ESNC Common Shares (CE)

NOTE 2 - MANAGEMENT'S PLANS AND FUTURE OPERATIONS

The accompanying condensed consolidated financial statements have been prepared on the basis of a going concern which contemplates that the Company will be able to realize assets and discharge its liabilities in the normal course of business. Accordingly, they do not give effect to any adjustments that would be necessary should the Company be required to liquidate its assets. The Company incurred a net loss of $2,771,694 attributable to EnSync, Inc. for the three months ended September 30, 2018, and as of September 30, 2018 has an accumulated deficit of $140,381,353 and total equity of $5,944,976. The ability of the Company to settle its total liabilities of $4,236,824 and to continue as a going concern is dependent upon raising additional investment capital to fund the Company’s business plan, increasing revenues and achieving profitability. The accompanying condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

The Company believes that cash and cash equivalents on hand at September 30, 2018, and other potential sources of cash, including net cash it generates from closing projects in backlog and pipeline, and potential financing options, will be sufficient to fund the Company’s current operations through the second quarter of fiscal 2020. While the Company believes its pipeline of projects is deep, there can be no assurances that projects will close in a timely manner to meet the Company’s cash requirements. The Company is also working to improve operations and enhance cash balances by continuing to drive cost improvements and reducing its spend on research and development. Also, the Company is currently exploring potential financing options that may be available to the Company, including strategic partnership transactions, PPA project financing facilities, working capital lines of credit, and additional sales of Common Stock or other debt or equity securities. However, the Company has no commitments to obtain any additional funds, and there can be no assurance such funds will be available on acceptable terms or at all. If the Company is unable to increase revenues and achieve profitability in a timely fashion or obtain additional required funding, the Company’s financial condition and results of operations may be materially adversely affected and the Company may not be able to continue operations, execute its growth plan, take advantage of future opportunities or respond to customers and competition.

NOTE 3 - CHINA JOINT VENTURE

On August 30, 2011, the Company entered into agreements providing for the establishment of a joint venture to develop, produce, sell, distribute and service advanced storage batteries and power electronics in China (the “China Joint Venture”). The China Joint Venture was established upon receipt of certain governmental approvals from China which were received in November 2011. China Joint Venture partners include the Company’s sixty percent owned subsidiary, ZBB PowerSav Holdings Limited (“Holdco”), AnHui XinLong Electrical Co., Wuhu Huarui Power Transmission and Transformation Engineering Co. and Wuhu Fuhai-Haoyan Venture Investment, L.P., a branch of Shenzhen Oriental Fortune Capital Co., Ltd.

The China Joint Venture operates through a jointly-owned Chinese company located in Wuhu City, Anhui Province named Anhui Meineng Store Energy Co., Ltd. (“Meineng Energy”). Meineng Energy manufactures certain products for the Company pursuant to a supply agreement under which the Company pays Meineng Energy 120% of its direct costs incurred in manufacturing such products. In addition, pursuant to a License Agreement (as amended on July 1, 2014) between Holdco and Meineng Energy, Meineng Energy assembles and manufactures certain of the Company’s products for sale in the power management industry on an exclusive, royalty-free basis in mainland China and on a non-exclusive, royalty-free basis in Hong Kong and Taiwan. Pursuant to a Research and Development Agreement with Meineng Energy, Meineng Energy may request the Company to provide research and development services upon commercially reasonable terms and conditions. Meineng Energy would pay the Company’s fully-loaded costs and expenses incurred in providing such services. The Company has the right to appoint a majority of the members of the Board of Directors of Holdco and Holdco has the right to appoint a majority of the members of the Board of Directors of Meineng Energy.

Pursuant to a Joint Venture Agreement between Holdco and Anhui Xinrui Investment Co., Ltd, a Chinese limited liability company, and subsequent investment agreements, Meineng Energy has been capitalized with approximately $14.8 million of equity capital as of September 30, 2018 and June 30, 2018.

