UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2013

 

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 33-46104-FW

 

THERMOENERGY CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware 71-0659511
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)  

 

10 New Bond Street,  
Worcester, Massachusetts 01606
(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s telephone number, including area code: (508) 854-1628

 

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 Web site, 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 or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨
   
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company 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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class – Common Stock, $.001 par value                                             Outstanding at August 9, 2013 – 135,760,516 shares

 

 
 

 

THERMOENERGY CORPORATION

 

INDEX

 

     

Page

No.

       
Part I. Financial Information  
  ITEM 1. Financial Statements 3
    Consolidated Balance Sheets as of  June 30, 2013 (Unaudited) and December 31, 2012 3
    Consolidated Statements of Operations for the three and six months ended June 30, 2013 and 2012 (Unaudited) 4
    Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 (Unaudited) 5
    Notes to Consolidated Financial Statements (Unaudited) 6
  ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
  ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 20
  ITEM 4. Controls and Procedures 20
     
Part II. Other Information  
  ITEM 1. Legal Proceedings 22
  ITEM 1A. Risk Factors 22
  ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 22
  ITEM 3. Defaults Upon Senior Securities 22
  ITEM 4. Mine Safety Disclosures 22
  ITEM 5. Other Information 22
  ITEM 6. Exhibits 22
       
Signatures   23

 

2
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements

THERMOENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and par value amounts)

 

   

June 30,

2013

   

December 31,

2012

 
    (unaudited)        
ASSETS                
Current Assets:                
Cash   $ 652     $ 4,657  
Accounts receivable, net     785       1,246  
Costs in excess of billings     530       597  
Inventories     50       53  
Deposits     148       1,566  
Other current assets     195       146  
Total Current Assets     2,360       8,265  
                 
Property and equipment, net     677       668  
Other assets     40       —  
                 
TOTAL ASSETS   $ 3,077     $ 8,933  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIENCY                
Current Liabilities:                
Accounts payable   $ 1,173     $ 2,143  
Short term borrowings     —       4,191  
Convertible debt, net - current portion     1,958       1,250  
Billings in excess of costs     212       4,922  
Derivative liabilities, current portion     1,067       20  
Accrued contract costs     6       1,545  
Other current liabilities     963       1,388  
Total Current Liabilities     5,379       15,459  
                 
Long Term Liabilities:                
Derivative liabilities     —       2,214  
Convertible debt, net     —       1,838  
Other long term liabilities     44       33  
Total Long Term Liabilities     44       4,085  
                 
Total Liabilities     5,423       19,544  
                 
Commitments and contingencies (Note 10)                
                 
Series C Convertible Preferred Stock, $0.01 par value; liquidation preference of $1.52 per share: designated: 15,000,000 shares at June 30, 2013; issued and outstanding: 13,853,106 shares at June 30, 2013     8,971       —  
                 
Stockholders' Deficiency:                
Preferred Stock, $0.01 par value: authorized: 50,000,000 shares at June 30, 2013 and 30,000,000 shares at December 31, 2012:                
Series A Convertible Preferred Stock, liquidation value of $1.20 per share: designated, issued and outstanding: 208,334 shares at June 30, 2013 and December 31, 2012     2       2  
Series B Convertible Preferred Stock, liquidation preference of $2.40 per share: designated: 1,000,000 shares at June 30, 2013 and 12,000,000 shares at December 31, 2012; issued and outstanding: 551,725 shares at June 30, 2013 and 11,664,993 shares at December 31, 2012     6       117  
Series B-1 Convertible Preferred Stock, liquidation preference of $2.40 per share: designated: 11,000,000 shares at June 30, 2013; issued and outstanding: 8,919,854 shares at June 30, 2013     89       —  
Common Stock, $0.001 par value: authorized: 800,000,000 shares at June 30, 2013 and 425,000,000 at December 31, 2012; issued: 135,894,313  shares at June 30, 2013 and 120,588,372 shares at December 31, 2012; outstanding: 135,760,516 shares at June 30, 2013 and 120,454,575 shares at December 31, 2012     136       120  
Additional paid-in capital     109,006       110,062  
Accumulated deficit     (120,538 )     (120,892 )
Treasury stock, at cost: 133,797 shares at June 30, 2013 and December 31, 2012     (18 )     (18 )
Total ThermoEnergy Corporation Stockholders’ Deficiency     (11,317 )     (10,609 )
Noncontrolling interest     —       (2 )
Total Stockholders’ Deficiency     (11,317 )     (10,611 )
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY   $ 3,077     $ 8,933  

 

See notes to unaudited consolidated financial statements.

 

3
 

 

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

In thousands, except share and per share amounts

(Unaudited)

 

    Three Months Ended
June 30, 		    Six Months Ended
June 30, 		 
    2013     2012     2013     2012  
                         
Revenue   $ 1,080     $ 1,900     $ 2,089     $ 3,588  
Less: cost of revenue     903       1,779       2,078       3,207  
Gross profit     177       121       11       381  
                                 
Operating Expenses:                                
General and administrative     739       1,885       1,725       2,916  
Engineering, research and development     173       94       368       203  
Sales and marketing     444       887       826       1,590  
Total operating expenses     1,356       2,866       2,919       4,709  
                                 
Loss from operations     (1,179 )     (2,745 )     (2,908 )     (4,328 )
                                 
Other income (expense):                                
Gain on contract termination     4,878       —       4,878       —  
Change in fair value of derivative liabilities     (38 )     351       869       526  
Interest expense, net     (2,185 )     (129 )     (2,374 )     (254 )
Equity in losses of joint ventures     (40 )     (5 )     (94 )     (10 )
Other expense     (10 )     (4 )     (17 )     (11 )
                                 
Net income (loss)     1,426       (2,532 )     354       (4,077 )
Net income (loss) attributable to noncontrolling interest     —       1       —       2  
                                 
Net income (loss) attributable to ThermoEnergy Corporation   $ 1,426     $ (2,531 )   $ 354     $ (4,075 )
                                 
Earnings (loss) per share attributable to ThermoEnergy Corporation:                                
Basic   $ 0.01     $ (0.03 )   $ 0.00     $ (0.04 )
Diluted   $ 0.03     $ (0.03 )   $ 0.02       (0.04 )
                               
Weighted average shares used in computing earnings (loss) per share:                                
Basic     134,919,530       91,085,825       127,727,011       90,713,078  
Diluted     135,238,160       91,085,825     128,065,279       90,713,078  

  

See notes to unaudited consolidated financial statements.

