# Birchtech Corp.: Form 10-Q for the period ended Sep 30, 2014

- Company: [Birchtech Corp.](/companies/bcht.md) (CIK 728385)
- Form: 10-Q
- Filed: 2014-11-14
- Accepted by EDGAR: Nov 14, 2014, 17:00 ET
- Period: 2014-09-30
- Accession: 0001477932-14-006277
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/728385/000147793214006277/meec_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/728385/000147793214006277/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2014-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2014-07-01 to 2014-09-30 | $1.4m | us-gaap:Revenues |
| Revenue | 9 months, 2014-01-01 to 2014-09-30 | $2.3m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2014-07-01 to 2014-09-30 | $829.7k | us-gaap:CostOfGoodsSold |
| Cost of revenue | 9 months, 2014-01-01 to 2014-09-30 | $1.2m | us-gaap:CostOfGoodsSold |
| Selling, general and administrative | 3 months, 2014-07-01 to 2014-09-30 | $487.0k | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 9 months, 2014-01-01 to 2014-09-30 | $1.5m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2014-07-01 to 2014-09-30 | −$1.3m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2014-01-01 to 2014-09-30 | −$5.3m | us-gaap:OperatingIncomeLoss |
| Net income | 3 months, 2014-07-01 to 2014-09-30 | −$2.0m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2014-01-01 to 2014-09-30 | −$6.8m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2014-07-01 to 2014-09-30 | −$0.05 | us-gaap:EarningsPerShareBasicAndDiluted |
| Diluted EPS | 9 months, 2014-01-01 to 2014-09-30 | −$0.17 | us-gaap:EarningsPerShareBasicAndDiluted |
| Operating cash flow | 9 months, 2014-01-01 to 2014-09-30 | −$1.9m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Cash and equivalents | at 2014-09-30 | $8.4m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2014-09-30 | $12.8m | us-gaap:AssetsCurrent |
| Total assets | at 2014-09-30 | $16.6m | us-gaap:Assets |
| Current liabilities | at 2014-09-30 | $8.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2014-09-30 | $23.1m | us-gaap:Liabilities |
| Shareholders' equity | at 2014-09-30 | −$6.6m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 24,906 characters.

### Background

We develop and employ patented and proprietary technologies to remove mercury from coal-fired power plant air emissions. The U.S. EPA MATS (“MATS”) rule requires that all coal and oil-fired power plants in the U.S., larger than 25MWs, must limit mercury in its emissions to below certain specified levels, according to the type of coal burned and the plant design. In general, MATS requires EGUs to remove about 90% of the mercury from their emissions. Our technology has been shown to be able to achieve mercury removal levels compliant with MATS and at a lower cost and plant impact than the most widely used approach of PAC or BAC injection. As is typical in this market, we are paid by the EGU based on how much of our material is injected to achieve the needed level of mercury removal. Our current clients pay and we expect future clients will pay us periodically (monthly or as material is delivered) based on their actual use of our injected material. Clients will use our material whenever their EGUs operate, but they do not operate all the time. EGUs typically are not operated due to maintenance reasons or when the price of power in the market is less than their cost to produce that power. As a result, our revenues from EGU clients will not typically be a consistent stream but will fluctuate, especially seasonally as the market demand for power fluctuates.

### Results of Operations

The Company’s performance in the third quarter was strong, as we produced the largest revenue quarter in the Company’s history, at $1,373,000, an improvement of approximately 50% versus the third quarter of 2013. Revenue was driven by product sales used in testing by our newly contracted customers. Deferred revenues within the quarter grew to over $3.6 million.

