Birchtech Corp.: Form 10-Q for the period ended Sep 30, 2023

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes that appear elsewhere within this report. Certain statements we make under this Item 2 constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. See “Forward-Looking Statements” in “Part I” preceding “Item 1 – Financial Statements.” You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors” in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2022, as well as our unaudited condensed consolidated financial statements, related notes and other financial information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission.

Overview

We are an environmental services and technologies company developing and delivering patented and proprietary solutions to the global power industry, specializing in mercury emissions removal technologies. We provide mercury capture solutions driven by our patented two-part Sorbent Enhancement Additive (“SEA”) technology. Our leading-edge services have been shown to achieve mercury emissions removal at a significantly lower cost and with less operational impact to coal-fired power plants than currently used methods, while maintaining and/or increasing power plant output and preserving the marketability of byproducts for beneficial use.

North America is currently the largest market for our technology. 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 facilities. 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 since being enacted. In June 2015, the U.S. Supreme Court, in Michigan v. EPA, 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, but left the rule in place. In April 2016, the EPA issued a supplemental finding in response to the Michigan decision and found that, after consideration of costs, it remained appropriate and necessary to regulate such emissions from coal- and oil-fired power plants. In May 2020, the EPA, then under the Trump Administration, reversed the determination, finding that, after weighing the costs of compliance against certain benefits of the regulation, the 2016 supplemental finding was erroneous but left the MATS rule in place. Upon taking office, the Biden Administration in January 2021 directed the EPA to review the previous Administration’s actions on various environmental matters including the withdrawal of the May 2020 “appropriate and necessary” determination, for conformity with Biden Administration environmental policy. On February 9, 2022, the EPA proposed to revoke the May 2020 finding and reaffirm the EPA’s 2016 finding. On February 15, 2023, the EPA reaffirmed that it remains appropriate and necessary to regulate hazardous air pollutants, including mercury, from power plants after considering cost, and revoked the May 2020 finding. Nevertheless, legal challenges may continue in the future with respect to the MATS regulation.

We remain focused on positioning the Company for short and long-term growth, including focusing 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. As part of our overall strategy, we have a number of initiatives which we believe will be able to drive our short and long-term growth.

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We continue to seek new utility customers for our technology in order for them to meet the MATS requirements as well as maintaining our contractual arrangements with our current customers. We also seek license agreements with utilities while allowing them to use our SEA® technologies without our supply of products. During 2021 and 2022, we have announced various supply contract extensions, new supply business and license agreements. We expect additional supply business and license agreements during the latter part of 2023 and thereafter, including converting certain licensees to supply customers.

On October 28, 2022, we executed Amendment No. 1 to Unsecured Note Financing Agreement with AC Midwest Energy LLC (“AC Midwest”) pursuant to which the maturity date of the Unsecured Note held by AC Midwest in the principal amount of $13.2 million (the “Unsecured Note”) was extended to August 25, 2025. The Unsecured Note, which was issued on February 25, 2019 pursuant to an Unsecured Note Financing Agreement entered into on such date, was scheduled to mature on August 25, 2022. It bears a zero cash interest rate. AC Midwest shall also be entitled to a profit participation preference (the “Profit Share”), which is “non-recourse” and shall only be derived from and computed on the basis of, and paid from, Net Litigation Proceeds from claims relating to our intellectual property, Net Revenue Share, Adjusted Free Cash Flow and Equity Offering Net Proceeds (as such terms are defined in the Unsecured Note Financing Agreement, as amended). Pursuant to Amendment No. 1 to Unsecured Note Financing Agreement executed on October 28, 2022, the Profit Share was increased by $4,500,000 from $13,154,931 (representing 1.0 times the original principal amount) to $17,654,931.

In addition, there remains outstanding to AC Midwest a principal balance of approximately $272,000 due under a secured note issued on November 29, 2016, in the original principal amount of approximately $9.6 million which also had a maturity date of August 25, 2022 (the “Secured Note”). On October 28, 2022, the maturity date of the Secured Note was also extended to August 25, 2025. In addition, the interest rate on the remaining principal balance was reduced from 15.0% to 9.0% per annum.