 

4
 

 

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

    Six Months Ended
June 30, 		 
    2013     2012  
Operating Activities:                
Net income (loss)   $ 354     $ (4,077 )
Adjustment to reconcile net loss to net cash used in operating activities:                
Gain on contract termination     (4,878 )     —  
Stock-based compensation expense     230       531  
Equity in losses of joint venture     94       10  
Derivative liability income     (869 )     (526 )
Common stock issued for services     —       88  
Non-cash interest added to note receivable     (3 )     —  
Non-cash interest added to debt     39       46  
Loss on disposal of equipment     —       131  
Depreciation     102       48  
Amortization of discount on convertible debt     2,159       114  
Increase (decrease) in cash arising from changes in assets and liabilities:                
Accounts receivable     461       2,927  
Costs in excess of billings     67       (323 )
Inventories     3       (129 )
Deposits     1,418       (877 )
Other current assets     (78 )     183  
Accounts payable     (970 )     15  
Billings in excess of costs     168       (1,463 )
Accrued contract costs     (1,539 )     1,114  
Other current liabilities     (1 )     (848 )
Other long-term liabilities     11     (60 )
                 
Net cash used in operating activities     (3,232 )     (3,096 )
                 
Investing Activities:                
Investment in joint venture     (100 )     —  
Purchases of property and equipment     (111 )     (109 )
                 
Net cash used in investing activities     (211 )     (109 )
                 
Financing Activities:                
Proceeds from short term borrowings     223       —  
Repayment of short term borrowings and accrued commitment fees     (785 )     —  
Proceeds from issuance of common stock, net of issuance costs of $38     —       498  
                 
Net cash (used in) provided by financing activities     (562 )     498  
                 
Net change in cash     (4,005 )     (2,707 )
Cash, beginning of period     4,657       3,056  
Cash, end of period   $ 652     $ 349  
                 
Supplemental schedule of non-cash financing activities:                
Accrued interest added to debt   $ 40     $ 23  
Debt discount recognized on convertible debt   $ 1,217     $ —  
Conversion of convertible debt and accrued interest to Series C Convertible Preferred Stock   $ 5,264     $ —  
Exchange of Series B Convertible Preferred Stock to Series C Convertible Preferred Stock   $ 4,486     $ —  
Exchange of Series B Convertible Preferred Stock to Series B-1 Convertible Preferred Stock   $ 89     $ —  
Cashless exercise of warrants for Common Stock   $ 288     $ —  
Anti-dilutive issuance of Common Stock to investors   $ 91     $ —  

 

See notes to unaudited consolidated financial statements.

 

5
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 1: Organization and summary of significant accounting policies

 

Nature of business

 

ThermoEnergy Corporation (“the Company”) was incorporated in January 1988 for the purpose of developing and marketing advanced municipal and industrial wastewater treatment and carbon reducing power generation technologies.

 

The Company’s wastewater treatment systems are based on its proprietary Controlled Atmosphere Separation Technology (“CAST”) platform.  The Company’s patented and proprietary platform technology is combined with off-the-shelf technologies (the “Technologies”) to provide systems that are inexpensive, easy to operate and reliable. The Company’s wastewater treatment systems have global applications in hydraulic fracturing (“fracking”) in the oil and gas industry, food and beverage processing, metal finishing, pulp and paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater. The CAST platform technology is owned by the Company’s subsidiary, CASTion Corporation (“CASTion”).

 

The Company also owns patents on technology for the combustion of coal at high pressure using pure oxygen (oxy-combustion) for clean, coal-fired power generation while producing near zero air emissions and removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. This technology is intended to be used to build new or to retrofit old fossil fuel power plants. This   technology is held in the Company’s subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”).

 

Principles of consolidation and basis of presentation

 

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The 15% third-party ownership interest in TEPS is recorded as a noncontrolling interest in the unaudited consolidated financial statements. Financial results for Unity Power Alliance (“UPA”) as a Joint Venture are accounted for under the equity method, as discussed in Note 5.

 

Certain prior year amounts have been reclassified to conform to current year classifications.

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

 

The preparation of these unaudited interim consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. 

 

The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information, refer to the financial statements and footnotes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2012, filed on March 26, 2013, of ThermoEnergy Corporation.

 

Significant Accounting Policies

 

There have been no material changes to the Company’s significant accounting policies during the six months ended June 30, 2013. For a complete summary of the Company’s significant accounting policies, please refer to Note 1 to the Company’s consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

6
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 2: Management's consideration of going concern matters

 

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years, and such losses have continued through the three and six-month periods ended June 30, 2013. Furthermore, as discussed in Note 4, the Company’s contract with the New York City Department of Environmental Protection (“NYCDEP”) was terminated for convenience effective November 29, 2012.

 

At June 30, 2013, the Company had cash on hand of $652,000. The Company has incurred net losses from operations since inception, including a net loss from operations of approximately $2.9 million during the six-month period ended June 30, 2013 and had an accumulated deficit of approximately $120.5 million at June 30, 2013.

 

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, to maintain present financing, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

 

These uncertainties raise substantial doubt about the Company's ability to continue as a going concern. The financial statements included in this Form 10-Q have been prepared on a going concern basis and as such do not include any adjustments that might result from the outcome of this uncertainty.

 

Management has determined that the financial success of the Company is dependent upon the Company’s ability to obtain profitability from contracts with financially sound third parties to pursue projects involving the Technologies. In addition, management will need to obtain substantial additional equity or debt financing that will allow the Company to operate until it becomes cash flow positive from operations. Even if the Company successfully obtains financing, there can be no assurance that this financing will be sufficient to continue operations for an extended period of time, and there is no assurance that the Company can obtain additional funding at reasonable terms.

 

As more fully described in Notes 6, 7 and 8, on April 5, 2013, the Company issued shares of Series C Convertible Preferred Stock in exchange for the entire principal and accrued interest amounts of the Company’s December 2011 Bridge Notes and the Company’s November 2012 Bridge Notes.

 

Note 3: NYCDEP Contract

 

On August 22, 2012, the NYCDEP issued a stop work order to the Company relative to its contract to install an Ammonia Removal Process (“ARP”) system at the NYCDEP’s wastewater treatment facility in the 26 th Ward.  The NYCDEP terminated the contract for convenience effective November 29, 2012.

 

Upon notification of the contract termination, the Company cancelled all orders from its major vendors. The Company ceased recognition of revenues as of November 29, 2012 and has recorded all incremental costs as period costs on its Consolidated Statement of Operations.

 

The Company has been paid for all amounts billed to the NYCDEP related to this contract, and the Company delivered all equipment, including all material from third party vendors, to the NYCDEP during the first quarter of 2013. In June 2013, the Company received notice from the NYCDEP that the contract has been closed. Accordingly, the Company recorded a gain on contract termination of approximately $4.9 million in the second quarter of 2013, which represents the amount the Company billed in accordance with the contract in excess of revenues recognized.

 

Because of this contract termination, the Company's revenues, expenses, and income will be adversely affected in future periods, as this contract represented approximately 73% of the Company's revenues for the year ended December 31, 2012.

 

Note 4: Earnings per share

 

Basic earnings (loss) per common share attributable to ThermoEnergy Corporation is computed by dividing: (i) net income attributable to ThermoEnergy Corporation by (ii) the weighted average number of common shares outstanding in the period (the “Basic Shares”).

 

Diluted earnings per common share attributable to ThermoEnergy Corporation is computed by dividing: (i) net income attributable to ThermoEnergy Corporation, plus interest expense on convertible debt by (ii) Basic Shares plus the additional shares that would be issued assuming that all dilutive stock awards are exercised. For periods in which the Company recorded a net loss, diluted loss per common share is equal to basic loss per share, as the effect of any common stock equivalents would be antidilutive.

