabilities – long-term portion
|
|
|
101
|
|
|
|
-
|
|
|
|
-
|
|
|
|
101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
807
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
807
|
|
The Monte Carlo Simulation lattice model
was used to determine the fair values at December 31, 2011. The significant assumptions used were: exercise prices between $0.185
and $0.36; the Company’s stock price on December 31, 2011, $0.19; expected volatility of 82.9%; risk free interest rate between
0.12% and 0.25%; and a remaining contract term between 1 and 2 years.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
The following table sets forth a reconciliation of changes in
the fair value of derivatives classified as Level 3 (in thousands):
Balance at December 31, 2011
|
|
$
|
807
|
|
Issuance of warrants as derivative liabilities
|
|
|
2,734
|
|
Change in fair value
|
|
|
(1,100
|
)
|
Balance at September 30, 2012
|
|
$
|
2,441
|
|
Note 9: Segments
Operating segments are identified as components
of an enterprise about which separate discrete financial information is available to the chief operating decision maker, or decision-making
group, in assessing performance and allocating resources. The Company markets and develops advanced municipal and industrial wastewater
treatment and carbon reducing clean energy technologies. The Company currently generates almost all of its revenues from the sale
and application of its water treatment technologies. Revenues from its clean energy technologies have been limited to grants received
from governmental and other agencies for continued development. In 2009, the Company established BTCC, a joint venture with Babcock
Power Development, LLC, for the purpose of developing and commercializing the Company’s clean energy technology. This joint
venture is currently in the dissolution process. In March 2012, the Company established UPA to work with partners and stakeholders
to develop and commercialize its pressurized oxycombustion technology, and in July 2012, Itea acquired a 50% ownership interest
in UPA, making it a joint venture.
Because revenues and costs related to the
Company’s clean energy technologies is immaterial to the entire Company taken as a whole, the financial information presented
in these financial statements represents all the material financial information related to the Company’s water treatment
technologies.
The Company’s operations are currently
conducted solely in the United States. While the Company has begun marketing and selling its products in Asia and Europe, the Company
has not generated any revenues from such activities. The Company will continue to evaluate how its business is managed and, as
necessary, adjust the segment reporting accordingly.
Note 10: Commitments and contingencies
On March 25, 2011, the Company was notified
by the U.S. Internal Revenue Service that it had accepted the Company’s Offer in Compromise with respect to its tax liabilities
relating to (i) employee tax withholding for all periods commencing with the quarter ended September 30, 2005 and continuing through
September 30, 2009 and (ii) federal unemployment taxes (FUTA) for the years 2005 through 2008. Pursuant to the Offer in Compromise,
the Company has satisfied its delinquent tax liabilities by paying a total of $2,134,636 (representing the aggregate amount of
tax due, without interest or penalties).
In connection with the Offer in Compromise,
the Company has agreed that any net operating losses sustained for the years ending December 31, 2010 through December 31, 2012
will not be claimed as deductions under the provisions of Section 172 of the Internal Revenue Code except to the extent that such
net operating losses exceed the amount of interest and penalties abated. The IRS acceptance of the Offer in Compromise is conditioned,
among other things, on the Company filing and paying all required taxes for five tax years commencing on the date of the IRS acceptance.
Accrued payroll taxes, which include taxes,
penalties and interest related to state taxing authorities, totaled approximately $399,000 and are included in other current liabilities
on the Company’s Consolidated Balance Sheets as of September 30, 2012. The Company continues to work with the various state
taxing authorities to settle its remaining payroll tax obligations.
On July 16, 2012, Andrew T. Melton, the
Company’s former Executive Vice President and Chief Financial Officer (“Melton”), filed a Complaint in the United
States District Court, Eastern District of Arkansas alleging, among other things, wrongful termination of employment. Mr. Melton
is claiming damages in the aggregate amount of approximately $2.2 million, including unpaid salary, reimbursement of expenses,
and other payments under his employment agreement. The Company is currently in the discovery process and intends to vigorously
defend this litigation.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
On October 16, 2012, Alexander
Fassbender, a creditor of the Company pursuant to a promissory note dated as of April 11, 2011, filed for entry of a
confessed judgment against the Company in Fairfax County, Virginia, Circuit Court seeking payment of $100,000 in principal,
default interest at 18% and attorneys’ fees of not less than $25,000, resulting from an alleged late monthly
installment payment by the Company under the Note. The Company disputes that it defaulted under the promissory note,
and Mr. Fassbender has acknowledged receipt of the monthly installment payment, although he claims that it was paid
late. The Company has filed a Motion to Set Aside or Vacate the Confessed Judgment and has requested a hearing on
November 30, 2012. The Company has accrued all costs as of September 30, 2012, pending resolution of this matter.
The Company is involved from time to time
in litigation incidental to the conduct of its business. Judgments could be rendered or settlements entered that could adversely
affect the Company’s operating results or cash flows in a particular period. The Company routinely assesses all of its litigation
and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate
loss in situations where it assesses the likelihood of loss as probable.
See Note 3 for a discussion of the
termination of the Company’s contract with NYCDEP.
Note 11: Subsequent events
On October 9, 2012, the Company entered
into Securities Purchase Agreements (the “Agreements”) with nine individuals (the “Investors”) pursuant
to which the Company issued an aggregate of 3,765,000 shares of Common Stock, Warrants for the purchase of an additional 4,141,500
shares of Common Stock at an exercise price of $0.15 per share and Warrants for the purchase of an additional 376,500 shares of
Common Stock at an exercise price of $0.10 per share. The aggregate purchase price for the Shares and Warrants was $376,500, and
the Company received proceeds of $331,196, net of issuance costs. The Common Stock and Warrants were issued on terms similar to
the Company’s financing transactions on July 11, 2012 and August 9, 2012 as discussed in Note 7.
On October 4, 2012, the Company entered
into a Loan Agreement (the “Loan Agreement”) with C13 Thermo LLC (the “Lender”) pursuant to which the Lender
established a credit facility allowing the Company to borrow up to $700,000 (the “Credit Facility”) to finance the
fabrication and testing of an Ammonia Reduction Process system utilizing the Company’s proprietary technology (the “Project”).
The Company issued to the Lender a promissory note in the principal amount of $700,000 (the “Note”).
Amounts borrowed under the Credit Facility
will not bear interest (except in the case of an event of default, in which case all amounts borrowed, together with all fees,
expenses and other amounts due, shall bear interest at the default rate of 8% per annum). Upon maturity of the Note, the Company
will be charged a commitment fee equal to 10% of the aggregate principal amount borrowed under the Credit Facility. The Credit
Facility expires, and all amounts due under the Note, together with all commitment fees incurred under the Loan Agreement, will
become due and payable, on the earlier of (i) March 4, 2013 or (ii) the date on which the Company first draws against an irrevocable
documentary letter of credit that has been issued for the Company’s benefit in connection with the Project. The Company may
repay the Note in whole or in part at any time without premium or penalty.
See Note 3 for a discussion of the
termination of the Company’s contract with NYCDEP.