NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
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 metal finishing, heavy manufacturing, hydraulic fracturing, petrochemical, refining, aerospace, food and beverage
processing, pulp and paper, microchip and circuit board manufacturing and municipal wastewater. The CAST
®
platform technology
is owned by its subsidiary, CASTion Corporation (“CASTion”).
The Company also
owns a patented pressurized oxycombustion technology 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”).
The Company’s
pressurized oxycombustion technology and the water technologies are collectively referred to as the “Technologies.”
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. Financial results for Unity Power Alliance (“UPA”) have been consolidated for the period from inception
until the date it became a Joint Venture on July 16, 2012. Financial results for UPA as a Joint Venture are accounted for under
the equity method of accounting for investments, as discussed in Note 4.
Certain prior year amounts have been reclassified
to conform to current year classifications. The Company separated the balance of accrued payroll and other taxes from other current
liabilities; these amounts were included as part of other current liabilities on the Company’s Consolidated Balance Sheet
as of December 31, 2012. Additionally, the Company reduced its balance of notes receivable, with an offsetting reduction of long
term liabilities, by $100,000 compared to amounts reports on the Company’s Consolidated Balance Sheet as of December 31,
2012 to consistently report activity related to its investments in UPA.
The preparation of financial
statements in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities 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. Significant estimates affecting amounts reported in the consolidated financial statements relate to revenue
recognition, recognition of derivative liabilities and accruals for payroll and other taxes.
The 15% third party ownership interest
in TEPS is recorded as a noncontrolling interest in the consolidated financial statements.
Revenue recognition
Historically, the Company has recognized
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. Project costs include all direct material and labor costs and indirect costs
related to project performance, such as indirect labor, supplies, tools, repairs and depreciation.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Recognition of revenue and profit under
the percentage-of-completion method 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, as well as 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.
Certain long-term projects 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 circumstances when the
Company cannot estimate the final outcome of a project, or when the Company cannot reasonably estimate revenue, the Company
utilizes the percentage-of-completion method based on a zero profit margin until more precise estimates can be made. If and
when the Company can make more precise estimates, revenues are adjusted accordingly and recorded as a change in an
accounting estimate. The Company recorded revenue from one project which represented 21% and less than 1% of its revenues for
the years ended December 31, 2013 and 2012, respectively, utilizing the percentage of completion method based on a zero
profit margin.
Effective October 1, 2013, the
Company launched changes to its operations to emphasize standardized systems and manufacturing processes and has commenced
selling wastewater treatment systems based on these changes. The Company recognizes revenue on the sale of its wastewater
treatment systems from this new standardized process at the point of shipment or transfer of title, provided there is
persuasive evidence of an arrangement, the fee is fixed and determinable, and the collectability of the related receivable is
probable. Amounts received from customers in advance of shipment are recorded within customer deposits.
The Company recognizes revenues on its
contract with UPA on a time-and-materials basis.
Revenue from spare parts sales is recognized
upon shipment or title transfer under the terms of the customer contract.
Service revenue is recognized upon the
completion and acceptance of the work performed.
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.
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 4 for further discussion of UPA as a variable interest entity.
Cash and cash equivalents
The Company places its cash in highly rated
financial institutions, which are continually reviewed by senior management for financial stability. Generally the Company’s
cash in interest-bearing accounts exceeds financial depository insurance limits. However, the Company has not experienced any losses
in such accounts and believes that its cash is not exposed to significant credit risk.
The Company has a cash management program
which provides for the investment of excess cash balances primarily in money market funds, which are valued using Level 1 inputs.
The Company considers such highly liquid investments with original maturities of three months or less when purchased to be cash
equivalents.
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.
The Company maintains allowances for specific
doubtful accounts based on estimates of losses resulting from the inability of customers to make required payments and record 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.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
The following is a summary of the Company’s
allowance for doubtful accounts activity for the year ended December 31, 2013: (in thousands)
|
Allowance for doubtful accounts, beginning of year
|
|
$
|
—
|
|
|
Bad debt expense
|
|
|
5
|
|
|
Write-offs
|
|
|
(5
|
)
|
|
Allowance for doubtful accounts, end of year
|
|
$
|
—
|
|
The Company did not have any activity in
its allowance for doubtful accounts for the year ended December 31, 2012.
At December 31, 2013, two customers accounted
for 81% of the Company’s total accounts receivable balance. At December 31, 2012, one customer accounted for 53% of the Company’s
accounts receivable balance. For the year ended December 31, 2013, three customers each accounted for more than 10% of the Company’s
revenues and collectively accounted for 76% of total revenues. For the year ended December 31, 2012, one customer accounted for
73% of the Company’s revenues.
Inventories, net
Inventories are stated at the lower of
cost or net realizable value using the first-in, first-out method and are comprised of the following as of December 31, 2013 and
2012: (in thousands)
|
|
|
2013
|
|
|
2012
|
|
|
Raw materials
|
|
$
|
192
|
|
|
$
|
187
|
|
|
Work in process
|
|
|
46
|
|
|
|
—
|
|
|
|
|
|
238
|
|
|
$
|
187
|
|
|
Less: Reserve for excess and obsolete inventory
|
|
|
(134
|
)
|
|
|
(134
|
)
|
|
|
|
$
|
104
|
|
|
$
|
53
|
|
The Company evaluates its inventory for
excess quantities and obsolescence on a periodic basis. In preparing its evaluation, the Company looks at the expected
demand for its products for the next three to twelve months. Based on this evaluation, the Company records provisions
to ensure that inventory is appropriately stated at the lower of cost or net realizable value.
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.
Property and equipment are comprised of the following as of December 31, 2013 and 2012: (in thousands)
|
|
|
Estimated Useful Lives
|
|
2013
|
|
|
2012
|
|
|
Computers and software
|
|
3-5 years
|
|
$
|
254
|
|
|
$
|
198
|
|
|
Furniture and fixtures
|
|
7 years
|
|
|
50
|
|
|
|
50
|
|
|
Demonstration equipment
|
|
7 years
|
|
|
464
|
|
|
|
604
|
|
|
Leasehold improvements
|
|
life of lease
|
|
|
168
|
|
|
|
110
|
|
|
Production and laboratory equipment
|
|
7 years
|
|
|
126
|
|
|
|
126
|
|
|
|
|
|
|
|
1,062
|
|
|
$
|
1,088
|
|
|
Less: Accumulated depreciation
|
|
|
|
|
(469
|
)
|
|
|
(420
|
)
|
|
|
|
|
|
$
|
593
|
|
|
$
|
668
|
|
Depreciation expense was $189,000 and $119,000
for the years ended December 31, 2013 and 2012, respectively.