In June 2021, we announced that we had entered into a Debt Repayment and Exchange Agreement (the “Debt Repayment Agreement”) with AC Midwest which was expected to repay all existing secured and unsecured debt obligations held by AC Midwest. Pursuant to such agreement, we were to repay the existing $272,000 principal amount outstanding under the Secured Note in cash as well as the existing $13.2 million principal amount outstanding under the Unsecured Note held by AC Midwest through a combination of cash and stock. The non-recourse profit share under the Unsecured Note was to have been satisfied through a combination of cash and stock. The closing was subject to various conditions including but not limited to the completion of an offering of equity securities resulting in net proceeds of at least $12.0 million by December 31, 2021, which was extended to June 30, 2022. Such closing conditions were not met by June 30, 2022. On October 28, 2022, the parties agreed to terminate the Debt Repayment Agreement with immediate effect pursuant to which none of the parties shall have any further responsibility or liability thereunder.

In July 2019, we announced that we had initiated patent litigation against defendants in the U.S. District Court for the District of Delaware for infringement of certain patents which relate to our two-part Sorbent Enhancement Additive (SEA®) process for mercury removal from coal-fired power plants. Between July 2020 and January 2021, we entered into agreements with each of the four major utility defendants in the patent litigation commenced in 2019 which agreements included certain monetary arrangements and pursuant to which we have dismissed all claims brought against each of them and their affiliates, and such parties have withdrawn from petitions for Inter Partes Review with the U.S. Patent and Trademark Office. Such agreements entered into with such parties provide each of them and their affiliates with a non-exclusive license to certain Company patents (related to our two-part Sorbent Enhancement Additive (SEA®) process) for use in connection with such parties’ coal-fired power plants. One of the agreements has facilitated an ongoing business relationship with that party. The above-described proceedings are continuing with respect to the other parties involved. In May 2021, a U.S. District Court Magistrate Judge issued a report and recommendation that such litigation should be permitted to proceed against 16 refined coal defendants named in the action directly involved in the refined coal program and operations, and be dismissed against 12 other defendants, primarily affiliated entities of the refined coal operators. In September 2021, such report and recommendation was approved by the District Judge for the United States District Court for the District of Delaware which will allow us to proceed against certain refined coal entities named in the lawsuit. As a result of an application made by the Company to the Court in March 2022 to add additional parties to the action (all affiliated entities of the already named defendants), there are now 24 refined coal defendants named in the action. In connection with such application, the District Court Magistrate Judge ruled in April 2022 that certain parties could be added but denied the application with respect to certain others. The fact discovery portion of the litigation has concluded. A jury trial date was scheduled for November 13, 2023.

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On November 9, 2023, the Company entered into a confidential binding term sheet with Arthur J. Gallagher & Co., and various of its affiliated entities (collectively “AJG”), and DTE Energy Resources LLC and various of its affiliated entities (collectively “DTE”), to resolve the ongoing patent litigation which was initiated in July 2019 by the Company against such parties and others in the U.S. District Court for the District of Delaware. Pursuant to the term sheet, the Company, on the one hand, and AJG and DTE, on the other, have dismissed with prejudice all claims and counterclaims asserted between the parties in the action. The financial aspects of the term sheet remain confidential pursuant to its terms. Such term sheet does not affect any other claim brought against any other remaining party. In connection therewith, the Court has ordered that the trial as to the claims against the remaining defendants (the CERT defendants), which was scheduled to begin Monday, November 13, 2023, be rescheduled for a later date via a further order of the Court.

In addition, effective November 9, 2023, Alistar Enterprises, LLC (“Alistar”), one of the remaining CERT defendants, entered into a settlement agreement with the Company which provided that all claims and counterclaims asserted in the action between the Company and Alistar be dismissed with prejudice. The financial terms of such settlement remain confidential.

During the first quarter of 2021, we announced new technologies under development intended to improve the processing of rare earth elements (REEs) in North America. Such technologies were under development in conjunction with our collaboration with an Alabama third party entity and its affiliates and pursuant to a license and development agreement entered into in October 2019. In October 2022, such license and development agreement expired and has not been extended or renewed. Prior to expiration, such technologies were being evaluated and tested but had not yet been commercialized. We plan to evaluate and test other related technologies for the extracting of REEs from their solvent state which we have developed and do not involve any of the technologies subject to the expired license and development agreement. In tandem with our efforts in REEs, we have been exploring remediation technologies for wastewater and coal ash from coal-fired power plants, as well as water treatment. We believe the market for water treatment is large and significantly growing both in the United States and abroad. This expansion in water treatment and wastewater remediation will allow us to support the growing needs of the energy sector, as well as provide vital technologies for considerable environmental concerns. There can be no assurance that we will be successful in the development of these technologies.