The Company’s investment in Meineng Energy was made through Holdco. Pursuant to a Limited Liability Company Agreement of Holdco between ZBB Cayman Corporation, the Company’s wholly-owned subsidiary, and PowerSav New Energy Holdings Limited (“PowerSav”), the Company contributed technology to Holdco via a license agreement with an agreed upon value of approximately $4.1 million and $200,000 in cash in exchange for a 60% equity interest. The Company’s basis in the technology contributed to Holdco was $0 due to US GAAP requirements related to research and development expenditures. The difference between the Company’s basis in this technology and the valuation of the technology by Meineng Energy of approximately $4.1 million is accounted for by the Company through the elimination of the amortization expense recognized by Meineng Energy related to the technology. PowerSav agreed to contribute to Holdco $3.3 million in cash in exchange for a 40% equity interest. For financial reporting purposes, Holdco’s assets and liabilities are consolidated with those of the Company and PowerSav’s 40% interest in Holdco is included in the Company’s condensed consolidated financial statements as a noncontrolling interest. As of September 30, 2018 and June 30, 2018, the Company’s indirect investment in Meineng Energy, after accounting for the Company’s share of the earnings or losses, was $870,001 and $831,433, respectively. As of September 30, 2018 and June 30, 2018, the Company’s indirect investment percentage in Meineng Energy equals approximately 30%.

The Company’s President and Chief Executive Officer (“President and CEO”) has served as the Chief Executive Officer of Meineng Energy since December 2011. The President and CEO owns an indirect 6% equity interest in Meineng Energy.

Pursuant to a Management Services Agreement between Holdco and Meineng Energy (the “Management Services Agreement”), Holdco will provide certain management services to Meineng Energy in exchange for a management services fee equal to five percent of Meineng Energy’s net sales for the five year period beginning on the first day of the first quarter in which the Meineng Energy achieves operational breakeven results, and three percent of Meineng Energy’s net sales for the subsequent three years, provided the payment of such fees will terminate upon Meineng Energy completing an initial public offering on a nationally recognized securities exchange. To date, no management service fee revenues have been recognized by Holdco under the Management Services Agreement.

Activity with Meineng Energy is summarized as follows:

The total amount due to Meineng Energy is as follows:

The operating results for Meineng Energy are summarized as follows:

The Company recorded depreciation expense of $38,344 and $97,392 for the three months ended September 30, 2018 and September 30, 2017, respectively.

See Impairment of Long-Lived Assets under Note 1 of the Notes to Condensed Consolidated Financial Statements for a discussion of the impairment charge related to the sale of the Company’s corporate headquarters.

NOTE 7 - LONG-TERM DEBT

During the year ended June 30, 2016, the Company entered into a sales-leaseback transaction with a non-related party, the net consideration received was $331,827 with interest payable in quarterly installments ranging between $1,510 and $2,555 at an imputed interest rate of approximately 2.44% over 20 years ending March 31, 2036.

NOTE 8 - EMPLOYEE AND DIRECTOR EQUITY INCENTIVE PLANS

The Company previously adopted the 2007 Equity Incentive Plan (“2007 Plan”) that authorized the board of directors or a committee to grant up to 300,000 shares to employees and directors of the Company. Unless defined in an employment agreement or otherwise determined, the stock options vest ratably over a three-year period. Stock options expire 10 years after the date of grant. No shares are available to be issued for future awards under the 2007 Plan.

In November 2010, the Company adopted the 2010 Omnibus Long-Term Incentive Plan (“2010 Omnibus Plan”), which authorizes a committee of the board of directors to grant stock options, stock appreciation rights, restricted stock, RSUs, unrestricted stock, other stock-based awards and cash awards. The 2010 Omnibus Plan, as amended, authorizes up to 13,950,000 shares plus shares of Common Stock underlying any outstanding stock option of other awards granted by any predecessor employee stock plan of the Company that is forfeited, terminated, or cancelled without issuance of shares, to employees, officers, non-employee members of the board of directors, consultants and advisors. Unless otherwise determined, options vest ratably over a three-year period and expire eight years after the date of grant. At the annual meeting of shareholders held on December 19, 2017, the Company’s shareholders approved an amendment of the 2010 Omnibus Plan which increased the number of shares of the Company’s Common Stock available for issuance pursuant to awards under the 2010 Omnibus Plan by 2,000,000 to 13,950,000.

