PROSPECTUS
7,537,949 Shares of Common Stock
This prospectus relates to the resale by selling stockholders identified in the section entitled “Selling Stockholders” beginning on page 16 of this prospectus (the “Selling Stockholders”) of up to an aggregate of 7,537,949 shares of common stock, par value $0.0001 per share, of Ener-Core, Inc. (“Ener-Core,” “we” or “our”).
The Selling Stockholders (which term as used herein includes their pledgees, assignees or other successors-in-interest) may offer and sell any of the shares of common stock from time to time at fixed prices, at market prices or at negotiated prices, and may engage a broker, dealer or underwriter to sell the shares. For additional information on the possible methods of sale that may be used by the Selling Stockholders, you should refer to the section entitled “Plan of Distribution” beginning on page 19 of this prospectus. We will not receive any proceeds from the sale of the shares of common stock by the Selling Stockholders.
No underwriter or other person has been engaged by Ener-Core to facilitate the sale of shares of common stock in this offering. The Selling Stockholders may be deemed underwriters of the shares of common stock that they are offering. We will bear all costs, expenses and fees in connection with the registration of such shares. The Selling Stockholders will bear all commissions and discounts, if any, attributable to their respective sales of such shares.
Our common stock is currently listed on the OTC Bulletin Board and on the OTC Markets Group, Inc.’s OTCQB tier under the symbol “ENCR”. On May 12, 2014, the last reported sales price of our shares on the OTC Bulletin Board was $0.45 per share. You should rely only on the information contained in this prospectus.
You should consider carefully the risks that we have described in the section entitled “Risk Factors” beginning on page 3 of this prospectus before deciding whether to invest in our common stock.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful and complete. Any representation to the contrary is a criminal offense.
This prospectus is dated May 14, 2014.
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. The Selling Stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.
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This summary highlights selected information more fully described elsewhere in this prospectus. You should read the following summary together with the entire prospectus, including the more detailed information regarding us and the common stock being sold in this offering, and our financial statements and the related notes. You should carefully consider, among other things, the matters discussed in the section entitled “Risk Factors” before deciding to invest in our common stock. Unless otherwise stated or the context requires otherwise, references in this prospectus to “we,” “our” or “us” refer to Ener-Core, Inc. and our operating subsidiary, Ener-Core Power, Inc.
Overview
We design, develop, and manufacture Gradual Oxidizer products and technology that aim to expand power generation into previously uneconomical markets, while, at the same time, reducing the emissions of gases produced from industrial processes that contribute to air pollution and climate change. We currently anticipate our products and technologies will provide customers with cost competitive power generation having lower emissions and greater fuel flexibility than conventional power plants.
Our patented and patent pending Gradual Oxidizer products and technology allow for the extraction of energy from previously unusable low Btu fuels, while significantly reducing harmful pollutants and creating useful energy products such as heat and electricity. Gradual Oxidation potentially can unlock power generation for a wide range of low-quality fuels that extend beyond traditional gas turbine and reciprocating engine operating limits. Our goal is to reduce the cost of our customers’ compliance with local, state, and federal air quality regulations by avoiding the chemicals, catalysts, and complex permitting required by competitive systems.
We currently expect to scale up our technology to be integrated with a variety of larger turbines for power generation, providing an alternative to typical combustion-based generation. Our first commercial product, the Ener-Core Powerstation FP250 (“FP250”), combines our Gradual Oxidizer technology with a 250 kilowatt gas turbine that was initially developed by Ingersoll-Rand, plc (“Ingersoll-Rand”), and subsequently enhanced by our predecessor FlexEnergy, Inc. (“FlexEnergy” or “Predecessor”). Because our Gradual Oxidizer replaces a turbine’s standard combustor, the FP250 can operate on a gaseous fuel that is much lower in quality, and with fewer emissions than a conventional turbine.
After deployment of FP250 development and field test units in 2011 and 2012, we shipped the first commercial FP250 on November 14, 2013 to the Netherlands per the terms of the Efficient Energy Conversion Turbo Machinery, B.V. (“EECT”) agreement.
We currently anticipate that our second commercial product will be the Ener-Core Powerstation KG2-3G/GO (“KG2-3G/GO”), which will combine our Gradual Oxidizer technology with a two megawatt gas turbine, developed by Dresser-Rand a.s., a subsidiary of Dresser-Rand Group Inc. (“Dresser Rand”). We have completed system layout and analytic models integrating our Gradual Oxidizer with this turbine and have initiated design and development of the KG2-3G/GO. We expect that we will field test units in late 2014 or 2015, with initial commercial shipments shortly thereafter.
We currently anticipate future development of additional commercial systems by integrating our Gradual Oxidizer with larger gas turbines from a select group of manufacturers.
We are subject to a number of risks, which the reader should be aware of before deciding to purchase the common stock in this offering. Such risks are discussed in the section entitled “Risk Factors” beginning on page 3 of this prospectus.
Recent Developments
April 2014 Private Placement
On April 16, 2014, we closed a securities purchase agreement (the “April 2014 SPA”), with five institutional and accredited investors. Pursuant to the terms of the April 2014 SPA, we issued and sold to these investors our senior secured convertible notes in the aggregate original principal amount of $4,575,000 (the “Notes”), and warrants to purchase up to 4,097,015 shares of our common stock (the “Warrants”), on the terms set forth below (the “April 2014 Private Placement”).
The Notes mature 18 months from their issuance and were purchased for $4,003,125 in the aggregate. The Notes bear an effective annual interest of 8.61%, which increases to 15% if there is an event of default (as defined in the Notes). The initial conversion price of the Notes is $0.67 per share (the “Conversion Price”).
The Warrants issued to the investors are immediately exercisable, have an initial exercise price of $0.78 per share (the “Exercise Price”), and expire on the 60-month anniversary of their initial issuance.
In connection with the sale of the Notes and the Warrants, we entered into a registration rights agreement (the “April 2014 RRA”) to register 135% of the shares issuable under the Notes and the Warrants. In addition, we entered into a pledge and security agreement (the “Security Agreement”) granting security interest of all of our personal property to the collateral agent for the investors (the “Collateral Agent”), as well as a special deposit account control agreement (the “Control Agreement”) granting the collateral agent control of the control account established to hold a portion of the proceeds from the investors (the “Control Account”).
We received gross proceeds of $4 million, less transaction expenses. The terms of the April 2014 SPA, the April 2014 RRA, the Security Agreement and the Control Agreement are more fully described in “Business – Our History – April 2014 Private Placement” beginning on page 22. The terms of the Notes and Warrants are more fully described in “Description of Securities” beginning on page 57.
We are subject to a number of risks, which the reader should be aware of before deciding to purchase the common stock in this offering. Such risks are discussed in the section entitled “Risk Factors” beginning on page 3 of this prospectus.
Corporate Information
Ener-Core was incorporated in Nevada in April 2010. Ener-Core’s operating subsidiary, Ener-Core Power, Inc. (“Ener-Core Power”), was incorporated in Delaware in July 2012 under the name “Flex Power Generation, Inc.” Ener-Core Power became Ener-Core’s subsidiary in July 2013 by merging with Flex Merger Acquisition Sub, Inc., a Delaware corporation wholly owned by Ener-Core (the “merger sub,” and such merging transaction the “Merger”).
The address of our corporate headquarters is 9400 Toledo Way, Irvine, California 92618, and our telephone number is (949) 616-3300. Our website can be accessed at www.ener-core.com. The information contained on, or that may be obtained from, our website is not a part of this prospectus. All of our operations are located in the United States. Our fiscal year ends December 31.
The Offering
| Shares outstanding prior to offering: | | As of January 10, 2014, we had 72,554,174 shares of common stock outstanding. |
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Common stock offered for resale to the public by the Selling Stockholders: | | Up to 7,537,949 shares of common stock (including 511,087 shares issuable upon exercise of common stock purchase warrants). |
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| Use of Proceeds: | | Proceeds from the sale of the shares of common stock covered by this prospectus will be received by the Selling Stockholders. We will not receive any proceeds from such sale. |
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| The OTC Bulletin Board and the OTC Markets Group, Inc.’s OTCQB tier symbol for our common stock: | | “ENCR” |
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| Risk Factors: | | See “Risk Factors” and the other information included in this prospectus for a discussion of risk factors you should carefully consider before deciding to invest in our common stock. |
We are subject to various risks that may materially harm our business, prospects, financial condition and results of operations. An investment in our common stock is speculative and involves a high degree of risk. In evaluating an investment in shares of our common stock, you should carefully consider the risks described below, together with the other information included in this prospectus.
The risks described below are not the only risks we face. If any of the events described in the following risk factors actually occurs, or if additional risks and uncertainties later materialize, that are not presently known to us or that we currently deem immaterial, then our business, prospects, results of operations and financial condition could be materially adversely affected. In that event, the trading price of our common stock could decline, and you may lose all or part of your investment in our shares. The risks discussed below include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Risks Related to Our Business and Industry
Our future is dependent upon our ability to obtain additional financing. If we do not obtain such financing, we may have to cease our activities and investors could lose their entire investment.
There is no assurance that we will operate profitably or generate positive cash flow in the future. We will require additional financing in order to proceed with the manufacture and distribution of our products, including our FP250 and other Gradual Oxidizer products. During the next 12 months, we currently project our cash needs to be in excess of $10.5 million and are currently budgeted for employee and related costs ($3.4 million), for our research and development programs ($3.5 million), for professional fees, corporate filings, and business development costs ($2.1 million) and for working capital ($1.5 million). We may require more funds if the costs of the development and operation of our existing technologies are greater than what we have currently anticipated. We will also require additional financing to sustain our business operations if we are not successful in earning revenues. Our sales and fulfillment cycle can exceed 24 months and, as noted, we do not expect to generate sufficient revenue in the next 12 months to cover our operating costs. Our short- and medium-term future is dependent upon our ability to obtain financing and upon future profitable operations. We anticipate that we will rely on debt or equity capital in order to continue to fund our business operations. Issuances of additional shares will result in dilution to our existing stockholders. We may not be able to obtain financing on commercially reasonable terms or terms that are acceptable to us when it is required. If we do not obtain such financing, our business could fail and investors could lose their entire investment.
If we are unable to continue as a going concern, our securities will have little or no value.
The report of our independent registered public accounting firm that accompanies our audited consolidated financial statements for the years ended December 31, 2013 and December 31, 2012 contains a going concern qualification in which such firm expressed substantial doubt about our ability to continue as a going concern. In addition to our history of losses, our accumulated deficit as of December 31, 2013 and December 31, 2012 was approximately $7.5 million and $0.38 million, respectively. At December 31, 2013 and December 31, 2012, we had cash and cash equivalents (including restricted cash) of $1.2 million and $93,285, respectively.
In order to continue as a going concern, we will need, among other things, additional capital resources. Our management’s plan is to obtain such resources by seeking additional equity and/or debt financing. Although we have raised approximately $4.0 million (2.3 million of which is restricted to our use) through the issuance of convertible debt and equity securities on April 16, 2014, management cannot provide any assurances that we will be successful in accomplishing any of our financing plans. If we are unable to obtain additional capital, such inability would have an adverse effect on our financial position, results of operations, cash flows, and business prospects, and ultimately on our ability to continue as a going concern. If we are unable to obtain adequate capital, we could be forced to cease operations.
Because we may never earn recurring revenues from our operations, our business may fail and investors may lose all of their investment in our Company.
We are a company with a limited operating history and our future profitability is uncertain. We have yet to generate recurring sales or positive earnings and there can be no assurance that we will ever operate profitably. If our business plan is not successful and we are not able to operate profitably, then our stock may become worthless and investors may lose all of their investment in our Company.
Prior to obtaining customers and distribution for our products, we currently anticipate that we will incur increased operating expenses without realizing any revenues. We, therefore, currently expect to incur significant losses into the foreseeable future. We recognize that, if we are unable to generate recurring revenues from the sale of our products in the future, we will not be able to earn profits or continue operations. There is no history upon which to base any assumption as to the likelihood that we will prove successful, and we can provide no assurance that we will generate recurring revenues or ever achieve profitability. If we are unsuccessful in addressing these risks, our business will fail and investors may lose all of their investment in our Company.
Our limited operating history makes evaluating our business and future prospects difficult, and may increase the risk of your investment.
We have a limited operating history on which investors can base an evaluation of our business, operating results, and prospects. Of even greater significance is that fact that we have limited operating history with respect to designing and manufacturing systems for producing continuous energy from a broad range of sources, including previously unusable ultra-low quality gas.
While the basic technology has been verified, we only recently have begun offering the FP250 as a commercial system, and have yet to commercialize the KG2-3G/GO or other Gradual Oxidizer systems. This limits our ability to accurately forecast the cost of producing and distributing our systems or technology or to determine a precise date on which our systems or technology will be widely released.
Our plan to complete the initial commercialization of our gas-to-heat and electricity conversion technology is dependent upon the timely availability of funds and upon our finalizing the engineering, component procurement, build out, and testing in a timely manner. Any significant delays would materially adversely affect our business, prospects, operating results, and financial condition. Consequently, it is difficult to predict our future revenues and appropriately budget for our expenses, and we have limited insight into trends that may emerge and affect our business. In the event that actual results differ from our estimates or we adjust our estimates in future periods, our operating results and financial position could be materially affected. If the market for transforming methane gas, especially ultra-low quality gas from landfills, coal mines, oil fields, and other low-quality methane sources into continuous electricity does not develop as we currently expect or develops more slowly than we currently expect, our business, prospects, operating results, and financial condition will be materially harmed.
A sustainable market for our technology may never develop or may take longer to develop than we currently anticipate which would materially adversely affect our results of operations.
Our products represent an emerging market, and we do not know whether our targeted customers will accept our technology or will purchase our products in sufficient quantities to allow our business to grow. To succeed, demand for our products must increase significantly in existing markets, and there must be strong demand for products that we introduce in the future. If a sustainable market fails to develop or develops more slowly than we currently anticipate, we may be unable to recover the losses we have incurred to develop our products, we may have further impairment of assets, and we may be unable to meet our operational expenses. The development of a sustainable market for our systems may be hindered by many factors, including some that are out of our control. Examples include:
| ● | customer reluctance to try a new product or concept; |
| ● | regulatory requirements; |
| ● | perceived cost competitiveness of our FP250 and other Gradual Oxidizer products; |
| ● | costs associated with the installation and commissioning of our FP250 and other Gradual Oxidizer products; |
| ● | maintenance and repair costs associated with our products; |
| ● | economic downturns and reduction in capital spending; |
| ● | customer perceptions of our products’ safety and quality; |
| ● | emergence of newer, more competitive technologies and products; |
| ● | financial stability of our turbine partners; |
| ● | inability of our turbine partners to fulfill orders in a timely manner; |
| ● | excessive warranty-related costs associated with parts replacement for Gradual Oxidizer or turbine components for power-stations operating in the field; and |
| ● | decrease in domestic and international incentives. |
We may not be able to effectively manage our growth, expand our production capabilities or improve our operational, financial and management information systems, which would impair our results of operations.
If we are successful in executing our business plan, we will experience growth in our business that could place a significant strain on our business operations, management and other resources. Our ability to manage our growth will require us to expand our production capabilities, continue to improve our operational, financial and management information systems, and to motivate and effectively manage our employees. We cannot provide assurance that our systems, procedures and controls or financial resources will be adequate, or that our management will keep pace with this growth. We cannot provide assurance that our management will be able to manage this growth effectively.
Product quality expectations may not be met, causing slower market acceptance or warranty cost exposure.
In order to achieve our goal of improving the quality and lowering the total costs of ownership of our products, we may require engineering changes. Such improvement initiatives may render existing inventories obsolete or excessive. Despite our continuous quality improvement initiatives, we may not meet our customers’ expectations. Any significant quality issues with our products or those of our turbine manufacturing partners could have a material adverse effect on our rate of product adoption, results of operations, financial condition, and cash flow. Moreover, as we develop new configurations for our gas-to-heat and electricity conversion systems and as our customers place existing configurations in commercial use, our products may perform below expectations. Any significant performance below expectations could materially adversely affect our operating results, financial condition, and cash flow and affect the marketability of our products.
Our business plan is to sell future products with warranties. There can be no assurance that the provision for estimated product warranty will be sufficient to cover our warranty expenses in the future. We cannot ensure that our efforts to reduce our risk through warranty disclaimers will effectively limit our liability. Any significant incurrence of warranty expense in excess of estimates could have a material adverse effect on our operating results, financial condition, and cash flow. Further, we may at times undertake programs to enhance the performance of units previously sold. These enhancements may at times be provided at no cost or below our cost. If we choose to offer such programs, such actions could result in significant additional costs to our business.
If we are unable to adequately control the costs associated with operating our business, including our costs of sales and materials, our business, prospects, operating results, and financial condition will suffer.
If we are unable to maintain a sufficiently low level of costs for designing, marketing, selling and distributing our gas transforming systems relative to their selling prices, our operating results, gross margins, business, and prospects could be materially and adversely impacted. We have made, and will be required to continue to make, significant investments for the design and sales of our system and technologies. There can be no assurances that our costs of producing and delivering our system and technologies will be less than the revenue we generate from sales, licenses and/or royalties or that we will achieve our currently expected gross margins.
We may be required to incur substantial marketing costs and expenses to promote our systems and technologies, even though our marketing expenses to date have been relatively limited. If we are unable to keep our operating costs aligned with the level of revenues we generate, our operating results, gross margins, business, and prospects will be harmed. Many of the factors that impact our operating costs are beyond our control. For example, the costs of our components could increase due to shortages if global demand for these products increases.
Market acceptance of our technology and products is difficult to predict. If our technology and products do not achieve market acceptance, our business could fail.
A number of factors may affect the market acceptance of our products and technology, including, among others, the perception by consumers of the effectiveness of our products and technology, the operational reliability of our products and technology over an extended period of time in the field, our ability to fund our sales and marketing efforts, and the effectiveness of our sales and marketing efforts. If our products and technology do not gain acceptance by our intended customers, we may not be able to fund future operations, including the development of new products, and/or our sales and marketing efforts for our current and currently anticipated products. Such inability would have a material adverse effect on our business, prospects, operating results, and financial condition.
Further, market acceptance of our technology and business is difficult to predict. If our technology does not achieve market acceptance, our business could fail. If we are unable to develop effectively and promote our technology timely and gain recognition in our market segment, we may not be able to achieve acceptable sales revenue and our results of operations and financial condition would then suffer. Our ability to achieve future revenue will depend highly upon the awareness of our potential customers of our products, services, and solutions. While we plan to achieve this awareness over time, there cannot be assurance that awareness of our Company and technology will develop in a manner or pace that is necessary for us to achieve profitability in the near term.
In addition, we cannot predict the rate of adoption or acceptance of our technology by potential customers or prospective channel partners. While we may be able to effectively demonstrate the feasibility of our technology, this does not guarantee the market will accept it, nor can we control the rate at which such acceptance may be achieved. In certain of our market segments, there is a well-established channel with a limited number of companies engaged in reselling to our target customers. Failure to achieve productive relations with a sufficient number of these prospective partners may impede adoption of our solutions. Additionally, some potential customers in our target industries are historically risk-averse and, on occasion, have been slow to adopt new technologies. If our technology is not accepted in the market, we may not generate sufficient revenue by selling or licensing our technology to support our operations, recover our research and development costs, or become profitable and our business could fail.
If we do not respond effectively and on a timely basis to rapid technological change, our business could suffer.
Our industry is characterized by rapidly changing technologies, industry standards, customer needs, and competition, as well as by frequent new product and service introductions. We must respond to technological changes affecting both our customers and suppliers. We may not be successful in developing and marketing, on a timely and cost-effective basis, new services that respond to technological changes, evolving industry standards or changing customer requirements. Our success will depend, in part, on our ability to accomplish all of the following in a timely and cost-effective manner:
| ● | effective use and integration of new technologies; |
| ● | continual development of our technical expertise; |
| ● | enhancement of our engineering and system designs; |
| ● | retention of key engineering personnel, which have played a critical role in the development of our technology; |
| ● | development of products that meet changing customer needs; |
| ● | advertisements and marketing of our products; and |
| ● | influence of and response to emerging industry standards and other changes. |
The market for alternative energy products is characterized by significant and rapid technological change and innovation. Although we intend to employ our technological capabilities to create innovative products and solutions that are practical and competitive in today’s marketplace, future research and discoveries by others may make our products and solutions less attractive or even obsolete compared to other alternatives that may emerge.
If we are unable to enforce our intellectual property rights or if our intellectual property rights become obsolete, our competitive position could be adversely impacted.
We utilize a variety of intellectual property rights in our products and technology. We view our portfolio of process and design technologies as one of our competitive strengths and we use it as part of our efforts to differentiate our product offerings. We may not be able to preserve these intellectual property rights successfully in the future and these rights could be invalidated, circumvented, challenged, or infringed upon. In addition, the laws of some foreign countries in which our products may be sold do not protect intellectual property rights to the same extent as the laws of the United States. If we are unable to protect and maintain our intellectual property rights, or if there are any successful intellectual property challenges or infringement proceedings against us, our ability to differentiate our product offerings could diminish. In addition, if our intellectual property rights or work processes become obsolete, we may not be able to differentiate our product offerings and some of our competitors may be able to offer more attractive products to our customers. As a result, our business and financial performance could be materially and adversely affected.
Developments or assertions by us or against us relating to intellectual property rights could materially impact our business.
We currently expect to own or license significant intellectual property, including patents, and intend to be involved in numerous licensing arrangements. We expect our intellectual property to play an important role in establishing and maintaining a competitive position in a number of the markets we intend to serve. We will attempt to protect proprietary and intellectual property rights to our products and gas system through available patent laws and licensing and distribution arrangements with reputable domestic and international companies. Despite these precautions, patent laws afford only limited practical protection in certain countries.
Litigation may also be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others or to defend against claims of invalidity. Such litigation could result in substantial costs and the diversion of resources. As we create or adopt new technology, we will also face an inherent risk of exposure to the claims of others that we have allegedly violated their intellectual property rights.
We cannot assure that we will not experience any intellectual property claim losses in the future or that we will not incur significant costs to defend such claims nor can we assure that infringement or invalidity claims will not materially adversely affect our business, results of operations and financial condition. Regardless of the validity or the success of the assertion of these claims, we could incur significant costs and diversion of resources in enforcing our intellectual property rights or in defending against such claims, which could have a material adverse effect on our business, results of operations and financial condition.
Any such imposition of a liability that is not covered by insurance, is in excess of insurance coverage or is not covered by an indemnification could have a material adverse effect on our business, results of operations, and financial condition.
Further, liability or alleged liability could harm our business by damaging our reputation, that could require us to incur expensive legal costs in defense, exposing us to awards of damages and costs and diverting management’s attention away from our business operations. Any such liability could severely impact our business operations and/or revenues. If any claims or actions are asserted against us, we may seek to settle such claim by obtaining a license from the plaintiff covering the disputed intellectual property rights. We cannot provide any assurances, however, that under such circumstances a license, or any other form of settlement, would be available on reasonable terms or at all.
Confidentiality agreements with employees and others may not adequately prevent disclosure of our trade secrets and other proprietary information.