 

(In thousands, except share and per share amounts)   Three Months Ended June 30,     Six Months Ended June 30,  
    2013     2012     2013     2012  
Basic Earnings per Share:                                
Net income (loss) attributable to ThermoEnergy Corporation   $ 1,426     $ (2,531 )   $ 354     $ (4,075 )
                                 
Basic weighted average shares outstanding     134,919,530       91,085,825       127,727,011       90,713,078  
                                 
Earnings (loss) per share - Basic   $ 0.01     $ (0.03 )   $ 0.00     $ (0.04 )
Diluted Earnings per Share:                                
Net income (loss) attributable to ThermoEnergy Corporation   $ 1,426     $ (2,531 )   $ 354     $ (4,075 )
Add: Interest expense on convertible debt     2,165       —       2,315       —  
Net income (loss) available to ThermoEnergy Corporation   $ 3,591     $ (2,531 )   $ 2,669     $ (4,075 )
                                 
Basic weighted average shares outstanding     134,919,530       91,085,825       127,727,011       90,713,078  
Additional dilutive common stock equivalents     318,630       —       338,268       —  
Diluted weighted average shares outstanding     135,238,160       91,085,825       128,065,279       90,713,078  
                                 
Earnings (loss) per share - Diluted   $ 0.03     $ (0.03 )   $ 0.02     $ (0.04 )

  

The following potentially dilutive common share equivalents were excluded from the calculation of diluted net income (loss) per common share, as their effect was antidilutive for each of the periods presented:

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2013     2012     2013     2012  
Series A Convertible Preferred Stock     208,334       208,334       208,334       208,334  
Series B Convertible Preferred Stock     5,517,250       116,649,930       5,517,250       116,649,930  
Series B-1 Convertible Preferred Stock     89,198,540       —       89,198,540       —  
Series C Convertible Preferred Stock     138,531,060       —       138,531,060       —  
Stock options     32,173,702       21,994,102       32,173,702       21,994,102  
Warrants     137,334,636       76,715,946       137,334,636       76,715,946  
Convertible debt     4,045,279       3,754,434       4,045,279       3,754,434  

 

7
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 5: Joint Ventures

 

Babcock-Thermo Clean Combustion LLC

 

On February 25, 2009, the Company’s majority-owned subsidiary, TEPS, and Babcock Power Development, LLC (“BPD”), a subsidiary of Babcock Power, Inc., entered into a Limited Liability Company Agreement (the “LLC Agreement”) establishing Babcock-Thermo Carbon Capture LLC, a Delaware limited liability company now known as Babcock-Thermo Clean Combustion LLC (the “Joint Venture”) for the purpose of developing and commercializing its pressurized oxy-combustion technology.

 

On March 2, 2012, TEPS entered into a Dissolution Agreement with BPD to terminate the Limited Liability Company Agreement and dissolve the Joint Venture, and the Joint Venture was dissolved on April 30, 2013.

 

Unity Power Alliance LLC

 

On March 8, 2012, the Company announced the formation of Unity Power Alliance LLC (“UPA”). UPA was formed with the intention to work with partners and stakeholders to develop and commercialize its pressurized oxycombustion technology. On July 16, 2012, Itea S.p.A. (“Itea”), an engineering and technology company headquartered in Italy, acquired a 50% ownership interest in UPA.

 

UPA is governed by a Board of Directors, with half of the directors nominated by each of the Company and Itea. Administrative expenses of UPA are borne jointly by the Company and Itea, and financing for development expenses will be obtained from third parties.

 

On June 20, 2012, the Company and Itea entered into a License Agreement whereby the Company, the Company’s majority-owned subsidiary, TEPS, and Itea granted a non-exclusive, non-transferable royalty-free license to UPA to use their intellectual property relating to pressurized oxycombustion. The licenses to UPA became effective upon Itea’s acquisition of its ownership interest in UPA. The License Agreement further provides that, if UPA successfully obtains funding and project support to construct the pilot plant, the parties may grant licenses of their respective intellectual property and know-how to each other or to third parties for the operation of power plants based on such intellectual property and know-how, and royalties will be shared as defined in the License Agreement.

 

In September 2012, UPA was awarded a $1 million Phase 1 grant from the U.S. Department of Energy to help fund a project on a cost-sharing basis under a special DOE program to advance technologies for efficient, clean coal power and carbon capture. As part of UPA's project, in October 2012, the Company received a $900,000 contract from UPA to build a bench-scale “flameless” combustion reactor under the grant. UPA and its subcontractors received contract definitization during the first quarter of 2013 and began to receive funding. As of June 30, 2013, UPA has received funding totaling $244,000 related to this grant. The Company recorded revenues totaling $390,000 and $547,000 on a time and materials basis related to this contract in the three and six-month periods ended June 30, 2013.

 

In accordance with ASC 810, Consolidation , the Company determined that it held a variable interest in UPA and that UPA was a variable-interest entity. However, the Company has concluded that it is not required to consolidate the financial statements of UPA as of and for the six-month period ended June 30, 2013. The Company reviewed the most significant activities of UPA and determined that because the Company shares the power to direct the activities of UPA equally with Itea, it is not the primary beneficiary of UPA. Accordingly, the financial results of UPA are accounted for under the equity method of accounting. The carrying value of the Company’s investment in the Joint Venture is $0 as of June 30, 2013 and December 31, 2012.

 

8
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 6: Short term borrowings

 

Short term borrowings consisted of the following at June 30, 2013 and December 31, 2012 (in thousands):

 

    June 30,
2013 		    December 31,
2012 		 
Project Financing Line of Credit   $ —     $ 491  
                 
November 2012 Bridge Notes, 8%, due April 15, 2013     —       3,700  
    $ —     $ 4,191  

 

Project Financing Line of Credit

 

On October 4, 2012, the Company entered into a Loan Agreement (the “Loan Agreement”) with C13 Thermo LLC (the “Lender”), a related party whose owners are related to an officer of the Company. Under this Loan Agreement, the Lender established a credit facility allowing the Company to borrow up to $700,000 (the “Credit Facility”) to finance the fabrication and testing of an Ammonia Reduction Process system utilizing the Company’s proprietary technology (the “Project”). The Company issued to the Lender a promissory note in the principal amount of $700,000 (the “Note”).

 

Amounts borrowed under the Credit Facility did not bear interest (except in the case of an event of default, in which case all amounts borrowed, together with all fees, expenses and other amounts due, shall bear interest at the default rate of 8% per annum). Upon maturity of the Note, the Company was charged a commitment fee equal to 10% of the aggregate principal amount borrowed under the Credit Facility. The Credit Facility expired, and all amounts due under the Note, together with all commitment fees incurred under the Loan Agreement, were originally due and payable on the earlier of (i) March 4, 2013 or (ii) the date on which the Company first draws against an irrevocable documentary letter of credit that has been issued for the Company’s benefit in connection with the Project. The Credit Facility was amended in March 2013 to extend the expiration date to the earlier of (i) April 5, 2013 or (ii) one business day following the date the Company first drew against the irrevocable documentary letter of credit. The Company could repay the Note in whole or in part at any time without premium or penalty. The Credit Facility was secured by all of the Company’s assets.

 

On April 5, 2013 the Company repaid in full all outstanding principal and accrued commitment fees totaling $785,000 related to this Credit Facility.

 

November 2012 Bridge Note Financing

 

On November 30, 2012 the Company entered into Bridge Loan Agreements with six of its principal investors pursuant to which the investors agreed to make bridge loans to the Company of $3.7 million in exchange for 8% Promissory Notes (the “November 2012 Bridge Notes”).  The November 2012 Bridge Notes bore interest at the rate of 8% per year and were due and payable on April 15, 2013.

