NOTE 2 - GOING CONCERN AND MANAGEMENTS’
PLAN
As of March 31, 2017, the Company had cash
of $53,578 and has reported a net loss of $1,781,159 and has used cash in operations of $1,546,607 for the three months ended March
31, 2017. In addition, as of March 31, 2017 the Company has a working capital deficit of $5,210,012 and an accumulated deficit
of $55,339,639. 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 a public or private offering.
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, including product development. The Company utilizes cash in its operations of approximately $515,000 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.
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 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, 2017 and 2016. 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, 2016, which contains the audited financial statements and notes thereto, for the years ended December 31, 2016 and
2015 included within the Company’s Form 10-K filed with the SEC on March 31, 2017. The interim results for the three months
ended March 31, 2017 are not necessarily indicative of the results to be expected for the year ended December 31, 2017 or for
any future interim periods.
Use of Estimates
The Company prepares its financial statements
in conformity with 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 financial statements
presented include inventory reserves, fair value of derivative financial 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 subsidiary Equipment Sales and Services, Inc.
and all material intercompany balances and transactions have been eliminated.
Concentrations of Credit Risk
The Company maintains its cash accounts
at financial institutions which are insured by the Federal Deposit Insurance Corporation ("FDIC"). At times, the Company
may have deposits in excess of federally insured limits.
Cash and Cash Equivalents
The Company considers all highly liquid
investments with an original maturity of three months or less when purchased to be cash equivalents. As of March 31, 2017
and December 31, 2016, the Company did not have any cash equivalents.
Property and Equipment
Property and equipment are stated at cost
less accumulated depreciation. Cost includes expenditures for machinery and equipment, furniture and equipment, transportation,
production units and building. Maintenance and repairs are charged to expense as incurred. When assets are sold, retired, or otherwise
disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in
operations. The cost of equipment is depreciated using the straight-line method over the estimated useful lives of the related
assets which are 3- 15 years. Depreciation expense for the three months ended March 31, 2017 and 2016 was $153,364 and $139,980,
respectively.
Revenue Recognition
The Company generates revenue through
two processes: (1) the sale of its MagneGas2® fuel for metal cutting and (2) the sale of its Plasma Arc Flow units. Additionally,
the Company also recognizes revenue from territorial license arrangements, and through the sales of metal cutting gases and related
products through their wholly owned subsidiary, Equipment Sales and Service, Inc. (“ESSI”), a Florida corporation.
●
|
Revenue
for metal-working fuel is recognized when shipments are made to customers. The Company recognizes a sale when the product
has been shipped and risk of loss has passed to the customer and collectability is reasonably assured.
|
●
|
Revenue
generated from sales of its production unit is recognized on a percentage of completion, based on the progress during manufacturing
of the unit. Our machine is a significant investment and generally requires a 6 to 9 month production cycle. During
the course of building a unit the actual costs are tracked to our cost estimates and revenue is proportionately recognized
during the process. Significant deposits are required before production. These deposits are classified
as customer deposits. During our production, costs and progress earnings are accumulated and included in “Costs
and earnings” as an asset, such amounts have been immaterial to date.
|
●
|
Licenses
are issued, per contractual agreement, for distribution rights within certain geographic territories. The Company
recognizes revenue ratably, based on the amounts paid or values received, over the term of the licensing agreement.
|
Fair Value Measurements
ASC 820, “Fair Value Measurements
and Disclosure,” defines fair value as the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. ASC 820 also
establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad
levels giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3).
The three levels are described below:
Level 1 Inputs –
Unadjusted quoted prices in active markets for identical assets or liabilities that is accessible by the Company;
Level 2 Inputs –
Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either
directly or indirectly;
Level 3 Inputs –
Unobservable inputs for the asset or liability including significant assumptions of the Company and other market participants.
The carrying amount of the Company’s
financial assets and liabilities, such as cash, accounts payable and accrued expenses approximate their fair value because of
the short maturity of those instruments.
Transactions involving related parties
cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings
may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions
were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.
The assets or liability’s fair value
measurement within the fair value hierarchy is based upon the lowest level of any input that is significant to the fair value
measurement. The following tables provides a summary of financial instruments that are measured at fair value as of March
31, 2017 and December 31, 2016, respectively.