Our success depends upon the skills, knowledge, and experience of our technical personnel, our consultants and advisors, as well as our licensees and contractors. Because we operate in a highly competitive field, we rely almost wholly on trade secrets to protect our proprietary technology and processes. However, trade secrets are difficult to protect. We enter, and currently expect that we will continue to enter, into confidentiality and intellectual property assignment agreements with our corporate partners, employees, consultants, outside scientific collaborators, developers, licensees and other advisors. These agreements generally require that the receiving party keep confidential and not disclose to third parties confidential information developed by us during the course of the receiving party’s relationship with us. These agreements also generally provide that inventions conceived by the receiving party in the course of rendering services to us will be our exclusive property. However, these agreements may be breached and may not effectively assign intellectual property rights to us. Our trade secrets also could be independently discovered by competitors, in which case we would not be able to prevent use of such trade secrets by our competitors. The enforcement of a claim alleging that a party illegally obtained and was using our trade secrets could be difficult, expensive, and time consuming and the outcome would be unpredictable. In addition, courts outside the United States may be less willing to protect trade secrets. The failure to obtain or maintain meaningful trade secret protection could adversely affect our competitive position.
Our growth depends in part on environmental regulations and programs that promote or mandate the conversion of ultra-low quality gas into heat and electricity and any modification or repeal of these regulations may adversely impact our business.
Enabling customers to meet environmental regulations and programs domestically and internationally that promote or mandate the conversion of ultra-low quality gas into heat and electricity is an integral part of our business plan. Industry participants with a vested interest in gas and electricity invest significant time and money in efforts to influence environmental regulations in ways that delay or repeal requirements for the conversion of ultra-low quality gas into heat and electricity. Furthermore, an economic recession may result in the delay, amendment, or waiver of environmental regulations due to the perception that they impose increased costs on the energy industries or the general public that cannot or should not be absorbed in a shrinking economy. The delay, repeal, or modification of United States federal or state regulations or foreign regulations or programs that encourage the use of technologies that convert ultra-low quality gas into heat and electricity, or similar national regulations in international markets, could slow our growth and adversely affect our business.
We operate in a highly regulated business environment, and changes in regulation could impose significant costs on us or make our products less economical, thereby affecting demand for our products.
Our products are subject to federal, state, local, and foreign laws and regulations, governing, among other things, emissions and occupational health and safety. Regulatory agencies may impose special requirements for the implementation and operation of our products or that may significantly affect or even eliminate some of our target markets. We may incur material costs or liabilities in complying with government regulations. In addition, potentially significant expenditures could be required in order to comply with evolving environmental and health and safety laws, regulations and requirements that may be adopted or imposed in the future. Furthermore, our potential utility customers must comply with numerous laws and regulations. The deregulation of the utility industry may also create challenges for our marketing efforts. For example, as part of electric utility deregulation, federal, state, and local governmental authorities may impose transitional charges or exit fees, which would make it less economical for some potential customers to switch to our products. We can provide no assurances that we will be able to obtain these approvals and changes in a timely manner, or at all. Non-compliance with applicable regulations could have a material adverse effect on our operating results.
The market for electricity and generation products is heavily influenced by federal and state government regulations and policies. The deregulation and restructuring of the electric industry in the United States and elsewhere may cause rule changes that may reduce or eliminate some of the advantages of such deregulation and restructuring. We cannot determine how any deregulation or restructuring of the electric utility industry may ultimately affect the market for our products. Changes in regulatory standards or policies could reduce the level of investment in the research and development of alternative power sources, including gas-to-heat and electricity conversion systems. Any reduction or termination of such programs could increase the cost to our potential customers, making our systems less desirable, and thereby materially adversely affect our revenue and other operating results.
Utility companies or governmental entities could place barriers to our entry into the marketplace, and we may not be able to effectively sell our products.
Utility companies or governmental entities could place barriers on the installation of our products or the interconnection of the products with the electric grid. Further, they may charge additional fees to customers who install on-site generation or have the capacity to use power from the grid for back-up or standby purposes. These types of restrictions, fees, or charges could hamper the ability to install or effectively use our products or increase the cost to our potential customers for using our systems. This could make our systems less desirable, thereby materially adversely affecting our revenue and other operating results. In addition, utility rate reductions can make our products less competitive, which would have a material adverse effect on our operations. The cost of electric power generation bears a close relationship to the cost of natural gas and other fuels. However, changes to electric utility tariffs often require lengthy regulatory approval and include a mix of fuel types, as well as customer categories. Potential customers may perceive the resulting swings in natural gas and electric pricing as an increased risk of investing in on-site generation.
Commodity market factors impact our costs and availability of materials.
Our products contain a number of commodity materials from metals, which include steel, special high temperature alloys, copper, nickel, and molybdenum, to computer components. The availability of these commodities could impact our ability to acquire the materials necessary to meet our production requirements. The cost of metals has historically fluctuated. The pricing could impact the costs to manufacture our products. If we are not able to acquire commodity materials at prices and on terms satisfactory to us or at all, our operating results may be materially adversely affected.
Turbine prices, availability and reliability factors impact our price competitiveness, reliability and warranty costs.
Our products are commercialized in a manner that is fully integrated with a gas turbine, thus providing a complete power-station to the ultimate customer and operator. The availability of these turbines is dependent on the current commercial backlog and financial stability of their manufacturers, and an unacceptable product fulfillment timeframe from them could impact our ability to timely deliver a power-station and book revenues. The pricing of these turbines could increase over time, causing the overall price of the integrated power-station to become commercially uncompetitive, which would hinder sales of our Gradual Oxidizer products. Once operational, any issues in the reliability of the turbine, either due to issues with the Gradual Oxidizer or the inherent reliability flaws in the turbine, could result in excessive warranty obligations for our company and a level of operational reliability that is deemed unsatisfactory by our customers, which could not only hurt our relationships with our customers, but materially and adversely affect our business, prospects, operating results and financial condition.
Our products involve a lengthy sales cycle and we may not currently anticipate sales levels appropriately, which could impair our results of operations.
The sale of our products typically involves a significant commitment of capital by customers, with the attendant delays frequently associated with large capital expenditures. Once a customer makes a formal decision to purchase our product, the fulfillment of the sales order by us and our turbine partners will require a substantial amount of additional time. For these and other reasons, the sales and fulfillment cycle associated with our products is typically lengthy and subject to a number of significant risks over which we have little or no control. We currently expect to plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. If sales in any period fall significantly below currently anticipated levels, our financial condition, results of operations and cash flow would suffer. If demand in any period increases well above currently anticipated levels, we may have difficulties in responding, incur greater costs to respond, or be unable to fulfill the demand in sufficient time to retain the order, which would negatively impact our operations. In addition, our operating expenses are based on currently anticipated sales levels, and a high percentage of our expenses are generally fixed in the short term. As a result of these factors, a small fluctuation in timing of sales could cause operating results to vary materially from period to period.
We face intense competition and currently expect competition to increase in the future, which could prohibit us from developing a customer base and generating revenue.
Many of our potential competitors have greater financial and commercial resources than us, and it may be difficult to compete against them. The energy industry is characterized by intense competition. Many of our potential competitors have better name recognition and substantially greater financial, technical, manufacturing, marketing, personnel, and/or research capabilities than we do. Although at this time we do not believe that any of our potential competitors have technology similar to ours, if and when we release products based on our technology, potential competitors may respond by developing and producing similar products. Many firms in the energy industry have made and continue to make substantial investments in improving their technologies and manufacturing processes. In addition, they may be able to price their products below the marginal cost of production in an attempt to establish, retain, or increase market share. Because of these circumstances, it may be difficult for us to compete successfully in the energy market.
If we are unable to attract, train, and retain technical and financial personnel, our business may be materially adversely affected.
Our future success depends, to a significant extent, on our ability to attract, train, and retain technical and financial personnel. Recruiting and retaining capable personnel, particularly those with expertise in our chosen industry, are vital to our success. There is substantial competition for qualified technical and financial personnel, and there can be no assurance that we will be able to attract or retain them. If we are unable to attract and retain qualified employees, our business may be materially adversely affected.
Our business depends substantially on the continuing efforts of certain personnel and our business may be severely disrupted if we lose their services.
Our future success depends substantially on the continued services of our executive officers, especially our Chief Executive Officer, Alain J. Castro, our President, Boris A. Maslov, Ph.D., our Chief Financial Officer, Kelly Anderson, as well as our engineering vice presidents, Steven Lampe and Douglas Hamrin. If one or more of these persons are unable or unwilling to continue in their present positions, we may not be able to replace them readily or timely, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain their replacements, if any acceptable persons may be found. In addition, if any of our executive or engineering officers joins a competitor or forms a competing company, we may lose some of our customers or potential customers.
We may face risks from doing business internationally.
We may license, sell, or distribute products outside of the United States of America and derive revenues from these sources. Our revenues and results of operations will be vulnerable to currency fluctuations. As of the date of this prospectus, we have shipped one of our FP250 systems to a customer in the Netherlands. We plan to install and commission that system in the second quarter of fiscal 2014, at which time we will be able to recognize revenue and collect balance of full payment. We will report our revenues and results of operations in U.S. dollars, but, in various reporting periods, a significant portion of our revenues might be earned outside of the U.S. We cannot accurately predict the impact of future exchange rate fluctuations on our revenues and operating margins. Such fluctuations could have a material adverse effect on our business, results of operations, and financial condition. Our business will also be subject to other risks inherent in the international marketplace, many of which are beyond our control. These risks include:
| ● | laws and policies affecting trade, investment, and taxes, including laws and policies relating to the repatriation of funds and withholding taxes, and changes in these laws; |
| ● | changes in local regulatory requirements, including restrictions on gas-to-heat and electricity conversions; |
| ● | differing degrees of protection for intellectual property; |
| ● | financial instability; |
| ● | instability of foreign economies and governments; and |
| ● | war and acts of terrorism. |
Any of the foregoing could have a material adverse effect on our business, financial condition, and results of operations.
Our future business depends in large part on our ability to execute our plans to market and license our gas-to-heat and electricity conversion systems.
Failure to obtain reliable sources of component supply that will enable us to meet the quality, price, engineering, design, and production standards, as well as the production volumes required to mass market our gas-to-heat and electricity conversion systems successfully, could negatively affect our Company’s revenues and business operations.
Even if we are successful in developing and marketing our gas-to-heat and electricity conversion systems and technology and in developing and securing reliable sources of component supply, we do not know whether we will be able to do so in a manner that avoids significant delays and cost overruns, including factors beyond our control, such as problems with suppliers and vendors, or shipping schedules that meet our customers’ requirements. Any failure to develop such capabilities within our projected costs and timelines could have a material adverse effect on our business, prospects, operating results, and financial condition.
Any changes in business credit availability or cost of borrowing could adversely affect our business.
Declines in the availability of business credit and increases in corporate borrowing costs could negatively impact the number of systems we can install. Substantial declines in the business and operations of our customers could have a material adverse effect on our business, results of operations and financial condition. In addition, the disruption in the capital markets that began in 2008 has reduced the availability of debt financing to support many of the businesses in which our potential customers operate. If our potential customers are unable to access credit, it would impair our ability to grow our business.
Our research and commercialization efforts may not be sufficient to adapt to changes in gas-to-heat and electricity conversion technology.
As technologies change, we plan to upgrade or adapt our gas-to-heat and conversion systems and technology in order to continue to provide customers with the latest technology, in particular gas-to-heat and electricity conversion technology. However, our technology may not compete effectively with alternative technologies if we are not able to source and integrate the latest technology into our gas-to-heat and electricity conversion systems. Any failure to keep up with advances in gas-to-heat and electricity conversion systems and technology would result in a decline in our competitive position that would materially adversely affect our business, prospects, operating results, and financial condition.
We will be dependent on our suppliers, some of which are single or limited source suppliers, and the inability of these suppliers to continue to deliver, or their refusal to deliver, necessary components at prices, volumes, and schedules acceptable to us would have a material adverse effect on our business, prospects, operating results, and financial condition.
We are currently and continually evaluating, qualifying, and selecting suppliers for our gas-to-heat and electricity conversion systems. We will source globally from a number of suppliers, some of whom may be single source suppliers for these components. While we attempt to maintain the availability of components from multiple sources whenever possible, it may not always be possible to avoid purchasing from a single source. To date, we have no qualified alternative sources for any of our single-sourced components.
While we believe that we may be able to establish alternate supply relationships and can obtain or engineer replacements for our single-source components, we may be unable to do so in the short term or at all at prices or costs that are favorable to us. In particular, while we believe that we will be able to secure alternate sources of supply for almost all of our single-sourced components in a relatively short time-frame, qualifying alternate suppliers or developing our own replacements for certain highly customized components may be time consuming and costly.
The supply chain will expose us to potential sources of delivery failure or component shortages. If we experience significant increased demand, or need to replace our existing suppliers, there can be no assurance that additional supplies of component parts will be available if or when required on terms that are favorable to us, or at all, or that any supplier would allocate sufficient supplies to us in order to meet our requirements or fill our orders in a timely manner. The loss of any single- or limited-source supplier or the disruption in the supply of components from these suppliers could lead to delays to our customers, which could hurt our relationships with our customers and also materially adversely affect our business, prospects, operating results, and financial condition.
Changes in our supply chain may result in increased cost and delay. A failure by our suppliers to provide the necessary components could prevent us from fulfilling customer orders in a timely fashion, which could result in negative publicity, damage our brand, and have a material adverse effect on our business, prospects, operating results, and financial condition.
Our internal controls and accounting methods may require modification.
We continue to review and develop controls and procedures sufficient to accurately report our financial performance on a timely basis. If we do not develop and implement effective controls and procedures, we may not be able to report our financial performance on a timely basis and our business and stock price would be adversely affected.
If we fail to achieve and maintain an effective system of internal controls in the future, we may not be able to accurately report our financial results or prevent fraud. As a result, investors may lose confidence in our financial reporting.
The Sarbanes-Oxley Act of 2002 requires that we report annually on the effectiveness of our internal control over financial reporting. Among other things, we must perform systems and processes evaluation and testing. We must also conduct an assessment of our internal controls to allow management to report on our assessment of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our assessment could reveal significant deficiencies or material weaknesses in our internal controls, which may need to be disclosed in our Annual Reports on Form 10-K. Disclosures of this type can cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. Deficiencies in our internal controls over financial reporting may negatively impact our business and operations.
Risks Related to Our Securities
If an orderly and active trading market for our common stock does not develop or is not sustained, the value and liquidity of your investment in our common stock could be adversely affected.
We cannot assure you that an orderly and active trading market in our common stock will ever develop or be sustained. This may be attributable to a number of factors, including the fact that we are a small company which is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk averse and would be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we became more seasoned and viable. As a consequence, there may be periods of several days, weeks or months when trading activity in our shares is minimal or non- existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price.
The historic bid and asked quotations for our common stock should not be viewed as an indicator of the current market price for our common stock. Further, the price at which shares of common stock were offered and sold in the Merger-related private placement or after may not have been indicative of the value of such shares and should not be viewed as an indicator of the current market price for our common stock. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained, or that current trading levels will be sustained or not diminish.
If a significant public market for our common stock develops, we expect to experience volatility in the price of our common stock. This may result in substantial losses to investors if they are unable to sell their shares at or above their purchase price.
If a significant public market for our common stock develops, we expect the market price of our common stock to fluctuate substantially for the foreseeable future, primarily due to a number of factors, including:
| ● | our status as a company with a limited operating history and limited revenues to date, which may make risk-averse investors more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the shares of a seasoned issuer in the event of negative news or lack of progress; |
| ● | announcements of technological innovations or new products by us or our competitors; |
| ● | the timing and development of our products; |
| ● | general and industry-specific economic conditions; |
| ● | actual or anticipated fluctuations in our operating results; |
| ● | liquidity; |
| ● | actions by our stockholders; |
| ● | changes in our cash flow from operations or earnings estimates; |
| ● | changes in market valuations of similar companies; |
| ● | our capital commitments; and |
| ● | the loss of any of our key management personnel. |
In addition, the financial markets have experienced extreme price and volume fluctuations. The market prices of the securities of technology companies, particularly companies like ours without consistent revenues and earnings, have been highly volatile and may continue to be highly volatile in the future, some of which may be unrelated to the operating performance of particular companies. The sale or attempted sale of a large amount of common stock into the market may also have a significant impact on the trading price of our common stock. Many of these factors are beyond our control and may decrease the market price of our common stock, regardless of our operating performance. In the past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Whether or not meritorious, litigation brought against us could result in substantial costs, divert management’s attention and resources and harm our financial condition and results of operations.
Our operating results may fluctuate significantly, and these fluctuations may cause our common stock price to fall.
Our quarterly operating results may fluctuate significantly in the future due to a variety of factors that could affect our revenues or our expenses in any particular quarter. You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. Factors that may affect our quarterly results include:
| ● | market acceptance of our products and those of our competitors; |
| ● | our ability to attract and retain key personnel; |
| ● | development of new designs and technologies; and |
| ● | our ability to manage our anticipated growth and expansion. |
Trading of our common stock may be volatile and sporadic, which could depress the market price of our common stock and make it difficult for our stockholders to resell their shares.
There is currently a limited market for our common stock and the volume of our common stock traded on any day may vary significantly from one day to another. Our common stock is currently quoted on the OTCQB tier of the OTC Market (“OTCQB”) and the OTC Bulletin Board (“OTCBB”). Trading in stock quoted on the OTCQB and the OTCBB is often thin and characterized by wide fluctuations in trading prices due to many factors that may have little to do with our operations or business prospects. The availability of buyers and sellers represented by this volatility could lead to a market price for our common stock that is unrelated to operating performance. Moreover, neither the OTCQB nor the OTCBB is not a stock exchange, and trading of securities quoted on the OTCQB and the OTCBB is often more sporadic than the trading of securities listed on a national stock exchange like NASDAQ. There is no assurance that there will be a sufficient market in our stock, in which case it could be difficult for our stockholders to resell their shares.
Our stock is categorized as a penny stock. Trading of our stock may be restricted by the SEC’s penny stock regulations which may limit a shareholder’s ability to buy and sell our stock.
Our stock is categorized as a penny stock. The SEC has adopted Rule 15g-9 which generally defines “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and accredited investors. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules; the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.
You should be aware that, according to SEC Release No. 34-29093, the market for “penny stocks” has suffered in recent years from patterns of fraud and abuse. Such patterns include (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our securities. The occurrence of these patterns or practices could increase the future volatility of our share price.
FINRA sales practice requirements may also limit a shareholder’s ability to buy and sell our stock.
In addition to the “penny stock” rules described above, the Financial Industry Regulatory Authority (“FINRA”) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
Our principal stockholders own a large percentage of our voting stock after this offering, which will allow them to control substantially all matters requiring stockholder approval.
Currently, our executive officers, directors, and principal stockholders and their affiliates own approximately 28.08% of our outstanding common stock. If these stockholders act together, and our principal stockholders and their affiliates by themselves, they would be able to elect our Board of Directors (our “Board”) and control all other matters requiring approval by stockholders, including the approval of mergers, going private transactions, and other extraordinary transactions, as well as the terms of any of these transactions. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could in turn have an adverse effect on the market price of our common stock or prevent our stockholders from realizing a premium over the then-prevailing market price for their shares of common stock.
The public sale of our common stock by existing stockholders could adversely affect the price of our common stock.
As of May 2, 2014, we have a total of 72,554,173 shares of common stock outstanding.
| ● | 24,972,513 of such total shares are freely tradable in the public market, should one develop and be maintained. |
| | |
| ● | 2,497,992 of such freely tradable shares have been placed into an escrow that expires on June 30, 2014. Thereafter, those shares may be sold in the public market, should one develop and be maintained. |
| | |
| ● | The remaining 47,581,660 shares constitute “restricted securities” and may be sold in the public market only if they have been registered or if they qualify for an exemption from registration under Rule 144 of the Securities Act. |
| ● | On January 16, 2014, our registration statement to register the resale of approximately 7,537,949 shares of our common stock was declared effective by the SEC. Such shares represent the shares sold and issued in connection with the Merger-related private placement. As of the Effective Date, the restricted securities became eligible to be sold in the public market. |
| | |
| ● | We have agreed to file a separate registration statement with the SEC to register the resale of 1,620,000 of such restricted securities and to use our reasonable best efforts to have it declared effective by the SEC. Such shares represent the shares of common stock that were sold and issued in connection with the private placement of our common stock in November 2013 (the “November 2013 Private Placement”) in a separate registration statement. The effectiveness of such registration statement would result in such shares becoming eligible to be sold in the public market. |
| | |
| ● | 39,180,652 of such shares represent the shares of Ener-Core Power that were outstanding prior to the Merger-related private placement and exchanged for a like number of shares of our common stock in the Merger. Commencing July 10, 2014, such shares will be eligible to be sold in the public market, subject to certain limitations, under Rule 144 under the Securities Act. |
Even if an orderly public market were to be sustained, the market price of our common stock could thereafter decline as a result of sales by our existing stockholders in the timeframes described above, or even by the perception that these sales will occur. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
The indemnification rights provided to our directors, officers and employees may result in substantial expenditures by the Company and may discourage lawsuits against its directors, officers, and employees.
Our Amended and Restated Articles of Incorporation and bylaws contain provisions permitting us to enter into indemnification agreements with our directors, officers, and employees. We also have contractual obligations to provide such indemnification protection to the extent not covered by directors and officers’ liability insurance. The foregoing indemnification obligations could result in the Company incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. These provisions and resultant costs may also discourage us from bringing a lawsuit against our directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit us and our stockholders.
To date, we have not paid any cash dividends and no cash dividends will be paid in the foreseeable future.
We do not currently anticipate paying cash dividends on our common stock in the foreseeable future and we may not have sufficient funds legally available to pay dividends. Even if the funds are legally available for distribution, we may nevertheless decide not to pay any dividends. We presently intend to retain all earnings for our operations.
We may be required to raise additional financing by issuing new securities, which may have terms or rights superior to those of our shares of common stock, which could adversely affect the market price (if any) of our shares of common stock and our business. Further, if we issue additional securities in the future, it could result in the dilution of our existing stockholders.
Our Amended and Restated Articles of Incorporation authorizes the issuance of up to 200,000,000 shares of common stock with a par value of $0.0001 per share, and 50,000,000 shares of preferred stock with a par value of $0.0001 per share. Our Board may choose to issue some or all of such shares to acquire one or more companies or properties and to fund our overhead and general operating requirements. The issuance of any such shares may reduce the book value per share and may contribute to a reduction in the market price (if any) of the outstanding shares of our common stock or preferred stock. If we issue any such additional shares, such issuance could reduce the proportionate ownership and voting power of all current stockholders. Further, such issuance may result in a change of control of our Company.
We and our security holders are not subject to some reporting requirements applicable to most public companies; therefore, investors may have less information on which to base an investment decision.
We do not have a class of securities registered under Section 12(b) or 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, we do not prepare proxy or information statements in accordance with Section 14(a) of the Exchange Act with respect to matters submitted to the vote of our security holders. Our officers, directors and beneficial owners of more than 10% of our common stock are not required to file statements of beneficial ownership on SEC Forms 3, 4 and 5 pursuant to Section 16 of the Exchange Act and beneficial owners of more than 5% of our outstanding common stock are not required to file reports on SEC Schedules 13D or 13G. Therefore, investors in our securities will not have any such information available in making an investment decision.
Risks Related to the April 2014 Private Placement
We are registering an aggregate of 16,369,254 shares of common stock in connection with the November 2013 Private Placement and the April 2014 Private Placement. The sales of such shares, or the perception that such sales could occur, could depress the market price of our common stock.