 

The November 2012 Bridge Notes contained other conventional terms, including representations and warranties regarding the Company’s business and assets and its authority to enter into such agreements, and provisions for acceleration of the Company’s obligations upon the occurrence of certain specified events of default.

 

On April 5, 2013 the investors converted the outstanding principal of the November 2012 Bridge Notes, plus accrued interest, into 5,005,250 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of 50,052,500 shares of the Company’s Common Stock.

 

9
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 7: Convertible debt

 

Unsecured convertible debt consisted of the following at June 30, 2013 and December 31, 2012 (in thousands):

 

    June 30,
2013 		    December 31,
2012 		 
December 2011 Convertible Promissory Notes, 12.5%, due on demand on or after January 31, 2013   $ —     $ 1,250  
Roenigk 2012 Convertible Promissory Note, 8%, due March 31, 2014, less discount of $65 at June 30, 2013 and $106 at December 31, 2012     1,958       1,838  
      1,958       3,088  
Less: Current portion     (1,958 )     (1,250 )
    $ —     $ 1,838  

 

December 2011 Convertible Promissory Notes

 

On December 2, 2011 the Company entered into Bridge Loan Agreements with four of its principal investors pursuant to which the investors agreed to make bridge loans to the Company of $1.25 million in exchange for 12.5% Promissory Notes (the “December 2011 Bridge Notes”).  The December 2011 Bridge Notes bore interest at the rate of 12.5% per year and were due and payable on December 31, 2012. The entire unpaid principal amount, together with all interest then accrued and unpaid under each December 2011 Bridge Note, was convertible into shares of a future series of Preferred Stock.

 

The December 2011 Bridge Notes contained other conventional provisions, including the acceleration of repayment obligations upon the occurrence of certain specified Events of Default.

 

On November 30, 2012, in conjunction with the issuance of the November 2012 Bridge Notes (see Note 6), the investors who participated in the December 2011 Bridge Note financing agreed to extend the maturity date such that the December 2011 Bridge Notes were due on demand on or after January 31, 2013. The Company accounted for this amendment as a debt modification.

 

On April 5, 2013 the investors converted outstanding principal of the December 2011 Bridge Notes, plus accrued interest, into 1,921,303 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of 19,213,030 shares of the Company’s Common Stock.

 

Roenigk 2012 Convertible Promissory Note

 

On June 20, 2012, the Company issued a Convertible Promissory Note dated April 1, 2012 (“the Note”) in the principal amount of $1,877,217 to the Roenigk Family Trust in exchange for a 5% Convertible Promissory Note issued on March 21, 2007 and due March 21, 2013 and a 5% Convertible Promissory Note issued on March 7, 2008 and due March 7, 2013 (the “Old Notes”). The Note bears interest at the rate of 5% per annum from April 1, 2012 through May 31, 2012, then bears interest at the rate of 8% per annum until the maturity date, March 31, 2014. The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $5,000 deferral fee. The Company recorded $79,000 of accrued interest to the principal balance of the Note during the six months ended June 30, 2013.

 

Note 8: Equity

 

On March 20, 2013, the Company’s shareholders approved an amendment to the Certificate of Incorporation for the following purposes:

 

· To increase the number of authorized shares of Common Stock to 800,000,000 and to increase the number of authorized shares of Preferred Stock to 50,000,000;

 

10
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

· To reduce the number of shares of Preferred Stock designated as “Series B Convertible Preferred Stock” from 12,000,000 to 1,000,000 and to re-designate the remaining 11,000,000 shares heretofore designated as “Series B Convertible Preferred Stock” as “Series B-1 Convertible Preferred Stock”, with the shares in each sub-series having identical voting powers, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations and restrictions except that the shares of Series B-1 Convertible Preferred Stock shall have priority in liquidation; and
· To designate 15,000,000 shares of the previously authorized but undesignated shares of Preferred Stock as “Series C Convertible Preferred Stock”.

 

Shares of Series B-1 Convertible Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock.  Series B-1 Convertible Preferred Stock is identical to the Company’s Series B Convertible Preferred Stock in every respect except that holders of the Series B-1 Convertible Preferred Stock shall receive a liquidation preference equal to the Stated Value of their shares ($2.40 per share) plus all declared and unpaid dividends with respect thereto prior to any distribution to the holders of shares of Series B Convertible Preferred Stock.

 

Shares of Series C Convertible Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock, subject to conventional weighted-average anti-dilution adjustment in the event the Company issues or is deemed to have issued shares of Common Stock at a price less than $0.076 per share. The Series C Convertible Preferred Stock will be redeemable, at a price equal to $0.76 per share, plus all accrued and unpaid dividends thereon, at the election of the holders of 66-⅔% of the then-outstanding shares, in three equal annual installments on or after December 31, 2017.

 

Because the Company’s Series C Convertible Preferred Stock has a redemption feature, this class of preferred stock is recorded at its issuance date fair value and is classified as temporary equity on the Company’s Unaudited Consolidated Balance Sheet at June 30, 2013.

 

The Company’s Board of Directors consists of seven members, four of whom are elected by holders of the Company’s Series B Convertible Preferred Stock, Series B-1 Convertible Preferred Stock and Series C Convertible Preferred Stock, and three who are elected by the holders of the Company’s Common Stock.

 

The amendment to the Certificate of Incorporation became effective on April 5, 2013.

 

Common Stock

 

In 2011, the Company requested certain holders of Common Stock Purchase Warrants to exercise such warrants or to surrender such warrants in exchange for shares of Common Stock. On April 5, 2013, the Company issued an aggregate of 6,031,577 shares of Common Stock as consideration for the surrender of Warrants for the purchase of an aggregate of 39,205,234 shares.

 

Also, on April 5, 2013, the Company converted its December 2011 Bridge Notes and November 2012 Bridge Notes into shares of the Company’s Series C Convertible Preferred Stock. Because the effective issuance price of the Series C Convertible Preferred Stock was less than $0.10 per equivalent share of Common Stock, the Company issued to investors who purchased shares of the Company’s Common Stock and Warrants at closings on July 11, 2012, August 9, 2012 and October 9, 2012 (the “PIPE”), for no additional consideration, a sufficient number of additional shares of Common Stock so that the effective price per share of Common Stock paid by the PIPE Investors equals the effective issuance price of the shares of Series C Convertible Preferred Stock on an as-converted basis ($0.076 per share). Accordingly, on April 5, 2013, the Company issued a total of 9,274,364 shares of Common Stock to the PIPE Investors.

 

At June 30, 2013, approximately 426 million shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements and other commitments.

 

Preferred Stock

 

As detailed in Notes 6 and 7, on April 5, 2013, holders of the Company’s December 2011 Bridge Notes and the Company’s November 2012 Bridge Notes exchanged such notes with an aggregate principal amount of $4,950,000 plus accrued interest totaling $314,177 for a total of 6,926,553 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of a total of 69,265,530 shares of Common Stock.

 

11
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

The effective price of the Series C Convertible Preferred Stock was $0.76 per share (or $0.076 per equivalent share of Common Stock). The Warrants entitle the holders to purchase, at any time on or before April 5, 2018, shares of Common Stock at an exercise price of $0.114 per share. The Warrants contain other conventional terms, including provisions for adjustment in the Exercise Price and/or the securities issuable upon exercise in the event of certain specified extraordinary corporate events, such as stock splits, combinations, and stock dividends.

