UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| [X] | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2018. |
OR
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934; |
For the transition period from ______________ to _______________.
Commission File Number: 001-35586
MagneGas Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 26-0250418 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
11885 44th Street North Clearwater, Florida |
33762 | |
| (Address of principal executive offices) | (Zip Code) |
(727) 934-3448
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer [ ] | Accelerated filer [ ] | |
| Non-accelerated filer [ ] | Smaller reporting company [X] | |
| (Do not check if a smaller reporting company) | Emerging growth company [X] |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 14, 2018, there were 15,724,282.28 shares of the issuer’s $0.001 par value common stock issued and outstanding.
MAGNEGAS CORPORATION
TABLE OF CONTENTS
FORM 10-Q REPORT
March 31, 2018
| Page Number | ||
| PART I - FINANCIAL INFORMATION | ||
| Item 1. | Financial Statements. | 3 |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 18 |
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk. | 21 |
| Item 4. | Controls and Procedures. | 21 |
| PART II - OTHER INFORMATION | ||
| Item 1. | Legal Proceedings. | 23 |
| Item 1A. | Risk Factors. | 23 |
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 23 |
| Item 3. | Defaults Upon Senior Securities. | 23 |
| Item 4. | Mine Safety Disclosures | 23 |
| Item 5. | Other Information. | 23 |
| Item 6. | Exhibits. | 23 |
| SIGNATURES | 24 | |
| 2 |
PART I - FINANCIAL INFORMATION
| Item 1. | Financial Statements. |
| 3 |
MagneGas Corporation
Condensed Consolidated Balance Sheets
| March 31, 2018 | December 31, 2017 | |||||||
| (Unaudited) | ||||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash | $ | 2,103,254 | $ | 586,824 | ||||
| Accounts receivable, net of allowance for doubtful accounts of $116,794 and $101,063, respectively | 645,491 | 389,652 | ||||||
| Inventory | 1,601,931 | 738,950 | ||||||
| Prepaid and other current assets | 278,038 | 198,056 | ||||||
| Total Current Assets | 4,628,714 | 1,913,482 | ||||||
| Property and equipment, net of accumulated depreciation and amortization of $2,176,870 and $2,032,265, respectively | 8,515,073 | 6,865,389 | ||||||
| Deposits on acquisition | 1,000,000 | 325,000 | ||||||
| Intangible assets, net of accumulated amortization of $471,776 and $457,171, respectively | 895,743 | 412,331 | ||||||
| Security deposits | 96,846 | 27,127 | ||||||
| Goodwill | 2,484,999 | 2,108,781 | ||||||
| Total Assets | $ | 17,621,375 | $ | 11,652,110 | ||||
| Liabilities and Stockholders’ Equity | ||||||||
| Current Liabilities | ||||||||
| Accounts payable | $ | 1,715,981 | $ | 1,716,661 | ||||
| Accrued expenses | 780,736 | 909,562 | ||||||
| Deferred revenue and customer deposits | 44,717 | 44,095 | ||||||
| Capital leases, current | 27,460 | 27,460 | ||||||
| Note payable, net of debt discount of $138,247 and $184,204, respectively | 217,586 | 451,754 | ||||||
| Promissory notes payable - related party | 42,458 | 100,000 | ||||||
| Total Current Liabilities | 2,828,938 | 3,249,532 | ||||||
| Long Term Liabilities | ||||||||
| Note payable | 520,000 | 520,000 | ||||||
| Capital leases, net of current | 75,840 | 63,839 | ||||||
| Total Liabilities | 3,424,778 | 3,833,371 | ||||||
| Commitments and Contingencies | ||||||||
| Series C Preferred stock: 25,000 shares designated; 0 and 115 shares issued and outstanding | - | 115,000 | ||||||
| Series E Preferred stock: 455,882 shares designated; 36,765 and 316,875 shares issued and outstanding with a liquidation preference of approximately $50,000 at March 31, 2018 | 50,000 | 430,950 | ||||||
| Stockholders’ Equity | ||||||||
| Preferred stock: $0.001 par; 10,000,000 shares authorized | ||||||||
| Series A Preferred stock: 1,000,000 shares authorized; 1,000,000 shares issued and outstanding with no liquidation preference at March 31, 2018 and December 31, 2017 | 1,000 | 1,000 | ||||||
| Series B Preferred stock: 2,700 shares designated, 0 shares issued and outstanding at March 31, 2018 and December 31, 2017 | - | - | ||||||
| Common stock: $0.001 par; 190,000,000 shares authorized; 13,264,655 shares issued and outstanding at March 31, 2018 and 1,782,864 shares issued and outstanding at December 31, 2017 | 13,265 | 1,783 | ||||||
| Additional paid-in-capital | 81,734,640 | 71,852,874 | ||||||
| Accumulated deficit | (67,602,309 | ) | (64,582,868 | ) | ||||
| Total Stockholders’ Equity | 14,146,596 | 7,272,789 | ||||||
| Total Liabilities, Temporary Equity and Stockholders’ Equity | $ | 17,621,375 | $ | 11,652,110 | ||||
See accompanying notes to the unaudited condensed consolidated financial statements.
| 4 |
MagneGas Corporation
Condensed Consolidated Statements of Operations
(Unaudited)
| For the three months ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| Revenue: | $ | 1,171,753 | $ | 871,788 | ||||
| Cost of Revenues | 757,874 | 503,388 | ||||||
| Gross Profit | 413,879 | 368,400 | ||||||
| Operating Expenses: | ||||||||
| Selling, general and administration | 3,153,994 | 2,607,866 | ||||||
| Research and development | 1,152 | 98,141 | ||||||
| Depreciation and amortization | 159,211 | 167,338 | ||||||
| Total Operating Expenses | 3,314,357 | 2,873,345 | ||||||
| Operating Loss | (2,900,478 | ) | (2,504,945 | ) | ||||
| Other Income and (Expense): | ||||||||
| Interest | (73,005 | ) | (103,080 | ) | ||||
| Amortization of debt discount | (45,958 | ) | - | |||||
| Other (expense) income | - | (4,554 | ) | |||||
| Change in fair value of derivative liability | - | 831,420 | ||||||
| Total Other Income (Expense) | (118,963 | ) | 723,786 | |||||
| Net Loss | (3,019,441 | ) | (1,781,159 | ) | ||||
| Deemed dividend | 930,300 | - | ||||||
| Net loss attributable to common shareholders | $ | (3,949,741 | ) | $ | (1,781,159 | ) | ||
| Net loss per share: Basic and Diluted | $ | (0.62 | ) | $ | (4.51 | ) | ||
| Weighted average common shares: Basic and Diluted | 6,350,695 | 394,531 | ||||||
See accompanying notes to the unaudited condensed consolidated financial statement
| 5 |
MagneGas Corporation
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
For the Fiscal Year Ended December 31, 2017 and the Three Months Ended March 31, 2018
| Series A Preferred Stock | Common | Additional Paid-in- | Accumulated | Stockholders’ | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | (Deficit) | Equity | ||||||||||||||||||||||
| Balance at December 31, 2017 | 1,000,000 | $ | 1,000 | 1,782,864 | $ | 1,783 | $ | 71,852,874 | $ | (64,582,868 | ) | $ | 7,272,789 | |||||||||||||||
| Common shares issued for services | 631,667 | 632 | 348,594 | 349,226 | ||||||||||||||||||||||||
| Common stock warrants issued for service | 63,474 | 63,474 | ||||||||||||||||||||||||||
| Exercise of Series C preferred stock warrants | 8,372,700 | 8,372,700 | ||||||||||||||||||||||||||
| Reclass from Series C temporary equity to common stock | 1,045,300 | 1,045,300 | ||||||||||||||||||||||||||
| Conversion of Series C preferred stock into common stock | 9,677,831 | 9,678 | (9,678 | ) | (0 | ) | ||||||||||||||||||||||
| Reclass from Series E temporary equity to common stock | 380,950 | 380,950 | ||||||||||||||||||||||||||
| Conversion of Series E preferred stock into common stock | 135,754 | 136 | (136 | ) | (0 | ) | ||||||||||||||||||||||
| Stock-based compensation | 105,075 | 105,075 | ||||||||||||||||||||||||||