We are registering an aggregate of 16,369,254 shares of common stock under a separate registration statement to be filed with the SEC as follows:
| ● | 1,620,000 shares in connection with the November 2013 Private Placement, including 120,000 shares underlying the warrant issued to the placement agent (the “November 2013 Warrant”); and |
| | |
| ● | 14,749,254 shares in connection with the April 2014 Private Placement, which may be obtained upon conversion on the Notes and exercise of the Warrants, including 3,823,881 shares that are being registered per the terms of the registration rights agreement, which requires to us to register for resale 135% of the number of shares issuable under the Notes and Warrants to cover shares that we may be required to issue as a result of the anti-dilution and other provisions of the Notes and Warrants. |
The 16,369,254 shares represent approximately 18.4% of our shares of common stock outstanding as of the date of this prospectus. The sale of these shares into the public market or the perception that such sales could occur could depress the market price of our common stock. If there are more shares of common stock offered for sale than buyers are willing to purchase, then the market price of our common stock may decline to a market price at which buyers are willing to purchase the offered shares of common stock and sellers remain willing to sell the shares. A decrease in the price of our stock could adversely impact your ability to sell the shares of common stock offered under this prospectus.
Pursuant to the terms of the April 2014 Private Placement, the occurrence of certain events may require us to pay cash to holders of the Notes, and we may not have sufficient working capital to make such cash payments.
Upon the occurrence of certain events, including but not limited to the following, we may be required to make a payment in cash to the holders of the Notes and Warrants:
| ● | upon maturity of the Notes, if not otherwise redeemed or converted; |
| ● | upon a change in control (as defined in the Notes); |
| ● | upon an events of default (as defined in the Notes), including our failure to pay any amount of principal, default interest, late charges or other amounts when due, after applicable cure periods; |
| ● | if shares issuable upon conversion of the Notes or exercise of the Warrants are not registered for resale on an effective registration statement or are otherwise not freely tradable under any state or federal securities laws; and |
| ● | our failure to issue shares of common stock upon conversion of the Notes or upon exercise of the Warrants on a timely basis. |
We may not have sufficient working capital to make such cash payments, or to the extent we are able to make such cash payments, it will reduce the amount of working capital we have to operate our business.
Anti-dilution and other provisions in the Notes and the Warrants may also adversely affect our stock price or our ability to raise additional financing.
The Notes and Warrants contain anti-dilution provisions that provide for adjustment of the Conversion Price and the Exercise Price under certain circumstances. If we issue or sell shares of our common stock, or securities convertible into our common stock, at prices below the Conversion Price or Exercise Price, as applicable, the Conversion Price and the Exercise Price will be reduced and the number of shares issuable under the Warrants will be increased. The amount of such adjustment if any, will be determined pursuant to a formula specified in the Notes and the Warrants and will depend on the number of shares issued and the offering price of the subsequent issuance of securities. Adjustments to the Notes and Warrants pursuant to these anti-dilution provisions may result in significant dilution to our existing stockholders and may adversely affect the market price of our common stock. The anti-dilution provisions may also limit our ability to obtain additional financing on terms favorable to us.
Moreover, we may not realize any cash proceeds from the exercise of the Warrants. A holder of Warrants may opt for a cashless exercise of all or part of the Warrants under certain circumstances. In a cashless exercise, the holder of a Warrant would make no cash payment to us, and would receive a number of shares of our common stock having an aggregate value equal to the excess of the then-current market price of the shares of our common stock issuable upon exercise of the Warrant over the exercise price of the Warrant. Such an issuance of common stock would be immediately dilutive to other stockholders.
The gross amount of funds realized under the April 2014 Private Placement may be affected by the requirement that a portion of the purchase price be maintained in restricted bank accounts controlled by the Collateral Agent, as well as the limitation on the percentage of beneficial ownership by the holders.
57.143% of each investor’s purchase price for its Notes and Warrants is placed into a restricted bank account in our name but controlled by the Collateral Agent. Such restricted funds will be applied to pay any redemption or other payment due under the applicable Note to the applicable holder from time to time. A portion of such restricted funds will be released to us at any time there is no equity conditions failure (as defined in the Notes), and the balance in the restricted account exceeds the principal of the applicable Note then outstanding.
In addition, under the terms of the April 2014 SPA, the number of shares a holder, together with its affiliates, is able to beneficially own at any given time is limited to 4.99% of our total common stock then outstanding. If a holder’s beneficial ownership reaches the 4.99% limit, it will not be able to convert any remaining portion of its Note or exercise its Warrant until such time that it sells enough shares to reduce its ownership percentage.
These restrictions could limit the amount of proceeds we expect to realize from the April 2014 Private Placement. If we realize less than the aggregate full purchase price of the investors, it will have a material adverse effect on our financial position, cash flows and our ability to continue operating as a going concern.
Some of the statements contained in this prospectus are forward-looking statements, including, in particular, statements about our plans, strategies and prospects, objectives, expectations, intentions, adequacy of resources, and industry estimates. These statements identify prospective information and include words such as “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects” and similar expressions.
Forward-looking statements are based on information available to us as of the date of this prospectus. Current expectations, forecasts and assumptions involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated by these forward-looking statements. We caution you therefore that you should not rely on any of these forward-looking statements as statement of historical fact or as guarantees of future performance. These forward-looking statements should not be relied upon as representing our views as of any subsequent date, and we undertake no obligation to update forward-looking statements to reflect events or circumstances after the date they were made.
Factors that could cause actual results to differ materially from those expressed or implied by forward-looking statements include, but are not limited to our expectations regarding results of operations, our ability to expand our market penetration, our ability to expand our distribution channels, customer acceptance of our products, our ability to meet the expectations of our customers, product demand and revenue, cash flows, product gross margins, our expectations to continue to develop new products and enhance existing products, our expectations regarding the amount of our research and development expenses, our expectations relating to our selling, general and administrative expenses, our efforts to achieve additional operating efficiencies and to review and improve our business systems and cost structure, our expectations to continue investing in technology, resources and infrastructure, our expectations concerning the availability of products from suppliers and contract manufacturers, anticipated product costs and sales prices, our expectations that we have sufficient capital to meet our requirements for at least the next twelve months, our expectations regarding materials and inventory management and other risks described under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations .”
We are registering the shares of common stock covered by this prospectus pursuant to the registration rights granted to the Selling Stockholders in connection with the Merger-related private placement. The Selling Stockholders will receive all of the net proceeds from the sale of the shares of our common stock offered for resale by them under this prospectus. We will not receive any proceeds from the resale of shares of our common stock by the Selling Stockholders covered by this prospectus.
An aggregate of 7,537,949 shares of our common stock may be offered for sale and sold from time to time pursuant to this prospectus by the Selling Stockholders. A description of the transaction in which such shares were issued is set forth in “Business - Our History” below.
The term “Selling Stockholders” includes the stockholders listed below and their pledgees, assignees or other successors-in-interest. We have agreed to register all of the shares offered hereby for resale by the Selling Stockholders under the Securities Act and to pay all of the expenses in connection with such registration and the sale of the shares, other than selling commissions and the fees and expenses of counsel and other advisors to the Selling Stockholders. Information concerning the Selling Stockholders may change from time to time, and any changed information will be set forth if and when required in prospectus supplements or other appropriate forms permitted to be used by the SEC.
Except as disclosed under this prospectus, none of the Selling Stockholders has held a position or office or had a material relationship with us within the past three years other than as a result of the ownership of our common stock or other securities.
The following table sets forth, for each of the Selling Stockholders to the extent known by us, the number of shares of our common stock beneficially owned, the number of shares of our common stock offered hereby and the number of shares and percentage of outstanding common stock to be owned after completion of this offering, assuming all shares offered hereby are sold.
Unless otherwise indicated, the Selling Stockholders have sole voting and investment power with respect to their shares of common stock. All of the information contained in the table below is based upon information provided to us by the Selling Stockholders, and we have not independently verified this information. The Selling Stockholders may have sold, transferred or otherwise disposed of, or may sell, transfer or otherwise dispose of, at any time or from time to time since the date on which it provided the information regarding the shares beneficially owned, all or a portion of the shares beneficially owned in transactions exempt from the registration requirements of the Securities Act.
The number of shares outstanding and the percentages of beneficial ownership are based on 72,554,173 shares of common stock outstanding as of May 2, 2014.
For the purposes of the following table, the number of shares of our common stock beneficially owned, has been determined in accordance with Rule 13d-3 under the Exchange Act and such information is not necessarily indicative of beneficial ownership for any other purpose. Under Rule 13d-3, beneficial ownership includes any shares as to which a selling stockholder has sole or shared voting power or investment power and also any shares which that selling stockholder has the right to acquire within 60 days of the date of this prospectus through the exercise of any stock option, restricted stock unit, warrant or other rights.
| | | Shares of common stock Beneficially Owned Prior to this Offering | | | | | | Shares of common stock Beneficially Owned After this Offering | |
| Name of Holder | | Number of Shares Owned Prior to this Offering | | | % of Outstanding Shares (1) | | | Number of Offered Shares | | | Number of Shares Beneficially Owned after the Offering (2) | | | % of Outstanding Shares (1) | |
| Aleksandar Jovanovic | | | 133,333 | | | | * | | | | 133,333 | (20) | | | - | | | | - | |
| Barry Rooth | | | 40,000 | | | | * | | | | 40,000 | (21) | | | - | | | | - | |
| BTG Investments LLC | | | 133,334 | (3) | | | * | | | | 133,334 | (20) | | | - | | | | - | |
| Blue Ox Capital, LLC | | | 333,333 | (4) | | | * | | | | 333,333 | (20) | | | - | | | | - | |
| Cobrador Multi Strategy Partners, LP | | | 66,666 | (5) | | | * | | | | 66,666 | (20) | | | - | | | | - | |
| Colorado Financial Services Corporation | | | 52,133 | (6) | | | * | | | | 52,133 | | | | - | | | | - | |
| Colt Ventures, Ltd. | | | 133,333 | (7) | | | * | | | | 133,333 | (20) | | | - | | | | - | |
| Craig Fingold | | | 66,666 | | | | * | | | | 66,666 | (20) | | | - | | | | - | |
| David Gross | | | 100,000 | | | | * | | | | 100,000 | (20) | | | - | | | | - | |
| Delos Investment Management LLC | | | 100,000 | (8) | | | * | | | | 100,000 | (20) | | | - | | | | - | |
| Lennox Capital Management, LP | | | 100,000 | (9) | | | * | | | | 100,000 | (20) | | | - | | | | - | |
| Gary Shapiro | | | 200,000 | | | | * | | | | 200,000 | (20) | | | - | | | | - | |
| Gerard Casale | | | 66,667 | | | | * | | | | 66,667 | (21) | | | - | | | | - | |
| John Weber | | | 13,334 | | | | * | | | | 13,334 | (20) | | | - | | | | - | |
| Joseph and Marla Schwawrtz | | | 66,667 | | | | * | | | | 66,667 | (21) | | | - | | | | - | |
| Kevin K. Leung | | | 133,333 | | | | * | | | | 133,333 | (20) | | | - | | | | - | |
| Khashayar Mokhber and Soheyla Mokhber Family Trust | | | 13,333 | (10) | | | * | | | | 13,333 | (20) | | | - | | | | - | |
| Lawrence M. Richman MD, Inc., Profit Sharing Trust dated 01/01/1992 | | | 133,333 | (11) | | | * | | | | 133,333 | (20) | | | - | | | | - | |
| Lion Gate Capital | | | 266,666 | (12) | | | * | | | | 266,666 | (20) | | | - | | | | - | |
| Mark Mays | | | 66,700 | | | | * | | | | 66,700 | (20) | | | - | | | | - | |
| Michael and Sonja Ogrizovich | | | 100,000 | | | | * | | | | 100,000 | (21) | | | - | | | | - | |
| Michael Stone | | | 400,000 | | | | * | | | | 400,000 | (20) | | | - | | | | - | |
| Paul Rosenberg | | | 66,666 | | | | * | | | | 66,666 | (20) | | | - | | | | - | |
| Perry Theodoros | | | 40,000 | | | | * | | | | 40,000 | (21) | | | - | | | | - | |
| Peter Geddes | | | 3,409,997 | | | | 4.69 | % | | | 133,333 | (20) | | | 3,276,664 | | | | 4.51 | % |
| American Investment Group, LLC | | | 333,333 | (13) | | | * | | | | 333,333 | (20) | | | - | | | | - | |
| Roth Capital Partners | | | 458,954 | (14) | | | * | | | | 458,954 | | | | - | | | | - | |
| SAIL Pre-Exit Acceleration Fund, LP | | | 1,318,109 | (15) | | | 1.81 | % | | | 1,318,109 | (20) | | | - | | | | - | |
| SAIL Sustainable Louisiana II, LP | | | 133,333 | (22) | | | * | * | | | 133,333 | (20) | | | - | | | | - | |
| SAIL Ventures Partners, II, LP | | | 18,053,879 | (23) | | | 24.88 | % | | | 415,224 | (20) | | | 17,638,655 | | | | 24.31 | % |
| Soheil and Kathy Rabbani Trust | | | 200,000 | (16) | | | * | | | | 200,000 | (20) | | | - | | | | - | |
| Stanley Silver | | | 133,333 | | | | * | | | | 133,333 | (20) | | | - | | | | - | |
| Steve Arnold | | | 40,000 | | | | * | | | | 40,000 | (20) | | | - | | | | - | |
| Sub LP | | | 1,333,333 | (17) | | | 1.84 | % | | | 1,333,333 | (20) | | | - | | | | - | |
| Susan Richards | | | 33,334 | | | | * | | | | 33,334 | (20) | | | - | | | | - | |
| Theodore D. Roth | | | 13,500 | (18) | | | * | | | | 13,500 | (20) | | | - | | | | - | |
| Thomas S. Bridges Revocable Trust | | | 100,000 | (19) | | | * | | | | 100,000 | (20) | | | - | | | | - | |
| William Shamlian | | | 66,666 | | | | * | | | | 66,666 | (20) | | | - | | | | - | |
| * | Less than one percent of the total number of shares of common outstanding. |
| | (1) | Based on 72,554,173 shares of common stock outstanding as of May 2, 2014. |
| | (2) | Assumes the sale of all shares of common stock offered by this prospectus. |
| | (3) | Donald Skrdlant is the Vice President, Finance and has voting and dispositive power over these shares. Mr. Skrdlant disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (4) | Oded Levy is the Managing Member and has voting and dispositive power over these shares. Mr. Levy disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (5) | David E. Graber is the Managing Principal and has voting and dispositive power over these shares. Mr. Graber disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (6) | Represents warrants to purchase 52,133 shares of common stock, received as compensation for services as a non-exclusive placement agent for the Company in connection with private placement of common stock in July 2013, for which compensation included a warrant to purchase 32,400 shares (see also note 20 below) and in August 2013, for which compensation included a warrant to purchase 19,733 shares (see also note 21 below). This selling stockholder is a broker-dealer. Chester Hebert is the Chief Executive Officer and has voting and dispositive power over these shares. Mr. Hebert disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (7) | Darren Blanton is the Managing Partner and has voting and dispositive power over these shares. Mr. Blanton disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (8) | Brian Ladin is the Member and has voting and dispositive power over these shares. Mr. Ladin disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (9) | Ted Hoffman is the Principal and has voting and dispositive power over these shares. Mr. Hoffman disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (10) | Kashayar Mokhber is the Trustee and has voting and dispositive power over these shares. Mr. Mokhber disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (11) | Lawrence M. Richman is the Trustee and has voting and dispositive power over these shares. Mr. Richman disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (12) | Kenneth Rickel is the President and has voting and dispositive power over these shares. Mr. Rickel disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (13) | Rami Rostami is the President and has voting and dispositive power over these shares. Mr. Rostami disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (14) | Represents a warrant to purchase 458,954 shares of common stock, received as compensation for services as financial advisor, placement agent and underwriter for the Company in connection with private placement of common stock in July 2013, for which compensation included a warrant to purchase 442,287 shares (see also note 20 below) and in August 2013, for which compensation included a warrant to purchase 16,667 shares (see also note 21 below). This selling stockholder is a broker-dealer. Bob Stephenson is the Managing Director and has voting and dispositive power over these shares. Mr. Stephenson disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (15) | SAIL Capital Management, LLC (“Sail Capital Management”) is the managing member of SAIL Capital Partners, LLC, which, in turn, is the general partner of this Selling Stockholder. The managing members of SAIL Capital Management are Mr. F. Henry Habicht (“Mr. Habicht”) and Mr. Walter Schindler (“Mr. Schindler”). As such, each of Sail Capital Management, Sail Capital Partners, LLC, Mr. Habicht and Mr. Schindler may be deemed to have shared voting and investment power in respect of the shares of common stock owned of record or beneficially by this Selling Stockholder. Sail Capital Management, Sail Sustainable Partners of Louisiana, LLC, Mr. Habicht and Mr. Schindler each disclaim beneficial ownership thereof except to the extent of each of their pecuniary interests therein. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Related Party Transactions,” “Security Ownership of Certain Beneficial Owners and Management” and “Certain Relationships and Related Transactions; Director Independence” for disclosures concerning our relationship with the Selling Stockholder. |
| | (16) | Soheil Rabbani is the Manager and has voting and dispositive power over these shares. Mr. Rabbani disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (17) | Scott Greenberg is the Manager of General Partner and has voting and dispositive power over these shares. Mr. Greenberg disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (18) | This Selling Stockholder is an affiliate of a broker-dealer as President of Roth Capital Partners (see note 14 above). The shares were purchased in the ordinary course of business and at the time of purchase, the Selling Stockholder had no agreements or understandings, directly or indirectly, with any person to distribute the shares. |
| | (19) | Thomas Bridges is the Trustee and has voting and dispositive power over these shares. Mr. Bridges disclaims beneficial ownership thereof except to the extent of his pecuniary interests therein. |
| | (20) | Shares acquired in connection with the Merger-related private placement of our common stock in July 2013. |
| | (21) | Shares acquired in connection with the private placement of our common stock in August 2013. |
| | | |
| | (22) | SAIL Capital Management is the managing member of SAIL Sustainable Partners of Louisiana, LLC, which, in turn, is the general partner of this Selling Stockholder. The managing members of Sail Capital Management are Mr. Habicht and Mr. Schindler. As such, each of Sail Capital Management, SAIL Sustainable Partners of Louisiana, LLC, Mr. Habicht and Mr. Schindler may be deemed to have shared voting and investment power in respect of the shares of common stock owned of record or beneficially by this Selling Stockholder. SAIL Capital Management, Sail Sustainable Partners of Louisiana, LLC, Mr. Habicht and Mr. Schindler each disclaim beneficial ownership thereof except to the extent of each of their pecuniary interests therein. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Related Party Transactions,” “Security Ownership of Certain Beneficial Owners and Management” and “Certain Relationships and Related Transactions; Director Independence” for disclosures concerning our relationship with the Selling Stockholder. |
| | | |
| | (23) | Michael J. Hammons is a partner of SAIL Venture Partners II, LLC, the general partner of this Selling Stockholder, and, as such, each of Mr. Hammons and SAIL Venture Partners II, LLC may be deemed to have shared voting and investment power in respect of the shares of common stock owned of record or beneficially by this Selling Stockholder. The amount of shares beneficially owned includes 18,053,879 shares, of which 781,401 are 10 month options (expiring April 30, 2014), to acquire additional shares of our restricted common stock from one or more of our shareholders. SAIL Venture Partners II, LLC and Mr. Hammons disclaim beneficial ownership thereof except to the extent of each of their pecuniary interests therein. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Related Party Transactions,” “Security Ownership of Certain Beneficial Owners and Management” and “Certain Relationships and Related Transactions; Director Independence” for disclosures concerning our relationship with the Selling Stockholder. |
Each Selling Stockholder and any of their pledgees, assignees and successors-in-interest may, from time to time, sell any or all of their securities covered hereby on the OTC Bulletin Board, the OTC Markets Group, Inc.’s OTCQB tier, or any other stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. A Selling Stockholder may use any one or more of the following methods when selling shares:
| ● | ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers; |
| ● | block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; |
| ● | purchases by a broker-dealer as principal and resale by the broker-dealer for its account; |
| ● | an exchange distribution in accordance with the rules of the applicable exchange; |
| ● | privately negotiated transactions; |
| ● | settlement of short sales; |
| ● | in transactions through broker-dealers that agree with the Selling Stockholders to sell a specified number of such shares at a stipulated price per share; |
| ● | through the writing or settlement of options or other hedging transactions, whether through an options exchange or otherwise; |
| ● | a combination of any such methods of sale; or |
| ● | any other method permitted pursuant to applicable law. |
The Selling Stockholders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus.
Broker-dealers engaged by the Selling Stockholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the Selling Stockholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated, but, except as set forth in a supplement to this prospectus, in the case of an agency transaction not in excess of a customary brokerage commission in compliance with NASD Rule 2440 of the Financial Industry Regulatory Authority (“FINRA”); and in the case of a principal transaction a markup or markdown in compliance with FINRA’s NASD IM-2440.
In connection with the sale of the common stock or interests therein, the Selling Stockholders may enter into hedging transactions with broker-dealers or other financial institutions, which may in turn engage in short sales of the common stock in the course of hedging the positions they assume. The Selling Stockholders may also sell shares of the common stock short and deliver these securities to close out their short positions, or loan or pledge the common stock to broker-dealers that in turn may sell these securities. The Selling Stockholders may also enter into option or other transactions with broker-dealers or other financial institutions or create one or more derivative securities which require the delivery to such broker-dealer or other financial institution of shares offered by this prospectus, which shares such broker-dealer or other financial institution may resell pursuant to this prospectus (as supplemented or amended to reflect such transaction).
The Selling Stockholders and any broker dealers or agents that are involved in selling the shares may be deemed to be “underwriters” within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Each Selling Stockholder has informed the Company that it does not have any written or oral agreement or understanding, directly or indirectly, with any person to distribute the common stock.
The Company is required to pay certain fees and expenses incurred by the Company incident to the registration of the shares, including SEC filing fees. The Company has agreed to indemnify the Selling Stockholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act.
Because the Selling Stockholders may be deemed to be “underwriters” within the meaning of the Securities Act, they will be subject to the prospectus delivery requirements of the Securities Act including Rule 172 thereunder. In addition, any securities covered by this prospectus which qualify for sale pursuant to Rule 144 under the Securities Act may be sold under Rule 144 rather than under this prospectus. Each Selling Stockholder has advised us that there is no underwriter or coordinating broker acting in connection with the proposed sale of the common stock by the Selling Stockholders.
The Company agreed to keep this prospectus effective for not less than 90 days, unless all of the shares are resold by the Selling Stockholders prior to such date. The shares registered hereunder will be sold only through registered or licensed brokers or dealers if required under applicable state securities laws. In addition, in certain states, such shares may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with.
Under applicable rules and regulations under the Exchange Act, any person engaged in the distribution of the shares registered hereunder may not simultaneously engage in market making activities with respect to the common stock for the applicable restricted period, as defined in Regulation M, prior to the commencement of the distribution. In addition, the Selling Stockholders will be subject to applicable provisions of the Exchange Act and the rules and regulations thereunder, including Regulation M, which may limit the timing of purchases and sales of shares of the common stock by the Selling Stockholders or any other person. The Company will make copies of this prospectus available to the Selling Stockholders and have informed them of the need to deliver a copy of this prospectus to each purchaser at or prior to the time of the sale, except where there is an exemption from such delivery requirements under applicable securities laws.