On April 20, 2023, we received conditional approval to list our shares of common stock on the TSX Venture Exchange (the “TSX-V”). The listing was subject to our fulfilling certain requirements of the TSX-V in accordance with the terms of the conditional approval letter. On July 6, 2023, the Company received final approval from the TSX-V. The Company’s shares commenced trading on the TSX-V on July 10, 2023 under the symbol “MEEC”. The Company is listed as a Tier 1 Industrial, Technology, or Life Sciences Issuer.

Results of Operations

Revenues

We generated revenues of approximately $6,747,000 and $7,486,000 for the three months ended September 30, 2023 and 2022, respectively, and approximately $13,872,000 and $15,956,000 for the nine months ended September 30, 2023 and 2022, respectively. Such revenues were primarily derived from sorbent product sales which were approximately $6,700,000 and $7,383,000 for the three months ended September 30, 2023 and 2022, respectively and approximately $13,104,000 and $15,372,000 for the nine months ended September 30, 2023 and 2022, respectively. The decrease in revenues from prior year periods is primarily due to the decreased supply demands from our customer base in the first nine months of 2023 along with the closure of one of our customer’s power plants which occurred at the end of 2022, offset by an increase in licensing revenues for the nine months ended September 30, 2023.

Licensing revenues were approximately $52,500 and $52,500 for the three months ended September 30, 2023 and 2022, respectively and approximately $671,000 and $286,000 for the nine months ended September 30, 2023 and 2022, respectively. Such increase in licensing revenues for the nine months ended September 30, 2023 is primarily due to licensing revenues received from a new license agreement entered into in December 2022.

Equipment sales and other revenues for the three months ended September 30, 2023 and 2022 were approximately $(4,800) and $23,600, respectively and approximately $15,800 and $217,300 for the nine months ended September 30, 2023 and 2022, respectively. This decrease was primarily due to decreased equipment rental revenues in the first nine months of 2023 compared to the prior year period.

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Costs and Expenses

Total costs and expenses were approximately $7,575,000 and $6,917,000 during the three months ended September 30, 2023 and 2022, respectively and approximately $16,911,000 and $16,892,000 during the nine months ended September 30, 2023 and 2022, respectively. The increase in total costs and expenses for the three and nine months ended September 30, 2023 is primarily attributable to an increase in legal fees from the patent litigation, offset by a decrease in cost of sales.

Cost of sales were approximately $4,472,000 and $5,105,000 for the three months ended September 30, 2023, and 2022, respectively, and approximately $9,118,000 and $10,810,000 during the nine months ended September 30, 2023 and 2022, respectively. This decrease in cost of sales of approximately $633,000 and $1,692,000 for the three and nine months ended September 30, 2023, is primarily attributable to the decrease in product sorbent sales in the first three quarters of 2023 compared to the prior year periods.

Selling, general and administrative expenses were approximately $2,459,000 and $1,325,000 for the three months ended September 30, 2023 and 2022, respectively. Such an increase was primarily due to an increase in legal fees from patent litigation. Selling, general and administrative expenses were approximately $6,160,000 and $4,286,000 for the nine months ended September 30, 2023, and 2022, respectively. Such an increase was primarily due to an increase in legal fees from patent litigation.

Interest expense related to the financing of capital was approximately $343,000 and $318,000 for the three months ended September 30, 2023 and 2022, respectively and $1,017,000 and $1,320,000 for the nine months ended September 30, 2023 and 2022. The breakdown of interest expense for the three and nine months ended September 30, 2023 and 2022 is as follows:

(In thousands)

(In thousands)

Loss on change in fair value of profit share liability was approximately $300,000 and $169,000 for the three months ended September 30, 2023 and 2022, respectively and $613,000 and $476,000 for the nine months ended September 30, 2023 and 2022, respectively. The change is primarily attributed to an increase in the amount of the profit share. There were no significant changes to the underlying model during the three and nine months ended September 30, 2023.