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 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 year ended December 31, 2012.
Taxes to governmental authorities
The Company collects sales taxes but excludes
such amounts from revenues.
Shipping and handling costs
Shipping and handling costs that are billed
to customers are included in cost of goods sold in the accompanying statements of operations.
Advertising costs
The Company expenses advertising costs
as incurred. During the years ended December 31, 2013 and 2012, the Company incurred advertising expense in the amounts of $27,000
and $37,000, respectively.
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 payroll tax and other accruals are reflected in income 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 contingent 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.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Stock options
The Company accounts for stock options
in accordance with Accounting Standards Codification (“ASC”) Topic 718, “Compensation – Stock Compensation.”
This topic requires that the cost of all share-based payments to employees, including grants of employee stock options, be recognized
in the 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.
Income taxes
The Company uses the liability method of
accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between
the financial reporting and tax basis of assets and liabilities and are measured using enacted rates and laws that will be in effect
when the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance for deferred tax assets
is provided if it is more likely than not that all or a portion of the deferred tax assets will not be realized. The Company recognizes
interest and penalties related to underpayments of income taxes as a component of interest and other expense on its Consolidated
Statement of Operations.
The Company estimates contingent income
tax liabilities based on the guidance for accounting for uncertain tax positions as prescribed in ASC Topic 740, “Income
Taxes.” The Company uses a two-step process to assess each income tax position. It first determines whether it is more
likely than not that the income tax position will be sustained, based on technical merits, upon examination by the taxing authorities.
If the income tax position is expected to meet the more likely than not criteria, the Company then records the benefit in the financial
statements that equals the largest amount that is greater than 50% likely to be realized upon its ultimate settlement. At
December 31, 2013 and 2012, there are no uncertain tax positions that require accrual.
The Company is subject to taxation in the
U.S. and various states. As of December 31, 2013 the Company’s tax years for 2010, 2011, 2012 and 2013 are subject to examination
by the tax authorities. As of December 31, 2013, the Company is no longer subject to U.S. federal, state or local examinations
by tax authorities for years before 2010. Tax year 2009 was open as of December 31, 2012.
Fair value of financial instruments
and fair value measurements
The carrying amount of cash and
cash equivalents, accounts receivable, other current assets, accounts payable, short term borrowings and other current
liabilities in the consolidated financial statements approximate fair value because of the short-term nature of those
instruments. The carrying amount of the Company’s convertible debt and short term borrowings was $6,083,000 and
$7,279,000 at December 31, 2013 and 2012, respectively, and approximates its fair value, as the interest rate on this debt
approximates the interest rate of the Company’s recent borrowings. The Company’s derivative liabilities are
recorded at fair value. See Note 8 for further information on derivative liabilities.
The Company's assets and liabilities carried
at fair value are categorized using inputs from the three levels of 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.
|
Earnings (loss) per share
Basic earnings
(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 earnings 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 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 computations of diluted net loss per share do not
include 0 and 392,326 options and warrants which were outstanding as of the years ended December 31, 2013 and 2012, respectively,
as the inclusion of these securities would have been anti-dilutive.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Concentration of Credit Risk
Financial instruments which potentially
expose the Company to concentrations of credit risk include cash equivalents, trade accounts receivable, accounts payable and accrued
liabilities. The Company restricts its cash equivalents to money market accounts with major banks and U.S. government and corporate
securities which are subject to minimal credit and market risk.
Recent accounting pronouncements
In July 2013, the FASB issued ASU 2013-11,
Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward
Exists
, an amendment to FASB Accounting Standards Codification (“ASC”) Topic 740, Income Taxes (“FASB ASC
Topic 740”). This update clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should
be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar
tax loss, or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed.
In situations where a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the
reporting date under the tax law of the applicable jurisdiction or the tax law of the jurisdiction does not require, and the entity
does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial
statements as a liability and should not be combined with deferred tax assets. This ASU is effective prospectively for fiscal years,
and interim periods within those years, beginning after December 15, 2013. The adoption of this ASU is not expected to have a material
impact on the Company’s financial statements.
There were no other accounting standards
recently issued that had or are expected to have a material impact on the Company’s consolidated financial statements and
associated 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 year ended December 31, 2013.
At December 31, 2013, the Company had cash
of approximately $2.5 million. The Company has incurred net losses since inception, including a net loss of approximately $1.6
million during the year ended December 31, 2013 and had an accumulated deficit of approximately $122.5 million at December 31,
2013.
In view of the matters described in the
preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is
dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing
requirements on a continuing basis, to maintain present financing, and to succeed in its future operations.
The financial
statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts
and classification of liabilities that might be necessary should the Company be unable to continue in existence.
These uncertainties raise substantial doubt
about the Company's ability to continue as a going concern. The financial statements included in this Form 10-K 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 is actively building
and developing its sales pipeline to generate future revenues. Management and an independent committee of the
Company’s Board of Directors are also evaluating alternatives for funding to continue operations under the
Company’s existing structure.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
As more fully
described in Notes 6, 7 and 8, on April 5, 2013, the Company issued shares of Series C Convertible Redeemable Preferred Stock in
exchange for the entire principal and accrued interest amounts of the Company’s December 2011 Bridge Notes and the Company’s
November 2012 Bridge Notes. Additionally, as more fully described in Note 5, on August 22, 2013, the Company received proceeds
totaling $4,000,000 from the issuance of 12% Promissory Notes.
Note 3: NYCDEP Contract
On August 22, 2012, the City of New York
Department of Environmental Protection (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 suspended all work with its major vendors. Upon notification of the contract termination, the
Company cancelled all orders from its major vendors. The Company ceased recognition of revenues as of November 29, 2012 with the
exception of processing one change order in the first quarter of 2013, and the Company recorded all incremental costs as period
costs on its Consolidated Statement of Operations.
The Company received all amounts billed
to the NYCDEP related to this contract, and the Company delivered all equipment, including all material from third party vendors,
to the NYCDEP during the first quarter of 2013. In June 2013, the Company received notice from the NYCDEP that the contract had
been closed. Accordingly, the Company recorded a gain on contract termination of approximately $4.9 million in the second quarter
of 2013, which represents the amount the Company billed in accordance with the contract in excess of revenues recognized.