The validity of the common stock offered in this prospectus will be passed upon for us by LKP Global Law, LLP, at 1901 Avenue of the Stars, Suite 480, Los Angeles, California 90067. As of May 2, 2014, LKP Global Law, LLP and/or certain of its principals holds Ener-Core’s common stock.
The consolidated financial statements appearing in this prospectus for the period ended December 31, 2013, have been audited by Kelly & Company, independent registered public accounting firm, as set forth in their report appearing in this prospectus, and are included in reliance upon such report given on the authority of said firm as experts in auditing and accounting.
Our History
Edan Prabhu began developing a solution to convert low-quality waste gases into electricity in 1999, first through FlexEnergy International, LLC, a California limited liability company, and then through FlexEnergy, Inc., a California corporation. In 2008, Mr. Prabhu and his team began development of the Gradual Oxidizer. In April 2008, the California corporation was converted into a Delaware limited liability company known as FlexEnergy, LLC, which, in turn, was converted into FlexEnergy, Inc., a Delaware corporation (“FlexEnergy” or “Predecessor”).
On December 31, 2010, FlexEnergy acquired selected assets and liabilities of Ingersoll-Rand’s Energy Systems division, including the MT250 gas turbine and manufacturing facility in Portsmouth, New Hampshire. During 2010 and 2011, the FP250 (which combines our Gradual Oxidizer with the MT250) reached significant development milestones. FlexEnergy began developing an FP250 sales pipeline and a final commercial product. In 2012, following a change in management, FlexEnergy changed its direction, primarily to focus on turbine sales for the oil and gas industry. Gradual Oxidizer marketing and FP250 sales efforts were deemphasized, although the engineering team took final steps towards technical completion and operational testing and validation of the product.
After operating as a combined company for the entire 2011, following the Ingersoll-Rand acquisition, and continuing through much of 2012, FlexEnergy’s management and board of directors decided to separate the turbine and Gradual Oxidizer businesses. To that end, effective November 12, 2012, FlexEnergy (i) transferred all of its Gradual Oxidizer assets (including intellectual property) and liabilities to Ener-Core Power (then known as “Flex Power Generation, Inc.”), and then (ii) “spun off” (the “spin-off”) Ener-Core Power. Ener-Core Power was incorporated on July 31, 2012, as a Delaware corporation under the name “Flex Power Generation, Inc.” Prior to November 12, 2012, however, Ener-Core Power did not operate as a separate legal entity.
In connection with the spin-off, Ener-Core Power (then as Flex Power Generation, Inc.) and various other parties entered into a variety of related agreements, as described below:
| ● | Contribution Agreement dated November 12, 2012, among FlexEnergy, its other wholly-owned subsidiary (FlexEnergy Energy Systems, Inc. “FEES”), and Ener-Core Power (the “Contribution Agreement”), and a related side letter. These are the agreements that documented the spin-off and the transfer to Ener-Core Power of the Gradual Oxidizer assets and the related intellectual property, as well as certain related liabilities. In that context, Ener-Core Power granted to FlexEnergy and its subsidiary (for use in their micro-turbine business only) a worldwide, royalty-free, fully paid up right and license to use on a non-exclusive basis (a) controls-related intellectual property that had been transferred in the spin-off, to the extent that it had been used in FlexEnergy’s micro-turbine business as of the date of the spin-off, and (b) certain other controls-related intellectual property developed, invented, or otherwise derived by FlexEnergy (or its affiliates) as “dual-use technology” for use in both FlexEnergy’s micro-turbine business and Ener-Core Power’s oxidizer business. The Contribution Agreement also provided that FlexEnergy and its subsidiary would supply Ener-Core Power and its affiliates with certain micro-turbines, for a three-year period, at the lowest price at which FlexEnergy had sold such or similar products in the immediately preceding six-month period to its other customers that had ordered similar quantities and had similar credit ratings/risks, provided that FlexEnergy could additionally charge Ener-Core Power at generally applicable rates for any special engineering or product specialization required for such sales. |
| | |
| ● | Restructuring Agreement dated November 12, 2012 with Ener-Core Power and various parties that owned a majority of its then-issued and outstanding capital stock (the “Restructuring Agreement”), which (in connection with the spin-off) documented the relative ownership of the capital stock among the various stockholders that held a majority of Ener-Core’s post-spin-off capital stock. |
| | |
| ● | Stockholders Agreement dated November 12, 2012 with Ener-Core Power and various stockholders, who are signatories thereto, which terminated as of the closing of the Merger, set forth certain of the rights and obligations of the various significant stockholders of Ener-Core Power. |
On April 16, 2013, Ener-Core Power entered into an Agreement and Plan of Merger, dated April 16, 2013, as amended June 4, 2013 (the “Merger Agreement”), with Ener-Core and its wholly owned subsidiary, the merger sub, in contemplation of the Merger whereby:
| ● | The merger sub would merge with and into Ener-Core Power, with Ener-Core Power as the surviving entity; |
| | |
| ● | Each share of Ener-Core Power’s common stock outstanding immediately prior to the closing of the Merger (excluding any treasury shares and shares held by Ener-Core, the merger sub or any dissenting stockholders) would convert into the right to receive one share of Ener-Core’s common stock; and |
Ener-Core was incorporated on April 29, 2010, as a Nevada corporation under the name “Inventtech Inc.” Prior to the Merger, it was focused on the development and marketing of a web-based, school peer-to-peer chat software. In contemplation of the Merger, Ener-Core:
| ● | Filed an Amended and Restated Articles of Incorporation on April 23, 2013, to change its name to Ener-Core, Inc., and to increase its total number of authorized common stock from 100,000,000 to 200,000,000; and |
| | |
| ● | Effectuated a 30-for-1 forward stock split of its issued and outstanding common stock on May 6, 2013, by way of a stock dividend. |
On July 1, 2013, the Merger closed, and Ener-Core issued 45,692,103 shares of its common stock to the then stockholders of Ener-Core Power in the aggregate, in one-for-one exchange for their shares of common stock of Ener-Core Power. As such stockholders of Ener-Core Power hold the majority of Ener-Core’s outstanding common stock after the Merger and the management of Ener-Core Power is now Ener-Core’s management, the transaction is accounted for as a “reverse merger.” Immediately prior to the closing of the transactions contemplated by the Merger Agreement, Ener-Core was a “shell company,” as defined in Rule 12b-2 of the Exchange Act. As the result of the completion of the Merger, Ener-Core is no longer a shell company.
In connection with the Merger, Ener-Core raised approximately $4.96 million (consisting of approximately $4.288 million in new equity and approximately $0.672 million in conversion of debt previously in favor of Ener-Core Power’s largest stockholder group), through the sale and issuance of approximately 6.6 million shares of its common stock at $0.75 per share (the “Merger-related private placement”). In connection therewith, Ener-Core Power entered into a Registration Rights Agreement with the parties to the Merger-related private placement, to file a registration statement on Form S-1 to register for resale the shares of common stock that such persons would be issued in the Merger in exchange for the shares of Ener-Core that they purchased in the Merger-related private placement. The Registration Rights Agreement requires the registration statement to be filed within six months of the closing of the Merger and reasonable best efforts to have it declared effective by the SEC.
The Registration Rights Agreement also provides for standard inclusion cut-backs upon the occurrence of certain limited events. Further, under certain circumstances, the filing or effectiveness of the registration statement may be postponed if such registration would (i) materially interfere with a subsequent financing or a significant acquisition, corporate reorganization, or other similar transaction; (ii) require premature disclosure of material information for which a bona fide business purpose for preserving as confidential exists; (iii) render an inability to comply with requirements under the Securities Act or the Exchange Act; (iv) require audited financial statements as of a date other than Ener-Core Power’s fiscal year end; (v) require the preparation of pro forma financial statements that are required to be included in a registration statement; or (vi) have a material adverse effect on Ener-Core Power. Finally, no additional securities (other than securities that may be issued on a one-time basis after the closing of the Merger) may be included, and no other registration statement may be filed, until the registration statement required by the Registration Rights Agreement has been filed with, and declared effective by, the SEC. The exceptions to such prohibition are limited to shelf registration statements on Form S-3 for primary offerings or registration statements on Form S-4 or Form S-8.
Concurrently on July 1, 2013, Ener-Core entered into an escrow agreement with five persons, who collectively hold 5,000,000 shares of its common stock, or approximately 7.07% of its post-Merger issued and outstanding shares. The escrow terminates on the first anniversary of the closing of the Merger. However, if, prior to such anniversary, Ener-Core is liquidated or is a party to a merger, stock exchange, or other similar transaction that results in its stockholders having the right to exchange their shares of common stock for cash, securities, or other property, then, upon the occurrence of such transaction, the escrowed shares shall be released from the escrow.
In July and August 2013, we sold and issued 413,333 shares of our common stock at $0.75 per share to six accredited investors, for which we received gross proceeds of approximately $300,000 (the “August 2013 Private Placement”). In November 2013, we sold and issued 1,500,000 shares of our common stock at $1.00 per share to two accredited investors, for which we received gross proceeds of approximately $1.5 million (the “November 2013 Private Placement”).
April 2014 Private Placement
On April 15, 2014, we entered into the following agreements with five institutional and accredited investors in connection with the April 2014 Private Placement:
| ● | The April 2014 SPA by and among Ener-Core and the investors; |
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| ● | The April 2014 RRA by and among Ener-Core and the investors; |
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| ● | The Security Agreement by and among Ener-Core, Ener-Core Power and the investors; and |
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| ● | The Control Agreement between the registrant, the Control Agent and Union Bank, N.A. (the “Bank”). |
The following is a brief description of the terms and conditions of each such agreement, and the transactions contemplated thereunder that are material to us. The terms of the Notes and Warrants are more fully described in “Description of Securities” beginning on page 57.
Pursuant to the April 2014 SPA, we agreed to sell and issue to the investors the Notes and Warrants. At the closing on April 16, 2014 (the “April 2014 Closing”):
| ● | Each investor paid $875 for each $1,000 of principal amount of Notes and Warrants, with $375 of such purchase price remitted to us, and the remaining $500 to the Control Account established by the Control Agreement; and |
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| ● | We issued to the investors Notes with aggregate principal amount of $4,575,000, and Warrants to initially purchase up to an aggregate of 4,097,016 shares of our common stock. |
The April 2014 SPA includes customary representations and warranties by each party thereto. In addition, we agreed:
| ● | To use proceeds received from the investors for general working capital; |
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| ● | To reimburse the lead investor for up to $100,000 in costs and expenses relating to the transactions contemplated under the April 2014 SPA; |
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| ● | Not to file any registration statement (including amendment or supplement thereto), or grant any registration rights to anyone that can be exercised before, all of the securities to be registered under the Registration Rights Agreement can be sold without restriction or limitation pursuant to Rule 144 under the Securities Act, and without the requirement to comply with Rule 144(c)(1), except that we may file a registration statement to issue securities on our own behalf, so long as such registration statement is not declared effective until 30 days after the earlier of (i) the date that all of the Registrable Securities may be sold without restriction or limitation pursuant to Rule 144 for a period of at least 30 uninterrupted days and (ii) the date that all of the Registrable Securities may be sold pursuant to an effective registration statement for at least 30 uninterrupted days (the “Trigger Date”); |
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| ● | Not to offer or sell any of its equity or equity equivalent securities from the April 2014 Closing until the Trigger Date, except that we may enter into solicitations, negotiations or discussions; and |
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| ● | To grant a right of first refusal to the investors to participate in any future sale of the registrant’s equity or equity equivalent securities on a pro rata basis up to 50% of the securities offered in such sale, from the Trigger Date until the two-year anniversary of the Closing. |
The Registration Rights Agreement
Pursuant to the Registration Rights Agreement, the registrant agreed to file a registration statement with the SEC to register the following shares of common stock (collectively the “Registrable Securities”):
| ● | 1,500,000 shares that we previously issued, and 120,000 shares underlying the November 2013 Warrant, with which we have registration obligations; and |
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| ● | 135% of the shares underlying the Notes (the “Conversion Shares”) and the Warrants (the “Warrant Shares”). |
We are required to file the registration statement covering the Registrable Securities within 30 days of a request for registration by holders of a majority of the Registrable Securities, and to have such registration statement declared effective within 90 days of its filing (or 120 days if the registration statement is subject to a full review by the SEC). We must also maintain the effectiveness of the registration statement until the earlier of (a) the date as of which the investors may sell all of their Registrable Securities covered by such registration statement without restriction or limitation pursuant to Rule 144 and without the requirement to be in compliance with Rule 144(c)(1) or (ii) the date on which the investors shall have sold all of their Registrable Securities covered by such registration statement.
If the SEC limits the number of Registrable Securities that can be registered on the registration statement, then the Warrant Shares shall first be excluded from such registration on a pro rata basis among the investors, followed by the Conversion Shares on a pro rata basis among the investors. Also, if the registration statement is not timely filed or declared effective, we will be subject to liquidated damages of 2% of the investors’ aggregate purchase price per month, up to 10%, and pro-rated for partial periods.
The Pledge and Security Agreement
Pursuant to the Pledge and Security Agreement, each of Ener-Core and Ener-Core Power agreed to grant the Collateral Agent, for the benefit of the investors, a security interest of all of its personal property to secure its obligations in connection with the April 2014 Private Placement.
The Special Deposit Account Control Agreement
Pursuant to the Special Deposit Account Control Agreement, we agreed that the Collateral Agent shall have control over the Control Account, and that the Bank shall only be subject to the written instructions of the Collateral Agent with respect to the funds held therein.
Our Products
Our first commercial product, the Ener-Core Powerstation FP250, combines our Gradual Oxidizer technology with a 250 kilowatt gas turbine that was initially developed by Ingersoll-Rand and subsequently enhanced by FlexEnergy. Because our Gradual Oxidizer replaces a turbine’s standard combustor, the FP250 can operate on a gaseous fuel that is much lower in quality, and with fewer emissions than a conventional turbine. After deployment of FP250 development and field test units in 2011-2012, we shipped the first commercial FP250 system on November 14, 2013. However, we cannot provide any assurance that we will receive orders in the future or that, if received, that we will be able to fill them.
On January 2, 2013, we entered into an OEM Supply Agreement with Dresser-Rand, whereby Dresser-Rand agreed to sell us certain of its gas turbines and parts. The KG2 3G/GO, which we are currently developing and which we anticipate to be our next commercial product, is a part of the agreement, whereas we combine our Gradual Oxidizer with a two megawatt gas turbine from Dresser-Rand. Additionally, Dresser-Rand has agreed to provide us with certain training to enable us to resell its turbines, whether packaged by us into our Gradual Oxidizer products or modified or improved by us through application of our proprietary technologies. More specifically, we are entitled to sell the turbines (i) with our designed recuperated and oxidized products on a worldwide basis and (ii) on a stand-alone basis in North America, Europe, and Russia and the countries of the former Soviet Union, and, with the prior written agreement of Dresser-Rand, on a case-by-case basis, in other countries. The agreement initially ends on December 31, 2021, and provides for automatic renewals for additional two-year terms.
We currently anticipate future development of additional commercial systems, integrating our Gradual Oxidizer with larger gas turbines from a select group of manufacturers. Currently, FlexEnergy is a key supplier, providing its MT250 micro-turbine for our Ener-Core Powerstation FP250. As disclosed above, pursuant to the terms of the Contribution Agreement, FlexEnergy and FEES are to supply Ener-Core Power and its affiliates with certain micro-turbines for a three-year period, at the lowest price at which FlexEnergy had sold such or similar products in the immediately preceding six-month period to its other customers that had ordered similar quantities and had similar credit ratings/risks, provided that FlexEnergy could additionally charge Ener-Core Power at generally applicable rates for any special engineering or product specialization required for such sales.
Our Technology
Our Gradual Oxidizer extends a historical trend in engine technology seeking to improve emissions and expand the gaseous fuel operating range. We believe that our approach provides a unique value proposition, by allowing for the extraction of energy from previously unusable fuels, while significantly reducing harmful pollutants and creating useful energy products such as heat and electricity.
We believe that the Gradual Oxidizer is well positioned and we plan to achieve the Lowest Achievable Emission Rate (“LAER”) for several major air pollutants in non-attainment areas and to become Best Available Control Technology (“BACT”) for these pollutants in attainment areas, as determined under the U.S. Environmental Protection Agency (“EPA”) New Source Review program as part of the 1977 Clean Air Act amendments.
Our Gradual Oxidation technology has completed a number of development and deployment milestones in the last several years. In 2012, our technology underwent testing and verification by Southern Research Institute (“SRI”) as part of a U.S. Department of Defense (“DoD”) demonstration program. SRI commissioned the testing, which was performed by Integrity Air Monitoring, Inc., on behalf of SRI. SRI is a not-for-profit 501(c)(3) scientific research organization that conducts advanced research in environmental, energy, and other fields, and we were one of its subcontractors.
The Fort Benning FP250 project was partially funded by the DoD Environmental Security Technology Certification Program, which seeks innovative and cost-effective technologies to address high-priority environmental and energy requirements for the DoD.
As discussed in more detail under “Research and Development” below, we entered into an agreement with SRI in April 2009 to perform all detailed design, fabrication, and site integration procedures for the installation of a Turbine/Thermal Oxidizer demonstration unit. The scope of work also required the Company to commission and start up the demonstration unit including operator and maintenance training. In January 2010 SRI and we amended the agreement, as a result of which we were required to provide two 200kw Flex Powerstations (known as Turbine 1 and Turbine 2) for installation at two DoD locations in the United States. In addition, the amended agreement required us to provide field integration, basic operator and maintenance training, including on-site support for the first year of operation and to maintain, operate, and train the operators of the equipment. We delivered Turbine 1 and installed the equipment in November 2011 and completed the operations and training phase in November 2012. SRI and we subsequently amended the agreement again to provide for us to deliver a second Turbine/Thermal Oxidizer unit and to upgrade the engine of Turbine 1. The amended agreement required the customer to identify a site for the second unit by December 31, 2012. However, a suitable site was not selected and the customer cancelled its order for the second unit.
The Gradual Oxidizer works by replacing a combustion reaction with a chemically similar, but slower chemical oxidation reaction that occurs at lower temperatures than combustion. We offer two system configurations for FP250 (low-quality fuels and ultra-low emissions) depending on specific customer needs.
Low-quality fuels configuration. This configuration is designed for customers intending to generate energy from low-quality fuels, including previously unusable gases, which are typically vented or flared by the industries that produce them. The process steps for our low-quality fuels FP250 configuration are as follows:
● | Fuel gas is mixed with ambient air, diluting the fuel and air mixture to approximately 1.5% concentration of fuel by volume. |
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| ● | The approximately 1.5% fuel and air mixture is compressed through a radial compressor constituting an integral part of 250kW gas turbine. A small amount of the mixture flows through engineered cooling paths in the gas turbine. The mixture is then pre-heated in a high-temperature heat exchanger. |
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| ● | Next, the mixture enters our Gradual Oxidizer, a packed-bed reactor adapted from thermal oxidizer technology. The fuel in the mixture oxidizes, generating heat, and oxidation byproducts (carbon dioxide and water). The Gradual Oxidation process is maintained such that the reaction is hot enough to destroy all carbon monoxide (“CO”), yet cold enough to preclude the formation of oxides of nitrogen (“NOx”). |
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| ● | The hot, pressurized gas exiting the Gradual Oxidizer then expands through the turbine, generating electricity and heat with low emissions that meet the strictest NOx emissions standards, and most other air quality regulatory standards. |
Ultra-low emissions configuration. This configuration is designed for customers intending to meet emissions regulations in areas with significant air quality problems. Generally, installation of new power generating equipment in such areas requires complicated air permitting and compliance with very strict air quality regulations and controls. The process steps for our ultra-low emissions FP250 configuration are as follows:
| ● | Ambient air feeds into the radial compressor of the gas turbine. A small amount of the compressed air flows through engineered cooling paths in the gas turbine. The compressed air then is pre-heated in a high-temperature heat exchanger. At this point, the fuel is injected into such high temperature, compressed and pre-heated air stream, such that approximately 1.5% concentration of fuel by volume is maintained in the mixture. |
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| ● | Next, all of the mixture enters our Gradual Oxidizer. The fuel in the mixture oxidizes, generating heat and oxidation byproducts (carbon dioxide and water). The Gradual Oxidation process is maintained such that the reaction is hot enough to destroy all CO, yet cold enough to preclude the formation of NOx. |
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| ● | The hot, pressurized gas exiting the Gradual Oxidizer then expands through the turbine, generating electricity and heat with ultra-low emissions of NOx, CO, and Volatile Organic Compounds (“VOCs”) that meet even the strictest air quality regulatory standards. |
Advantages of Gradual Oxidation. Gradual Oxidation may provide certain advantages over alternative technologies, including the following:
| ● | Designed to operate on a wider range of fuels. When configured for low-quality fuels, our systems are designed to operate on gas with concentrations as low as 50 Btu/scf (1700 kJ/m3). By comparison, most turbine, engine, and fuel cell systems require fuel quality of significantly higher concentrations. |
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| ● | Less fuel conditioning may be required. When configured for low-quality fuels, our systems are designed to require minimal fuel pre-treatment or conditioning. When configured for ultra-low emissions, we may require some additional fuel conditioning. However, regardless of configuration, our systems are designed to require substantially less fuel pre-treatment than competitive systems. |
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| ● | Lower air emissions. Particularly when configured for ultra-low emissions, our Gradual Oxidizer technology may produce substantially lower emissions of NOx, CO, and VOCs than competitive systems. |
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| ● | No chemicals or catalysts for emissions control. Unlike other emissions control systems, such as selective catalytic reduction, our Gradual Oxidizer does not use chemicals or catalysts and, thus, cannot be rendered inactive from catalyst poisoning. |
Markets
We believe that our Gradual Oxidizer can tap into several available multibillion dollar gas markets worldwide, including landfill and biogas, coal mines, associated petroleum gas, and mainstream power generation markets.
We currently anticipate that our unique low-quality fuels configuration can open up new markets by allowing cost effective power generation from previously wasted or flared gases, all while maintaining low emissions, and that our ultra-low emissions configuration can open up new markets by substantially reducing costs of emission controls, including elimination of chemicals and catalysts, while achieving even lower emissions.
The development and deployment of the KG2-3G/GO will enable operators of this larger powerstation to produce power at significantly lower costs than the electricity produced by the operators of the FP250. We anticipate that this enhanced ability to produce power at lower costs, combined with the product’s appropriate size for larger market applications, will result in a greater demand from the same wide range of markets, and enable Ener-Core to penetrate countries and regions with lower market electricity tariffs and/or less financial incentives for clean power generation.
Landfills and Biogas
Our systems can leverage the currently anticipated worldwide trend toward increasing biogas collection and utilization. In addition to municipal solid waste, we currently anticipate projects from a variety of methane sources, including food, waste water, and animal waste digesters. We currently expect that a majority of our FP250 customers in the next 18 months will come from the landfills gas and biogas market, whereas, we currently anticipate that only a small percentage of our KG2-3G/GO customers in the first 18 months of that product’s availability will come from this market.
In most cases, the solid wastes currently deposited in landfills generate methane for between 25 and 100 years. In many active landfills, a trend towards recycling and the diversion of organic materials is lowering available gas quality. Some operators of existing landfill projects that utilize reciprocating engines and gas turbines for the collection and disposal of landfill-generated gases (“LFGs”) may explore the possibility of a transition to our technology as the fuel quality of those landfill projects decreases to levels below the normal operating range of reciprocating engines and gas turbines. Our low-quality fuel capability allows a greater percentage of the LFGs created from landfill-waste to be used for local electricity generation.