In November 2012, the Company adopted the 2012 Non-Employee Director Equity Compensation Plan, as amended (“2012 Director Equity Plan”), under which the Company may issue up to 4,400,000 RSUs and other equity awards to our non-employee directors pursuant to the Company’s director compensation policy. At the annual meeting of shareholders held on November 14, 2016, the Company’s shareholders approved an amendment of the 2012 Director Equity Plan which increased the number of shares of the Company’s Common Stock available for issuance pursuant to awards under the 2012 Director Equity Plan by 1,200,000 to 4,400,000.

As of September 30, 2018, there were a total of 1,350,217 shares available to be issued for future awards under the 2010 Omnibus Plan and 298,375 shares available to be issued for future awards under the 2012 Director Equity Plan.

Stock Options

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing method. The Company uses historical data to estimate the expected price volatility, the expected option life and the expected forfeiture rate. The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future. The following assumptions were used to estimate the fair value of stock options granted during the three months ended September 30, 2018 and September 30, 2017 using the Black-Scholes option-pricing model:

Time-vested and performance-based stock options are accounted for at fair value at date of grant. Total fair values of stock options granted for the three months ended September 30, 2018 and September 30, 2017 were $0 and $9,319 respectively. Compensation expense is recognized over the requisite service and performance periods. The amounts recognized in the condensed consolidated financial statements related to stock options were $11,300 and $188,439, based on the amortized grant date fair value of stock options granted under its various equity incentive plans, during the three months ended September 30, 2018 and September 30, 2017, respectively. At September 30, 2018, there was $314,235 in unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 1.3 years.

Information with respect to stock option activity is as follows:

The following table summarizes information relating to the stock options outstanding as of September 30, 2018:

During the three months ended September 30, 2017, stock options to purchase 27,000 shares were granted to employees exercisable at $0.39 to $0.48 per share based on various service-based vesting terms from July 2017 through September 2020 and exercisable at various dates through September 2025.

There is no aggregate intrinsic value of outstanding stock options based on the Company’s adjusted closing stock price of $0.26 as of September 30, 2018.

Information with respect to unvested employee stock option activity is as follows:

RSUs

The Company compensates its directors with time-vested RSUs and cash. On September 24, 2018 and June 26, 2018, 148,276 and 119,444 RSUs were granted under the 2012 Director Equity Plan to the Company’s directors in lieu of cash based director’s fee payments of $43,000 for services rendered during each of the first quarter of fiscal 2019 and fourth quarter of fiscal 2018, respectively. The RSUs vested immediately on the date of grant. On November 14, 2017, 1,163,075 RSUs were granted to the Company’s directors in partial payment of director’s fees through November 2018 under the 2012 Director Equity Plan. As of September 30, 2018, all of the RSUs from the November 14, 2017 grant had vested.

On November 14, 2016, 581,816 RSUs were granted to the Company’s directors in partial payment of director’s fees through November 2017 under the 2012 Director Equity Plan. As of September 30, 2017, 563,635 of the RSUs from the November 14, 2016 grant had vested and 18,181 had forfeited.

The Company also compensates its key employees with time-vested and performance-based RSUs. No RSUs were granted to the Company’s employees under the 2010 Omnibus Plan and inducement awards during the three months ended September 30, 2018 and September 30, 2017.

Time-vested and performance-based RSUs are accounted for at fair value at date of grant. Total fair value of RSUs granted for the three months ended September 30, 2018 and September 30, 2017 was $43,000 and $0, respectively. Compensation expense is recognized over the requisite service and performance periods. The amount recognized in the condensed consolidated financial statements related to RSUs was $303,342 and $247,169, based on the amortized grant date fair value of RSUs granted under its various equity incentive plans, during the three months ended September 30, 2018 and September 30, 2017, respectively. As of September 30, 2018, there were 3,855,000 of unvested RSUs and $1,487,901 in unrecognized compensation cost. Generally, shares of Common Stock related to vested RSUs are to be issued six months after the holder’s separation from service with the Company.