March 31, 2017
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
In Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Liabilities
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Warrant liability
|
|
$
|
5,994,895
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
5,994,895
|
|
Embedded conversion feature
|
|
|
446,702
|
|
|
|
—
|
|
|
|
—
|
|
|
|
446,702
|
|
Derivative liability – March 31, 2017
|
|
$
|
6,441,597
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
6,441,597
|
|
December 31, 2016
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
In Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Liabilities
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
Total
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Warrant liability
|
|
$
|
7,195,617
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
7,195,617
|
|
Embedded conversion feature
|
|
|
504,968
|
|
|
|
—
|
|
|
|
—
|
|
|
|
504,968
|
|
Derivative liability – December 31, 2016
|
|
$
|
7,700,585
|
|
|
|
—
|
|
|
|
—
|
|
|
$
|
7,700,585
|
|
The table below provides a summary of
the changes in fair value, including net transfers in and/or out, of all financial assets and liabilities measured at fair value
on a recurring basis using significant unobservable inputs (Level 3) during the interim period ended March 31, 2017:
|
|
|
|
|
Embedded
|
|
|
Total
|
|
|
|
Warrant
|
|
|
Conversion
|
|
|
Derivative
|
|
|
|
Liability
|
|
|
Feature
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
Balance – December 31, 2016
|
|
$
|
7,195,617
|
|
|
$
|
504,968
|
|
|
$
|
7,700,585
|
|
Change in fair value
|
|
|
(803,868
|
)
|
|
|
(27,552
|
)
|
|
|
(831,420
|
)
|
Reclassifications of derivative liabilities to equity
|
|
|
(396,854
|
)
|
|
|
(30,714
|
)
|
|
|
(427,568
|
)
|
Balance – March 31, 2017
|
|
$
|
5,994,895
|
|
|
$
|
446,702
|
|
|
$
|
6,441,597
|
|
The Company’s Level 3 liabilities
shown in the above table consist of warrants that contain a cashless exercise feature that provides for their net share settlement
at the option of the holder. In addition, the convertible debt conversion feature has a price reset provision with no floor. The
warrants also contain a fundamental transactions provision that permits their settlement in cash at fair value at the option of
the holder upon the occurrence of a change in control. Such change in control events include tender offers or hostile takeovers,
which are not within the sole control of the Company as the issuer of these warrants. Accordingly, the warrants are considered
to have a cash settlement feature that precludes their classification as equity instruments. Settlement at fair value upon the
occurrence of a fundamental transaction computed using the Black Scholes Option Pricing Model using the following assumptions:
Assumptions utilized in the valuation
of Level 3 liabilities are described as follows:
|
|
For
the three months ended March 31,
|
|
|
2017
|
|
2016
|
Risk free interest rate
|
|
0.2%-1.42%
|
|
0.33%
|
Expected term
|
|
.25 to 7.25 years
|
|
1.0 years
|
Volatility
|
|
62% to 102%
|
|
93%
|
Dividends
|
|
$0
|
|
$0
|
The risk-free interest rate was determined
from the implied yields from U.S. Treasury zero-coupon bonds with a remaining term consistent with the expected term of the instrument
being valued. The expected term used is the contractual life of the instrument being valued. Volatility was calculated using the
Company’s historical common stock price over the expected term of the instruments valued. Dividends were deemed to be $0
as the Company has historically never declared any dividends to its stock holders.
Derivative Liability
The Company evaluates its options, warrants
or other contracts, if any, to determine if those contracts or embedded components of those contracts qualify as derivatives to
be separately accounted for in accordance with ASC 815-10-05-4 and 815-40-25. The result of this accounting treatment is that
the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as either an asset or a liability.
In the event that the fair value is recorded as a liability, the change in fair value is recorded in the consolidated statement
of operations as other income or expense. Upon conversion, exercise or cancellation of a derivative instrument, the instrument
is marked to fair value at the date of conversion, exercise or cancellation and then the related fair value is reclassified to
equity.
The classification of derivative instruments,
including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting
period. Equity instruments that are initially classified as equity that become subject to reclassification are reclassified to
liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities will be classified
in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument is expected
within 12 months of the balance sheet date.
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.