| Common shares issued for the exercise of warrants | 75,000 | 75 | 675 | 750 | ||||||||||||||||||||||||
| Common shares issued for acquisition of assets | 961,539 | 962 | 1,258,654 | 1,259,616 | ||||||||||||||||||||||||
| Stock issuance costs | (753,543 | ) | (753,543 | ) | ||||||||||||||||||||||||
| Deemed Dividend | (930,300 | ) | (930,300 | ) | ||||||||||||||||||||||||
| Net loss | (3,019,441 | ) | (3,019,441 | ) | ||||||||||||||||||||||||
| Balance at March 31, 2018 | 1,000,000 | $ | 1,000 | 13,264,655 | $ | 13,265 | $ | 81,734,640 | $ | (67,602,309 | ) | $ | 14,146,596 | |||||||||||||||
| 6 |
MagneGas Corporation
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2018 and 2017
(Unaudited)
| For the three months ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| (Unaudited) | (Unaudited) | |||||||
| Cash Flows from Operations | ||||||||
| Net Loss | $ | (3,019,441 | ) | $ | (1,781,159 | ) | ||
| Adjustments to reconcile net loss to cash used in operating activities: | ||||||||
| Depreciation and amortization | 159,211 | 167,338 | ||||||
| Accretion of debt discount | 45,958 | 103,080 | ||||||
| Stock based compensation | 105,075 | 102,905 | ||||||
| Common stock and warrants issued for services | 412,700 | 326,349 | ||||||
| Provision for bad debt | - | 50,000 | ||||||
| Provision for slow moving spare parts | - | 25,000 | ||||||
| (Gain) loss on sale and disposal of property and equipment | - | (12,597 | ) | |||||
| Change in fair value of derivative liability | - | (831,420 | ) | |||||
| Changes in operating assets: | ||||||||
| Accounts receivable | 76,161 | (67,911 | ) | |||||
| Inventory | (5,981 | ) | (133,102 | ) | ||||
| Prepaid and other current assets | 263,018 | (131,827 | ) | |||||
| Accounts payable | (303,406 | ) | 525,622 | |||||
| Accrued expenses | (128,826 | ) | 111,116 | |||||
| Deferred revenue and customer deposits | 622 | - | ||||||
| Net cash used in operating activities | (2,394,909 | ) | (1,546,606 | ) | ||||
| Cash Flows from Investing Activities | ||||||||
| Cash acquired in acquisition of business | 15,000 | |||||||
| Net payments for acquisition of businesses | (1,767,500 | ) | - | |||||
| Deposit on acquisitions | (1,000,000 | ) | - | |||||
| Purchase of property and equipment and intangible assets | (588,469 | ) | (42,948 | ) | ||||
| Security deposit | (69,719 | ) | - | |||||
| Proceeds from sale of assets | 27,787 | 20,100 | ||||||
| Net cash used in investing activities | (3,382,901 | ) | (22,848 | ) | ||||
| Cash Flows from Financing Activities | ||||||||
| Common shares issued for the exercise of warrants | 750 | - | ||||||
| Capital lease payments | 12,001 | - | ||||||
| Repayment of notes payable | (280,126 | ) | (1,314 | ) | ||||
| Net proceeds on related party notes and advances | 22,588 | - | ||||||
| Repayment of related party notes | (80,130 | ) | - | |||||
| Net proceeds on issuance of series C preferred stock units, net of costs | 7,619,157 | - | ||||||
| Cash proceeds from exercise of warrants | - | 7,937 | ||||||
| Net cash provided by financing activities | 7,294,240 | 6,623 | ||||||
| Net increase/(decrease) in cash | 1,516,430 | (1,562,831 | ) | |||||
| Cash, beginning of period | 586,824 | 1,616,410 | ||||||
| Cash, end of period | $ | 2,103,254 | $ | 53,579 | ||||
| Supplemental disclosure of cash flow information Cash paid during the year for: | ||||||||
| Interest | $ | 56,625 | $ | 5,950 | ||||
| Noncash Transactions | ||||||||
| Reclassification of derivative liability to equity | $ | - | $ | 427,568 | ||||
| Conversion of Series C Preferred Stock to common stock | $ | 1,045,300 | $ | - | ||||
| Common shares issued for debt | $ | - | $ | 57,000 | ||||
| Conversion of Series E Preferred Stock to common stock | $ | 380,950 | $ | - | ||||
| Acquisition of GGNG Enterprises Inc: | ||||||||
| Assumption of assets other than cash | $ | 540,000 | ||||||
| Assumption of liabilities | $ | (148,719 | ) | |||||
| Acquisition of Green Arc Supply, L.L.C.: | ||||||||
| Assumption of assets other than cash | $ | 2,398,625 | ||||||
| Assumption of liabilities | $ | (154,009 | ) | |||||
See accompanying notes to the unaudited condensed consolidated financial statements.
| 7 |
MagneGas Corporation
Notes to the Unaudited Condensed Consolidated Financial Statements
March 31, 2018
NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
MagneGas Corporation (the “Company”) was organized in the State of Delaware on December 9, 2005.
The Company is an alternative energy company that has developed a proprietary plasma arc system (“Plasma Arc Flow Units” or “Plasma Arc Flow System”) which generates hydrogen based synthetic gases through the gasification of various types of liquid feedstocks. The Company’s synthetic gas – MagneGas2® - is bottled in cylinders and is distributed to the metalworking market as an alternative cutting fuel to acetylene and propane. Through the course of its business development, the Company has established a retail and wholesale platform and a network of brokers to sell its MagneGas2® for use in the metalworking and manufacturing industries throughout the world. Additionally, the Company is in the process of developing ancillary uses of MagneGas2® for additional end-user applications. The Company’s Plasma Arc Flow Units include various commercial applications, most notably the sterilization of liquid waste, which has resulted in the Company’s marketing and sale of Plasma Arc Flow Units for third-party commercial use.
In the second quarter of 2014 the Company began implementing an acquisition-focused growth strategy that was highlighted by the October 2014 purchase of Equipment Sales and Services, Inc. (“ESSI”). ESSI is a full line seller of industrial gases and equipment for the welding and metal cutting industries. Since acquiring ESSI, the Company has opened four retail locations and distributes MagneGas2® as a metal cutting fuel as well as other gases and welding supplies. Additional acquisitions and the success of ESSI has allowed the Company to augment its acquisition growth model with significant organic growth. In January 2018, the Company acquired all of the assets of GGNG Enterprises, Inc. and began doing business in Southern California under the name “Complete Welding San Diego”. In February 2018, the Company acquired all of the assets of Green Arc Supply, L.L.C. and began doing business in Texas and Louisiana under the name “Green Arc Supply”.
The Company’s chief operating decision maker is the Chief Executive Officer.
The Company discusses three major marketing initiatives in this Report. However, operating segments are defined as components of an enterprise about which separate financial information is available and that is evaluated regularly by the chief operating decision maker, or decision–making group in deciding how to allocate resources and in assessing performance. Therefore, even though the Company discusses discrete initiatives it is actually three product offerings within one operating segment.
NOTE 2 - GOING CONCERN AND MANAGEMENTS’ PLAN
As of March 31, 2018, the Company had cash of $2,103,254 and has reported a net loss of $3,019,441 and has used cash in operations of $2,394,909 for the three months ended March 31, 2018. In addition, as of March 31, 2018 the Company has working capital of $1,799,776 and an accumulated deficit of $67,602,309. These conditions indicate that there is substantial doubt about the Company’s ability to continue as a going concern within one year from the issuance date of the financial statements.