Information with respect to RSU activity is as follows:

NOTE 9 - WARRANTS

On August 7, 2017, 220,000 warrants were issued in connection with a professional services agreement. The warrants are exercisable at $0.40 per share and vest upon the satisfaction of certain performance targets prior to March 31, 2018. As of March 31, 2018, 40,000 warrants vested and expire in March 2021, and the remaining 180,000 warrants did not vest as the result of not achieving certain performance targets, and therefore expired in March 2018.

On June 22, 2017, 357,500 warrants were issued in connection with the Underwriting Agreement entered into with Roth Capital Partners, LLC as part of underwriting compensation which provided for the sale of $2.5 million of Common Stock on June 22, 2017. The warrants are exercisable at $0.42 per share and expire in June 2022.

Information with respect to warrant activity is as follows:

NOTE 10 - BASIC AND DILUTED NET LOSS PER SHARE

Basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period reported. Diluted net loss per common share is computed giving effect to all dilutive potential common shares that were outstanding for the period reported. Diluted potential common shares consist of incremental shares issuable upon exercise of stock options and warrants and conversion of preferred stock and RSUs. In computing diluted net loss per share for the three months ended September 30, 2018 and September 30, 2017, no adjustment has been made to the weighted average outstanding common shares as the assumed exercise of outstanding stock options, RSUs and warrants and conversion of preferred stock is anti-dilutive.

Potential common shares not included in calculating diluted net loss per share are as follows:

NOTE 11 - EQUITY

Series B Convertible Preferred Stock

On September 26, 2013, the Company entered into a Securities Purchase Agreement with certain investors providing for the sale of 3,000 shares of Series B Convertible Preferred Stock (the “Series B Preferred Stock”). Certain Directors of the Company purchased 500 shares. Shares of Series B Preferred Stock have a $1,000 per share stated value (the “Stated Value”) and accrue dividends on the Stated Value at an annual rate of 10%. At September 30, 2018, 2,300 shares of Series B Preferred Stock remain outstanding and were convertible, along with accrued and unpaid dividends, into 3,967,176 shares of Common Stock of the Company at a conversion price equal to $0.95. Upon any liquidation, dissolution or winding up of the Company, holders of the Series B Preferred Stock are entitled to receive out of the assets of the Company an amount equal to two times the Stated Value, plus any accrued and unpaid dividends thereon. At September 30, 2018 and June 30, 2018, the liquidation preference of the Series B Preferred Stock was $6,068,818 and $5,976,896, respectively.

Series C Convertible Preferred Stock

On July 13, 2015, the Company entered into a Securities Purchase Agreement with SPI Energy Co., LTD. (“SPI”) in connection with entering into a global strategic partnership, which included a Securities Purchase Agreement, a Supply Agreement and a Governance Agreement. Pursuant to the Securities Purchase Agreement, the Company sold to SPI for an aggregate purchase price of $33,390,000 a total of (i) 8,000,000 shares of Common Stock based on a purchase price per share of $0.6678 and (ii) 28,048 shares Series C convertible preferred stock (the “Series C Preferred Stock”) based on a price of $0.6678 per common equivalent. At the closing of the SPI transaction, the Company recognized the fair value of (i) $6,800,000 for the Common Stock (determined by reference to the closing price of the Company’s Common Stock on the NYSE American) as an increase to equity; (ii) $13,300,000 for the Series C Preferred Stock, ignoring the contingent convertibility on the closing date, as an increase to equity; and (iii) $13,290,000 as deferred revenue for the cash received by the Company in excess of the fair value of the Common Stock and the nonconvertible attribute of the Series C Preferred Stock, which was allocated to the Supply Agreement.

As the result of SPI’s failure to perform any of its purchase obligations under the Supply Agreement, on May 4, 2017, the Company terminated the Supply Agreement. As a result of the termination of the Supply Agreement, it is no longer possible for SPI to satisfy the conditions that would have enabled it to convert the Series C Preferred Stock into a total of up to 42,000,600 shares of Common Stock or exercise the warrant to purchase 50,000,000 shares of Common Stock issued pursuant to the Securities Purchase Agreement, and for the Company to recognize revenue as sales occurred under the Supply Agreement.