 

As additional consideration to the investors for their participation in the Bridge Note issuances mentioned above, for each $100 of principal and interest converted into Series C Convertible Preferred Stock and Warrants, each Investor exchanged 41.67 shares of Series B Convertible Preferred Stock held for 131.58 additional shares of Series C Convertible Preferred Stock (the number of shares of Series C Convertible Preferred Stock that would be purchased for $100 at a purchase price of $0.76 per share). Accordingly, the Company issued an aggregate of 6,926,553 additional shares of Series C Convertible Preferred Stock in exchange for an aggregate of 2,193,414 previously-outstanding shares of Series B Convertible Preferred Stock. The additional shares of Series C Convertible Preferred Stock were issued without warrant coverage. The shares of Series B Convertible Preferred Stock surrendered were cancelled and are no longer outstanding.

 

Additionally, as an inducement to effect the transactions on April 5, 2013 as detailed above, the Company agreed to allow such holders to exchange shares of Series B Convertible Preferred Stock for an equal number of shares of Series B-1 Convertible Preferred Stock. Accordingly, on April 5, 2013 the Company issued an aggregate of 8,839,500 shares of Series B-1 Convertible Preferred Stock in exchange for an equal number of shares of Series B Convertible Preferred Stock.

 

Stock Options

 

On March 20, 2013, the Company’s shareholders approved amendments to the 2008 Incentive Stock Plan (the “2008 Plan”) to increase the number of shares available for grant to 40,000,000 and to increase the number of shares with respect to which automatic stock options are granted to non-employee Directors to 100,000.

 

During the six-month period ended June 30, 2013, the Board of Directors awarded employees and an advisor to the Board of Directors a total of 14,450,000 stock options under the 2008 Plan. The options are exercisable at $0.0468 - $0.089 per share for a ten year period. The exercise price was equal to or greater than the market price on the respective grant dates. Options granted to non-employee directors vest on the date of the Company’s 2013 Annual Meeting of Stockholders; options granted to employees vest ratably over a four-year period.

 

The following table presents option expense included in expenses in the Company’s Unaudited Consolidated Statements of Operations for the six-month periods ended June 30, 2013 and 2012:

    2013     2012  
             
Cost of revenue   $ —     $ 6  
General and administrative     187       442  
Engineering, research and development     29       49  
Sales and marketing     14       34  
Option expense before tax     230       531  
Benefit for income tax     —       —  
Net option expense   $ 230     $ 531  

 

The fair value of options granted during the six-month periods ended June 30, 2013 and 2012 were estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:

 

    2013     2012  
Risk-free interest rate     0.92% - 1.07%       1.1% - 1.2%  
Expected option life (years)     6.25       6.25  
Expected volatility     90% - 91%       92%
Expected dividend rate     0%     0%

 

12
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods over the expected life of the option. The expected option life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the Company’s historical exercise patterns. Expected volatility is based on the historical volatility of the Company’s common stock over the expected life of the option granted.

 

Option expense for the six-month periods ended June 30, 2013 and 2012 was calculated using an expected annual forfeiture rate of 5%.

 

A summary of the Company’s stock option activity and related information for the six-month periods ended June 30, 2013 and 2012 follows:

    2013     2012  
    Number of
Shares 		    Wtd. Avg.
Exercise
Price per
Share 		    Number of
Shares 		    Wtd. Avg.
Exercise
Price per
Share 		 
Outstanding, beginning of year     24,896,678     $ 0.32       19,674,102     $ 0.38  
Granted     14,450,000     $ 0.09       3,060,000     $ 0.25  
Canceled     (7,172,976 )   $ 0.28       (740,000 )   $ 0.31  
                                 
Outstanding, end of period     32,173,702     $ 0.23       21,994,102     $ 0.36  
                                 
Exercisable, end of period     15,142,140     $ 0.37       12,557,554     $ 0.46  

 

The weighted average fair value of options granted was approximately $0.07 and $0.17 per share for the six-month periods ended June 30, 2013 and 2012, respectively. The weighted average fair value of options vested was approximately $269,000 and $678,000 for the six-month periods ended June 30, 2013 and 2012, respectively.

 

Exercise prices for options outstanding as of June 30, 2013 ranged from $0.0468 to $1.50. The weighted average remaining contractual life of those options was approximately 8.2 years at June 30, 2013. The weighted average remaining contractual life of options vested and exercisable was approximately 6.9 years at June 30, 2013.

 

At June 30, 2013, there was approximately $1.25 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plans. That cost is expected to be recognized over a weighted-average period of 1.4 years. The Company recognizes stock-based compensation on the graded-vesting method.

 

Warrants

 

At June 30, 2013, there were outstanding warrants for the purchase of 137,751,306 shares of the Company’s Common Stock at prices ranging from $0.01 per share to $0.55 per share (weighted average exercise price was $0.15 per share). The expiration dates of these warrants are as follows:

 

Year  

Number of

Warrants

 
2013     870,004  
2014     781,103  
2015     296,293  
2016     20,625,815  
2017     44,570,061  
After 2017     70,608,030  
      137,751,306  

 

13
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 9: Derivative Liabilities

 

The Company has periodically issued Common Stock and Common Stock purchase warrants with anti-dilution provisions as additional consideration with certain debt instruments. Additionally, certain debt instruments have been convertible into shares of the Company’s Series B Convertible Preferred Stock, which are convertible into shares of the Company’s Common Stock and have anti-dilution provisions and liquidation preferences. Because these instruments contain provisions that are not indexed to the Company’s stock, the Company is required to record these as derivative instruments.

 

Liabilities measured at fair value on a recurring basis as of June 30, 2013 are as follows: (in thousands)

 

          Fair Value Measurements at Reporting Date Using  
Description   Balance as of
June 30, 2013 		    Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) 		    Significant
Other
Observable
Inputs
(Level 2) 		    Significant
Unobservable
Inputs
(Level 3) 		 
Derivative liabilities – current portion   $ 1,067     $ -     $ -     $ 1,067  
                                 
Total   $ 1,067     $ -     $ -     $ 1,067  

 

The Monte Carlo Simulation lattice model was used to determine the fair values at June 30, 2013. The significant assumptions used were: exercise prices between $0.10 and $0.36; the Company’s stock price on June 28, 2013, $0.03; expected volatility of 50% - 55%; risk free interest rate between 0.14% and 1.04%; and a remaining contract term between 3 months and 49 months.

 

Liabilities measured at fair value on a recurring basis as of December 31, 2012 are as follows: (in thousands)

 

          Fair Value Measurements at Reporting Date Using  
Description   Balance as of
December 31,
2012 		    Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) 		    Significant
Other
Observable
Inputs
(Level 2) 		    Significant
Unobservable
Inputs
(Level 3) 		 
                         
Derivative liabilities – current portion   $ 20     $ -     $ -     $ 20  
Derivative liabilities – long-term portion     2,214       -       -       2,214  
                                 
Total   $ 2,234     $ -     $ -     $ 2,234  

 

The Monte Carlo Simulation lattice model was used to determine the fair values at December 31, 2012. The significant assumptions used were: exercise prices between $0.10 and $0.36; the Company’s stock price on December 31, 2012, $0.09; expected volatility of 55% - 75%; risk free interest rate between 0.16% and 0.72%; and a remaining contract term between 5 months and 55 months.