The ability of the Company to continue as a going concern is dependent upon its ability to further implement its business plan and generate sufficient revenue and its ability to raise additional funds by way of public or private offerings.
Historically, the Company has financed its operations through equity and debt financing transactions and expects to continue incurring operating losses for the foreseeable future. The Company’s plans and expectations for the next 12 months include raising additional capital to help fund commercial operations and product development. The Company utilizes cash in its operations of approximately $240,000 per month. Management believes, but it cannot be certain, its current holdings of cash, along with the cash to be generated from expected product sales and future financings, will be sufficient to meet its projected operating requirements for the next twelve months from the date of this report.
If these sources do not provide the capital necessary to fund the Company’s operations during the next twelve months from the date of this Report, the Company may need to curtail certain aspects of its operations or expansion activities, consider the sale of its assets, or consider other means of financing. The Company can give no assurance that it will be successful in implementing its business plan and obtaining financing on terms advantageous to the Company or that any such additional financing would be available to the Company.
| 8 |
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim financial information. In the opinion of the Company’s management, the accompanying condensed consolidated financial statements reflect all adjustments, consisting of normal, recurring adjustments, considered necessary for a fair presentation of the results for the interim periods ended March 31, 2018 and 2017. As this is an interim period financial statement, certain adjustments are not necessary as with a financial period of a full year. Although management believes that the disclosures in these unaudited condensed consolidated financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements that have been prepared in accordance U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.
The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s financial statements for the year ended December 31, 2017, which contains the audited financial statements and notes thereto, for the years ended December 31, 2017 and 2016 included within the Company’s Form 10-K filed with the SEC on April 16, 2018. The interim results for the three months ended March 31, 2018 are not necessarily indicative of the results to be expected for the year ended December 31, 2018 or for any future interim periods.
Use of Estimates
The Company prepares its financial statements in conformity with U.S. GAAP. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that these estimates are reasonable and have been discussed with the Board of Directors; however, actual results could differ from those estimates. The consolidated financial statements presented include inventory reserves, fair value of derivative financial instruments along with other equity instruments, recoverability of deferred tax assets and collections of its receivables.
Principles of Consolidation
The condensed consolidated financial statements have been prepared using the accounting records of MagneGas and its wholly owned subsidiaries and all material intercompany balances and transactions have been eliminated.
Inventory
Inventory is stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. Inventory is comprised of industrial gases, welding supply finished goods and MagneGas2®. The Company carries little to no inventory classified as work in progress at any time. Estimates of lower of cost or net realizable value are based upon economic conditions, historical sales quantities and patterns, and in some cases, the specific risk of loss on specifically identified inventories. The Company evaluates inventories on a regular basis to identify inventory on hand that may be slow moving. Inventory that is in excess of current and projected use is reduced by an allowance to the level that approximates its estimate of future demand.
Goodwill and Other Indefinite-lived Assets
The Company records goodwill and other indefinite-lived assets in connection with business combinations. Goodwill, which represents the excess of acquisition cost over the fair value of the net tangible and intangible assets of acquired companies, is not amortized. Indefinite-lived assets are stated at fair value as of the date acquired in a business combination.
| 9 |
The Company assesses the recoverability of goodwill and certain indefinite-lived intangible assets annually in the fourth quarter and between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Impairment testing for goodwill is done at a reporting unit level. Under Financial Accounting Standards Board (“FASB”) guidance for goodwill and intangible assets, a reporting unit is defined as an operating segment or one level below the operating segment, called a component. However, two or more components of an operating segment will be aggregated and deemed a single reporting unit if the components have similar economic characteristics. The Company operates as one reporting unit.
Authoritative accounting guidance allows the Company to first assess qualitative factors to determine whether it is necessary to perform the more detailed two-step quantitative goodwill impairment test. The Company performs the quantitative test if its qualitative assessment determined it is more likely than not that a reporting unit’s fair value is less than its carrying amount. The Company may elect to bypass the qualitative assessment and proceed directly to the quantitative test for any reporting unit or asset. The quantitative goodwill impairment test, if necessary, is a two-step process. The first step is to identify the existence of a potential impairment by comparing the fair value of a reporting unit (the estimated fair value of a reporting unit is calculated using a discounted cash flow model) with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, the reporting unit’s goodwill is considered not to be impaired and performance of the second step of the quantitative goodwill impairment test is unnecessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step of the quantitative goodwill impairment test is performed to measure the amount of impairment loss to be recorded, if any. The second step of the quantitative goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds its implied fair value, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined using the same approach as employed when determining the amount of goodwill that would be recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of its assets and liabilities as if the reporting unit had been acquired in a business combination and the fair value was the purchase price paid to acquire the reporting unit.
For the 2017 annual goodwill and certain indefinite-lived intangible assets impairment tests, the Company elected to bypass the qualitative assessment and proceeded directly to the quantitative analysis using the market price of the stock and determined that no impairment was deemed to exist as of December 31, 2017.
Revenue Recognition
In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers - Principal versus Agent Considerations”, in April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing” and in May 9, 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606)”, or ASU 2016-12. This update provides clarifying guidance regarding the application of ASU No. 2014-09 - Revenue From Contracts with Customers which is not yet effective. These new standards provide for a single, principles-based model for revenue recognition that replaces the existing revenue recognition guidance. In July 2015, the FASB deferred the effective date of ASU 2014-09 until annual and interim periods beginning on or after December 15, 2017. It has replaced most existing revenue recognition guidance under U.S. GAAP. The ASU may be applied retrospectively to historical periods presented or as a cumulative-effect adjustment as of the date of adoption. We have adopted Topic 606 using a modified retrospective approach and will be applied prospectively in our financial statements from January 1, 2018 forward. Revenues under Topic 606 are required to be recognized either at a “point in time” or “over time”, depending on the facts and circumstances of the arrangement, and will be evaluated using a five-step model. The adoption of Topic 606 did not have a material impact on the financial statements, either at initial implementation nor will it have a material impact on an ongoing basis.
Based on the Company’s analysis the Company did not identify a cumulative effect adjustment for initially applying the new revenue standards. The Company principally generates revenue through the sales of: (1) MagneGas2®, other industrial gases and welding supply goods and (2) Plasma Arc Flow Units, either directly or through one or more of its wholly owned welding supply and gas distribution subsidiaries. The Company’s revenue recognition policy for the year ending December 31, 2018 is as follows:
| ● | Revenue for metal-working fuel, industrial gases and welding supplies is recognized at the point where the customer obtains control of the goods and we satisfy our performance obligation. The majority of the Company’s terms of sale have a single performance obligation to transfer products. Accordingly, the Company recognizes revenue when control has been transferred to the customer, generally at the time of shipment of products. Under the previous revenue recognition accounting standard, the Company recognized revenue upon transfer of title and risk of loss, generally upon the delivery of goods. |
| ● | Revenue generated from sales of a Plasma Arc Flow Unit (“Units”) is no longer recognized on a percentage of completion. Even though our Units are cost intensive and generally require a 6 to 9 month production cycle, revenue will now be recognized upon shipment of the completed machine. We require purchasers of our Units to make significant payments before we proceed with production and at 75% completion; these payments are now classified as customer deposits instead of revenue. |
The following table summarizes our revenue recognized in the condensed consolidated financial statements of operations:
| For the three months ended March 31. | ||||||||
| 2018 | 2017 | |||||||
| Metal-working fuel, industrial gases and welding supplies | 1,171,753 | 871,788 | ||||||
| Plasma Arc Flow Unit | - | - | ||||||
| Total revenues | 1,171,753 | 871,788 | ||||||
Information on Remaining Performance Obligations and Revenue Recognized from Past Performance
We do not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at March 31, 2018.
