# Birchtech Corp.: Form 10-K for the period ended Dec 31, 2016

- Company: [Birchtech Corp.](/companies/bcht.md) (CIK 728385)
- Form: 10-K
- Filed: 2017-03-28
- Accepted by EDGAR: Mar 28, 2017, 13:36 ET
- Period: 2016-12-31
- Accession: 0001477932-17-001322
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/728385/000147793217001322/meec_10k.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/728385/000147793217001322/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2016-12-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 12 months, 2016-01-01 to 2016-12-31 | $32.3m | us-gaap:Revenues |
| Cost of revenue | 12 months, 2016-01-01 to 2016-12-31 | $23.0m | us-gaap:CostOfGoodsSold |
| Selling, general and administrative | 12 months, 2016-01-01 to 2016-12-31 | $7.3m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 12 months, 2016-01-01 to 2016-12-31 | $2.1m | us-gaap:OperatingIncomeLoss |
| Income tax | 12 months, 2016-01-01 to 2016-12-31 | −$472.7k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 12 months, 2016-01-01 to 2016-12-31 | −$16.9m | us-gaap:NetIncomeLoss |
| Diluted EPS | 12 months, 2016-01-01 to 2016-12-31 | −$0.34 | us-gaap:EarningsPerShareBasicAndDiluted |
| Operating cash flow | 12 months, 2016-01-01 to 2016-12-31 | $3.2m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Cash and equivalents | at 2016-12-31 | $7.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2016-12-31 | $12.1m | us-gaap:AssetsCurrent |
| Total assets | at 2016-12-31 | $15.9m | us-gaap:Assets |
| Current liabilities | at 2016-12-31 | $6.5m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2016-12-31 | $20.8m | us-gaap:Liabilities |
| Shareholders' equity | at 2016-12-31 | −$5.0m | us-gaap:StockholdersEquity |

## Risk factors

As filed, 20,918 characters.

*In your evaluation of the Company and our business, you should carefully consider the risks and uncertainties described below, together with the information included elsewhere in this report and the other documents we file with the SEC. The following factors describe the risks and uncertainties that we consider significant to the operation of our business, but should not be considered a complete listing of all potential risks and uncertainties that could adversely affect our operating results, financial position or liquidity. Additionally, our business is subject to the same general risks and uncertainties that affect many other companies, such as but not limited to the overall economic conditions, changes in laws or accounting rules, fluctuations in interest and exchange rates or other disruptions of expected economic and business conditions.*

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### Risks Related to our Business

**We operate in a single market, mercury removal from power plant emissions, which is driven primarily by regulation. Any significant changes in mercury emission regulation could have a major impact on the Company.**

The Company currently operates in a single market of mercury reduction in flue gas emissions from large coal-fired utility and industrial boilers. This market is primarily based on air pollution control regulations and enforcement of those regulations. Any significant change in these regulations would have a dramatic effect on the Company. Specifically, on December 16, 2011, the EPA published the Mercury and Air Toxics Standards (MATS), which sets forth federal mercury emission levels. Power plants were required to begin complying with MATS on April 16, 2015, unless they were granted a one-year extension to begin to comply. In June 2015, the U.S. Supreme Court held that the EPA unreasonably failed to consider costs in determining whether it is appropriate and necessary to regulate hazardous air pollutants, including mercury, from power plants and remanded the case back to the U.S. Court of Appeals for the District of Columbia Circuit for further proceedings, but left the rule in place. In December 2015, the D.C. Circuit remanded the rule back to the EPA for further consideration, but without vacatur, allowing MATS to remain in effect pending the EPA’s finding. On April 14, 2016, the EPA issued a final supplemental finding upholding the rule and concluding that a cost analysis supports the MATS rule. In addition, on June 13, 2016, the U.S Supreme Court denied a petition for certiorari to review the D.C. Circuit’s decision to remand without vacatur. As a result of the issuance by the EPA of its supplemental finding as described above, the Company expects MATS to remain in effect going forward. However, certain issues surrounding the MATS Rule remain subject to litigation in the D.C. Circuit and the Company is unable to predict with certainty the outcome of any such proceedings.