Additionally, on May 8, 2018, the Company filed a lawsuit against SPI in the Circuit Court for Waukesha County in the State of Wisconsin seeking a declaratory judgment releasing the Company from its obligations under the Governance Agreement between the Company and SPI dated July 13, 2015 (the “SPI Dispute”).  The Company’s complaint in the SPI Dispute asserted, among other things, that the Company should be released from its obligations under the Governance Agreement due to the Doctrine of Frustration of Purpose. As detailed in the complaint, the basis for this claim was that the Company’s principle purpose for entering into the Governance Agreement was as a condition and inducement to SPI to enter into the Supply Agreement between the Company and SPI dated July 13, 2015, and that due to SPI’s failure to perform its obligations under the Supply Agreement, that purpose was frustrated.

On June 19, 2018, the Circuit Court for Waukesha County in the State of Wisconsin granted the Company’s motion for a default judgment in the SPI Dispute.  Pursuant to this default judgment, the Court ordered that the Governance Agreement was terminated and unenforceable, and the Company was completely and fully released from its obligations, covenants and agreements thereunder.

The Series C Preferred Stock are non-voting, are perpetual, are not eligible for dividends, and are not redeemable. While the Series C Preferred Stock is outstanding, the Company may not pay dividends on its Common Stock and may not redeem more than $100,000 in Common Stock per year. Upon any liquidation, dissolution, or winding up of the Company (a “Liquidation”) or a Fundamental Transaction (as defined in the Certificate of Designation for the Series C Preferred Stock), holders of the Series C Preferred Stock are entitled to receive out of the assets of the Company an amount equal to the higher of (1) the stated value, which was $28,048,000 as of September 30, 2018 and (2) the amount payable to the holder if it had converted the shares into Common Stock immediately prior to the Liquidation or Fundamental Transaction, for each share of the Series C Preferred Stock after any distribution or payment to the holders of the Series B Preferred Stock and before any distribution or payment shall be made to the holders of the Company’s existing Common Stock, and if the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed shall be ratably distributed in accordance with respective amount that would be payable on such shares if all amounts payable thereon were paid in full. At September 30, 2018 and June 30, 2018, the liquidation preference of the Series C Preferred Stock was $0.

Common Stock

September 5, 2018 Registered Direct Offering

On September 5, 2018, the Company completed a registered direct offering, pursuant to a Registration Statement on Form S-3, of 11,334,616 shares of Common Stock at a price of $0.26 per share for net proceeds of $2,701,569, after deducting customary expenses.

NOTE 12 - COMMITMENTS

Leasing Activities

Operating Leases

Operating lease expense recognized during the three months ended September 30, 2018 and September 30, 2017 was $52,670 and $21,264, respectively. Operating lease expense is included in operating expenses in the condensed consolidated statements of operations.

In December 2017, the Company entered into a seven-year office lease agreement to replace the Company’s former headquarters, which was sold on January 31, 2018. Monthly rent for the first twelve months of the lease is $13,845 and increases by approximately 1.5% for each succeeding 12-month period. Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements for further detail related to the sale of the Company’s headquarters.

As of September 30, 2018, and June 30, 2018, the carrying value of the right of use asset was $1,011,620 and $1,087,249, respectively, and is separately stated on the condensed consolidated balance sheets. The related short-term and long-term liabilities as of September 30, 2018 were $164,597 and $847,023 and as of June 30, 2018 were $197,616 and $889,633, respectively. The short-term and long-term liabilities are included in “Accrued expenses” and “Other long-term liabilities,” respectively, in the condensed consolidated balance sheets.

Information regarding the weighted-average remaining lease term and the weighted-average discount rate for operating leases are summarized below:

The table below reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the condensed consolidated balance sheet as of September 30, 2018:

Short-term Leases

The Company leases facilities in Honolulu, Hawaii, Milwaukee and Madison, Wisconsin, Petaluma, California and Shanghai, China from unrelated parties under lease terms that will expire over the next twelve months. Monthly rent for the twelve-month rental periods is between $400 and $3,150 per month. Rent expense of $23,864 and $8,922 was recognized during the three months ended September 30, 2018 and September 30, 2017, respectively. Short-term rent expense is included in operating expenses in the condensed consolidated statements of operations.