 

The following table sets forth a reconciliation of changes in the fair value of the Company’s derivative liabilities classified as Level 3 for the six-month periods ended June 30, 2013 and 2012 (in thousands):

 

    2013     2012  
Balance at beginning of period   $ 2,234     $ 807  
Exercise of derivative instruments     (298 )     —  
Change in fair value     (869 )     (526 )
Balance at end of period   $ 1,067     $ 281  

 

14
 

 

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2013

(Unaudited)

 

Note 10: Commitments and contingencies

 

On July 16, 2012, Andrew T. Melton, the Company’s former Executive Vice President and Chief Financial Officer (“Melton”), filed a Complaint in the United States District Court, Eastern District of Arkansas alleging, among other things, wrongful termination of employment. On June 19, 2013, the lawsuit was dismissed upon motion of the plaintiff.

 

The Company is involved from time to time in litigation incidental to the conduct of its business. Judgments could be rendered or settlements entered that could adversely affect the Company’s operating results or cash flows in a particular period. The Company routinely assesses all of its litigation and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate loss in situations where it assesses the likelihood of loss as probable.

 

15
 

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.

 

Forward Looking Information

 

The part of this Quarterly Report on Form 10-Q captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains certain forward-looking statements, which involve risks and uncertainties.  Forward-looking statements include, without limitation, statements as to our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations.  These statements are based on current expectations, estimates and projections about the industries in which we operate, and the beliefs and assumptions made by management.  Readers should refer to the discussions under “Forward Looking Information” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 concerning certain factors that could cause our actual results to differ materially from the results anticipated in such forward-looking statements. These discussions are hereby incorporated by reference into this Quarterly Report.

 

Overview

 

Founded in 1988, we are a diversified technologies company engaged in the worldwide development, sale and commercialization of patented and/or proprietary technologies for the recovery and recycling of wastewater, chemicals, metals, and nutrients from waste streams at oil & gas, biogas, power plant, industrial, and municipal operations. In addition, the company holds patents on technology for the combustion of coal at high pressure using pure oxygen (oxy-combustion) for clean, coal-fired power generation.

 

Wastewater Solutions

 

The Company has spent nearly two decades developing sustainable water treatment and recovery systems that help industries and municipalities operate more efficiently, save money, reduce their carbon footprint and meet their sustainability goals.

 

Award-Winning Technology

 

We believe our TurboFrac system provides versatile and cost effective solutions to recover and recycle clean, usable water from contaminated produce water, including water with high Total Dissolved Solids (“TDS”), created by the hydraulic fracturing of oil and gas wells. Our FracGen systems create hydraulic fracturing-grade water from briny water in local aquifers located in arid areas. FracGen reduces demand on local potable water supplies and reduces the need to transport fresh water from other geographic locations, reducing operating costs for drillers.

 

Our versatile, award-winning CAST® (Controlled Atmospheric Separation Technology), RCAST®, and high-flow TurboCAST systems can be utilized as an effective stand-alone wastewater, chemical, metal or nutrient recovery system, or as part of an integrated recovery solution. These state-of-the-art vacuum assisted distillation units offer significant advantages over other evaporative technologies such as thin film and nucleate boiling. They are specially designed for high-strength wastewaters with high Total Dissolved Solids and Total Suspended Solids typically found in industrial, municipal and agricultural recovery processes.

 

In industrial applications, our Zero-Liquid-Discharge (ZLD) Systems can recover nearly 100% of valuable chemical resources or wastewater for immediate reuse or recycling with no liquid leaving the facility. CAST concentrates mixed hazardous waste down to as little as 5% of its original volume for economical disposal or reclaim. This patented technology is designed and constructed to withstand the demands of harsh chemical environments.

 

Fast Return on Investment

 

We believe our wastewater recovery systems reduce costs by recovering process chemicals, metals, and clean water for reuse or recycling and eliminating most of the costly disposal of hazardous waste or process effluent. These solutions offer a solid return on our customers’ investments and a quick payback with continued savings and efficiency for many years.

 

16
 

 

Our wastewater treatment systems not only meet local, state and federal environmental regulations, but typically provide a rapid rate of return on investment by recovering and reusing expensive feedstocks, reducing contaminated wastewater discharge and recovering and reusing wastewater used in process operations. Our systems utilize proven technology to cost effectively process and treat brackish and produced water in the hydraulic fracturing (“fracking”) process in the oil and gas industries. Our wastewater treatment systems also have global applications in aerospace, food and beverage processing, metal finishing, pulp and paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater.

 

Specific wastewater solutions include:

 

· Creating new supplies of usable water and recycling wastewater in the oil and gas industry
· Recovering and recycling ammonia in industrial and municipal operations
· Recovering ammonia and creating fertilizer from anaerobic digesters
· Recovering chemicals or metals from industrial wastewater
· Recovering and recycling used glycol

 

Power Generation Technologies

 

We are also the owner of a patented pressurized oxycombustion technology that has the potential to convert fossil fuels (including coal, oil and natural gas) and biomass into electricity while producing near zero air emissions, and at the same time removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. The technology is held by our subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”) and is being developed and commercialized through a joint venture, Unity Power Alliance (UPA). 

 

On June 20, 2012, we entered into an Agreement with Itea S.p.A. (“ITEA”) for the development of pressurized oxycombustion in North America. The two parties, through UPA, will utilize their patented technologies to advance, develop and promote the use of the coal application of pressurized oxycombustion, construct a pilot plant utilizing the technology, and pending the outcome of pilot plant testing, seek additional partners to construct a demonstration facility based on the technology as implemented in the pilot plant. ITEA was granted the option to acquire a 50% ownership interest in UPA for nominal consideration. On July 16, 2012, ITEA exercised its option and acquired the 50% ownership interest in UPA. As of June 30, 2013, the financial results of UPA are accounted for as a joint venture under the equity method of accounting and are not consolidated in our financial statements as a variable interest entity as defined by ASC 810, Consolidation, as we have concluded that we are not the primary beneficiary.

 

In September 2012, Unity Power Alliance received a $1 million Phase 1 grant from the U.S. Department of Energy (“DOE”) to help fund a project under a special DOE program to advance technologies for efficient, clean coal power and carbon capture. As part of UPA's project, in October 2012, we received a $900,000 contract from UPA to build a bench-scale “flameless” combustion reactor under the grant. We have received funding totaling $244,000 as of June 30, 2013, and we have recorded revenues of $390,000 and $547,000 on a time and materials basis related to this contract in the three and six-month periods ended June 30, 2013, respectively. We expect the bench-scale unit will be operational during the third quarter of 2013.

 

Except for revenues from the UPA contract as stated above, we generate revenues from the sale and development of wastewater treatment systems. We enter into contracts with our customers to provide a wastewater treatment solution that meets the customer’s present and future needs. Our revenues are tied to the size and scale of the wastewater treatment systems required by our customers, as well as the progress made on each customer contract.

 

Historically we marketed and sold our products primarily in North America. In 2011, we began marketing and selling our products in South America, Asia and Europe. These marketing and sales activities are performed by our direct sales force and authorized independent sales representatives.

 

On August 22, 2012, the New York City Department of Environmental Regulation (“NYCDEP”) issued a stop work order to us relative to our contract to install an Ammonia Removal Process (“ARP”) system at the NYCDEP’s wastewater treatment facility in the 26 th Ward. The NYCDEP terminated the contract for convenience effective November 29, 2012. Subsequently, we delivered all equipment, including all material from third party vendors, to the NYCDEP during the first quarter of 2013. In June 2013, we received notice from the NYCDEP that the contract was closed, resulting in a gain on contract termination of approximately $4.9 million during the second quarter of 2013.