Note 4: Joint Ventures
Babcock-Thermo Clean Combustion LLC
On February 25, 2009, the Company’s
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 (the “Joint Venture”) for the purpose of developing its proprietary pressurized
oxycombustion technology. In 2011, the joint venture changed its name to Babcock-Thermo Clean Combustion LLC.
Pursuant to the LLC Agreement, each of
ThermoEnergy Power Systems and BPD owned a 50% membership interest in the Joint Venture. The LLC Agreement provides
that each member may be required, from time to time, to make capital contributions to the Joint Venture to fund its operations.
The Company accounted for the Joint Venture
using the equity method of accounting. Accordingly, the Company reduced the value of its investment in the Joint Venture by $2,000
in 2013 and $26,000 in 2012 to account for its share of net losses incurred by the Joint Venture. The carrying value of the Company’s
investment in the Joint Venture is $10,000 as of December 31, 2012, and is classified as Other Assets on the Company’s Consolidated
Balance Sheets.
On March 2, 2012, TEPS entered into a Dissolution
Agreement with BPD to terminate the Limited Liability Company Agreement and dissolve the Joint Venture, and the Joint Venture was
dissolved on April 30, 2013.
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.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
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 and the members of the joint venture.
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 part of UPA's project, in October 2012, the Company received a $900,000
subcontract order from UPA to build a bench-scale “flameless” combustion reactor under the grant using Itea’s
design. As a subcontractor for this project, the Company was required by the DOE to provide a guarantee that the project would
be completed in its entirety. UPA and its subcontractors received contract definitization during the first quarter of 2013 and
began to receive funding. As of December 31, 2013, UPA has received funding totaling $901,000 related to this grant from the DOE.
The Company, as a subcontractor to UPA, has recorded revenues of $842,000, as well as related expenses totaling $896,000, associated
with this contract during the year ended December 31, 2013, and the Company has accounts receivable related to this contract of
approximately $293,000 as of December 31, 2013.
In October 2012, the Company and Itea entered
into a Loan Agreement with UPA through which funds required to maintain the operations of the joint venture would be loaned in
the form of notes receivable. The notes bear interest at the three-month LIBOR rate plus 2% per year, with interest calculated
monthly and added to the balance of the notes. The Company loaned $100,000 and converted accounts receivable of $200,000 into a
loan under this Loan Agreement; Itea loaned $300,000 to UPA in 2013. Each party loaned $100,000 in 2012 in conjunction with this
Loan Agreement. Investments and loans made by the Company to UPA are being utilized to fund UPA’s share of the costs to complete
the project and operating expenses of UPA.
In accordance with ASC 810,
Consolidation
,
the Company determined that it held a 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 for the years ended December 31, 2013 and
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 are accounted
for under the equity method of accounting for investments.
Financial results for UPA have been consolidated
for the period from inception until July 16, 2012, when Itea acquired its 50% ownership interest in UPA. Accordingly, the Company
included $129,000 of sales and marketing expense related to UPA on its Consolidated Statement of Operations for the year ended
December 31, 2012. The Company accounted for UPA using the equity method of accounting after Itea acquired its ownership interest.
The Company decreased the value of its investment in the Joint Venture by $296,000 in 2013 and increased the value of its investment
by $18,000 in 2012 to account for its share of net income and losses. The carrying value of the Company’s investment in the
Joint Venture is $0 as of December 31, 2013 and 2012, as the Company’s share of losses incurred by UPA exceeds the Company’s
investments.
The following is a summary of the assets,
liabilities and results of operations for UPA for the year ended December 31, 2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
Current assets
|
|
$
|
87
|
|
|
$
|
77
|
|
|
Non-current assets
|
|
|
4
|
|
|
|
7
|
|
|
Current liabilities
|
|
|
1,111
|
|
|
|
305
|
|
|
Non-current liabilities
|
|
|
0
|
|
|
|
0
|
|
|
Revenue
|
|
|
901
|
|
|
|
0
|
|
|
Operating expenses
|
|
|
1,687
|
|
|
|
222
|
|
|
Net loss
|
|
|
799
|
|
|
|
223
|
|
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Note 5: Short term borrowings
Short term borrowings consisted of the
following at December 31, 2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
Project Financing Line of Credit
|
|
$
|
—
|
|
|
$
|
491
|
|
|
November 2012 Bridge Notes, 8%, due April 15, 2013
|
|
|
—
|
|
|
|
3,700
|
|
|
August 2013 Bridge Notes, 12%, due February 1, 2014
|
|
|
4,000
|
|
|
|
—
|
|
|
|
|
$
|
4,000
|
|
|
$
|
4,191
|
|
Project Financing Line of Credit
On October 4, 2012, the Company entered
into a Loan Agreement (the “Loan Agreement”) with C13 Thermo LLC (the “Lender”), a related party whose
owners are related to an officer of the Company. Under this Loan Agreement, 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”). The Company borrowed approximately $680,000 against
this Credit Facility, and the Company agreed to reimburse legal fees of $34,000 to the Lender in 2013. As of December 31, 2012
the Company borrowed approximately $491,000 against this Credit Facility.
Amounts borrowed under the Credit Facility
did 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, would bear interest at the default rate of 8% per annum). Upon maturity of the Note, the Company was charged
a commitment fee equal to 10% of the aggregate principal amount borrowed under the Credit Facility. The Credit Facility expired,
and all amounts due under the Note, together with all commitment fees incurred under the Loan Agreement, became due and payable,
on the earlier of (i) March 4, 2013 or (ii) the date on which the Company first drew against an irrevocable documentary letter
of credit that was issued for the Company’s benefit in connection with the Project. The Credit Facility was amended in March
2013 to extend the expiration date to the earlier of (i) April 5, 2013 or (ii) one business day following the date the Company
first drew against the irrevocable documentary letter of credit. The Company could repay the Note in whole or in part at any time
without premium or penalty. The Credit Facility was secured by all of the Company’s assets.
On April 5, 2013 the Company repaid in
full all outstanding principal, legal fees and accrued commitment fees totaling $785,000 related to this Credit Facility.
November 2012 Bridge Note Financing
On November 30, 2012 the Company entered
into Bridge Loan Agreements with six of its principal investors pursuant to which the investors agreed to make bridge loans to
the Company of $3.7 million in exchange for 8% Promissory Notes (the “November 2012 Bridge Notes”). The
November 2012 Bridge Notes bore interest at the rate of 8% per year and were due and payable on April 15, 2013.