**The results of the 2016 United States presidential and congressional elections creates regulatory uncertainty.**

During the 2016 U.S. Presidential election campaign, then Presidential candidate Donald Trump broadly criticized a wide range of government regulations, voicing complaints that the U.S. is over-regulated. He has since appointed as EPA Administrator the former Attorney General of Oklahoma, a vocal critic of various EPA regulations who has also mounted many challenges to those regulations, including EPA’s mercury and air toxics standards (MATS). While it remains unclear what specific actions the President may wish to pursue now that he is in office, and what actions will have the support of the U.S. Congress, the results of the 2016 Presidential and congressional elections in which the Republicans maintained control of both the House of Representatives and the Senate, does create regulatory uncertainty, especially in the environmental field. Some industrial trade associations have suggested they may seek reconsideration of MATS by EPA. To date, EPA has not indicated publicly any intent to reconsider that rule. Any change in the MATS regulation could have a detrimental impact on our business.

**The risks associated with technological change may make the Company’s products and services obsolete.**

The market for new technology in which the Company is involved is characterized by periodic new product introductions and evolving industry standards and regulations. The emerging nature of these products and services with their rapid evolution will require that we continually improve the performance, features, and reliability of our service, particularly in response to possible competitive offerings. There can be no assurance that we will be successful in achieving widespread acceptance before competitors offer products and services with features similar to or better than the Company, but we continue to invest into innovation, while believing that our licensed patent portfolio is defensible within an industry that has high barriers to entry.

**We compete against large, well-established companies which are highly competitive. We may not be able to compete effectively.**

We are an emerging company operating in a market currently dominated by much larger companies. The size and financial strength of these competitors may enable them to offer incentives such as free large scale demonstrations that the Company may not be able to offer. In addition, these large corporations have the ability to spend significantly more on research and development and may develop a technology superior to that employed by the Company and these corporations also have large, established sales forces that are highly-experienced in fending off competing, including superior technologies on their client units. This is especially true in the utility market which is very risk averse and where long-standing trusted supplier relationships are common.

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**We may not be able to successfully defend our patent rights or protect proprietary aspects of our technology.**

We have the exclusive rights to a number of significant patents, and patents pending covering the U.S., Canada, Europe and China. There can be no assurance that outstanding patents will not be challenged or circumvented by competitors. Certain critical technology related to our systems and products is protected by trade secret laws and confidentiality and licensing agreements. There can be no assurance that such protection will prove adequate or that we will have adequate remedies against contractual counterparties for disclosure or our trade secrets or violation of MEEC’s intellectual property rights. In addition, the current lack of adequate long-term capital may prevent the Company from being able to enforce any patent-infringement by competitors or EGUs.

**Lower natural gas prices and increasing regulations can pose significant risks to our addressable market.**

Upon MATS becoming effective, there were roughly 1,100 coal-fired EGU’s in the U.S. With lower natural gas prices and due to regulations such as MATS, the industry has become significantly smaller. Management estimates that perhaps as much as 40% of the EGUs in the U.S. have faced, or will face, retirement due to the impact of the MATS regulation.

**We are reliant upon third-party manufacturers for our materials; any problems they encounter may detrimentally impact our business.**

As we do not manufacture any of the chemicals that we use, we are dependent upon key suppliers of our materials, some of whom are also competitors of ours. There can be no assurance that such manufacturers will be reliable in meeting delivery schedules, or that such manufacturers will not experience their own financial difficulties or encounter other problems which could detrimentally impact our business. In the event we need to secure other manufacturers, there can be no assurance that we will be able to secure such arrangements on terms acceptable to the Company.

**Our operations are subject to operational risks and have the potential to cause environmental or other damage as well as personal injury, which could adversely affect our business, results of operations and cash flows.**

Our operations involve safety, health and environmental risks. Mercury removal from power plant emissions involves the handling, transportation, manufacture or use of certain substances or components that may be considered toxic or hazardous. Our operations entail risks such as leaks, fires, explosions, toxic releases, mechanical failures or unscheduled downtime. If operational risks materialize, they could result in injury or loss of life, damage to the environment or damage to property. Although we maintain insurance coverage, in the event we incur substantial loss or liabilities and our insurance does not cover such losses or liabilities adequately or at all, our business, results of operations and cash flows may be materially and adversely affected. In addition, the occurrence of any of such losses or liabilities could harm our reputation.