We believe that low NO x emissions and less fuel conditioning provide us with a potential advantage in regions that regulate air emissions and require fuel cleanup. The reduced fuel conditioning requirements of our Gradual Oxidizer systems may also lower overall lifetime operating costs when compared to other technologies.
Coal Mines
We currently expect increased global demand for systems that can convert coal mine methane into electricity. Our systems may be a particularly attractive solution for methane generated in closed or abandoned coal mines, as well as for ventilation air methane (“VAM”). We believe that our systems may provide advantages over other low-quality coal mine methane power generating alternatives, such as integration of a thermal oxidizer and steam turbine, because our Gradual Oxidation system generates electricity directly without the complex design, operation, water usage, and costs associated with a steam turbine.
We currently expect that a small percentage of our FP250 and KG2-3G/GO customers will come from the coal mine market. Currently, when configured for low-quality fuel, our Gradual Oxidizer is designed to dilute fuel gas to 1.5% concentration by volume. In some countries, VAM is currently regulated at levels below 1.5% concentration. Accordingly, our low-quality fuels configuration may require additional development to operate on some VAM sources. If we could develop a version of our Gradual Oxidizer technology that could operate effectively on VAM at levels below 1.5% concentration (as to which successful development there can be no assurance), sales opportunities for the FP250 and the KG2-3G/GO in this market could be enhanced.
Associated Petroleum Gas
We currently anticipate a strong worldwide trend toward the reduction of venting, flaring, and waste of associated petroleum gas, also known as flare gas or associated gas, which is a form of natural gas that is commonly found associated with deposits of petroleum. For example, the Russian Federation has mandates that require beneficial use of associated petroleum gas. We currently expect more restrictive regulations on NO x emissions from power generation in a variety of oil and gas producing countries, such as the Russian Federation and United States. The FP250 and KG2-3G/GO (as anticipated) both destroys harmful pollutants and produces electricity from this currently wasted resource, creating significant cost savings over time. We expect the KG2, when developed, to do the same.
We currently expect that a small percentage of our FP250 customers will come from the associated petroleum gas market; whereas, we currently anticipate that a significant percentage of our KG2-3G/GO customers will come from this market.
Mainstream Power Generation
The Gradual Oxidizer is designed to meet the most stringent emissions regulations, providing a potential advantage over conventional reciprocating engines and gas turbines currently used for mainstream power generation. The Gradual Oxidizer may provide a more cost-effective alternative to upgrading older existing gas-powered generation systems through the use of chemicals, catalysts, and add-on systems to comply with most recent environmental regulations. We currently anticipate a strong worldwide trend towards upgrading and replacing older systems.
Sales, Marketing, and Distribution
The FP250, our first commercial product, is currently available for sale. We have primarily marketed the FP250 for sales through distributors although, in some cases, we will sell the FP250 directly to end users. During the two years prior to the spin-off of Ener-Core Power, the combined FlexEnergy began to develop a sales pipeline for the FP250, while continuing to invest in the technical development of the product and conduct field testing on the equipment to reach reliability targets prior to commercialization. However, the 2012 change in management at the combined FlexEnergy resulted in a de-emphasis of the sales and marketing efforts for Gradual Oxidizer products, including the FP250, pending final reliability tests in the field. Upon the completion of the spin-off in November 2012, the management of Ener-Core Power began to pursue certain of the earlier FP250 customer opportunities. On December 31, 2012, Ener-Core Power received a conditional purchase order from Efficient Energy Conversion Turbo Machinery, B.V. (“EECT”), our distributor in the Netherlands, for one FP250. The condition (the issuance of an irrevocable letter of credit in favor of Ener-Core Power) was met on March 1, 2013 and the purchase order became binding on the customer and on us. On November 14, 2013, we shipped the first commercial FP250 to EECT. Although we generated certain revenue from our agreement with SRI (see “Research and Development” below), the transaction through EECT represents our first and only commercial order of the FP250.
We have completed system layout and analytic models integrating our Gradual Oxidizer with the Dresser Rand two megawatt turbine and have initiated design and development of our next Gradual Oxidation system, the KG2-3G/GO, which we plan to sell through existing and new distributors and, in some cases, directly to end users. Our parts are available through distributors and directly to end users.
In developing our sales opportunities, we have focused on vertical markets that we have identified as having the greatest near-term potential. In addition, we have identified the need to address various local requirements, which include fuel supply characteristics, electric grid interconnection standards, gas utility connection requirements, air quality regulations, and availability and pricing of power purchase agreements. The costs and scheduling ramifications of these various requirements can be significant to the completion of an installation. Our goal is to work with customers and applicable regulatory agencies to minimize the cost and timing of each installation.
North America
In North America, we are focused on opportunities where our low-quality fuels configuration and our ultra-low emissions configuration may provide competitive advantages.
For our low-quality fuels configuration, we have identified several opportunities for the FP250 to operate in low-quality fuel environments, such as closed landfills. Our domestic biogas market focus includes public entities that operate landfill and biogas facilities, including cities, counties, and federal government agencies, such as the DoD. We have also identified potential projects and customers, who may wish to generate electricity from a variety of waste gas streams that would otherwise be flared or vented. Such potential projects include gas processing facilities, oil fields, and coal mines.
For our ultra-low emissions configuration, we have focused on territories with strict environmental and air pollution regulations, such as the South Coast Air Quality Management District, San Joaquin Air Pollution Control District, and other areas in air quality nonattainment as defined by the federal Clean Air Act. In such areas, we believe that our system can greatly reduce the time and cost associated with air permitting and compliance under Title V of the Clean Air Act when compared with other systems. This potential opportunity may be of more significance for our larger system, the KG2-3G/GO. We currently expect that we will introduce our products to many stakeholders in non-attainment areas, including project developers, engineering firms, government regulators, and other potential partners, and currently anticipate significant domestic revenues as a result.
Our sales and marketing strategy in North America has been to develop and strengthen distributor relationships throughout the continent. We currently expect to enter into distribution agreements with several companies throughout North America for the resale of our products. Many of these distributors will serve multiple markets in their select geographic regions. We cannot provide any assurance that we will enter into any such agreements or that such distributors will be successful in selling our products.
International
In international markets, we have been primarily focused on identifying and developing opportunities where our low-quality fuels configuration may provide us with a competitive advantage, particularly LFGs and coal mine gases that are low quality and on biogas with the potential reduced need for fuel conditioning.
Our sales and marketing strategy generally has been to develop and strengthen distributor relationships. We currently expect to enter into distribution agreements with a number of companies throughout Asia, Europe, and Russia for the resale of our products. We would expect that many of these prospective distributors will serve multiple markets in their select geographic regions.
Distribution in Europe and Russia was started ahead of other international regions. Distributors have been established in their respective territories and we have established relationships with potential end-customers and their engineering, procurement, and construction firms in the Russian oil and gas market.
We believe that there are potential, immediate opportunities with existing landfills in the Netherlands, the United Kingdom, Italy, France, and Greece. We also believe that there are potential, immediate opportunities in Germany, Ukraine, and Russia with ventilation air methane gas and abandoned coal mine gas, and in Russia with associated petroleum gas. The quality of such gases in Europe and Russia may be trending to lower quality, which potentially fits into our technology’s competitive advantage.
The environmental policy trend in these regions for reduction in venting and flaring of methane gases is potentially supportive of our technology’s low quality gas capacity. These policies also have the potential of increasing the price paid for electricity generated by our products using low quality gas.
Licensing
We may also license our technology to others, which could form an additional revenue stream for us. In particular, we currently anticipate long-term licensing agreements with large turbine partners and original equipment manufacturers who can provide stronger worldwide presence and greater resources. We have not yet entered into any such licensing agreements and cannot provide any assurances that we will or that any such agreements will provide any appreciable amount of revenues.
Competition and Barriers to Entry
The target markets for the Gradual Oxidizer are new and fairly undeveloped. There are essentially two markets, each with its distinct competitive landscape, where we commercialize our products:
| ● | Low-quality fuels - Within applications where the gas source has an energy density (BTU/ft3) below the minimum level required by reciprocating engines and standard gas turbines, our Gradual Oxidizer does not have a direct technological or manufacturing competitor. In these situations, the prospective customer can elect to do nothing and allow low BTU gas to simply be emitted into the atmosphere. Alternatively, the customer can purchase gas such as propane or natural gas, mix it with the low BTU gas to make combustion feasible, and then flare the mixture. Because such alternative results in the destruction of the low BTU gas instead of converting the gas into a form of energy that could be sold or monetized, we do not consider it a direct form of competition. |
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| ● | Ultra-low emissions - Within applications where a customer is required, typically by national, regional or local legislation, to meet emissions regulations and controls limits, our systems compete with pollution control technologies, such as Selective Catalytic Reduction (SCR), Dry-Low- NOx , or Dry-Low-Emissions (DLN or DLE) systems, and in some cases, with low-emission flares and thermal oxidizers. As many of our competitors are large, well-established companies, they derive advantages from production economies of scale, worldwide presence, and greater resources, which they can devote to product development or promotion. |
Our technology represents a value-added pre-process for power generation equipment such as gas turbines, reciprocating engines or other power generation equipment, and does not compete directly with them. If a site already has gas with high enough energy density to generate power with these standard equipment, and the resulting emissions levels do not exceed regulatory limits, then we deem such site to be outside of our target market.
Research and Development
We have a long track record of research, development, and initial deployment of our Gradual Oxidizer. In our 2011 fiscal year, as carved-out of our Predecessor, we expended approximately $2.4 million on research and development. In the following year, we expended approximately an additional aggregate (both on a carve-out basis and as a stand-alone from and after the spin-off) of $2.3 million. We expense our research and development costs as they are incurred. None of such costs were borne by SRI or EECT.
Our engineering team is led by a group of experienced mechanical and electrical engineers who have worked together on the Gradual Oxidizer for the last five years. Our engineers have worked in a number of larger firms, including Honeywell International, Inc., General Motors Company, Inc., AlliedSignal, Inc., Capstone Turbine Corporation, General Electric Company, Underwriters Laboratories Inc., and Solar Turbines Incorporated. Combined, they have many decades of experience developing and commercializing a number of gas turbines, reciprocating engines, and related products.
Since 2008, our engineers have developed several Gradual Oxidizer test systems with improved system functionality and performance, leading to the commercialization of the FP250:
| ● | November 2008 – we tested and operated the first F100 development test unit in a San Diego, California test facility. This system was the first to combine the Gradual Oxidizer with a gas turbine (a 100 kilowatt gas turbine developed by Elliott Energy Systems, Inc.). Integration of the major components of the system required the design of proprietary software, hardware, and controls. Our team learned how to match the operating conditions of a gas turbine to the Gradual Oxidizer, which ultimately led to the scale up of the technology to our FP250. |
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| ● | April 2009 - we entered into an agreement with SRI to perform all detailed design, fabrication, and site integration procedures for the installation of a turbine/thermal oxidizer demonstration unit. In January 2010, the agreement was amended for us to provide two 200kw Flex Powerstations (known as Turbine 1 and Turbine 2) for installation at two DoD locations in the United States, and to provide field integration, basic operator and maintenance training, including on-site support for the first year of operation. We delivered Turbine 1 and installed the equipment in November 2011 and completed the operations and training phase in November 2012. The agreement was later amended again to require us to upgrade the engine of Turbine 1 as well as deliver the second unit. SRI subsequently cancelled the order for the second unit. |
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| ● | In August 2010, we commissioned the first F100 field test unit at the Lamb Canyon Landfill in Beaumont, California, with cooperation from the County of Riverside. This field test unit was the first successful operation of the Gradual Oxidizer in an active landfill environment. Internal emissions testing verified the ultra-low emissions profile of the Gradual Oxidation technology. This unit was the first to be evaluated for prolonged test periods, which led to significant improvements to key components. |
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| ● | In November 2010, as part of our agreement with SRI, we began testing the first FP250 alpha development test unit in a San Diego, California test facility. The purpose of this unit was to demonstrate the scalability of the Gradual Oxidizer technology to a 250 kilowatt gas turbine (developed by Ingersoll-Rand and FlexEnergy). We also completed our first development phase for software, controls, systems, and components, enabling the deployment of our field test unit. |
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| ● | In July 2011, we installed the second FP250 beta development test unit at the Portsmouth, New Hampshire, manufacturing facility of FlexEnergy, which was previously Ingersoll-Rand’s facility. The purpose of this unit was to complete our second development phase for software, controls, systems, and components. In September 2013, we shipped this unit to the University of California, Irvine, for additional product improvements, cost reductions, and testing of alternative fuel sources. |
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| ● | In November 2011, SRI commissioned the first FP250 field test unit at the U.S. Army base at Fort Benning, Georgia. The project was funded by the DoD Environmental Security Technology Certification Program (“ESTCP”), which seeks innovative and cost-effective technologies to address high-priority environmental and energy requirements for the DoD. As part of the ESTCP protocol, SRI conducted independent verification tests in October 2012. Exhaust emission measurements were taken in accordance with standard EPA reference methods. The FP250 emissions were far below the allowable NOx limits of the California Air Resources Board 2013 waste gas standards, which standards are considered to be among the strictest in the world. To our knowledge, the FP250 is the only power generation solution to meet this standard using a gas turbine or reciprocating engine without chemical or catalytic enhancements. The field test unit is now the property of the base. |
The project provided us with an opportunity to operate the FP250 on a closed landfill with application challenges. The landfill collection system initially provided fuel of insufficient volume to operate the unit. Our team then adapted the FP250 to accept supplementary fuel in addition to the LFGs. Also, an unreliable electric grid caused impediments to operation. Our team addressed this application challenge by modifying the hardware and software to ensure robust, continuous operation in this harsh environment. In addition to overcoming these application challenges, we also made key improvements to core components, such as the filter, insulation systems, and system controls. These changes and improvements will be included in future applications and the commercial product.
Throughout the project, we successfully adapted the FP250 to accommodate a number of site-specific, extraneous factors, which led to further improvements of the commercial FP250. For example, given a lack of available landfill gas at the site, we implemented a process of supplemental fuel blending, by which propane and landfill gas were mixed to provide adequate energy content to operate the Fort Benning FP250.
Current and Future Efforts
Our research and development efforts are now focused on the following sequence of activities:
| ● | Develop the Dresser-Rand KG2-3G/GO. We are currently in joint development with Dresser-Rand on the KG2-3G/GO, which incorporates our Gradual Oxidation technology with Dresser-Rand’s KG2-3G two megawatt gas turbine. We have completed system layout and analytic models integrating our Gradual Oxidizer with this turbine. |
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| ● | Scale up to other large gas turbines. We have already established close working relationships with several other gas turbine manufacturers and large industrial partners to facilitate the potential development of additional systems. We have evaluated the feasibility of several larger gas turbines and have exchanged technical information and have received positive responses from manufacturers and industry partners. |
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| ● | Create test rig to simulate alternative fuel sources and oxidizer operating conditions . We are currently planning for the installation of a test rig to provide a simulated environment to enhance further the performance, efficiency, and fuel flexibility of our Gradual Oxidizer (including potential application to coal mine VAM). We currently anticipate the test rig to be operational by late-2013. |
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| ● | Continued development of academic relationships. Over the past five years, we have developed a number of strong research relationships with the University of Cincinnati and University of California, Irvine. In conjunction with the University of Cincinnati, we have developed analysis tools to simulate our Gradual Oxidation process. We currently anticipate further strengthening these relationships. |
Intellectual Property Protection
Management believes that a policy of protecting intellectual property is an important component of our strategy and will provide us with a long-term competitive advantage.
We are pursuing an aggressive intellectual property strategy, including development of what we expect will become a strong patent portfolio. We believe that Gradual Oxidation technology is a patent domain largely independent from combustion. We have filed over 50 patent applications, five of which have been granted as of the date of this prospectus:
US Patent Number 6,393,821: Method for Collection and Use of Low-Level Methane Emissions
| ● | Filing Date: November 14, 2000 |
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| ● | Issue Date: May 28, 2002 |
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| ● | Expiration Date: November 14, 2020 (est.) |
US Patent Number 8,393,160: Managing Leaks in a Gas Turbine System
| ● | Filing Date: October 17, 2008 |
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| ● | Issue Date: March 12, 2013 |
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| ● | Expiration Date: October 17, 2028 (est.) |
US Patent Number 8,621,869: Heating a Reaction Chamber
| ● | Filing Date: August 27, 2010 |
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| ● | Issue Date: January 7, 2014 |
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| ● | Expiration Date: August 27, 2030 (est.) |
US Patent Number 8,671,658: Oxidizing Fuel
| ● | Filing Date: August 27, 2010 |
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| ● | Issue Date: March 18, 2014 |
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| ● | Expiration Date: March 18, 2028 (est.) |
US Patent Number 8,671,917: Gradual Oxidation with Reciprocating Engine
| Filing Date: March 18, 2008 |
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| ● | Issue Date: March 18, 2014 |
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| Expiration Date: March 9, 2032 (est.) |
We have hundreds of pages of descriptive support, with over 100 independent claims and over 600 dependent claims. We aim to continue to protect our Gradual Oxidation technology in multiple applications for various implementations, markets, and uses. We currently expect to file a significant number of additional patent applications. We cannot predict when our patent applications may result in issued patents, if at all, or that any patents will issue from these applications or that, if issued, such patents will cover all or a substantial portion of the claims currently set forth in the applications. There can be no assurance that any patents issued will provide us with any competitive advantages, will not be challenged by any third parties, or that such third parties will not design competitive products around the patents. In addition, there can be no assurance that any of our patents would be held valid by a court of law of competent jurisdiction or, if held valid, that we will have sufficient economic resources to enforce or defend our patent rights. In the event we are found to have infringed upon the patent rights of others, there can be no assurance that we would be able to obtain a license to use any of such patents.
In addition, we have confidentiality agreements with our suppliers, distributors, employees, and certain visitors. With respect to proprietary know-how, we rely on trade secret protection and confidentiality agreements. Monitoring the unauthorized use of our proprietary technology is difficult and the steps we have taken may not prevent unauthorized disclosure or use of such technology. The disclosure or misappropriation of our trade secrets and other proprietary information could harm our ability to protect our rights and our competitive position.
Government Regulations
Air pollutants, such as NOx, CO, and VOCs, are produced as by-products of combustion. These pollutants are regulated by the EPA as well as by state and local air districts, because they are associated with negative health consequences and/or damage to the environment. Our Gradual Oxidation technology can achieve emissions of NO x that are noticeably lower than traditional combustion techniques without compromising the emissions of CO or VOCs.
Emissions regulations requiring a reduction in commonly found air pollutants such as NO x, CO, and VOCs could enhance market demand for our technology. An example of the advantages of ultra-low levels of NO x emissions is with respect to EPA’s New Source Review requirements under the Title V of the Federal Clean Air Act. Accordingly, potential legislation on greenhouse gases or general reductions in required criteria pollutant levels could assist with our achieving our business objectives. Although the timing of such regulations is uncertain, the general trend in recent decades continues to be increases in governmentally-mandated reductions for all criteria pollutants and the addition of new emissions to those regulated.
We continue to engage with federal and state policymakers to develop government programs to promote the deployment of our products. Since 2010, we have developed relationships with many regulators and legislators of interest, both at the federal and state levels, and we continue to pursue government funding, legislative, and regulatory opportunities.
Ultimately, it may be possible for our technology to achieve EPA BACT and LAER designations, as determined under the EPA New Source Review program.
Environmental Laws
We have not incurred and do not anticipate incurring any expenses associated with compliance with environmental laws. Our products may provide a more cost-effective alternative to upgrading older existing gas-powered generation systems through the use of chemicals, catalysts, and add-on systems to comply with most recent environmental regulations.
Employees
As of the date of this prospectus, we have 18 full-time employees and two part-time employees. None of our employees are covered by a collective bargaining agreement, and we believe our relationship with our employees is good. We also employ consultants, including technical advisors and other advisors, on an as-needed basis to supplement existing staff. When we engage consultants or technical advisors, we typically enter into intellectual property assignment and non-disclosure agreements with them.
Property
Our current headquarters is located at 9400 Toledo Way, Irvine, California 92618. The property consists of a mixed use commercial office, production, and warehouse facility of 32,649 square feet.
On September 26, 2013, we entered into an Assignment and Assumption of Lease (the “Assignment”) with FlexEnergy for the property, with an effective date of August 1, 2013. Pursuant to the Assignment, we are now formally obligated under the Standard Industrial/Commercial Single-Tenant Lease, dated May 26, 2011 (the “Lease”), originally between FlexEnergy and Meehan Holdings, LLC (“Meehan”).
Previously, as provided in the Contribution Agreement, we had occupied a portion of the property, and assumed one-third of all liabilities, under the Lease (with FlexEnergy remaining responsible for the remaining two-third). Notwithstanding such arrangement, Meehan did not view us as formally obligated under the Lease.
Prior to the Assignment, on September 4, 2013, Meehan executed a Lessor’s Consent to Assignment and Sublease with FlexEnergy and us. We also entered into a letter agreement with Meehan, by which we agreed to the following rent prepayments under the Lease:
| ● | $26,044 by September 30, 2013, to be applied to the December 2014 rent payment, and |
| ● | $26,825 by July 31, 2014, to be applied to the December 2015 rent payment. |
The Lease terminates on December 31, 2016. Our unpaid, outstanding obligation for the remainder of the Lease is $1,025,429. The current monthly rent under the Lease is $25,285.25, which increases to $26,044 on August 1, 2014, to $26,825 on August 1, 2015, and to $27,630 on August 1, 2016.
We lease space from the Regents of the University of California, Irvine, for the installation and demonstration of the FP250 equipment. The lease expires on April 1, 2015 and the monthly payment is $7,780 from August 1, 2013 through March 31, 2014. The university will provide us with certain goods and services including certain research and development services.
Legal Proceeding
We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial stockholder, is an adverse party or has a material interest adverse to our company.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On July 1, 2013, we dismissed Weinberg & Baer LLC (“W&B”) as our independent registered accounting firm effective on such date. The reports of W&B on our financial statements for fiscal years 2012 and 2011 did not contain an adverse opinion or a disclaimer of opinion, were not qualified or modified as to uncertainty, audit scope, or accounting principles, with the exception of a qualification with respect to uncertainty as to our ability to continue as a going concern. We engaged Kelly & Company (“Kelly”) as our new independent registered accounting firm effective as of July 1, 2013. The decision to change accountants was recommended and approved by our Board in connection with the Merger.
During fiscal years 2012 and 2011, the fiscal quarter ended March 31, 2013, and the subsequent interim period through July 1, 2013, the date of dismissal, there were no disagreements with W&B on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedures, which disagreement(s), if not resolved to the satisfaction of W&B, would have caused it to make reference to the subject matter of the disagreement(s) in connection with its report, nor were there any reportable events as defined in Item 304(a)(1)(iv) of Regulation S-K.
During fiscal years 2012 and 2011, the fiscal quarter ended March 31, 2013, and the subsequent interim period through July 1, 2013, neither we nor anyone on our behalf engaged Kelly regarding either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements, or any matter that was either the subject of a “disagreement” or a “reportable event,” both as such terms are defined in Item 304 of Regulation S-K.