NOTE 13 - RETIREMENT PLANS

The Company sponsors a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code, the EnSync, Inc. 401(k) Savings Plan. Employees may elect to contribute up to the Internal Revenue Service annual contribution limit. The Company matches employees’ contributions up to 4% of eligible compensation and Company contributions are limited in any year to the amount allowable by government tax authorities. Eligible employees are 100% immediately vested. Total employer contributions recognized in the condensed consolidated statements of operations under this plan were $49,589 and $51,753 for the three months ended September 30, 2018 and September 30, 2017, respectively.

NOTE 14 - INCOME TAXES

The Company had no current or deferred provision (benefit) for income taxes for the three months ended September 30, 2018 and September 30, 2017. The income tax provision for the three months ended September 30, 2018 and September 30, 2017 was determined by applying an estimated annual effective tax rate of 0.0% to the loss before income taxes. The estimated effective income tax rate was determined by applying statutory tax rates to pretax loss adjusted for certain permanent book to tax differences and tax credits, and the continuing assessment of a valuation allowance against all of the deferred income tax assets that will not be realized in the foreseeable future. Deferred income tax assets are reviewed for recoverability based on historical taxable income, the expected reversals of existing temporary differences, tax planning strategies and projections of future taxable income. As a result of this analysis, the Company has provided for a valuation allowance against all of its net deferred income tax assets as of September 30, 2018 and June 30, 2018.

On December 22, 2017, the President of the U.S. signed the Tax Act into law. The Tax Act includes several changes to existing tax law, including a permanent reduction in the U.S. federal statutory tax rate from 35% to 21%, further limitations on the deductibility of interest expense and certain executive compensation, repeal of the corporate Alternative Minimum Tax and imposition of a territorial tax system. While some of the new provisions of the Tax Act will impact the Company in fiscal 2019 and beyond, the change in the U.S. federal statutory tax rate was effective January 1, 2018. During the second quarter of fiscal 2018, the Company was required to revalue its U.S. federal deferred tax assets and liabilities at the new U.S. federal statutory tax rate in the period of enactment, and as the Company has provided for a full valuation allowance against all of its net deferred income taxes, the revaluation resulted in no charge to income tax expense.

The following discussion and analysis of our financial position and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q, as well as our audited consolidated financial statements and notes thereto included in the Company’s Annual Report filed on Form 10-K for the fiscal year ended June 30, 2018.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are intended to be covered by the “safe harbor” created by those sections. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of forward-looking terms such as “believe,” “expect,” “may,” “will,” “should,” “could,” “seek,” “intend,” “plan,” “goal,” “estimate,” “anticipate” or other comparable terms. All statements other than statements of historical facts included in this Quarterly Report on Form 10-Q regarding our strategies, prospects, financial condition, operations, costs, plans and objectives are forward-looking statements. Examples of forward-looking statements include, among others, statements we make regarding project completion timelines, our ability to monetize our PPA assets, statements regarding the sufficiency of our capital resources, expected operating losses, expected revenues, expected expenses and our expectations concerning our business strategy. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following: our historical and anticipated future operational losses and our ability to continue as a going concern; our ability to raise the necessary capital to fund our operations and the risk of dilution to shareholders from capital raising transactions; our ability to remain listed on the NYSE American; the effects of a sale or transfer of a large number of shares of our Common Stock; the competitiveness of the industry in which we compete; our ability to successfully commercialize new products, including our EnSync Home Energy System, Matrix ^TM Energy Management, DER Flex ^TM , DER Supermodule ^TM System and Agile ^TM Hybrid Storage Systems; our ability to lower our costs and increase our margins; the failure of our products to perform as planned; our ability to improve the performance of our products; our ability to build quality and reliable products and market perception of our products; our ability to grow rapidly while successfully managing our growth; our ability to maintain our current strategic partnerships and establish new strategic partnerships; our dependence on sole source and limited source suppliers; our limited experience manufacturing our products on a large-scale basis; our product, customer and geographic concentration, and lack of revenue diversification; the potential of Melodious Investments Company Limited and its affiliates to acquire complete control; the effect laws and regulations of the Chinese government may have on our China joint venture; our ability to enforce our agreements in Asia; our ability to retain our managerial personnel and to attract additional personnel; our ability to manage our international operations; the length and variability of our sales cycle; our increased emphasis on larger and more complex system solutions; our lack of experience in the PPA business; our reliance on third-party suppliers and contractors when developing and constructing systems for our PPA business; our dependence on governmental mandates and the availability of rebates, tax credits and other economic incentives related to alternative energy resources and the regulatory treatment of third-party owned solar energy systems; our ability to protect our intellectual property and the risk we may infringe on the intellectual property of others; the cost of protecting our intellectual property; future acquisitions could disrupt our business and dilute our stockholders; and the other risks and uncertainties discussed in the Risk Factors and in Management's Discussion and Analysis of Financial Condition and Results of Operations sections on our most recently filed Annual Report on Form 10-K for the fiscal year ended June 30, 2018 and our subsequently filed Quarterly Report(s) on Form 10-Q. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