 

Because of this contract termination, our revenues, expenses, and income will be adversely affected in future periods, as this contract represented approximately 73% of our revenues for the year ended December 31, 2012.

 

17
 

 

We have made significant progress in resolving our past legal and financial issues, strengthening our balance sheet through various conversions of debt into equity, hiring key management personnel and building our business for future growth. We realized net income of $354,000 for the six-month period ended June 30, 2013; however, net income includes a one-time, non-cash gain of approximately $4.9 million related to the termination of our contract with the NYCDEP. Excluding this item, we continued to incur net losses and negative cash flows from operations. We incurred net losses from operations of $2.9 million for the six-month period ended June 30, 2013 and $7.4 million for the year ended December 31, 2012. Cash outflows from operations totaled $3.2 million for the six-month period ended June 30, 2013 and $5.4 million for the year ended December 31, 2012. As a result, we will require additional financing and/or capital to continue to fund our operations.

 

Critical Accounting Policies and Revenue Accounting Guidance

 

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Management believes there have been no material changes during the six months ended June 30, 2013 to the critical accounting policies reported in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

Accounting Standards Update (ASU) 2013-11, “Income Taxes (Topic 740) - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” was issued in July, 2013.  T he amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  Early adoption is permitted.  The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company does not expect adoption of this ASU to have a material impact on its financial statements.  

 

Results of Operations

 

Comparison of Quarters Ended June 30, 2013 and 2012

 

Revenues totaled $1,080,000 for the second quarter of 2013, a decrease of 43% compared to $1,900,000 for the second quarter of 2012. Revenues in the second quarter of 2013 were primarily driven by two industrial projects utilizing our Ammonia Recovery Process (“ARP”) technology and our work related to Unity Power Alliance’s grant with the U.S. Department of Energy. Revenues in the second quarter of 2012 were primarily derived from our contract with the New York City Department of Environmental Protection ("NYCDEP").

 

Gross profit for the second quarter of 2013 was $177,000 (16.4% of revenues) compared to $121,000 (6.4% of revenues) in the second quarter of 2012. Gross profit in 2013 is attributable to recognizing profit on one industrial project that was completed during the second quarter, partially offset by unallocated overhead costs. Gross profit in the second quarter of 2012 is primarily related to work performed on the NYCDEP contract.

 

General and administrative expenses totaled $739,000 for the second quarter of 2013, a decrease of $1.1 million compared to $1,885,000 for the second quarter of 2012. The decrease is primarily due to significantly lower professional and consulting expenses in 2013 resulting from management’s efforts to reduce our cost structure.

 

Engineering, research and development expenses for the second quarter of 2013 totaled $173,000 compared to $94,000 for the second quarter of 2012. The increase is attributable to reduced utilization of our engineering team in the second quarter of 2013 compared to 2012. Costs directly related to our projects are charged to cost of sales.

 

Sales and marketing expenses for the second quarter of 2013 totaled $444,000, a decrease of $443,000 compared to $887,000 for the second quarter of 2012. The decrease is attributable to reduced headcount as we continue to reallocate our resources to the oil and gas markets, as well as lower consulting and pre-sales pilot expenses in 2013.

 

We recognized a non-cash gain of $4,878,000 related to the termination of our contract with the NYCDEP during the second quarter of 2013. This gain represents the amount by which our billings to the NYCDEP exceeded revenues recognized related to the contract. We did not record any such gains during the second quarter of 2012.

 

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market expense of $38,000 in the second quarter of 2013 compared to mark-to-market income of $351,000 in the second quarter of 2012. Expense in the second quarter of 2013 relates primarily to an increase in instruments that are classified as derivative liabilities, partially offset by a decrease in our stock price; income in the second quarter of 2012 relates primarily to the passage of time and the decrease in our stock price.

 

We recognized losses in our joint ventures totaling $40,000 in the second quarter of 2013 compared to losses of $5,000 in the second quarter of 2012. Losses in the second quarter of 2013 are attributable to UPA’s efforts on the grant with the DOE and are recorded up to the total value of our investment in UPA. Because this grant is a cost-sharing arrangement, UPA is required to absorb a portion of the costs necessary to complete this project. Losses in the second quarter of 2012 relate to activity in our former joint venture, BTCC.

 

Interest expense was $2,185,000 during the second quarter of 2013 compared to $129,000 for the second quarter of 2012. This increase is due to amortization of debt discounts recognized on our December 2011 Bridge Notes and our November 2012 Bridge Notes in the second quarter of 2013.

 

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Comparison of Six-Month Periods Ended June 30, 2013 and 2012

 

Revenues totaled $2,089,000 for the first six months of 2013 compared to $3,588,000 for the first six months of 2012, a decrease of $1,499,000 or 42%. Revenues in the second quarter of 2013 were primarily driven by two industrial projects utilizing our Ammonia Recovery Process (“ARP”) technology and our work related to Unity Power Alliance’s grant with the U.S. Department of Energy. Revenues in the second quarter of 2012 were derived from construction-related activities on our NYCDEP contract, which accounted for most of our revenues in the first six months of 2012.

 

Gross profit for the first six months of 2013 was $11,000 (0.5% of revenues), a decrease of $370,000 compared to $381,000 (10.6% of revenues) in the first six months of 2012. The decrease is attributable to recognizing lower margins on two of our three active projects in 2013 compared to construction-related activities for the NYCDEP contract in 2012, as well as absorbing unallocated overhead costs during 2013.

 

General and administrative expenses decreased by $1,191,000, or 41%, to $1,725,000 from $2,916,000 in the six-month period ended June 30, 2013 compared to 2012, primarily due to significantly lower professional, consulting and stock option expenses in 2013 resulting from management’s efforts to reduce our cost structure.

 

Engineering, research and development expenses increased by $165,000, or 81%, to $368,000 from $203,000 in the six-month period ended June 30, 2013 compared to 2012. The increase is attributable to reduced utilization of our engineering team on our various projects in 2013 compared to 2012. Costs directly related to our projects are charged to cost of sales.

 

Sales and marketing expenses decreased by $764,000, or 48%, to $826,000 from $1,590,000 in the six-month period ended June 30, 2013 compared to 2012. We recorded a loss of $131,000 related to the disposal of a system previously used for pre-sales testing in the first quarter of 2012. This loss did not repeat in 2013. This decrease is also attributed to reduced pre-sales pilot activity, temporary decreases in headcount and lower expenses related to our international business development activities as we continue to redirect our efforts on the oil and gas industries.

 

We recorded a non-cash gain of $4,878,000 related to the termination of our contract with the NYCDEP during the six-month period ended June 30, 2013. This gain represents the amount by which our billings to the NYCDEP exceeded revenues recognized related to the contract. We did not record any such gains during the six-month period ended June 30, 2012.

 

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market income of $869,000 in the six-month period ended June 30, 2013 compared to $526,000 in the six-month period ended June 30, 2012. Income in the first half of 2013 relates primarily to the passage of time and decrease in our stock price, partially offset by an increase in the number of warrants classified as derivative liabilities. Income in 2012 relates to the change in our stock price and the passage of time.