The following discussion and analysis of our results of operations and financial condition for fiscal year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012 (Predecessor) should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the “Risk Factors” and “Description of Business” sections and elsewhere in this report. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” “predict” and similar expressions to identify forward-looking statements. Although we believe the expectations expressed in these forward-looking statements are based on reasonable assumptions within the bound of our knowledge of our business, our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section of this report. We undertake no obligation to update publicly any forward-looking statements for any reason even if new information becomes available or other events occur in the future.
Prior to November 12, 2012, Ener-Core Power did not operate as a separate legal entity. As a result the historical financial information for the cumulative period from January 1, 2012 through November 11, 2012 has been “carved out” of the financial statements of FlexEnergy, which we will refer in the following discussion as “Predecessor.” Such financial information is limited to Ener-Core Power related activities, assets and liabilities only.
The carved-out financial information includes both direct and indirect expenses. The historical direct expenses consist primarily of the various costs of direct operations. Indirect costs represent expenses that were allocable to the business. The indirect expense allocations are based upon: (1) estimates of the percentage of time spent by FlexEnergy employees working on or supporting Ener-Core Power business matters; and (2) allocations of various expenses associated with the employees, including salary, benefits, travel and entertainment, rent associated with the employees’ office space, accounting and other general administrative expenses.
Management believes the assumptions and allocations underlying the carve-out financial information are reasonable, although they are not necessarily indicative of the costs the Gradual Oxidizer business would have incurred if it had operated on a standalone basis or as an entity independent of FlexEnergy. Accordingly, the financial position, operating results and cash flows may have been materially different if the Ener-Core Power business had operated as a stand-alone entity during the periods presented.
Overview
We design, develop, and manufacture Gradual Oxidizer products and technologies that aim to expand power generation into previously uneconomical markets, while at the same time reducing the emissions of gases produced from industrial processes that contribute to air pollution and climate change. Our first product, the Ener-Core Powerstation FP250, is able to generate electric power using low energy content gas or vapor while emitting low levels of air pollutants. The FP250 integrates a modified conventional micro-turbine (Ingersoll Rand MT250, now manufactured by FEES) with a proprietary gradual thermal oxidizer in place of a conventional turbine’s combustor.
Reverse Merger
We entered into the Merger Agreement with Ener-Core Power and the Merger Sub, pursuant to which the Merger Sub merged with and into Ener-Core Power, with Ener-Core Power as the surviving entity. Prior to the Merger, we were a public reporting “shell company,” as defined in Rule 12b-2 of the Exchange Act. The Merger Agreement was approved by the boards of directors of each of the parties to the Merger Agreement. In April 2013, the pre-merger public shell company effected a 30-for-1 forward split of its common stock. All share amounts have been retroactively restated to reflect the effect of the stock split.
As provided in the Contribution Agreement, dated November 12, 2012, by and among FlexEnergy, FEES, and Ener-Core Power, Ener-Core Power was spun-off from FlexEnergy as a separate corporation. As a part of that transaction, Ener-Core Power received all assets (including intellectual property) and certain liabilities pertaining to the Gradual Oxidizer business (Predecessor), the business carved out of Parent. The owners of Predecessor did not distribute ownership of Successor entity pro rata. The assets and liabilities were transferred to the Company and recorded at their historical carrying amounts since the transaction was a transfer of net assets between entities under common control.
On July 1, 2013, Ener-Core Power completed the Merger with us. Upon completion of the merger, the operating company immediately became a public company. The Merger was accounted for as a “reverse merger” and recapitalization. As part of the reverse merger, the pre-merger public shell company shareholders cancelled 120,520,000 of common stock which were then outstanding. This cancellation has been retroactively accounted for as of the inception of Ener-Core Power on November 12, 2012. Accordingly, Ener-Core Power was deemed to be the accounting acquirer in the transaction and, consequently, the transaction was treated as a recapitalization of Ener-Core Power. Accordingly, the assets and liabilities and the historical operations that are reflected in the financial statements are those of Ener-Core Power and are recorded at the historical cost basis of Ener-Core Power. Our assets, liabilities and results of operations were de minimis at the time of merger.
Going Concern
Our consolidated financial statements are prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities in the normal course of business. Since our inception, we have made a substantial investment in research and development to develop the Gradual Oxidizer, have successfully deployed a FP250 field test unit at the U.S. Army base at Fort Benning, Georgia, and shipped our first commercial product in November 2013.
We have sustained recurring net losses and negative cash flows since inception and have not yet established an ongoing source of revenues sufficient to cover our operating costs and allow us to continue as a going concern. As of April 15, 2014, we have a substantial working capital deficit and require significant additional capital to continue operations. We must secure additional funding to pay our current liabilities, continue as a going concern and execute our business plan.
Management’s plan is to obtain such resources by obtaining capital sufficient to meet our operating expenses by seeking additional equity and/or debt financing, although no definitive agreement has been entered into in connection therewith as of April 15, 2014. The cash and cash equivalents balance as of December 31, 2013 was $1.2 million, of which $0.1 million remained on April 15, 2014. On April 16, 2014, we closed $4.6 million of senior secured financing (Note 17), whereby the lender made available gross proceeds of $4.0 million, of which $2.3 million is constrained in a Control Account subject to be released at the lender’s option when we are not in default and there is no Equity Control Failure (as defined in the Note 17) and to the extent such funds exceed the aggregate principal amount then outstanding. We project that the net proceeds of $1.7 million received by us will continue to meet our working capital needs, general corporate purposes, and related obligations into the second quarter of 2014. To the extent that the lender, at its sole option, releases funds from the Control Account, we will be able to meet our operating needs and obligations further into 2014.
We will pursue raising additional debt or equity financing to fund our operations and product development. If future funds are raised through issuance of stock or debt, these securities could have rights, privileges, or preferences senior to those of common stock and debt covenants that could impose restrictions on the Company’s operations. The sale of additional equity securities or debt financing will likely result in additional dilution to the Company’s current shareholders. We cannot make any assurances that any additional financing will be completed on a timely basis, on acceptable terms or at all. Management’s inability to successfully complete any other financing will adversely impact our ability to continue as a going concern. Even if we are able to secure financing, we may still have to significantly reduce costs and delay projects, which would adversely affect our business, customers and program development. If our business fails or we are unable to seek immediate financing, our investors may face a complete loss of their investment.
Our audited consolidated financial statements included elsewhere in this prospectus do not give effect to any adjustments that might be necessary if we were unable to meet our obligations or continue operations as a going concern.
Critical Accounting Policies and Estimates
While our significant accounting policies are more fully described in Note 2 to our audited consolidated financial statements included elsewhere in this prospectus, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis.
Segments
The Company operates in one segment. All of the Company’s operations are located domestically.
Use of Estimates
The preparation of 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 expenses during the reporting period. Significant items subject to such estimates and assumptions include the allocation of operations during the carve-out periods, valuation of certain assets, useful lives, and carrying amounts of property and equipment, equity instruments, and share-based compensation; provision for contract losses; valuation allowances for deferred income tax assets; and exposure to warranty and other contingent liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Foreign Currency Adjustments
Our functional currency for all operations worldwide is the U.S. dollar. Nonmonetary assets and liabilities are translated at historical rates and monetary assets and liabilities are translated at exchange rates in effect at the end of the year. Income statement accounts are translated at average rates for the year. At December 31, 2013 and 2012 we did not hold any foreign currency asset or liability amounts. Gains and losses resulting from foreign currency transactions are reported as other income in the period they occurred. During 2013, we recognized foreign currency transaction gain of $34,000 and none during 2012. There have not been foreign currency translation gains or losses incurred in 2012, 2013 and from January 1, 2014 through the date of this prospectus.
Concentrations of Credit Risk
Cash and Cash Equivalents
We maintain our non-interest bearing transactional cash accounts at financial institutions for which the Federal Deposit Insurance Corporation (“FDIC”) provides insurance coverage of up to $250,000. For interest bearing cash accounts, from time to time, balances exceed the amount insured by the FDIC. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk related to these deposits. At December 31, 2013, we had $951,000 amounts in excess of the FDIC limit.
We consider all highly liquid investments available for current use with an initial maturity of three months or less and are not restricted to be cash equivalents. We invest our cash in short-term money market accounts.
Restricted Cash
Under a credit card processing agreement with a financial institution that was entered in 2013, we are required to maintain funds on deposit with the financial institution as collateral. The amount of the deposit is at the discretion of the financial institution and as of December 31, 2013 was $50,000.
Accounts Receivable
Our accounts receivable are typically from credit worthy customers or, for international customers are supported by guarantees or letters of credit. For those customers to whom we extend credit, we perform periodic evaluations of our customers and maintain allowances for potential credit losses as deemed necessary. We generally do not require collateral to secure accounts receivable. We have a policy of reserving for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
At December 31, 2013 and 2012, we did not have any allowance for doubtful accounts. Although we expect to collect amounts due, actual collections may differ from the recorded amounts.
As of December 31, 2013, one customer, accounted for 100% of total accounts receivable. There was no accounts receivable at December 31, 2012. Two customers accounted for 100% of net revenues for the year ended December 31, 2013. One customer accounted for 100% of net revenues for the period from November 12, 2012 through December 31, 2012. There were no revenues for the period from January 1, 2012 through November 11, 2012 (Predecessor).
Accounts Payable
As of December 31, 2013, two vendors accounted for approximately 48% of total accounts payable. As of December 31, 2012, two vendors accounted for 66% of total accounts payable. These were the only vendors that individually accounted for more than 10% of accounts payable. Three vendors accounted for approximately 65% of purchases for the year ended December 31, 2013. No vendors accounted for more than 10% of purchases for the period from November 12, 2012 through December 31, 2012 (Successor) and one vendor accounted for 72% of purchases for the period from January 1, 2012 through November 11, 2012 (Predecessor). These vendors provided commonly available services and we do not anticipate that a loss of these vendors will impact our results of operations.
Inventories
Inventories, which consist of raw materials, are stated at the lower of cost or net realizable value, with cost being determined by the average-cost method, which approximates the first-in, first-out method. At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence. This evaluation primarily includes an analysis of forecasted demand in relation to the inventory on hand, among consideration of other factors. Based upon the evaluation, provisions are made to reduce excess or obsolete inventories to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the respective inventories. At December 31, 2013, we did not have a reserve for slow-moving obsolete inventory. We had no inventory at December 31, 2012.
Costs in Excess of Billings on Uncompleted Contracts
Costs in excess of billings on uncompleted contracts in the accompanying consolidated balance sheets represents accumulation of costs for labor, materials and other costs that have been incurred in excess of a provision for contract loss that has previously been recognized as further discussed below under the section “Southern Research Contract.” These costs were recognized as costs of goods sold in the period from November 12 through December 31, 2012 when the contract was considered completed in accordance with the completed-contract method.
Property and Equipment
Property and equipment are stated at cost, and are being depreciated using the straight-line method over the estimated useful lives of the related assets, ranging from three to ten years. Maintenance and repairs that do not improve or extend the lives of the respective assets are expensed. At the time property and equipment are retired or otherwise disposed of, the cost and related accumulated depreciation accounts are relieved of the applicable amounts. Gains or losses from retirements or sales are reflected in the consolidated statements of operations.
Deposits
Deposits primarily consist of amounts incurred or paid in advance of the receipt of fixed assets or are deposits for rent and insurance.
Deferred Rent
We record deferred rent expense, which represents the temporary differences between the reporting of rental expense on the financial statements and the actual amounts remitted to the landlord. The deferred rent portion of lease agreements are leasing inducements provided by the landlord. Also, tenant improvement allowances provided are recorded as a deferred rent liability and recognized ratably as a reduction to rent expense over the lease term.
Intangible Assets
We amortize our intangible assets with finite lives over their estimated useful lives. See Note 6 of the notes to our audited consolidated financial statements included elsewhere in this prospectus for additional details regarding the components and estimated useful lives of intangible assets.
Impairment of Long-Lived Assets
We account for our long-lived assets in accordance with the accounting standards which require that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the historical carrying value of an asset may no longer be appropriate. We consider the carrying value of assets may not be recoverable based upon its review of the following events or changes in circumstances: the asset’s ability to continue to generate income from operations and positive cash flow in future periods; loss of legal ownership or title to the assets; significant changes in our strategic business objectives and utilization of the asset; or significant negative industry or economic trends. An impairment loss would be recognized when estimated future cash flows expected to result from the use of the asset are less than its carrying amount. As of November 11, 2012, we performed an annual review of the FP 250 Beta development test unit fixed asset, to assess potential impairment, at which time management deemed the asset to be partially impaired. As a result, we expensed $329,000 to impairment of long-lived assets. As of December 31, 2013 and 2012, we do not believe there have been any other impairments of our long-lived assets. There can be no assurance, however, that market conditions will not change or demand for our products will continue, which could result in impairment of long-lived assets in the future.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, and capital lease liabilities. The carrying amounts of the financial instruments are reasonable estimates of their fair values due to their short-term nature or proximity to market rates for similar debt.
We determine the fair value of our financial instruments based on a three-level hierarchy established for fair value measurements under which these assets and liabilities must be grouped, based on significant levels of observable or unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect management’s market assumptions. This hierarchy requires the use of observable market data when available. These two types of inputs have created the following fair-value hierarchy:
| ● | Level 1: Valuations based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Currently, we do not have any items classified as Level 1. |
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| ● | Level 2: Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. Funds maintained in our money market account are classified as Level 2. |
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| ● | Level 3: Valuations based on inputs that require inputs that are both significant to the fair value measurement and unobservable and involve management judgment (i.e., supported by little or no market activity). Currently, we do not have any items classified as Level 3. |
If the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement.
Revenue Recognition
We generate revenue from the sale of our clean power energy systems and from consulting services. Revenue is recognized when there is persuasive evidence of an arrangement, product delivery and acceptance have occurred, the sales price is fixed or determinable and collectability of the resulting receivable is reasonable assured. Amounts billed to clients for shipping and handling are classified as sales of product with related costs incurred included in cost of sales.
Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related revenue is recorded. We defer any revenue for which the services have not been performed or is subject to refund until such time that we and our customer jointly determine that the services have been performed or no refund will be required.
Revenues under long-term construction contracts are generally recognized using the completed-contract method of accounting (ASC 605-35). Long-term construction-type contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates difficult are accounted for under the completed-contract method. Revenues under the completed-contract method are recognized upon substantial completion - that is acceptance by the customer, compliance with performance specifications demonstrated in a factory acceptance test or similar event. Accordingly during the period of contract performance, billings and costs are accumulated on the balance sheet but no profit or income is recorded before completion or substantial completion of the work. Anticipated losses on contracts are recognized in full in the period in which losses become probable and estimable. Changes in estimate of profit or loss on contracts are included in earnings on a cumulative basis in the period the estimate is changed. We have deferred all amounts received on our contract EECT until the contract is substantially complete, at which time all advanced payments received on the contract ($701,000), will be recorded as revenue. As of December 31, 2013, we had a provision for contract loss of approximately $100,000 related to our contract with EECT. The provision was included in cost of goods sold at December 31, 2013.
Southern Research Contract
In April 2009, the Company entered into an initial contract with SRI to perform all detailed design, fabrication and site integration of installing a Turbine/Thermal Oxidizer demonstration unit. The scope of work also required the Company to commission and start up the demonstration unit including operator and maintenance training. In January of 2010 the Company and SRI amended the contract to a fixed price contract valued at $1,226,776, which required the Company to provide two 200kw Flex Powerstations (“Turbine 1” and “Turbine 2,” respectively) to be installed at two Department of Defense locations in the United States. In addition, the contract, as amended, required the Company to provide field integration, basic operator and maintenance training including on-site support for the first year of operation and also to maintain, operate and train operators of the equipment. The Company delivered Turbine 1 and installed the equipment in November 2011 and completed the operations and training phase in November 2012. The third amendment to the contract provided for the Company to deliver a second Turbine/Thermal Oxidizer unit and upgrade the engine of Turbine 1. The contract required the customer to identify a site for the second unit by December 31, 2012. However, a suitable site was not selected and the customer cancelled its order for the second unit. The SRI contract has been accounted for in accordance with the completed-contract method. We deferred all amounts received on this contract for Turbine 1 and Turbine 2 until the contract was substantially completed on December 31, 2012, at which time all advanced payments received on the contract ($991,000) was recorded as revenue and the remaining accumulated deferred costs of $991,000 were recorded as cost of goods sold in the period from November 12 through December 31, 2012 (Successor).
Research and Development Costs
Research and development costs are expensed as incurred. Research and development was $2.3 million, $0.1 million and $2.3 million, for the year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 (Successor) and the period from January 1, 2012 through November 11, 2012 (Predecessor), respectively.
Share Based Compensation
We maintain a stock option plan and record expenses attributable to the stock option plan. We amortize share-based compensation from the date of grant on a straight-line basis over the requisite service (vesting) period for the entire award.
We account for equity instruments issued to consultants and vendors in exchange for goods and services at fair value. The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant’s or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
In accordance with the accounting standards, an asset acquired in exchange for the issuance of fully vested, non-forfeitable equity instruments should not be presented or classified as an offset to equity on the grantor’s balance sheet once the equity instrument is granted for accounting purposes. Accordingly, we record the fair value of the fully vested, non-forfeitable common stock issued for future consulting services as prepaid expense in our consolidated balance sheets.
Income Taxes
We account for income taxes under the provisions of the accounting standards. Under the accounting standards, deferred tax assets and liabilities are recognized for the expected future tax benefits or consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided for significant deferred tax assets when it is more likely than not that such asset will not be realized through future operations.
The accounting guidance for uncertainty in income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. We recognize any uncertain income tax positions on income tax returns at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. As of December 31, 2013 and 2012 and November 11, 2012, there were no unrecognized tax benefits included in the consolidated balance sheet that would, if recognized, affect the effective tax rate. Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrual for interest or penalties on our consolidated balance sheets at December 31, 2013 and 2012, and November 11, 2012, respectively and have not recognized interest and/or penalties in the consolidated statement of operations for the year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012.
We are subject to taxation in the U.S. and various state and foreign jurisdictions. Our tax year for 2012 is subject to examination by the taxing authorities.
We do not foresee material changes to our gross uncertain income tax position liability within the next twelve months.
Earnings (Loss) per Share
Basic earnings (loss) per common share is computed by dividing earnings (loss) to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential shares had been issued and if the additional common shares were dilutive. Options and warrants to purchase approximately 9.5 million and 3.2 million shares of common stock were outstanding at December 31, 2013 and 2012, respectively, but were excluded from the computation of diluted loss per share due to the anti-dilutive effect on net loss per share. There were no options or warrants outstanding at November 11, 2012.
| | Successor | | | Predecessor (carve-out) | |
| | Year ended December 31, 2013 | | | November 12 - December 31, 2012 | | | January 1 - November 11, 2012 | |
| | | | | | | | | |
| Net loss | $ | (7,130,000 | ) | | $ | (375,000 | ) | | $ | (6,548,000 | ) |
| Weighted average number of common shares outstanding: | | | | | | | | | | | |
| Basic and diluted | | 67,803,000 | | | | 60,883,000 | | | | — | |
| Net loss attributable to common stockholders per share: | | | | | | | | | | | |
| Basic and diluted | $ | (0.11 | ) | | $ | (0.01 | ) | | $ | — | |
Recently Issued Accounting Pronouncements
In August 2013, the FASB issued Accounting Standards Update (ASU) No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists,” that sets forth circumstances in which an unrecognized tax benefit, generally reflecting the difference between a tax position taken or expected to be taken on a company’s income tax return and the benefit recognized on its financial statements, should be presented in the company’s financial statements as a liability rather than as a reduction of a deferred tax asset. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. The adoption of these provisions is not expected to have a material impact on the consolidated financial statements of the Company.
Subsequent Events
Sublease – 9400 Toledo
On March 7, 2014, we subleased 5,000 square feet of office space at our headquarters, commencing March 1, 2014 to a third party tenant. The lease is for 34 months and requires payments of $7,000 per month for twelve months increasing to $7,210 for the next twelve months and $7,426.30 for the remaining ten months. The lease includes use of the existing furniture and telephone equipment over the life of the lease.
April 2014 Private Placement
On April 16, 2014, we closed a securities purchase agreement (the “April 2014 SPA”), with five institutional and accredited investors. Pursuant to the terms of the April 2014 SPA, we issued and sold to these investors our senior secured convertible notes in the aggregate original principal amount of $4,575,000 (the “Notes”), and warrants to purchase up to 4,097,015 shares of our common stock (the “Warrants”), on the terms set forth below (the “April 2014 Private Placement”).
The Notes mature 18 months from their issuance and were purchased for $4,003,125 in the aggregate. The Notes bear an effective annual interest of 8.61%, which increases to 15% if there is an event of default (as defined in the Notes). The initial conversion price of the Notes is $0.67 per share (the “Conversion Price”). Beginning on July 1, 2014, we will pay to the Note holder an amount equal to (i) one-sixteenth (1/16th) of the original principal amount of the Note (or the principal outstanding on such date, if less) plus (ii) the accrued and unpaid interest with respect to such principal plus (iii) the accrued and unpaid late charge (if any) with respect to such principal and interest (each, an “Installment Amount”). The Holder has the ability to defer such monthly payment s in its sole discretion. Up to four times prior to maturity of the Notes, each holder may accelerate payment of the sum of the following: (a) the Installment Amount, (b) any Installment Amount which payment such Note holder previously deferred, and (c) any accrued and unpaid interest and late charges, if any; provided, however, that any such accelerated amount shall not be greater than two times the amount set forth in clause (a) above. Each monthly payment may be made in cash, in shares of our common stock, or in a combination of cash and shares of its common stock. Our ability to make such payments with shares of our common stock will be subject to the satisfaction of certain equity conditions. Subject to the satisfaction of certain equity conditions, we may redeem all, but not less than all, of the Notes then outstanding at any time at 115% of the Conversion Amount being redeemed.
The Warrants issued to the investors are immediately exercisable, have an initial exercise price of $0.78 per share (the “Exercise Price”) and expire on the 60-month anniversary of their initial issuance. If we sell or issue shares of Common Stock at less than the then applicable exercise price (subject to certain exceptions), then the exercise price shall be reduced to the price of such dilutive issuance.
In connection with the sale of the Notes and the Warrants, we entered into a registration rights agreement (the “April 2014 RRA”) to register 135% of the shares issuable under the Notes and the Warrants. In addition, we entered into a pledge and security agreement (the “Security Agreement”) granting security interest of all of our personal property to the collateral agent for the investors (the “Collateral Agent”), as well as a special deposit account control agreement (the “Control Agreement”) granting the collateral agent control of the control account established to hold a portion of the proceeds from the investors (the “Control Account”).
We received gross proceeds of $4 million, less transaction expenses of approximately $250,000, of which $2.3 million was placed in a control account pursuant the Control Agreement.