The November 2012 Bridge Notes contained
other conventional terms, including representations and warranties regarding the Company’s business and assets and its authority
to enter into such agreements, and provisions for acceleration of the Company’s obligations upon the occurrence of certain
specified events of default.
On April 5, 2013 the investors converted
the outstanding principal of the November 2012 Bridge Notes, plus accrued interest, into 5,005,250 shares of the Company’s
Series C Convertible Redeemable Preferred Stock and Warrants for the purchase of 50,052,500 shares of the Company’s Common
Stock.
August 2013 Bridge Note Financing
On August 22, 2013 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 $4 million in exchange for 12% Promissory Notes (the “August 2013 Bridge Notes”). The August 2013 Bridge
Notes bear interest at the rate of 12% per year and are due and payable on February 1, 2014. The August 2013 Bridge Notes are secured
by substantially all of the Company’s assets.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
The August 2013 Bridge Notes contain other
conventional terms, including representations and warranties regarding the Company’s business and assets and its authority
to enter into such agreements, and provisions for acceleration of the Company’s obligations upon the occurrence of certain
specified events of default.
As further detailed in Note 14, on February
28, 2014 the Company entered into a Standstill Agreement with the holders of the August 2013 Bridge Notes and the Roenigk 2012
Convertible Promissory Note (see Note 6), where the holders of these notes agreed not to commence enforcement, collection or similar
proceedings with respect to these notes until May 1, 2014.
Note 6: Convertible debt
Convertible debt consisted of the following
at December 31, 2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
December 2011 Convertible Promissory Notes, 12.5%, due on demand on or after January 31, 2013
|
|
$
|
—
|
|
|
$
|
1,250
|
|
|
Roenigk 2012 Convertible Promissory Note, 8%, due March 31, 2014, less discount of $22 at December 31, 2013 and $106 at December 31, 2012
|
|
|
2,083
|
|
|
|
1,838
|
|
|
|
|
|
2,083
|
|
|
|
3,088
|
|
|
Less: Current portion
|
|
|
(2,083
|
)
|
|
|
(1,250
|
)
|
|
|
|
$
|
—
|
|
|
$
|
1,838
|
|
March 21, 2007 Financing
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 was convertible into
shares of common stock at a conversion price of $0.50 per share at any time at the election of the holder. As further
consideration, the Company issued a warrant to purchase 750,000 shares of common stock at an exercise price equal to the daily
volume weighted average price per share of the common stock for the 365-day period immediately preceding the date on which the
warrant is exercised, subject to a minimum exercise price of $0.50 per share and a maximum exercise price of $1.00 per share. The
warrant expired on March 21, 2013.
Interest on the Note was payable semi-annually.
The Company could, 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 $213,000 of accrued interest to the principal balance of the Note 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.
March 7, 2008 Financing
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 was convertible into shares
of common stock at a conversion price of $0.50 per share at any time at the election of the holder. As further consideration, the
Company issued a warrant to purchase 750,000 shares of common stock at an exercise price equal to the daily volume weighted average
price per share of the Company’s common stock for the 365-day period immediately preceding the date on which the warrant
is exercised, subject to a minimum exercise price of $0.50 per share and a maximum exercise price of $1.00 per share. The warrant
expires on March 7, 2014.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Interest on the Note was payable semi-annually.
The Company could, 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 $165,000 of accrued interest to the principal balance of the Note 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 Bridge Note Financing
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 bore interest at the rate of 12.5% per year and were 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, was convertible
into shares of a future series of Preferred Stock.
The December 2011 Bridge Notes contained
other conventional provisions, including the acceleration of repayment obligations upon the occurrence of certain specified Events
of Default.
On November 30, 2012, in conjunction with
the issuance of the November 2012 Bridge Notes (see Note 5), the investors who participated in the December 2011 Bridge Note financing
agreed to extend the maturity date such that the December 2011 Bridge Notes were due on demand on or after January 31, 2013. The
Company accounted for this amendment as a debt modification; accordingly, no gain or loss was recorded related to this modification.
On April 5, 2013 the investors converted
the outstanding principal of the December 2011 Bridge Notes, plus accrued interest, into 1,921,303 shares of the Company’s
Series C Convertible Redeemable Preferred Stock and Warrants for the purchase of 19,213,030 shares of the Company’s Common
Stock.
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 to the Roenigk Family Trust in exchange
for the 2007 Convertible Promissory Note and the 2008 Convertible Promissory Note discussed above (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 $161,000 and $67,000 of accrued interest to the principal balance
of the Note during the years ended December 31, 2013 and 2012, respectively. During the years ended December 31, 2013 and 2012,
the Company recognized $84,000 and $153,000 in non-cash interest expense related to the amortization of the debt discount. The
debt discount is being amortized over the term of the related convertible debt using the effective interest rate method.
The exchange of the Old Notes for this
Note has been accounted for as a troubled debt restructuring. 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.
As further detailed in Note 14, on February
28, 2014 the Company entered into a Standstill Agreement with the Roenigk Family Trust and the holders of the August 2013 Bridge
Notes (see Note 5), where the holders of these notes agreed not to commence enforcement, collection or similar proceedings with
respect to these notes until May 1, 2014.
Note 7: Equity
On March 20, 2013, the Company’s
shareholders approved an amendment to the Certificate of Incorporation for the following purposes:
|
|
·
|
To increase the number of authorized shares
of Common Stock to 800,000,000 and to increase the number of authorized shares of Preferred Stock to 50,000,000;
|
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
|
|
·
|
To reduce the number of shares of Preferred
Stock designated as “Series B Convertible Preferred Stock” from 12,000,000 to 1,000,000 and to re-designate the remaining
11,000,000 shares heretofore designated as “Series B Convertible Preferred Stock” as “Series B-1 Convertible
Preferred Stock”, with the shares in each sub-series having identical voting powers, designations, preferences and relative,
participating, optional or other special rights, and qualifications, limitations and restrictions except that the shares of Series
B-1 Convertible Preferred Stock shall have priority in liquidation; and
|
|
|
·
|
To designate 15,000,000 shares of the
previously authorized but undesignated shares of Preferred Stock as “Series C Convertible Redeemable Preferred Stock”.
|
Shares of Series B-1 Convertible Preferred
Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock. Series
B-1 Convertible Preferred Stock is identical to the Company’s Series B Convertible Preferred Stock in every respect except
that holders of the Series B-1 Convertible Preferred Stock shall receive a liquidation preference equal to the Stated Value of
their shares ($2.40 per share) plus all declared and unpaid dividends with respect thereto prior to any distribution to the holders
of shares of Series B Convertible Preferred Stock.