Contract Balances
The timing of our revenue recognition may differ from the timing of payment by our customers. We record a receivable when revenue is recognized prior to payment and we have an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, we record deferred revenue until the performance obligations are satisfied. The Company expects to satisfy its remaining performance obligations and recognize the deferred revenue over the next twelve months.
Contract Costs
Contract costs include labor and other costs to fulfill contracts associated with our Plasma Arc Flow are capitalized where the revenue is recognized at a point in time and the costs are determined to be recoverable.
| 10 |
Preferred Stock
The Company applies the accounting standards for distinguishing liabilities from equity under U.S. GAAP when determining the classification and measurement of its Preferred stock. Preferred shares subject to mandatory redemption are classified as liability instruments and are measured at fair value. Conditionally redeemable preferred shares (including preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control) are classified as temporary equity. At all other times, preferred shares are classified as permanent equity.
Stock-Based Compensation
The Company accounts for stock-based compensation costs under the provisions of ASC 718, “Compensation—Stock Compensation”, which requires the measurement and recognition of compensation expense related to the fair value of stock-based compensation awards that are ultimately expected to vest. Stock based compensation expense recognized includes the compensation cost for all stock-based payments granted to employees, officers, and directors based on the grant date fair value estimated in accordance with the provisions of ASC 718. ASC 718 is also applied to awards modified, repurchased, or canceled during the periods reported.
The Company incurred stock-based compensation charges, net of estimated forfeitures of $105,075 and $102,905 for the three months ended March 31, 2018 and 2017, respectively and has included such amounts in selling, general and administrative expenses in the consolidated statements of operations.
Stock-Based Compensation for Non-Employees
The Company accounts for warrants and options issued to non-employees under ASC 505-50, Equity – Equity Based Payments to Non-Employees, using the Black-Scholes option-pricing model. The value of such non-employee awards unvested are re-measured over the vesting terms at each reporting date.
The Company incurred stock-based compensation charges, net of estimated forfeitures of $413,450 and $326,349 for the three months ended March 31, 2018 and 2017, respectively and has included such amounts in selling, general and administrative expenses in the condensed consolidated statements of operations.
Basic and Diluted Net (Loss) per Common Share
Basic (loss) per common share is computed by dividing the net (loss) by the weighted average number of shares of common stock outstanding for each period. Diluted (loss) per share is computed by dividing the net (loss) by the weighted average number of shares of common stock outstanding plus the dilutive effect of shares issuable through the common stock equivalents.
As of March 31, 2018, and 2017 the Company’s common stock equivalents outstanding are described as follows:
| March 31, | ||||||||
| 2018 | 2017 | |||||||
| Options | 206,084 | 15,874 | ||||||
| Warrants | 222,222 | 147,991 | ||||||
| Convertible secured debentures | 0 | 9,696 | ||||||
| Convertible preferred stock | 70,923 | 0 | ||||||
| Total common stock equivalents outstanding | 499,229 | 173,561 | ||||||
Subsequent Events
The Company evaluates events that have occurred after the balance sheet date but before the financial statements are issued. Based upon the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the consolidated financial statements, except as disclosed in Note 14.
NOTE 4 – ACQUISITIONS
January 2018 Asset Purchase:
On January 19, 2018, the Company entered into an Amended and Restated Asset Purchase Agreement (“Amended Asset Purchase Agreement”) with GGNG Enterprises Inc. (formerly known as NG Enterprises, Inc.) and Guillermo Gallardo (collectively, the “Seller”) and closed the purchase of certain assets related to the Seller’s welding supply and gas distribution business in San Diego, California. The total purchase price for the Purchased Assets was $767,500. $22,500 was paid as a business broker commission and is included in goodwill. Upon consummation of the closing, on January 19, 2018, the Company commenced business operations in San Diego, California through its wholly owned subsidiary NG Enterprises Acquisition, LLC and is doing business as “Complete Welding San Diego”.
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The preliminary allocation of the consideration transferred is as follows:
| Cash | $ | 767,500 | ||
| Total purchase price | $ | 767,500 |
| Accounts receivable | $ | 55,000 | ||
| Inventory | 150,000 | |||
| Cylinders | 325,000 | |||
| Trucks | 10,000 | |||
| Accounts payable assumed | (148,719 | ) | ||
| Total purchase price allocation | $ | 391,281 | ||
| Goodwill | $ | 376,219 |
February 2018 Asset Purchase:
On February 16, 2018, the Company entered into an Asset Purchase Agreement (“Asset Purchase Agreement”) with Green Arc Supply, L.L.C. (the “Seller”) and closed the purchase of certain assets related to the Seller’s welding supply and gas distribution business located in Louisiana and Texas. The total purchase price for the Purchased Assets and Assumed Liabilities was $2,259,616, which was comprised of a $1,000,000 cash payment and the issuance of 961,539 shares of restricted common stock having a fair value of $1,259,616. The Asset Purchase Agreement also included certain conditional and bonus payments to the Seller, subject to certain performance criteria being met, as well as other terms and conditions which are typical in asset purchase agreements.
Further, in conjunction with the Asset Purchase Agreement, the Company entered into four (4) Assignment, Assumption and Amendment to Lease Agreements (each a “Lease Assumption Agreement”) with the Seller and the landlords of certain real property leased by the Seller for the operation of the Seller’s business locations in Louisiana and Texas. Upon consummation of the closing, the Company commenced operations in Texas and Louisiana through its wholly owned subsidiary MWS Green Arc Acquisition, LLC and is doing business as “Green Arc Supply”.
The preliminary allocation of the consideration transferred is as follows:
| Cash | $ | 1,000,000 | ||
| Shares issued in connection with acquisition | 1,259,616 | |||
| Total purchase price | $ | 2,259,616 |
| Cash | $ | 15,000 | ||
| Accounts receivable | 277,000 | |||
| Inventory | 707,000 | |||
| Other current assets | 18,000 | |||
| Cylinders | 750,000 | |||
| Trucks | 250,000 | |||
| Fixed assets | 321,625 | |||
| Other assets | 75,000 | |||
| Accounts payable assumed | (154,009 | ) | ||
| Total purchase price allocation | $ | 2,259,616 | ||
| Goodwill | $ | 0 |
| 12 |
The following unaudited proforma financial information presents the consolidated results of operations of the Company with MWS Green Arc Acquisition, LLC and NG Enterprises Acquisition, LLC for the three months ended March 31, 2018 and 2017, as if the above discussed acquisitions had occurred on January 1, 2017 instead of February 16, 2018 and January 19, 2018, respectively. The proforma information does not necessarily reflect the results of operations that would have occurred had the entities been a single company during those periods.
| For the three months ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| Revenues | $ | 1,454,691 | $ | 1,421,070 | ||||
| Gross Profit | 531,195 | 617,111 | ||||||
| Operating Loss | (2,946,511 | ) | (2,682,028 | ) | ||||
| Net Loss | $ | (3,055,203 | ) | $ | (1,958,242 | ) | ||
| Weighted Average Common Stock Outstanding | 6,350,695 | 394,531 | ||||||
| Loss per Common Share – Basic and Diluted | $ | (0.48 | ) | $ | (4.96 | ) | ||
NOTE 5 - INVENTORY
Inventory, consisting primarily of production materials consumables, spare parts and accessories was $1,609,931 and $738,950 at March 31, 2018 and December 31, 2017, respectively.
| March 31, 2018 | December 31, 2017 | |||||||
| Production materials consumables, spare parts, and accessories | $ | 1,609,931 | $ | 738,950 | ||||
| Work in process | - | - | ||||||
| Total at cost | 1,609,931 | 738,950 | ||||||
| Slow moving inventory allowance | - | - | ||||||
| Inventory, net | $ | 1,609,931 | $ | 738,950 | ||||
NOTE 6 – NOTES PAYABLE
Point Financial Promissory Note Payable
The Company entered into a short-term note agreement with a financing company on November 15, 2017. The new note has an implicit interest rate of 25% and the Company received net proceeds of $500,000. The short-term note agreement has a term of twelve (12) months and requires the Company to make monthly payments in the amount of $10,416.67 with a $625,000 balloon payment at end of term, which includes a $125,000 buy back premium. The Company has the right prepay the amounts owed under the note at any time without penalty. The short-term note agreement has a blanket lien on the Company’s assets.