OVERVIEW

We are a renewable energy systems and services company whose innovative and differentiated technologies and capabilities are designed to deliver the least expensive, highest value and most reliable electricity. With the Company's May 2018 announcement of the EnSync Home Energy System, we now serve all three major markets in the renewable energy space: Residential Energy Systems, Commercial Energy Systems and Independent Utility Energy Systems. Our systems utilize highly configurable modules, that together with our Auto-Sync DC Bus and DER Flex ^TM internet of energy control platform, enable simple design, configuration and deployment of mass-customized systems that meet the specific needs of each project with the best possible economics in a highly dynamic environment with multiple economic value streams. We are vertically integrated, from lead generation to system design and deployment, to warranty and operating and maintenance services. We typically utilize a 20-year PPA structure where the offtaker contracts to purchase electricity from a completed system owned by a third-party that acquires the PPA from us. We recognize revenue from these PPA arrangements on a percentage of completion basis as we build out and commission the system. We also sell systems directly to the end customer or through our channel partners.

NEW ACCOUNTING PRONOUNCEMENTS

Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes in the Company’s critical accounting policies and estimates since the filing of its Annual Report on Form 10-K for the fiscal year ending June 30, 2018.

As discussed in our annual report, the preparation of our financial statements conforms to US GAAP, which requires management, in applying our accounting policies, to make estimates and assumptions that have an important impact on our reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of our financial statements.

On an on-going basis, management evaluates and bases its estimates and judgments on historical experience and on various other factors that are believed 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 management’s estimates.

The most significant accounting estimates inherent in the preparation of the Company's financial statements include revenue recognition, estimates as to the realizability of our inventory assets, impairment of long-lived assets, goodwill assessment, warranty obligations, stock-based compensation and going concern assessment.

Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements for further detail about our significant accounting estimates inherent in the preparation of our financial statements.

RESULTS OF OPERATIONS

Three months ended September 30, 2018, as compared with the three months ended September 30, 2017

Revenue

Our revenues for the three months ended September 30, 2018 increased $376,158, or 15.9%, to $2,738,206, as compared to the three months ended September 30, 2017. The increase in revenues in the three months ended September 30, 2018 was principally the result of an increase in revenues recognized under the percentage of completion method from our existing PPA projects and the sale of two new PPA projects. The Company had 10 PPA projects contribute to revenues in the three months ended September 30, 2018, as compared to 7 projects in the three months ended September 30, 2017.

Costs and Expenses

Total costs and expenses for the three months ended September 30, 2018 decreased $777,554, or 12.2%, to $5,585,366, as compared to the three months ended September 30, 2017. This decrease in total costs and expenses were primarily due to the following factors:

Gross margin improved to 13.2% during the three months ended September 30, 2018, as compared to 12.5% in the three months ended September 30, 2017.

Other Income (Expense)

Total other income (expense) for the three months ended September 30, 2018 decreased by $22,741, to an expense of $6,893, as compared to an income of $15,848 for the three months ended September 30, 2017. The decrease in other income (expense) was attributable to a gain on sale of property, plant and equipment in the three months ended September 30, 2017.