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 $102,950 and $49,794 for the three months ended March 31, 2017 and 2016, 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, 2017 and 2016 the Company’s common stock
equivalents outstanding.
|
|
March
31,
|
|
|
|
2017
|
|
|
2016
|
|
Options
|
|
|
2,381,000
|
|
|
|
4,100,000
|
|
Warrants
|
|
|
22,198,554
|
|
|
|
7,702,819
|
|
Convertible secured debentures
|
|
|
1,454,386
|
|
|
|
—
|
|
Total common stock equivalents
outstanding
|
|
|
26,033,940
|
|
|
|
11,802,819
|
|
Derivative Financial Instruments
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 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.
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.
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 8.
NOTE 4 - INVENTORY, NET
Inventory primarily consists of:
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Production materials consumables, spare
parts, and accessories
|
|
$
|
1,068,718
|
|
|
$
|
937,133
|
|
Work in process
|
|
|
855,317
|
|
|
|
853,800
|
|
Total at cost
|
|
|
1,924,035
|
|
|
|
1,790,933
|
|
Slow moving inventory reserve
|
|
|
(200,000
|
)
|
|
|
(175,000
|
)
|
|
|
|
|
|
|
|
|
|
Inventory, net
|
|
$
|
1,724,035
|
|
|
$
|
1,615,933
|
|
NOTE 5 - STOCKHOLDERS’ EQUITY
Common shares issued for services
During the first quarter of 2017, the
Company issued 412,500 shares of common stock to employees under the 2014 Amended and Restated Equity Incentive Award Plan. Additionally,
the Company issued 31,056 shares of common stock to a director of the Company as director compensation and 220,000 shares of common
stock to consultants for services rendered. The total value of these issuances is $326,349.
Common Stock Issued for Exercise of Warrants
During the quarter ended March 31, 2017
the Company issued 793,708 shares of common stock for the exercise of warrants, cash proceeds were $7,937. The exercise of these
warrants resulted in a reduction of the derivative liability associated with these warrants of $396,854, which has been reclassified
to additional paid in capital.
Common Stock Issued for the Settlement of Debt
During the quarter ended March 31, 2017
the Company issued 100,000 shares of common stock for the settlement of $57,000 of senior convertible debentures. The settlement
of the $57,000 resulted in the reduction of the derivative liability associated with the embedded conversion feature of $30,714,
which has been reclassified to additional paid in capital.
Options
Options outstanding as of March 31, 2017
consisted of the following:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
|
|
Options
|
|
|
Exercise
|
|
|
Remaining
|
|
|
Intrinsic
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life in Years
|
|
|
Value
|
|
December 31, 2016
|
|
|
4,681,000
|
|
|
|
1.37
|
|
|
|
1.23
|
|
|
|
1.36
|
|
Granted
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(2,300,000
|
)
|
|
|
1.50
|
|
|
|
|
|
|
|
|
|
March 31, 2017
|
|
|
2,381,000
|
|
|
|
1.08
|
|
|
|
2.31
|
|
|
|
1.36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2017
|
|
|
1,855,997
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2017, the fair value of
non-vested options totaled $525,003 which will be amortized to expense over the weighted average remaining term of 2.31 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 2016 were as follows:
Risk free interest rate
|
|
1.10
|
%
|
Expected term
|
|
3-5 years
|
|
Volatility
|
|
55.6
|
%
|
Dividends
|
$
|
0
|
|
Warrants
Warrants outstanding as of March 31, 2017
consisted of the following:
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Warrants
|
|
|
Exercise
|
|
|
Remaining
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life
in Years
|
|
Balance -December 31, 2016
|
|
|
22,992,262
|
|
|
|
0.91
|
|
|
|
5.8
|
|
Granted
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(793,708
|
)
|
|
|
0.01
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance- March 31, 2017
|
|
|
22,198,554
|
|
|
|
1.24
|
|
|
|
3.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2017
|
|
|
22,198,554
|
|
|
|
|
|
|
|
|
|
During the three months ended March 31,
2016 the Company issued 793,708 shares of common stock for the exercise of warrants, cash proceeds were $7,937
NOTE 6 - RELATED PARTY TRANSACTIONS
The Company occupies 5,000 square feet
of the building owned by a related party. Rent is payable at $4,000 on a month to month basis. The facility allows for expansion
needs. The lease is 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, 2017 and 2016 under this lease was approximately $12,000.