**We are dependent on key customers. A significant adverse change in such relationships could adversely impact our results of operations and financial condition.**

Our customers are concentrated, so the loss of one or more key customers or a material reduction in business performed for them could significantly harm our business. In addition, there can be no assurance that such customers will not experience financial difficulties or other problems which could delay such customers in paying for product and services on a timely basis or at all. Any problems with such customers can be expected to have a material adverse impact on our results of operations and financial condition.

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**We are dependent on a small number of key employees. The loss of more than one of these employees could seriously impair our ability to survive as a going concern.**

Our management team is crucial to the success of the Company and the loss of more than one member of this team, could have a material adverse impact on the ability of the Company to properly execute its business plan. We have expanded our team and developed redundancy within our operations to mitigate this risk as much as possible.

### Our lack of diversification increases the risk of an investment in the Company.

Our business lacks significant diversification and is dependent on the success of our mercury emission control technologies. As a result, we are impacted more acutely by factors affecting our industry or the regions in which we operate that we would if our business were more diversified, enhancing our risk profile.

### We may not be able to properly manage our potential growth.

Since we have a limited operating history, any significant growth will place considerable strain on our financial resources and increase demands on our management and on our operational and administrative systems, controls and other resources. There can be no assurance that our existing personnel, systems, procedures or controls will be adequate to support our operations in the future or that we will be able to successfully implement appropriate measures consistent with our growth strategy. As part of this growth, we may have to implement new operational and financial systems, procedures and controls to expand, train and manage our employees and maintain close coordination among our technical, accounting, finance, marketing, sales and other staff. We cannot guarantee that we will be able to do so, or that if we are able to do so, we will be able to effectively integrate them into our existing staff and systems. We may fail to adequately manage our anticipated future growth. We will also need to continue to attract, retain and integrate personnel in all aspects of our operations. Failure to manage our growth effectively could detrimentally impact our business.

**Maintaining and improving our financial controls may strain our resources and divert management’s attention.**

We are subject to the requirements of the Securities Exchange Act of 1934, including the requirements of the Sarbanes-Oxley Act of 2002. The requirements of these rules and regulations have increased in recent years, causing an increase in legal and financial compliance costs, and make some activities more difficult, time-consuming or costly and may also place undue strain on our personnel, systems and resources. Such rules and regulations require, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. This can be difficult to do. As a result of this and similar activities, management’s attention may be diverted from other business concerns, which could have a material adverse effect on our business, financial condition and results of operations.

### Risks Related to our Common Stock

**In our efforts to raise capital through the sale of restricted stock and convertible debt, dilution could be significant.**

The mechanisms we have used to raise money have been to sell restricted stock or convertible notes, along with issuing warrants under certain circumstances, to qualified investors. Raising capital in this manner is dilutive to current stockholders and the dilution could be substantial. As of December 31, 2016, we have 73,509,663 shares of common stock outstanding of a total of 150,000,000 shares authorized by the Company. Approximately 94,000,000 shares of common stock are outstanding on a fully diluted basis as of December 31, 2016.

**We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.**

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. In addition, pursuant to the terms of our financing agreement with AC Midwest Energy, LLC, we are prohibited from issuing dividends. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in its value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

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**If our internal control over financial reporting is found not to be effective or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls, investors could lose confidence in our financial reports, and our stock price may be adversely affected.**

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include an internal control report with our Annual Report on Form 10-K. That report must include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year. We evaluate our existing internal control over financial reporting based on the framework issued in 2013 by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. During the course of our ongoing evaluation of the internal controls, we may identify areas requiring improvement, and may have to design enhanced processes and controls to address issues identified through this review. Remedying any deficiencies, significant deficiencies or material weaknesses that we identify may require us to incur significant costs and expend significant time and management resources. Based on such evaluation, our management concluded our internal control over financial reporting was not effective as of December 31, 2016. The ineffectiveness of our internal control over financial reporting was due to the following material weaknesses which are indicative of many small companies: (i) lack of a sufficient complement of personnel commensurate with the Company’s reporting requirements; and (ii) insufficient written documentation or training of our internal control policies and procedures which provide staff with guidance or framework for accounting and disclosing financial transactions. While certain remedial actions have been completed, we continue to actively plan for and implement additional control procedures to improve our overall control environment.