Net Loss

Our net loss attributable to EnSync, Inc. for the three months ended September 30, 2018 decreased by $1,120,100, or 28.8%, to $2,771,694, as compared to the $3,891,794 net loss for the three months ended September 30, 2017. This decrease in net loss was principally due to the increase in PPA revenues and cost saving initiatives.

LIQUIDITY AND CAPITAL RESOURCES

Since our inception, our research, advanced engineering and development, and operations have been primarily financed through debt and equity financings, and engineering, government and other research and development contracts. Total capital stock and paid in capital as of September 30, 2018 was $147,299,915, as compared with $144,283,704 as of June 30, 2018. We had an accumulated deficit of $140,381,353 as of September 30, 2018, as compared to $137,609,659 as of June 30, 2018. At September 30, 2018, we had net working capital of $3,668,864, as compared to $3,322,404 as of June 30, 2018. Our shareholders’ equity as of September 30, 2018 and June 30, 2018, exclusive of noncontrolling interests, was $5,330,860 and $5,086,343, respectively.

On January 31, 2018, we completed the sale of our corporate headquarters pursuant to which we received net proceeds of $1,725,326, after payment in full of our mortgage, related interest and customary closing costs.

On September 5, 2018, we completed a registered direct offering, pursuant to a Registration Statement on Form S-3, of 11,334,616 shares of Common Stock at a price of $0.26 per share for net proceeds of $2,701,569, after deducting customary expenses.

At September 30, 2018, our principal sources of liquidity were our cash and cash equivalents, which totaled $2,981,785, accounts receivable of $17,504 and costs and estimated earnings in excess of billings of $863,841.

We believe that cash and cash equivalents on hand at September 30, 2018, and other potential sources of cash, including net cash we generate from closing projects in our backlog and pipeline, and potential financing options, will be sufficient to fund our current operations through the second quarter of fiscal 2020. While we believe our pipeline of projects is deep, there can be no assurances that projects will close in a timely manner to meet our cash requirements. We are also working to improve operations and enhance cash balances by continuing to drive cost improvements and reducing our spend on research and development. Also, we are currently exploring potential financing options that may be available to us, including strategic partnership transactions, PPA project financing facilities, working capital lines of credit, and additional sales of Common Stock or other debt or equity securities. However, we have no commitments to obtain any additional funds, and there can be no assurance such funds will be available on acceptable terms or at all. If the Company is unable to increase revenues and achieve profitability in a timely fashion or obtain additional required funding, the Company’s financial condition and results of operations may be materially adversely affected and the Company may not be able to continue operations, execute our growth plan, take advantage of future opportunities or respond to customers and competition.

Cash Flows

Cash decreased $2,747 in the three months ended September 30, 2018, ending the period at $2,981,785. Cash decreased $2,678,983 in the three months ended September 30, 2017, ending the period at $9,103,979.  The decrease in the usage of cash in the three months ended September 30, 2018, as compared to the three months ended September 30, 2017, is due to the following:

Operating Activities

Our operating activities used cash of $2,640,010 for the three months ended September 30, 2018, as compared to cash used of $2,792,050 in the three months ended September 30, 2017. The decrease in the cash used in the three months ended September 30, 2018 is attributable to the reduction in net loss in the three months ended September 30, 2018 from the increase in PPA revenues and cost saving initiatives, offset by working capital changes.

Investing Activities

Our investing activities used cash of $64,306 for the three months ended September 30, 2018, as compared to cash provided of $76,000 in the three months ended September 30, 2017. The increase in the cash used is attributable to capital expenditures of $75,430 in the three months ended September 30, 2018, offset by proceeds of $70,000 from the sale of property, plant and equipment in the three months ended September 30, 2017.

Financing Activities

Our financing activities provided cash of $2,701,569 for the three months ended September 30, 2018, as compared to cash provided of $37,067 in the three months ended September 30, 2017. The increase in the cash provided is attributable to the proceeds from the registered direct offering of 11,334,616 shares of Common Stock at a price of $0.26 per share for net proceeds of $2,701,569, after deducting customary expenses.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of September 30, 2018.