NOTE 7 - 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.
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, 2016 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, 2017 the Company has not accrued for any contingency.
NOTE 8 – SUBSEQUENT EVENTS
On May 9, 2017, MagneGas Corporation (the
“Company”) entered into an Exchange Agreement (“Exchange Agreement”) with an institutional investor (“Investor”).
Under the terms of the Exchange Agreement, the Investor has agreed to exchange with the Company (the “Exchange”), Warrants,
exercisable for 22,198,554 shares of Company Common Stock, for (i) 2,700 shares of newly issued Series B Convertible Preferred
Stock at a stated value of $1,000 per share and convertible into 9,000,000 shares of Common Stock at a conversion price of $0.30
and (ii) 1,000,000 shares of newly issued Common Stock (collectively, the “Exchange Securities”).
Pursuant to terms of the Exchange Agreement,
the Company also agreed to amend the terms of the Convertible Debentures, which has a current outstanding principal amount of $829,000,
as follows: (i) the Conversion Price of the Convertible Debenture is reduced from $0.57 to $0.30, subject to adjustment under the
Exchange Agreement or under the terms of such Convertible Debenture, which will result in an increase of 1,308,947 shares of Common
Stock that may be issuable upon conversion of the Convertible Debenture and (ii) the Company shall be permitted to prepay the then-outstanding
principal amount of the Convertible Debenture, together with a prepayment premium in the amount of 10% of the principal amount
being prepaid.
On May 9, 2017, the Company entered into a Securities Purchase Agreement (“SPA”) with the
Investor providing for the sale and issuance of 8% Senior Debentures. Pursuant to the SPA, the Company agrees to sell, and the
Investor agrees to purchase up to an aggregate of $1,000,000 principal amount of Senior Debentures (“Debenture”). The
Debenture is due in November 2017 and bears interest at a rate of 8% per annum based on a 360-day year. The Company is required
to make interest payments quarterly beginning on the original issuance date of the Debenture. The Debenture is unsecured and is
not convertible.
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 is a technology company
that utilizes a plasma based system for the gasification and sterilization of liquid waste. A byproduct of our process is a hydrogen
based fuel that we sell for metal cutting as an alternative to acetylene (“MagneGas2®”). In addition, we are developing
the use of our fuel for co-combustion with hydrocarbon fuels to reduce emissions. We also market, for sale or licensure, our proprietary
plasma arc technology for the processing of liquid waste (the “Plasma Arc Flow® System”). We have established
a retail and distribution platform to sell our fuel for use in the metalworking industries; we have developed a global network
of brokers to sell our system for processing liquid waste and we are testing our fuel through a third party laboratory for use
in the reduction of coal emissions. Additionally, we intend to acquire complementary gas distribution businesses in order to become
a larger distributor of MagneGas2®, other industrial gases and related equipment.
In October of 2014, we purchased Equipment
Sales and Services, Inc. (“ESSI”) for $3 million cash. ESSI is a full line seller of industrial gases and equipment
for the welding and metal cutting industries. Since acquiring ESSI, we have opened three additional retail locations and distribute
our proprietary MagneGas2® product as well as other gases and welding supplies through ESSI, our wholly owned subsidiary.
On February 1, 2017, the Company formed
two wholly owned subsidiaries in the State of Delaware called MagneGas Energy Solutions, LLC and MagneGas Welding Supply, LLC,
respectively.
On March 3, 2017, the Company formed three
wholly owned subsidiaries in the State of Delaware called MagneGas Real Estate Holdings, LLC, MagneGas IP, LLC and MagneGas Production,
LLC, respectively.
Results of
Operations.
Comparison
for the three and nine months ended March 31, 2017 and 2016
Revenues
For the three
months ended March 31, 2017 and 2016 we generated revenues of $871,788 compared to $665,663. For the three months ended March 31,
2017 and 2016, we generated revenues from our metal cutting fuel of $871,788 compared to $665,663, respectively. The increase in
revenues was due to our sales force having much more success during the first quarter of 2017.