Shares of Series C Convertible Redeemable
Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock,
subject to conventional weighted-average anti-dilution adjustment in the event the Company issues or is deemed to have issued shares
of Common Stock at a price less than $0.076 per share.
The Company’s Board of Directors
consists of seven members, four of whom are elected by holders of the Company’s Series B Convertible Preferred Stock, Series
B-1 Convertible Preferred Stock and Series C Convertible Redeemable Preferred Stock, and three who are elected by the holders
of the Company’s Common Stock.
The amendment to the Certificate of Incorporation
became effective on April 5, 2013.
Common Stock
The Company issued 419,180 shares of Common
Stock valued at $88,000 for services during 2012.
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.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
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.
On October 9, 2012, the Company entered
into Securities Purchase Agreements (the “Agreements”) with nine additional 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 Warrants entitle the holders thereof to purchase shares
of Common Stock at any time on or prior to July 11, 2017.
The July, August and October 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.
In 2011, the Company requested certain
holders of Common Stock Purchase Warrants to exercise such warrants or to surrender such warrants in exchange for shares of Common
Stock. On April 5, 2013, the Company issued an aggregate of 6,031,577 shares of Common Stock as consideration for the surrender
of Warrants for the purchase of an aggregate of 39,205,234 shares.
Also, on April 5, 2013, the Company converted
its December 2011 Bridge Notes and November 2012 Bridge Notes into shares of the Company’s Series C Convertible Redeemable
Preferred Stock. Because the effective issuance price of the Series C Convertible Redeemable Preferred Stock was less than $0.10
per equivalent share of Common Stock, the Company issued to investors who purchased shares of the Company’s Common Stock
and Warrants at closings on July 11, 2012, August 9, 2012 and October 9, 2012 (the “PIPE”), for no additional consideration,
a sufficient number of additional shares of Common Stock so that the effective price per share of Common Stock paid by the PIPE
Investors equals the effective issuance price of the shares of Series C Convertible Redeemable Preferred Stock on an as-converted
basis ($0.076 per share). Accordingly, on April 5, 2013, the Company issued a total of 9,274,364 shares of Common Stock to the
PIPE Investors.
At December 31, 2013, approximately 426
million shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements
and other commitments.
Preferred Stock
As of December 31, 2013 and 2012, the Company
has 208,334 shares of Series A Convertible Preferred Stock outstanding, which is held by a single investor. Each share of Series
A Convertible Preferred Stock is convertible into one share of the Company’s Common Stock and has a liquidation value of
$1.20 per share.
The Company designated and began issuing
shares of its Series B Convertible Preferred Stock in 2009. Each share of the Company’s Series B Convertible Preferred Stock
is convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
As an inducement to effect
the transactions on April 5, 2013 as detailed below, the Company agreed to allow such holders to exchange shares of Series B Convertible
Preferred Stock for an equal number of shares of Series B-1 Convertible Preferred Stock. Accordingly, on April 5, 2013 the Company
issued an aggregate of 8,839,500 shares of Series B-1 Convertible Preferred Stock in exchange for an equal number of shares of
Series B Convertible Preferred Stock. The surrendered shares of Series B Convertible Preferred Stock were cancelled and are no
longer outstanding.
Redeemable Preferred Stock
As stated above, shares of Series C Convertible
Redeemable Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s
Common Stock, subject to conventional weighted-average anti-dilution adjustment in the event the Company issues or is deemed to
have issued shares of Common Stock at a price less than $0.076 per share.
As detailed in Notes 5 and 6, on April
5, 2013, holders of the Company’s December 2011 Bridge Notes and the Company’s November 2012 Bridge Notes exchanged
such notes with an aggregate principal amount of $4,950,000 plus accrued interest totaling $314,177 for a total of 6,926,553 shares
of the Company’s Series C Convertible Redeemable Preferred Stock and Warrants for the purchase of a total of 69,265,530 shares
of Common Stock.
The effective price of the Series C Convertible
Redeemable Preferred Stock was $0.76 per share (or $0.076 per equivalent share of Common Stock). The Warrants entitle the holders
to purchase, at any time on or before April 5, 2018, shares of Common Stock at an exercise price of $0.114 per share. The Warrants
contain other conventional terms, including provisions for adjustment in the exercise price and/or the securities issuable upon
exercise in the event of certain specified extraordinary corporate events, such as stock splits, combinations, and stock dividends.
As additional consideration to the investors
for their participation in the Bridge Note issuances mentioned above, for each $100 of principal and interest converted into Series
C Convertible Redeemable Preferred Stock and Warrants, each Investor exchanged 41.67 shares of Series B Convertible Preferred Stock
held for 131.58 additional shares of Series C Convertible Redeemable Preferred Stock (the number of shares of Series C Convertible
Redeemable Preferred Stock that would be purchased for $100 at a purchase price of $0.76 per share). Accordingly, the Company issued
an aggregate of 6,926,553 additional shares of Series C Convertible Redeemable Preferred Stock in exchange for an aggregate of
2,193,414 previously-outstanding shares of Series B Convertible Preferred Stock. The additional shares of Series C Convertible
Redeemable Preferred Stock were issued without warrant coverage. The shares of Series B Convertible Preferred Stock surrendered
were cancelled and are no longer outstanding.
The Series C Convertible
Redeemable Preferred Stock will be redeemable, at a price equal to $0.76 per share, plus all accrued and unpaid dividends
thereon, at the election of the holders of 66-⅔% of the then-outstanding shares, in three equal annual installments on
or after December 31, 2017. As of December 31, 2013, redemption requirements of the Series C Convertible Redeemable Preferred
Stock would be approximately $3,509,500 in each of the years 2017, 2018 and 2019. The Company has elected not to accrete the
Series C Redeemable Convertible Preferred Stock to its redemption value over the redemption period due to the low likelihood
of redemption by the holders of this series of stock.
Because of this redemption feature, this
class of preferred stock is recorded at its issuance date fair value and is classified as mezzanine equity on the Company’s
Consolidated Balance Sheet at December 31, 2013.