During 2014, the Company achieved significant growth and a number of milestones. In the second quarter, the Company announced that its first customer has extended its contract with the Company for an additional three years. This contract extension serves as a very important business development for us. We have valued our relationship with this customer highly, dating back to 2011 when we first installed our technology to manage the plant's compliance with its state mercury emissions requirements. Over these three years, the patented Sorbent Enhancement Additive (SEA) solution consistently and accurately performed, and this new three-year contract extension demonstrates confidence from a large customer in our commitment to execution. The contract extension for these two large electric generating units is expected to generate approximately $3 million in revenues annually when MATS takes effect in the second quarter of 2015. We now have 13 electric generating units under contract for MATS.

Additionally, in the second quarter the Company announced that it delivered the first of its newly designed mercury-control feeder systems to the site of a major utility customer. This system was designed by ME2C to be operational in both enclosed and outdoor environments, and reduces the required space needed for system operations. This initial equipment delivery is for the first of the 11 electric generating units that the Company contracted for MATS regulations in the first quarter of 2014.

We anticipate continued growth in our business as the initial compliance date of 2015 for the MATS regulation looms, and demand for mercury control solutions increases.

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### Revenues

*Sales* - We generated revenues of approximately $1,373,000 and $917,000 for the quarter ended September 30, 2014 and 2013, respectively, and $2,252,000 and $1,425,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase during the current year was due to product delivered for tests being performed by commercial customer sites to prepare for compliance with the MATS rule in the second quarter of 2015. During the nine months ended September 30, 2014, we billed customers a total of $3,576,000 for progress billings on new equipment contracts that are associated with new supply contracts. This amount is included in deferred revenue at September 30, 2014 and will be reported as revenue in 2014 and 2015 when the equipment is delivered and commissioned for use by the customer. Anticipated revenue from new contracts for equipment signed in the quarter ended September 30, 2014 total approximately $8.4 million and the delivery of this equipment is scheduled to be completed during 2014 and 2015.

### Cost and Expenses

*Costs and expenses* were $2,640,000 and $1,475,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $7,595,000 and $3,928,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase in costs and expenses from the same period in the prior year is primarily attributable the increases in cost of goods sold and stock based compensation discussed below in the nine months ended September 30, 2014.

*Cost of goods sold* were $830,000 and $206,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $1,195,000 and $285,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase in 2014 is associated with product purchased for a commercial customer for use in testing performed at their sites to prepare for compliance with the MATS rule in the second quarter of 2015.

*Operating expenses* were $469,000 and $359,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $725,000 and $809,000 for the nine months ended September 30, 2014 and 2013, respectively. The decreased costs in 2014 were associated with six demonstrations of our technologies on the power generating units of potential customers performed in 2013. There were four demonstrations performed on the power generating units of potential customers performed during 2014, however, the scope of these tests was more limited. This decrease is offset in the three months ended September 30, 2014 with increased labor and technical consulting costs associated with assisting our customers with testing being performed at their sites.

*License Maintenance Fees* were $75,000 and $50,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $225,000 and $150,000 for the nine months ended September 30, 2014 and 2013, respectively. The expenses relate to the amortization of the annual maintenance fee.

*Selling, general and administrative expenses* were $487,000 and $438,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $1,500,000 and $1,408,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase in selling, general and administrative expenses during 2014 is primarily attributed to the continued expansion of the efforts to commercialize our technologies.

*Depreciation and amortization* was $191,000 and $48,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $326,000 and $137,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase in depreciation and amortization in 2014 is attributable to accelerated depreciation incurred on the equipment held on our customer’s site in and amortization of customer acquisition costs which began in the second quarter of 2014.

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*Professional fee expenses* were $120,000 and $110,000 for the quarter ended September 30, 2014 and 2013, respectively, and were $463,000 and $409,000 for the nine months ended September 30, 2014 and 2013, respectively. The increase in professional fee expenses during 2014 is primarily attributed to costs incurred related to the continued expansion of our business operations.