Nevertheless, we cannot assure you that any of the measures we implement to remedy any such deficiencies will effectively mitigate or remedy such deficiencies. Investors could lose confidence in our financial reports, and our stock price may be adversely affected, if our internal controls over financial reporting continue to be found not to be effective by management or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls in the future.

### The trading price of our common stock may be volatile.

The trading price of our shares has, from time to time, fluctuated widely and in the future may be subject to similar fluctuations. The trading price may be affected by a number of factors including the risk factors set forth in this report as well as our operating results, financial condition, announcements of innovations or new products by us or our competitors, general conditions in the market place, and other events or factors. Although we believe a number of registered broker dealers currently make a market in our common stock, we cannot assure you that any of these firms will continue to serve as market makers or have the financial capability to stabilize or support our common stock. A reduction in the number of market makers or the financial capability of any of these market makers could also result in a decrease in the trading volume of and price of our shares. In recent years, broad stock market indices in general have experienced substantial price fluctuations. Such broad market fluctuations may adversely affect the future trading price of our common stock.

### The trading market for securities quoted on the OTCQB is less liquid.

Our common stock currently trades on the OTCQB. The trading market for securities of companies quoted on the OTCQB or other quotation systems is substantially less liquid than the average trading market for companies listed on a national securities exchange. The quotation of our shares on the OTCQB or other quotation system may result in a less liquid market available for existing and potential shareholders to trade shares of our common stock, could depress the trading price of our common stock and could have a long-term adverse impact on our ability to raise capital in the future.

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### Potential future sales pursuant to Rule 144.

Many of the shares of our common stock presently held by management and others are “restricted securities” as that term is defined in Rule 144, promulgated under the Securities Act of 1933, as amended. Under Rule 144, a person (or persons whose shares are aggregated) who has satisfied a certain holding period, may, under certain circumstances sell such shares or a portion of such shares. Such holding periods have already been satisfied in many instances. Therefore, actual sales or the prospect of sales of such shares under Rule 144 in the future may depress the prices of the Company’s securities.

**Our common stock may be characterized as a “penny stock” under applicable SEC regulations.**

Our common stock may be characterized as “penny stock” under SEC regulations. As such, broker-dealers dealing in our common stock may be subject to the disclosure rules for transactions involving penny stocks, which generally require that, prior to a purchase, the broker-dealer has approved the proposed purchaser’s account for transactions in penny stocks and has received from the purchaser an agreement to the transaction setting forth the identity and quantity of the common stock to be purchased. In order to approve a person’s account for transactions in penny stocks, the broker-dealer must obtain from the person information concerning the person’s financial situation, investment experience and investment objectives, and reasonably determine that transactions in penny stocks are suitable for the person. These additional burdens imposed upon broker-dealers may discourage them from effecting transactions in our common stock, which could make it difficult for an investor to sell his, her or its shares at any given time.

Except as required by the Federal Securities Law, the Company does not undertake any obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or for any other reason.

## Properties

As filed, 583 characters.

We lease our corporate headquarters facility in Lewis Center, Ohio. The lease for this facility expires in February 2018, subject to our option to extend for up to three additional one year periods. In addition, we pay for the lease of a 3,800 square feet warehouse near a commercial customer in Centralia, Washington on a month-to-month basis, and we pay for the lease of a 20,000 square feet warehouse in Corsicana, Texas. The lease for this facility expires in June 2020. We also lease office space in Grand Forks, North Dakota. The lease for this facility expires in August 2018.

## Legal proceedings

As filed, 354 characters.

There are no material pending legal proceedings to which we are a party or to which any of our property is subject, nor are there any such proceedings known to be contemplated by governmental authorities. None of our directors, officers or affiliates is involved in a proceeding adverse to our business or has a material interest adverse to our business.

## Management's discussion and analysis

As filed, 24,784 characters.