Stock Options
The Company’s 1997 Stock Option Plan
(the “Plan”) provided for incentive and non-incentive stock options for an aggregate of 750,000 shares of Common Stock
for key employees and non-employee Directors of the Company. The Plan, which expired on December 31, 2007, provided that the exercise
price of each option must be at least equal to 100% of the fair market value of the Common Stock on the date of grant. The Plan
contained automatic grant provisions for non-employee Directors of the Company.
The ThermoEnergy Corporation 2008 Incentive
Stock Plan (the “2008 Plan”) provides for the granting of non-qualified stock options, restricted stock, stock appreciation
rights (“SAR”) and incentive stock options for officers, employees, non-employee members of the Board of Directors,
consultants and other service providers. Options may not be granted at an exercise price less than the fair market value
of the Company’s Common Stock on the date of grant and the term of the options may not be in excess of ten years. On
March 20, 2013 the Company’s shareholders approved an amendment to the 2008 Plan to increase the number of shares reserved
from 20,000,000 shares to 40,000,000.
Although the granting of awards under the
2008 Plan is generally at the discretion of the Compensation Committee of the Board of Directors, the 2008 Plan provides for automatic
grants of stock options to the non-employee members of the Board of Directors. Each non-employee Director who is elected or appointed
to the Board for the first time shall automatically be granted a non-qualified stock option to purchase 30,000 shares of the Company’s
Common Stock. Thereafter, at each subsequent Annual Meeting of Stockholders, each non-employee Director who is re-elected
to the Board of Directors or continues to serve a term that has not expired will receive a non-qualified stock option grant
to purchase an additional 30,000 shares. All options granted to non-employee Directors vest and become fully exercisable on the
date of the first Annual Meeting of Stockholders occurring after the end of the fiscal year of the Company during which such option
was granted and shall have a term of ten years. On March 20, 2013 the Company’s shareholders approved an amendment to the
2008 Plan to increase the number of shares granted to non-employee Directors to 100,000.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
The following table presents non-cash stock
option expense included in expenses in the Company’s Consolidated Statements of Operations for the years ended December 31,
2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
$
|
—
|
|
|
$
|
4
|
|
|
General and administrative
|
|
|
223
|
|
|
|
548
|
|
|
Engineering, research and development
|
|
|
26
|
|
|
|
77
|
|
|
Sales and marketing
|
|
|
6
|
|
|
|
126
|
|
|
Option expense before tax
|
|
|
255
|
|
|
|
755
|
|
|
Income tax benefit
|
|
|
—
|
|
|
|
—
|
|
|
Net option expense
|
|
$
|
255
|
|
|
$
|
755
|
|
During 2013, the Board of Directors awarded
officers and various members of the Board of Directors a total of 14,450,000 stock options. The options are exercisable
at exercise prices ranging from $0.0468 to $0.089 per share for a ten year period. The exercise price was equal to or greater than
the market price on the respective grant dates during the year.
During 2012, the Board of Directors awarded
officers, employees, and various members of the Board of Directors a total of 7,560,000 stock options. The options are
exercisable at exercise prices ranging from $0.085 to $0.268 per share for a ten year period. The exercise price was equal to or
greater than the market price on the respective grant dates during the year.
The fair value of options granted during
2013 and 2012 were estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
|
0.92% - 1.07%
|
|
|
|
0.83% - 2.23%
|
|
|
Expected option life (years)
|
|
|
6.25
|
|
|
|
6.25 – 10.0
|
|
|
Expected volatility
|
|
|
90% - 91%
|
|
|
|
90% - 92%
|
|
|
Expected dividend rate
|
|
|
0%
|
|
|
|
0%
|
|
The risk-free interest rate is based on
the U.S. Treasury yield curve in effect at the time of grant for periods over the expected life of the option. The expected option
life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to
vesting schedules and the Company’s historical exercise patterns. Expected volatility is based on the historical volatility
of the Company’s common stock over the expected life of the option granted.
Option expense for the years ended December
31, 2013 and 2012 was calculated using an expected forfeiture rate of 5%.
A summary of the Company’s stock
option activity and related information for the years ended December 31, 2013 and 2012 follows:
|
|
|
2013
|
|
|
2012
|
|
|
|
|
Number of
Shares
|
|
|
Wtd. Avg.
Price per
Share
|
|
|
Number of
Shares
|
|
|
Wtd. Avg.
Price per
Share
|
|
|
Outstanding, beginning of year
|
|
|
24,896,678
|
|
|
$
|
0.32
|
|
|
|
19,674,102
|
|
|
$
|
0.38
|
|
|
Granted
|
|
|
14,450,000
|
|
|
$
|
0.09
|
|
|
|
7,560,000
|
|
|
$
|
0.16
|
|
|
Canceled and expired
|
|
|
(7,838,601
|
)
|
|
$
|
0.28
|
|
|
|
(2,337,424
|
)
|
|
$
|
0.29
|
|
|
Outstanding, end of year
|
|
|
31,508,077
|
|
|
$
|
0.22
|
|
|
|
24,896,678
|
|
|
$
|
0.32
|
|
|
Vested and exercisable, end of year
|
|
|
17,254,952
|
|
|
$
|
0.33
|
|
|
|
14,700,574
|
|
|
$
|
0.40
|
|
The weighted average grant date
fair value of options granted were $0.065 per share and $0.11 per share for the years ended December 31, 2013 and
2012, respectively. The total fair value of options vested were approximately $499,000 and $1,137,000 as of December 31, 2013
and 2012, respectively. Options vested and expected to vest are not meaningful as of December 31, 2013 and 2012, as the price
of the Company’s stock would not allow the holders to reasonably exercise these options.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
Exercise prices for options outstanding
as of December 31, 2013 ranged from $0.0468 to $1.50. The weighted average remaining contractual life of those options was approximately
7.7 years at December 31, 2013. The weighted average remaining contractual life of options vested and exercisable was approximately
6.7 years at December 31, 2013.
As of December 31, 2013, there was $568,000
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 1.5 years. The
Company recognizes stock-based compensation on the graded-vesting method.
Warrants
At December 31, 2013, there were outstanding
warrants for the purchase of 137,631,302 shares of the Company’s Common Stock at prices ranging from $0.10 per share to $0.55
per share (weighted average exercise price was $0.15 per share). The expiration dates of outstanding warrants as of December 31,
2013 are as follows:
|
Expiration
|
|
Warrants
Outstanding
|
|
|
2014
|
|
|
1,531,103
|
|
|
2015
|
|
|
296,293
|
|
|
2016
|
|
|
20,625,815
|
|
|
2017
|
|
|
44,570,061
|
|
|
2018
|
|
|
69,265,530
|
|
|
2019 and later
|
|
|
1,342,500
|
|
|
|
|
|
137,631,302
|
|
Note 8: Derivative Liabilities
The Company has periodically issued Common
Stock and Common Stock purchase warrants with anti-dilution provisions as additional consideration with certain debt instruments.