*Stock based compensation* was $468,000 and $263,000 for the quarter ended September 30, 2014 and 2013, respectively, and $3,161,000 and $729,000 for the nine months ended September 30, 2014 and 2013, respectively. In the quarter and nine months ended September 30, 2014, these costs were associated with stock options issued to officers, directors and consultants. In the quarter and nine months ended September 30, 2013, these costs were associated with the amortization of stock awards included in the employment agreements of officers.

### Net Loss

For the quarter ended September 30, 2014 and 2013 we had a net loss from continuing operations of $1,982,000 and $742,000, respectively, and for the nine months ended September 30, 2014 and 2013 we had a net loss from operations of $6,764,000 and $2,862,000, respectively. This increase from the prior year is primarily associated with increased costs associated with employee stock option grants and increased interest expense associated with increased debt from the prior year.

### Other Expense

Given our financial constraints and our reliance on financing activities, interest expense related to the financing of capital was $715,000 and $184,000 during the quarter ended September 30, 2014 and 2013, respectively. Interest expense was $1,422,000 and $440,000 during the nine months ended September 30, 2014 and 2013, respectively. The outstanding principal balances of convertible promissory notes were $15,841,000 and $4,704,000 at September 30, 2014 and 2013, respectively. Interest expense incurred for the amortization of the discount on notes payable and debt issuance costs totaled $657,000 and $81,000 in the nine months ended September 30, 2014 and 2013, respectively.

### Taxes

As of September 30, 2014, our deferred tax assets are primarily related to accrued compensation and net operating losses. A 100% valuation allowance has been established due to the uncertainty of the utilization of these assets in future periods. As a result, the deferred tax asset was reduced to zero and no income tax benefit was recorded. The Company’s net operating loss carryforward will begin to expire in 2025.

Section 382 of the Internal Code allows post-change corporations to use pre-change net operating losses, but limit the amount of losses that may be used annually to a percentage of the entity value of the corporation at the date of the ownership change. The applicable percentage is the federal long-term tax-exempt rate for the month during which the change in ownership occurs.

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### Liquidity and Capital Resources

Our principal source of liquidity is cash generated from financing activities. On August 14, 2014, the Company entered into a financing agreement with a newly created independent entity, AC Midwest Energy LLC, pursuant to which, the Company borrowed $10,000,000 from AC Midwest Energy LLC (for more information, see Note 9 to the Condensed Consolidated Financial Statements). Management believes that this financing agreement should allow the Company to implement its business plan and sustain its ongoing operations.

As of September 30, 2014, our cash and cash equivalents were $8.4 million and we had a working capital of approximately $6.6 million. Per the financing agreement entered into with the AC Midwest, LLC , the Company is required to pay all interest accruing on unsecured convertible promissory notes with payment in kind interest. Also, should the Company be unable to raise sufficient capital to pay off such notes at their maturity or otherwise induce the holders thereof to convert their notes to common stock, it will not be permitted to pay them off under the terms of the Financing Agreement without the prior consent of the lender. Unsecured notes with a current principal balance of $3.2 million mature during 2015. Also, we continue to have recurring losses and anticipate cash needs for working capital and capital expenditures for the next twelve months of approximately $4.0 million. With our expected gross margins on customer contracts announced during 2014, we anticipate that we will be at break-even on a cash flow basis when our product revenues reach approximately $16 million annually. This break-even target is subject to achieving sales at that level with our expected gross margins and our effective operating performance and. No assurance can be made that we will be able to achieve our operating performance goals or execute on the awarded customer contracts.

*Total assets* were $16,560,000 at September 30, 2014 versus $1,924,000 at December 31, 2013. The change in total assets is primarily attributable to the increases in inventory and customer acquisition costs associated with the signing of three new customers during the nine months ended September 30, 2014, the associated costs of beginning to fabricate the equipment our customers will need to install at their individual sites and debt issuance costs associated with the financing agreement with AC Midwest Energy, LLC. Total current liabilities increased from $1,881,000 at December 31, 2013 to $8,018,000 at September 30, 2014. This increase is primarily attributable to increases in deferred revenue, customer credits and accounts payable associated with the increases to assets noted above and the reclassification of convertible promissory notes payable with maturity dates within the next twelve months.