Net Loss

For the three months ended September 30, 2023, we had a net loss of approximately $828,000 compared to a net income of approximately $569,000 for the three months ended September 30, 2022. For the nine months ended September 30, 2023, we had a net loss of approximately $3,039,000 compared to a net loss of approximately $935,000 for the nine months ended September 30, 2022. Such change was primarily due to the decrease in revenues for the three and nine months ended September 30, 2023, the increase in selling, general and administrative expenses (substantially due to a significant increase in legal fees from the patent litigation) and an increase in the change in value of the profit share liability, offset by a decrease in interest expense for the nine months ended September 30, 2023.

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Liquidity and Capital Resources

We had approximately $2,497,000 in cash on our balance sheet at September 30, 2023 compared to approximately $1,504,000 at December 31, 2022. Total current assets were approximately $6,074,000 and total current liabilities were approximately $4,404,000 at September 30, 2023, resulting in working capital of approximately $1,670,000. This compares to total current assets of approximately $5,540,000 and total current liabilities of approximately $3,225,000 at December 31, 2022, resulting in working capital of approximately $2,315,000. Our accumulated deficit was approximately $71.7 million at September 30, 2023 compared to $68.7 million at December 31, 2022. Additionally, we had a net loss in the amount of approximately $3,039,000 and cash provided by operating activities of approximately $786,000 for the nine months ended September 30, 2023.

The accompanying condensed consolidated financial statements as of September 30, 2023 have been prepared assuming the Company will continue as a going concern. As reflected in the condensed consolidated financial statements, we had approximately $2.5 million in cash at September 30, 2023. In addition, we had cash provided by operating activities of approximately $0.8 million for the nine months ended September 30, 2023, had working capital of $1.7 million and an accumulated deficit of $71.7 million at September 30, 2023. On October 28, 2022, our principal lender agreed to extend the maturity date of all of its existing secured and unsecured debt in the principal amount of $10.9 million from October 31, 2022 to August 25, 2025. As a result, such liabilities have been classified as long-term liabilities in the accompanying condensed consolidated financial statements. Based upon such extension of the maturity date of such secured and unsecured debt, our current cash position and our revenue from operations, management believes substantial doubt regarding the Company’s ability to continue as a going concern has been mitigated. We believe we will have sufficient working capital to fund operations for at least the next twelve months from the date of issuance of these financial statements.

Total Assets

Total assets were approximately $9,682,000 at September 30, 2023 versus approximately $9,340,000 at December 31, 2022. The change in total assets is primarily attributable to a decrease in accounts receivable offset by an increase in cash.

Total Liabilities

Total liabilities were approximately $19,538,000 at September 30, 2023 versus approximately $16,757,000 at December 31, 2022. The increase is primarily attributable to an increase in the outstanding debt as a result of the amortization of discount and issuance costs and an increase in the fair value of the profit share liability.

Operating Activities

Net cash provided by operating activities consists of net loss, adjusted by certain non-cash items, and changes in operating assets and liabilities.

Net cash provided by operating activities was approximately $786,000 for the nine months ended September 30, 2023 compared to net cash used in operating activities of approximately $368,000 for the nine months ended September 30, 2022.

Investing Activities

There was $3,000 net cash used in investing activities for the nine months ended September 30, 2023 compared to net cash used in investing activities of approximately $11,000 for the nine months ended September 30, 2022 due to the purchase of property and equipment.

Financing Activities

Net cash provided from financing activities was approximately $210,000 for the nine months ended September 30, 2023 compared to approximately $247,000 provided by financing activities for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, we received approximately $210,000 from the exercise of stock options compared to $0 in the prior year. During the nine months ended September 30, 2022, we received a $250,000 short term loan from a related party.

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Critical Accounting Policies and Estimates

Our critical accounting policies and estimated are discussed in our Annual Report on Form 10-K for the year ended December 31, 2022, and there have been no material changes to such policies or estimates during the nine months ended September 30, 2023.

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.

The following table shows our reconciliation of net loss to adjusted EBITDA for the three and nine months ended September 30, 2023 and 2022, respectively:

(In thousands)

(In thousands)

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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.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness 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. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted 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, and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. Based on that evaluation, our principal executive officer and principal financial officer concluded, as of the end of the period covered by this report, that the Company’s disclosure controls and procedures were not effective as a result of material weaknesses in our internal control over financial reporting. The ineffectiveness of our disclosure controls and procedures was due to the following material weaknesses in our internal control over financial reporting: (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.

Despite the existence of the material weaknesses above, we believe that the consolidated financial statements contained in this Form 10-Q 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

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 the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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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.