Additionally, certain debt instruments have been convertible into shares of the Company’s Series C Convertible Redeemable
Preferred Stock, which are convertible into shares of the Company’s Common Stock and have anti-dilution provisions and liquidation
preferences. Because these instruments contain provisions that are not indexed to the Company’s stock, the Company is required
to record these as derivative instruments.
Assets and liabilities measured at fair value on a recurring
basis as of December 31, 2013 are as follows: (in thousands)
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Description
|
|
Balance as of
December 31,
2013
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liability – long-term portion
|
|
$
|
186
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
186
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
186
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
186
|
|
During 2013, as discussed in Note 6, the
Company’s December 2011 Bridge Notes and November 2012 Bridge Notes were converted into shares of the Company’s Series
C Convertible Redeemable Preferred Stock at a rate of $0.76 per share. Additionally, as discussed in Note 7, the investors in these
notes were allowed to exchange an equal value of Series B Convertible Preferred Stock into shares of Series C Convertible Redeemable
Preferred Stock. The Series C Convertible Redeemable Preferred Stock is convertible into 10 shares of the Company’s Common
Stock at any time. The Series C Convertible Redeemable Preferred Stock also contains anti-dilution provisions that allow for a
reduction on the conversion price in the event of a future financing at an exercise price lower than the conversion price of the
Preferred Stock and contains liquidation preferences to the holder. Because these provisions in the Series C Convertible Redeemable
Preferred Stock are not indexed to the Company’s Common Stock, the value of these conversion features must be bifurcated
and treated as derivative liabilities. As a result, the Company recorded derivative liabilities totaling $607,000 in the second
quarter of 2013.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
The fair value of these derivative liabilities
as of December 31, 2013 was $186,000, which are classified as long-term liabilities on the Company’s Consolidated Balance
Sheets. The Monte Carlo Simulation lattice model was used to determine the fair values at December 31, 2013. The significant assumptions
used were: exercise price of $0.076; the Company’s stock price on December 31, 2013, $0.029; expected volatility of 70%;
risk free interest rate between 0.04% and 1.39%; a remaining contract term between 2 and 51 months; and probability of financing
options and effects on the Company’s capitalization.
The risk-free interest rate is based on
the U.S. Treasury yield curve in effect at the time of issuance for periods over the expected life of the derivative. Expected
volatility is based on the historical volatility of the Company’s common stock over the expected term of the derivative.
The decrease in fair value of the Company’s
derivative liabilities resulted in income of $2,357,000 for the year ended December 31, 2013. The income results primarily from
the passage of time, decreases in the Company’s stock price and the probability of financing options and effects on the Company’s
capitalization.
Assets and liabilities measured at fair
value on a recurring basis as of December 31, 2012 are as follows: (in thousands)
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Description
|
|
Balance as of
December 31,
2012
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liability – current portion
|
|
$
|
20
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
20
|
|
|
Derivative liability – long-term portion
|
|
|
2,214
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
2,234
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,234
|
|
As part of the financing transactions in
July, August and October 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.
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 $3,064,000 in the third and fourth quarters of 2012. Because the Company recorded derivative liabilities that
exceeded the proceeds received, the Company recorded a charge of approximately $567,000. This amount is recorded as other derivative
expense on the Company’s Consolidated Statement of Operations for the year ended December 31, 2012.
The fair value of these derivative liabilities
as of December 31, 2012 was $2,234,000, of which derivative liabilities with an aggregate value of $20,000 expire in one year or
less and are classified as current liabilities on the Company’s Consolidated Balance Sheets. The Monte Carlo Simulation lattice
model was used to determine the fair values at December 31, 2012. The significant assumptions used were: exercise prices between
$0.10 and $0.36; the Company’s stock price on December 31, 2012, $0.09; expected volatility of 55% - 75%; risk free interest
rate between 0.16% and 0.72%; and a remaining contract term between 5 months and 55 months.
The risk-free interest rate is based on
the U.S. Treasury yield curve in effect at the time of issuance for periods over the expected life of the derivative. Expected
volatility is based on the historical volatility of the Company’s common stock over the expected term of the derivative.
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
The decrease in fair value of the Company’s
derivative liabilities resulted in income of $1,637,000 for the year ended December 31, 2012. The income results primarily from
the passage of time and decreases in the Company’s stock price.
The following table sets forth a reconciliation of changes in
the fair value of the Company’s derivative liabilities classified as Level 3 for the years ended December 31, 2013 and 2012
(in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
Balance at beginning of year
|
|
$
|
2,234
|
|
|
$
|
807
|
|
|
Recognition of derivative liabilities
|
|
|
607
|
|
|
|
3,064
|
|
|
Exercise of derivative instruments
|
|
|
(298
|
)
|
|
|
—
|
|
|
Change in fair value
|
|
|
(2,357
|
)
|
|
|
(1,637
|
)
|
|
|
|
$
|
186
|
|
|
$
|
2,234
|
|
Note 9: Related party transactions
The Company has an 85% ownership interest
in ThermoEnergy Power Systems, LLC, a Delaware limited liability company (“TEPS”) for the purpose of transferring the
Company’s rights and interests in its pressurized oxycombustion technology. Alexander Fassbender, the Company’s former
Executive Vice President and Chief Technology Officer, as the inventor of the technology, has a 7.5% ownership interest, and the
remaining 7.5% is owned by an unrelated third party. Accordingly, the Company records the value of the noncontrolling interest
on the Company’s Consolidated Balance Sheets, which totaled $0 and $2,000 as of December 31, 2013 and 2012, respectively.
See Note 4 for detailed information on
UPA, a joint venture in which the Company has a 50% ownership stake.
The Company has employment agreements with
certain of its officers that specify base compensation, stock options and lump sum payment amounts in the event of a change in
control of the Company.
See Notes 5 and 6 for additional related
party transactions.
Note 10: Income taxes
The Company has not recorded a provision
for income taxes, as the Company has historically incurred operating losses and maintains a full valuation allowance against its
net deferred tax assets. The reported amount of income tax expense for the years differs from the amount that would result from
applying domestic federal statutory tax rates to pretax losses primarily because of changes in the valuation allowance.