The Company recorded $250,000 in commitment fees, buy back premiums and interest as an original issue discount and recorded a face amount of $750,000. The $250,000 in discount is being accreted over the 12-month life of the agreement using the straight-line method, which approximates the interest rate method.
During the three months ended March 31, 2018 the Company has made discretionary principal prepayments in the amount of approximately $280,000 which included the minimum payments under the terms of the agreement. The Company accretion of the debt discount for the three months ended March 31, 2018 of approximately $46,000. As of March 31, 2018, the principal amount of the note was approximately $217,600, net of the debt discount of approximately $138,300.
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NOTE 7 - STOCKHOLDERS’ EQUITY
Reverse Stock Splits
On January 16, 2018, the Company filed an amendment to the Certificate of Incorporation to effect a one-for-fifteen reverse split of the Company’s issued and outstanding common stock which was effectuated on January 16, 2018.
The reverse stock splits did not modify the rights or preferences of the common stock. Proportional adjustments have been made to the conversion and exercise prices of the Company’s outstanding common stock warrants, convertible notes, common stock options, and to the number of common stock shares issued and issuable under the Company’s equity compensation plan. The Company did not issue any fractional shares in connection with the reverse stock splits or change the par value per share. Fractional shares issuable entitle shareholders, to receive a cash payment in lieu of the fractional shares without interest. All share and per share amounts for the common stock have been retroactively restated to give effect to the reverse splits.
Common Shares Issued for Services
During the first quarter of calendar 2018, the Company issued 631,667 shares of common stock to consultants. The total fair value of these issuances is $1,730,750. These shares shall be vested over the service term from the date of issuance and $349,226 were recognized as stock-based compensation during three months ended March 31, 2018 and $1,381,524 remains unvested.
Common Stock Issued for Exercise of Warrants
During the quarter ended March 31, 2018 the Company issued 75,000 shares of common stock for the exercise of warrants, cash proceeds were $750. The fair value of the common stock warrants is $316,501, of which $63,474 was recognized as stock-based compensation for the quarter ended March 31, 2018.
NOTE 8 – PREFERRED STOCK
Series E Convertible Preferred Stock
During the three months ended March 31, 2018, investors converted 280,110 shares of Preferred Series E which had a stated value of $380,950 into 135,754 shares of the Company’s Common Stock.
NOTE 9 – COMMON STOCK OPTIONS
Options outstanding as of March 31, 2018 consisted of the following:
| Weighted | Weighted | |||||||||||||||
| Average | Average | |||||||||||||||
| Options | Exercise | Remaining | Intrinsic | |||||||||||||
| Outstanding | Price | Life in Years | Value | |||||||||||||
| December 31, 2017 | 15,342 | $ | 159.34 | 1.58 | - | |||||||||||
| Granted | 200,000 | $ | 0.94 | 10 | - | |||||||||||
| Exercised | - | |||||||||||||||
| Forfeited | - | |||||||||||||||
| Expired | (9,258 | ) | $ | 169.52 | - | - | ||||||||||
| March 31, 2018 | 206,084 | $ | 5.16 | 9.54 | $ | - | ||||||||||
| Exercisable at March 31, 2018 | 118,300 | |||||||||||||||
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As of March 31, 2018, the fair value of non-vested options totaled $81,725 which will be amortized to expense over the weighted average remaining term of 9.54 years.
The fair value of each employee option grant is estimated on the date of the grant using the Black-Scholes option-pricing model. Key weighted-average assumptions used to apply this pricing model during the three months ended 2018 were as follows:
| Risk free interest rate | 2.84 | % | ||
| Expected term | 10 years | |||
| Volatility | 183 | % | ||
| Dividends | $ | - |
NOTE 10 – COMMON STOCK WARRANTS
Common Stock Warrants outstanding as of March 31, 2018 consisted of the following:
| Weighted Average | ||||||||||||
| Outstanding | Exercise Price | Remaining Life | ||||||||||
| Balance- December 31, 2017 | 22,222 | 456 | 4.45 | |||||||||
| Granted | 75,000 | 0.01 | 0.08 | |||||||||
| Exercised | (75,000 | ) | 0.01 | |||||||||
| Expired | - | |||||||||||
| Balance- March 31, 2018 | 22,222 | 455.63 | 4.20 | |||||||||
At March 31, 2018 and December 31, 2017, the total intrinsic value of warrants outstanding and exercisable was $0 and $0, respectively.
NOTE 11 – PREFERRED STOCK WARRANTS
Preferred Stock Warrants outstanding to purchase Series C Preferred Stock as of March 31, 2018 consisted of the following:
| Weighted | Weighted | |||||||||||
| Average | Average | |||||||||||
| Warrants | Exercise | Remaining | ||||||||||
| Outstanding | Price | Life in Years | ||||||||||
| Balance -December 31, 2017 | 21,397 | $ | 900 | - | ||||||||
| Granted | - | |||||||||||
| Exercised | (9,303 | ) | $ | 900 | ||||||||
| Forfeited | - | - | ||||||||||
| Expired | ||||||||||||
| Balance- March 31, 2018 | 12,094 | $ | 900 | 4.20 | ||||||||
| Exercisable at March 31, 2018 | 12,094 | |||||||||||
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During the three months ended March 31, 2018, the warrant holders exercised 9,303 Preferred Warrants into 9,303 Series C Convertible Preferred Shares. The investors simultaneously converted 9,418 shares (and the previously outstanding 115 Preferred Shares) which had a stated value of $9,418,000 into 9,677,831 shares of the Company’s Common Stock. Management analyzed the conversion features of the Series C Preferred stock underlying the Series C Preferred Warrants and recorded a beneficial conversion feature in the amount of $930,300. The beneficial conversion feature was recognized as a deemed dividend for the three months ended March 31, 2018.
At March 31, 2018 and December 31, 2017, the total intrinsic value of preferred stock warrants outstanding and exercisable was $0 and $0, respectively.
NOTE 12 - RELATED PARTY TRANSACTIONS
Operating Leases – Related Party
The Company previously occupied 5,000 square feet of a building owned by a related party. Rent was payable at $4,000 on a month-to-month basis. The facility allowed for expansion needs. The lease was held by EcoPlus, Inc., a company that is effectively controlled by Dr. Ruggero Santilli, a former officer and director of the Company and one of the people who currently has voting and investment control over 1,000,000 shares of Series A Preferred Stock which, in turn, has 100,000 votes per share on any matters brought to a vote of the common stock shareholders. Rent expense for both the three months ended March 31, 2018 and 2017 under this lease was approximately $12,000. The lease was terminated on May 27, 2017.
Notes Payable – Related Parties
As of December 31, 2017, the Company had a $50,000 promissory note with a member of the Board of Directors. The note bore interest of 15% per annum and was due on July 3, 2017. During the first quarter of 2018 the Company repaid $40,000 in principal and $6,313 in interest. As of March 31, 2018, the balance payable was $11,229 including interest of $1,229.
As of December 31, 2017, the Company had a $50,000 promissory note with the Company’s Chief Executive Officer (“CEO”). The note bears interest of 15% and was due on July 11, 2017. During the first quarter of 2018 the Company repaid $20,000 in principal and $6,146 in interest. As of March 31, 2018, the balance payable was $31,229 including interest of $1,229.