### Background

Midwest Energy Emissions Corp. (the “Company”, “we”, “us” and “our”) develops and deploys patented, proprietary technologies to remove mercury emissions from coal-fired power plants. The U.S. EPA MATS (Mercury and Air Toxics Standards) 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. Power plants were required to begin complying with MATS on April 16, 2015, unless they were granted a one-year extension to begin to comply. MATS, along with many state and provincial regulations, form the basis for mercury emission capture at coal fired plants across North America. Under the MATS regulation, Electric Generating Units (“EGUs”) are required to remove about 90% of the mercury from their emissions. We believe that we continue to meet the requirements of the industry as a whole and our technologies have been shown to achieve mercury removal levels compliant with all state, provincial and federal regulations at a lower cost and with less plant impact than our competition.

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 us as material is delivered to their facility. Clients will use our material whenever their EGUs operate, although EGUs are not always in operation. EGUs typically may not be in operation due to maintenance reasons or when the price of power in the market is less than their cost to produce power. Thus, our revenues from EGU clients will not typically be a consistent stream but will fluctuate, especially seasonally as the market demand for power fluctuates.

The MATS regulation has been subject to legal challenge, and in June 2015, the U.S. Supreme Court held that the EPA unreasonably failed to consider costs in determining whether it is appropriate and necessary to regulate hazardous air pollutants, including mercury, from power plants and remanded the case back to the U.S. Court of Appeals for the District of Columbia Circuit for further proceedings, but left the rule in place. In December 2015, the D.C. Circuit remanded the rule back to the EPA for further consideration, but without vacatur, allowing MATS to remain in effect pending the EPA’s finding. On April 14, 2016, the EPA issued a final supplemental finding upholding the rule and concluding that a cost analysis supports the MATS rule. In addition, on June 13, 2016, the U.S Supreme Court denied a petition for certiorari to review the D.C. Circuit’s decision to remand without vacatur. As a result of the issuance by the EPA of its supplemental finding as described above, the Company expects MATS to remain in effect going forward. However, certain issues surrounding the MATS rule remain subject to litigation in the D.C. Circuit and the Company is unable to predict with certainty the outcome of any such proceedings.

We remain focused on positioning the Company for short and long-term growth. For the year ended December 31, 2016, we focused on execution at our customer sites and on continual operation improvement. We continue to make refinements to all of our key products, as we continue to focus on the customer and its operations. We hired a new regional sales managers to cover U.S. Southwest and Midwest and continued to expand our employee base as we plan for future growth. As described below, we achieved substantial increases in revenues compared to the prior year. We ended 2016 with 20 fully operational MATS compliant EGU’s utilizing our technologies. Due to our strengthening financial position, we negotiated a debt exchange agreement with AC Midwest Energy, LLC, which reduced dilution by over 34 million shares and simplified our capital structure and worked with many of our earliest investors to convert their promissory notes into equity just after the end of the third quarter. These events not only improve our balance sheet significantly, but position the Company to further increase shareholder value well into the future.

### Results of Operations

The year ended 2016 was a year of continued revenue growth and business plan execution. The compliance efforts of our customer base resulted in exponential sales growth over the same period last year and positive cash flow from operations.

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### Revenues

*Sales* - We generated revenues of approximately $32,346,000 and $12,632,000 for the years ended December 31, 2016 and 2015. Total sorbent product sales for the year ended December 31, 2016 and 2015 were $28,920,000 and $5,028,000, respectively. These increases from the prior year were associated with the MATS compliance activities of our customers, which began in April 2016, with our all customers in operation by the end of the year.

Equipment sales for the years ended December 31, 2016 and 2015 were $2,699,000 and $6,939,000, respectively. Equipment sales during 2016 are primarily related to the commissioning of one customer project that included both a front end and back end product injection systems. In 2015, equipment sales were related to the completion of nine equipment projects at customer sites, one of which included both a front end and back end product injection system.

Other revenues for the years ended December 31, 2016 and 2015 were $726,000 and $664,000, respectively. This increase is primarily associated with increased consulting revenues earned at current and potential customers.

### Costs and Expenses

*Costs and expenses* were $30,288,000 and $16,321,000 during the years ended December 31, 2016 and 2015, respectively. The increase in costs and expenses from the prior year is primarily attributable to an increase in costs of sales compared to the prior year. These increases are primarily associated with the significant increase in revenues for the year ended December 31, 2016.