Management has considered the Company’s
history of losses and concluded that it is more likely than not that the Company will not recognize the benefits of federal and
state deferred tax assets. Accordingly, a full valuation allowance of approximately $24.5 million and $25.4 million has been established
as of December 31, 2013 and 2012, respectively.
Significant components of the Company's
deferred tax assets are as follows as of December 31, 2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
22,071
|
|
|
$
|
22,114
|
|
|
Derivative liabilities
|
|
|
(48
|
)
|
|
|
849
|
|
|
Stock options and warrants
|
|
|
2,227
|
|
|
|
2,140
|
|
|
Valuation discount
|
|
|
(9
|
)
|
|
|
(40
|
)
|
|
Other
|
|
|
251
|
|
|
|
352
|
|
|
|
|
|
24,492
|
|
|
|
25,415
|
|
|
Valuation allowance – deferred tax assets
|
|
|
(24,492
|
)
|
|
|
(25,415
|
)
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
A reconciliation of income tax expense
(benefit) at the statutory rate to income tax expense at the Company's effective rate is shown below for the years ended December
31, 2013 and 2012 (in thousands):
|
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Computed at statutory rate (34%)
|
|
$
|
(549
|
)
|
|
$
|
(2,510
|
)
|
|
(Decrease) increase in valuation allowance for deferred tax assets
|
|
|
495
|
|
|
|
3,130
|
|
|
Stock and stock options
|
|
|
81
|
|
|
|
130
|
|
|
Derivative liabilities
|
|
|
—
|
|
|
|
(849
|
)
|
|
Non-deductible items and other
|
|
|
(27
|
)
|
|
|
99
|
|
|
Benefit for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
At December 31, 2013, the Company has net
operating loss carryforwards, which expire in various amounts during 2014 through 2033, of approximately $62.2 million. Utilization
of net operating losses and research and development credit carryforwards may be subject to a substantial annual limitation under
Section 382 of the Internal Revenue Code of 1986 due to ownership change limitations that have occurred previously or that could
occur in the future. These ownership changes may limit the amount of net operating losses and research and development credit carryforwards
that can be utilized annually to offset future taxable income and tax, respectively. Additionally, the Internal Revenue Code provides
for limitations on the use of net operating loss carryforwards for acquired entities. The Company’s annual limitation for
the use of CASTion’s net operating loss carryforwards for periods prior to the date of acquisition for income tax reporting
purposes is approximately $300,000.
As further discussed in Note 13, the Company
has agreed, in conjunction with the Offer in Compromise accepted by the IRS in March 2011, 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, which totaled $2,263,000.
Note 11: Employee benefit plans
The Company has adopted an Employee Stock
Ownership Plan. However, as of December 31, 2013, the Plan had not been funded nor submitted to the Internal Revenue Service for
approval. The Company has a 401(k) Plan, but no employer contributions have been made to date.
Note 12: 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. As stated in Note 1, the Company markets and develops advanced municipal
and industrial wastewater treatment and carbon reducing clean energy technologies. The Company currently generates its revenues
from the sale and service of its wastewater treatment systems and from its contract with UPA. The Company’s efforts to develop
and commercialize its clean energy technologies are discussed in Note 4. Separate disclosure of financial information related to
the Company’s clean energy technologies is not required, as all operating activity is captured in the Company’s joint
venture. The financial information presented in these financial statements represents all the material financial information related
to the Company’s water treatment technologies as the sole reportable segment.
The Company’s operations are currently
conducted solely in the United States. Approximately 74% and 91% of the Company’s revenues came from customers in the United
States in 2013 and 2012, respectively; the remainder of its revenues in 2013 and 2012 came from customers in Asia. The Company
will continue to evaluate how its business is managed and, as necessary, adjust the segment reporting accordingly.
Note 13: Commitments and contingencies
The Company leases its primary
facility in Worcester, MA under an operating lease with an unaffiliated third party which expires in January 2017. The following
table summarizes the Company’s operating lease commitments on its primary facility at December 31, 2013: (in
thousands)
THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
|
Payments due in:
|
|
Amount
|
|
|
2014
|
|
$
|
178
|
|
|
2015
|
|
|
183
|
|
|
2016
|
|
|
188
|
|
|
2017
|
|
|
16
|
|
|
|
|
$
|
565
|
|
The Company recognized rent expense
of $173,000 and $168,000 related to this lease agreement for the years ended December 31, 2013 and 2012, respectively.
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 that were not paid by the Company’s
former Chief Financial Officer. Pursuant to the Offer in Compromise, it has agreed to satisfy its delinquent tax liabilities by
paying a total of $2,134,636 (representing the aggregate amount of tax due, without interest or penalties). The Company made its
final payment of $176,636 in January 2012. 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 includes penalties
and interest related to state taxing authorities, totaled $399,000 as of December 31, 2013 and 2012.
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.
Note 14: Subsequent Event
On February 28, 2014, the Company entered
into a Standstill Agreement (the “Standstill Agreement”) with The Roenigk Family Trust dated November 10, 2004 (“Roenigk”),
Robert S. Trump (“Trump”) and Empire Capital Partners, L.P., Empire Capital Partners, Ltd., Empire Capital Partners
Enhanced Master Fund, Ltd. (collectively, “Empire” and, together with Roenigk and Trump, the “Creditors”)
who hold promissory notes issued in the aggregate principal amount of $5,877,217.12 (the “Notes”). The Company’s
obligations under the Notes held by Trump and Empire are secured by a first priority security interest in substantially all of
the Company’s assets (the “Collateral”) pursuant to a Security Agreement dated as of August 22, 2013 (the “Security
Agreement”).
Pursuant to the Standstill Agreement, the
Creditors agreed that, subject to certain exceptions, from the date of the Standstill Agreement until May 1, 2014 (the “Forbearance
Period”), notwithstanding the maturity of any of the Notes nor the occurrence or continuance of any Event of Default under
any of the Notes or under the Security Agreement, none of the Creditors shall commence enforcement, collection or similar proceedings
with respect to any of the Notes or the Collateral or exercise any other rights or remedies any of the Creditors may have under
the Notes or the Security Agreement or otherwise, at law or in equity, with respect to the Company’s obligations under the
Notes or the Security Agreement. The Creditors have not waived any of their rights under the Notes or the Security Agreement and,
during the Forbearance Period, interest will continue to accrue on the Notes in accordance with their terms.