Accrued Expenses – Related Parties
During the period January 1, 2018 through March 31, 2018, working capital advances, funded by the CEO, in the amount of $182,070, were settled.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
Litigation
Certain conditions may exist as of the date the consolidated financial statements are issued which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company, or unasserted claims that may result in such proceedings, the Company evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability and an estimate of the range of possible losses, if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed, unless they involve guarantees, in which case the guarantees would be disclosed. There can be no assurance that such matters will not materially and adversely affect the Company’s business, financial position, and results of operations or cash flows.
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On April 16, 2015, there was an accident at the Company’s facilities which occurred during the gas filling process. As a result of the accident, one employee was killed and one was injured but has recovered and has returned to work. Although the Company has Workers Compensation Insurance and General Liability Insurance, the financial impact of the accident is unknown at this time. No customers have terminated their relationship with the Company as a result of the accident. On October 14, 2015 the Company received their final report from the Occupational and Safety Hazard Administration (“OSHA”) related to the accident. The OSHA report included findings, many of which were already resolved and a proposed citation. The Company was not cited for any willful misconduct and no final determination was made as to the cause of the accident. The Company received citations related to various operational issues and received an initial fine of $52,000. The Company has also been informed by the U.S. Department of Transportation that it has closed its preliminary investigation with no findings or citations to the Company. The U.S. Department of Transportation has the right to re-open the investigation should new information become available.
The Company is still investigating the cause of the accident and there have been no conclusive findings as of this time. It is unknown whether the final cause of the accident will be determined and whether those findings will negatively impact Company operations or sales. The Company continues to be fully operational and transparent with all regulatory agencies. As of March 31, 2018, the Company has not accrued for any contingency.
On November 18, 2016 a lawsuit was filed in District Court in Pinellas County, Florida by the Estate of Michael Sheppard seeking unspecified damages. The lawsuit alleges that the Company was negligent and grossly negligent in various aspects of its safety, training and overall work environment that led to the accident. The Company was not cited by OSHA for any willful misconduct nor did it receive any citations from the Department of Transportation. As of March 31, 2018, the Company has not accrued for any contingency.
Employment Agreements
On March 13, 2018, the Company entered into a new employment agreement with Ermanno Santilli (“Santilli Employment Agreement”). Pursuant to the terms of the agreement Mr. Santilli continues to serve as the Company’s chief executive officer and receives an annual salary of $235,000 per year. The agreement included the grant of 100,000 time-vested common stock options with strike price set at the Company’s closing share price on March 13, 2018. 50,000 common stock options vested on March 13, 2018 and the remaining 50,000 common stock options will vest 1/24th per month for a period of 24 months. The agreement also includes the opportunity for performance bonuses, subject to Mr. Santilli meeting certain objectives. If the performance objectives are met, the bonus compensation will vest 1/3 after December 31, 2018 followed by the balance vesting 1/36th per month for 36 months thereafter. If Mr. Santilli’s agreement is not renewed for an additional Term (as defined in the Santilli Employment Agreement), the achieved performance cash and common stock options shall be subject to an accelerated vesting schedule with such cash and common stock options fully vesting thirty (30) days after his agreement terminates. If Mr. Santilli terminates his agreement unilaterally, any unvested cash or common stock options shall be forfeited.
On March 13, 2018, the Company entered into a new employment agreement with Scott Mahoney (“Mahoney Employment Agreement”). Pursuant to the terms of the agreement Mr. Mahoney continues to serve as the Company’s chief financial officer and receives an annual salary of $215,000 per year. The agreement included the grant of 100,000 time-vested common stock options with strike price set at the Company’s closing share price on March 13, 2018. 50,000 common stock options vested on March 13, 2018 and the remaining 50,000 common stock options will vest 1/24th per month for a period of 24 months. The agreement also includes performance bonuses, subject to Mr. Mahoney meeting certain objectives. If the performance objectives are met, the bonus compensation will vest 1/3 after December 31, 2018 followed by the balance vesting 1/36th per month for 36 months thereafter. If Mr. Mahoney’s agreement is not renewed for an additional Term (as defined in the Mahoney Employment Agreement), the achieved performance cash and common stock options shall be subject to an accelerated vesting schedule with such cash and common stock options fully vesting thirty (30) days after his agreement terminates. If Mr. Mahoney terminates his agreement unilaterally, any unvested cash or common stock options shall be forfeited.
NOTE 14 – SUBSEQUENT EVENTS
Securities Purchase Agreement:
On April 3, 2018, the Company entered into a Securities Purchase Agreement (“SPA”) with Robert Baker, Joseph Knieriem (collectively, the “Sellers”) and Trico Welding Supplies, Inc., a California corporation (“Trico”) for the purchase of all of the issued and outstanding capital stock of Trico by the Company. Under the terms of the SPA, the Company purchased one hundred percent (100%) of Trico’s issued and outstanding capital stock for the gross purchase price of $2,000,000 (“Trico Stock”). The SPA includes certain other terms and conditions which are typical in securities purchase agreements. On March 21, 2018, the Company made an initial non-refundable deposit for the purchase of the Trico Stock. Upon execution of the SPA the Company funded the remaining $1,000,000 balance due. Effective at closing, the Company commenced business operations in northern California through its new wholly owned subsidiary Trico Welding Supplies, Inc.
| 17 |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Cautionary Notice Regarding Forward Looking Statements
The following is a “safe harbor” statement under the Private Securities Litigation Reform Act of 1995. Statements contained in this document that are not based on historical facts are “forward-looking statements.” This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q contain forward-looking statements. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions that are not statements of historical facts. This document and any other written or oral statements made by us or on our behalf may include forward-looking statements, which reflect our current views with respect to future events and financial performance. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “continue,” “should,” “would,” “could,” “potentially,” “will,” “may” or similar words and expressions that convey uncertainty of future events or outcomes to identify these forward-looking statements.
The forward-looking statements in this document are based upon various assumptions, many of which are based on management’s discussion and analysis or plan of operations and elsewhere in this Report. Although we believe that these assumptions were reasonable when made, these statements are not guarantees of future performance and are subject to certain risks and uncertainties, some of which are beyond our control, and are difficult to predict. Actual results could differ materially from those expressed in forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements, which reflect management’s view only as of the date of this Report.
Certain Terms Used in this Report
When this report uses the words “we,” “us,” “our,” and the “Company,” they refer to MagneGas Corporation and our wholly-owned subsidiaries. “SEC” refers to the Securities and Exchange Commission.
Overview
MagneGas Corporation (the “Company”) was organized in the State of Delaware on December 9, 2005.
The Company is an alternative energy company that has developed a proprietary plasma arc system (“Plasma Arc Flow Units” or “Plasma Arc Flow System”) which generates hydrogen based synthetic gases through the gasification of various types of liquid feedstocks. The Company’s synthetic gas – MagneGas2® - is bottled in cylinders and is distributed to the metalworking market as an alternative cutting fuel to acetylene and propane. Through the course of its business development, the Company has established a retail and wholesale platform and a network of brokers to sell its MagneGas2® for use in the metalworking and manufacturing industries throughout the world. Additionally, the Company is in the process of developing ancillary uses of MagneGas2® for additional end-user applications. The Company’s Plasma Arc Flow Units include various commercial applications, most notably the sterilization of liquid waste, which has resulted in the Company’s marketing and sale of Plasma Arc Flow Units for third-party commercial use.
In the second quarter of 2014 the Company began implementing an acquisition-focused growth strategy that was highlighted by the October 2014 purchase of Equipment Sales and Services, Inc. (“ESSI”). ESSI is a full line seller of industrial gases and equipment for the welding and metal cutting industries. Since acquiring ESSI, the Company has opened four retail locations and distributes MagneGas2® as a metal cutting fuel as well as other gases and welding supplies. Additional acquisitions and the success of ESSI has allowed the Company to augment its acquisition growth model with significant organic growth. In January 2018, the Company acquired all of the assets of GGNG Enterprises, Inc. and began doing business in southern California under the name “Complete Welding San Diego”. In February 2018, the company acquired all of the assets of Green Arc Supply, L.L.C. and began doing business in Texas and Louisiana under the name “Green Arc Supply”.