*Costs of sales* were $23,030,000 and $10,765,000 for the year ended December 31, 2016 and 2015, respectively. The increase in cost is primarily attributable to the significant increase in product sales in 2016. Equipment cost of sales during the year ended December 31, 2016 and 2015 was $2,626,000 and $5,612,000, respectively. The decrease in the equipment costs of sales in the year ended December 31, 2016 is due to the decrease in equipment sales from the same period in the prior year. The margin on equipment sales decreased during the year ended December 31, 2016 is primarily attributable to the large project that was completed during the year which was subcontracted to a third party with the Company receiving no margin on the project. The Company also had increases in license costs, overhead, depreciation and amortization during the year ended December 31, 2016 compared to 2015 due to the increase in business operations as its customers began MATS compliance activities in 2016.

*Selling, general and administrative expenses* were $7,257,000 and $4,221,000 for the years ended December 31, 2016 and 2015. The increase in selling, general and administrative expenses is primarily attributed to increases in salaries and wages, depreciation and amortization and stock based compensation offset by a decrease in settlement charges and license maintenance fees.

### Other Expenses

Interest expense related to the financing of capital was $4,913,000 and $6,214,000 for the years ended December 31, 2016 and 2015, respectively. In connection with change in the conversion terms and repayment of principal during the year ended December 31, 2015, per the Amendment with AC Midwest Energy, LLC, the Company incurred a loss of $2,246,000 which was primarily related to accelerated amortization of the discount on convertible notes payable and is included in interest expense during that year. During the year ended December 31, 2016, The Company incurred a charge of $1,125,000 related to warrants issued in connection with the issuance of a letter of credit which was included in interest expense.

During the year ended December 31, 2016 and 2015 a loss of $14,681,000 and $3,194,000, respectively, on the change in value of warrant liability was recorded. During the year ended December 31, 2016 the Company recognized a gain of $407,000 on the amendment and restatement of the financing agreement with its senior lender (see Note 6 to the Consolidated Financial Statements). Also, the Company recognized non-cash inducement expenses of $1,123,000 associated with these conversions of convertible promissory notes during 2015. The conversions took place after the Company negotiated amendments which extended the terms of the notes and adjusted the conversion price.

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### Net Loss

Net loss for the years ended December 31, 2016 and 2015 was $16,883,000 and 14,262,000 respectively. The increased net loss is primarily attributed to a loss on the change in value of warrant liability and was offset by the increase in operating earnings and decreased interest expense from the previous year.

### Taxes

Our deferred tax assets are primarily related to net operating losses and a valuation allowance has been established due to the uncertainty of the utilization of all of these assets in future periods. As of December 31, 2016, a benefit for income taxes of $500,000 was recorded due to sufficient evidence available to support the realization of certain tax assets in future years. The net operating loss carryforward will begin to expire in 2030.

### Non-GAAP Financial Measures

#### Adjusted EBITDA

To supplement our consolidated financial statements presented in accordance with GAAP and to provide investors with additional information regarding our financial results, we consider and are including herein Adjusted EBITDA, a Non-GAAP financial measure. We view Adjusted EBITDA as an operating performance measure and, as such, we believe that the GAAP financial measure most directly comparable to it is net income (loss). We define Adjusted EBITDA as net income adjusted for interest and financing fees, income taxes, depreciation, amortization, stock based compensation, and other non-cash income and expenses. We believe that Adjusted EBITDA provides us an important measure of operating performance because it allows management, investors, debtholders and others to evaluate and compare ongoing operating results from period to period by removing the impact of our asset base, any asset disposals or impairments, stock based compensation and other non-cash income and expense items associated with our reliance on issuing equity-linked debt securities to fund our working capital.

Our use of Adjusted EBITDA has limitations as an analytical tool, and this measure should not be considered in isolation or as a substitute for an analysis of our results as reported under GAAP, as the excluded items may have significant effects on our operating results and financial condition. Additionally, our measure of Adjusted EBITDA may differ from other companies’ measure of Adjusted EBITDA. When evaluating our performance, Adjusted EBITDA should be considered with other financial performance measures, including various cash flow metrics, net income and other GAAP results. In the future, we may disclose different non-GAAP financial measures in order to help our investors and others more meaningfully evaluate and compare our future results of operations to our previously reported results of operations.