 

We recognized losses in our joint ventures totaling $94,000 in the six-month period ended June 30, 2013 compared to losses of $10,000 in the six-month period ended June 30, 2012. Losses in 2013 are attributable to UPA’s efforts on the grant with the DOE and are recorded up to the total value of our investment in UPA. Because this grant is a cost-sharing arrangement, UPA is required to absorb a portion of the costs necessary to complete this project. Losses in 2012 relate to activity in our former joint venture, BTCC.

 

Interest expense was $2,374,000 in the six-month period ended June 30, 2013 compared to $254,000 for the similar period of 2012. This increase is primarily due to amortization of debt discounts recognized on our December 2011 Bridge Notes and our November 2012 Bridge Notes in the second quarter of 2013.

 

Liquidity and Capital Resources

 

Cash and cash flow data for the periods presented were as follows (in thousands of dollars):

 

   

Six-Month Period Ended

June 30,

 
    2013     2012  
             
Cash   $ 652     $ 349  
                 
Net cash used in operating activities     (3,232 )     (3,096 )
Net cash used in investing activities     (211 )     (109 )
Net cash (used in) provided by financing activities     (562 )     498  

 

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We have historically lacked the financial and other resources necessary to market the Technologies or to build demonstration projects without the financial backing of government or industrial partners. During 2013 and 2012, we funded our operations primarily from the sale of convertible debt, short-term borrowings, preferred stock and common stock, generally from stockholders and other parties who are sophisticated investors in clean technology. We raised a total of $7.3 million of funding in 2012, and we will require substantial additional funding to continue existing operations. We believe that we will be able to obtain additional equity or debt financing at market terms and interest rates; however, there is no certainty that we will be able to do so. These issues raise substantial doubt about our ability to continue as a going concern.

 

Cash used in operations amounted to $3,232,000 and $3,096,000 for the six-month periods ended June 30, 2013 and 2012, respectively.  Cash used in operations in 2013 is primarily a result of our continued net losses from operations as well as paying down our trade payables in 2013. Cash used in operations in 2012 is primarily the result of our continued net losses. Cash used in investing activities included the issuance of a new loan receivable to UPA of $100,000 in 2013 and purchases of property and equipment of $111,000 and $109,000 for the six-month periods ended June 30, 2013 and 2012, respectively. Cash used in financing activities for the six-month period ended June 30, 2013 included advances from our project line of credit totaling $223,000, offset by the repayment in full of our project line of credit totaling $785,000; cash provided by financing activities for the six-month period ended June 30, 2012 were derived from the exercise of common stock warrants, which generated net proceeds of $498,000.

  

On April 5, 2013, investors in our December 2011 Bridge Notes and November 2012 Bridge Notes exchanged such Notes with an aggregate principal amount of $4,950,000 plus accrued interest totaling $314,177 for a total of 6,926,553 shares of our Series C Convertible Preferred Stock and Warrants for the purchase of a total of 69,265,530 shares of Common Stock.

 

On April 5, 2013, we repaid in full all outstanding principal and accrued interest totaling $785,059 related to our Loan Agreement with C13 Thermo, LLC.

 

We continue to take measures to increase our sales pipeline to generate future business and to reduce our operating costs through a reduction in force and the elimination of certain non-essential administrative costs.

 

At June 30, 2013, we do not have sufficient working capital to satisfy our anticipated operating expenses for the next 12 months. As of June 30, 2013, we had a cash balance of $652,000 and current liabilities of approximately $5.4 million, which consisted primarily of accounts payable of approximately $1.2 million, convertible debt of approximately $2.0 million, derivative liabilities of approximately $1.1 million and other current liabilities of $963,000.

 

Although our financial condition has improved, there can be no assurance that we will be able to book additional orders or obtain the funding necessary to continue our operations and development activities. Management continues to engage current and potential new investors in discussions for equity or debt financing to fund our operations until we can operate on a cash flow positive basis.

 

ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

ITEM 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company, under the direction of its Chief Executive Officer and Interim Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Company’s management, consisting of the Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

 

The Company’s Chief Executive Officer and Interim Chief Financial Officer carried out an evaluation of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Interim Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of June 30, 2013 due to (i) our failure to adequately allocate proper and sufficient amount of resources to ensure that necessary internal controls were implemented and followed, specifically, but not limited, to the accounting and valuation of complex debt and equity transactions; (ii) a lack of segregation of duties in our significant accounting functions to ensure that internal controls were designed and operating effectively; and (iii) our contract administration procedures were deficient in that we have not been able to consistently estimate contract costs.

 

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Changes in Internal Controls

 

In the first quarter of 2013, we reviewed and implemented new procedures to ensure that we budget and estimate contract costs accurately. We have yet to determine whether these new procedures are sufficient to remediate our material weakness in our contract administration procedures. We did not make any other changes to our internal controls over financial reporting during the quarter ended June 30, 2013 that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

21
 

 

PART II — OTHER INFORMATION

 

ITEM 1. Legal Proceedings

 

On July 16, 2012, Andrew T. Melton, our former Executive Vice President and Chief Financial Officer (“Melton”), filed a Complaint in the United States District Court, Eastern District of Arkansas alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $2.2 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement. On June 19, 2013, the litigation was dismissed upon motion of the plaintiff.

 

From time to time, we may become subject to various legal proceedings that are incidental to the ordinary conduct of our business. We are not currently party to any material legal proceedings other than those listed above.

 

ITEM 1A.  Risk Factors

 

Not applicable.

 

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

ITEM 3. Defaults Upon Senior Securities

 

None.

 

ITEM 4. Mine Safety Disclosures

 

Not applicable.

 

ITEM 5. Other Information

 

None.

 

ITEM 6. Exhibits

 

The following exhibits are filed as part of this report:

 

Exhibit No.   Description
     
3 (i)   Certificate of Incorporation and all Amendments thereto - Filed herewith
     
3 (ii)   Amended and Restated By-Laws of ThermoEnergy Corporation – Incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed July 17, 2013
     
31.1   Sarbanes Oxley Act Section 302 Certificate of Principal Executive Officer  —  Filed herewith
     
31.2   Sarbanes Oxley Act Section 302 Certificate of Principal Financial Officer  —  Filed herewith
     
32.1   Sarbanes Oxley Act Section 906 Certificate of Principal Executive Officer  —  Filed herewith
     
32.2   Sarbanes Oxley Act Section 906 Certificate of Principal Financial Officer  —  Filed herewith
     
101.INS *   XBRL Instance Document 
     
101.SCH *   XBRL Taxonomy Extension Schema Document 
     
101.CAL *   XBRL Taxonomy Extension Calculation Linkbase Document 
     
101.DEF *   XBRL Taxonomy Extension Definition Linkbase Document 
     
101 LAB *   XBRL Extension Labels Linkbase Document 
     
101.PRE *   XBRL Taxonomy Extension Presentation Linkbase Document

 

* In accordance with SEC rules, this interactive data file is deemed “furnished” and not “filed” for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or acts.

 

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SIGNATURES

 

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.

 

Date: August 14, 2013 THERMOENERGY CORPORATION
   
  /s/ James F. Wood
  James F. Wood
  Chairman and Chief Executive Officer
   
  /s/ Gregory M. Landegger
  Gregory M. Landegger
  Chief Operating Officer and Interim
  Chief Financial Officer

 

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