For the three
months ended March 31, 2017 and 2016 cost of revenues were $503,388 compared to $365,763, respectively. For the three months ended
March 31, 2017 and 2016, we generated a gross profit of $368,400 compared to $299,900. An improved gross profit can be attributed
to strategic price increases and controlling the cost of materials.
Operating
Expenses
Operating costs
for the three months ended March 31, 2017 and 2016 were $2,873,345 compared to $2,868,151. During the three months ended
March 31, 2017 we recognized a non-cash charge of $102,905 in stock based compensation, compared to $49,794 in the comparable
three months ended March 31, 2016, common stock issued for services of $326,349 for the three months ended March 31, 2017, compared
to $175,500 in the comparable three months ended March 31, 2016 . Other non-cash operating expenses were due to depreciation
and amortization charges of $167,338 for the three month period ended March 31, 2017, compared to $153,953 for the three months
ended March 31, 2016. The corresponding decrease of approximately $190,000 during the quarter was due to the fact that we did
not incur any costs during the first quarter of 2017 in completing our new headquarters.
In the current
quarter, as in prior quarters, we 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, 2017 have recognized losses in the amount of $1,781,159 compared to $1,621,395
for the three months ended March 31, 2016. The increase in our loss was primarily attributable to a reduction in the
gain on the change of the fair market value of our derivative liability related to our pre-2014 warrants and, the warrants associated
with the June 2016 financing. The interest expense associated with the Derivative Liability is a non-cash item.
Liquidity and Capital Resources.
As of March 31, 2017, the Company had cash
of $53,578 and has reported a net loss of $1,781,159 and has used cash in operations of $1,546,607 for the three months ended March
31, 2017. In addition, as of March 31, 2017 the Company has a working capital deficit of $5,210,012 and an accumulated deficit
of $55,339,639. 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 a public or private offering.
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, including product development. The Company utilizes cash in its operations of approximately $515,000 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.
Cash Flows from Continuing Operations
.
Cash flows from continuing operations
for operating, financing and investing activities for the three months ended March 31, 2017 and 2016 are summarized in the following
table:
|
|
Three Months Ended March
31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Operating activities
|
|
$
|
(1,546,607
|
)
|
|
$
|
(2,414,614
|
)
|
Investing activities
|
|
|
(22,848
|
)
|
|
|
(671,400
|
)
|
Financing activities
|
|
|
6,623
|
|
|
|
(16,413
|
)
|
|
|
|
|
|
|
|
|
|
Net (decrease)
increase in cash from continuing operations
|
|
$
|
(1,562,832
|
)
|
|
$
|
(3,102,427
|
)
|
For the three months ended March 31, we
used cash of $1,546,607 in operations in 2017 and used cash of $2,414,614 in operations in 2016. Our cash use for 2017 was primarily
attributable to general operations. Our cash use for 2016 was primarily attributable to the completion of our new headquarters
and consulting expenses related to research and development, investor relations, public relations and new business development.
During the three months ended March 31, 2017, cash used by investing activities consisted of $22,848. During the three months ended
March 31, 2016, cash used by investing activities consisted of $671,400 primarily due to the purchases of assets offset by the
sale of land. Cash provided by financing activities for the three months ended March 31, 2017 was $6,623 as compared to cash used
for financing activities for the three months ended March 31, 2016 of $16,413. The net decrease in cash during the three months
ended March 31, 2017 was $1,562,832 as compared to $3,102,427 for the three months ended March 31, 2016.
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 generates revenue through
two processes: (1) the sale of its MagneGas2® fuel for metal cutting and (2) the sale of its Plasma Arc Flow units. Additionally
the Company also recognizes revenue from territorial license arrangements, and through the sales of metal cutting gases and related
products through their wholly owned subsidiary, ESSI.
|
●
|
Revenue for metal-working
fuel is recognized when shipments are made to customers. We recognize a sale when the product has been shipped and risk of
loss has passed to the customer.
|
|
●
|
Our machines are
a significant investment and generally requires a 6 to 9 month production cycle. During the course of building
a unit the actual costs are tracked in work in process. Significant deposits are required before production. These
deposits are classified as customer deposits.
|
|
●
|
Licenses are issued,
per contractual agreement, for distribution rights within certain geographic territories. We recognize revenue
ratably, based on the amounts paid or values received, over the term of the licensing agreement.
|
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.