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The following table shows our reconciliation of Net Income to Adjusted EBITDA for the years ended December 31, 2016 and 2015, respectively:

*(in thousands)*

|  | Year Ended December 31, 2016 | 2015 |
| --- | ---: | ---: |
| Net loss | $(16,883) | $(14,262) |
| Non-GAAP adjustments: |  |  |
| Depreciation and amortization | 913 | 391 |
| Interest and letter of credit fees | 5,139 | 6,214 |
| Income taxes | (473) | 41 |
| Stock based compensation | 1,159 | 789 |
| Change in warrant liability | 14,681 | 3,194 |
| Settlement charges | - | 1,335 |
| Gain on debt restructuring | (407) | - |
| Debt conversion costs | - | 1,123 |
| Adjusted EBITDA | $4,129 | $(1,175) |

### Liquidity and Capital Resources

Our principal source of liquidity is cash generated from operating activities. As of December 31, 2016, our cash and cash equivalents totaled $7,752,000.

*Total assets* were $15,878,000 at December 31, 2016 versus $7,315,000 at December 31, 2015. The change in total assets is primarily attributable to the increases in cash, accounts receivable, property and equipment.

*Total liabilities* were $20,849,000 at December 31, 2016 versus $20,260,000 at December 31, 2015. For the year ended December 31, 2016 there was a decrease in current liabilities associated with the recognition of deferred revenue and current portion of notes payable, which was offset by an increase in accounts payable and accrued liabilities due to the increased sales operations during the period. Long term liabilities increased during 2016 due to the increase in long term notes payable and is offset by the decrease in warrant liability. The changes to long term liabilities are the result of an amendment with our senior lender, described in Note 6 and Note 8 to the Consolidated Financial Statements.

*Operating activities* provided $3,226,000 of cash for the year ended December 31, 2016 compared to using $2,738,000 during the year ended December 31, 2015. The change in cash provided by operating activities is primarily attributable to the increase in revenues and gross margin during 2016.

*Investing activities* used $1,686,000 and $957,000 during the year ended December 31, 2016 and 2015, respectively. In 2016 and 2015, additions of property and equipment associated with the expansion of our operations in preparation for MATS compliance activities of our customers were responsible for these expenditures.

*Financing activities* provided $5,129,000 during the year ended December 31, 2016 compared to using $2,434,000 during the year ended December 31, 2015. For the year ended December 31, 2016, the cash provided was due to a private placement for common stock and was offset by the repayment principal of convertible promissory notes. For the year ended December 31, 2015, the use of cash was primarily due to a repayment of principal of convertible promissory notes.

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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, and results of operations, liquidity or capital expenditures.

### Critical Accounting Policies and Estimates

Our discussion and analysis of our financial conditions and results of operation are 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.

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.

### 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 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 December 31, 2016 or 2015. 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 2013 or state tax examinations for years prior to 2012.

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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.

### Warrant Liability

On August 14, 2014, Company issued the Lender a warrant to purchase 12,500,000 shares of the Company’s common stock at $1.00 per share, subject to the adjustments. On November 29, 2016 the liability was relieved upon the exercise and surrender of all shares associated with this warrant (See Note 6). The Company also issued to Drexel for the transaction: (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, both subject to adjustments similar to the Warrant issued to the Lender (see Note 11 for changes to the terms of these warrants). During the year ended December 31, 2016, Drexel and its assigns exercised 1,060,929 warrants (see Note 10).

On November 16, 2015, Company issued the Lender a contingent warrant to purchase up to 5,000,000 shares of the Company’s common stock at $0.35 per share, subject to adjustments, which warrant shall be immediately exercisable for 3,600,000 shares with the balance of 1,400,000 shares exercisable proportionately to such additional Senior Convertible Notes up to $1,400,000 purchased by the Lender. On November 29, 2016 the liability was relieved upon the exercise and surrender of all shares associated with this warrant (See Note 6).

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On January 28, 2016, in consideration for the issuance of the Letter of Credit, the Company has agreed to issue to Lender (i) a five year warrant to purchase 2,000,000 shares of common stock, subject to certain anti-dilution adjustment provisions at an exercise price of $0.35 per share of common stock. On November 29, 2016 the liability was relieved upon the exercise and surrender of all shares associated with this warrant (See Note 6).