Between February and March of 2017, the Company formed five wholly owned subsidiaries in the State of Delaware respectively called MagneGas Energy Solutions, LLC, MagneGas Welding Supply, LLC, MagneGas Real Estate Holdings, LLC, MagneGas IP, LLC and MagneGas Production, LLC. The Company formed these entities to hold the various types of Company assets their names indicate.
Results of Operations
Comparison for the three and nine months ended March 31, 2018 and 2017
Revenues
For the three months ended March 31, 2018 and 2017 we generated revenues of $1,171,753 and $871,788, respectively. The 35% increase in revenue was due primarily to our two acquisitions in January and February 2018 and organic sales growth in the area of pre-existing operations. The Company expanded through acquisition into the San Diego market in January 2018. This expansion contributed $109,984 in revenue during the period. The Company also expanded through acquisition into the East Texas and Louisiana markets in February 2018. This expansion contributed $156,361 in revenue during the period.
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For the three months ended March 31, 2018 and 2017 cost of revenues were $757,874 compared to $503,388, respectively. For the three months ended March 31, 2018 and 2017, we generated a gross profit of $413,879 compared to $368,400. Gross margins for the three months ended March 31, 2018 and 2017 were 35% and 42%, respectively. The decline in gross margins was due to acquisition accounting treatment of the acquired inventory values. The Company anticipates that margins will improve as all acquired inventory is sold and our cost basis for replacement inventory is reflected in our future cost of goods sold. Partially offsetting this increase in cost of goods sold, the Company has achieved better pricing and terms on select products as we achieve economies of scale and greater buying power.
Operating Expenses
Operating costs for the three months ended March 31, 2018 and 2017 were $3,314,357 and $2,873,345, respectively. The increase in our operating costs in 2018 was primarily attributable to the completion of our two acquisitions in January and February 2018 and significant capital markets activity during the period. The Company spent $547,810 on consulting related to three acquisitions, including the acquisition of Trico Welding Supplies, Inc. which closed April 2, 2018. The Company also recognized significant non-recurring charges related to integration of these acquisitions. The Company incurred $56,383 in computer and IT integration activities. Travel expenses were also significantly higher due to ongoing personnel training, integration and other non-recurring activities. During the three months ended March 31, 2018 we recognized a non-cash charge of $105,075 in stock-based compensation for employees, compared to $102,905 in the comparable three months ended March 31, 2017, common stock issued for services of $413,450 for the three months ended March 31, 2018, compared to $326,349 in the comparable three months ended March 31, 2017. Other non-cash operating expenses were due to depreciation and amortization charges of $159,211 for the three-month period ended March 31, 2018, compared to $167,338 for the three months ended March 31, 2017.
In the current quarter, as in prior quarters, we selectively used common stock as a method of payment for certain services, primarily the advertising and promotion of the technology to increase investor and customer awareness and as incentive to its key employees and consultants. We expect to continue these arrangements, though due to a stronger operating position, this method of payment may become limited to employees.
Net Loss
Our operating results for the three months ended March 31, 2018 have recognized losses in the amount of $3,019,441 compared to $1,781,159 for the three months ended March 31, 2017. The increase in our loss was primarily attributable to acquisition and integration expenses.
Liquidity and Capital Resources
As of March 31, 2018, the Company had cash of $2,103,254 and has reported a net loss of $3,019,441 and has used cash in operations of $2,394,909 for the three months ended March 31, 2018. Partly offsetting our negative cash flows, as of March 31, 2018 the Company had a positive working capital position of $1,799,776, and a stockholder’s equity balance of $14,146,596. As a result of the Company’s negative cash flow generation, there is reasonable doubt about the Company’s ability to continue as a going concern within one year from the issuance date of the financial statements.
The ability of the Company to continue as a going concern is dependent upon its ability to further implement its business plan and generate sufficient revenue and its ability to raise additional funds by way of public or private offerings or through the use of indebtedness.
Historically, the Company has financed its operations through equity and debt financing transactions and expects to continue incurring operating losses for the foreseeable future. The Company’s plans and expectations for the next 12 months include raising additional capital to help fund commercial operations, make select acquisitions, and new product development. The Company utilizes cash in its operations of approximately $240,000 per month. Management believes, but it cannot be certain, its current holdings of cash along with the cash to be generated from expected product sales and future financings will be sufficient to meet its projected operating requirements for the next twelve months from the date of this report.
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Cash Flows from Continuing Operations
Cash flows from continuing operations for operating, financing and investing activities for the three months ended March 31, 2018 and 2017 are summarized in the following table:
| Three Months Ended March 31, | ||||||||
| 2018 | 2017 | |||||||
| (unaudited) | (unaudited) | |||||||
| Operating activities | $ | (2,394,909 | ) | $ | (1,546,606 | ) | ||
| Investing activities | (3,382,901 | ) | (22,848 | ) | ||||
| Financing activities | 7,294,240 | 6,623 | ||||||
| Net (decrease) increase in cash from continuing operations | $ | 1,516,430 | $ | (1,562,831 | ) | |||
For the three months ended March 31, 2018, we used cash of $2,394,909 in operations in 2018 and used cash of $1,546,606 in operations in 2017. Our cash use for 2018 was primarily attributable to cash used to reduce vendor balances, accrued expenses and other short-term liabilities. Our cash use for 2017 was primarily attributable to general corporate needs, personnel restructuring, the overhaul of our capital structure, and organic growth initiatives. During the three months ended March 31, 2018, cash used by investing activities consisted of $3,382,901 primarily due to the acquisition of all of the assets of two companies and a $1,000,000 deposit on a third acquisition which closed April 2, 2018. During the three months ended March 31, 2017, cash used by investing activities consisted of $22,848. Cash provided by financing activities for the three months ended March 31, 2018 was $7,294,240 as compared to cash provided by financing activities for the three months ended March 31, 2017 of $6,623. The net increase in cash during the three months ended March 31, 2018 was $1,516,430 as compared to a net decrease in cash of $1,562,831 for the three months ended March 31, 2017.
Insurance
The Company has insurance to cover Liabilities related to environmental and pollution contingencies of $1,000,000 per loss and $2,000,000 in the aggregate.
Critical Accounting Policies
Our significant accounting policies are presented in this Report in our Notes to financial statements, which are contained in this Quarterly Report. The significant accounting policies that are most critical and aid in fully understanding and evaluating the reported financial results include the following:
The Company prepares its financial statements in conformity with U.S. GAAP. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that these estimates are reasonable and have been discussed with our Board of Directors (the “Board”); however, actual results could differ from those estimates.
We issue restricted stock to consultants for various services. Cost for these transactions are measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The value of the common stock is measured at the earlier of (i) the date at which a firm commitment for performance by the counterparty to earn the equity instruments is reached or (ii) the date at which the counterparty’s performance is complete.
Long-lived assets such as property, equipment and identifiable intangibles are reviewed for impairment whenever facts and circumstances indicate that the carrying value may not be recoverable. When required impairment losses on assets to be held and used are recognized based on the fair value of the asset. The fair value is determined based on estimates of future cash flows, market value of similar assets, if available, or independent appraisals, if required. If the carrying amount of the long-lived asset is not recoverable from its undiscounted cash flows, an impairment loss is recognized for the difference between the carrying amount and fair value of the asset. When fair values are not available, the Company estimates fair value using the expected future cash flows discounted at a rate commensurate with the risk associated with the recovery of the assets.