Results of Operations for the Fiscal Year Ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012 (Predecessor)
| | | Successor | | | Predecessor (carve-out) | |
| | | Year Ended December 31, 2013 | | | November 12 - December 31, 2012 | | | January 1 - November 11, 2012 | |
| | | | | | | | | | |
| Revenues: | | | | | | | | | |
| Revenues from unrelated parties | | $ | 7,000 | | | $ | 991,000 | | | $ | — | |
| Revenues from related parties | | | 9,000 | | | | — | | | | — | |
| Total revenues | | | 16,000 | | | | 991,000 | | | | — | |
| Cost of Goods Sold | | | | | | | | | | | — | |
| Cost of goods sold to unrelated parties | | | 106,000 | | | | 991,000 | | | | — | |
| Cost of goods sold to related parties | | | 6,000 | | | | — | | | | — | |
| Total costs of goods sold | | | 112,000 | | | | 991,000 | | | | | |
| Gross Profit (Loss) | | | (96,000 | ) | | | — | | | | — | |
| | | | | | | | | | | | | |
| Operating expenses: | | | | | | | | | | | | |
| Selling, general, and administrative | | | 4,802,000 | | | | 237,000 | | | | 2,887,000 | |
| Research and development | | | 2,257,000 | | | | 138,000 | | | | 2,301,000 | |
| Impairment loss of long-lived assets | | | — | | | | — | | | | 329,000 | |
| Total operating expenses | | | 7,059,000 | | | | 375,000 | | | | 5,517,000 | |
| Operating loss | | | (7,155,000 | ) | | | (375,000 | ) | | | (5,517,000 | ) |
| | | | | | | | | | | | | |
| Other income (expenses): | | | | | | | | | | | | |
| Other income, net | | | 36,000 | | | | — | | | | — | |
| Interest expense – related party | | | (10,000 | ) | | | — | | | | (1,031,000 | ) |
| Total other income (expenses), net | | | 26,000 | | | | — | | | | (1,031,000 | ) |
| Loss before provision for income taxes | | | (7,129,000 | ) | | | (375,000 | ) | | | (6,548,000 | ) |
| Provision for income taxes | | | 1,000 | | | | — | | | | — | |
| Net loss | | $ | (7,130,000 | ) | | $ | (375,000 | ) | | $ | (6,548,000 | ) |
| | | | | | | | | | | | | |
| Loss per share – basic and diluted | | $ | (0.11 | ) | | $ | (0.01 | ) | | $ | — | |
| Weighted average common shares – basic and diluted | | | 67,803,000 | | | | 60,883,000 | | | | — | |
Revenue
Our revenue primarily consists of General Oxidizer sales as well as engineering services. For the year ended December 31, 2013, we had $16,000 of revenue from engineering services, including $9,000 from a related party. During the period from November 12, 2012 (inception) through December 31, 2012, revenue was $991,000, that represented the revenue recognized on the SRI Contract. For January 1, 2012 through November 11, 2012, the Predecessor did not record any revenue.
Cost of Goods Sold
Cost of goods sold primarily consisted of materials, labor to produce the Gradual Oxidizer, warranty, applicable overhead allocations and labor related to engineering services. The cost of goods sold for the year ended December 31, 2013, was $112,000 and was primarily from the expected loss on the EECT contract of $100,000 resulting from production and capacity inefficiencies. Further contributing to the cost of goods sold were the costs of labor for engineering services, including $6,000 of costs attributable to related party income.
Cost of goods sold from November 12, 2013 (inception) through December 31, 2012, was to $991,000, which is the cost of revenue for the SRI Contract. For January 1, 2012 through November 11, 2012, the Predecessor did not record any cost of goods sold.
Gross Profit (Loss)
Our gross loss for the year ended December 31, 2013 of $96,000 was primarily attributable to the loss on the EECT contract offset in part by the net profit on engineering services, including related parties of approximately $2,000.
Our gross profit for the period from November 12, 2012 (inception) through December 31, 2012, was zero, as the cost of goods matched the revenues recorded on the SRI Contract.
For January 1, 2012 through November 11, 2012, the Predecessor did not record any sales and of cost of goods sold.
As sales increase, management anticipates that costs of sales will continue to decrease as a percentage of sales.
Selling, general and administrative expenses
Selling, general and administrative expenses costs include officer compensation, salaries and benefits, stock-based compensation expense, consulting fees, legal expenses, intellectual property costs, accounting and auditing fees, investor relations costs, insurance, public company reporting costs and listing fees, and corporate overhead related costs. Total selling, general and administrative expenses for the year ended December 31, 2013 was approximately $4,802,000, including approximately $1.2 million of costs associated with the reverse merger and predecessor carve-out and $1.7 million of stock-based compensation expense related to stock options granted during 2013.
For the period from November 12, 2012 through December 31, 2012, selling, general and administrative expenses were $237,000 and were primarily payroll and related costs.
For the period from January 1, 2012 through November 11, 2012 (Predecessor), selling, general and administrative expenses were approximately $2,887,000.
As we continue to further develop our infrastructure, expand our business and incur expenses related to being a public company, we anticipate that our selling, general and administrative expenses will increase in absolute dollars as well as a percentage of total revenues.
Research and development
Research and development costs include development expenses for the Gradual Oxidizer including salaries and benefits, consultant fees, cost of supplies and materials for samples and prototypes, depreciation, as well as outside services costs. Research and development expense for the year ended December 31, 2013, were approximately $2,257,000. For the period from November 12, 2012 through December 31, 2012, our research and development expenses were approximately $138,000 and for the period from January 1, 2012 through November 11, 2102 (Predecessor) such expenses were approximately $2,301,000. As we continue to develop future generations of our product, we anticipate that our research and development costs will increase in absolute dollars as well as a percentage of our total revenues.
Impairment of long-lived asset
For the period from January 1, 2102 through November 11, 2012 (Predecessor), impairment expenses of approximately $329,000 were due to the write-down of the FP250 beta development test unit in Portsmouth, New Hampshire.
Other Expenses:
Other expenses, which consisted primarily of interest expense, offset in part by interest income, included the following:
For the year ended December 31, 2013, other income consisted of $34,000 related to foreign currency transaction gains related to our EECT contract and interest expense was primarily due to interest on convertible loans and interest on our Import Export Bank line of credit. The interest expense was offset in part for interest income resulting from maintaining excess cash in interest bearing accounts.
For the period from November 12, 2012 through December 31, 2012, we did not incur interest expense nor interest income. For the period from January 1, 2012 through November 11, 2012 (Predecessor), we incurred related party interest expense of approximately $1,031,000 which represented our portion of the Predecessor’s debt that was allocated to us.
Management believes these allocations are reasonable but not necessarily indicative of the cost that would have incurred if the Business had been operated on a stand-alone basis.
Net Loss
For the year ended December 31, 2013, we incurred a net loss of $7.1 million primarily from selling, general and administrative expenses, including stock-based compensation expenses and expenses related to the reverse merger. For the period from November 12, 2012 through December 31, 2012, we incurred a net loss of $0.4 million, consisting of operating expenses, and zero gross profit on Sales of $1.0 million. For the period of January 1, 2012 through November 11, 2012 (Predecessor), we incurred a net loss of $6.548 million, primarily consisting of $1.031 million in interest expense and $5.517 million in operating expenses.
Earnings per share
Earnings per share, basic and diluted were ($0.11) and ($0.01) for the year ended December 31, 2013 and the period from November 12, 2012 through December 31, 2012, respectively.
Liquidity
Cash Flows used in Operating Activities
Our cash used in operating activities were approximately $4.9 million, $0.4 million and $6.2 million for the year ended December 31, 2013, the period from November 12, 2102 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012 (Predecessor), respectively. Cash flow used in operations resulted primarily from net losses, of $7.1 million, $0.4 million and $6.5 million, for the year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2102 (Predecessor), respectively, offset in part by stock-based compensation, depreciation and amortization and increases in accounts payable. Further contributing to the cash used for operations were the increases in costs in excess of billings.
Cash Flows from Investing Activities
Cash used in investing activities was attributable to the purchase of property and equipment of $54,000, $0 and $24,000 for the year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012, respectively.
Cash Flows from Financing Activities
Net cash provided by financing activities was approximately $6.0 million, $0.5 million and $6.2 million for the year ended December 31, 2013, the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012, respectively. Cash from financing activities for the year ended December 31, 2013 primarily consisted of proceeds from issuance of stock of approximately $5.5 million, loans/advances from related parties of $1.0 million, proceeds from line of credit of $0.4 million, offset in part by repayments of the line of credit of ($0.4 million) and repayments of related party notes of ($0.45 million).
For the period from November 12, 2012 through December 31, 2012 and the period from January 1, 2012 through November 11, 2012 (Predecessor), net cash provided by financing activity consisted of $0.5 million and $6.2 million, respectively from cash contributions from Parent.
Capital Resources
Our principal capital requirements are to fund our working capital requirements, invest in research and development and capital equipment and the continued costs of public company filing requirements. We have historically funded our operations through debt and equity financings. In July and August 2013, we completed a private placement and received net proceeds of approximately $4.1 million, after deduction of offering expenses. In November 2013, we raised approximately $1.4 million, after deductions of offering expenses as part of a private placement offering.
For the year ended December 31, 2013, we have incurred losses from operations and have an accumulated deficit of approximately $7.5 million, a net loss of approximately $7.1 million and we used cash in operations of approximately $4.9 million as of and for the year ended December 31, 2013, which raises substantial doubt about our ability to continue as a going concern.
We expect to continue to incur substantial additional operating losses from costs related to the continuation of product and technology development and administrative activities. Our cash on hand at December 31, 2013 and April 15, 2014 was approximately $1.2 million and $0.1 million, respectively. On April 16, 2014, we closed $4.6 million of senior secured financing (Note 16), whereby the lender made available gross proceeds of $4.0 million, of which $2.3 million is constrained in a Control Account subject to be released at the lender’s option when we are not in default and there is no Equity Control Failure (as defined in the Note 16) and to the extent such funds exceed the aggregate principal amount then outstanding. We project that the net proceeds of $1.5 million received by us will continue to meet our working capital needs, general corporate purposes, and related obligations into the second quarter of 2014. To the extent that the lender, at its sole option, releases funds from the Control Account, we will be able to meet our operating needs and obligations further into 2014. We will need to obtain additional financing to continue operations. We cannot guaranty that we will be able to complete the financing on a timely basis, with favorable terms or at all. In addition, we may have to significantly reduce costs and delay projects, which would adversely affect our business, customers and program development.
Our sales cycle can exceed 24 months and we do not expect to generate sufficient revenue in the next twelve months to cover our operating costs. We anticipate that we will pursue raising additional debt or equity financing to fund new product development and execute on the commercialization of our product plans. We cannot make any assurances that management's strategies will be effective or that any additional financing will be completed on a timely basis, on acceptable terms or at all. Our inability to successfully implement our strategies or to complete any other financing will adversely impact our ability to continue as a going concern.
Until we achieve our product commercialization plans and are able to generate sales to realize the benefits of the strategy and sufficiently increase cash flow from operations, we will require additional capital to meet our working capital requirements, research and development, capital requirements and compliance requirements and will continue to pursue raising additional equity and/or debt financing.
Our principal sources of liquidity are cash and receivables. As of December 31, 2013, cash and cash equivalents (including restricted cash) were $1.2 million or 40.4% of total assets compared to $0.1 million, or 9.0%. The increase in cash and cash equivalents was primarily attributable to the issuance of $5.5 million in equity, offset by net cash used in operating activities of $4.9 million.
The Company has not yet achieved profitable operations and has yet to establish an ongoing source of revenue to cover operating costs and meet its ongoing obligations. Our cash needs for the next 12 months are projected to be in excess of $10.5 million which includes the following:
| ● | Employee, occupancy and related costs: $3.4 million |
| ● | Professional fees and business development costs: $1.6 million |
| ● | Research and development programs: $3.5 million |
| ● | Corporate filings: $0.5 million |
| ● | Working capital: $1.5 million |
Contractual Obligations
As of the date of this prospectus, we have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant obligations in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows.
| Estimated amounts due ($) | | less than 1 year | | | 1-3 years | | | 3-5 years | | | Total | |
| | | | | | | | | | | | | |
| Capital lease payables | | $ | 9,000 | | | $ | 21,000 | | | $ | 8,000 | | | $ | 38,000 | |
| Lease and other commitments | | $ | 333,000 | | | $ | 648,000 | | | $ | 5,000 | | | $ | 986,000 | |
| Total | | $ | 342,000 | | | $ | 669,000 | | | $ | 13,000 | | | $ | 1,024,000 | |
Off-Balance Sheet Arrangements
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity that are not reflected in our financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Warrants
From time to time, we issue warrants to purchase shares of our common stock to investors, note holders and to non-employee consultants for services rendered or to be rendered in the future. Warrants issued in conjunction with equity, are recorded to equity as exercised.
A list of the warrants outstanding as of December 31, 2013 is as follows:
| | | Warrants Outstanding | |
| | | Number of Warrants | | | Weighted-Average Exercise Price per Share | |
| Balance outstanding at January 1, 2013 and January 1, 2012 | | | — | | | $ | — | |
| Warrants issued | | | 631,087 | | | | 0.80 | |
| Warrants exercised | | | — | | | | — | |
| Balance outstanding at December 31, 2013 | | | 631,087 | | | $ | 0.80 | |
Related Party Transactions
Commencing with the spin-off, Ener-Core Power entered into a series of debt and equity transactions with our major stockholder group - the SAIL Entities, a group of affiliated entities described in Item 2 under “Security Ownership of Certain Beneficial Owners and Management” below. As a result of such transactions, the SAIL Entities were issued a sufficient quantity of Ener-Core Power’s capital stock which, when converted into shares of our common stock in connection with the Merger-related private placement, constitutes a controlling interest in us - some of the issuances were for cash consideration and others were for the conversion of debt directly owed by Ener-Core Power to one or more of the SAIL Entities or were incurred by one or more of the SAIL Entities on its behalf. A description of those transactions is set forth in Note 13 (Related Party Transactions) to our audited consolidated financial statements included elsewhere in this prospectus. Further, two of our five directors are affiliated with certain SAIL Entities, as described in Item 2 under “Security Ownership of Certain Beneficial Owners and Management” below. . Michael J. Hammons is a partner of SAIL Venture Partners II, LLC, and Christopher J. Brown is a principal of SAIL Capital Partners, LLC.
Prior to the spin-off, for the period from January 1, 2012 through November 11, 2012, our predecessor recorded allocated interest expense related to its parent company’s debt of $1,031,000. The allocation of interest expense was based on the net loss of the predecessor compared to the aggregate net income loss of its parent company. There were a number of parent company debt instruments issued in 2011 and 2012 in favor of significant stockholders of Ener-Core Power, who are related parties. All assets of Ener-Core Power were held as collateral as part of the debt instruments. Under the terms of the Restructuring Agreement, all debt was converted to equity and all collateral was released from encumbrance without recourse.
Following the spin-off, in January 2013, Ener-Core Power borrowed $250,000 from RNS Flex, LLC, one of its then-significant stockholder and the controlling stockholder of its former parent FlexEnergy, under a secured convertible note payable that was due at the earliest of February 28, 2013 or upon completion of a $1,000,000 financing event. The note accrued interest at the rate of 12% and was convertible at the lender’s option into common stock at 85% of the price of a future financing or $3.6056 per share. Such note and accrued interest was repaid in March 2013 using funds that Ener-Core Power obtained from a new $260,200 note that it wrote in favor of the SAIL Entities (the “March Note”).
In March 2013, we borrowed $260,200 from a SAIL Entity under a note payable that was due on the earlier of the completion of the Merger or March 28, 2014. The note accrued interest at the rate of 12% and was convertible at the lender’s option into shares of common stock at $0.75 per share. The note was subsequently converted in April 2013.
In March 2013, a SAIL Entity advanced Ener-Core Power $184,127 for operating capital. The advance did not bear interest and was due on demand. In April 2013, the SAIL Entity converted the advance into shares of common stock of Ener-Core Power at $0.75 per share.
In April 2013, Ener-Core Power sold and issued to the SAIL Entities 666,667 shares of its common stock at $0.75 per share for an aggregate purchase price of $500,000.
In April 2013, an aggregate of approximately $671,618 that was owed by Ener-Core Power to SAIL Entities was converted into an aggregate of approximately 895,491 shares of its common stock. Such economic obligations consisted of (i) the March $260,200 note payable, (ii) $180,000 that had been advanced to Ener-Core Power in March 2013, (iii) $220,710 that had been advanced on Ener-Core Power’s behalf under a letter of credit entered into in connection with the spin-off transaction under the Contribution Agreement; and (iv) $11,708 for certain reimbursable legal expenses incurred in February, March, and April 2013.
In June 2013, Ener-Core Power sold and issued to the SAIL Entities 304,509 shares of its common stock at $0.75 per share for an aggregate purchase price of $228,382.
In June 2013, we borrowed $100,000 each from three significant Company stockholders, Peter Geddes, Morrie Tobin and Jonathan Spanier, under notes payable that were due on the earlier of the completion of the Merger or December 31, 2013. The notes accrued interest at the rate of 8% and are convertible at the lenders’ option into shares of our common stock at $.75 per share. On July 1, 2013, the note payable owed to Mr. Geddes was converted into shares of our common stock in the Merger-related private placement and the remaining notes payable for $200,025 (inclusive of $25 in accrued interest), was repaid at the closing of the Merger.
In July 2013, all of the shares of Ener-Core Power’s common stock held by the SAIL Entities were converted into shares of our common stock as a part of the Merger-related private placement.
Revenue
During 2013, we recorded $9,000 in revenue associated with providing engineering services to Professional Energy Solutions which is owned by our VP of Engineering. Costs associated with these revenues totaled $6,000.
Inflation
We believe that inflation has not had a material effect on our operations to date.
Michael T. Levin, who served as our Secretary and Vice President of Legal and Regulatory Affairs since the Merger, resigned from all such positions as well as from his positions with Ener-Core Power, effective March 31, 2014.
The following table sets forth the names, ages, and principal positions of our executive officers and directors as of the date of this prospectus:
| Name | | Age | | Positions Held |
| Alain J. Castro | | 43 | | Chief Executive Officer and Director |
| Boris A. Maslov, Ph.D. | | 53 | | President, Chief Operating Officer, and Chief Technology Officer |
| Kelly Anderson | | 46 | | Treasurer/Chief Financial Officer |
| Michael J. Hammons | | 43 | | Chairman of the Board of Directors |
| Christopher J. Brown, Ph.D. | | 36 | | Director |
| Stephen L. Johnson | | 62 | | Director, Chairman of the Compensation Committee |
| Bennet P. Tchaikovsky | | 44 | | Director, Chairman of the Audit Committee |
Biographical Information
Alain J. Castro became our Chief Executive Officer and a Director as of the closing of the Merger. He is also the Chief Executive Officer and a Director of Ener-Core Power since May 14, 2013. He founded International Energy Ventures Limited, a United Kingdom-based investor into clean tech companies and renewable energy projects, in May of 2003 and remains active with it. Between February of 2008 and June of 2011, Mr. Castro served in various capacities (including president and a director) of the North and South America divisions of Akuo Energy, an international developer and operator of renewable energy projects. Prior to his career in the renewable energy sector, he was a partner at Ernst & Young Consulting (in the Mercosur region of Latin America), an international advisory services firm. Mr. Castro participated in the Sloan Executive Masters Program at the London Business School and received his B.S. in Industrial and Mechanical Engineering from the University of Texas. We concluded that Mr. Castro’s experience with clean tech companies and renewable energy projects, as well as his previous executive-level experience, coupled with his position as our Chief Executive Officer, made his appointment as one of our Directors appropriate.
Boris A. Maslov, Ph.D., became our President, Chief Operating Officer, and Chief Technology Officer as of the closing of the Merger. Commencing with the inception of Ener-Core Power until the closing of the Merger, he served as its President, Chief Operating Officer, and Chief Technology Officer and served as its interim Chief Executive Officer from inception until May 14, 2013. Previously, between January of 2011 and November of 2012 (the inception of Ener-Core Power), Dr. Maslov was Vice President of FlexEnergy. Prior to that, between October of 2007 and January of 2011, he was Chief Executive Officer of Energy One Management LLC, a renewable energy project development company located in McLean, Virginia. He received his Ph.D. in Electrical Engineering and his B.S. and M.S. in Electrical Engineering and Computer Science, all from the Moscow Institute of Physics and Technology.
Kelly Anderson became our Chief Financial Officer and Treasurer effective November 15, 2013. From October 2012 through September 2013, Ms. Anderson was the Chief Accounting Officer of Fisker Automotive, Inc. from October 2012 through September 2013, the Chief Financial Officer of WindPower Innovation from June through September 2013, and served on the board of directors of the Psychic Friends Network, Inc. from 2012 through May 2013, including chairing its audit committee and serving on its compensation committee. Between April 2010 and February 2012, Ms. Anderson was the President and Chief Financial Officer of T3 Motion, Inc., (“T3”) an electric vehicle technology company. Between March 2008 and April 2010, she served as T3’s Executive Vice President and Chief Financial Officer, and as a director from January 2009 until January 2010. From 2006 until 2008, Ms. Anderson was Vice President at Experian, a leading credit reporting agency. From 2004 until 2006, Ms. Anderson was Chief Accounting Officer for TripleNet Properties, G REIT, Inc., T REIT, Inc., NNN 2002 Value Fund, LLC, and Chief Financial Officer of NNN 2003 Value Fund, LLC and A REIT, Inc., all of which were real estate investment funds managed by TripleNet Properties. From 1996 to 2004, Ms. Anderson held senior financial positions with The First American Corp., a Fortune 500 title insurance company. Ms. Anderson is a 1989 graduate of the College of Business and Economics at California State University, Fullerton.
Michael J. Hammons became Chairman of the Board of Directors (our “Board”) as of the closing of the Merger. Commencing with the inception of Ener-Core Power until the closing of the Merger, he served as its Chairman of the Board. Since June of 2009, Mr. Hammons has been a partner at SAIL Capital Partners, LLC (and its predecessor, SAIL Venture Partners, LLC), an investor in energy and water technology companies and the management company of SAIL Venture Partners II, LP; SAIL Sustainable Louisiana, LP; SAIL 2010 Co-Investment Partners, LP; and SAIL 2011 Co-Investment Partners, LP. From September of 2008 through March of 2009, he was the chief executive officer of Vigilistics, Inc., a Mission Viejo, California-based software company and, from August of 2007 to May of 2008, the chief executive officer of Nexiant, Inc., an Irvine, California-based a provider of proprietary technology solutions for the maintenance, repair, and operations inventory space. Mr. Hammons received his B.S. in Industrial Engineering from California Polytechnic State University, San Luis Obispo, and his M.B.A. from Harvard Business School. We concluded that Mr. Hammons’ experience as a partner SAIL Capital Partners, LLC (one of the SAIL Entities), with their investment portfolio, his management expertise in respect of companies similarly situated, and his familiarity with us, both prior and subsequent to the spin-off, coupled with his service as the Chairman of Ener-Core Power’s board prior to the closing of the Merger, made his appointment as one of our Directors appropriate.
Christopher J. Brown, Ph.D., became one of our directors as of the closing of the Merger. Commencing with the inception of Ener-Core Power until the closing of the Merger, he served as a director of the operating company. Since December of 2010, Dr. Brown has been a principal of SAIL Capital Partners, LLC. From May through August of 2009, he was a business development consultant for Stion Corporation, a San Jose, California-based high-efficiency, low-cost thin film solar panel manufacturer and, from October 2005 through October 2008, the chief executive officer of Chromafix, a Raleigh, North Carolina-based cleantech textile dye manufacturing company. Dr. Brown received his M.B.A. from Harvard Business School in 2010, his Ph.D. in physics from North Carolina State University in 2008, and his B.S. in physics from the College of Charleston in 1999. We concluded that Dr. Brown’s experience as a principal in SAIL Capital Partners, LLC (one of the SAIL Entities), with their investment portfolio, and his familiarity with us, both prior and subsequent to the spin-off, coupled with his service on Ener-Core Power’s board prior to the closing of the Merger, made his appointment as one of our Directors appropriate.