*Operating activities* used $1,909,000 of cash during the quarter ended September 30, 2014 compared to $1,081,000 during the quarter ended September 30, 2013. The increase in cash used for operating activities is primarily attributable to the increases in accounts receivable and inventory that are offset by increased deferred revenue. These changes all relate to the increased business activity associated with the execution of customer contracts signed during the nine months ended September 30, 2014.

*Investing activities* used $125,000 and zero during nine months ended September 30, 2014 and 2013, respectively. The increase in 2014 is attributable to the fabrication of product delivery equipment needed to execute on the customer contracts won during the first nine months of the year.

*Financing activities* provided $9,965,000 during the quarter ended September 30, 2014, primarily due to the issuance of common stock and related warrants which provided $1,005,000 and the proceeds from the issuance of convertible note payable which provided $10,000,000. These increase were offset by the payment of $748,000 of debt issuance costs and net principal payments of $300,000 made on notes payable during the period. Financing activities provided $1,176,000 during the nine months ended September 30, 2013 due to proceeds from the issuance of convertible promissory notes. In connection with the issuance of the convertible note in 2014, the Company issued the noteholder a five year warrant to purchase 12,500,000 shares of the Company’s common stock at $1.00 per share. The Company also paid the noteholder a fee of $100,000 for issuing the loan, reimbursed it $125,000 for its legal fees and costs associated with the transactions and compensated the placement agent for the transaction with a cash fee of $350,000 and: (i) a 5-year warrant to purchase up to 800,000 shares of common stock at $1.00 per share; and (ii) a 5-year warrant to purchase up to 1,000,000 shares of common stock at $0.50 per share. The Company incurred additional legal fees and expenses of $169,000 associated with the transaction. The total transaction costs incurred in connection with the issuance of the convertible note were $1,999,000, including the warrants issued to the placement agent which were valued at $1,251,000.

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### Off-Balance Sheet Arrangements

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.

### Critical Accounting Policies and Estimates

Our discussion and analysis of our financial conditions and results of operation is based upon the accompanying consolidated financial statements which have been prepared in accordance with the generally accepted accounting principles in the U.S. The preparation of the consolidated financial statements requires that we make estimates and assumptions that affect the amounts reported in assets, liabilities, revenues and expenses. Management evaluates on an on-going basis our estimates with respect to the valuation allowances for accounts receivable, income taxes, accrued expenses and equity instrument valuation, for example. We base these estimates on various assumptions and experience that we believe to be reasonable. The following critical accounting policies are those that are important to the presentation of our financial condition and results of operations. These policies require management’s most difficult, complex, or subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

The following critical accounting policies affect our more significant estimates used in the preparation of our consolidated financial statements. In particular, our most critical accounting policies relate to the recognition of revenue, and the valuation of our stock-based compensation.

### Accounts Receivable

Trade accounts receivable are stated at the amount the Company expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.

### Revenue Recognition

The Company records revenue from sales in accordance with ASC 605, *Revenue Recognition (“*ASC 605”). The criteria for recognition are as follows:

1\. Persuasive evidence of an arrangement exists;

2\. Delivery has occurred or services have been rendered;

3\. The seller’s price to the buyer is fixed or determinable; and

4\. Collectability is reasonably assured.

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Determination of criteria (3) and (4) will be based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments will be provided for in the same period the related sales are recorded.

The Company recorded customer acquisition costs totaling $1,120,500 during the nine months ended September 30, 2014. The Company entered into agreements with three new customers during this period. The Company’s consolidated financial statements for the year ended December 31, 2013 showed accounts receivable for one of these new customers in the amount of $150,000, which resulted from a demonstration performed for that customer in 2013. In accordance with the contractual arrangement with that customer, because the customer entered into a long-term contract with the Company, the customer’s account was credited for the full amount of the demonstration fee. Additional customer credits towards future deliveries totaling $970,500 were accrued in the first quarter of 2014 in accordance with the terms of the customer contracts entered into during the first quarter of 2014. Customer acquisition costs will be amortized over the life of the new customer agreements. Amortization expense for the nine months ended September 30, 2014 was $81,862.