The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective method which would require a cumulative effect adjustment for initially applying the new revenue standard as an adjustment to the opening balance of retained earnings and the comparative information would not require to be restated and continue to be reported under the accounting standards in effect for those periods.
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Based on the Company’s analysis the Company did not identify a cumulative effect adjustment for initially applying the new revenue standards. The Company principally generates revenue through the sales of: (1) MagneGas2®, other industrial gases and welding supply goods and (2) Plasma Arc Flow Units, either directly or through one or more of its wholly owned welding supply and gas distribution subsidiaries. The Company’s revenue recognition policy for the year ending December 31, 2018 is as follows:
| ● | Revenue for metal-working fuel, industrial gases and welding supplies is recognized when performance obligations of the sale are satisfied. The majority of the Company’s terms of sale have a single performance obligation to transfer products. Accordingly, the Company recognizes revenue when control has been transferred to the customer, generally at the time of shipment of products. Under the previous revenue recognition accounting standard, the Company recognized revenue upon transfer of title and risk of loss, generally upon the delivery of goods. |
| ● | Revenue generated from sales of a Plasma Arc Flow Unit (“Units”) is no longer recognized on a percentage of completion. Even though our Units are cost intensive and generally require a 6 to 9 month production cycle, revenue will now be recognized upon shipment of the completed machine. We require purchasers of our Units to make significant payments before we proceed with production and at 75% completion; these payments are now classified as customer deposits instead of revenue. |
The fair value of an embedded conversion option that is convertible into a variable amount of shares and warrants that include price protection reset provision features are deemed to be “down-round protection” and, therefore, do not meet the scope exception for treatment as a derivative under Accounting Standards Codification (“ASC”) ASC 815 “Derivatives and Hedging”, since “down-round protection” is not an input into the calculation of the fair value of the conversion option and warrants and cannot be considered “indexed to the Company’s own stock” which is a requirement for the scope exception as outlined under ASC 815. The accounting treatment of derivative financial instruments requires that the Company record the embedded conversion option and warrants at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income or expense for each reporting period at each balance sheet date. The Company reassesses the classification of its derivative instruments at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified as of the date of the event that caused the reclassification. As a result of entering into a convertible credit facility for which such instruments contained a variable conversion feature with no floor, the Company has adopted a sequencing policy in accordance with ASC 815-40-35-12 whereby all future instruments may be classified as a derivative liability with the exception of instruments related to share-based compensation issued to employees.
The Black-Scholes option valuation model was used to estimate the fair value of the warrants and conversion options. The model includes subjective input assumptions that can materially affect the fair value estimates. The Company determined the fair value of the Binomial Lattice Model and the Black-Scholes Valuation Model to be materially the same. The expected volatility is estimated based on the most recent historical period of time equal to the weighted average life of the warrants. Conversion options are recorded as debt discount and are amortized as interest expense over the life of the underlying debt instrument.
Off Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
The Company is a “Smaller Reporting Company” as defined by § 229.10(f)(1) and is not required to provide the information required by this Item.
| Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of this report, an evaluation was carried out by the Company’s management, with the participation of the chief executive officer and chief financial officer of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)) as of March 31, 2018. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to management, including the chief executive officer and the chief financial officer, to allow timely decisions regarding required disclosures.
During the evaluation of disclosure controls and procedures as of March 31, 2018, management concluded that Company’s disclosure controls and procedures were not effective.
Notwithstanding the existence of these material weaknesses, management believes that the consolidated financial statements in this report on Form 10-Q fairly present, in all material respects, the Company’s financial condition as reported, in conformity with United States Generally Accepted Accounting Principles (“GAAP”).
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Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act. The Company’s internal control over financial reporting is a process, under the supervision of the chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that:
| ● | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets; | |
| ● | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and the board of directors; and | |
| ● | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Management has not completed a proper evaluation, risk assessment and monitoring of the company’s internal controls over financial reporting as of March 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a result, management has concluded controls were not effective and identified material weaknesses in internal control over financial reporting.
A material weakness is a control deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The material weaknesses identified are disclosed below:
Failure to Segregate Duties. Management has not maintained adequate segregation of duties within the Company due to its reliance on a few individuals to fill multiple roles and responsibilities. Our failure to segregate duties has been a material weakness for the period covering this report.
Sufficiency of Accounting Resources. The Company has limited accounting personnel to prepare its financial statements and handle complex accounting transactions. The insufficiency of our accounting resources has been a material weakness for the period covering this report.
Evaluation. The Company did not perform a proper evaluation, risk assessment or monitor their internal controls over financial reporting.
As a result of the material weaknesses in internal control over financial reporting described above, the Company’s management has concluded that, as of March 31, 2018, the Company’s internal control over financial reporting was not effective based on the criteria in Internal Control – Integrated Framework issued by the COSO.
This report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. We were not required to have, nor have we, engaged the Company’s independent registered public accounting firm to perform an audit of internal control over financial reporting pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Changes in Internal Controls over Financial Reporting
There has been no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or 15d-15 under the Exchange Act that occurred during the quarter ended March 31, 2018 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
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| Item 1. | Legal Proceedings. |
The Company is involved in certain claims and pending litigation arising from the normal conduct of business. Many of these claims are covered in whole or in part by insurance. Based on knowledge of the facts and, in certain cases, opinions of outside counsel, management believes that adequate provisions have been made for probable losses with respect to the resolution of all such claims and pending litigation and that the ultimate outcome, after provisions therefor, will not have a material adverse effect on the financial condition of the Company, but could have a material effect on the results of operations in a given quarter or year.
| Item 1A. | Risk Factors. |
For a discussion identifying additional risk factors and other important factors that could cause actual results to differ materially from those anticipated, see the discussions under Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
During the first quarter of 2018, the Company issued 631,667 shares of common stock to consultants. The total value of these issuances is $1,730,750. These shares shall be vested per service term from the date of issuance and $349,226 were recognized as stock-based compensation during three months ended March 31, 2018.
During the quarter ended March 31, 2018 the Company issued 75,000 shares of common stock for the exercise of warrants, cash proceeds were $750.
| Item 3. | Defaults Upon Senior Securities. |
None
| Item 4. | Mine Safety Disclosures. |
Not Applicable.
| Item 5. | Other Information. |
None.
| Item 6. | Exhibits |
| Exhibit | Incorporated by Reference | Filed
or Furnished | ||||||||
| Number | Exhibit Description | Form | Exhibit | Filing Date | Herewith | |||||
| 3.1 | Amendment No. 1 to By-Laws of MagneGas Corporation. | 8-K | 3.1 | 09/29/2016 | ||||||
| 31.1 | Certification of Principal Executive Officer, pursuant to 18 U. S. C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
| 31.2 | Certification of Principal Financial Officer, pursuant to 18 U. S. C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
| 32.1* | Certification of Principal Executive Officer, pursuant to 18 U. S. C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
| 32.2* | Certification of Principal Financial Officer, pursuant to 18 U. S. C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
| 101.INS | XBRL Instance. | X | ||||||||
| 101.SCH | XBRL Schema. | X | ||||||||
| 101.CAL | XBRL Calculation. | X | ||||||||
| 101.DEF | XBRL Definition. | X | ||||||||
| 101.LAB | XBRL Label. | X | ||||||||
| 101.PRE | XBRL Presentation. | X | ||||||||
* In accordance with SEC Release 33-8238, Exhibits 32.1 and 32.2 are being furnished and not filed.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| MagneGas Corporation | ||
| By: | /s/ Ermanno Santilli | |
| Ermanno Santilli | ||
| Chief Executive Officer | ||
| (Principal Executive Officer) | ||
| Dated: | May 15, 2018 | |
| By: | /s/ Scott Mahoney | |
| Scott Mahoney | ||
| Chief Financial Officer | ||
| (Principal Financial and Accounting Officer) | ||
| Dated: | May 15, 2018 |
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