Stephen L. Johnson became one of our directors as of the closing of the Merger. From May 3, 2013 to the closing of the Merger, he served as a director of Ener-Core Power. He is currently the President and Chief Executive Officer of Stephen L. Johnson and Associates Strategic Consulting, LLC, a Maryland-based strategic provider of business, research, and financial management and consulting services that he formed in 2009. For the 30 years prior to his establishing his consulting business, Dr. Johnson was employed by the U.S. Environmental Protection Agency, where he became the first career employee and scientist to serve as Administrator, a position he held from January 2005 through January 2009, having previously served in various other positions, including acting deputy administrator and assistant administrator. Since 2010, he has served as a Director of The Scotts Miracle-Gro Company, a leading supplier of consumer products for lawn and garden care, and commencing April 2011, as a director of M2 Renewables, Inc., an Orange County, California-based wastewater-into-reclaimed water and energy company. Between 2009 and 2011, he was a director of FlexEnergy. Dr. Johnson received his B.A. in Biology from Taylor University, and honorary D.Sc. from Virginia Wesleyan University and from Taylor University. We concluded that Dr. Johnson’s scientific background, his experience with the U.S. Environmental Protection Agency, and his consulting background, as well as his service on the boards of directors of various companies, made his appointment as one of our Directors appropriate.
Bennet P. Tchaikovsky became one of our directors and chairman of our audit committee on November 25, 2013. From April 2010 through August 2013, Mr. Tchaikovsky served as the Chief Financial Officer of VLOV Inc., a China-based clothing designer and distributor that was also a U.S. publicly traded company. From September 2009 to July 2011, Mr. Tchaikovsky served as Chief Financial Officer of China Jo-Jo Drugstores, Inc., a U.S. public company operating a chain of pharmacies in China, where he also served as a director from August 2011 through January 2013. From May 2008 to April 2010, Mr. Tchaikovsky served as the Chief Financial Officer of Skystar Bio-Pharmaceutical Company, a U.S. public company that manufactures and distributes veterinary medicines and related products in China, which he performed on a part-time basis and assisted primarily with preparing its financial statements and other financial reporting obligation. From March 2008 through November 2009, Mr. Tchaikovsky was a director of Ever-Glory International Group, a U.S. public company and apparel manufacturer based in China, and served on the audit committee as chairman and on the compensation committee as a member. From December 2008 through November 2009, Mr. Tchaikovsky was a director of Sino Clean Energy, Inc, which was a U.S. public company and manufactures a coal fuel substitute in China, and served on the audit committee as chairman and on both the compensation and nominating committees as a member. None of the foregoing companies is related to or affiliated with us. Mr. Tchaikovsky is a licensed Certified Public Accountant and an active member of the California State Bar. He received a B.A. in Business Economics from the University of California at Santa Barbara, and a J.D. from Southwestern University School of Law. We concluded that Mr. Tchaikovsky’s experience with U.S. public companies, as well as his legal and accounting backgrounds, made his appointment as one of our Directors appropriate.
Our Board and Its Committees
Our Board is currently composed of five members, two of which, as discussed further under “Certain Relationships and Related Transactions; Director Independence” below, have been determined to be “independent” directors. All members of our Board serve in this capacity until their terms expire or until their successors are duly elected and qualified.
Our Board formally established separate audit, nominating and compensation committees by adopting their charters on November 25, 2013.
Audit Committee
Mr. Tchaikovsky is currently the sole member of the audit committee. Our Board has determined, based on information that Mr. Tchaikovsky furnished and other available information, that he meets the requirements of an “audit committee financial expert” as such term is defined in the rules promulgated under the Securities Act and the Exchange Act, and has accordingly designated him as such as well as chairman of the committee.
The responsibilities of our audit committee include:
| ● | meeting with our management periodically to consider the adequacy of our internal control over financial reporting and the objectivity of our financial reporting; |
| ● | appointing our independent registered public accounting firm, determining its compensation and pre-approving its engagement for audit and non-audit services; |
| ● | overseeing our independent registered public accounting firm, including reviewing independence and quality control procedures and experience and qualifications of audit personnel that are providing us audit services; |
| ● | meeting with our independent registered public accounting firm and reviewing the scope and significant findings of the audits performed by them, and meeting with management and internal financial personnel regarding these matters; and |
| ● | reviewing our financing plans, the adequacy and sufficiency of our financial and accounting controls, practices and procedures, the activities and recommendations of the auditors and our reporting policies and practices, and reporting to our Board. |
Compensation Committee
Mr. Johnson is currently the sole member of the compensation committee as its chairman. The compensation committee will oversee and, as appropriate, make recommendations to the Board regarding the annual salaries and other compensation of our executive officers and our employees, and other policies, and provide assistance and recommendations with respect to our compensation policies and practices.
Nominating Committee
The nominating committee will assist in the selection of director nominees, approves director nominations to be presented for stockholder approval at our annual general meeting and assist in filling any vacancies on our Board, and consider any nomination of director candidates validly made by stockholders. The nominating committee currently does not have any member.
Other Information
There are no family relationships among our directors or among our executive officers.
Securities holders may send communications to our Board by writing to 9400 Toledo Way, Irvine, California 92618, attention: Board of Directors or any specific director. Any correspondence received at the foregoing address to the attention of one or more directors is promptly forwarded to such director or other directors.
Corporate Governance
We promote accountability for adherence to honest and ethical conduct; endeavors to provide full, fair, accurate, timely and understandable disclosure in reports and documents that we file with the SEC and in other public communications we make, and strive to be compliant with applicable governmental laws, rules and regulations. We have not formally adopted a written code of business conduct and ethics that governs our employees, officers and directors as we are not required to do so.
Our Board is responsible for reviewing and making recommendations concerning the selection of outside auditors, reviewing the scope, results and effectiveness of the annual audit of our financial statements and other services provided by our independent public accountants. Our Chief Executive Officer and Chief Financial Officer review our internal accounting controls, practices and policies.
Executive Compensation
The following executive compensation disclosure reflects all compensation for the periods ended December 31, 2013 and 2012, received by our principal executive officer, principal financial officer, and most highly compensated executive officers. We refer to these individuals in this prospectus as “named executive officers.”
| Name and Principal Position | | Fiscal Year Ended | | Salary ($) | | Bonus ($) | | Stock Awards ($)(1) | | Option Awards ($)(2) | | Non- Equity Incentive Plan Comp ($) | | Non- qualified Deferred Comp Earnings ($) | | All Other Comp ($) | | Total ($) | |
| Alain J. Castro | | | 2013 | | 136,410 | | | n/a | | n/a | | | 469,161 | | n/a | | | n/a | | n/a | | $ | 605,571 | |
| Chief Executive Officer (3) | | | 2012 | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | |
| Boris A. Maslov | | | 2013 | | 225,000 | | | 67,875 | | 58,501 | | | 168,436 | | n/a | | | n/a | | n/a | | | 530,128 | |
| President, COO, and CTO (4) | | | 2012 | | 225,000 | | | n/a | | n/a | | | 146,493 | | n/a | | | n/a | | n/a | | | 371,493 | |
| James M. Thorburn, former interim | | | 2013 | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | | 154,388 | | | 154,388 | |
| Treasurer/Chief Financial Officer (5) | | | 2012 | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | |
| Kelly Anderson | | | 2013 | | 21,875 | | | n/a | | n/a | | | 32,240 | | n/a | | | n/a | | n/a | | | 54,115 | |
| Treasurer/Chief Financial Officer (6) | | | 2012 | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | | n/a | | | n/a | |
| Michael T. Levin | | | 2013 | | 162,400 | | | 13,470 | | 6,702 | | | 63,163 | | n/a | | | n/a | | n/a | | | 247,077 | |
| former VP Government Affairs(7) | | | 2012 | | 162,400 | | | n/a | | n/a | | | 16,981 | | n/a | | | n/a | | n/a | | | 179,381 | |
____________________________________
| | (1) | The amounts shown in this column represent the dollar amount recognized for financial statement reporting purposes for the years ended December 31, 2013 and 2012 with respect to the shares issued pursuant to the stock option agreement that are subject to company buy-back rights. |
| | (2) | The amounts shown in this column represent the dollar amount recognized for financial statement reporting purposes for the years ended December 31, 2013 and 2012 with respect to stock options granted, as determined pursuant to the accounting standards. See Note 9 of the notes to our audited consolidated financial statements for a discussion of valuation assumptions made in determining the grant date fair value and compensation expense of our stock options. |
| | (3) | Mr. Castro became Chief Executive Officer of Ener-Core Power under the terms of his employment agreement on April 25, 2013. His compensation is $200,000 per annum. |
| | (4) | Dr. Maslov served in a variety of officer roles with Ener-Core Power subsequent to the spin-out from Flex-Energy and with FlexEnergy prior to the spin-out. Thus, his 2012 compensation includes compensation from FlexEnergy and Ener-Core Power, as relevant. Effective December 31, 2012, Dr. Maslov was granted options under Ener-Core Power’s 2012 Equity Incentive Plan for the purchase of up to 1,200,000 shares of its Series D Preferred Stock and 187,500 shares of its common stock, all of which he exercised in January 2013. The shares of Series D Preferred Stock were converted into 1,500,000 shares of Ener-Core Power common stock immediately prior to the Merger. |
| | (5) | Mr. Thorburn was not affiliated with us or with Ener-Core Power during 2012. He became interim Treasurer/Chief Financial Officer of the operating company under the terms of his Consulting Agreement on May 8, 2013, and continued as our interim Treasurer/Chief Financial Officer after the Merger. His Consulting Agreement expired effective November 11, 2013. |
| | (6) | Ms. Anderson became our Treasurer and Chief Financial Officer effective November 15, 2013, to replace Mr. Thorburn. Her compensation is $175,000 per annum per the terms of her employment agreement. |
| | (7) | Mr. Levin has resigned effective March 31, 2014. Mr. Levin’s 2012 compensation includes compensation from FlexEnergy and Ener-Core Power, as relevant. Effective December 31, 2012, Mr. Levin was granted options under Ener-Core Power’s 2012 Equity Incentive Plan for the purchase of up to 50,000 shares of its Series D Preferred Stock and 135,333 shares of its common stock, all of which he exercised in January 2013. The shares of Series D Preferred Stock were converted into 62,500 shares of Ener-Core Power common stock immediately prior to the Merger. |
Compensation Philosophy
Our basic objectives for executive compensation are to recruit and keep top quality executive leadership focused on attaining long-term corporate goals and increasing stockholder value.
Employment Agreements
We have entered into various employment and employment-related agreements with certain of our executive officers. Set forth below is a summary of many of the material provisions of such agreements, which summaries do not purport to contain all of the material terms and conditions of each such agreement.
Our Agreements with Mr. Castro and Dr. Maslov:
Mr. Castro is employed by us pursuant to his Executive Employment Agreement, dated April 25, 2013, with Ener-Core Power (the operating company), which agreement was assumed by us as of the closing of the Merger. Under the agreement, the term of his employment is one year, renewing automatically for successive one-year terms as of April 25 of each year unless either party gives the other party notice of non-renewal not less than 30 day prior to the end of the relevant term. We will pay Mr. Castro a base salary of $200,000 per year that may be increased but not decreased by our Board in its sole discretion. Mr. Castro is eligible (i) for an annual bonus and/or other annual incentive compensation in accordance with any applicable executive bonus plan as our Board may adopt in its sole discretion and (ii) to participate in our equity incentive plan or incentive option plan, as applicable, with grants and vesting schedules as determined by the Board from time to time.
Dr. Maslov is employed by us pursuant to his Amended and Restated Executive Employment Agreement, dated December 31, 2012, with Ener-Core Power (the operating company), which agreement was assumed by us as of the closing of the Merger. Under the agreement, the term of his employment is one year, renewing automatically for successive one-year terms as of December 31 of each year unless either party gives the other party notice of non-renewal not less than 30 day prior to the end of the relevant term. We will pay Dr. Maslov a base salary of $225,000 per year that may be increased but not decreased by our Board in its sole discretion. Dr. Maslov is eligible (i) for an annual bonus and/or other annual incentive compensation in accordance with any applicable executive bonus plan as our Board may adopt in its sole discretion and (ii) to participate in our equity incentive plan or incentive option plan, as applicable, with grants and vesting schedules as determined by the Board from time to time.
The termination provisions for Mr. Castro’s or Dr. Maslov’s employment are substantially similar and are set forth below. If we terminate Mr. Castro or Dr. Maslov’s services for cause (whether during or at the end of an employment year), then we are obligated to pay him the sum of (i) his salary and bonuses, if any, through the date of termination, (ii) any earned but unused vacation and PTO time, and (iii) any unreimbursed expenses. “Cause” means his (A) willful dishonesty or fraud with respect to our business affairs, (B) willful falsification of any employment or other of our records, (C) misappropriation of or intentional damage to our business or property of the Company, (D) his conviction (including any plea of guilty or nolo contendere) of a felony or crime that involves moral turpitude, (E) his willful and continued failure to comply with our reasonable written directives after his receipt of written notice from us of such refusal and a reasonable opportunity to cure, or (F) the misappropriation of any corporate opportunity, or otherwise obtaining personal profit from any transaction which is adverse to our interests or to the benefits of which we are entitled.
If we terminate Mr. Castro or Dr. Maslov’s services upon his death or Disability, then we are obligated to pay him or his estate (i) the same economic benefits as if his services were terminated for cause and (ii) upon a determination by our Board in its sole discretion, he or his estate may also be granted (A) additional vesting of then-unvested stock or stock options, (B) a proportional amount of any earned and unpaid annual bonus based on his performance through the date of termination, and/or (C) severance payments. “Disability” means his inability to perform one or more of the essential functions of his job due to his physical or mental impairment, with or without reasonable accommodation as required by law, for any period aggregating more than 120 days in any 365-consecutive day period.
If we terminate Mr. Castro or Dr. Maslov’s services for any other reason, then we are obligated to pay him (i) the same economic benefits as if his services were terminated for cause and (ii) monthly cash severance payments at his then-salary rate during the six-month period immediately following the termination date, subject to earlier termination in the event that he obtains new employment or engages (or assists any other person or entity to engage) in any activity competitive with our business. Further, if, during the six-month period immediately preceding or following a “Change of Control,” we terminate his employment without Cause, then all of his then-unvested outstanding options shall immediately vest. “Change of Control” occurs when (i) any person becomes the beneficial owner of our securities that then represents 50% or more of the total voting power of our outstanding voting securities, unless such person was the beneficial owner of at least 20% of our voting power as of February 1, 2012, and does not become the beneficial owner of 80% or more of our voting power, (ii) we consummate the sale, exchange, lease, or other disposition of all or substantially all of our assets to a person or group of related persons, (iii) we consummate a merger, reorganization, recapitalization, consolidation, or similar transaction with any other corporation or other business entity, in one transaction or a series of related transactions (except one in which (A) the holders of our voting securities outstanding immediately before such transaction continue to hold at least 50% of the voting power in the surviving entity or (B) a transaction in which a single party (or a group of affiliated parties) acquires voting securities of the Company and the holders of our voting securities immediately before the transaction do not dispose of a majority of their interests in us in connection with that transaction), or (iii) we dissolve or liquidate.
Mr. Castro or Dr. Maslov may terminate his employment relationship with us at any time and for any reason. If he does so, he has agreed to make himself available to us during the 30-day period following his termination, without any compensation, (i) to facilitate an efficient transition of his job-related responsibilities and duties and (ii) to respond to questions from us regarding information and/or activities in which he had been engaged while employed by us.
Our Agreements with Ms. Anderson:
Our offer letter to Ms. Anderson dated November 1, 2013 provides for an annual base salary of $175,000 and an option under our 2013 Equity Award Incentive Plan (the “Plan”) to purchase 1,000,000 shares of our common stock at an exercise price equal to the per share closing price on November 15, 2013, being the fair market value on such date. She will also be eligible for a one-time bonus of $50,000 if we successfully raise at least $10 million in a public offering of our common stock.
In addition to the offer letter, we entered into an executive employment agreement with Ms. Anderson dated as of November 15, 2013, which, in addition to her annual compensation as described in the offer letter, provides for her eligibility to annual bonus and other annual incentive compensation that the Board may adopt, as well as benefits that we make available to other employees. We will also reimburse Ms. Anderson for reasonable expenses that she incurs in performing her duties.
We may terminate Ms. Anderson’s employment for cause upon written notice if at any time she: (a) engages in willful dishonesty or fraud with respect to our business affairs; (b) willfully falsifies any employment or our records; (c) misappropriates or intentionally damaged our business or property, including confidential or proprietary information; (d) is convicted of a felony or crime that involves moral turpitude (including any plea of guilty or nolo contendere); (e) willfully and continuously fails to comply with our reasonable written directives after written notice thereof and a reasonable opportunity to cure (as described below); or (f) misappropriates any corporate opportunity, or otherwise obtaining personal profit from any transaction which is adverse to our interests or to the benefits of which we are entitled. Upon termination for cause, Ms. Anderson shall be entitled to her accrued but unpaid base salary, bonuses, benefits and expense reimbursement through her termination date (collectively the “accrued obligations”).
If at any time we terminate or do not renew her employment without cause, Ms. Anderson shall, in addition to the accrued obligations, be entitled to monthly cash severance payment at her base salary rate (less standard withholdings and deductions) for up to six months or until she obtains new employment or competes against our business, whichever occurs sooner; provided, however, that if the termination occurs during the six months before or after our change in control, then all of Ms. Anderson’s unvested option shall also immediately vest.
On the other hand, Ms. Anderson may terminate her employment at any time by written notice to the Board; provided that: (a) her resignation will become effective on the earlier of 90 days after her notice or a date that we specify; and (b) she will be available for 30 days following her effective resignation date to facilitate and cooperate with transition.
The executive employment agreement also contains restrictive covenants prohibiting: (a) competition with us during her employment and for a period of up to 12 months after termination (including contact with or solicitation of our customers, employees or suppliers), (b) disparagement of us or our affiliates, and (c) the use or disclosure of confidential business information during or at any time after termination of her employment.
In connection with the option granted under the executive employment agreement, we entered into a stock option agreement with Ms. Anderson dated as of November 15, 2013. The agreement provides for the option to vest as follows: (i) 1/4 of the total number of shares after twelve months from the grant date, and (ii) 1/48 of the total number of shares each month thereafter.
Equity Awards
The following disclosure reflects all outstanding equity awards at the end of our 2013 fiscal year for each named executive officer, who served in such capacity as of December 31, 2013.
Option Awards (1) | | Stock Awards | | | All Awards | |
| Name | | Number of securities underlying unexercised options (#) exercisable | | | Number of securities underlying unexercised options (#) unexercisable | | | Equity incentive plan awards: Number of securities underlying unexercised unearned options (#) | | | Weighted Average Option Exercise Price ($) | | Option Expiration Date | | Number of Shares or Units of Stock That Have Not Vested (#)(2) | | | Value of Shares or Units of Stock That Have Not Vested ($)(3) | |
| Alain Castro | | | 444,444 | | | | 1,705,556 | | | | - | | | | 1.13 | | May 8, 2018 | | | - | | | | 1,085,424 | |
| Boris Maslov | | | - | | | | 800,000 | | | | - | | | | 1.30 | | August 23, 2020 | | | 975,000 | | | | 629,261 | |
| Kelly Anderson | | | - | | | | - | | | | 1,000,000 | | | | 1.53 | | November 15, 2020 | | | - | | | | 1,081,212 | |
| Michael Levin (4) | | | - | | | | 300,000 | | | | - | | | | 1.30 | | August 23, 2020 | | | 114,306 | | | | 214,127 | |
| | (1) | The shares are on an as-converted into common stock basis. |
| | (2) | The shares represent the shares issued pursuant to the stock option agreement that are subject to our buy-back rights. |
| | (3) | Represents the remaining dollar amount to be recognized for financial statement reporting purposes with respect to all option awards and stock awards. |
| | (4) | Mr. Levin has resigned as of March 31, 2014. |
Director Compensation and Agreement
The following table provides compensation information for our directors during the fiscal year ended December 31, 2013:
| Director Compensation Table |
| Name | | Fiscal Year ended | | Fees Earned or Paid in Cash ($) | | | Stock Awards ($) | | | Option Awards ($)(2) | | | Non-Equity Incentive Plan Compensation ($) | | | Nonqualified Deferred Compensation Earnings ($) | | | All Other Compensation ($) | | | Total ($) | |
| Alain J. Castro (1) | | 2013 | | | - | | | | -0- | | | | -0- | | | | -0- | | | | -0- | | | | -0- | | | | -0- | |
| Michael J. Hammons | | 2013 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Chris Brown | | 2013 | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Stephen L. Johnson | | 2013 | | - | | | | - | | | | 54,115 | | | | - | | | | - | | | | - | | | | 54,115 | |
| Bennet P. Tchaikovsky | | 2013 | | | - | | | | - | | | | 6,245 | | | | - | | | | - | | | | - | | | | 6,245 | |
| (1) | Compensation is reflected in the Summary Compensation Table on page 50 above. |
| (2) | The amounts shown in this column represent the dollar amount recognized for financial statement reporting purposes for the years ended December 31, 2013 and 2012 with respect to stock options granted, as determined pursuant to the accounting standards. See Note 11 of the notes to our audited consolidated financial statements for a discussion of valuation assumptions made in determining the grant date fair value and compensation expense of our stock options. |
Other than with Messrs. Stephen Johnson and Bennet Tchaikovsky, we do not have written agreements with our other directors for their services on our Board.
Our Agreement with Mr. Johnson:
In April 2013, Ener-Core Power entered into a letter agreement with Mr. Johnson to serve on its board, commencing May 1, 2013. The agreement provides as compensation and subject to the approval of the board, a grant to Mr. Johnson of an option to purchase up to 250,000 shares of Ener-Core Power’s common stock at an exercise price equal to the per share fair market value on the date that the board of directors approve the grant. One-fourth of the option vests 12 months from May 1, 2013, with the balance to vest in 48 monthly installments thereafter. In addition, the agreement provides for reimbursement of all reasonable travel expenses in connection with attending board meetings. The agreement also provides for indemnity of Mr. Johnson.
Mr. Johnson joined our Board at the closing of the Merger, and we assumed his letter agreement with Ener-Core Power accordingly. In connection therewith, and pursuant to the letter agreement, we entered into a stock option agreement with Mr. Johnson on July 3, 2013, granting him an option to purchase up to 250,000 shares of our common stock under the Plan.
Our Agreement with Mr. Tchaikovsky:
On November 22, 2013, Mr. Tchaikovsky accepted his appointment to our Board and as chairman of our audit committee pursuant to our offer letter dated November 10, 2013, which provides for an option under the Plan to purchase 250,000 shares of our common stock at an exercise price equal to the per share closing price on November 25, 2013, being the fair market value on such date. In addition, we agreed to reimburse Mr. Tchaikovsky for reasonable travel expenses incurred to attend Board meetings, and to indemnify him in his capacity as a director. The offer letter also contemplates an annual director’s fee of $40,000 commencing sometime next year, subject to review by the Compensation Committee and approval by the Board and stockholders as appropriate.
In connection with the option granted under the offer letter, we entered into a stock option agreement with Mr. Tchaikovsky dated as of November 25, 2013. The agreement provides for the option to vest as follows: (i) 1/4 of the total number of shares after twelve months from the grant date, and (ii) 1/48 of the total number of shares each month thereafter.