In accordance with the terms of the new customer agreements, the Company made progress billings to three customers a total of $2,760,028, which relate to the future fabrication, delivery and installation of new equipment. This amount is included as deferred revenue at September 30, 2014 and will be shown as revenue in 2014 and 2015 when the equipment is delivered and expected to be commissioned for use by the customers.

The Company generated revenues of $2,252,250 and $1,424,992 for the nine months ended September 30, 2014 and 2013, respectively. The Company generated revenue for the nine months ended September 30, 2014 and 2013 by performing demonstrations of its technology at potential customers and delivering product to its commercial customers.

### Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carryforwards, 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s consolidated financial statements are based on a more-likely-than-not recognition threshold. The Company did not have any unrecognized tax benefits at September 30, 2014 or December 31, 2013. When necessary, the Company would accrue penalties and interest related to unrecognized tax benefits as a component of income tax expense.

The Company and its subsidiaries file a consolidated income tax return in the U.S. federal jurisdiction and three state jurisdictions. The Company is no longer subject to U.S. federal examinations for years prior to 2010 or state tax examinations for years prior to 2009.

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### Stock-Based Compensation

We have adopted the provisions of *Share-Based Payments*, which requires that share-based payments be reflected as an expense based upon the grant-date fair value of those grants. Accordingly, the fair value of each option grant, non-vested stock award and shares issued under our employee stock purchase plan, were estimated on the date of grant. We estimate the fair value of these grants using the Black-Scholes model which requires us to make certain estimates in the assumptions used in this model, including the expected term the award will be held, the volatility of the underlying common stock, the discount rate, dividends and the forfeiture rate. The expected term represents the period of time that grants and awards are expected to be outstanding. Expected volatilities were based on historical volatility of our stock. The risk-free interest rate approximates the U.S. treasury rate corresponding to the expected term of the option. Dividends were assumed to be zero. Forfeiture estimates are based on historical data. These inputs are based on our assumptions, which we believe to be reasonable but that include complex and subjective variables. Other reasonable assumptions could result in different fair values for our stock-based awards. Stock-based compensation expense, as determined using the Black-Scholes option-pricing model, is recognized on a straight-line basis over the service period, net of estimated forfeitures. To the extent that actual results or revised estimates differ from the estimates used, those amounts will be recorded as an adjustment in the period that estimates are revised.

### Warrants

Unless sold and issued warrants are subject to the provisions of FASB ASC 815-10, the Company utilized a Black-Scholes options pricing model to value the warrants sold and issued. This model requires the input of highly subjective assumptions such as the expected stock price volatility and the expected period until the warrants are exercised. When calculating the value of warrants issued, the Company uses a volatility factor of 72.8%, a risk free interest rate and the life of the warrant for the exercise period. When sold and issued warrants were valued in accordance with FASB ASC 815-10, the fair value was determined using a Monte Carlo Simulation Model.

## Market risk

As filed, 163 characters.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

## Controls and procedures

As filed, 862 characters.

Under the supervision and with the participation of our management, including the principal executive officer (“PEO”) and principal financial officer (“PFO”), we have evaluated the effectiveness, the design and operations of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the PEO and the PFO determined that as of September 30, 2014, the Company’s disclosure controls and procedures were effective.

### Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2014 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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## Risk factors

As filed, 163 characters.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

Filed Nov 14, 2014.
Source: SEC EDGAR, the filing index for accession 0001477932-14-006277. Last ingested by Listed: Nov 13, 2026, 16:05 ET. No prices; not investment advice.