On February 19, 2016, in connection to Amendment No. 2 and Amendment No. 3, the Company issued Drexel: a 5-year warrant to purchase up to 300,000 shares of common stock at $0.35 per share as compensation for services rendered. During the year ended December 31, 2016, Drexel and its assigns exercised 95,000 warrants (see Note 10).

These warrants are valued in accordance with FASB ASC 815-10 as liabilities using a Monte Carlo Simulation Model as of each reporting period date and the change in value can have a significant impact on the Company’s bottom line. The significant assumptions considered by the model were the remaining term of the warrants, operational forecasts provided by the Company, the fair value per share stock price, a risk free treasury rate and an expected volatility rate at each measurement date.

### 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 74.9%, 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, 194 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.

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## Controls and procedures

As filed, 8,450 characters.

### Report of Disclosure Controls and Procedures

Regulations under the Exchange Act require public companies to maintain “disclosure controls and procedures,” which are defined as controls and other procedures that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we have evaluated the effectiveness, the design and operations of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the principal executive officer and principal financial officer determined that as of December 31, 2016, the Company’s disclosure controls and procedures were ineffective.

### Management’s Annual Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, the Company conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in *Internal Control - Integrated Framework* issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013 (COSO). The Company has not adopted the new framework due to its size and limited resources available for developing an internal control program compliant with the new framework.

Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Despite these controls, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. Furthermore, smaller reporting companies, like us, face additional limitations. Smaller reporting companies employ fewer individuals and can find it difficult to employ resources for complicated transactions and effective risk management. Additionally, smaller reporting companies tend to utilize general accounting software packages that lack a rigorous set of software controls.

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Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2016 based on the criteria established in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, our management concluded our internal control over financial reporting was not effective as of December 31, 2016. The ineffectiveness of our internal control over financial reporting was due to the following material weaknesses which are indicative of many small companies: (i) lack of a sufficient complement of personnel commensurate with the Company’s reporting requirements; and (ii) insufficient written documentation or training of our internal control policies and procedures which provide staff with guidance or framework for accounting and disclosing financial transactions.

This annual report does not include an attestation report of our registered public accounting firm regarding our internal controls over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to Section 404(c) of the Sarbanes-Oxley Act that permit us to provide only management’s report in this annual report.

Despite the existence of the material weaknesses above, we believe that our consolidated financial statements contained in this Form 10-K fairly present our financial position, results of operations and cash flows as of and for the periods presented in all material respects.

### Changes in Internal Control over Financial Reporting

Except as discussed below, there have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15 (f) under the Exchange Act) during 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

### Material Weakness

In connection with our annual audit for the year ended December 31, 2016, management determined that controls as described above constitute material weaknesses in disclosure controls and internal control over financial reporting. As a result, it was determined that a control deficiency that constitutes a material weakness in the design and operation of our internal control over financial reporting was present. Management believes that these material weaknesses did not have an effect on our financial results. However, management believes that the lack of these items results in ineffective internal controls, which could result in a material misstatement in our financial statements in future periods.

Due to our size and nature, segregation of duties within our internal control system may not always be possible or economically feasible. Likewise, we may not be able to engage sufficient resources to enable us to have adequate staff and supervision within our accounting function.

### Remediation

During 2016, certain actions were taken to address certain aspects of the material weaknesses disclosed above. We hired a full-time Controller, completed the installation of ERP software used to manage our business activities and hired two additional administrative personnel to create a more effective internal control environment with the necessary segregation of duties.

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Although we believe that these efforts effectively strengthen out disclosure control processes and procedures, our management team intends to take the following additional actions to further remediate the material weaknesses disclosed above:

- Complete the current process of documenting necessary internal control policies;
- Continue with the appropriate training of our personnel on our internal controls and procedures, including these remedial measures.

While certain aspects of these remedial actions have been completed, we continue to actively plan for and implement additional control procedures to improve our overall control environment and expect these efforts to continue throughout 2017.

Filed Mar 28, 2017.
Source: SEC EDGAR, the filing index for accession 0001477932-17-001322. Last ingested by Listed: Nov 13, 2026, 16:05 ET. No prices; not investment advice.